Greece's Default Dilemma
Why an Argentine-style default could destroy Greece.
In the January 18, 2002, issue of the Spanish newspaper El Pais, Anne Krueger, then the first deputy managing director at the IMF, pointed out that more than ninety sovereign defaults had occurred over the last two centuries. She added that “defaults are always painful . . . but when a country’s debts become truly unsustainable, it is in everyone’s interest that the problem [be] addressed promptly and in an orderly way.”
Inevitably, given Greece’s inability to service its sovereign debt, increasing numbers of observers are asking whether its debts have become “truly unsustainable” and, if so, whether the problem should be addressed under terms of what Krueger called “in an orderly way”—meaning default. Some have pointed to Argentina’s default on its loans in 2001 and the result—no particularly high price for not honoring its debts. If Argentina could do it, goes the refrain, why not Greece?
Argentina did not seem to suffer much from the experience, at least over the medium run. After experiencing a sharp drop in its gross domestic product around the immediate period of the default (4.4 percent drop in national income in 2001 and 10.9 percent drop in 2002), the economy recovered quickly, with a growth rate of 8.8 percent in 2003 and generally high growth rates in successive years. Exports remained at high levels, and imports, which had fallen sharply in 2002, recovered by 2004. The unemployment rate rose to 20.8 percent in 2002 but fell significantly in 2003 and in later years. All in all, it would be easy to conclude that the Argentine experience indicates there is life after a sovereign default.
However, before we accept that conclusion too quickly and apply the Argentine lesson to Greece, we should consider some of the differences that exist between the two countries and the two situations. These differences suggest the outcome of a sovereign default for Greece could be significantly less favorable.
There are, first of all, significant quantitative differences between the two countries. In mid-2001, before Argentina defaulted, the spread on its bonds reached astronomical dimensions. Argentina did not have (as Greece still has today) other sources of loans obtainable at reasonable rates. After the IMF cut its financial support, because Argentina was not complying with its negotiated program with the Fund, the country could only borrow from the foreign market at extremely high rates. At that time, its public debt was only around 50 percent of GDP and its fiscal deficit (which, according to some observers, may have been underestimated) was only 2.5 percent of GDP. With those statistics it would have easily met the Maastricht criteria. Argentina’s constitution did not allow the printing of money, just as the government of Greece cannot print money to finance its deficit because of Eurozone constrictions. Argentina had already privatized all that it could to get public revenue. It was thus in a straitjacket.
By contrast in Greece, in 2011, the public debt is estimated to be around 165 percent of GDP, and a significant part of it is owed to its own banks. The general government fiscal deficit was 10.6 percent of GDP in 2010, having declined from 15.6 in 2009. If Greece stopped servicing all its debt, thus at the same time losing the cheap financial support that it has been getting from official sources (EU, IMF etc.), it would still have a large (primary) deficit that would need to be financed. The primary deficit is the deficit calculated excluding the payment of interest on the public debt. That primary deficit would likely grow after the default because the tax revenue would fall. The impact of the default on Greek banks and on Greek imports would almost guarantee that Greece would experience a sharp recession that would increase the primary deficit.
In 2001, in Argentina, the public spending of the general government was less than 30 percent of GDP. In Greece, in 2010-2011, that number was about 50 percent of GDP. This very high public spending provides employment, pensions and various subsidies to a large share of the population—those working for the government (under labor contracts guaranteed by laws and defended by strong unions) , and those receiving equally protected and difficult-to-reduce public pensions and other benefits. There has been huge political resistance to changing the existing arrangements that are clearly unsustainable. Street demonstrations have occurred daily. In case of a debt default, most of these obligations would still be there. And they would be there after such a default sharply reduced the tax revenue. This reduction in revenue is especially likely because of the impact the default would have on the Greek banking system. Meanwhile, some foreign lenders would go to foreign courts to grab Greek assets in order to recover some of their losses. In Argentina, much of the public debt before the default was due to foreign banks and to other foreign financial institutions. Therefore, the impact on Argentine banks was less stark.
There are other reasons why a Greek default would have more serious consequences than the Argentine’s. Before the Argentina’s default, the country’s economy had been hurt by three external shocks. First came the strong appreciation of the dollar in that period, to which the peso had been tied. This link had made Argentine goods relatively expensive, reducing exports. Second was the economic crisis in Brazil, Argentina’s major trading partner. Third, commodity prices had dropped sharply in the 1990s. These factors reversed themselves after (but not because of) the default. The link to the dollar was removed so that Argentina was able to devalue its currency, reducing imports and stimulating exports. Second, the Brazilian economy recovered from the crisis, which increased its imports from Argentina. Third and most importantly, there was a sharp and sustained increase in the world prices of commodities that Argentina exports. Furthermore, the Argentine authorities managed to control the fiscal accounts after the default. For Greece, it would be much more difficult to control the fiscal accounts after a default.
Greece does not export commodities and, as long as it stays within the Eurozone, cannot devalue. Even if it could, the devaluation would not translate automatically in a significant improvement in its balance of payment and in its fiscal accounts because of the power of the labor unions that would push for compensating wage increases, because of the many rigidities in the economy and because of the absence of obvious export possibilities, such as commodities.
If Greece left the euro and went back to its old currency in order to devalue and to default on its debt, it would face a lonely and difficult world. One should hesitate to predict what that world would look like for Greece. The sad conclusion is that, with all the current difficulties that Greece faces, the least painful option may still be the one that it is pursuing with the cooperation of the EU, the IMF and the ECB. It has made more progress than newspapers’ accounts keep reporting.
Vito Tanzi was director of the IMF Fiscal Affairs Department for 20 years, from 1981 to 2000. He has served as senior associate at the Carnegie Endowment for International Peace, undersecretary for economy and finance in the Italian government, and consultant and scholar to various international institutions and research institutes.