19 August 2015

How much debt relief does the IMF want?

The obvious answer is that it’s not immediately clear. The IMF has rightly kept its options open while it ultimately cannot perform a full debt sustainability analysis (DSA) until it sees how the bailout is shaping up and the economy progressing. Nevertheless, there are some indications.

  • Firstly, IMF Chief Christine Lagarde said on Friday that the IMF would need to see “significant debt relief, well beyond what has been considered so far” – this is an important point which I’ll come back to.
  • Secondly, there are also some clear indications from the IMF’s DSAs released at the end of June and mid-July. The former suggested a “significant further extension” of maturities combined with a “doubling of grace and repayment period” on all loans to Greece (this would likely amount to 20 years or so), including new financing. However, due to economic deterioration around capital controls, this was expanded to “a very dramatic extension with grace periods of, say, 30 years on the entire stock of European debt, including new assistance.”
  • Thirdly, the IMF had previously accepted targets of debt-to-GDP of 124% in 2020 and 110% in 2022. Presumably, these are the sorts of levels they would be looking for again. This compares to 174.5% in 2020 and 159.7% in 2022 according to the latest European Commission DSA. However, it is worth noting that, at Friday’s press conference, Eurogroup Chairman Jeroen Dijsselbloem suggested that the Eurozone would take the “gross financing needs” approach to assessing debt sustainability  (the needs should be below 15% of GDP each year), and that the IMF would also consider this (the second IMF DSA admits a “case could be made” for such a change in approach).

What options does the Eurozone have in terms of debt relief?

It is clear now (as it has always been in my view) that any kind of nominal debt cut is very unlikely to happen for Greece inside the Eurozone. As such, the options for debt relief are quite limited and focus around rescheduling Greece’s debt. There are three basic options here: extend debt maturities, lower interest rates and increase grace periods on interest and principal payments.

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It should be remembered that these apply to the Eurozone loans which are comprised of the €52.9bn from the Greek Loan Facility (GLF, the original bailout) and €130.9bn from the EFSF under the second bailout. The IMF and ECB (the other official sector creditors) will not take part in any debt relief, while there is limited scope to write down private creditors again as the debt is now issued under English law and would provide little real relief. However, it is important to note that just having the bailout itself gives a de facto element of debt rescheduling. The short term costly ECB and IMF debt is replaced by very long term and cheaper ESM loans. This shift, which will happen gradually as the money is disbursed over time and used to pay off the ECB and IMF, itself helps make the debt look more sustainable (though the IMF knows this already and still has concerns).

1. Extend debt maturities

This is of course something which has already been done a number of times (see this useful ESM document for further details). The original GLF loans were for five years but via a number of extensions now run for 30 years. The second bailout loans via the EFSF originally had a weighted maturity of 17.5 years, but this was increased to 32.5 years. The new loans will also have a weighted maturity of 32.5 years.

Clearly, the maturities on these loans are already long. They could be extended once again, with Handelsblatt already reporting that plans are on the table to extend the maturities out to 60 years. This would make little difference to Greece in the short and medium term. Of course, further extending the repayment period would make Greek debt look more sustainable, particularly in net present value terms – such a delay in payment then has both economic and political advantages.

2. Lower interest rates

Again, this has already been undertaken to some extent. The GLF loans have seen their rates reduced substantially to 0.5% + 3 month Euribor (the average rate at which banks make unsecured loans to each other at in the wholesale market) – which at the time of writing was negative at -0.027%. The EFSF loans are already provided at their funding rate. The same goes for the new loans.

ESM Head Klaus Regling said at Friday’s press conference that this means the interest rate on the EFSF and ESM loans is around 1% currently, and that further reductions should not be expected as this would require someone to make up the difference as they would be provided at a lower cost than which the ESM borrows on the markets. As such, the scope for further interest rate cuts looks limited at the moment.

One option might be to lock in the low rates rather than link them to market rates, but if markets rates rose this would amount to a subsidy/transfer to Greece. Additionally, the large sustained fall in market rates such as Euribor has itself helped lower Greece’s funding costs. Another would be to remove the 0.5% charge on the GLF loans, though this is tricky when the three-month Euribor is negative – would states be willing to pay to lend to Greece? Financially, the amounts are small but the political message behind that would be toxic. Neither option would deliver any savings immediately, but over time it could provide some savings (see here for estimates from Bruegel).

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3. Grace periods on interest and principal payments

This is another measure which has already been used. The grace period on the GLF loans started out at three years but has gradually been raised to ten years (payments don’t start until 2020). There is a ten-year grace period on EFSF interest payments, meaning they have been deferred until 2023 as shown in the chart above. There does not seem to have been any mention of the grace period on the new loans – suggesting a deliberate decision to leave this open.

As noted above, this is an option which the IMF has specifically endorsed – meaning the grace periods could well be extended once again, possibly to between 20 and 30 years. However, this should not be taken as a given. German Finance Minister Wolfgang Schäuble, who now backs the bailout as the “right decision”, has said that scope for relief in this and the other two areas is “not very big”.

Will the Eurozone be able to agree on such changes to the third Greek bailout?

Despite the principle of debt relief having been agreed already and there being a commitment to examine it after the first review, the actual changes may still require some national approvals. Changing the terms of the GLF loans will require approval in each member state which backs them, most likely in the form of parliamentary approval. For example, the Irish Parliament had to approve similar maturity changes in 2011. As for the EFSF/ESM loan, they will likely require certain national approvals (see my recent post on national procedures) including from the German and Estonian parliaments, which could prove tricky. More broadly, many politicians in the Eurozone will be loath to back a huge 30-year grace period, as it amounts to a significant subsidy to Greece and possibly a tacit admission that the loans will in reality never be repaid.

What is the most likely outcome and will it be enough for the IMF to join the third Greek bailout?

The most likely outcome looks to be that the maturities are extended again, probably to around 50 years, with the grace period extended to between 20 and 30 years. I doubt there will be much movement on interest rates.

However, these are all options which have been used before, so they don’t seem to satisfy the IMF’s call for debt relief “well beyond what has been considered so far”. The length of the maturities and grace period may be sufficient to appease the IMF but it is far from a given. As the chart below from the IMF’s June DSA shows, raising the grace period to 20 years and the debt maturity to 40 years does not alone bring Greek debt sustainability back in line with the targets of the programme from mid-2014 (left hand chart). It does though allow Greek debt to look more sustainable from the ‘gross financing need’ viewpoint (below 15% of GDP) and closer to the old programme in this sense.

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Such a move will likely be enough to get IMF Chief Christine Lagarde to back involvement, but it should be remembered that she alone is not the IMF. The staff have made it clear they are unhappy with the fund’s role and believe its rules of operating have been pushed to the limit. Many member states, particularly from Emerging Markets, do not want it to have any more involvement. If it does end up joining the bailout once again it will likely be with limited financial commitment (possibly the €16bn which was remaining under its previous programme) while making it clear it has adjusted its debt sustainability approach to follow that of the ‘gross financing need’ rather than its standard DSA approach given that the large majority of Greek debt is held by the official sector.

All this might just be enough to get the IMF on board, but it is far from a foregone conclusion and it seems unlikely that the debt relief will really differ substantially from what has gone before – it will just be on a slightly larger scale.