Greece, private investors struggle to agree on high-stake debt deal

The Greek government and its private bondholders are locked in high-stake debt negotiations in Athens. If they fail to reach a deal, it could finally trigger the oft-predicted Greek default and cause huge problems for the eurozone.

In the proposed debt swap plan, private investors will write off a certain amount of the Greek debt they hold, known as a haircut. At an EU summit in October, leaders agreed to a target of 50 percent, with the rest to be paid out in a combination of cash and new bonds. Negotiations are held up over both the size of the haircut and the interest rate for new bonds. 

The participation of private creditors is a vital part of the international effort to save Greece’s economy from collapsing. Without it, the second bailout package for Greece, set up by EU and International Monetary Fund (IMF) and worth €130 billion ($169.5 billion), will not be paid out. On March 20, Greece has to pay back €14.5 billion ($18.4 billion) of bonds – money it does not have.

“The financial and political costs of a Greek default and subsequent departure from the eurozone by far outweigh the costs of keeping the country afloat,” says Thomas Klau, Senior Policy Fellow at the European Council on Foreign Relations in Paris.

Greek Prime Minister Lucas Papademos and Charles Dallara, director of the Institute of International Finance (IIF), which represents Greece’s private creditors, are also trying to agree on the interest rate for the new bonds. Greece has offered an average rate of 3.5 percent, while the IIF is asking for a minimum of 4 percent.

If the deal goes ahead, it would cut about €100 billion ($129 billion) off Greece’s €350 billion ($451 billion) debt load. But the involvement of private creditors – pushed for mainly by Germany – is voluntary and it's unlikely all of them will agree to the haircut. Several European banks holding Greek bonds are reluctant to accept such a large write-off, as are hedge funds that bought Greek bonds cheaply and are hoping to cash in on Credit Default Swaps (CDS) they purchased, which pay out when a debtor defaults.

Greece has announced that if a deal was blocked by a relatively small number of creditors, it would consider legal options. Prime Minister Papademos said he would introduce a law commonly known as a collective action clause (CAC), which forces creditors into a write-off, provided a large enough group of bondholders accepts the conditions. 

Should the negotiations fail, the consequences could be severe. In the worst-case scenario, according to Mr. Klau, there would be a chain-reaction leading to further destabilization of other European economies. “It would be foolish and dangerous to hope for a more benign scenario,” he says. 

Some observers see reason for cautious optimism. "Neither party is interested in a disorderly default,” says Ben May, European economist at the London-based consultancy Capital Economics. “So there will be some bargaining up to the last moment, but in the end we’ll see a deal.”

Finance Minister Evangelos Venizelos told the Greek parliament that a deal with the IIF would be sealed by Monday, coinciding with the next meeting of eurozone finance ministers in Brussels. But even with a deal, there is no guarantee a Greek default can be averted.

Officials from the EU, IMF and European Central Bank – the so-called troika – are currently in Athens to check on progress in Greece’s efforts to cut spending and reform its public sector. Although the troika representatives are not scheduled to report their findings until next week, it is already clear that Greece is lagging behind – the sale of public assets is slow and not enough tax revenue is being raised.

Olli Rehn, the EU Commissioner for Economic and Monetary Affairs, blames Greek politics. Parties are already campaigning for parliamentary elections in the spring and the various austerity measures demanded by the troika are unpopular in Greece.

In an interview with German daily Süddeutsche Zeitung on Friday, Mr. Rehn asked Europe’s political leaders to put pressure on their Greek colleagues. "The Greeks have done a lot. If they are not making progress it is for domestic political reasons. It is crucial that major European political parties contact their political families in Greece to convince their leaders to make a firm commitment to the EU aid package," the commissioner said.