The preliminary data for 2011 are discouraging: a primary deficit (d) of about 5% of GDP, an average interest rate on debt (i) that the Greek Economic Minister Papacostantinou (optimistically) estimates around 4.5%, a rate of Inflation (π) at 2.6%, a negative growth rate of about 3 points and a debt ratio (b) at 150%. These numbers imply that in order to stabilize the debt/output ratio at the current level, it would be necessary to achieve and maintain a primary surplus (-d *) of 7.5 points of GDP. Thus the required cuts would top 12.5% of GDP (see first row in Table 1). Of course, such a consolidation could not be achieved in a single year, and for a time the debt will continue to grow (assuming that Greece may access the capital market).
A new 60 billion loan from the EU-IMF would be of little help (second row of the table). This figure represents about one-fifth of the outstanding debt, so even if Greece could access the new money at subsidized rates (say two points below the actual average cost), this would have only a tiny effect on the average cost of debt, about 40 basis points (= 200 bp / 5). Consequently, the budget surplus needed to stabilize the debt ratio would be reduced only marginally, from 7.5 to 6.9%.
In contrast, a partial default would considerably reduce the required adjustment: a “hair cut” of 40% of the debt’s face value, in addition to the reduction in rates, would imply a sharp reduction in the stabilizing primary surplus, to little over 4 per cent of GDP. The only realistic option to avoid a default would be a resumption of growth: if growth could be revamped into positive territory and stabilized there e (say at 1%) a meager 1.3% primary surplus (see last line) would do to stabilize the debt. But markets do not seem to believe it.
Note: d = primary surplus / GDP ratio, i = average cost of debt, Π = growth rate of consumer prices, r = real interest rate, b = ratio of gross public sector debt to GDP ratio, d * = ratio of primary deficit GDP ratio required to stabilize the debt, d = d *- maneuver necessary in relation to GDP
Sources: EIU, statements by the Minister Greek Papacostantinou, author’s calculations.