Re-profiling Sovereign Debt

Stavros A. Zenios

University of Cyprus

Senior Fellow the Wharton School, USA

Outline

¤ An Overview of Sovereign Debt Crises

¤ Sovereign Debt Re-profiling Challenge

¤  Issues in Debt Re-profiling

¤ Argentina, Greece, Cyprus

¤ Scenario Analysis for Optimal Debt Restructuring

An Overview of Sovereign Debt Crises

Eurozone debt

Is the Eurozone public debt too high?

¤ Reinhart-Rogoff and others § The 90% threshold § Some debate (exogeneity and instruments) § Good reasons

¤ Theory § Tax burden § Financial risk, borrowing costs, shocks, multiple

equilibria § Policy constraint

Special features of Eurozone debt

¤ The diabolic loop (Brunnermeier et al., 2011) § Governments at risk borrow from banks § Banks are at risk: need government rescue § ECB is not lender of last resort

¤ More generally: governments borrow in foreign currency (De Grauwe, 2012)

¤ Both are sources of multiple equilibria

¤ Eurozone countries like developing countries

¤ Lower public debt thresholds (R&R, Cecchetti et al.)

Historical note: For young countries

¤ Average years to default-rescheduling for African and Asian countries

¤ 31.5 years

¤ Average years to default-rescheduling for Latin American countries

¤ 36 years, including Great Depression ¤ 38 years, excluding Great Depression

Historical note: Share of time in default or rescheduling since 1800

¤ All European Countries: ¤  Share of years 14.3%

¤  Number of episodes 3.8

¤  European countries that defaulted at least once ¤  Share of years 22.8%

¤  Number of episodes 6.1

¤  Greece 50.6%, 5 episodes

¤  Germany 13%, 8 episodes

¤ Latin American countries ¤  Share of years 34.7%

¤  Number of episodes 7

Sovereign Debt Restructuring Challenge

Debt is Fragile: Hyman Minsky

¤ Phase I. Hedge finance

¤ Phase II. Speculative finance

¤ Phase III. Ponzi scheme

¤ Where do Governments operate?

Factors of fragility of public debt

¤ Ability to repay: ¤  Interest rate ¤ Debt/GDP ratio

¤  Interest rate goes UP as ability to repay goes DOWN

¤  Increase debt servicing cost = “Snowball effect” on GDP

Spreads of 5-year CDS of government bonds for European countries under assistance programs.

!

Marked!with!a!triangle!are!the!dates!of!applying!for!a!assistance!and!with!bullet!point!the!dates!of!reaching!agreement.!Graph!as!presented!by!A.!Orphanides!at!the!Tassos!Papadopoulos!Center!

Conference!on!“Five!Years!Euro”,!17!May!2013.!!!!

Snowball effect - Cyprus

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Public Debt to Revenues

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External Debt to GDP

Getting out of a debt trap

IMF Board notice 13/61, May 2013

«debt restructurings have often been too little and too late in recent crisis cases, thus failing to reestablish debt sustainability and market access in a durable way.»

Getting out of a debt trap

Charles Wyplosz and Pierre Pâris, 2013.

Mutual Agreement for Public Debt Restructuring in the Eurozone: The MADRE Plan

Debt re-profiling

¤ Extend maturity

¤ Adjust interest rate

¤ Preserve (or not) present value

¤ Preserve (or not) nominal value

Rescheduling vs Restructuring

Re-profiling the Cyprus debt

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Original debt Restructured debt

Issues in Debt Re-profiling

Issues in debt re-profiling

1.  Face and market value of bonds or loans

2.  Amortization schedule (bullet vs amortization, existence of a sinking fund)

3.  Interest rate and coupon (fixed vs flexible, step-up or linked)

4.  Currency of denomination of the instruments (local vs foreign)

5.  Enhancements, including embedded options or collateral

6.  Legal clauses (CACs, non-default clauses, exit consents).

Who does it?

¤ OSI vs PSI

¤ Paris Club

¤ London Club

¤  International Institute of Finance

¤ ECB, EC, IMF (the Troika)

¤ Coordination problems

How to do it?

Principles for Stable Capital Flows and Fair Debt Restructuring, 2013, Washington, DC: International Institute of Finance.

1.  Transparency and Timely Flow of Information

2.  Close Debtor-Creditor Dialogue and Cooperation to Avoid Restructuring

3.  Good-Faith Actions

4.  Fair Treatment

Argentina and Greek Debt Restructuring

Argentina 2000-2005 crisis buildup

¤  Asian crisis 1997-1998 => -10% price of Argentinean exports

¤  Russian crisis 1998 => Increase Argentinean borrowing costs

¤  Devaluation of Brazilian real 1999 => -20% price of exports

Parliament refuses budget cuts in 1999!

¤  Debt to GDP ratio 1998:

Canada 94%, USA 64%, Brazil 42%, Argentina 38%,

¤  Interest paid on external debt as % of exports 1995 => 21% 2001 => 36%

(Brazil 25%, Chile 9%)

Argentinean debt crisis unravels

¤  $40 billion “blindaje” with international lenders, Dec. 2000

¤  Rates drop by 300bp

¤  Swap $4 billion bonds with longer maturities, Feb. 2001

¤ Mega-swap $30 billion at higher interest rates, June 2001 ¤  $8 billion deferred 2002 ¤  $16 billion deferred 2005 ¤  $8 billion IMF financing

¤  $55 billion bond swap with debt guarantees from financial tax, Nov. 2001

Argentinean debt climax

¤ Downratings by agencies

¤  Spread 2000 bp

¤  Bank runs

¤ Corralito in Dec. 2001

¤  IMF suspends disbursement

¤  Political instability

¤  January 2002 defaults on $28 million lira-denominated bond

¤ Argentinean bonds trade at 80% discount

Argentinean debt crisis management

¤ Peso devaluation in 2002

¤  IMF refinancing $21 billion 2003 UNCONDITIONAL

¤ GDP growth in 2003 and 2004

¤ Debt restructuring 2005: ¤ Bond exchange 35 cents per $

¤ Local law

¤ Holdouts – vulture funds.

The Greek public debt crisis

IMF projections of Greek program

PSI and PSI+

¤  July 2011, 21% PV haircut

¤  October 2011, 80% haircut on PV and 50% on nominal

¤  Euro 130 billion assistance package

¤  Euro 100 billion debt write-off

Bank of Cyprus exposure to GGB

The greatest carry trade ever

¤  Acharya and Steffen, May 2013

¤  ECB repos and invest in periphery countries

¤  Bank of Cyprus ¤  Euro 3 billion repos T 1.25%

¤  20% of bank profitability

¤  Sovereign default NOT in EBA stress tests!

Who paid the Greek PSI

!! CY!! GR! Germany!! Belgium!! France!! Portugal!PSI!losses!!(!bil!!€)! 4,14! 24,3! 3,6! 2,1! 5,04! 0,42!%!GDP!! 23.03! 11.65! 0.14! 0.56! 0,25! 0,25!!

Was Cyprus in trouble?

0 100 200 300 400 500 600 700

Ireland

Greece

Cyprus

Cyprus -post Greek PSI

Mature economies

Households NFC FINANCIAL Govt

35

Cyprus Tipping Point: the banking sector?

Source¨ECB, 2009.

0%

500%

1000%

1500%

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2500%

Κυπρος Ελλαδα Ιρλανδια Λουξεμβουργο Μαλτα Ολλανδια ΗνωμενοΒασιλειο

ΣΥΝΟΛΟ

ΕΝΕΡΓΗΤΙΚΟΥ

(%

ΤΟΥ

ΑΕΠ

)

Ξενα Υποκαταστηματα Ξενες Θυγατρικες Ντοπιες Τραπεζες

New meaning to political risk

Bail in

•  Bad Politics in the Way of Good Policy •  Haircut money laundering Russian oligarchs

Basel Institute of Governance AML Index

Cyprus 4.93

Holland 5.03

Germany 5.80

Financial Action Task Force

Who gets a haircut?

68.4 billion in Jan. 2013

26-30 billion Russian money

What does a haircut look like?

Russian “oligarchs” è Eurobankers

Wipe out wealth 30% GDP

Slash business activity 9%-25% GDP

Freeze 70% of domestic lending

Freeze working capital of SMEs

And the GDP?

IMF projections pre-eurogroup -3.5%

IMF projections post-eurogroup

-9%

Massive legal problems

Emergency Liquidity Assistance worth 9.2 billion

Extended to an apparently insolvent bank for 1 year

Passed on improperly to a solvent bank

Where was ECB?

What does a haircut look like?

Scenario Analysis for Optimal Debt Restructuring

¤ Multi-period

¤ Dynamic

¤ Snowball effects

¤ Risk adjusted sustainability analysis

Exampled: Cyprus debt profile

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Original debt Restructured debt

Multi-period scenario tree

Scenario arithmetic for fiscal dynamics

Scenario arithmetic for debt sustainability

Model equations

Stress Debt

Sturzenegger and Zettelmeyer, 2006 Debt defaults and lessons from a decade of crises, MIT Press

Risk profile of debt

Conditional Debt-at-Risk

¤  Arzner et al. CVaR

¤  Uryasev and Rockafellar CVaR optimization

IMF Stylized example

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Original debt Restructured debt

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Original debt Restructured -no haircut Restructured -haircut

IMF example re-profiled

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Cyprus discretized example

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Original debt Restructured -no haircut Restructured -haircut

Cyprus debt re-profiling

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Conditional VaR

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Debt to GDP for re-profiled debt

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European Stability Bonds

¤  Blue bonds-red bonds

¤  Debt redemption fund

61

Debt/GDP ratio

Debt/GDP ratio

Borrowing rate

Borrowing rate

European Stability Bonds

¤  Pool sovereign bonds and collateralize ¤  European Safe Bonds –ESBies

¤  European Junior Bonds –EJBies

¤  ESBies have no country risk

¤  ESBies create reserve currency

¤  Flight from EJBies to ESBies

¤  No EU institutional or Treaty modification

62

European Stability Bonds

Suspiciously similar to CMOs

The Greek debt profile with eurobonds

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Cost-at-Risk

Greece with Eu-bonds Germany Greece

Conclusions

¤ Debt restructuring is costly

¤ Debt restructuring is mutually beneficial to debtors and creditors

¤ Need for better debt restructuring technology

¤ Risk adjusted

My own papers on this

¤  Cyprus debt. The perfect crisis and a way forward http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2233239

¤  Fairness and reflexivity in the Cyprus banking crisis http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2409284

¤  With Andrea Consiglio Risk profiles for sovereign debt restructuring (in preparation).