The Greek Debt Tragedy

Heavily indebted Greece was taken to task by bond investors who demanded higher yield to offset higher default risk and rating agencies who threatened to downgrade its bonds.

Greece needs to raise about €54 billion this year (2010) to retire its maturing bonds (WSJ 2/26/2010). But the Greek economy is in poor health. Its national debt is already 125% of its GDP and its budget deficit for 2009 is expected to be around 13% of the GDP (WSJ 2/10/2010). At this rate, the national debt could exceed 200% of its GDP in 5 – 6 years.

Nervous bond investors are understandably driving up yields of existing bonds by selling or shorting them and demanding higher yields for new bond issues. The yield spread between 10-year Greek bond and the much more solid 10-year German bonds was close to 4 percentage points in late January. The premium for insuring against Greek bond default has soared to 400% that of the previous summer (BW 2/22/2010). And S&P, the bond rating agency, threatens to lower the ratings of Greek bonds to junk status making it more expensive for Greece to sell new bonds.

The socialist Greek government has promised to shrink its budget deficit to 8.7% in 2010 and below 3% (the legally required EU deficit ceiling for members) by 2012. But the austerity package was greeted by a 24-hour general strike, forcing Greece to cancel a planned auction of new bonds. At the bottom of the bond crisis is Greece’s long-standing failure to collect enough taxes from its citizens. The size of Greece’s underground economy which is largely shielded from taxation is estimated to be about 25%, the largest among EU countries (WSJ 2/10/2010). The estimated amount of tax evaded was about 37% of the 2009 budget deficit.

The market pressure on Greek bonds eased somewhat as hope of a rescue package from leading EU countries gathered pace (WSJ 3/3/2010). But as long as the bond yield exceeds the GDP growth rate, the debt/GDP ratio will continue to rise just to service exiting debt even if the budget deficit is otherwise reduced to zero. (Economist. 2/13/2010). To reduce the debt/GDP ratio, the Greek government must generate budget surplus every year far into the future. And that is not how a Greek tragedy is supposed to end.

To the extent that Greek bonds are held by foreign investors, foreign bond holders are taking the profligate Greek government to task. Any country, including the US, whose budget deficits are being funded by foreigners is in effect giving up its sovereignty to foreign bond holders for the sake for short-term domestic spending binges.