Wednesday, June 22, 2011

More notes on the Hellenic tragedy

Simon Johnson is spot on in his assessment of Greece's macroeconomic situation,

"The Greek government owes more than it can afford to pay, now or in the near future, at market interest rates. There are two options: reduce the payments through some form of restructuring, or move the debt into the hands of people who are willing to charge below market rates for the foreseeable future."

Alan Cibils has lessons for Greece from Argentina, which in the nineties pegged the peso to the US dollar on a 1 to 1 exchange rate and undertook agressive free-market reforms. It finally defaulted in 2001, devalued its currency in 2002, recovered its competitiveness and enjoyed nearly a decade of robust growth.

"Greece (and Ireland, Portugal and Spain) should learn lessons from Argentina's experience. First, the I.M.F. still promotes policies that inevitably make matters worse, demonstrating an inability to learn from past mistakes. Second, default can be a solution, since it can end an unsustainable situation, frees up fiscal resources for more productive use and eliminates the need for access to bond markets. And third, regaining control of the national currency and the ability to conduct independent monetary and fiscal policies are essential for economic recovery."

Dani Rodrik too advocates much the same, debt restructuring instead of the current policy of austerity and buying time,

"When Argentina defaulted on its debt a decade ago, the country became a pariah in the eyes of foreign bankers and bondholders and was shut off from international financial markets. Yet its economy recovered quickly and experienced rapid growth thanks to a large boost in external competitiveness provided by a vastly depreciated currency. The lesson is that default can be the better option when the alternative is years of continued austerity."

As this graphic highlights pointing to evidence of sovereign defaults since 1999, post-default five year average annual growth rates belies conventional wisdom that debt repudiations inflict long-term damage to those economies.

The Economist has this cartoon illustration of the Hellenic disaster.

Update 1 (24/6/2011)

NYT article has some interesting comparisons and contrasts with Argeentina. Highlighting the fact that sovereign defaults are not without costs, it writes that, a decade later, Argentina has still not been able to re-enter the global credit market.

At the time of its default, Argentina had a fiscal deficit of 3.2% of GDP to Greece's 10.5% of GDP in 2010. As a percentage of GDP, Greece's debt is at avery high 150% to Argentina's 54% at the time of its default. As Times writes,

"But perhaps the biggest bind for Greece is that it shares a common currency with the other European nations that use the euro. And so, unless it takes the imponderable and unprecedented step of breaking from the euro zone, Greece does not have access to one big tool — devaluing its sovereign currency — that has helped Argentina weather its economic storm... The big problem for Greece is that they have a strong currency, much stronger in relation to their productivity".

In 2001, Argentina defaulted and devalued its currency. However, the government waited until 2005, when its economy was already in recovery, to conduct the first of two debt restructurings. Non-government foreign investors — the biggest included pension funds from Italy, Japan and the United States — took haircuts costing them two-thirds of their investments.


sai prasad said...

I agree that default is a better option than continued years of austerity. However, i feel that this ac has to be part of a larger strategy towards improvement of the economy.

Mere default, without a robust recovery strategy would only continue the downward spiral.

The additional concern that i have is that the inability to pay is not limited to foreign debt, in fact it is also on count of taking up programs(welfare or otherwise) which cannot be funded. Governments are also not in a position to withdraw them.

So, do we need a balance between austerity and default/restructuring ?

gulzar said...

agree with both your points sir. the point about a medium to long term plan is critical. After default, what?

and here it is necessary to prune down populist but wasteful welfare spending. currency devaluations, to increase global competitiveness, is another important macroeconomic decision.

the terms of the debt restructuring deal, the haircuts on bond holders, is important.