SYMPOSIUM | Greece, Out of The Crisis: Debt-End or Dead-End Is there a ‘debt trap’ in the Greek economy? Panagiotis Liargovas University of Peloponnese & Greek Parliamentary Budget Office, 17 May, 2017 Webster Vienna Private University

What is the debt trap? Short- run Long-run Debt Growth Debt Growth productive spending or unproductive spending Public Deficits & Interest rates Savings, investments, productivity Debt unproductive spending Growth

Previous empirical literature Some find a strong negative relationship Some argue that high debt affects growth negatively only when the country’s quality of institutions is low Some argue that the negative relation between high debt and growth is valid only for developing countries (but not for industrial countries)

The main conclusion from previous literature There is no consensus about the debt – growth relation, nor for the tools that should be used for its analysis; rather such a relation seems to be affected by various factors

The basic estimation equation Yit = β0 + β1Χ1,it + β2Χ2,it + … + β15 Χ15,it + β16Χ16,it +uit, The growth model is based on a conditional convergence equation where real GDP per capita is related with savings, investments, population growth and technological level. Then, apart from the public debt, various other independent variables - related to growth – are added to the model.

Data and Methodology The sample includes annual observations for the 28 EU countries over the period 1995-2014 and data were collected from AMECO. We use a regression model using OLS, OLS for panel data with random and fixed effects methods and also the GMM model. Also, two dependent variables were used: annual real GDP per capita growth rate and cumulative 5-year non- overlapping real GDP per capita growth rate.

Results – Graphical summary

Results For Greece the overhang debt reduces its real GDP per capita growth rate by almost 3% (annually). If the primary surplus increases by 1%, the real GDP per capita growth rate will increase by 0.32%. A positive statistically significant relation is found for the TFP, for the participation in a monetary union and for the Voice and Accountability.

Debt and private/public investments in Greece(1995-2014, bn €) During the crisis, public investments decreased by almost 50%, private investments by 70% (from €49 bn in 2007 to €14 bn in 2014), thus confirming findings of relevant empirical studies for the impact of debt overhang to investments.

Debt and savings in Greece (1995-2014, bn €) During the crisis, savings (annual) were reduced by 50%,

Debt and Total Factor Productivity in Greece (1995-2014, bn €) During the crisis, TFP decreased

Greece is trapped in a self-reinforcing recession; Conclusions Greece is trapped in a self-reinforcing recession; its high debt burden (that affects key development factors), in addition to uncertainty and low institutional quality create a vicious cycle.

Debt Laffer curve when a country’s debt is on the “bad” side of the curve (right of point B, Graph 5 ) an extensive debt haircut is in the benefit of both the indebted country and of its creditors.

Conclusions What does all this mean for Greece? the debt overhang constitutes a huge burden for the Greek economy, hindering growth prospects, thus a debt restructuring is necessary. the necessity for the continuation of structural reforms (related to productivity, State functions, institutions) is also evident, so as to establish the foundations for economic recovery.

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DDA We perform a debt sustainability analysis (based on gross financing needs, the methodology that the institutions are using) following the hypotheses of the institutions (surplus, growth rate)

Privatization revenues Interest rates (scenarios) Growth Rates 2019 3% 2020 2,8% 2021 2% 2022 - 2029 1,5% 2030 - 2060 1,25% Primary Surplus 2019 - 2028 3,5% 2029 - 2060 2% Privatization revenues € 500 ml. Per year (till 2059) Interest rates (scenarios) 1,5% 3% 6%

Debt evolution (%of GDP) with different interest rates (1,5%, 3% and 6%) Due to its current high debt, restoring Greece’s access to bond markets in 2018 is challenging. A Greek debt restructuring is necessary so that Greece can escape from its debt trap.Also, keeping the GFNs under the limit set does not ensure Greece’s debt sustainability.

Therefore Even if Greece manages to restore market access with a 3 per cent interest, that would be short-lived as its debt will continue to increase at high rate reaching 330% in 2060 (even if positive growth rates are registered and primary surpluses are achieved). As a result, investors will demand an even higher interest, thus Greece will lose again access to market. On the other hand, borrowing with very low rates (close to 1.5%) can only be provided by the European financing mechanism.

There are two options: a debt haircut and, What are the solutions? There are two options: a debt haircut and, an extension of principal and interest payment and grace periods (in essence, an indirect debt restructuring)

How extensive a debt «haircut» should be? We calculate the primary surpluses that Greece can achieve. The GFNs include both amorti-zation and interest. We assume that principal is being refinanced perpetually through markets. Thus, based on Krugman’s argument what matters is interest repayment (through the primary surplus) so that Greece does not create new debt and remains solvent.

How extensive a debt «haircut» should be? In this context, we calculate the primary surpluses that Greece can achieve over a 20-year period (2019-2040) on a more realistic basis in comparison to institutions’ projections

How extensive a debt «haircut» should be? Based on these, it is estimated that Greece can devote (on average) €5.12 bn per year for interest payments so as not to create new debt. This amounts (assuming that after a debt «haircut» Greece could borrow at a 3 per cent rate) to a total debt of €170 bn. Thus Greece’s debt should be cut by €150 bn after which its debt/GDP ratio will be reduced to 92%, a level that is being considered sustainable (in the Eurozone, the average debt/GDP ratio is 90.1% ).

Extending principal and interest payments and grace periods In this context, the IMF – which argues that the Greek debt is unsustainable – proposes that repayment of GLF, EFSF and ESM loans should be extended till 2080 and interest should be fixed at low levels (around 1.5%). According to IMF projections, through the implementation of such measures debt could reach 60% of GDP, while GFNs at 19.5%.