quarta-feira, fevereiro 09, 2011

Debt reduction without default?

By Daniel Gros and Thomas Mayer, Economic Policy CEPS Policy Briefs 
Date of publication:  3 February 2011
This paper proposes a two-step, market-based approach to debt reduction:
  Step 1. The European Financial Stability Facility (EFSF) would offer holders of debt of the countries with an EFSF programme (probably Greece, Ireland and Portugal = GIP) an exchange into EFSF paper at the market price prior to their entry into an EFSF-funded programme. The offer would be valid for 90 days. Banks would be forced in the context of the ongoing stress tests to write down even their banking book and thus would have an incentive to accept the offer.
Step 2. Once the EFSF had acquired most of the GIP debt, it would assess debt sustainability country by country.
If the market price discount at which it acquired the bonds is enough to ensure sustainability, the EFSF will write down the nominal value of its claims to this amount, provided the country agrees to additional adjustment efforts (and, in some cases, asset sales).
If under a central scenario this discount is not enough to ensure sustainability, the EFSF might agree on a lower interest rate, but with GDP warrants to participate in the upside.
A key condition for this approach to succeed in restoring access to private capital markets is that the EFSF claims are not made senior to the remaining claims and the new private bondholders. EFSF support must be comparable to an injection of equity into the country.
While the EFSF concentrates on the exchange of the stock of bonds, the IMF could fund the remaining deficits in the usual way with bridge financing, until the fiscal adjustment is completed. The ECB would of course immediately stop its ‘Securities Market Programme’, which would have lost its raison d’être.
Daniel Gros is Director of the Centre for European Policy Studies. Thomas Mayer is Chief Economist with Deutsche Bank London.

Our summary:
1. - Existing Govt bond holders sell (Greek, Irish and Portuguese) Govt bonds at discount to the EFSF, thus taking some portion of the sacrifice.
2- The EFSF passes this debt reduction on to the Government bond issuers, which reduces the amount payable on the relevant Goverment bonds
3. The EFSF might also reduce the interest rates due on the remaining debt balance, with upside warrants in case of faster than expected recoveries (salvo regresso de melhor fortuna)
4. The IMF provides new funding for the continuing (Greek, Irish, Portuguese) CAB deficits which should undergo a marked reduction, matched by “fiscal adjustment” on the budget side. 
This might require important changes in the Single Market to overcome the divergence in competitiveness.
5. These measures would replace the ECB’s Securities Market Programme (Govt bond purchases)
6. The ECB would reduce and eventually stop the exceptional bank funding programme, and domestic credit would have to be forcibly redirected to the tradeable sector but away from imports, through special taxes and restricitions on consumer credit. 

The proposal has merit as it follows basic principles of debt workout (sacrifice sharing, long term adjustment) and it seems to be an adaptation of the Brady Bonds, whose key innovation was to allow the commercial banks to exchange their illiquid claims on developing countries into tradable instruments.

But its success would depend greatly on the reducation of intra-Eurozone trade imbalances and CAB deficits, a key element in the adjustment process which is sadly lagging.

Mariana Abrantes de Sousa, economist and former international banker   
PPP Lusofonia, PORTUGAL 

See more about credit workout principles and practices in Debt Workout 101 in 20 parts