PARIS (MNI) – Greece’s official creditors released a report late
Friday indicating that much bigger haircuts on Greek sovrereign bonds
will be required to get the country’s outstanding debt load down to
anything resembling long-term sustainability.

With a haircut of 50%, for example, the Greek public debt ratio
would be cut to 120% of GDP by 2020 — still extremely high — the
report argued. To get it down below 110% by 2020, it would require
haircuts of 60% or more on Greek bonds, the report added.

If only the 21% haircut from the July 21 private sector deal were
applied, Greece’s debt ratio would top out at a whopping 186% of GDP in
2013, and would still be at 152% by the end of 2020. In this scenario,
E252 billion worth of new public money would be required to fill the
hole — nearly 2.5 times the E109 billion pledged in the now-moribund
July 21 agreement on a new bailout plan.

The report noted that the European Central Bank, one of the
so-called “troika” of Greece’s lenders, disagreed with the inclusion of
the haircut scenarios in the text. The ECB has been an outspoken critic
of haircuts for private sector bondholders.

The text of the report was published Saturday in UK daily newspaper
The Telegraph. It is below, in two installments:

“Since the fourth review, the situation in Greece has taken a turn
for the worse, with the economy increasingly adjusting through recession
and related wage-price channels, rather than through structural reform
driven increases in productivity. The authorities have also struggled to
meet their policy commitments against these headwinds. For the purpose
of the debt sustainability assessment, a revised baseline has been
specified, which takes into account the implications of these
developments for future growth and for likely policy outcomes. It has
been extended through 2030 to fully capture long term growth dynamics,
and possible financing implications.

The assessment shows that debt will remain high for the entire
forecast horizon. While it would decline at a slow rate given heavy
official support at low interest rates (through the EFSF as agreed at
the July 21 Summit), this trajectory is not robust to a range of shocks.
Making debt sustainable will require an ambitious combination of
official support and private sector involvement (PSI). Even with much
stronger PSI, large official sector support would be needed for an
extended period. In this sense, ultimately sustainability depends on the
strength of the official sector commitment to Greece.

1. Recent developments call for a reassessment of the assumptions
used for the debt sustainability analysis. Since the fourth review, the
situation in Greece has taken a turn for the worse, with the economy
increasingly adjusting through recession and related wage-price
channels, rather than through structural reform-driven increases in
productivity. The authorities have also struggled to meet their policy
commitments against these headwinds, and due to administrative capacity
limitations in the Greek government. The growth and fiscal policy
adjustments assumed under the program individually have precedent in
other countries’ experience, but experience to date under the program
suggests that Greece will not be able to set a new precedent by
realizing at the same time and from very weak initial conditions a large
internal devaluation, fiscal adjustment, and privatization program.

2. To give the debt sustainability analysis a firmer foundation,
the following set of more likely policy and macroeconomic outcomes has
been assumed (the financing and other assumptions are discussed in more
detail in Annex I):

– A slower recovery. In keeping with experience to date under the
program, it is assumed that Greece takes longer to implement structural
reforms, and that a longer timeframe is necessary for them to yield
macroeconomic dividends (e.g. due to complementarities). A longer and
more severe recession is thus assumed, with output contracting by 5.5
percent in 2011, and by 3 percent in 2012. Growth then averages about
1.25 percent per year in 2013-14, 2.67 percent in 2015-20 (as a cyclical
rebound kicks in, and structural reforms start to pay off); and 1.67
percent per year in 2021-30 (as the economy reverts to potential growth,
which is constrained by demographic trends). All told, real output
growth is projected to be cumulatively 7.25 percent lower through 2020,
versus the projections made at the time of the 4th Review.

– Lower privatization proceeds. Given the adverse market conditions
and technical constraints faced by Greece, a more conservative but still
suitably ambitious path is assumed for privatization proceeds for the
purpose of the debt sustainability analysis. Receipts rise from 1.5
percent of GDP in 2012 to 2 percent of GDP for the period 2013-14, and
peak at 2.5 percent of GDP during 2015-17. They fall back at 2 percent
of GDP per year for 2018-20. Through 2020, total privatization proceeds
would amount to E46 billion, instead of the E66 billion assumed in the
program (i.e. the original target of E50 billion plus an additional
amount reflecting the fact that bank recapitalization will likely create
additional assets to be disposed of).

– Reduced fiscal adjustment needs. The nominal fiscal targets are
maintained through the program (mid-2013) and after that, the primary
surplus is assumed to improve further until it reaches 4.5 percent of
GDP for the period 2014-16. The primary surplus steps down to 4.25
percent of GDP in 2017-20 and to 4 percent of GDP in 2021-25 (a level
which in the past Greece has been able to sustain). Since few countries
have been able to sustain a 4 percent primary surplus, it is assumed
that from 2026 onwards, the primary surplus is maintained at 3.5 percent
of GDP. Under this path, which requires sustained and unwavering
commitment to fiscal prudence by the Greek authorities, the overall
fiscal balance would not drop below 3 percent of GDP until 2020.

– Delayed access to market financing. The PSI agreed at the July 21
Summit is assumed to be put into place. The issue of when market
financing will be restored is inherently uncertain. For the purposes of
this analysis, new market financing is assumed to become available only
once Greece has achieved 3 years of growth, three years of primary
surpluses above the debt stabilizing level, and once debt drops below
150 percent of GDP. This is admittedly an arbitrary rule, and is used
for illustrative purposes to give an indication of the scale of official
support that could be needed to fill any financing gap until market
access is restored in 2021.

3. Under these assumptions, Greece’s debt peaks at very high levels
and would decline at a very slow rate pointing to the need for further
debt relief to ensure sustainability.

Debt (net of collateral required for PSI) would peak at 186 percent
of GDP in 2013 and decline only to 152 percent of GDP by end-2020 and to
130 percent of GDP by end-2030. The financing package agreed on July
21(especially lower rates on EFSF loans) does help the debt trajectory,
but its impact is more than offset by the revised macro and policy
framework. Greece would not return to the market until 2021 under the
market access assumptions used, and cumulatively official additional
financing needs (beyond what remains in the present program, and
including the eventual rollover of existing official loans) could amount
to some E252 billion from the present through to 2020.

4. Stress tests to this revised baseline illuminate further the
problem with sustainability, revealing that the downward debt trajectory
would not be robust to shocks:

All else unchanged, significant shortfalls relative to the revised
fiscal and privatization targets would deteriorate debt dynamics even
further:

– Lower primary balances. If due to policy slippages, the primary
balance gets stuck at any level below 2.5 percent of GDP (a level which
under the program would only be exceeded in 2013), debt would be on an
increasing trajectory from already very high levels. (At the time of the
fourth review, the debt stabilizing primary balance was calculated to be
3.8 percent of GDP; under the revised baseline, largely due to the
reduction in the average interest rate on public debt, the debt
stabilizing primary balance is 2.25 percent of GDP.)

– Shortfalls with privatization receipts. Failures with
privatization (only E10 of E46 billion realized), would have a
significant impact on the level of debt and the debt trajectory
(noticeably slowing the rate of decline). Debt would end at 169 percent
of GDP by end-2020 and 153 percent of GDP by end-2030 (without
additional fiscal adjustment to compensate for higher interest
payments). With market access unlikely, financing gaps would arise
(further testing the willingness of the official sector to provide
additional financing).”

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