Tackling the Greek debt problem, a look at the Chilean experience (Part 2)

In my previous note, I recounted how a country like Chile in the 1980s had solved its external debt problem better and more durably than its peers.  Two key contributors to its success were voluntary debt swaps and well conceived privatizations.  The debt swaps permitted Chile to reduce its foreign commercial debt by one third.  It now seems that the privatization route is gaining advocates when dealing with Greece.

Today, Mr. Juergen Stark, a European Central Bank board member, stated that Greece could privatize over €300 billion of assets, far more than the €50 billion it has agreed to.  To put this number in perspective, let us remember that the Greek public debt amounts to some €320 billion.

It is my view that privatizations should be the main focus of the Greek rescue.  Doing so would reduce the need for ‘haircuts”, and benefit all parties involved.  There are compelling arguments to choose this strategy.

To begin with, it would be excessively difficult to convince creditors to forgive as much as 50% (the number most often quoted) of the debt of someone whose sellable assets equal such debt.  No bank would agree to do so for any of its corporate debtors, nor would anyone of us, individually or as tax-payers.

While it may appear tempting for a debtor to erase half of his debts, the cost of doing so is usually much higher than imagined.  In the 1980s, after years of muddling through, Latin American countries reduced their external debts by less than one third through the issuance of new (Brady) bonds (the effective haircut ended up being much lower that anticipated because of the secular drop in interest rates worldwide).  It took a decade before markets were willing to buy new Latin bonds at a reasonable premium over US treasuries.  Russia played hard ball, extracting a 55% haircut from the holders of its hybrid Soviet bonds (IAN, PRINs) but escaped durable punishment from investors by excluding its more recent sovereign bonds from any restructuring.  In 2005, Argentina stiffed bond investors with an average 70% haircut and has yet to return to the international bond market.

A 50% haircut would make it very difficult for Greece to regain access to the financial markets.  It would discredit it for years to come.  It would make tax collection and the collection of debts by the Greek state very difficult: after all, if the state does pay its debts, what authority does it have to convince its citizens to behave better?  It would also destabilize other sovereign European debtors by association so that support from the rest of the EU would not be likely.  Finally, it is worth remembering that negotiating a haircut with hedge funds and other non-bank creditors that have little if any long-term interests to protect will not be easy.

Assuming that Greece could durably service a debt amounting to 80% of its GDP, it would need to cut its debt down by half, or some €160 billion.  Assuming further that a 15-20% haircut would be viewed by markets as acceptable retribution for imprudent lending, Greece would need to privatize at least €100-€112 billion in state assets.  This is double what is currently under consideration but less than a third of what Mr. Juergen Stark considers the privatization capacity of Greece to be.  I think it would be a big mistake not to pursue the route of enhanced privatization.

Timing would be an important factor.  There are some assets, such as blocks of shares in well run companies, which can be sold now.  But the Chilean example shows very clearly that companies earmarked for privatization should first be brought back to financial health.  In the case of Greece, some labor laws also need to be revamped to allow for stronger economic growth.  Once these laws are enacted, the value of privatization candidates would appreciate greatly.  Subject to appropriate legislation, some state companies earmarked for privatization could be put in a trust for the benefit of the likes of the ECB and IMF; these institutions could then retire maturing Greek sovereign debt, having secured appropriate collateral with the assets held in trust.  Such a scheme would allow for the timely reduction of the Greek debt while allowing time for corporate remediation so to speak.  

As in the case of Chile three decades ago, the Greek government would be well advised to implement some sort of capitalismo popular so that the Greek people could participate in some key privatizations thanks to low interest bank loans.  It would be fair for them to participate in some upside since they will have to bear their share of the downside of the crisis.  It would also help sell a strategy of private ownership and free markets which is key for a real economic recovery. 

It is very much welcome that an ECB member is prodding all the interested parties to consider voluntary debt reduction via the sale of state assets as the principal avenue for sovereign debt reduction.  Hopefully, this will redirect and invigorate a debate which had stalled lately.