Greece’s debt is unsustainable. The International Monetary Fund has said so, and it’s hard to find anyone who disagrees. The Greek government sees structural reform without debt reduction as politically and economically toxic. The main governing party, Syriza, has made debt reduction a central plank of its electoral platform and will find it hard to hold on to power — much less implement painful structural measures — absent this achievement.
Moreover, tax increases and spending cuts by themselves will only deepen the Greek slump. Other measures are needed to attract the investment required to jump-start growth. Reducing the debt and its implicit claim on future incomes is an obvious first step.
But German Finance Minister Wolfgang Schaeuble and Chancellor Angela Merkel refuse to consider any cut in the nominal stock of Greece’s debt to the European Union. They refuse to agree to debt-service reductions without prior structural reforms. In their view, lower interest rates, grace periods and more generous amortization terms should be a reward for prior action on the structural front. If they are offered now, Greece will only be let off the hook.
There’s an obvious way of squaring this circle: Greece and the EU should contractually link changes in the terms of the country’s EU loans to milestones in structural reform. Think of the result as structural-reform-indexed (SRI) loans, akin to former Greek Finance Minister Yanis Varoufakis’s gross-domestic-product-indexed bonds.
Under the new loan terms, if Greece implements more reforms, future interest payments would be permanently lower and principal payments would be extended indefinitely. Full implementation of the specified reforms would turn Greece’s debt into the equivalent of zero-coupon, infinitely lived bonds that drain little if anything from the public purse.
Greece should welcome this arrangement, because it would receive a guarantee of debt reduction, not just vague reassurances. The German government and other creditors should welcome it as well, because debt reduction would only be conferred if Greece follows through with structural reform. Both sides would appreciate that Greece’s incentive to push ahead with reforms would be heightened insofar as successful reform conferred an additional reward.
Even better, Euro-group members could convert their bilateral loans and European Financial Stability Facility/European Stability Mechanism funding for Greece into SRI bonds. These could then be used for debt-for-equity swaps with private investors and for other forms of investment-friendly debt conversion.
There is precedent for this kind of arrangement. In 1991, Western governments, negotiating as the Paris Club, offered Poland a deal in which debt reduction was linked to structural reform. In the first stage, Poland received a 30 percent cut in the present value of its debt in return for agreeing with the IMF on the terms of a structural adjustment program. In the second stage, Poland received a further 20 percent cut contingent — importantly — on fulfillment of the structural conditions of its IMF program.
The second stage was also contingent on Poland negotiating a comparable reduction, totaling 50 percent, in its privately held debt. In Greece’s case, this element is conveniently already in place, as Greece’s private bondholders already had their holdings “haircutted” by some 60 percent in 2012.
As a result, as in Poland in 1991, the majority of the troubled country’s debt is in official hands. This makes the kind of contractual agreement we propose relatively straightforward to arrange.
Converting Greece’s debt into SRI bonds would have to surmount two hurdles. First, the parties would have to specify a list of reforms and a corresponding timeline, and incorporate these into their debt contact. Agreeing on a comprehensive list of reforms and the priority attached to each would not be straightforward. But doing so would be a valuable form of intellectual discipline. Asking the Greek authorities to do everything, without a timeline and without attaching degrees of importance to different policy measures, is easy. Specifying corresponding weights and schedules — prioritizing, in other words — is harder, but no less important for the fact.
Second, there would have to be an impartial body to monitor and verify implementation of the measures. In Poland’s 1991 debt deal, the IMF played this role. But the Greek government doubts the fund’s impartiality, not least because the IMF itself is a not-entirely-disinterested creditor. It would be better under the circumstances for implementation to be verified by a panel of three independent experts: one nominated by the Greek government, one nominated by the Euro group and one acceptable to both parties.
A final noteworthy aspect of the 1991 deal is that Poland’s principal creditor at the time was none other than Germany. That Germany has seen this kind of arrangement before is one reason it should consider it again.
Barry Eichengreen is George C. Pardee and Helen N. Pardee professor of economics and political science at the University of California at Berkeley.