Let’s not overplay the benefits of debt relief
During his trip to the United States, Alexis Tsipras repeatedly raised the issue of debt relief. He is not alone. Back in July 2015, the International Monetary Fund produced a sustainability report which also raised the issue of a “voluntary” haircut on the debt holdings of Greece’s eurozone partners. Tsipras has been more explicit. For example, peaking to The Wall Street Journal, he argued that a possible Greek debt restructuring will almost immediately be followed by access to international financial markets. Needless to say, he is wrong. This is because gaining access to financial markets works through the “blessing” of credit rating agencies.
Let us elaborate on this. We will focus on Moody’s Investor Services because academic research has shown that investors value decisions made by Moody’s “more” than those by either Standard & Poor’s or Fitch Ratings. Faced with a Caa3 credit rating by Moody’s, Greece is in desperate need of an upgrade of nine notches to exit so-called junk territory. Using the empirical model from our new academic paper (to appear in the peer-reviewed academic journal Economics Letters1), we come to the conclusion that a deep front “voluntary” haircut of as many as 40 percentage points in the debt-to-GDP ratio (that is, from the current 177 percent to 137 percent) will raise Greece’s credit rating by only three notches. That credit upgrade would be too little to take Greece out of junk territory. Nevertheless, combined with a swift improvement in regulatory quality, which has the potential of raising Greece’s credit rating by some six notches, Greece could exit the junk territory sooner than later.
Needless to say, regulatory quality in Greece is poor. To understand this, one can look at the World Bank’s regulatory quality index. The index captures perceptions of the government's ability to formulate and implement sound policies that promote private sector development. Among 215 countries, the index ranks Greece in the 73rd percentile. Spain is ranked higher, in the 79th percentile, and Ireland much higher, at the 94th percentile.
In other words, Greece is lagging behind other peripheral countries in terms of regulatory quality. With this in mind, Tsipras does not have sufficient room for maneuver. The Greek prime minster needs to start implementing structural reforms before even contemplating a return to the financial markets. Needless to say, he has to do this whether or not debt restructuring is agreed.
1. Our paper, titled “Has the crisis affected the behavior of the rating agencies? Panel evidence from the eurozone,” is available here.
* Costas Milas is a professor of finance at Liverpool University, Theodore Panagiotidis is an associate professor at the University of Macedonia, Thessaloniki, and Periklis Boumparis is an MSc graduate from the University of Macedonia, Thessaloniki.
