Mr. Regling's "Alternative Facts" About the Greek Debt
(This is a joint post by Mark Weidemaier and Mitu Gulati.)
In November 2016, Klaus Regling, managing director of the European Stability Mechanism, announced that reforms were going so well in Greece that it would be able to return to the private debt markets by 2017. It's 2017, and neither the markets nor the IMF seem to share the sentiment. Yields on Greek bonds, already high, have increased, and the IMF has concluded the debt is unsustainable. Greece needs an infusion of cash to make a large payment due in July, but the private debt markets aren't willing to oblige.
What does Mr. Regling say? That the IMF (and, apparently, the markets) are wrong; that the ESM's long time horizon and Greece's relatively low debt servicing costs mean there is no cause for alarm (Financial Times, subscription required). Referring to the 174bn euros that the ESM and EFSF have already lent to Greece, he says: "We would not have lent this amount if we did not think we would get our money back." Implication: the IMF and the Euro area nations should lend even more.
What is really going on? As is made clear in this recent Financial Times column by Wolfgang Münchau, and this Bloomberg column by Ashoka Mody, no one seriously believes Greece will repay its debt in full--at least, not within the lifetime of anyone alive today. The real dispute is not about sustainability; it is about the timing of debt relief. For the most part, any new money will be recycled back into the pockets of official creditors. But while official actors keep busy shuffling money from one pocket to another, this mountain of debt will continue to darken Greece's economic prospects.
For political actors in some Euro area countries, there is a compelling political case for deferring questions of debt relief. Elections loom (in the Netherlands, France, Germany, and perhaps Greece), and politicians in northern Europe are reluctant to acknowledge the fiscal transfers that have taken place over the past seven years. Greek politicians are likewise unwilling to admit that they have presided over the creation of an ineradicable debt burden that will blight economic prospects for the foreseeable future.
One solution, favored by some northern European politicians, is to boot Greece out of the Euro area, perhaps accompanied by debt relief. Legally, this may be a plausible option. The question is whether there is a politically and legally realistic alternative given the current political reality, in which politicians in northern Europe need to tell voters that every penny lent will be repaid.
One option is to maintain the status quo, perpetuating the illusion that Greece's debt is sustainable. This appears to be the course favored by Mr. Regling. But as we said a few weeks ago in discussing Paul Blustein's Laid Low, that movie never ends well. Rather than perpetuating Greece's mammoth debt overhang, Euro area leaders need to create incentives for private sector lending to Greece. This will require modifications to the current loan arrangements, but these need not reduce the amount of the Greek debt. (To be clear, we think the amount should be reduced; we are simply acknowledging what appears to be the current political reality.) Instead, the modifications must make clear that new private sector loans will be functionally and legally senior to the existing pile of official debt. Two years ago, this would have been a relatively simple task. Perhaps there is still time. In that event, Mr. Regling's alternative facts might become, well, facts.