by Barry Eichengreen, Peter Allen and Gary Evans
Appeared originally at Voxeu.org 07 September 2015
Greece needs debt restructuring. Yet, to get debt reduction, the Greek government is required to implement structural reforms. This column proposes a way to square the circle by introducing a Structural Reform Index in Greek loan contracts.
The central feature of the proposal is the linkage of debt relief to progress in structural reforms. The features and conditions of the proposal should make it desirable both for Greece and the German government and other creditors.
Greek debt restructuring and structural reforms
Greece needs debt restructuring. On this, a growing chorus of voices is agreed (Manasse 2015, Taylor 2015). Even the IMF (2015) now acknowledges that Greece’s debt is unsustainable. Restructuring is required, it now insists, for the workability of the third programme between the country and ‘the institutions’ that is currently being finalised.
Yet, the German government refuses to agree to debt reduction absent evidence of prior structural reform. Debt reduction should be a reward, it insists, for prior action on the structural front. If it is offered now, the Greeks will be let off the hook, and the incentive to proceed with hard structural measures will be blunted.
Greek politicians – and many of their voters – insist to the contrary that they deserve a credible promise of debt reduction and restructuring now. Absent such a promise, they are reluctant to commit to painful structural reforms. In the presence of a crushing debt burden, they argue that they have already suffered enough.
Others like the IMF, putting considerations of fairness aside, imply that the third adjustment programme is doomed to fail absent an up-front commitment to restructuring. The Fund appears to be prepared to condition its financial participation in that programme on a German concession on the issue.
An agreement to a structural reform index – a way to square the circle
There is an obvious way of squaring this circle. Greece and its creditors should agree to include a ‘Structural Reform Index’ in Greek loan contracts and use it to link future terms of debt service to progress on structural reform.
With this agreement, interest paid to the creditors would decline or repayment terms would be extended with the number of structural measures taken by Greece. If Greece were to implement more reforms, future loan terms would then be made even less burdensome.
Greece would welcome the arrangement, since it would receive a guarantee of debt reduction contingent on structural reform. The German government and other creditors should welcome it as well, since debt reduction would only be conferred if Greece followed through with reform. Germany would also appreciate the fact that Greece’s incentive to push ahead with structural reforms would be heightened insofar as successful reform conferred an additional reward.
Under the proposal, Greece would incorporate these terms into its three loan agreements with the EU or convert the loan agreements, in agreement with individual creditor governments, into Structural Reform Index bonds containing these terms. The terms in question would establish a contractual mechanism that would grant pre-arranged instalments of debt relief upon completion of the structural reforms agreed upon in the forthcoming Third Economic Adjustment Programme.
The form of debt relief that Greece would receive would be improved debt-servicing terms, namely lower annual interest rates and longer grace periods and final maturities. Principal reduction has been avoided in order to accommodate what we understand to be the positions of certain of Greece’s creditors. However, this mechanism is sufficiently flexible to also accommodate principal reduction should these constraints change.
The effect of this programme would be to remove the need to negotiate debt relief at a future date, thereby avoiding new uncertainties, and to enable Greece to pronounce a solution to its debt sustainability problem. It would be received by capital markets as pre-programmed debt relief and clarify expectations of Greece’s future debt payments, which will boost confidence and reverse capital flows as the country implements its structural adjustment programme. It would give Greece an additional pecuniary incentive to pursue structural reform measures. And it would assure Germany that there will be no debt relief without structural reform.
An obvious question is who would monitor the country’s progress in implementing structural reform and determine its financial consequences. One option would be to delegate this function to the IMF. Another would be to appoint a panel of experts (one nominated by the Greek government, one by the creditors, and a third by mutual agreement). If the International Swaps and Derivatives Association can rely on determination committees to decide when a credit event affecting a credit default swap (CDS) has occurred, there’s no reason why a Greek Structural Reform Index committee couldn’t do likewise.
Including additional features to the proposal
While the central feature of the proposal is the linkage of debt relief to progress in structural reforms, the resulting instruments could be further enhanced by the inclusion of additional features, including:
- GDP-indexed value recovery.
GDP indexed warrants attached to the Structural Reform Index loans would, after a lengthy period of grace, make concessional SRI loan terms vary with the performance of Greece’s GDP. In the event that Greece’s GDP recovers to 10% above the peak Q4 2008 level, and annual real GDP growth is greater than 3%, these warrants would increase both the coupon interest rate and principal instalments. Greece’s creditors insist that structural reform will jumpstart growth. These warrants are a way for them to put their money where their mouth is.
- Pullback clause.
Creditors would have the right to revoke prior concessions and reset loans to ex ante terms in the event of substantial slippage on structural reforms. This clause would make the resulting instruments more attractive to the lenders.
- Bond conversion option and debt swaps.
At completion of the Third Programme, individual creditors could elect to convert their Structural Reform Index loans into bonds. This would allow individual creditors to take different approaches with their bailout loans, including selling them to private investors. Greece could then accept these as payment for various programmes such as debt-for-equity swaps (privatisation), debt-for-environment, debt-for-education, debt-for-poverty swaps, etc. These would result in an early exit for the creditor, reduction of nominal debt stock for Greece, and an incentive for much-needed private foreign investment in the Greek economy.
Feasibility of the proposal
So is all this feasible? In Eichengreen et al. (2015b) we provide a detailed term sheet for converting the Greek government’s eligible debt to the EU into Structural Reform Indexed loans. Using the second agreement between Greece and the Troika for illustrative purposes, we show exactly how structural reforms could be scored for purposes of these instruments. Finally, we provide a financial analysis of the proposal, showing how much debt reduction Greece will receive in present value terms. Greece is in urgent need of a confidence shock that would reset expectations, reverse capital outflows, and revive investment. A comprehensive resolution to the country’s debt problem could impart just such a shock. But a comprehensive resolution requires Greece and its creditors to think outside the box. To them we say, the ball is in your court.
- Eichengreen, B, P Allen and G Evans (2015a), “Escaping the Greek Debt Trap,” Bloomberg View, 26 July.
- Eichengreen, B, P Allen and G Evans (2015b), “Structural Reform Indexed Loans for Greece”, 31 August.
- IMF (2015), “Greece: An Update of IMF Staff’s Preliminary Public Debt Sustainability Analysis,” Washington, DC: IMF, 14 July.
- Manasse, P (2015), “Syriza and Debt Talks: Estimates from a Rubinstein Bargain Approach,” VoxEU.org, 27 January.
- Taylor, C(2015), “Realistic Debt Restructuring Needed to Give Greek Deal a Chance,” Irish Times, 11 August.
Leave a Reply