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Friday, January 2, 2015

SYRIZA Should Focus On Interest Rates and Not on Nominal Value of Debt!

Given the multiple sources of information (with differing numbers, I should add), let me first clarify that I am looking at the Ministry of Finance's latest State Budget Execution Monthly Bulletin which shows an interest expense for 2014 of 5,7 BEUR. The same Ministry of Finance reports in its Public Debt Bulletin that Greece's public debt stands around 320 BEUR.

It could well be that these two numbers are not directly comparable to each other because an interest expense of 5,7 BEUR on debt of 320 BEUR would represent an interest rate of 1,8%. I know that Greece's debt to official lenders is very cheap but there is still other debt due to private creditors and the interest rates there are much higher. An overall rate of 1,8% seems very low. Perhaps the 5,7 BEUR is not the entire interest expense which Greece pays on its entire public debt.

A significant debt forgivensess is a pillar of SYRIZA's economic plan. Let's just assume that the Troika were prepared to forgive Greece enough debt so that the remaining debt is within the Maastricht level, i. e. within 60% of GDP. In exchange, the Troika would likely insist that the remaining debt must be priced at market rates, say 6%.

Assuming that 60% of Greece's GDP is around 110 BEUR, which would be the remaining amount of Greece's debt, then the annual interest expense on that reduced amount of debt at 6% interest would be 6,6 BEUR annually, or quite a bit more than Greece is paying now.

I think SYRIZA is making a mistake by focusing exclusively on the nominal level of debt and ignoring totally the equally important elements of maturities and interest rates. What matters for Greece is how much debt service flows through the budget and, thereby, reduces government revenues which could be used for other purposes.

The interest rate has a far greater impact on the debt service in the budget than the nominal amount of debt. To wit: if all of Greece's debt were at 0% interest, Greece could easily double its indebtedness without a budgetary problem. Greece would still have a maturity problem but that could be solved by stretching maturities way into the future.

One can assume that it is easier for the Troika to give in on interest rates than on the nominal value of debt. For Greece, the interest expense should matter much more than the nominal value of debt. One thing is clear beyond any doubt: both sides will have to be prepared to make a compromise. If they are adamant about the current positions, there will be no solution.

A good compromise allows both sides to declare victory. The Troika's victory would be that they did not forgive any debt (the lowering of the interest rate to something close to zero would only be a footnote in the press release). SYRIZA's victory would be that they brought down the interest expense to an extremely low level. So low that there wouldn't be much difference between the primary balance and the overall balance of the budget. Thus, SYRIZA's press release would state that Greece managed to keep the entire primary surplus for its own benefit (with only a footnote saying that the nominal amount of debt would remain unchanged).

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