Why Greece faces a 76% debt haircut - and could still default

Around a decade ago the Greek economy was one of the fastest growing in the Eurozone – but now it seems few interventions are able to halt the country’s crisis.

Standing at an estimated €326 billion (around £289 billion) Greece’s debt to GDP ratio long ago breached all accepted thresholds.  However the situation is set to get far worse if a gloomy scenario painted by Citigroup plays out.

Greece hasn’t run a total balance surplus since the mid 1990s and without severe haircuts to its spiralling debt posting even a figure marginally in the black will be virtually impossible.

As pointed out by the bank a 10% haircut each year between now and 2013 would be necessary if Greece is to achieve its a primary surplus of just 1.5% by 2013, something not seen on the country’s balance sheet since 1995.

But analysts on the bank’s global markets team expect Greece’s debt crisis to extend even further, outlining a worrying scenario in a recent report in which the country’s debt to GDP grows to a whopping 178%.

Moreover, its analysts point out that no country with a debt to GDP level this high has ever been able to avert a default.

‘The question about what debt level is sustainable at the national level has not been fully resolved,’ its analysts said, pointing out that no country with a debt to GDP ratio in excess of 150% has ever been able to avoid default so why should Greece be any different?

Indeed, most economists agree a debt to GDP level of 90% is the maximum sustainable as above this threshold any new wealth – be it from international bailouts or progress made domestically – has to be used to service debt.  ‘The EU’s Maastricht Treaty has set 60% debt/GDP (and 3% budget deficit) as the limit for any euro area country,’ Citi’s Ronit Gose and Alex Atienza explained.

At more than three times this it seems Greece has little option but to default on its eye watering debt. And in addition to this, although Italy, Belgium and Japan are in a similar state, with debt to GDP ratios of 120%, 100% and 200%, respectively, each of these have a way out that is not open to Greece: their aging populations.  Analysts argue that as spenders become savers in each of these nations a natural avenue for their savings will be the bonds of the sovereign.  Citi believes this would help stabilise the debtholder base and if the scenario plays out, would also see the interest payments linked to these bonds channelled back into the domestic economy.

A 76% debt haircut looks inevitable

In order to restore the Greek debt to GDP level to a more credible 60%, Citi expects the country will be pushed towards a 76% haircut on its debt, and if its policymakers hold off over the near term, this figure could comfortably rise to 95%.