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Restructuring Euro Debt and Latin Lessons

Interviewee: William R. Cline, Senior Fellow, Peterson Institute for International Economics
Interviewer: Christopher Alessi, Associate Staff Writer, CFR.org
November 17, 2011

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As part of a deal to tackle Greece's sovereign debt crisis and provide it with a second EU bailout package, private holders of Greek sovereign bonds agreed to take a haircut of 50 percent, paving the way for a restructuring of the country's massive debt. Comparing past sovereign restructurings, William R. Cline, a senior fellow at the Peterson Institute for International Economics, says that Uruguay's orderly default in 2003 offers a constructive example for Greece. The tentative Greek plan is similar to the path Uruguay took in that "the creditors are cooperating on a fairly voluntary basis because they think that the relief that's being asked under the circumstances is reasonable," says Cline.

Can you provide an overview of Argentina's and Uruguay's debt restructurings at the beginning of the last decade?

The Argentine default was at the end of 2001 [It officially began its restructuring in 2002]. It involved a deep devaluation from a fixed exchange rate to the dollar and a very confrontational debt default that, by 2005 [when Argentina conducted the first of two restructurings], finally wound up with a very deep debt reduction. [Argentina defaulted on $100 billion in mainly foreign debt, forcing foreign investors to take haircuts worth two-thirds of their investments].

The Uruguay episode was quite different. That involved spillover from Argentina, but Uruguay very consciously wanted to avoid permanent damage to its credit reputation. So, what they did was essentially a very clean stretch out of their bonds for a five-year period [extending the maturity date of the bonds]. They kept the interest rate unchanged. Of all the debt restructurings that we've seen in the last couple of decades, that was the one that had the lowest haircut in terms of loss of the present value of the claims. It had a high degree of acceptance among the bonds holders.

Of all the debt restructurings in the last couple of decades, [Uruguay's] was the one that had the lowest haircut in terms of loss of the present value of the claims.

It is a difference between a confrontational approach in which the debtor asks for a much deeper forgiveness than the creditors think is warranted, and a cooperative approach in which the debtor is saying, "We've got a temporary cash flow problem, but we intend to honor the full value of the debt."

What role did the restructurings play in the recovery of Argentina's and Uruguay's economies?

The record for Argentina shows that the decline of the economy in 2002 was extremely severe and was greatly aggravated by the default at the [start of 2002]. Once you have a huge decline in your economy then [even if you] just get back to where you started from, [it appears] you have high growth rates. Argentina had the windfall gain in recent years of very strong international commodity prices.

The gauge that I use as an indication of who did it better is whether they are back in the international capital markets [Uruguay returned to the capital markets (Reuters) in 2003]. Argentina remains cut off, effectively, from international capital markets. But you certainly would not want to look at recent Argentine growth rates and say, "well, this is because they defaulted in [2002]." You would want to look at the entire performance over that period, take out commodity windfalls.

What lessons do the Argentine and Uruguayan restructurings hold for Greece, which has a debt to GDP ratio that is expected to hit 160 percent by 2012?

The Greece picture has changed after the agreement of October 27, where the private holders agreed to take a voluntary 50 percent reduction in debt, and that's going to cut about €100 billion [$139 billion] off of their debt. It is key to keep it on a voluntary basis, because otherwise you get into these confrontations and legal disputes and you get access to future credit markets cut off.

I did an analysis of this a couple of weeks before the 50 percent haircut, and I came to the same conclusion that the new [Greek] Prime Minister, Lucas Papademos, came to before that agreement: they should not go for a deep haircut because the debt was basically manageable. German politics was very aggressively pushing for a deep haircut that trumped other considerations. Certainly with this latest private initiative, it should be sufficient on economic grounds to manage the debt. It is certainly the case that these things often turn much more on politics than on economics, but from that standpoint it is promising because the domestic Greek parties have been particularly emphatic that they want to honor the debt.

It's highly likely that the net effect [of Greece exiting the euro] would be negative, that any gains from competitiveness on the exchange rate would be offset by losses on the valuation of the debt, or by general dislocations from [its] exit from single currency.

The Greek deal is pretty much on track. It is important to keep in mind that a lot of the private holders in Greece are actors who have associated interests, and the Greek banks alone hold about €50 billion

[about $67 billion]. The other European banks that hold claims on Greece have a very clear interest in making sure that things do not fall apart. So there is a lot of scope for coordinating action, so they will be able to get a large proportion of people who sign up for that. For the overall European picture, however, what happens in Greece has suddenly become radically transcended by what happens in Italy.

If the Greek plan goes forward, how will it compare with that of Uruguay at the beginning of the last decade?

The Uruguayan exchange offer is not that different in the sense that there were probably a similar proportion of non-participants, about 10 percent or so that did not participate [in the bond swap]. One can anticipate that this time around as well. It is similar in that the creditors are cooperating on a fairly voluntary basis because they think that the relief that is being asked under the circumstances is reasonable.

What is the trajectory for Greece if this plan goes forward?

The growth rates that the IMF was using as of midyear--and they have scaled it down a little bit--had Greece gradually getting back to 3 percent growth. The average is only 2 percent over the next six or seven years. It is not high growth. A lot is going to depend on whether Greece can shake up the public sector to do a lot of privatization and get the economy oriented more toward exports. But Greek growth will be sluggish for a long time.

Does Greece's inability to devalue its currency--because of its membership in the eurozone--hinder it from addressing its sovereign crisis?

That is a mixed curse or a mixed blessing. The devaluation can be a stimulus to growth by increasing the export sector, but it also balloons up the local currency cost of the debt that has been contracted abroad. It's highly likely that the net effect [of Greece exiting the euro] would be negative, that any gains from competitiveness on the exchange rate would be offset by losses on the valuation of the debt, or by general dislocations from [its] exit from single currency.

The Greek deal is pretty much on track. It is important to keep in mind that a lot of the private holders in Greece are actors who have associated interests, and the Greek banks alone hold about €50 billion.

That being said, Greece and others, including Portugal and Ireland, are carrying out what they call internal devaluation, which means actual wage reductions, liberalizing the labor markets so it is much more flexible and capable of competing. In the case of Portugal, they are shifting from labor taxes toward value-added taxes that can be rebated at the border. That is called a fiscal devaluation. So there are approaches that can try to replicate currency devaluation without leaving the single currency.

With yields on Italy's ten-year bonds hovering around 7 percent, how likely is an Italian restructuring?

The key to the Italian outcome is the willingness of the ECB [European Central Bank] to act as the lender of last resort. If the ECB essentially intervenes in the secondary market, buys up Italian government bonds to a sufficient amount that the interest rate is kept somewhere in the vicinity of 6-7 percent, then they can get through all of this.

In principle you could have the EFSF [European Financial Stability Facility] essentially do leveraging arrangements that would enable it to have a balance sheet of, say, a couple trillion euros, and that would be enough. The argument is, once it was there, that would solve the problem because the markets would not try to fight against that. So far, there has been an unwillingness to put either Germany on the hook or to put the ECB on the hook to get a convincing war chest of that magnitude. So you continue to have, instead, this sort of unannounced and ambiguous intervention of the ECB on the secondary market instead.

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