By Marcus Walker, THE WALL STREET JOURNAL
BERLIN -(Dow Jones)- Divisions in the euro zone are deepening over how to handle Greece’s suffocating debt burden, with German officials open to a voluntary restructuring of Greek bonds but a majority of euro-zone policy makers fearful of the consequences.
Europe’s line has been that Greece will slash its outlays and repay all of its debts. But investors and, in private, some European governments increasingly doubt the country can. In that case, Greece will need more aid and, many believe, will have to restructure its debts.
The debate in the euro zone is about whether and how to restructure. German officials believe Greece should be encouraged to sit down with its bondholders this year to discuss extending the maturity dates on its bonds, a step known as a debt rescheduling, said people familiar with the matter.
Such a step would reduce Greece’s new borrowing needs in coming years, while sparing investors the pain of a “haircut,” or reduction in what they are owed. ” We are cautiously open to voluntary measures that avoid imposing haircuts,” said a senior German official, adding: “But our ideas are not being well received in Europe.”
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Other key players including France, the European Central Bank and the European Commission are opposed to discussing even a gentle form of Greek debt restructuring, arguing that financial markets would conclude that other crisis- hit countries such as Ireland and Portugal also won’t repay their debts.
Greece is open to the idea of talking to its creditors about a rescheduling, but the country first needs political approval from the rest of the euro zone, its vital financial backstop, Greek officials say.
The debate could become more urgent in coming weeks, when a team of European Union and International Monetary Fund officials, who arrived in Athens on Tuesday, report on Greece’s fiscal progress and the sustainability of its debt.
The background to the debate is the fact that Greece has failed to win back investors’ trust in its creditworthiness since getting a EUR110 billion ($162.9 billion) bailout from euro-zone governments and the IMF in May 2010. Greece’s two-year government bonds currently yield about 24.5% interest, a clear signal that investors don’t believe the bonds will be repaid in full.
Under its bailout plan, Greece is supposed to return to bond markets in 2012 to meet nearly EUR30 billion of its funding needs. But few European officials believe Greece will be able to tap bond markets next year. Greece therefore faces a messy debt default, or else it will need additional loans from the euro zone and IMF.
Lending billions more to Greece is a hard sell in Germany, where parliamentary resistance to bailouts is growing. If Greece can borrow only within the euro zone, then over time its debt will consist increasingly of emergency loans and ever less of bonds held by private investors.
“Taxpayers will end up buying out the private sector,” said Thomas Mayer, chief economist at Deutsche Bank in Frankfurt. Finally, when Greece seeks debt relief, the cost will fall on taxpayers, he said.
Postponing the repayment of Greek bonds would slow down the transfer of Greece’s debt risks to taxpayers, analysts point out.
If nothing changes and Greece needs further bailout loans, euro-zone taxpayers will end up holding around EUR142 billion of Greek debt by the end of 2013, according to a calculation by David Mackie, economist at J.P. Morgan in London.
But rescheduling Greek bonds that would otherwise fall due in 2012 and 2013 would reduce the amount that Greece needs to borrow from euro-zone governments, limiting taxpayer exposure to EUR77 billion, Mr. Mackie estimates.
A rescheduling could be modeled on Uruguay’s 2003 agreement with investors to postpone repayment of its bonds by five years. That agreement was enough to help Uruguay avoid default and didn’t impose major losses on creditors, analysts said.
Greece’s financial woes, however, are more severe, and a rescheduling alone won’t bring the country back to health, economists say. Greece will still need painful fiscal retrenchment to slash its budget deficit, which stood at 10.5% of gross domestic product in 2010. Also, Greece’s overall public debt, which reached nearly 143% of GDP at the end of 2010, is probably too much for the country to bear, given its weak economic-growth prospects, many economists believe.
A rescheduling would thus probably be only a first step, with a haircut coming later, economists said.
Financial markets, anticipating the second step, might also lose faith that Ireland and Portugal will repay their bond debts on time and in full. That would undermine Europe’s hopes of weaning its problem countries off aid loans and returning them to bond markets.
That fear is behind the widespread opposition in Europe to letting Greece talk to bondholders. Germany, however, is edging toward the view that Greece ultimately won’t avoid a full-blown haircut–and that an early rescheduling will limit the final cost to German taxpayers.
ECB President Jean-Claude Trichet is particularly adamant that any form of Greek bond restructuring could trigger chaos in financial markets, according to officials involved in recent euro-zone discussions with him. A spokesman for Mr. Trichet declined to comment.
Some in Berlin hope Mario Draghi, the front-runner to succeed Mr. Trichet this fall, might show more flexibility on the issue.
“Draghi is not dogmatic and is open to using a mix of instruments,” says a senior German official.
Other ECB members, however, have also spoken out against all talk of restructuring, and only Nout Wellink, the Dutch central bank’s chief, has so far said he is open to the idea of a Greek rescheduling.
Although the ECB can’t stop Greece from seeking talks with its bondholders, euro-zone governments are loath to allow such a move against the will of the central bank, which is also playing a key role in supporting stricken euro members by buying government bonds and lending to banks.
