26/07/2011: Greek deal will increase Greek debt

Eurointelligence.com today reports that (emphasis is mine):

"Hugo Dixon, at Reuters Breakingviews, did the math on the Greek package, and concludes that the calculation by the European Council and the IIF regarding the projected rate of debt reduction is wrong. He said that Nicolas Sarkozy’s calculation of a 24 percentage point fall in the Greek debt-to-GDP ratio ignores the effect of credit enhancement, which is going to be massive.

Once you include the efforts Greece has to make to secure the rollover deal, the debt-to-GDP ratio rise by 14% to 179% of GDP.

As part of the deal with the IIF, Greece will need to secure some of the rolled over bonds with zero coupon bonds. The four options have different implications for the extent of the credit enhancement. But on the IIF’s own assumptions, the costs of the exercise would be €42bn for Greece to finance credit enhancements for the €135bn of bonds in the IIF’s scheme."

You can read the entire proposal by IIF here. And, by the way - I run through their proposal figures. The massive savings for Greece stated in this are referencing the future payouts that are being saved assuming Greece were to pay full set of coupon payments and principal on its bonds over their history. This is slightly misleading, as the markets have been pricing significant (40%+) discounts on much of Greek bonds for over 1 year now.

Aside from that, the IIF calculations assume 9% discount rate through 2030. This is a strange assumption, given that the deal replaces / writes down bonds with an average coupon yield of ca 4.5% and Greece can borrow from EFSF/EFSM at ca 5% effective rate.

Adjusting for these, my 'back of the envelope' calculations suggest that the actual value of the Greek programme is closer to €26-32 billion instead of €37 billion when it comes to net private sector contribution.

In addition, rollovers to longer maturity, in my opinion, are reducing peak debt levels, but extend payments burden over time, implying that adverse impact of debt on growth and economic performance in Greece are simply extended into the future. In other words, extended maturities do not do much to improve Greek situation. They can be effective if the Greek debt spike were a 'one-off' event. But since debt overhang in Greece is structural (see chart below - showing Greek debt becoming a structural problem around 1993) and underpinned by long term (endemic since at least 1987) current account deficits, extending maturity of debt simply increases life-time cycle of debt overhang.

In summary, there is no substitute to a full default by Greece. The latest 'deal' simply, potentially, pushes this default into 2016-2020 period, and that with optimistic forecasts for growth at hand.

Another can meets the EU boot, and... fails to roll far down the proverbial road.