Photo: New York Times Syndicate
While UBS analysts continue to believe that Greece will not leave the euro, it does face another disturbing reality: the Greek government will likely need a second debt restructuring to keep its debt under control.Since public sector lending virtually replaced debts held by the private sector in Greece, this time around a default will target the European taxpayer. UBS enumerates the kind of losses he will see in a recent note:
The maths is simple. Europeans have lent in various forms to Greece: via bilateral loans, and via EFSF more recently but also via the ECB’s SMP. The total exposure is currently €181.9Bn. A one-third haircut on this debt would thus mean a €60.6Bn loss of the European taxpayer, or 0.5% of Euro Area GDP. A 50% haircut on this debt would thus mean a €91.0Bn loss for the European taxpayer, or 0.7% of Euro Area GDP.
However, the effects of currency depreciation and liabilities in central Eurosystem banks would nearly quadruple these costs should Greece decide to leave the euro area:
Greek public debt is denominated in euros, so the euro face value of the debt would not change if Greece leaves. But the 50% depreciation of the currency means that Greek GDP in euro would be halved too. As a consequence, the debt to GDP ratio would double. This means that, in order to reduce the ratio by one third, our original target to make the trajectory “sustainable”, the haircut needed is now two-thirds. This simply doubles the loss for foreign investors. In the case of a ½ haircut, it would have to become a 3/4 haircut.
Hence the estimated cost for the European taxpayer of a one-third haircut is no longer €60.6Bn, but potentially €121.3Bn. The cost for the European taxpayer in case of a 50% haircut is no longer €91.0Bn, but €136.4Bn…
If Greece leaves, €104Bn of debt will appear. Where from? Target 2 imbalances…In our view we have to assume that the recovery rate would be zero on Target 2, either because it will not be repaid, or because if it is repaid in part, it would be in hard currencies that would not be available for public debt repayment. We thus need to add €104Bn to the number above mentioned, the total cost for the European taxpayer of a Greek exit would then be €225.3Bn in the case of a one-third haircut (1.8% of the Euro Area GDP), €240.4Bn in the case of a 50% haircut (1.9% of the Euro Area GDP).
Clearly, there are still strong monetary reasons for Europe to compromise on some of its demands and keep Greece in the euro, but either way the euro area as a whole is setting itself up for some pretty significant losses.
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