Remember Greek PSI?
December 19, 2011 4 Comments
Leading up to the October EU summit, there was a lot of speculation about the size and nature of the haircut that would be involved in a private sector involvement (PSI) deal for private bondholders of Greek government debt. The speculation was partly put to rest when EU leaders agreed a 50% haircut on Greek government debt in a debt exchange that would be voluntary. Many details of this deal must still be ironed out, and a hard deadline is coming soon. If a PSI deal is not agreed with significant take-up by February, Greece could face a hard default.
The Greek government and EU leaders agreed the outlines for a PSI deal at the October EU summit, but one key interest group was not consulted: the bondholders. Greece has €14.4bn in debt to rollover in March, and it has neither enough money in its coffers nor enough bailout funding to actually roll this debt over. To avoid a hard default, those bonds must be exchanged for new debt with longer maturities. Unsurprisingly, a voluntary debt restructuring requires significant paperwork, and the documents must be circulated at least 30 days before their signature is required. This pushes the deadline up to February.
Among the many questions that remain on the Greek PSI is what to do about holdouts. The second Greek bailout had a 50% haircut on Greek government debt and a participation rate of nearly 100% built into the calculation for how much official financing Greece will receive over the next few years. If there are holdouts and the participation rate is lower than 100%, Greece will need additional official financing to make the holdouts whole. The troika may not be willing to pony up for this purpose.
Furthermore, the IMF released its 5th review of Greece on December 13th, in which it gave its forecasts for Greek debt sustainability. According to the IMF, Greek debt could stabilize at 120% of GDP in 2020 if Greek PSI involves a haircut of 50% and has participation of nearly 100%, and if interest rates are around 4% (an optimistic assumption). This is the maximum debt level that the IMF considers sustainable. If there are holdouts, the IMF forecasts that Greek debt could remain above 145% of GDP. According to the IMF’s Exceptional Access Criteria (EAC), it can only lend to a country if that country’s public debt seems sustainable in the medium term. If there are a number of holdouts in the Greek PSI, therefore, the IMF’s EAC forbids it from continuing to lend to Greece.
One way holdouts may be convinced to participate in the Greek PSI without the debt restructuring becoming technically coercive is to impose a collective action clause (CAC) on the debt that is governed by domestic law (around 93% of the total debt burden). If this occurred, a supermajority of bondholders would have to agree to the deal and it would be binding for all debt holders. The CAC would need to be ratified by the Greek parliament, which should be relatively easy to do. The IMF would accept this move—it recommended it in the 5th review, saying universal participation in the debt exchange might be achieved through the “legislation of CACs in domestic law bonds”.
If there is a seemingly simple way of achieving a 100% participation rate in Greek PSI while still being able to argue the debt restructuring was voluntary, why has it not been implemented yet? EU leaders have insisted that Greece is a unique case and the voluntary Greek PSI will not be repeated elsewhere, but talk is cheap and there is no reason to believe this is really the case. If Greece introduces retroactive CACs by changing its domestic legislation, investors will immediately wonder which country will change its law next. This would send bond yields soaring, could cause a buyer’s strike in Italy and Spain (if they are still borrowing in the markets at that point) and would likely result in the spread of the eurozone crisis even further into the core.
For more analysis on the Greek PSI deal, see this piece published by Roubini Global Economics.