The "French Plan" For Greece is Doomed to Fail

John T. Sullivan is a foreign exchange market analyst for Reuters. The opinions expressed are his own --

By John T. Sullivan

NEW YORK, June 30 (Reuters) - The French Plan for restructuring Greece's national debt will fail for several reasons.
The plan draws some of its framework from the historic Brady Plan that arose in 1989.
The French plan envisions rolling over fifty per cent of Greece's sovereign debt maturing between 2011 and 2014 into thirty year bonds.
As of March 31, Greece's Ministry of Finance estimates that the total debt due between 2011 and 2014 is approximately Euro 157.6Billion. The remaining fifty percent would have a bullet maturity in thirty years.
The cost of servicing the maturing debt and then rolling over a portion of the debt with a thirty year zero coupon bonds is prohibitively high. According to Eurostats, gross government revenue was Euro 89.9Bn, nearly 51 percent received in taxes.
Direct taxes, presumably corporate and individual, amounted to only Euro 17.4 Billion. The remaining 49% of government revenues comes principally from social contribution. The market discount for a high grade Euro denominated thirty year zero coupon bond is approximately Euro 0.32.
A simple arithmetic calculation would indicate that at a fifty per-cent debt rollover, the cost of the guarantee would be Euro 25.59 Billion between 2011 and 2014.
The Greek redemption profile of debt maturities between 2011 and 2014 clearly illustrates the problem will not be solved. For the balance of 2011 (March - December) Greek public debt maturities amount to Euro 27 Billion.
Thereafter, the redemption schedule worsens: Euro 35.3 Billion - 2012, Euro 37.6 Billion - 2013 and finally Euro 57.7 Billion in 2014. The proposed restructuring does not cover 2015 which is equally alarming with Euro 39.4Bn due.
A pro-forma "Sources and Uses" of revenues and expenditures will clearly show that Greece will continue to run deficits for several years in spite of the proposed French Plan.
A combination of debt forgiveness and outside funding will be necessary to meet the cost of social benefits, government employee payrolls, interest on debt and capital investments. The "French Plan" does not go far enough to address the Greek problem.
The French Plan fails for several reasons:
1) The cost of the Euro zero coupon bonds cannot be absorbed solely by the Greeks. The cost of 0.32 Euro per every Euro of outstanding debt is onerous in part because the implied yield on Euro denominated zero coupon bonds is low.
One of the reasons the Brady Plan was successful was that the USD Treasury zero coupon yield curve was high, permitting a larger discount to face. Specifically, the French Plan envisions capturing and guaranteeing debt between 2011 and 2014. The outstanding debt guarantee would thus cost approximately Euro 25.6 Billion - a figure that would absorb nearly 30 percent projected Greek government revenue in 2012.
2) There is no provision to allow Greek sovereign debt to be used in any proposed privatizations. Greece has agreed to privatize certain industries as part of its bailout.
One way to add value to any restructuring is to designate a particular class of the restructured debt to be use in privatizations. The immediate impact would be to raise the value of the designated bonds. In turn, the use of the bonds as part payment for any privatization would help alleviate the guarantee costs and reduce the overall stock of debt.
3) The proposed 50 percent debt relief does not envision the reduction of the stock of debt. Greece will continue to service an additional Euro 75Billion of debt that would have otherwise matured. The interest servicing cost will likely add another Euro 3-5 Billion to an already stressed fiscal budget. Furthermore, the IMF projects that Greeks gross borrowing requirements through 2015 will amount to over Euro 300 Billion. The proposed French Plan will maintain maturities of approximately Euro 76 Billion plus interest service plus the Euro 39.4 Billion due in 2015. The Greek financing gap will explode.
4) The French Plan does not address all of Greece's creditors. The Plan limits itself to Greek sovereign bond holders. A successful restructuring must look at the whole body of debt. Greece has also internal government arrears to its service providers and social security system. Hospitals, medical staff, pharmacists, construction contractors, legal advisers are owed over Euro 3.5 Billion. Total restructuring is necessary.
5) The Plan has not made public any enforcement caveats or covenants that would bind the Greek government to meet certain requirements that would pay down the debt. The three largest sources of Greek government revenues are indirect and direct taxes and social security contributions. If the latter is sequestered, the Greeks must improve their ability to collect and grow the tax base.
The Brady Plan was also a painful exercise, requiring creditors to accept significant asset write-downs and the debtors to improve fiscal transparency and discipline. The outcome though appears to have been beneficial for both the creditors and debtor nations as there was economic recovery, new investment and a socio-economic re-ordering that improved the welfare of the debtor's populace. The central bank mandarins in Frankfurt need to concentrate and their efforts and re-calculate the arithmetic.



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