15 January 2011

Are Debts of PIIGS Ever Meant to Be Paid Back?

PIIGS – Portugal, Italy, Ireland, Greece, Spain – all they have either already passed or on the very edge of passing the Point of No Return with their government debts. Of course, they aren’t the only ones, by far. There are several other countries too. But some of them may easily turn out to be among the first ones of the developed countries who have to admit this. What doesn’t make sense to common sense is that their debts appear never meant to be paid back in full.

The data depicted on a simple graph below basically summarise the issue for Greece: government debt as a percentage of GDP and government budget surplus/deficit (financial balances) since 1995. We see that by 2012, general government debt is forecasted to be more than 140% of GDP. We also see that its budget has been in deficit over the entire observation period – in fact, it has been in deficit since early seventies. So the debt crisis is not because of general hard times in economy. 

For Italy, the picture right now looks a bit better but not much. By the end of 2012, OECD forecasts its government debt to be 133% of GDP. Also Italy’s government budget has been in deficit for a long time: I don’t have the whole history in front of me right now, but a quick look to OECD data shows that at least since 1995 (and probably much earlier).

What about Portugal? You guessed it. The story is the same: big debts and chronic budget deficit. Spain? Hold your breath now: if Spain fails... well, it’s too big to save. Currently, government debt is smaller: “only” around 72% of GDP. However, there are “skeletons in cupboard” and government budget also tends to be in deficit all the time.

We all know what happened with Ireland because of its banking sector. 32% of budget deficit for a developed country sounds almost unbelievable.

Let’s do a bit math while using Greece as an example. What we attempt to find is a rough estimate of how many years it would take for Greece to repay (and not just refinance) all of its government debts.

As of at the end of second quarter 2010, according to the data from Eurostat, Greece’s government debt was EUR 314 billion. Its estimated GDP at market prices was around EUR 230 billion for the year 2010. This means that if Greece’s government would somehow (selling assets, increasing taxes, cutting costs or whatever, and not taking into account current interest payments in the expenditures side) manage to end up with a budget surplus of 3% of GDP, its debt would still be more than 45 times the hypothetical budget surplus of EUR 6.9 billion (3% of EUR 230 billion). Read: it would take more than 45 years for Greece just to pay down all its debts even if we assume zero interests.

Of course, nominal GDP grows too. Let’s assume that the annual GDP growth is a healthy 4%. So, budget surplus which is the source of cash for paying pack debts would also grow 4%. In that case and if still assuming zero interest rate for the debt, the number of years needed for paying down the debts, reduces to some 26 years (mathematically a troublesome calculation, so I just prolonged the time series in Excel to see what happens). 26 years even with such unrealistic assumptions!

Let’s make the calculation a bit more realistic and assume that annual interest rate which Greece has to pay for its debts, is 3%. This is again a very optimistic assumption compared to the reality where Greece’s 10-year government bond yield has rallied from around 6% to almost 10% during 2010 alone, and been above 3% even in best of times. Yields of all outstanding 3 year bonds and 5 year bonds are also comfortably above 3% (see the data from the website of Greece’s Ministry of Finance). The result is almost 40 years. It would take 40 years even with a healthy economic growth in each year to repay all the debts.

To conclude, the good news is that there is at least a theoretical possibility that Greece and others can pay back all their debts during the coming, let’s say, 50 years (we added 10 years to the calculated 40 for dealing with all the current struggles, as well as for the so much needed restructuring of the economy). However, given the optimistic assumptions that we made (very low interest rates, historically unprecedented strict budget controls for all those years, achieving a healthy economic growth somehow) and the way our current debt-based monetary system functions, repaying all the debts is a hard to believe scenario. For example, a steady 2% GDP growth combined with the 4% interest rate would mean 115 years instead of 40-50. A 5% interest rate combined with the 2% GDP growth would mean an unsustainable path.

Finally a question to the lenders: have you guys ever conducted sensitivity analyses to government debts? I mean checked what happens to a country’s debts servicing ability if interest rates are rising and/or its economic growth slows down? It would be interesting to take a look to this kind of analyses.

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