Greece has taken a big step toward getting the debt relief it needs to fix its economy and stay in the euro area. Now the question is whether other strapped countries that use the single currency should follow its lead.
Despite the Greek deal’s flaws -- and they are many -- it offers a model that some other sovereigns will inevitably be tempted to experiment with, no matter how much European officials insist on Greece’s uniqueness. The legal precedent is set: By retroactively inserting so-called collective-action clauses in its debt contracts, the government managed to coerce 95.7 percent of its private creditors into participating. As a result, Greece will lop about 100 billion euros ($131 billion) off a debt burden of more than 350 billion euros.
To some extent, it is in Europe’s best interests to encourage such managed defaults by governments that can’t afford their debts. The primary uncertainty weighing on the region’s markets and economy is the extent to which governments will ultimately need to renege on their debts, and how much banks will lose as a result. Emergency financing from the European Central Bank is no more than a temporary solution. Postponing the final reckoning will only increase the economic pain and the cost of the inevitable bailouts.
Who, then, should default? Let’s take a tour of the most likely candidates.
Portugal is the prime one. Estimates of interest rates and economic growth from theInternational Monetary Fund suggest that, in order to keep its debt burden stable, the government would need to run a primary budget surplus (excluding debt payments) of nearly 2 percent of gross domestic product -- a feat it has achieved in only three of the past 17 years. If it wrote down its debts by 40 percent, the required surplus would be a much more manageable 1 percent of GDP. Markets seem amply prepared for such an outcome: As of Friday, Portugal’s 10-year bonds were trading at a 47 percent discount to face value.
Ireland, too, could use some debt relief, though probably not the kind of writedowns that might impair its access to credit markets. Instead, the ECB should consider adjusting the terms of 30 billion euros in promissory notes Ireland’s central bank took on when it bailed out Anglo-Irish Bank -- an operation that was less crucial for Ireland’s banking system than for the bank’s euro-area creditors. The ECB is understandably reluctant to forgive the debt, which has saddled the government with an annual tab of 3 billion euros over the coming 15 years. But in the hope of boosting growth, it should extend the repayment period to reduce Ireland’s annual payments.
Spain’s immediate problem is its budget deficit, not its level of debt. So for now it does not need a Greek-style deal. And Italy? Thankfully, its obligations are just barely within its means, which is a good thing, for an Italian default would probably be more than the European banking system and the euro could bear.
Hence, the bloodletting doesn’t need to go much beyond Portugal. The government’s debts amount to only about half those of Greece, so a Portuguese restructuring doesn’t have to be too painful. The ECB, though, would need to prevent contagion from spreading to governments such as Spain and Italy. That would require a large enough guarantee to cover the medium-term borrowing needs of all euro-area countries likely to come under market attack -- at least 3 trillion euros, by our estimate. That’s far more than European nations have so far committed to any rescue fund.
Europe’s leaders should not let themselves be fooled by the recent lull in market turmoil. Capital flight from Italy has been accelerating, and the ECB’s operations have encouraged banks to get more heavily invested in the debts of financially troubled governments. The sooner Europe faces reality, the more credible its efforts to resolve its fiscal problems will be.