C.T.: Antes existía la idea de que lo que funcionaba eran las películas dirigidas hacia un público más bien juvenil que tenía por tendencia de ocio ir a los centros comerciales, a los grandes centros donde 

Hypothesis 3: The success of sovereign debt restructuring is minimized by the costs it incurs, particularly the reputation and domestic costs.

The direct costs of debt restructuring in the case of Greece are limited (see Table 8). Since the debt restructuring happened two years after the beginning of the Greek sovereign debt crisis, the markets had enough time to prepare for the ‘shock’ and the risk of the loss in value of Greek instruments was already priced in by the markets (see Graph 1, p.13). Nevertheless, the restructuring may have serious implications for the eurozone as a whole. Table 8. Implications of debt restructuring

Restructuring inefficiency Relevance for the case

of Greece Comments

Market exclusion High The bailout programme assumes market exclusion until the end of 2014. Serious doubts remain however, whether Greece will return to the markets from 2015 onwards. Domestic costs Medium The direct costs of the PSI deal are equal to

€78.3 billion, out of which almost €50 billion is devoted for the recapitalization of banks. Nevertheless, the banking sector is going through a difficult period, as the write-downs go together with a decrease in the quality of loan portfolios, loss in deposits and limited access to liquidity.

Contagion and reputation spill-

overs Medium ISDA declared the PSI agreement a ‘credit event’ which led to repayments of about $2.5 billion in CDS – a relatively small sum. The restructuring did not cause particular distress on financial markets.

Nevertheless, the reputation of other periphery countries and the eurozone as a whole is under question, as markets anticipate that PSI restructuring could be extended to other countries.

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Market exclusion

The market exclusion that Greece experiences in 2012 is not a direct ‘punishment’ for the current debt restructuring: Greece is without access to international financing for two years. The second bailout package assumes that Greece will only return to capital markets in 2015.

The success of the bailout package is under threat though, if Greece does start sustainable bond issues as planned. There are number of problems that could complicate the timely market access in 2015 (European Commission 2012b, p.39). Firstly, the reduction of Greek debt will only commence from 2014, which may keep investors wary of investing in Greek bonds. Secondly, the restructured Greek bonds that are swapped in the current deal will be senior to new instruments issued in 2015, which is a disincentive for investors. Finally, in 2014 around two thirds of Greek debt will be held by the official sector. Since official debt is typically repaid first, investors may feel discouraged to invest in subordinate class of bonds.

If these expectations materialize, the success of the second bailout package will be limited and Greece will require another rescue programme.

Domestic costs

The direct costs of debt restructuring in Greece do not pose a serious threat to the success of sovereign debt restructuring as they will be covered by the bailout funding. The costs of PSI equal €78.3 billion and include €29.5 billion of upfront cash payment of the EFSF sweetener and €48.8 billion for bank recapitalization (European Commission 2012b, p.46). In fact, the effect of sovereign debt restructuring on the banking sector was one of the main concerns when the PSI deal was being designed (Darvas 2011). As can be seen from Table 9, the Greek banking sector held around a quarter of the private debt that was to be restructured, while around a fifth was kept by the other European banks.

The banking sector of Greece has suffered badly in the sovereign debt crisis. The four biggest Greek banks reported in April 2012 that the combined write-downs on Greek bonds in their balance sheets following the sovereign debt restructuring amounted to €27.9 billion (Benasson et al. 2012). It is another hit to the Greek banking sector in the fifth year of a recession. More than 20% of bank deposits have been lost only in 2010, the quality of loan portfolios is steadily decreasing and the access of banks to international markets is shut off (Pascual and Ghezzi 2011). Luckily, the banking sector in distress can rely on official lenders, and even more so, if the currently discussed European Banking Union project enters into

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force. Unless there is a major fall-back of confidence and no recapitalisation of banks from the private sector, the domestic costs of debt restructuring do not jeopardise its success. Table 9. Distribution of Greek debt under restructuring

Debt distribution in billion €

Total debt in 2011 (A+B) 355

A. Official loans 95 EU 53 IMF 20 Other 22 B. Government bonds 260 B.1. ECB 55

B.2. Private sector (debt under restructuring) 205 Investment funds, pensions, sovereign wealth funds and hedge funds 70

Greek banks 50

Other European banks 40

Greek social security funds 30

European insurers 15

Source of data: Spiegel (2011), European Commission and ELSTAT.

The outlook for the banking sector remains uncertain though. As the Economic and Financial Committee (EFC), that advises the Council, anticipates: “contagion may (...) re- emerge at very short notice (…) and re-launch a potentially perverse triangle between sovereign, bank funding risk and growth” (EFC 2012, p.1). Weakening growth perspective and sensitivity of banking sector to investor sentiments may lead to a failure to achieve the ambitious goals of the second bailout package.

Contagion and reputation spill-overs

The contagion effect of debt restructuring, measured through CDS exposure, was not overwhelming and does not pose a threat to the success of the bailout package. The ECB was against debt restructuring in the first place, as little information was available about the nature and the size of exposures in the CDS market, given the opacity of that market and the fact that many market participants are simultaneously both sellers and buyers of insurance (Interview, ECB official 13.04.2012). In the end, ISDA did announce the credit event on the day that Greece executed the CACs leading to a situation “such that the right of all holders of the Affected Bonds to receive payments has been reduced” (ISDA 2012). Nonetheless, the auction of the outstanding CDS transactions on 19th _{of March went smoothly without any}

major hit to any market. It led to repayments of CDS at the level of $2.5 billion, mostly in the United States (Whitthall 2012).

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The reputation costs of the debt restructuring are more important in the case of Greece. Greek debt restructuring was the largest performed in history and set a precedent. It was the first such restructuring in a developed economy – a member of the powerful EU block and an OECD country. As such, it marks a historic moment when ‘pacta sunt servanda’ no longer applies and acutely undermines the confidence of investors. Without supply of credit and incoming FDI, the future debt sustainability of Greece is under serious threat.

What is more important, the reputation costs apply to the eurozone as a whole. One of the risks that the EFC saw in March 2012 was that markets believed that Greece was not a unique case and expected similar PSI deals in other countries of the eurozone (EFC 2012). The concern for the policy makers is thus that the markets will not discern between periphery countries and trigger self-fulfilling confidence crisis jeopardizing the sustainability of debt of the wider eurozone. As a result, sovereign debt restructuring in Greece could put a pressure on debt sustainability of other eurozone countries. Uncertainty of the markets and the resulting decrease in credit provision and potential postponement of investment decisions can further exacerbate the weak growth prognosis, preventing the exit from the European sovereign debt crisis.

* * *

The third hypothesis is only partially validated in the case of Greece. There are serious grounds to believe that Greece will be excluded from the markets for longer than until the end of 2014, in which case the second bailout programme will essentially fail. The domestic costs, particularly on banks, should not be big enough to jeopardize the success of the restructuring, since the programme entails resources specifically to recapitalize the banks. The reputation implications of the restructuring are valid both to Greece and to the whole eurozone, and of major concern to the European policy makers.

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5 Policy implications

“Rather go to bed without dinner than to rise in debt.”

Benjamin Franklin, 1732 As was argued in the previous chapter, the factors jeopardising the success of the debt restructuring process stem mostly from fundamental characteristics of the Greek economy: low growth outlook coupled with an inability to sustain primary and external surpluses given weak administrative capacity (1). To a lesser extent, the process has been put under risk due to market uncertainty over the ambiguous nature of PSI and the treatment of holdouts (2). Finally, the event is likely to have significant reputation implications, not only for Greece, but for the whole eurozone (3). These three findings lead to specific policy implications outlined in the chapter.