Europe ponders letting bailed-out nations default

The unthinkable has become the inevitable three times in Europe's debt crisis: First Greece, then Ireland and now Portugal have all appealed to their neighbors to bail them out after insisting they would never do so.

Now a growing number of economists are urging European finance officials to take a rare and drastic step: Let one or more of the countries go into default.

Euphemistically it's called restructuring their debt, a move that would involve easing the terms of the loans and possibly writing off a portion altogether. Despite the initial shock such a move would cause, advocates say it offers the best chance for the countries' economies to get up and running again rather than remain crippled by debt that becomes ever more of a burden, not less.

Calls for restructuring are coming from experts across the continent, and politicians have broken the taboo on talking about it. German Finance Minister Wolfgang Schaeuble, whose government has put up much of the bailout money, suggested this week that restructuring could be an option if the countries' debts were judged unsustainable.

The official European line is still "No way." Officials fear that even talking about a nation defaulting will frighten investors and spread the crisis to bigger Eurozone countries such as Spain.

"A lot of people who discuss this fail to do the analysis of the costs and put those up against the potential benefits," George Papaconstantinou, Greece's finance minister, said in an interview here this week.

Forcing creditors to take "haircuts," or losses, would devastate Greek banks, which hold a major share of their country's debt, and potentially set off a wider panic, he said.

"Therefore we do not entertain this idea. I know that a big part of the market expects it, but both ourselves as well as the institutions that are backing us … do not consider this as an option," Papaconstantinou said.

Any debt-relief program would certainly have fallout. Bondholders would cry foul, voters in lending nations would be outraged, and the fiscal reputations of Greece, Ireland and Portugal would suffer. Clawing their way back into the markets would be difficult.

But better that, say supporters of restructuring, than saddling those countries with debts they'll struggle to service, much less repay, as their economies sink further through rising unemployment, slumping demand and ever increasing austerity. And instead of fanning the flames of the crisis toward Spain and beyond, restructuring would help confine it to the three small economies engulfed so far.

On Friday, Papaconstantinou unveiled a three-year plan for cutting public spending and privatizing state assets to show that Greece is capable of taming its budget deficit, making its economy more competitive and meeting the demands of the $159-billion rescue package it received last year from the European Union and the International Monetary Fund.

The new plan, subject to approval by lawmakers, envisions $38 billion in budget cuts and a greatly expanded role for private enterprise. In a nationally televised address, Prime Minister George Papandreou said his government's aim was "to restructure Greece altogether, not its debt."

Athens has already undertaken a raft of austerity measures that last year scaled back the deficit from more than 15% of gross domestic product to about 10%. Public-sector salaries and pensions have been cut and taxes have gone up, igniting violent street protests.

Even so, Athens has missed some of the targets set by the EU and IMF, raising fears about its ability to fulfill its obligations.

Ratings agencies continue to downgrade Greek bonds, whose interest rates are currently higher than they were even before the bailout. The economy shrank by a painful 4.5% last year, more than expected. And though exports grew in the past quarter and tourist bookings are up, a further contraction of the economy is predicted this year.

Greece's debt load relative to its GDP is therefore rising, with projections that it will hit nearly 160% next year, precisely when Athens is supposed to return to the markets for some of its funding — 25 billion euros, or about $36 billion. Many analysts are already doubtful that investors will step forward.

"The market is not going to give Greece 25 billion," said Yanis Varoufakis, an economist who teaches at the University of Athens. "So Europe will have to come up with new loans next year."

Arguably, the EU itself has already offered Greece a restructuring of sorts. Last month, it agreed to lower the interest rates on its emergency loans and extend the period over which they must be paid back.

Some experts say European officials, through leaked comments expressing doubt over Greece's ability to dig itself out of its economic hole, are already trying to soften public opinion about an inevitable default.

Here in Greece, a recent poll found that a majority of respondents believe their country will ultimately go for some kind of formal debt relief.

To Miranda Xafa, a former member of the IMF's executive board, a restructuring seems "very, very probable," more a matter of when than if. Xafa, who is Greek, thinks the when comes in 2013. At present, Athens is still nursing a budget shortfall before interest payments are factored in. So even if its debts were slashed by 90%, it would still have no money to service the little that remained.

"Creditors have no incentive to go to the negotiating table, because Greece has nothing to offer," said Xafa, now a strategist with IJ Partners, a Geneva-based investment firm. "It will have to happen at some point, but now is a bad time, because from Greece's viewpoint, it will just slow the momentum for reform."

If the Greek government can hold its nerve in the face of the backlash, then a debt restructuring will be neither necessary nor desirable, maintains Yannis Stournaras, director of the Foundation for Economic and Industrial Research in Athens.

Stournaras and other optimists essentially plead for time for Greek's retrenchment plan, time that the markets have so far been disinclined to give. They also warn against viewing restructuring as a substitute for the tough economic reforms and the crackdown on Greece's endemic tax evasion that still must take place to put the economy on a competitive footing.

"A lot of people in society look at restructuring as a way out of these painful choices," said Michael Massourakis, chief economist for Alpha Bank. "They don't understand that even if you restructure, the amount of austerity will remain the same or even intensify."

For now, Athens insists that there are no plans for a restructuring.

"We are not engaged in any official sense in such negotiations," Papaconstantinou said. "I keep reading we have mandated people to do that. There is no mandate for any entity to prepare or undertake such an exercise for us.

"Obviously, we read the analysis and we follow the debate," he added. "But we are sticking to doing what we have committed to do and what we have agreed with our partners."

Special correspondent Anthee Carassava in Athens contributed to this report.

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