A one-off debt restructuring of 50% of the Eurozone sovereign debt — Charles Wyploz explains its PADRE proposal
Eurozone has a problem with overghang sovereign debt in a group of member countries with public debt-to-GDP above 100% . CEPR and the International Center for Monetary and Banking Studies (ICMB) released a new report end of January that fleshes out a plan for restructuring the sovereign debt, by banker Pieere Pâris and professor Charles Wyplosz. The acronim for the plan is PADRE for Politically Acceptable Debt Restructuring in the Eurozone.
Basics of the Plan: «PADRE plan starts from the view that several Eurozone countries have accumulated unsustainable public debts. Unsustainability here does not imply that the governments are bankrupt; technically, given sufficient time, governments are rarely unable to raise adequate resources, one way or another. Some governments may run out of time when they lose market access or face high borrowing costs, which is a case of illiquidity, not insolvency. Unsustainability here means that once the sovereign debt crisis is over, several governments will face a debt burden that will stunt economic growth, prevent the use of fiscal policy – the only macroeconomic instrument left in a monetary union – to deal with cyclical swings, and generally make them excessively vulnerable to market sentiment. The implication is that public debts must be restructured.»
Proposal: «The plan involves an agency that acquires at face value on average a share of 50% of existing public debts and swaps them into zero-interest perpetuities. In practice, therefore, the corresponding debts are wiped out. To that effect, the agency borrows on the financial markets the amount needed to acquire the debts. The agency best suited for the task is the ECB, for three main reasons. First, it is the only institution that can mobilise the required resources (in our main example, we assume that half of existing debts are bought and swapped, which amounts to some €4.5 billion, or $USD 6.2 trillion). Second, because central banks do not have to worry about their capital, they have a unique credibility and can sustain large losses. Third, the ECB passes on its profits to Eurozone member countries. This applies to losses as well.»
Visit PADRE at: http://www.voxeu.org/content/padre-politically-acceptable-debt-restructuring-eurozone
Charles Wyplosz interviewed by Jorge Nascimento Rodrigues, February 2014
A Portuguese version was published at Expresso weekly newspaper included on an article by João Silvestre and Jorge Nascimento Rodrigues
Charles Wyplosz is Professor of International Economics at the Graduate Institute, Geneva, where he is Director of the International Centre for Money and Banking Studies. Previously, he has served as Associate Dean for Research and Development at INSEAD and Director of the PhD program in Economics at the Ecole des Hautes Etudes en Science Sociales in Paris. He is a CEPR Research Fellow and has served as Director of the International Macroeconomics Programme at CEPR.
Question: Incidentally “PADRE” in Portuguese is the word for priest. Your proposal is a disguised debt “pardon” of 50% of the eurozone sovereign debt, particularly for the group of 5 peripherals?
Answer: Sorry, the PADRE plan does not include any debt pardon and it is designed to be adopted by all the Eurozone countries. This is why it is an innovation and, I believe, useful.
Q: In your judgment the peripheral sovereign debts are unsustainable, despite IMF and EU insists they are sustainable?
A: Sustainability is a completely misleading word. We do not know whether the Portugese debt is sustainable because it depends on how much the governments will spend and raise taxes on the text hundreds of years. There are related questions that can be answered. For example, do financial markets want to lend to the Portugese government? The answer is: they used to, now they don’t, soon they will. My question is: can Portugal grow at a rate that keeps full employment with the current debt level. My answer is: most likely no.
Q: The European Union is prepared (politically speaking) to accept as a “normal way” a Eurozone wide debt restructuring after considering for years that the Greek PSI of 2012 was a “unique” solution and that debt restructuring is “normally” a proposal from “radicals”?
A: The question really is: do we prefer slow growth and lasting high unemployment, or debt restructuring? Governments never want to make these choices. This is how we ended up with the worst European economic crisis ever. Remember, PSI was ruled out for more than one year and then, guess what, it happened when governments discovered that it was that or an explosion of the euro.
Q: Could this kind of general restructuring avoid some stigma over countries like Portugal, considered fiscal “delinquents”?
A: This is one reason why the PADRE plan requires a restructuring of public debts of all Eurozone countries.
Q: Do you really believe that debt restructuring could be “well-planned” and “non-disruptive”? Or there are always risks of a «credit event» considered by the market?
A: The PADRE plan restructures debt without imposing losses on any one. Restructuring here means that the Portugese public debt will be repaid entirely but very, very slowly as the profits of the ECB are not distributed back to governments but used instead to retire the debt. Why would markets panic? On the contrary, markets will be totally and rationally exuberant.
Q: To give the ECB a status of a kind of “fiscal agent” is not to confer excessive political power to a non-elected institution by citizens, at the moment an European Parliament initiative state we must not repeat the democratically “uncontrolled” troika processes?
A: The troika means that the ECB gives orders to governements, alongside the Commission and the IMF. This is indeed not the ECB’s mission and one reason why the Troika arrangement is a big mistake. In the PADRE plan, the ECB has no authority. It is asked not to pay its profits to governments but to repay their debts.
Q: That would mean a fiscal union with a shadow role for the ECB beyond its supervisor role in the banking union?
A: Absolutely not. A fiscal union means some common taxes and some common spending. There is not a word about that in the PADRE proposal because these are unrelated issues.
Q: Do you think Bundesbank and others will accept a change in the ECB mandate to accommodate the role of full lender of last resort that you propose directly or indirectly?
A: You should ask them. And you should ask yourself who will make such a decision.
Q: Your basic conditionality is the approval – including the use of a referendum – of a new constitutional iron rule of a debt ceiling for the debt ratio to GDP. The golden rule regarding the fiscal structural deficit had problems so far to be accepted as legal enforcement. Do you think your rule will be accepted by citizens?
A: Indeed one of our conditions it to apply fully the TSGE, as you describe it. Many governments do not want a fiscal rule to be in their constitutions because they still hope to run budget deficits for ever. For example, Portugal has had deficits every year since 1977. Portugese people older than 37 have never seen in their lives a year of budget equilibrium or surplus! Fiscal discipline is not something that you accept or not. Either you do it, or you eventually face a crisis. The citizens should force their governments to inscribe fiscal discipline in their constitutions. They have done so in a number of countries, in Europe and in Latin America, as well as in every single state of the USA.
Q: What is your main critic to Eurobonds proposals?
A: It means that Germany guarantees Portugese debt. Would you guarantee my personal debt? One day, we will have Eurobonds, but first we need a guarantee that fiscal discipline is in place. Your previous question seems to indicate that we are not ready for fiscal discipline. Then it means that we are not ready for Eurobonds.
Q: You propose a process of progressive swaps in the secondary market and not a one-off event. Why?
A: I am happy with a one-off but a progressive purchase of bonds will reduce the short-run losses of the agency in charge. The difference is of a second order of magnitude.
Q: Even with your proposal in the basic scenario, there are 3 countries that remain in a danger zone – Greece, Italy and Ireland – with post-restructuring ratio debts above 80% of GDP. What can be done complimentary?
A: I would support, in addition to the PADRE plan, some debt cancellation for these countries. But PADRE should come first.