How the Greeks and the EU forgot to argue about debt relief and learned to cooperate

17 November 2017/1 Comment
By Nick Dunbar

Two weeks ago, the European Commission gave a cautious thumbs up on Greece’s prospects in the wake of its review of the current EU support programme – the third given to the country since its debt crisis began in 2010.

Having flirted with default in 2015, when the incoming Syriza government imposed capital controls on the country’s banking system, Greece seems to have dodged a bullet. A projected recession never happened, unemployment fell and economic sentiment indicators are rising. The Commission forecasts a strong rebound in GDP growth next year.

Observers might be forgiven for having a feeling of déjà vu. Since 2010, Greek lenders have repeatedly convinced themselves that the country was on the brink of a turnaround – as shown by the successive International Monetary Fund forecasts on the chart below. Among major economies shown in the second chart, only Indonesia has diverged more from its five-year GDP forecast on the downside, according to IMF data.

Screenshot of an interactive visualisation available to Risky Finance subscribers.

Events kept proving the lenders wrong, as Greece’s economy contracted for almost nine years in a row. This was partly caused by the lenders’ austerity policies, and partly by their incomprehension of Greece’s deep-seated governance problems.

Yet there are reasons why this time the cynics may be confounded. Having got things wrong twice, when they were accused of ‘fiscal waterboarding’ by firebrand finance minister Yannis Varoufakis, Greece’s lenders have learned a thing or two. Last week’s report is peppered with phrases like ‘social justice’, and the EU is now careful to check tricky areas like pension reforms for compliance with the European Charter of Human Rights.

On the Greek side, Syriza may have proved its populist chops by taking things to the brink back in 2015, but having pulled back from the edge, the government has had to take ownership of the reforms it agreed to. For example, progress is now being made addressing what was a chronic problem in Greece of payment arrears from the public to private sector (such as tax refunds). Fixing this stimulates the economy.

In a sign of how far things have come, the debate over Greek debt relief has gone off the boil. Although Greece still owes €315 billion of debt (as recorded by Eurostat), a patently unsustainable amount compared with Greece’s current GDP of €181 billion, both sides have tacitly agreed the number is meaningless.

That wasn’t the case in 2013 when investor Paul Kazarian bought billions in Greek government bonds via his firm Japonica Partners. Kazarian’s thesis was a simple one: If all the interest reductions and maturity extensions granted by Greece’s official sector lenders were priced in at market value, the country’s debt-to-GDP ratio would be below 70 per cent. That would put Greece in a similar bracket to Belgium, which currently pays less than one per cent interest on its bonds.

Kazarian launched a lobbying campaign to push Greece and its official lenders to adopt new accounting standards. He argued that recognising this reality would give Greece a ‘fresh start’, allowing the company to re-enter the capital markets and borrow cheaply again.

A couple of years ago, Kazarian’s thesis found a receptive audience in Athens, where austerity-weary Greeks preferred the idea of borrowing to the EU’s painful reforms. Some Germans too preferred Kazarian’s honest approach to the sleight of hand of EU institutions.

Yet among the policymakers that mattered, Kazarian’s proposals fell on stony ground, with both Eurostat and the IMF sticking with the €315bn gross debt figure, along with Greece’s own government statistics agency. By 2017, Kazarian was venting his frustrations against the IMF. At first sight, the IMF looked like the most receptive target for his campaign. The lender had been widely criticised for straying from its core mission by lending to Greece in the first place. Reaching €25 billion in 2013, the IMFs Greek exposure dwarfed the rest of its loan portfolio.

Within the IMF itself, officials initially converged with Kazarian’s views with their debt sustainability analyses (DSAs) for Greece, which argued forcefully for official recognition of debt relief. Then the organisation changed its DSA methodology to focus on gross financing requirements, kicking the toxic issue of debt-to-GDP sustainability into the long grass. Eventually the drawbridge went up against Kazarian.

He made a final attempt with a diatribe against the IMF published by Japonica in April 2017. The document accused the organisation of using €3 billion of interest payments from Greece to pad out its payroll, comparing its profitability per employee to Goldman Sachs and JP Morgan. According to the document, the IMF was building an over-budget headquarters in Washington DC on the back of Greek revenues.

Stung by the criticism, the IMF responded to Japonica. Highlighting Japonica’s vested interest as a distressed bond investor that would benefit from recognition of Greek debt relief, the IMF said: “If the intention were to maximise profits by lending more to Greece, then the Fund would simply find Greece’s debt to be sustainable (as Japonica would like the IMF to do)”.

Since this exchange was published in April, Kazarian seems to have gone quiet, and Japonica didn’t respond to a request for comment. Although his campaign may have stalled, he is still likely to earn a substantial profit on his Greek bond holdings.

More importantly, the EU won the argument that allowing Greece to borrow again before reforms were followed through was putting the cart before the horse. If Greek reforms are working – and only a tentative conclusion can be reached on the basis of the latest report – then that will be a far more positive signal to prospective bond investors than any agreement over accounting changes.

As for the EU, surging GDP growth for Greece next year would be a sweet vindication in the final year before Brexit.


Related Articles