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A Greek flag flies east of Athens (Yiorgos Karahalis/Reuters)
A Greek flag flies east of Athens (Yiorgos Karahalis/Reuters)

Greece's deficit bigger than forecast Add to ...

Greece's chances of avoiding a debt-crunching exercise faded to almost nothing with the revelation that its budget deficit is going in the wrong direction in spite of robust efforts to reduce government spending.

The country's budget deficit in 2010 was 10.5 per cent of gross domestic product, Eurostat, the European Union's statistics agency, reported on Tuesday. The figure was considerably bigger than Greek government's own deficit target of 9.4 per cent and the European Commission's estimate of 9.6 per cent.

The fat deficit pushed up the yields on two-year Greek bonds to more than 23.5 per cent, a record since the euro was introduced a dozen years ago. The yields on 10-year bonds reached 15.26 per cent. Both levels are considered unsustainable and an indication that investors are starting to price in a debt restructuring.

In a statement, the Athens government said the missed target was "mainly the result of the deeper-than-anticipated recession of the Greek economy that affected tax revenue and social security contributions."

Portugal, which is negotiating a bailout package with the EU and the International Monetary Fund, also seems to be fighting a losing war on the deficit front. Eurostat put its 2010 deficit at 9.1 per cent of GDP. But that came as no surprise, because the Portuguese government over the weekend trotted out an identical figure. Its previous estimated called for an 8.6 per cent deficit while the European Commission last autumn had expected only 7.3 per cent.

Many economists had forecast a debt restructuring even before Tuesday's Eurostat figures were published, as Greece's vigorous austerity program had an unpleasant side effect in the form of a deepening recession. "Debt restructuring in Greece has transitioned from 'will likely happen' to 'will happen,' " Toronto-Dominion Bank economists Craig Alexander and Martin Schwerdtfeger said in a note last week.

That warning came amid reports that Greek officials had raised the idea of a voluntary debt maturity extension at an EU finance ministers' meeting and that the German government is modelling a Greek restructuring plan even though the official EU and European Central Bank (ECB) positions insist a restructuring is not under consideration. The governments of the EU countries fear that Europe's weakest banks, some of which are heavily exposed to the sovereign debt of Greece, Portugal and Ireland, would not survive a Greek debt implosion.

Greece's rising debt load is simply too big to be repaid, economists say. Rising interest rates will only make the problem worse as the ECB tries to rein in above-target inflation rates. Greece's debt hit 142.8 per cent of GDP in 2010, up from 127.1 in 2009, Eurostat said. The latest figures make Greece the most indebted of the EU's 27 countries, measured as a percentage of GDP. Italy, with a debt-to-GDP ratio of 119 per cent, ranks second, followed by Belgium, Ireland and Portugal.

Estonia, the newest EU member, is the healthiest. It recorded a budget surplus last year and a mere 6.6 per cent debt-to-GDP ratio.

Sovereign debt restructurings are fairly common events. In recent decades, Poland, Russia, Turkey, Argentina and Uruguay have all defaulted on their debt, resulting in "haircuts" to debt holders ranging from 13 per cent (Uruguay in 2003) to 74 per cent (Argentina in 2005).

Uruguay restructuring was relatively painless, partly because its debt load was about half of Greece's and partly because economic growth was strong, thanks to the commodities rally. Argentina's restructuring was difficult. During the country's four-year financial crisis, the economy shrank by 18.4 per cent in real terms and unemployment surged to more than 30 per cent, TD said.

Economists hare varying views about the method, and severity, of Greece's probable debt restructuring. Some say nothing less than a 50 per cent debt reduction would be required to make Greece's finance's sustainable, given its grim economic growth outlook.

Others say an outright haircut can be avoided in favour of a debt rescheduling - the extension of maturities possibly combined with an interest rate rebate (Greece has already been treated to a one percentage point reduction on its €110-billion [$153-billion]bailout package).

Deutsche Bank economists Gilles Moec and Mark Wall said a "rescheduling is probably superior to haircuts" because it would be less damaging to the banks that hold Greek bonds and would not require a recapitalization of the ECB, which has been buying the bonds of Greece, Portugal and Ireland to support their debt operations.

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