to substantial primary budget surpluses for two It is now nearly eight full years since the first IMF-
generations. One might ask whether it is morally EU emergency loan of €73 billion, which denied the
defensible to require future generations to pay for need for debt restructuring and was based on what
the sins of their forefathers, not to mention the appear in hindsight to have been wildly unrealistic
consequences of poor crisis management by European assumptions about growth and fiscal adjustment.
institutions and the IMF. One might also ask whether It is more than six years since the EU and the IMF
it is politically feasible that future generations can be committed to a second bailout of almost €165 billion
mandated to repay the debts of others for the better in conjunction with a deep write-down for private
part of their adult lives. At stake are mutual trust and bondholders. It is over five years since the revision
solidarity among EU member states. Both stand to of the second aid deal that included lower interest
be challenged by continued oversight of Greece and rates on EU loans and foresaw Greece as reducing its
by a long-term creditor/debtor relationship based on debt-to-GDP ratio to 124% by 2020. It is almost three
unrealistic assumptions. We favour instead incentives years since the third, €86 billion bailout, to which the
that promote genuine reforms and reduce moral IMF refused to contribute and which only narrowly
hazard. averted the country’s exit from the Eurozone.
Beyond these considerations, we ask whether this In the meantime, Greek GDP has fallen by 22%,
scenario is vulnerable to being thrown off track by an output collapse unprecedented in the annals of
even modest shocks to growth rates, interest rates modern Europe and one that rivals the severity of the
and fiscal performance. Is the risk of more crises, Great Depression in the United States. Unemployment
remains in excess of 20%, youth unemployment in
excess of 40%. The debt-to-GDP ratio, rather than
1 The authors are very grateful to the European Public Law
falling, has continued to rise and exceeded 180%
Organization (EPLO) for hosting the initial meeting of
our group and for helpful discussions, comments and already in 2017. None of this is as promised in official
suggestions. This report is simultaneously published by forecasts.
EPLO and CEPR.
2 See Eurogroup statement on Greece, 15 June 2017; and
Zettelmeyer (2017) for an interpretation of the statement.
All this points to the need for a further – and final to begin. That new private debt will be effectively
– rethink of the official approach to managing the senior, rendering the private sector willing to lend
country’s debt. Unfortunately, the participants in whether or not the Greek government is on course
negotiations over Greece’s debt all have deeply to meet its official obligations. As a consequence, the
entrenched positions. This became evident once market discipline on which Greece’s official creditors
more in 2017, which was occupied by yet further are counting will be weak or non-existent. The result
negotiations between Greece and the Troika (the in all likelihood will be yet another renegotiation of
European Commission, the ECB and the IMF) the government’s debt to the official sector before
and within the Troika itself. It culminated in the major repayments come due, accompanied by the
release of a pair of documents that encapsulate the predictable uncertainty, political noise, and negative
unsatisfactory state of affairs. The statement released consequences for investment and growth.
on 15 June by the Eurogroup (the group of finance
ministers of the members of the Eurozone, including Any plan that seeks to do better must begin by
Greece) anticipated a primary budget surplus of 3.5% recognising the difficulties of both the economics
of GDP through 2022 and then a surplus “equal to or and the political economy of Greek debt. The Greek
above but close to” 2% of GDP from 2023 through authorities prioritise economic recovery but also
2060. The document reiterated the readiness of the want to limit invasive oversight by the Troika while
Eurogroup to extend the average maturity of Greek at the same time convincing their neighbours that
debt held by the European Stability Mechanism past problems are unlikely to recur. They have been
(ESM), to defer further interest and amortisation on moving in the right direction with structural reforms
Greek bonds held by the European Financial Stability and fiscal consolidation, but their critics question
Facility (or EFSF, the predecessor of the ESM), and to whether they have gone far enough. The creditors,
create a link between Greece’s debt service to the EFSF meanwhile, are struggling to reconcile four potentially
and its economic growth, all in the “medium term”, irreconcilable objectives: to facilitate that same Greek
meaning after 2022. The statement also “reaffirmed economic recovery, but also to recoup some of their
and confirmed the commitments and principles in money while limiting their ongoing involvement
the statements of May 2016”, in which the Eurogroup in Greece and not setting bad precedents for the
had ruled out reductions in principal of officially held Eurozone. They are constrained by EU law. They too
debt. Finally, the Eurogroup envisaged a quick return have been moving in the right direction, by offering
of Greece to capital markets at the conclusion of the interest rate reductions and maturity extensions and
programme in 2018. signalling that further “recalibration” of the debt
might be possible at some future date. But the result
A troubling aspect of this plan is the tightness of the still does not meet the objectives that the creditors
fiscal path, starting with a primary surplus of 3.5% of have set for themselves.
CEPR POLICY INSIGHT No. 92
A further problem with the Eurogroup’s plan is that it We then consider a scenario where the full set of
lacks an incentive mechanism that would discourage potential debt relief instruments described and hinted
new overborrowing by Greece. The provision at in Eurogroup statements is deployed, including
that comes closest is the requirement that Greece EFSF re-profiling and capping and deferral of interest
should cover its gross finance needs through private payments. Under the Eurogroup’s relatively optimistic
borrowing as early as this year. The Eurogroup’s assumptions about growth and fiscal policy, this
hope is that this need to access private markets renders Greece’s debt just sustainable, maybe. But
will discipline the Greek government and ensure recall that those assumptions include that Greece
continued good fiscal outcomes. In fact, however, maintains a primary surplus of 2% or higher for more
this is unlikely to be the case. New borrowing from than 40 years, an outcome that is unprecedented and,
the private sector can be structured to amortise before in our view, unrealistic. Stuff happens – both political
major repayments to the official sector are scheduled stuff and economic stuff. A primary budget surplus
extending them to the indefinite future means the accounting identity to track debt accumulation
making arbitrary and implausible assumptions. over time and shares key elements of the IMF’s
methodology. The key elements of this approach are
• For all these reasons, the IMF – which pioneered the following:
Debt Sustainability Analysis (DSA) in the late
1990s – focuses on debt sustainability rather • For comparison with the IMF and Commission
than solvency. The Fund considers debt to be DSAs, the horizon is set at 2060. While we adopt
sustainable when “the primary balance needed the Commission data for the medium term,
to at least stabilize debt under both the baseline meaning typically the next five years, we then
and realistic shock scenarios is economically and attempt to describe the steady state as explained
politically feasible, such that the level of debt is below.
consistent with an acceptably low rollover risk and
with preserving potential growth at a satisfactory • Debt sustainability is defined in terms of two
level” (IMF 2013). This definition has the merit of criteria: that by 2060 the debt-to-GDP ratio must
being intuitive. It requires that the debt be at least be declining, and that the government gross
stabilised, i.e. not indefinitely growing relative to financing needs – the sum of the primary deficit
the size of the economy. Furthermore, the level and interest and amortisation – must not exceed
at which it is stabilised must be such that debt 20% of GDP in any given year.
service is possible without disruption to growth
prospects that are sufficiently serious to create • In each scenario, the implications of various
serious economic hardship and political turmoil, assumptions about the path of the primary budget
and without a high risk of being excluded from deficit are explored over the entire horizon. The
the financial markets, as happened to Greece in aim is to find out which of these assumptions
deliver debt sustainability, as previously defined.
2.00 2.00
1.50 1.50
1.00 1.00
0.50 0.50
0.00 0.00
20 7
20 0
20 3
20 6
20 9
20 2
20 5
20 8
20 1
20 4
20 7
20 0
20 3
20 6
59
20 7
20 0
20 3
20 6
20 9
20 2
20 5
20 8
20 1
20 4
20 7
20 0
20 3
20 6
59
1
2
2
2
2
3
3
3
4
4
4
5
5
5
1
2
2
2
2
3
3
3
4
4
4
5
5
5
20
20
• In contrast to other DSAs, the scenarios are not 3.1 GDP growth
meant to be sensitivity tests of the baseline result; The left-hand chart in Figure 1 displays the most
we have no baseline. Instead, we construct the recent forecasts published by the IMF and the
scenarios to evaluate various options. European Commission in July 2017 and January
2018, respectively.4 The Commission envisages
• Uncertainty is crucial to interpreting the results. three scenarios labelled A (baseline), B (moderately
Based on the historical properties of Greek GDP pessimistic), C (more pessimistic) and D (optimistic).
growth, inflation and interest rate, we run a We ignore Scenario D, which we (and the IMF) view as
large number of ‘Monte Carlo’ simulations that overly optimistic for reasons explained in Appendix
generate fan charts. 1. All these forecasts assume that the steady state is
reached between 2025 and 2030.
• The methodology allows for two-way feedback
between debt and the interest rate, as explained We experiment with two paths. For the period 2017-
below. This feedback is important because it is a 2022, in both cases we adopt Scenario B (which is
17
21
25
29
33
37
41
45
49
53
57
17
21
25
29
33
37
41
45
49
53
57
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
Source: European Commission (2018), IMF (2017) and Zettelmeyer et al. (2017).
Note: The left-hand chart shows IMF baseline primary surplus paths for Greece from IMF (2017), primary surplus paths corresponding
to scenarios A, B and C from European Commission (2018), and a primary surplus path taken from Zettelmeyer et al. (2017). The
right-hand chart shows the three primary surplus paths used in the debt sustainability analyses below.
For the short to medium term, it has already been 3.3 Inflation (percentage change in the GDP
agreed between the Greek government and the deflator)
Commission that the budget surplus will be of 3.5%
of GDP over 2018-2022. The IMF departs marginally Debt accumulation is computed in real terms. A
from this assumption by considering that this target higher inflation rate raises nominal GDP and reduces
CEPR POLICY INSIGHT No. 92
will only be reached in 2019, with a 2.2% surplus in the debt-to-GDP ratio. In its baseline scenario, the
2018; such a small and brief difference does not really Commission assumes that inflation rises from 0.9%
affect debt sustainability. The left-hand chart in Figure in 2017 to 2% in 2024 and remains unchanged
2 shows what is assumed thereafter. The Commission’s afterwards. The IMF foresees a slow rise in inflation
Scenario A envisions that the surplus declines in two from 1.2% in 2017 until it reaches 1.8% in 2023, after
steps to reach 2.2% in 2025 and remains at that level which it remains there. In what follows, we adopt
thereafter. In Scenario B, the lowest primary surplus the Commission’s relatively optimistic assumption,
path consistent with the Eurogroup’s June 2017 including 2% inflation in the medium and long term,
statement, the surplus settles at 2% of GDP by 2025. except when we adopt the IMF forecasts (growth,
Scenario C portrays an immediate reduction to 1.5% surplus, inflation and privatisation proceeds).
as soon as 2023. This is also the assumption made
by the IMF, which is therefore almost identical to the 3.4 Privatisation proceeds
Commission’s Scenario C. A number of privatisations – including of some banks
– have been agreed and may or may not be realised. In
We consider three possible paths, shown in the right- its baseline scenario, the European Commission takes
hand chart of Figure 2: into account those achieved in 2017, valued at €3.4
billion. From 2018 onward, it anticipates additional
• The Commission’s Scenario B (consistent with the privatisation receipts of about €13 billion. The IMF
Eurogroup statement, as indicated above), called envisions a much smaller total of €4.9 billion for
“2% long run”. Over 2018-2060, the average 2017-2068. We consider the implications of both
primary surplus is 2.21% of GDP. the relatively optimistic Commission privatisation
revenue forecasts and the IMF’s more conservative
• A path proposed by Zettelmeyer et al. (2017) forecasts in the scenarios that follow.
based on international evidence on the duration
of primary fiscal surpluses. Starting in 2023, the
Luckily (for us), a large part of the Greek debt is owed 3.6 Four scenarios
to official lenders. The Greek Loan Facility (GLF) is
a set of bilateral loans provided in May 2010 at the All these assumptions can be combined in a large
start of the crisis. It charges Greece the three-month number of ways. To keep the analysis manageable, we
EURIBOR rate plus a spread of 50 basis points. focus on just four scenarios that span the range of
Afterwards, loans were provided by the ESM and plausible outcomes.
its predecessor, the EFSF. These institutions charge
Greece their funding costs related to borrowing from 1. Optimistic growth, 2% surplus. This assumes a
Greece plus a 10-basis-point spread in the case of the steady-state growth rate of 1.25% and a primary
ESM and no spread in the case of the EFSF. Currently, surplus path of at least 2% of GDP, as in Scenario
these rates stand at around 1-1.2%.7 Finally, Greece B of European Commission (2018) and consistent
has also borrowed from the IMF. The interest rate with the June 2017 Eurogroup statement. Inflation
charged by the IMF is considerably higher than those and privatisation proceeds follow the Commission
charged by the European official lenders (for 2018, baselines.
about 3.2%), but these loans are of a much shorter
maturity.8 2. Moderate growth, 2% surplus. Same as the
optimistic scenario except that steady-state growth
Key questions are when Greece will return to the is assumed to be 1.0%.
markets for its borrowing needs, possibly rolling over
maturing official loans, and then at what interest 3. Moderate growth, 1% surplus. This scenario is
rate. We proceed on the following assumptions. the same as the previous one, assuming a steady-
state GDP growth rate of 1%, but it accepts that
• EFSF rates: We use the EFSF projections shown in the primary surplus eventually declines to 1% of
European Commission (2018, Table 4, Scenarios A, GDP, as in Zettelmeyer et al. (2017).
B and D), with interpolation for years not shown
in the table. 4. IMF. The steady-state growth rate is 1% and the
primary surplus after 2022 is set at 1.5% of GDP.
• ESM and GLF rates: We follow the approach used This scenario assumes low privatisation revenues
3 presents the results for all four scenarios. Even sense. However, it may violate the Eurogroup’s upper
under the optimistic scenario (upper two fan charts), limit of 15 years for amortisation deferral, since the
the debt is unsustainable: the debt ratio declines, deferral is endogenous. In this sense, the mechanism
but never below 100%, and gross financing needs considered below may be slightly more generous than
are significantly above the thresholds that the what the Eurogroup is willing to include as part of its
Eurogroup accepted for the purposes of establishing “medium-term” measures.
sustainability. The situation is even worse under
all three less-optimistic scenarios, which imply a In addition to “medium-term” measures, the
continuously rising debt ratio. Eurogroup also promised a “contingency mechanism
on debt” which could be activated, subject to
4.2 Full use of all debt relief instruments a decision by the Eurogroup, “in the case of an
described in recent Eurogroup unexpectedly more adverse scenario.” This could
statements entail measures such as a further EFSF reprofiling and
capping and deferral of interest payments. Hence,
In addition to the “short-term measures” already this “contingency mechanism” would not consist of
implemented and incorporated in Figure 4, the additional debt relief measures, but merely extend
following potential debt relief instruments are the re-profiling and capping and deferral of interest
mentioned in the Eurogroup statements of 15 June payments already envisaged in the “medium-term”
2017 and (in slightly more detail) in May 2016 bundle beyond 2037.
(quotes below are from the 25 May 2016 Eurogroup
statement; see Zettelmeyer et al. 2017).
$!
!"#$"%&'()'*+,
percent of GDP
150
#"
100
#!
" 50
! 0
$!#& $!$$ $!$' $!%! $!%( $!%& $!($ $!(' $!"! $!"( $!"& $!'$ 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
20
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
IMF (1% growth, 1.5% surplus, low inflation and privatisation proceeds)
30 250
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
20
percent of GDP
CEPR POLICY INSIGHT No. 92
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
IMF (1% growth, 1.5% surplus, low inflation and privatisation proceeds)
30 250
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
• Full deferral and capitalisation of interest 4.3 Option I: Conditional face-value debt
payments for the maximum period that the June relief
2017 Eurogroup statement allows, i.e. until 2037
inclusive. From 2038 onward, interest is paid The Eurogroup and the ministries of finance of
normally (including on capitalised interest). creditor countries have explicitly rejected face-value
debt relief, citing two arguments. One is concern
The top two rows of Figure 4 show that these measures about moral hazard. Once face-value debt relief
would make the Greek debt sustainable under the has been granted – even if conditional on some
Eurogroup’s fiscal assumptions of a surplus of 2% of primary surplus path – what stops a country from
GDP. However, for reasons argued in Zettelmeyer et underperforming this surplus path and then asking
In the following, we present such an incentive- post-programme period in 2023 triggers maturity
compatible scheme.12 We assume that Greece wants reprofiling, interest deferrals, and capping of
to avoid default to the EFSF/ESM because of its annual amortisation at a fixed 0.3% share of GDP.
economic and political repercussions, but not at any
cost – there is a level of austerity at which it would • In addition, in 2023, put in place the following
perceive no alternative. Consider two fiscal paths, the scheme:
first more ambitious than the second. ◦◦ For every euro by which Greece over-performs
the lower fiscal surplus path, EFSF debts will be
• The more austere (‘upper’) fiscal path is sufficiently reduced by an equal amount, but only up to
ambitious that it is unrealistic unless Greece is the point at which Greece achieves the upper
given additional incentives, but not so ambitious fiscal path. For example, if the upper target
that Greece would not even try to achieve it if it in 2025 is 2% and the lower target 1.5%, the
is the only way to avoid default. The path agreed maximum face value debt relief that Greece
with the Eurogroup in June 2017 (3.5% primary can earn based on its 2025 performance is 0.5%
surplus until 2022, followed by a surplus of at least of GDP.
2% for the next 38 years) falls in this category. Even ◦◦ A clawback rule ensures that the debt relief is
though the chance that Greece could deliver this reversed if Greece falls below the lower target.
path without strong incentives is almost zero, 2% This would make it impossible to game the
is less than the primary surpluses that Greece has scheme by alternating fiscal splurges with years
already achieved. In addition, this path is based in which adjustment triggers debt relief.
on current European fiscal rules (as the Eurogroup ◦◦ The scheme would end after 2037, in line
statement argues), so Greece would give it a shot. with the time limits the Eurogroup has set for
From the point of view of Greece, attempting to reprofiling and interest deferrals. This implies a
stick to the path is preferable to default. maximum for face value debt relief that Greece
could earn over that period. For example, if
• The less austere (‘lower’) path describes a primary the upper path is the Commission’s Scenario B
surplus that Greece may be able to achieve even described above (i.e. 3% in 2023, 2.5% in 2024,
without further incentives, but which is not and 2% from 2025-2037) and the lower path
ambitious enough to make the debt sustainable is 1.5% over 2023-2037, then the maximum
even if accompanied by the entire arsenal of debt face value debt relief would be 9% of GDP,
relief measures that the Eurogroup has put on the or approximately €24 billion – a manageable
table. The primary surplus paths considered in the amount compared to both Greece’s official
moderate surplus scenario or IMF (2017) arguably debts (€131 billion to the EFSF alone) and the
fall into this category. magnitude of net transfers to Greece from the
CEPR POLICY INSIGHT No. 92
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
path assumed by the IMF (see Figure 2); second, a be powerful enough to deliver sustainability when
composite path which takes the minimum of the the primary surplus is allowed to decline to just 1%
surpluses of the IMF and of the 1% surplus scenarios. in the long run. The answer is yes (just).
Until 2038, as shown in Figure 2, this path is identical
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
20
percent of GDP
percent of GDP
150
15
100
10
50
5
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
Reprofiling of amortisations, interest deferral until 2038, and zero GLF lending spread
IMF scenario
30 250
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
Combination of all EFSF and GLF measures with further ESM financing for 21 years
Moderate growth, 1% surplus scenario
30 250
25
200
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
Combination of all EFSF and GLF measures with further ESM financing for 21 years
IMF scenario
30 250
20
percent of GDP
percent of GDP
150
15
100
10
50
5
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
16 400
320
12
280
10
240
8 200
6 160
120
4
80
2 40
0 -
2018 2024 2030 2036 2042 2048 2054 2060 2066 2072 2078
EFSF ESM GLF
IMF ECB Other
T-Bills Bonds EFSF outstanding
ESM outstanding EFSF+ESM+GLF outstanding GLF outstanding
Repaying these debts could take until the end of the envisaged by the Eurogroup and described in Section
century and beyond. An increase in European official 4.2 of this report, must be delivered ‘in one swoop’
sector exposure of such length and magnitude is in 2022 or soon thereafter, because falling back to
hardly plausible, particularly in combination with the status quo would overburden Greece under any
seven consecutive additional ESM programmes. It is reasonable fiscal effort, and the country would likely
therefore hard to avoid the conclusion that Option be forced to default.
III could play a useful role only in combination with
some degree of face-value debt relief, i.e. Option I. 5 Conclusion
Importantly, the second option can be credibly The Eurogroup statement of June 2017 that provides
applied only if it applies solely to the GLF relief. Debt the framework for negotiations does not satisfy
relief measures that refer to the EFSF, along the lines these requirements. It does not render Greece’s debt
sustainable even under the Eurogroup’s own relatively be enough. Combining the Eurogroup’s “medium-
optimistic assumptions about inflation, growth term” measures with a new ESM programme would
and primary surpluses. It certainly does not render not restore debt sustainability with high probability
that debt sustainable under the more conservative either. Still, this combination would be preferable to
assumptions of the IMF and others. Even with the ending Greece’s access to official financing in 2018. It
adoption of the additional medium-term measures to would give Greece’s creditors the option of applying
which the Eurogroup has alluded but not yet officially additional debt relief measures in the future without
committed, the debt is only borderline sustainable. the need to repay or restructure additional private
Any number of economic or political disturbances debts.
could throw the programme off track. The likelihood
of such disturbances is high when the programme Option III applies the Eurogroup measures, i.e.
is scheduled to extend over more than 40 years. reprofiling of amortisations and deferral of interest,
Neither is the statement clear about how incentives not just to EFSF loans but also the bilateral loans of
would be created to increase the chances that Greece the 2010 Greek Loan Facility. Our analysis shows
will deliver on fiscal surpluses that are presumed to that this is unlikely to be sufficient. To achieve debt
underpin future debt relief. sustainability without face-value debt relief, it would
be necessary to combine Options II and III. But while
An essential requirement for an adjustment and this would suffice to restore debt sustainability, it
debt relief programme, as nine years of turmoil in would imply a very large increase in the total exposure
Greece have reminded us, is that the programme to Greece of the European official sector. It would
be robust. Another one is that it be clear about why mean that Greece could still be paying off debts to
Greece would have an incentive to actually adhere European official creditors well into the 22nd century.
to the programme. So far, the plans sketched by the
European official sector deliver neither. In sum, it is hard to avoid the conclusion that any
solution to the Greek debt crisis that does not fall
We have explored three alternatives in this report. All on the shoulders of taxpayers several generations
three may be understood as ‘add-ons’ to the package removed will require conditional face-value debt
of medium-term debt relief that the Eurogroup has relief.
put on the table. Our Option I adds conditional face-
value debt relief. We describe a scheme that avoids Later this year there will be another programme
creating moral hazard and satisfies EU law. For every negotiation between Greece and the European
euro by which Greece over-performs a baseline fiscal authorities. The goal should be to make it the last
path, EFSF debts will be reduced by an equal amount, one. Continuing uncertainty about Greek debt
but only up to the point at which Greece achieves sustainability does no-one any good. It creates
CEPR POLICY INSIGHT No. 92
a specified upper-limit fiscal path. This formula, the spectre of yet further renegotiations and
augmented by a few additional provisions consistent restructurings, which depress investment and roil
with the Eurogroup’s own approach, would render politics. It does not burnish the reputation of the
Greece’s debt sustainable. European authorities when their claims that debt
sustainability has been definitively restored are first
In a nutshell, this option trades debt relief for long- questioned and then falsified. The result is finger
lasting fiscal discipline. The risk of relapse cannot be pointing and recrimination, and more pain for the
eliminated, but the claw-back clause that we propose Greek people and problems for their economy.
should discourage the Greek authorities from going
in this direction. The crux is to establish that this By thinking more creatively while still respecting the
clause will be implemented with full certainty. parties’ respective red lines, however, Greece’s debt
can be restructured in ways that restore sustainability
Option II substitutes relatively economical ESM with high probability, limit moral hazard, conform
financing for expensive market financing. This to EU law, and avoid the indefinite involvement of
reliance on the ESM, together with only the institutions like the ESM in the Greek economy. The
Eurogroup’s short-term debt relief measures, would European authorities and the Greek government
require a very lengthy ESM programme and a large should take the opportunity of the impending
increase in total European official sector exposure negotiation to move in this direction.
to the country. Even extending ESM programmes
for two more decades, in combination with EFSF
maturity extensions and interest deferrals, may not
effect of this will wane once the capital stock returns to its long-run $%& $
level. Staff’s medium-term projections already assume a temporary
boost to growth from higher investment (with real growth rates where β = 0.02 and A is the TFP level in Greece (G)
averaging over 2% during the investment recovery). Once the and the US, as indicated by the superscript.
transition to the new, higher capital ratio is completed, however,
the impact of increased investment will fade and growth dynamics
will be determined by the evolution of output per worker and of the
number of workers.”
GREECE
Figure A1.1 IMF assumptions
Labor Force Participation (15-64 age group) Average TFP Growth
(Percent) (Percent, annualized)
78 1.5
Greece
76 EA
EA (2020-2060)
1.2 (1970-2016) Greece
74 (2016)
(2020-2060)
72 Greece 0.9
(2016)
EA
70
0.6 (2000-2016)
68 Greece
0.3 (1970-2016)
66
64 0.0
Sources:
Sources: AMECO AMECO European
database; database; European Commission
Commission 2015 Aging
2015 Aging Report,
Report; and IMF
IMF staff staff estimates.
estimates.
11. Inflation is expected to remain subdued, and below the ECB’s target for the euro area.
Stronger demand is expected to contribute to a gradual increase in inflation in the medium run. In
the long run, however, inflation
To download is projected
this and otherto stabilize
Policy at about
Insights, visit1.7 percent. This reflects Greece’s
www.cepr.org
lower labor productivity relative to the euro area average, which, together with persistently high
MARCH 2018 20
Figure A1.2 Estimates of ln(AG/AUS)
0 Looking forward, we can project the 2% convergence
path to 2060 starting from the actual estimate of
Actual ln(AG/AUS) for 2016. If US TFP grows at annual rate
-0.1
estimate
γ:
-0.2
-0.3
𝑙𝑙𝑙𝑙𝐴𝐴'( '(
$%& = 𝑙𝑙𝑙𝑙𝐴𝐴$ + 𝑛𝑛𝑛𝑛
-0.4
then the convergence assumption implies that the
n-period growth rate of Greek TFP is:
-0.5
-0.6 ,0 ,0
𝑙𝑙𝑙𝑙 -./
= 𝑛𝑛𝑛𝑛 − [1 − (1 − 𝛽𝛽)& ]𝑙𝑙𝑙𝑙 ,89
-
.
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
,0
- -
20
percent of GDP
percent of GDP
150
15
100
10
5 50
0 0
2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045 2048 2051 2054 2057 2060
repay continues to exist.15 policies are guaranteed. As the Court notes in Pringle,
the Treaty foresees the possibility of such financial
The text of Article 125 TFEU regulates financial assistance in Article 122(2) “where a Member State is
payments within a triangle that comprises the initial in difficulties or is seriously threatened with severe
creditor, the debtor state and the debt-assuming state/ difficulties caused by natural disasters or exceptional
institution (Steinbach, 2016). In this sense it prohibits occurrences beyond is control”. In addition, nothing
transfer of repayment ‘liability’ and the assumption in the Treaties prevents member states from providing
of the debt ‘commitments’ of another member state. any form of financial assistance to one other (in the
The Treaty does not just rule out joint liability for the same way that they can provide it to third states). It
payment of debts of another member, although it would, thus, be absurd to exclude the possibility that
prohibits the voluntary assumption of such liability one or more states might decide on a voluntary and
by the Union or any of the member states. bilateral basis to offer financial assistance to another
member state. What is forbidden is the provision
The objective is to impose market discipline on of financial assistance that would undermine the
member state budgetary and fiscal policies since their conduct of sound budgetary policies by another
debt is not ‘guaranteed’ by the Union or other member EMU state. The Court concludes therefore that such
states. As the Court of Justice states in Pringle: financial assistance can be provided but subject to
certain strict conditions:
The Treaty therefore does not prohibit financial This construction explains why Article 125 is
assistance; on the contrary, it foresees it. But, for structured in terms of a trilateral relationship: the EU
the Court, such financial assistance needs to be or a member state being liable for or assuming the
“indispensable” to safeguarding financial stability commitments that another member state undertakes
in the euro area as a whole and in its member states. with respect to third parties. Thus, a contrario,
This requirement means that financial assistance Article 125 does not rule out the possibility of debt
cannot be granted just for the sake of solidarity, forgiveness (including face-value debt relief) in the
it needs to be systemically justified in light of the context of the bilateral relationship amongst member
overall interests of the euro area. states. In this instance, it would be the creditor itself
forgiving the debt and not a third part assuming
While this restriction can be seen as limiting solidarity, liability for a member state’s debt.
it can also help to buttress it within the EMU, since it
is made clear that such solidarity can still be offered The most significant obstacle to financial assistance
but only when it is in the interests of all of the euro resulting from the text of Article 125 is the prohibition
area. In any event, as recent history has proved and for a state to assume the commitments undertaken
the reasoning of the Court judgement in Pringle made by another member state. In her Opinion in Pringle,
clear, a member state in need of financial assistance AG Kokott states that assuming commitment means
may pose, per se, a systemic threat to the whole euro discharging the commitment either by making a
area, making this a criterion easier to fulfil than might substitute payment or by becoming liable itself for the
otherwise be thought. Safeguarding the interests of future payment.17 Does this mean that the Union or
the euro area as whole is also the typical criterion member states cannot substitute third-party creditors
repaid is to include an appropriate margin”.19 Thus, debtor state, its market creditors, and the Union or
the reasoning of the Court in Pringle does make other member states, not in the relationship that is
financial assistance possible. At the same time, it established once a debtor state receives assistance
appears to do so in such a way as to strongly limit from the Union or other member states. It is in this
forms of debt relief. light that one can understand AG Kokott’s statement
that direct support to the creditors is prohibited by
Does the formulation of permitted financial assistance Article 125 while indirect support, via support to the
under Pringle require that transferred/substituted debtor state, is not prohibited. Nonetheless, indirect
loans are always honoured by the debtor state? To support should not be certain or guaranteed when
forgive (or offer substantial relief for) those loans at the original financial assistance is offered, otherwise
a later stage would be to discharge part of the debt of market discipline exerted by interest rate spreads
that member state and, therefore, to assume it. would disappear.21
But it is far from clear that both the Treaty and What is crucial therefore is to determine whether the
Pringle actually exclude debt forgiveness. First, the assumption of commitments is made a priori and with
two “requirements” mentioned by the Court (that regard to other creditors (this is the focus in Pringle). If
the “new debt” needs to be repaid and that new it is, it becomes an implicit guarantee that withdraws
loans should include an appropriate margin) are the impact of market discipline exerted by interest
mentioned in the judgement as conditions resulting rate differentiation (spreads). If no assumption of
from the ESM Treaty but not from Article 125 itself. the commitments of a member state is made a priori,
They are used by the Court to highlight how the then the purpose of the provision is respected, even
ESM Treaty imposes strict conditions on financial if there is a hypothetical possibility that financial
assistance granted by the ESM, therefore supporting assistance granted to a state may be used to facilitate
the conclusion that the ESM Treaty does not violate the discharge of the state’s commitments to its fellow
Article 125. This is different from establishing that member state creditors or the EU. The type (but not
respecting ESM Treaty requirements is an essential the conditions) of such financial assistance is largely
condition for any financial assistance to be permitted irrelevant.
under Article 125.
Legally, therefore, it is necessary to assess if the form
Second, it would be paradoxical for the violation of and conditions of financial assistance protect the goals
Article 125 to emerge not when the Union or other of ensuring market discipline and sound budgetary
member states assist a member state in honouring its policies. In itself, even face-value debt relief is not
commitments towards other creditors but only when, prohibited per se, so long as the way it is structured
as the new creditors of that state, they voluntarily will safeguard those goals. Moreover, for the reasons
CEPR POLICY INSIGHT No. 92
decide to provide relief on the debt owed to them by mentioned above, other forms of financial assistance
that state. It is with respect to the first action (assisting are actually more likely to endanger those goals than
a member state to honour its obligations to other a face-value debt relief on debt already owned by the
creditors) that the purpose of the provision is at stake: EU or other member states, including through the
to protect creditor-imposed market discipline by not ESM.
having their loans to one member state guaranteed
by the Union or other member states. ESM buying Further support for this position comes from
bonds providing loans to replace market loans would Gauweiler. In this judgement, the Court of Justice
seem more likely to put into question the purpose of accepts the possibility of a debt loss by the ECB with
the provision than any form of debt relief including respect to bonds it buys from member states.22 The
forgiveness of debt already owned by ESM or EFSF (so Court simply assumes that this is a risk inherent in
long as such debt relief remains discretionary and,
therefore, uncertain).
In light of the above, different forms of debt relief are Third, one should not ignore that the more legally
possible so long as the means chosen do not endanger controversial the debt relief, the higher its political
the purpose of market discipline enshrined in the cost. In this light, it should not be ignored that a face-
Treaty and so long as they respect the conditionality value debt relief is considered by some to infringe on
requirement aimed at guaranteeing sound budgetary the ‘no bailout’ clause (Steinbach, 2016). Although
policies. This, however, does not mean that the form this is not the view expressed here, one must
and extent of debt relief are irrelevant. recognise that the absence of a legal consensus will
make a political agreement harder to reach.
First, the more substantial the debt relief, the harder
it becomes to demonstrate that conditionality-based In this instance, the position of national constitutional
financial aid represents a functional equivalent to and supreme courts is also relevant since it is bound
market-based refinancing according to the CJEU's to determine the positions taken by the respective
interpretation in Pringle. Debt relief, particularly national governments. The best-known example
face-value debt relief, may reduce governments’ is that of the German Constitutional Court. In a
incentives to consolidate budget policies and can series of cases, this Court has established important
heighten moral hazard (Steinbach, 2016; Kerber and limits to the forms of financial assistance that could
Städter, 2011; Frenz and Ehlenz 2010). Naturally, this be provided by the German state. It has done so in
depends on the extent, form and conditions of the light of the democratic principle, including in this
debt relief. In other words, there is a trade-off between case the protection of budgetary autonomy and
the extent of debt relief provided to a state and the self-determination. It accepted that Germany could
extent to which market discipline and the incentives become liable for other member states or EU financial
for sound budgetary policies are protected. Debt relief needs but required for such financial assistance to be
still must preserve the goals of market discipline and limited, controlled by Parliament and subject to strict
furtherance of sound budgetary policies. This can conditionality.
be achieved by how the relief is structured and the
incentives attached to it.25 What is important therefore, in light of the ECJ and
a sound budgetary policy are not lessened”.27 These Eichengreen, B. and U. Panizza (2016), “A Surplus
guarantees, inherent in conditionality, are also likely of Ambition: Can Europe Rely on Large Primary
to reduce the risk of losses.28 Strict conditionality Surpluses to Solve its Debt Problem?”, Economic
must therefore always be part of any debt relief. Policy 31(85): 5-49.
European Commission (2018), “Compliance Report,
What is crucial, with regard to both the form and ESM Stability Support Programme for Greece, Third
conditions of debt relief, is that they are structured Review”, 20 January.
so as to provide the right incentives for budgetary Frenz, W. and C. Ehlenz (2010), “Europäische
discipline. This is at the core of our three options. We Wirtschaftspolitik nach Lissabon”, Gewerbearchiv:
recognise that Option I (conditional face-value debt 329-336.
relief) will cause more legal controversy than Options Hall, R.E. and C.I. Jones (1996) “The Productivity of
II and III (that fundamentally extend measures already Nations”, NBER Working Paper No. 5812.
in place). But, for the reasons already explained, we International Monetary Fund (2013), Staff Guidance
believe it to be equally compatible with the TFEU, in Note for Public Debt Sustainability Analysis in Market-
light of the incentives it will create, if administered in Access Countries.
the form we propose. International Monetary Fund (2017) “Greece: Request
for Stand-By Arrangement”, Country Report 17/229,
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Ardagna, S., F. Caselli, and T. Lane, (2007) “Fiscal Individualrechtsschutz gegen Rechtsverstöße der
Discipline and the Cost of Public Debt Service: Some EZB”, Europäische Zeitschrift für Wirtschaftsrecht 22:
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Purpose and Teleology”, Maastricht Journal of Zettelmeyer, J., E. Kreplin, and U. Panizza (2017),
European and Comparative Law 20: 3-11. “Does Greece Need More Official Debt Relief? If So,
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the Legality of Outright Monetary Transactions”,
European Law Review 41: 1.
Barry Eichengreen is the George C. Pardee and Helen N. Pardee Professor of Economics and Professor of Political
Science at the University of California, Berkeley, where he has taught since 1987. He is a CEPR Research Fellow, and a
fellow of the American Academy of Arts and Sciences, and the convener of the Bellagio Group of academics and economic
officials. In 1997-1998, he was Senior Policy Advisor at the International Monetary Fund. He was awarded the Economic
History Association's Jonathan R.T. Hughes Prize for Excellence in Teaching in 2002 and the University of California at
Berkeley Social Science Division's Distinguished Teaching Award in 2004. He is also the recipient of a doctor honoris causa
from the American University in Paris. His research interests are broad-ranging, and include exchange rates and capital
flows, the gold standard and the Great Depression; European economics, Asian integration and development with a focus
on exchange rates and financial markets, the impact of China on the international economic and financial system, and IMF
policy, past, present and future.
Emilios Avgouleas is the inaugural holder of the International Banking Law and Finance Chair at the University of
Edinburgh and the founding director of the Edinburgh LLM in International Banking Law and Finance. He is a Member of
the Stakeholder Group of the European Banking Authority (EBA) elected in the so-called 'top-ranking' academics section.
He is also an independent member of the Select panel for the Hellenic Financial Stability Fund, the major shareholder
of the Greek banking sector. Emilios is currently a visiting Research Professor at the Faculty of Law, University of Hong
Kong (HKU), and a Visiting Professorial Fellow at the department of European Political Economy, LUISS, Rome. Between
2008 and 2017 he served, at different times, as a distinguished visiting professor, visiting professor, visiting professorial
fellow and senior research scholar at Yale Law School, Harvard Law School, National University of Singapore, Hong Kong
University, Duke Law School, CUPL (China-Europe School of Law), and the Athens Univ. of Economics & Business.He
has published extensively in the wider field of International and European finance law and economics, banking theory
and regulatory policy, systemic risk, and behavioural finance. He is the author of a large number of scholarly articles
and research monographs including Governance of Global Financial Markets: The Law, the Economics, the Politics (Cambridge
University Press, 2012) and The Mechanics and Regulation of Market Abuse: A Legal and Economic Analysis (Oxford University
Press, 2005). He recently co-authored the Principles of Banking Law (Oxford University Press, 3rd ed., 2018). He has also
co-authored and co-edited Reconceptualizing Global Finance and its Regulation (Cambridge University Press, 2016), Capital
Markets Union in Europe (Oxford University Press, 2018), and Political Economy of Financial Regulation (Cambridge University
Press, 2018 forthcoming).
Maduro Miguel Poiares Maduro is Director of the School of Transnational Governance at the European University
Institute. Before, he was Professor at the Law Department and at the Robert Schuman Centre of the European University
Institute where he was the Founding Director of the Global Governance Programme (from 2010 to 2013). From 2013 to
Ugo Panizza is Professor of Economics and Pictet Chair at the Graduate Institute, Geneva. He is also the Director of the
Institute's Centre on Finance and Development and a CEPR Research Fellow. Prior to joining the Institute, Ugo was the
Chief of the Debt and Finance Analysis Unit at the United Nations Conference on Trade and Development (UNCTAD). He
also worked at the Inter-American Development Bank and the World Bank and was an Assistant Professor of Economics at
the American University of Beirut and the University of Turin.His research interests include international finance, sovereign
debt, banking, and political economy. He is a former member of the executive committee of the Latin American and
Caribbean Economic Association (LACEA) and an Editor of the Association's journal Economia. He is also a member of the
editorial board of the IMF Economic Review, the Review of Development Finance, and the Review of Economics and Institutions.
He holds a PhD in Economics from The Johns Hopkins University and a Laurea from the University of Turin.
Richard Portes, Professor of Economics at London Business School, is Founder and Honorary President of the Centre
for Economic Policy Research (CEPR), inaugural holder of the Tommaso Padoa-Schioppa Chair at the European University
Institute, and Senior Editor and Co-Chairman of the Board of Economic Policy. He is an elected Fellow of the Econometric
Society and of the British Academy. He is Chair of the Advisory Scientific Committee to the European Systemic Risk
Board, Co-Chair of the ESRB committee on shadow banking. member of the Steering Committee of the Euro50 Group
and of the Bellagio Group on the International Economy.Professor Portes was a Rhodes Scholar and a Fellow of Balliol
College, Oxford (of which he is now an Honorary Fellow), and has also taught at Princeton, Harvard, and Birkbeck College
(University of London). He has been Distinguished Global Visiting Professor at the Haas Business School, University of
California, Berkeley, and Joel Stern Visiting Professor of International Finance at Columbia Business School. He holds
three honorary doctorates. His current research interests include international macroeconomics, international finance,
European bond markets, macroprudential policy and European integration. He has written extensively on globalisation,
sovereign borrowing and debt, European monetary issues, European financial markets, international capital flows, centrally
planned economies and transition, and disequilibrium macroeconomics.
Beatrice Weder di Mauro is the Economic Policy and International Macroeconomics Professor at Gutenberg University
Mainz, Germany and Distingished Fellow, Emerging Markets Institute, INSEAD Singapore. From 2004- to 2012 she was
a member on the German Council of Economic Experts. Previously she had worked at the University of Basel and the
International Monetary Fund. She has held visiting positions at Harvard University, the National Bureau of Economic
Research and the United Nations University in Tokyo.She received a PhD from the University of Basel and has served as
consultant to governments, international organizations and central banks (European Commission, International Monetary
Fund, World Bank, European Central Bank, Deutsche Bundesbank, OECD, among others). She is an independent director
on the board of Bombardier, UBS and Bosch. She is a senior fellow of the Center for International Governance Innovation
(CIGI), the Asian Bureau of Finance and Economics Research (ABFER), a member of the ETH Foundation, the Scientific
Council of the Fondation Banque de France and of the Bellagio Group on the international economy. She writes regular
op-eds and contributions to the public policy debate.
Charles Wyplosz is Professor of International Economics at the Graduate Institute, Geneva, where he is Director of
the International Centre for Money and Banking Studies. Previously, he has served as Associate Dean for Research and
Development at INSEAD and Director of the PhD program in Economics at the Ecole des Hautes Etudes en Science Sociales
in Paris. He is a CEPR Research Fellow and has served as Director of the International Macroeconomics Programme at
CEPR POLICY INSIGHT No. 92
CEPR. He is also CEPR’s Policy Director and Co-Chair of the Board of the journal Economic Policy.
Jeromin Zettelmeyer is a senior fellow of the Peterson Institute for International Economics, a CEPR research fellow,
and a member of CESIfo. From 2014 until September of 2016, he served as Director-General for Economic Policy at the
German Federal Ministry for Economic Affairs and Energy. Previously, he was Director of Research and Deputy Chief
Economist at the European Bank for Reconstruction and Development (2008–2014) and a staff member of the IMF
(1994–2008). His research interests include financial crises, sovereign debt and economic growth.
The Centre for Economic Policy Research (CEPR) is a network of almost 1,200 research economists based mostly in
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