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Victoria Mindova

The Greek foreign debt haircut is a fact. For now, it would be 50% of the face value of Greek government bonds held by private investors, but there is no guarantee that this percentage would not increase.

The professor of economics at the University of Athens Panagiotis Petrakis explained GRReporter the reasons that have led to the defeatist cut of the Greek debt and why the whole Euro Area is concerned with the problems of small Greece.

Why was the haircut of the Greek dept needed?

Within the past year, the Greek economy faced higher contraction rates relative to the projections of the troika, while the government –also– failed the budget deficit targets set by the program. As a result, the debt dynamics became much worse, with projections for the debt to GDP ratio climbing to 180% within the next couple of years. Even if such high levels of debt are serviceable (which is highly unlikely), paying interest on such level of debt would deprive necessary resources for the capital-strapped Greek economy.

In fact, since the debt burden is lower, it is possible that confidence in the stability program of Greece may improve.

How has the Greek dept crisis become a Euro Area problem?

The Greek economy constitutes a mere 2.5% of the Euro Area GDP. Therefore, Greece alone could not threaten the common currency. However, the global financial system is so tightly interconnected that a Greek default would damage bond holders and CDS issuers, thus provoking a Lehman Brothers type of domino effect. In that case, the crisis would most likely spread rapidly to the rest of the European "periphery" (i.e. Italy, with currently the second highest debt to GDP ratio after Greece; Spain, fragile enough due to the notorious real estate bubble burst, threatening the regional banks that had fueled it; Portugal that faces similar competitiveness issues as Greece and Belgium that for more than a year could not form a government). In addition, the fact that core Euro Area countries enter the non-growth zone only enlarges the possibility that some of the main economies (e.g. Italy, Spain) may not be able to meet the public debt future finance requirements.

That is exactly why non Euro Area countries like the UK and the US (but also emerging markets like China) were preoccupied if not furious with the inability of the European leaders to conclude to a solution for so many months.

Do you think that the decisions of the last summit of the EU leaders will put the end of the spreading Euro crisis? Is there a real danger a credit event and the CDS market to be triggered?

The latest decision is definitely in the right direction and for the time being the European stability mechanism has enough firepower to handle the Euro zone problems. Now, whether it will put an end to the Greek crisis will depend highly on the ability of the Greek government to achieve its target of primary budget balance.

So far, it seems that the restructuring will not trigger a credit event, since it is characterized as a voluntary transaction by ISDA executives. Event though the final decision has not yet been made by the ISDA committee, it seems that it is unlikely for the restructuring to be classified as a credit event.

What will be the consequences for the financial sector in Greece and the banks in the region, which are of a Greek interest? (35% of the Bulgaria banking sector is represented by Greek banks).

The Greek financial system will have to write down its Greek government bond holdings to 50% of face value, at a time when the private sector non-performing loans are –also– high due to the unprecedented crisis. However, bank deposits are not at risk, since the European Financial Stability Facility and the Hellenic Financial Stability Fund are ready to provide any support to troubled institutions. Furthermore, the ECB will provide liquidity support where necessary.

What will happen with the private insurance companies, which hold a big share of Greek bonds in their portfolios, since there is already a problem with the liquidity and recapitalization is not an easy task?

A recent report by the confederation of enterprises (SEV, October 21) estimates that the private insurance companies will necessitate about a billion euro of financial support if a 50% haircut is to be decided, which is not a high figure in absolute terms. In any case, most of insurance corporations are subsidiaries or affiliates of major Greek banks; hence, the necessary support can be negotiated in the broader context of financial sector re-capitalization.

Will decline in the pensions and salaries in Greece follow the haircut? What will happen with the bank loans of the people, who cannot afford to cover their obligations? Is it possible their credits to be haircut too?

The reduction in salaries and pensions has already taken place, long before the latest EU summit decision for debt forgiveness. However, if the current negative growth rates do not improve substantially within the next quarters, further reductions cannot be ruled out, although at a slower pace.

So far, banks have agreed to some consumer debt rescheduling (i.e. smaller installments and longer maturities, though capital write-offs are uncommon) with borrowers that have suffered income declines (most notably public employees) or are currently unemployed. Moreover, in many cases creditors are negotiating debt into equity conversions for liquidity constrained, but solvent, enterprises.

What is the role of the European Financial Stability Facility in solving the Euro dept crisis and do you see in the near future issuing Eurobonds? What would be the price for Greece in this scenario?

From a political standpoint, the European Financial Stability Facility along with the permanent mechanism, the European Stability Mechanism highlights the solidarity between EU member states. In economic terms, it ensures that Greece will not go under, at least as long as Greek policymakers comply with the decisions of the EU summits. However, for the stability mechanism to be able to support the bond markets of bigger economies (Spain, Italy, or even France) the European leaders decided to leverage the European Financial Stability Facility 4 to 5 times, for the mechanism to acquire a fire power of around €1,100 billion. Equally important is the decision to create Special Purpose Vehicles in order to attract (along with European and IMF funds) capital investment from various sovereign wealth funds (e.g. Norway, China and the Gulf oil-exporting states) and re-capitalize the capital-strapped European banks.

It is well known that the northern European surplus nations rebuff the idea of Eurobonds because such financial instruments remove any incentives for productivity enhancing reforms in the deficit-addict states of the South. Additionally, some nations in particular (i.e. Germany) are intimidated by the inflationary pressures provoked by irresponsible spending of the rest of the member states (fueled by the low borrowing costs that the Eurobonds would provide).

In order to finance its operation European Financial Stability Facility has already issued its own bonds. Therefore, one could argue that European Financial Stability Facility constitutes some sort of Eurobonds in stages. The fund management cannot issue bonds and finance a member state in distress, unless the council has provided the mandate.

Is there danger Greece to be bounded from the Euro zone and in what conditions?

The latest EU leaders decision rules out the event of Greek insolvency and hence the possibility of exit from the common currency in the short and medium term. However, in the long term it is up to the Greek society to decide its business model and how it fits to the Euro zone. In any case, however, an attempt to secede from the euro area is technically impossible and can end up economically (and politically) disastrous.