Greek default — another challenge for the euro area

Riga, Latvia, July 3, 2015, 11:47 / Investments / Leonid Alshanskiy, Dr. Math., Chief Analyst

Greek nonpayment of debt to the IMF on 30 June, in reality, is not a default in the current meaning of this term. Therefore, this term does not exist in the glossary of the IMF, and the current situation is called “overdue debt”. It implies default interest and the termination of new loans from the IMF, but it does not initiate the insolvency process. In particular, it, in no way, hurts the relationship between the borrower and other lenders.

Today we call a situation to be a default when public (bond) debts are not paid back causing a so-called cross-default. All holders, who possess other bonds of the same borrower, have the right to apply for immediate redemption of these bonds — it equals the initiation of bankruptcy. This situation may take place, if Greece does not pay off any of its government debts. However, at the moment, Greece does not have a lot of these debts — these debts are less than 15% of the total debt. Besides, the repayment of large amounts is not due earlier than 2023. Greece can easily manage the government debt not bringing the country to the default.  

Currently, Greece owes the main part of its debt amounting to EUR 317 billion or more than 60% to so-called three lenders — the EU, the IMF and the ECB.

At the same time, money from the EU (which in reality does not possess itself — the union is in debt to the armpit) is transferred to Greece through the mechanism of the EFSF that itself borrows money in the same public bond market. These bonds are jointly guaranteed by all members of the euro area. In other words, Greek nonpayment of money received from the EFSF will be compensated evenly by all euro area countries with the payments from their budgets. If Greece does not repay the whole amount of this loan (that equals EUR 142 billion), then losses for all members will be immense — starting with EUR 65 billion for Germany and several hundred million for Latvia.   

It is obvious that the situation when the total Greek debt to the EU is written off is close to impossible and it is not an issue to discuss. However, Greek appeal to postpone the terms of repayment and to decrease debt interest will also cause first real (not big) but losses for all countries of the euro area. Then the members of the monetary union will reconsider their membership in the union and its principles will be put under question. It is vitally important for the stability of the whole monetary union that Greece services its debt by itself. The three lenders share the same strict approach: cut down any costs you can but leave money in the budget to service the debt.   

However, as life shows — this recipe does not work as well. During five years that Greeks were following the austerity policy (however, there are certain doubts about its stickiness and correct direction), the situation has even worsened. Due to the decline of GDP that equalled about 25% within the period from 2008 to 2014, the ratio of debt to GDP has become bigger. Consequently, the share of the budget that services the debt is also growing. An attempt of new Greek government to cut the Gordian knot failed. 

How to solve this situation without losses to all participants is not clear yet.

Even after the referendum on 5 July (if only Greeks do not vote for toughening economy measures) the situation will not be cleared. Please note that having voted against the conditions of European aid, Greece will not have to leave the euro area. This mechanism was not even determined at all, and according to the Greek Finance Minister Yanis Varoufakis the country is not going to step out from the union of its own free will. Certainly, if Greece continues to be stubborn at the negotiations and not to pay the debts back, it may face the situation when life for Greece within the euro area will become unbearable. This may include the rejection of the ECB to finance Greek banks.

However, these measures may cause the collapse of the Greek economy and a huge humanitarian crisis in the centre of Europe, in the very heart of European democracy. In turn, it contradicts declared European values and the principles of European solidarity. 

Thus, the resolution of this crisis will become a serious challenge and reliability check for both the monetary and European Union.