Greece has become the center of attention in the global economic crisis. It faces a very complicated economic situation since, in the middle of a recession, it has had to deal with an extremely high fiscal deficit — 12.7% of GDP — and a public debt equivalent to 115% of GDP. As if this weren’t enough, Greece also must secure about 11 billion euros by the end of May in order to avoid default on government bonds. For 2010 as a whole, the country needs 53 billion euros to finance its obligations.
The Greek government has the option of financing itself or issuing more debt to keep bond payments current, but the market has been unreceptive to Greek bonds, fearing the country won’t pay what it already owes much less be able to finance new debt at sustainable rates. The premium that investors demand for buying 10-year Greek government bonds has gone well above 7%, the threshold that makes a loan unsustainable, according to the government. The differential with the German 10-year bund (the market standard for quality and solvency within the euro zone) was reaching new highs in mid-April.
Given fears that Greece may default and damage euro zone bond markets and the euro itself, the European Union (EU) has agreed to an assistance plan for Greece for up to 30 billion euros. Added to this, as part of the overall plan, would be between 10 billion and 15 billion euros from the International Monetary Fund (IMF). Greece is now expected to agree to activate this plan, along with the austerity measures it would require. Talks to finalize the plan, scheduled for Monday, have been postponed because of the shutdown in air service due to the spread of volcanic ash from the eruption in Iceland.
According to Rafael Pampillón, professor of economics at the IE Business School, the agreement would alleviate some problems but would not solve everything. Greece’s public debt will continue to snowball until the Greek government recognizes its inability to repay its debts. “The only way out is the suspension of payments…this will obviously harm those people who hold Greek bonds.” Such action would be similar to that taken by Argentina followed in 2001, and Pampillón thinks that financial pressures ultimately will force Greece to take a similar path.
Will History Repeat Itself?
As Pampillón explains, in 2000 the government of Argentina borrowed US$40 billion from international and Argentine institutions. In return, it committed to making economic reforms that would lead to cuts in public spending. “That loan did not generate the anticipated results, so it became necessary to restructure the debt and also get help from the IMF. Still, the crisis continued to undermine the Argentine government, and finally IMF suspended disbursements because of Argentina’s failure to comply with the conditions of the loans. In response, on December 1, 2001 the Argentine government restricted access to bank deposits by the public to prevent capital flight in a process so-called “el corralito.”
“Both of these situations [Greece and Argentina] originated in a combination of lax fiscal policies and euphoric foreign markets,” says Guido M. Sandleris, director of financial research at the Torcuato Di Tella University in Buenos Aires. This created a high current account deficit and deeper indebtedness. For both Greece today and Argentina in 2001, policy choices are limited because they have in effect a fixed currency. But Argentina’s peg to the U.S. dollar could be changed, while Greece’s adoption of the euro does not allow for such flexibility. As a result, “The adjustment of prices to a more devalued real exchange rate must occur through the deflation of prices; a much slower and more painful process than the earlier one [in Argentina],” he notes.
Fernando Méndez Ibisate, a professor in the department of economic history and institutions at the Complutense University in Madrid, “If you peg yourself to a currency that guarantees you better performance in terms of inflation, that forces you to maintain an economy that, in terms of costs, productivity and efficiency (competitiveness) is similar to the other currency” (the U.S. currency in the case of Argentina, and an average of the two or three best countries in the case of the euro.) “This sets off a process of deterioration in your economy and the value of your goods and services do not continue to be reflected in the value of your currency; and the markets will understand that you cannot sustain that parity for much longer, or sustain the value of your currency within the zone of the common currency,” he argues.
For Robert Tornabell, professor of banking and international finance at the ESADE Business School, the situations in Greece and Argentina do not offer a perfect parallel. For one thing, Argentina’s population is about four times that of Greece, and as a result, so was the potential ripple effect of Argentina’s international debt. At that time, Argentina debt was denominated American dollars, and when it devalued the [Argentine] peso, the debt in Argentina currency increased several-fold, and the Argentines could not pay it. “In contrast, Greece has indebted itself in a currency that it uses internally — the euro. What’s more, the main buyers of the country’s sovereign debt also use euros. More than 50% of the Greek debt is in the hands of banks from Germany, France, Switzerland and the U.K., according to the Bank for International Settlements in Basle,” he says.
Pampillón points out that “The agencies lowered their ratings on Argentine debt, like Greek debt today, which led to a steep fall in the price of Argentine bonds and a major increase in their interest rates.” Then, at the beginning of 2002, Argentina failed to fulfill its payments on a series of bonds, leading to great uncertainty among creditors, and a resulting collapse in the value of its debt. The government had to take emergency measures. The most outstanding measure was to break with the fixed exchange rate and let the Argentine currency depreciate drastically.
The Argentine Debt Restructuring
Pampillón notes that these were the conditions when Nestor Kirchner won the elections. He realized that he did not have sufficient resources to pay the debt, so he decided in 2005 to unilaterally cut the debt by 65%. “This measure obliged [Argentina’s] creditors to make a one-sided restructuring instead of a going through the traditional channels, such as the Paris Club and the London Club, to restructure the debt at lower interest rates and with better expiration terms.” The unilateral decision “threatened the orderly processes of negotiation and repayment of the debt. Not every creditor accepted the restructuring – and the 65% loss of value it entailed. The government repudiated the debt of those non-conformists who did not accept its conditions.”
According to Tornabell, Greece does not have to do a unilateral debt reduction since “that is the last thing that its French and German creditors would want. Greece would lose what it gained, and it would then become necessary to have a rescue plan for the banks of those countries that are holders of Greek debt.” He believes, “Greece’s advantage is that it now has two institutions that endorse its debts – the European Central Bank and the IMF.”
Sandleris says that Greece realizes that a unilateral debt reduction, such as the one that was carried out in Argentina in 2005, “will depend on the help that it receives from the EU.” That’s because “if it winds up being insufficient, it is likely, sooner or later, that [Greece] will have to renegotiate its foreign obligations.” In his view, “this does not necessarily imply that we see a unilateral debt reductionof the magnitude we saw in Argentina.” Like Tornabell, Sandleris believes that Greece’s advantage over Argentina is the help that Greece is receiving from its European partners (and likely from the IMF).
A departure from the euro zone by Greece would be a seismic event for the euro, and would exacerbate worries over contagion to Portugal, Spain, Italy and possibly other euro zone countries. For now, such worries work in Greece’s favor as it negotiates an aid package. Since Greece is a small economy within the EU, it is not so expensive to bail it out compared with the impact of a debt default or a unilateral debt reduction by Greece. Argentina lacked this leverage. There was only a limited chance of contagion in the case of Argentina during its crisis and that reduced Argentina’s power to negotiate an aid package. Letting Argentina fall did not appear to generate any important systemic risks.
“The only alternative that Greece has is, under the auspices of the IMF, to go to the Paris Club and the London Club and present a negotiated suspension of its payments,” according to Pampillón. That would help to “avoid the moral hazard, and the perverse behavior that happens when creditors, facing the inability of the borrower to meet its obligations, continue to lend money to that borrower because there will always be a moneylender of the last resort (in the countries of the euro zone) who will resolve the problem.” He adds, “There doesn’t have to be a rescue for Greece because that sends a message to investors that it is not important that Spain, Portugal and Italy have excessive and unsustainable public spending and fiscal deficits, because ultimately someone will pay.”
Méndez Ibisate adds that the EU and the IMF have provided Greece with a bail out in order to prevent Greece from getting into a situation where it cannot repay its debt and might have to withdraw from the euro zone.” The other euro countries want to avoid shattering confidence in the zone – “there is something different about the Greek case from what happened in Argentina.” Nevertheless, he has doubts about the European initiative. “It is not clear that what Europe and the EU have done is better either for Greece or for the euro zone, or for the countries that will operate with this currency in the future.”
Sandleris says that Greece and the international community have to draw conclusions from what happened in Argentina. “They must learn from the Argentine experience that the deflationary road in any rigid economy is prolonged and painful when imbalances are great. They must also learn that the road often leads to situations that are politically unsustainable.” Argentina spent three years pursuing this route, between 1999 and 2001, until the social cost of the crisis became unsustainable. “That is why it is essential to act carefully to avoid these [kinds of] imbalances in the first place,” he explains. “A second lesson is that there is life after the crisis. The Argentine economy, aided by external factors and some successes in economic policy, has enjoyed phenomenal growth since the crisis.”