OSI likely, but not to give Greece a new lease on life in the EZ
October 4, 2012 2 Comments
Ever since the introduction of PSI (private sector involvement) in Greece, there has been talk of OSI (official sector involvement) occurring down the line. Mention of OSI in Greece has only intensified since the IMF openly advocated it last week. This was not the first time the IMF had spoken in favor of Greek OSI, but the fact that it was mentioned against a backdrop of protracted negotiations between the Greek government and the troika (the ECB, IMF and European Commission) made some wonder if OSI is imminent. I do think we will see OSI in Greece, but I expect it to accompany Greece’s exit from the Eurozone rather than returning Greece to public debt sustainability within the common currency area.
First, I think OSI in Greece as a way of lengthening Greece’s tenure in the EZ will be politically impossible to agree. There is no way the IMF would take a haircut on its Greek government holdings given that it is both de facto and de jure senior. The ECB doesn’t seem likely to agree to a net present value (NPV) hit on its Greek government bonds (GGBs) either. At the September ECB governing council meeting Mario Draghi very clearly highlighted that debt bought under the SMP would be senior and debt under the OMT would not (of course it is all de jure pari passu). There has been some discussion of the ECB rolling over its Greek government bond holdings and kicking out the maturity. This would not only result in a NPV hit for the ECB, but it would also increase the ECB’s risk significantly. Some of countries that have lent money to Greece—either through bilateral loans or indirectly through their contribution of guarantees to the EFSF—are also unlikely to be willing to accept a NPV haircut or rescheduling of their loans. This is the case for core countries, where there is bailout fatigue, as well as for some peripheral countries, which can ill afford the losses (ahem, Spain).
Let’s pretend that the ECB, EU creditors and the EFSF would sign up for a haircut on their GGBs. The ECB and other national central banks have an estimated €57bn in GGBs according to an estimate by BNP Paribas. In addition to this, EU countries have lent Greece around €53bn in bilateral loans and the EFSF has lent around €74bn (h/t Yiannis Mouzakis for some of this number crunching). At the end of 2012, the IMF has estimated that Greece’s general government debt burden will be around €327bn. Assuming that real GDP contracts by around 7% in 2012 and inflation accelerates by 1.2%, nominal GDP should be around €195bn in Greece this year. A 50% haircut on non-IMF official sector loans and GGB holdings would reduce Greece’s public debt burden to around €235bn, or 120.5% of GDP.
This would reduce Greece’s public debt burden in line with the IMF’s definition of debt sustainability for Greece. But who really believes public debt is sustainable at 120% of GDP for a country that is in a depression—a depression that will only deepen as austerity measures and structural reforms are implemented? And who really thinks the ECB, EU countries and EFSF would accept such a huge whack on their Greek government exposure? I certainly have my doubts.
Rather than Greek OSI being used to return Greece to debt sustainability and extend its time in the EZ, I think the trigger for OSI will come when the troika deems that Greece has failed in its adjustment program and cuts Greece off from further tranches of loans. In that case the ECB, EU creditors and EFSF won’t have much of a say whether their Greek government bonds and loans are senior or not—they are all de jure pari passu.
When do I think this trigger for OSI will come? Possibly as early as the first half of next year if the current Greek coalition collapses and is replaced by a Syriza-led, hard bargaining coalition that goes to the brink with the troika and is too inexperienced to pull back. There is also a chance the troika will continue to keep Greece on life support until after the German elections (September 2013) and until both Spain and Italy are in partial bailout programs (Spain: any day now, Italy: probably after their election in Q2 2013). Either way, we are likely to see OSI in Greece, but only once everyone has given up hope on Greece’s EZ membership, not as a way to extend Greece’s lease on life in the currency area.