Greece’s 2nd bailout: Debt restructuring with no debt reduction?

by Ricardo Cabral

Vox
July 29, 2011

On 21 July 2011, the Council of the EU agreed to a second bailout for Greece. The deal was predicated on “private-sector involvement”. This column explores what this actually means. It estimates that the haircut for private bondholders may well be one-third of the figure initially proposed. It stresses that such uncertainties could spell more trouble for Greece and Europe as a whole.

The Council of the EU agreed on 21 July 2011 to a second bailout for Greece (Council 2011). This deal is predicated on “private-sector involvement”. The Council seems to have implicitly endorsed a form of private-sector involvement made by a private institution – the Institute of International Finance.

The proposal consists in a voluntary debt restructuring with a bond-exchange menu with four options (IIF 2011). The Institute indicated the exchange will result in a 21% “haircut” or reduction in the net present value of an estimated €135 billion of Greece’s sovereign debt that matures between 2011 and 2020. Two recent press columns, Nascimento-Rodrigues (2011) and Dixon (2011), argue that this will likely result in an increase – not a reduction – in Greece’s indebtedness.

This column uses one of the exchange options to replicate and explain the issues with the Institute of International Finance haircut estimate. It argues that a much lower post-exchange discount rate should be used and that in such a case the net present value of Greece’s debt subject to the exchange offer would actually increase.

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