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Greece's Debt Plan Is a Hidden Haircut

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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The new Greek government has offered the world a tantalizing glimpse of the debt restructuring plan it wants its European creditors to accept. It contains no outright haircut, but it appears to involve a restructuring of Greek bonds into a collection of exotic instruments with loose repayment terms. If this is all Syriza wants, it has blinked first. But its game of chicken with Germany has barely started.

Greek Finance Minister Yanis Varoufakis shared some details of the plan with the Financial Times and in a meeting with 100 financiers in London Monday night. The idea is to leave Greece's debt to the International Monetary Fund and to private creditors alone, but to restructure the country's obligations to the European Central Bank and the European Financial Stability Facility. The former are to be converted into something Varoufakis called "perpetual bonds", and the latter into paper indexed to nominal economic growth.

That is a far cry from the demands for 50 percent debt relief heard from Greek Prime Minister-to-be Alexis Tsipras during the recent election campaign in which his party, Syriza, came out on top. The markets liked the unexpected mildness of Varoufakis's proposal: The yield of the 3-year benchmark Greek bond went down sharply on the news.

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Could it be, however, that Varoufakis's plan is merely a haircut under a different name, disguised so as to make it more palatable to German and French voters? Their approval, after all, is crucial for Greece to lighten its 315.5 billion euro ($358 billion) debt burden, and as Tsipras and his government has discovered in their first days in power, not even France -- which is no fan of austerity -- is prepared to cut the headline value of the debt. The Syriza government could have gone for a head-on collision, threatening default and an exit from the euro, but they would have risked being stonewalled and ultimately unseated. Instead, they have offered non-threatening optics, while still aiming for major relief -- with the ECB expected to take the biggest hit.

Right now, Greece owes 141.8 billion euros to the EFSF, paying the ultra-low rate of 1.5 percent on the debt. Repayment of the loan's principal has been deferred until 2023. In essence, Greece is required to make annual payments of about 1 percent of its 2014 gross domestic product. If Greece swapped this debt for new bonds that would only need servicing if the Greek economy grows, it could lower its payments but probably not eliminate them (unless Greece asks for the growth threshold to be set higher than the 2.9 percent growth rate the EU predicts for the country this year). 

That part of the proposal is positive for Greece's creditors. According to a 2014 Bank of England working paper, GDP-linked bonds reduce the probability of a country's default and give it the flexibility to weather tough periods. 

The ECB, for its part, holds 27 billion euros of Greek bonds bought at the height of the 2011 debt crisis. The value of the bonds coming due this summer is 6.5 billion euros. Varoufakis wants to swap this debt for paper that would not pay a coupon and would be held by the ECB in perpetuity. Essentially, this is where the proposed write-off is hidden. The proposal is based on the work of Syriza's economic theorist John Milios, who last year suggested the ECB buy up 50 percent of the debt of 18 euro area countries and turn it into such bonds, making up for the lost income with seigniorage profits in the very long run -- but mainly stimulating economic growth at its own expense.

The write-off doesn't amount to the 55 percent debt relief that West Germany received from creditors in 1953. Unless the Syriza government changes its mind or Varoufakis says he was misunderstood, Greece just wants to get rid of 8.6 percent of its debt, and to soften the terms on the 40 percent owed to the EFSF.

Nobel Prize-winning economist Paul Krugman called the Syriza proposals "reasonable," arguing that they allow Greece to reduce the amount of resources transferred to creditors from 4.5 percent GDP each year to 1-1.5 percent GDP. That's a modest estimate: This year, Greece's debt payments would be reduced by about 9 percent GDP, if one takes into account the upcoming redemption of ECB-held bonds. In any case, Krugman wrote, Germany -- the country most exposed to Greek debt -- would not be able to reject the Greek proposal outright:

If the German position is that debt must always be paid in full, no relief in substance even if it manages to avoid debt write-offs on paper, then that position is basically crazy, and all assertions that Germany understands reality are proved wrong. 

But just as Varoufakis is not a kamikaze, Chancellor Angela Merkel is not crazy, either. The Greek finance minister is taking care to disguise the desired write-off (which, called by its proper name, would be illegal, since according to European rules, debt to the ECB cannot be forgiven). The German leader, for her part, won't give an answer before learning all the details. Instead, she is digging in for the long haul: Bloomberg News reports that she expects the debt talks to drag on for months. 

She knows her voters aren't easy to fool about a Greek debt write-off -- 68 percent of Germans oppose any forgiveness, while only 21 percent favor it. It will even be hard work to sell a GDP-linked bond idea to them. The ECB won't be eager for a haircut, either: It would create a bad precedent and eliminate 1.3 percent of the central bank's assets.

So, in classic Merkel style, this will be a protracted siege. The Greek government will need to further temper its extremism and refrain from keeping many of its expensive spending promises. By the time the EU is done with the Syriza novices, Greece's debt may be a little lower, but the government's radicalism will be a tattered banner.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Cameron Abadi at cabadi2@bloomberg.net