Private sector debt default inevitable, say analysts

A “PLAN B” in the European sovereign debt crisis will eventually result in a default on as much as 82 per cent of Irish private sector debt, according to an analysis by Citi Economics.

The report states that haircuts for private sector investors in Ireland, Greece and Portugal will “eventually become unavoidable”, as even with the full or near-full implementation of austerity packages, debt will continue to pile up to unsustainable levels.

“Given the high share of debt held by official creditors by then, losses for the private sector will likely be substantial – probably in none of the countries less than 50 per cent,” the report, titled A Plan B for the Euro Periphery, notes.

The haircuts – or the percentage of the debt on which there is a default – are likely to be the largest in the case of Greece.

For Ireland to reduce its debt-to-GDP ratio to 80 per cent by 2014, Citi estimates Irish debt would require a haircut of around €105 billion, or 45 per cent of the total outstanding, which will be circa €236 billion.

When the International Monetary Fund share is stripped out of the total, haircuts to non-IMF debt may have to increase to 50 per cent, and to 63 per cent in case all the official debt is repaid in its entirety. To reach a debt-to-GDP ratio of 60 per cent, haircuts on non-IMF debt could be 65 per cent, or 82 per cent if the IMF debt is repaid in full.

Without debt restructuring, Ireland’s debt-to-GDP ratio is forecast by Citi to reach 145 per cent in 2014. This same measure is set to reach 179 per cent in Greece and 133 per cent in Portugal.

“We believe debt restructurings with haircuts to the debt principal will be necessary to restore fiscal sustainability in these three countries,” the report by analysts Michael Saunders, Jürgen Michels and Giada Giani states.

Spanish debt ratios may still be sustainable in 2014, they add.

The distribution of the losses between private investors and official debt holders such as the IMF “will most likely constitute another critical political issue” for Europe, the report concludes.

The set of economic conditions underpinning Citi’s analysis includes an assumption that all euro peripheral countries will “continue on the road of fiscal tightening” over the next three years. It allows, however, for “some slippages” in the implementation of the fiscal plans.

German finance minister Wolfgang Schäuble has admitted the EU is hoping for the best but bracing itself for the worst ahead of this week’s parliamentary vote in Greece.

If MPs in Athens fail to back austerity measures, that could trigger a full or partial Greek default. If this happened, Mr Schäuble said the EU would “act quickly to ensure that the danger of contagion for the financial system and other euro states is kept in check”.

He expressed confidence that further austerity measures demanded from Greece would be passed but, in a notable rhetorical shift, said the euro zone would survive the possible knock-on effect of a default. “We are doing everything we can to prevent a perilous escalation for Europe but must at the same time be prepared for the worst,” Mr Schäuble said to Bild am Sonntag newspaper.

Berlin has portrayed the collapse of Lehman Brothers as a cautionary tale of market contagion to be avoided at all costs. But Mr Schäuble suggested yesterday that the moral of the Lehman Brothers tale is the ability of finance markets to bounce back from shocks.

Mr Schäuble insisted it was in the “most basic interest” of private creditors to contribute to a second Greek bailout. “I expect precise figures as to how much the private sector in Europe will voluntarily contribute at the special meeting of the Eurogroup on July 3rd.”