What If Greece Doesn't Default?
By RICHARD BARLEY
As far as the market is concerned, a Greek government-debt default is pretty much baked in the cake.
Greece, the International Monetary Fund, the European Commission and the European Central Bank may refuse to even countenance the D-word. But the cost of insuring $10 million of Greece's debt is currently $770,000 a year, similar to a rock-bottom triple-C credit rating. This investor skepticism may be overdone.
A common argument in the market goes thus: once Greece closes its primary deficit—the deficit stripping out interest payments—it could be in the country's interest to restructure its debt. At that point, tax receipts will cover current spending so there will be no need for immediate spending cuts.
Under IMF projections, this balance could arrive as soon as 2012—when debt to gross domestic product is forecast to be nearly 150%, a crushing burden. To reduce that, Athens will need to run a sustained, large primary surplus for many years. Doubting this is possible, the market fears a default.
But would this really be in Greece's interest? If Athens does close its primary budget deficit on target, that will mean the euro-zone and IMF program is succeeding; so far this year Greece is ahead of targets, particularly on spending cuts.
Higher-than-expected inflation could boost nominal GDP and tax receipts, further improving debt metrics. In that case, an enforced debt restructuring in 2012 would be counterproductive. Not only would it severely damage Greek banks, who hold €45 billion ($57.46 billion) of government bonds, and Greek companies, who would be shut out of international capital markets, it would also cause a European political storm and potentially destabilize the continent.
True, Greece might still not be able to access capital markets in 2012-13, when the IMF and euro-zone funding package expires. But if Greece is meeting targets, it seems more likely a further loan package would be put in place.
Even a modest voluntary debt restructuring—for example, an extension of maturities in order to give breathing space while avoiding reducing notional value—could be unpalatable, as it might give investors reason to fear a more destructive renegotiation down the road.
The big risk to all this is growth: if the Greek economy is sunk by fiscal austerity, then the debt will snowball and a restructuring may become inevitable. But if the country can make progress rebalancing the economy in the next three years, then the outlook might not be so bad.
On that basis, Greece's 30-year bonds, yielding 9% and priced at 54 cents on the euro, might look attractive, opening up the possibility that Greek banks might finally start to come off European Central Bank life support. That could lead to lower private sector borrowing costs, easier credit conditions, a stronger economy - and less talk of default.