Tuesday, April 27, 2010
Should Greece repudiate its external debt?
In downgrading Greece to BB+, S&P raised the issue of severity of loss in the event of a restructuring. S&P estimated a recovery rate of 30% to 50%.
Severity of loss for sovereign defaulters is very difficult to predict. A crucial question is whether Greece could avoid a default judgement by obtaining creditor approval of a "distressed restructuring" in which existing bonds are exchanged for long-maturity, low-yield substitutes. This would be the most esthetically pleasing form of resolution.
But some economists have argued (and I agree) that Greece's debt burden is too high to successfully restructure. In all likelihood, no matter how Greece is resolved, it is going to lose access to the external debt markets and will be forced to balance its budget overnight. Under such circumstances (along with with who knows what kind of political turmoil), what will be the incentive for Greece to continue to service its restructured external debt?
Recent defaults (Argentina, Ecuador) suggest that creditors have really no meaningful recourse to the courts in the event of default. It would appear that the only downside to outright repudiation would be permanent loss of market access (although even that may not be true, as Argentina is attempting to show).
Needless to say, the EU and the ECB would be quite cross at Greece, but it appears very difficult to expel an EU member. The ECB, which would lose billions in the event of a Greek default, would be an unlikely lender to Greece or its banks. But that door is already closing.
My prediction is that Greece would begin by seeking to restructure its external debts (next month), but within a year or so will default permanently, resulting in a worse recovery rate than S&P has suggested.