February 4, 2015
And here it is now that we are starting pondering on different alternatives on how to manage the debt of Greece and Eurozone. In an interview with The Financial Times, the Greek Minister of Finance Yanis Varoufakis introduced the term “perpetual bond” to explain his plan to ease Greece’s immense debt burden. As the confrontation with the country’s creditors is increasing, Varoufakis’ proposal to unlock the stand-off between both parties is genuinely interesting.
The Proposal of Varoufakis
It is clear that Greece and his Minister of Finance are trying to come a step closer to the creditors. While PM Tsipras is meeting with EU leaders this week, Mr Varoufakis is preparing the floor for the official stage of negotiations next week. The first thing we need to point out is that the Greek national debt is not viable. It does not necessitate special economic notion to understand it. But the discussion on debt becomes even more precarious when we take into account that Greece without a growth clause or a certain growth plan, cannot escape this vicious circle of bailout programs. And when a state is borrowing continuously, public policy and structural reforms cannot be fruitful and effective.
In this context, Varoufakis, already since 2012, has proposed a specific debt policy in order to build a new smart debt engineering program for Greece and Eurozone. The proposal entails the introduction of two types of new bonds: The first type, indexed to nominal economic growth, would replace European rescue loans; the second type, termed as “perpetual bonds” would replace ECB-owned Greek bonds. Both types aim to substitute the sensitive term of “debt haircut” that is literally considered by the creditors as politically incorrect, as the haircut is synonym to bankruptcy. Nonetheless, it is vital to point out that the Greek state is already bankrupt, in a sense that it cannot serve its loan obligations and debt repayments, being in a constant need of soaring though rescue programs. Therefore, the proposal of Varoufakis aims to both accommodate concerns of European creditors, while endeavoring to bring Greece back from economic anomaly and recession.
The essence of Varoufakis’ proposal is the prolongation of debt and the debt restructuring in a way that repayments can be served though the share of growth rate into debt rate. Growth increases national GDP, and therefore it revitalizes consumption and boosts inflation (i.e. both major targets of ECB’s Quantitative Easing Policy). In other words, the first type of bonds keeps Greece into the continuous handling of Eurozone’ creditors (i.e the member-states) while the second type satisfies ECB’ concerns and prospects for growth and inflation. Both ways necessitate a primary budget surplus around 1 to 1,5 % of GDP per year, meaning that the government should seek for higher public income stemming from taxation, targeted to highest incomes and wealthy Greeks. In addition to that, the government should also clamp down tax evasion effectively. And here lies the biggest and most demanding challenge, as state’ mechanisms need a long way to go to increase counter-evasion mechanisms in order to increase public income and be able to fulfill public spending promises.
The Burdens Ahead
The first burden to overcome is merely economic and deals with the relatively small benefit and the risk for the creditors. Perpetual bonds keep repayment obligations alive, but in practice the creditor does not take any profit other than the annual interest rate. In simple words, this means that when you give for instance 100 euro you receive back 5% of the amount in annual basis. Similarly, if the creditor decides to sell the bond, then it would take back the amount agreed in the beginning regardless of the fluctuations – positive or negative – at the time of selling. In other words, the perpetual bond is useful for the creditor only if the creditor decides to keep it “perpetually” as gains would always be low.
The second burden to overcome is strictly political. At this stage, there are two blocks in Eurozone, with the first being aligned with Germany (i.e. counting for 15 member-states of Eurozone), while the second is led by Greece, Ireland, and France. Here comes the effect of power games and how such balances can be positive or negative for Greece in the negotiations. In this respect, the pressure exerted by the United States and the firm support of President Obama towards relaxing austerity politics in Eurozone is something Greece will claim for. Notwithstanding, there is additionally the unofficial will of Russia to assist Greece at this stage of negotiations by supporting the country with a new loan. Such a development is not necessarily positive for Greece, as it would widen the interlocutors on the country’s debt, but politically it could generate second thoughts on the austerity block in Eurozone, that stands critically on Varoufakis’ proposal and the economic plan of the Greek government.
The next two weeks will be crucial for Greece and Eurozone, both economically and politically. In any case, we should never forget the role of the US in the global run of influence, and the high stakes for the Obama Administration should struggles in Eurozone keep alive.
Small tip for the debate: Many US and European funds have been investing in the narrowing of exchange rate between dollar and euro. A possible rise of euro, after a mutually accepted agreement on Greece’s debt and austerity negotiations, would increase the gains for those that during this period are buying euro and are ready to sell it once the global market get some positive signs over Eurozone’s future.
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Twitter: @rapidisDimitris Rapidis