Quite a lot of people believe that, given that Greece had a large primary deficit during 2010, signing an MoU was the only actual alternative available to the country. A possible default would have been devastating by not allowing the Greek government to carry out basic expenditures (wages, pensions, medicine bills) and bankrupting its banking system. The latter would mean that access to central bank financing would be severely limited or stopped and Greek citizens would not be able to withdraw their funds and imports would be restricted, leading eventually to an exit from the Euro area.

In my view, actual facts are not quite as dramatic as the above narrative.

Fiscal Position

The 2010 primary deficit was (according to Ameco) €10.9bn, compared to €24.2bn during 2009. According to the Greek Ministry of Finance 2010Q1 Debt Bulletin, cash deposits were close to €7.16bn. Based on Bank of Greece data, up to the end of April 2010, the (cash flow basis) primary deficit was €4,3bn while the change in cash balances was around €46mn. As a result, the Greek government held €7.2bn in cash with a need for another €6.6bn to cover the primary deficit until the end of 2010. In terms of interest, up to April €3.3bn out of €13.2bn had already been paid. Although long-term notes could not issued, Greece had not lost access to short-term (T-Bill) financing at any point (issuance actually almost doubled from 9bn to 16bn during 2011).

It is clear that any financing from the EU/IMF would not be used to cover primary deficit needs but in order to avoid a debt default / renegotiation. The Greek government actually had quite a lot of leverage and was not under any time pressure to quickly find funds to continue its operations.

Banks Position

Although the cash balance was quite positive, it is also argued that defaulting on its negotiable debt would threaten the stability of the Greek banking system by requiring an immediate recapitalization and closing down its access to central bank financing of its liquidity needs, putting a huge constraint on imports and withdrawals which would quickly lead to mass panic.

Based on Bank of Greece data, Greek banks held an aggregate of €44.6bn in central government securities (of which around €3bn were in T-Bills). The IMF Financial Stability Indicators show that during 2010Q1, the banking system had total regulatory capital of €28,13bn (for 2€40.45bn in risk-weighted assets), a capital ratio of 11.7%.

In 2010, the necessary NPV loss to return Greek debt on a sustainable path was much lower than the losses actually taken in the PSI. Based on the Greek MFI exposure, even a 30% loss on their holdings would mean a reduction of €12.5bn from their capital which would lower their capital to €15.6bn (still positive) and the tier-1 ratio to 5.9% (for comparison, PSI losses reached €25bn). Although there would have been a need for capital injections, Greek banks would still maintain a strongly positive capital position and access to central bank liquidity.

Deficit Reduction

The major advantage of an early debt default is that interest expenses would be immediately lowered. As a result, the deficit reduction exercise would be more front-loaded and would not require large reductions in primary expenditures (and tax increases) but rather a more long-term, structural approach (including the pensions reform, lowering the public employment wage bill and targeting high health expenses). The table below shows the actual interest expenses during 2009 – 2011 and probable primary ‘savings’ in an alternative early default scenario. It is clear that the savings are substantial and would allow for almost an elimination of all measures carrying a high fiscal multiplier in the alternative scenario.

interest savings