Greece and the Brady Plan

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UNIVERSITEIT VAN AMSTERDAM FACULTY ECONOMICE AND BUSINESS BACHELOR BETA GAMMA

MAJOR ECONOMICS

GREECE AND THE BRADY PLAN

ABSTRACT – Mexico struggled with a severe crisis at the end of the 80s. They had difficulties handling their debt overhang problem. The Brady Plan was invented and it helped Mexico back on track through restructurings and debt relief. Greece is pulled down into a crisis around 2007 and the way Greece and the Troika are handling the case is very similar to the Brady Plan. Third parties, like the IMF and the World Bank, were/are involved and both countries experienced the same pitfalls. Both crises are examined and their components are separated. This paper is a literature study comparing both situations and research is done on whether the Brady Plan that helped Mexico can add some features for resolving the Greek crisis. The main conclusion is that all characteristics that the Brady Plan had are already in the way the Greek crisis is approached; collective action, third parties and overlapping pitfalls.

Author: M.J.H. Westerouen van Meeteren Student number: 6094945

Thesis supervisor: Christiaan van der Kwaak Finish date: March 2014

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INTRODUCTION

The current Greek crisis has endured for a long time now and there have been many reports in the public debate on how to tackle this crisis. Intuitively, one should look at the past and learn from it. Find a crisis that looks much alike and try to separate the components that helped resolve this crisis.

For the Greek crisis the Brady Plan might be such a solution. Both countries were in a situation where the country had too much debt and the expected present value of potential future resource transfers were less than its debt. Krugman (1988) calls this the debt overhang problem. When such a problem occurs, argues Sachs (1984), a free riders problem comes at hand. In this paper some historical cases are being looked at to find the nature of such a problem.

In such crises third parties often have a big role to play. International financial institutions can aid the country financially and in return they demand internal restructurings. Examples of these restructurings are explained in this paper. Under close surveillance these countries must then commit to certain reforms otherwise they do not get any money (Das, Trebesch and Papaioannou, 2012).

The Mexican crisis was resolved with the Brady Plan with debt relief and restructuring. Awareness was created that Mexico could not come out of the crisis if not every party helped. The commercial banks did not cooperate at first but later they also (voluntarily) contributed money and debt relief to the aiding package (Van Wijnbergen, 1991).

The Greek and European crisis started when spillovers from the US sub-prime crisis revealed the underlying problems. The years preceding the crisis Greece had much growth but also a lot of debt. In addition, Greece had high inflation resulting in a substantial deviation of purchasing power parity, pronounced competitiveness and current account deficits (Arghyrou, 2010). The EU had to react quick but failed to do so and the credit rating agencies worsened the problem (De Grauwe, 2010).

This paper addresses al the different aspects of both crises and does this in the following way. First the theory behind the debt overhang problem is discussed. Then the role third parties play is examined, and their conditions in aiding a country. Then the Mexican crisis is explained, along with the Brady Plan. Finally, the Greek crisis and the causal actors are looked at. All this has to confirm or reject the hypothesis that the Brady Plan can add some features for Greece that can help them tackle their crisis

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1. DEBT OVERHANG THEORY

For fully understanding what happened in Mexico during their crisis in the 1980s - 1990s and match it with the current Greek situation, one must understand what the underlying problem of that crisis was. By identifying the problem and its components the comparison can be made and the recognition points can be observed. Both countries were drawn in a debt overhang problem so first the theory behind this concept is explained.

First the basics behind the debt overhang problem are explained, also involving the differences between equity holders and debt claimants. Both types of creditors have a different interest in the matter, which is discussed more into detail. Then comes the important differentiation of corporate debt and sovereign debt. Both cases have a few subtle differences. The main difference is whether a firm or a country is the debt holder. Finally the nature of the problem comes to hand, the discussion whether it is a liquidity problem or a solvency problem. All this gives a clear view of the different components that carry weight in a debt overhang problem.

1.1 Debt overhang basics

Companies and countries all choose a different capital structure to finance their activities. The capital structure is the way they finance their assets, with equity or debt. The capital structure is then the composition of the companies’ or countries’ liabilities. Without going into too much detail about all different kinds of financing, one particular situation is important for this paper. It is when a country has so much debt that the expected present value of potential future resource transfers is less than its debt (Krugman, 1988). This is the so-called debt overhang problem.

When new debt is issued there is a certain amount of risk attached to this debt. In such a situation the debtor pays an equally valued amount of interest for this risk and pays back the loan at maturity. But there is a difference in who bears this risk. Using a proper degree of simplification there are two kinds of financiers: equity holders and debt claimants. Debt claimants always have a prioritized position for getting back their money opposed to equity holders. So this is where a few incentive problems and agency costs arise. The debt burden is so large that the country cannot take on additional debt to finance future projects; even those that have a positive net

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present value (NPV) and are able to reduce its indebtedness over time. For equity holders it is too risky to allow such an investment because they are second in line to receive back their investment. So there is an incentive for equity holders to reject the project while it has the potential to have a positive net present value. In that case, only debt holders will benefit from the project. Also, equity holders are not willing to issue new stock because then they would send out a signal that their stocks are overpriced. From the debt holder’s point of view, starting from the point that the debt level is already too high, old debt holders are unwilling to finance this party again and new debt holders do not want to get involved. The chance of getting back their full amount of money could be too small even to start with.

From this information one could derive a conflict between collective interest of creditors and the interest of an individual creditor. New lending will bring about a free riders problem, while it may also protect creditor’s existing claims (Sachs (1984), Krugman (1985)). On the one hand, preventing default is in everybody’s best interest. On the other hand, all creditors prefer to opt out without any loss. The creditors that are not participating in the new financing round are taking advantage of the creditors that are willing to finance. They then see their credit improve without any favour in return. Now those creditors are free riding on the other creditor’s willingness to help. In practise, those kinds of incentives could prevent a market solution to be found (Vásquez, 1996).

1.2 Corporate debt vs. sovereign debt

But before looking at what the nature of the problem is there must be a clarification. The debt overhang situation mentioned above is how it works in theory for firms with corporate debt. There for instance, equity holders actually have something to say. Intuitively, in a country the government is in control. When talking about countries, we talk about sovereign debt. This is a kind of debt that cannot be forced by creditors and is thus subject to rescheduling or repudiation. In the case of sovereign debt creditors do not have that much of protection other than the threat of credibility loss or lower status rates. This makes lending more difficult and expensive in the future. Here some of the characteristics of both debt configurations are given to make the difference clear.

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When talking about corporate debt all of the company’s assets are considered to be collateral. With sovereign debt there is no specific collateral. Creditors may impose penalties on defaulting creditors, such as exclusion from the world trading system. But still, a debtor country seldom accepts a transfer of more than 5% of national income for many years. So, when a company does decide to invest, all or most of the generated returns might go to the creditors. In addition, when a company defaults the creditors can go to court and try to liquidate the business or obtain control. But with a country a creditor can only count on a small part of the gains. With sovereigns debtors there are no such options, because they retain most of their income and cannot be obligated to hand over control. In addition, people are also unwilling to finance a sovereign, because later on they expect too many taxes. Sovereign debt thus needs much more specifications and negotiation. It even tends to be an on-going process, while with corporate debt it is often a once and for all agreement (Bulow and Rogoff, 1992).

1.3 The nature of the problem

Opinions about the nature of the debt overhang problem are divided in two options. One might argue that it is a liquidity problem. When it is a liquidity problem the country has a shortage on money and can solve its problems if it receives more short-term money. Others might say it is a solvency problem. When it is a solvency problem some bankruptcy procedure is called for and no short-term borrowing is going to change that fact. Throughout the years the public opinion diverted to a more blurred area where both problems are more converged. The liquidity problem is now seen as a part of the solvency problem. Krugman (’88) states that there is no such thing as a pure liquidity problem. De Beaufort Wijnholds (1989) agrees on this calling it a long-winded solvency affair. It arises only when there are doubts about the solvency of a country. Looking at historical data, Sachs (’88) designates only a few pure liquidity problems, but mainly supports the idea that countries that have dealt with liquidity problems in the end had more fundamental problems regarding solvency. This became particularly clear when the countries in trouble already received an amount of money to finance their ‘liquidity’ problem, but after that were still struggling. The Baker Plan was such a situation.

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2. THIRD PARTIES: IMF AND THE WORLD BANK

Now we know it is a solvency problem and private financiers are not always willing to finance a country in need. Third parties are needed to council and support the country to get back up and restructure its debt. Two of the parties that can back and support a country’s credibility are the IMF and the World Bank (the Bank). They were established after the Second World War to reconstruct the world economy and as a lender of last resort for countries who needed it. Their covering goal is to establish a framework for economic cooperation and development that would lead to a more stable and prosperous global economy (IMF, 2013a). Since the IMF and the Bank played such a big role in a lot of debt restructurings it is interesting to see what their framework is in how to handle these debt restructurings and what their conditionality is for engaging in helping the indebted countries.

First both their policies are discussed along with common concepts and definitions. After that the key elements of starting the debt restructurings in general are explained. Then the possible pitfalls are determined and the conditionality of the IMF is looked at in further detail. Finally some additional costs and implications during restructuring periods are reviewed.

2.1 Mandates and definitions

In short, the IMF’s mandate consists of three tasks. 1) Promote international monetary collaboration 2) Giving policy advice and technical support to keep all countries economically strong 3) Provide loans and assist in formulating policy programs when international payments are insufficiently financed against reasonably priced conditions. The Bank’s mandate consists of only one task and that is to promote long-term economic development and reduce poverty in the world with technical and financial support for restructuring industries and implementing projects (IMF, 2013a). Further elaboration on their activities during the Mexican and Greek crises will be discussed later on, but for now we only focus on their prescriptions for borrowing and overall policy.

First some facts and definitions: Das et al. (2012) found that all restructurings occurred in developing or emerging market economies and the speed of processing a debt restructurings increased since the 1980s. Within debt restructuring you have debt

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rescheduling and debt reduction, which mean lengthening the maturities of the old debt (debt relief), respectively, and a reduction in the (nominal) face value of old instruments. In most of the cases it was a distressed debt exchange. Logically, this means that the restructurings are at terms less favourable than the original bond or loan. Also the difference between default and restructuring must be clear. When a government cannot make a principal or interest payment on due time it is called a default. Restructurings, however, are the debt exchanges that occur after a payment default. That is why often they are called post-default restructurings (Das et al, 2012). Over the recent years we have also seen preemptive debt restructuring, as a precaution for default. Mexico was a good example of the post-default restructurings and Greece is a good example of the preemptive debt restructuring. Important to know is that not all defaults have a restructuring before or after. Sometimes a government just does not pay one or more periods, but eventually pays later. Then the default is resolved as well.

2.2 Key elements of starting the debt restructuring process

Some key elements in the process of debt restructurings are discussed in this section. Das et al. (2012) discovered a few ingredients all cases had in common. For instance, it all starts with a default on debt payments or the announcement that a debt restructuring is going to take place. When this has happened the concerning government sets in motion a series of negotiations with all their creditors. The purpose for these negotiations is to agree on the terms of debt restructuring that are eminent for solving the crisis. These restructurings are country-specific for every different case, but for example their fiscal policy needs to be changed. At the same time the government needs to sort out all their finances to evaluate their monetary financial situation, a specific notation of all assets and liabilities. This part of the debt restructuring process is very time consuming, because the country needs to verify its total debt claims. Lim, Medeiros, and Xiao (2005) suggest that the governments should take the following characteristics in consideration: 1) the face value and market value of bonds or loans 2) the amortization schedule 3) all interest rates and coupons (linked features and to what extent it is fixed/flexible) 4) the denomination of currency of the instruments 5) any other features like enhancements or collateral and

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6) legal clauses. When all this is acquired and visualized the country has a good view on their position in debt stock, debt-service profile, and the value of debt instruments. A detailed debt sustainability analysis (DSA) is then required which indicates the size of debt relief needed and what efforts the country needs to make. Part of this analysis is to project a country’s debt burden over the next 20 years and calculate the vulnerability to (external) shocks. These results are compared with a threshold and looked at whether they exceed this debt burden indicator or stay below baseline. According to that level a risk of external public debt distress rating is given to that country. The analysis distinguishes four levels: low risk, moderate risk, high risk and in debt distress. Then the DSA also classifies the country in one of the three policy performance categories (strong, medium and poor). Combining these two qualifications gives a good overview for that country (IMF, 2014). Once this analysis is performed the governments in question sets up a set of restructuring scenarios and prepare a proposal. This offer is discussed with its creditors and on the basis of a democratic approval system the offer is accepted or rejected. As you can imagine, all creditors are very keen on their preferences and cautious when to accept or reject. Such sort of negotiations can cause a large delay in the process.

2.3 Possible pitfalls of the restructurings process

Building on the last statement above, according to some literature there are some pitfalls that can delay the restructuring process. Two of the main reasons for delay are the creditor holdouts and litigation. In both cases the creditor is trying to get a better deal by stalling and refusing to participate in the offer, possibly by suing the sovereign debt holder in a court. Reason for this behaviour has been explained as a characteristic named creditor coordination failure and comes from the shift from bank to bond financing in emerging markets (Pitchford and Wright, 2007). Intuitively this occurs when a large group of bondholders find it hard to coordinate and agree on a deal compared to a small group of commercial banks. Trebesch (2008) contradicts that theory and emphasizes that in debt restructurings the creditor characteristics do not play a major role. He even states that troublesome holdouts are rather an exception than the rule. Bi, Chamon and Zettelmeyer (2011) give a reason why holdout strategies and litigations are not common, they argue that they are simply too

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expensive. Also, specialized knowledge is needed which is hard to find and thus costly as well.

Complementary to creditor behaviour, the debtor country can also be debit for delaying the restructuring process. The debtor country is responsible for the level of communication and sometimes fails to keep on a certain level of transparency. Evidence shows that sharing information and close consultations with all parties (banks, bondholders, financial institutions, etc.) always has a positive effect on the speed and successfulness of the restructuring (Andritzky, (2006), and Sturzenegger and Zettelmeyer, (2006)). Unfortunately, not all debtor countries are succeeding to do so. A reason for this can be that for those governments the debt negotiations are not always their priority. For example, political factors and other economical problem distract their attention. Upcoming elections, wars or other conflict, riots or strikes, resignation of an important government member can all, for instance, play a part in delaying the restructuring. Also think of the lag caused by a different government who is motivated and determined to change the agreement. After all, there is room for renegotiations with sovereign debt. Finally, the last cause of potential delay, Bi et al. (2011) argue that the size of the haircut is important to enhance the prospects. The haircuts should stay in line with the government’s capacity to pay, for it discourages the incentive for small countries to coordinate and block the exchange offer. Because if the haircut is too big, a small country could say it is impossible to difficult to cope with such a haircut from the start.

2.4 IMF specific: Their conditionality for debt relief and procedures One of IMF’s core responsibilities is to provide loans to member countries with (actual or potential) balance of payments problems. With this financial aid countries can restore their losses in growth, reserves, currency stability, import payments and underlying difficulties. That is, if the country cannot find sufficient alternative methods of financing while maintaining enough reserves. To become an eligible candidate for the IMF’s resources the country must formulate an economic policy program in consultation with the IMF. In this “Letter of Intent” the candidate stipulates their planned reforms and policies (IMF, 2013b). It then needs the approval of the Fund’s Executive Board and when this is done the instalment payments are processed. Depending on the situation, like its economic position and historical

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performance, some countries get all the payments at once. Others receive their consolidation package step by step with close surveillance of advancements. Over the years a lot of different lending instruments were developed, but these are not being discussed in more details in this paper.

The Executive Board’s judgement is based upon a report written by an IMF staff team that is sent to the country to map the macroeconomic situation. The team holds discussions with the local government and discusses what an appropriate policy response could possibly be. They look at all kinds of key factors: macroeconomic policies, the domestic financial system, persistent imbalances (both external as domestic), the level of external and public debt, exchange rates, spillovers from other countries or crises and maybe even (social) situations like conflicts and/or natural disaster consequences (IMF, 2013c). Together they assess the size of the country’s financial needs and whether the IMF’s resources are for insurance or actual overdue payments. In addition, these formulizations are important for securing the conditions of the program, safeguarding IMF’s resources and to monitor the progress later.

This monitoring has two functions: backward looking and forward looking. On the one hand it is necessary for reviewing whether the IMF-supported plan is on track, and on the other hand they can predict and act on modifications that might be needed to refine the program’s objectives. Then the government and the IMF staff team must agree on the program of economic reforms and policy including commitments. These commitments are inspected over time during the process and come in four different forms. 1) Prior actions. Before the country receives anything from the IMF it has to make clear that the foundation for reforms is solid. 2) Quantitative performance criteria. Measurable conditions which are specific for that country’s situation. Those are variables that can be controlled by the government and checked whether they are actually involved in the program. Variables like monetary aggregates, fiscal balances and/or external borrowing. 3) Indicative targets. These are used as supplements on the criteria variables and are somewhat goals on the horizon. These targets become reality and criteria themselves when the uncertainty is reduced over time and these vaguely formed targets become more concrete. 4) Structural benchmarks. These are more like measures that are critical for the program but are not quantifiable. Themes like social safety nets or strengthen public financial management (IMF, 2013d).

It is clear now how third parties support the process from the start and approaches each case. Debt restructuring is a very delicate case and a lot of interests

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are at hand. Take in mind that the IMF needs their funding back so it can help other countries in the future, so it is logical they ask for some serious commitments. For that purpose, the IMF and the World Bank also have the highest priority status over all creditors for repayment. In the next part we will discuss other factors that influence or get influenced as well while dealing with the restructurings. Second-hand factors that are not necessarily in danger because of the crisis or the debt overhang problem, but the crisis does infect them or they contribute as catalysts.

2.5 Additional costs and implications during restructuring periods

Obviously it cost a lot of money to default or prevent a default for both governments and its creditors, but the following factors get dragged down as well. Among others the following implications come forward. First, the debtor government’s position in the capital markets will change post-crisis. Defaults and restructurings lead to higher interest premia or even exclusion. Borensztein and Panizza (2009) argue, however, that this resentment only takes for one or two years, implying an accommodating and forgiving mentality of banks and bondholders on short notice. Cruces and Trebesch (2011), on the other hand, come to the conclusion that it depends on the size of the haircuts. The bond spread in their study increased with a haircut size raise and would hold much longer when the haircut is bigger.

Secondly, output and trade are also infected by the debt restructurings. Unanimous, studies conclude that trade drops before, around and after debt restructurings from 4% to 10%. Trade punishments by creditors are suggested in the literature but Martinez and Sandleris (2008) reject that strongly.

Thirdly, banks and the financial sector can get strongly affected. The asset side on the balance sheet gets affected directly because it will hold restructured assets. On the liability side deposit withdrawals and distortions of interbank credit lines are the main dangers, because banks and clients do not trust each other anymore and they do not consider all banks solvent enough (Fissel, Goldberg & Hanweck, 2006). The cost of funding will increase due to the increased interest rates on sovereign debt due to increased risk. So banks are not willing to lend money to countries anymore. Banks with large interbank connections are prone for contagion, as in spillovers from surrounding nations.

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Fourth, another factor is the investment policy. What can be seen from Deshpande (1997), with his regression analysis over 13 Latin American countries, is that the external debt ratio has a negative influence on the investment ratio. Furthermore, a low investment ratio implies a growth decrease, which in turn worsened their capacity to repay. It creates a vicious circle. From Moyen’s quantitative analyses (2005) comes further acknowledgement that the debt overhang problem becomes larger when there is a flexible investment policy. In addition, the investment opportunities are also influenced by the capital structure in a debt overhang situation. Attracting more leverage might give some tax benefits, but it is also an incentive for equity claimants to underinvest. What implications this brings for countries are not clear.

Finally, the debtor government face large expenses during the negotiation period. Legal and financial advisors, but also travel expenses when they negotiate with (international) banks or financial institutions abroad. All government staff and officials are working overtime to prepare the debt exchange, not to mention the fees charged by external consulting professionals. Although it does not seem a very big macro economical problem, it does cost additional money and can increase up to large amounts.

2.6 Concluding remarks

Third parties like the IMF and the World Bank are indispensable when a country is in a serious crisis. They function as a lender of last resort on a global scale, because financial markets are vulnerable to self-reinforcing collapses of confidence unless these lenders of last resort are there (Krugman, 1998). Their goals and mandates are very simple in general, but to become eligible serious reforms and commitments must be promised. The procedures are very strict and can take a lot of time. Along the way there can be many pitfalls and obstacles, but in the end after many negotiations the third parties always do what they are created for. In the next chapters the Mexican and the Greek crises are discussed. Here, also, the third parties played a major role in the deb restructurings and reforms.

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3. MEXICO AND THE BRADY PLAN

Mexico is as of this writing (2014) one of the world’s largest economies; it is the tenth largest oil producer in the world, the largest silver producer in the world and is considered an upper-middle income country by the World Bank. Their state-owned oil company Pemex has brought them a lot of prosperity, but it has not always been like this. Across history they have had some considerable downturns and this paper looks into one of the last major interventions, which saved the Mexican economy around 1990. But before looking at the event (the Brady Plan) what this paper is really about, the economical history of Mexico is being looked at. Because the predecessor of the Brady Plan was the Baker Plan and did not work out, both plans are worked out into more detail and the differences between both plans are examined. When you divide both plans between the concepts discussed earlier in this paper, then the Baker plan was more focussed on solving the crisis as a liquidity problem and failed to solve it as a solvency problem.

First Mexico’ situation is discussed preceding the Brady Plan, then the actual plan is talked over, finally the overall outcome is considered. Some opposing arguments against both the Baker Plan and the Brady Plan are inserted along the way and in the end some separate counterarguments are assembled. This chapter is finished off with a small part on the Mexican national bank during those years and their policy. Especially important is to find what made it possible that such a crisis could happen, the major components of such a crisis and what made it possible that the Brady Plan worked out positively.

3.1 Pre-crisis

Mexico was doing quite well from 1950 until 1970s. After that time social development was included in the governmental administration, which entailed more public spending (Van Wijnbergen, 1986). The 1973 oil shock brought a lot of deterioration, which led to a devaluation of the peso in 1976 with 58%. Luckily, in 1976 the Mexicans also had some significant oil discoveries allowing them to recover from the worsened situation. Mexico instantly went from a net importer of oil and petroleum products to a significant exporter. It became its most dynamic industry. They continued with its expansionary fiscal policy, partially financed with higher

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foreign borrowing. The reason they had to borrow was that domestic production fell short while demand was growing (due to population increases) and international prices rose. Mexico became a net food importer and by raising tariffs to shield the domestic producers from foreign competition, it hampered the modernization and competitiveness of Mexican industry. Mexico’s external indebtedness mounted and the peso depreciated in their managed floating rate regime. Banco de Mexico’s 1976 Annual report stated: “Domestic savers showed a clear preference for liquid banking instruments, triggering a process whereby local currency-denominated financial assets were converted into foreign currency-denominated assets” (Banco de Mexico, 2009). This led to a second peso devaluation in 1980. The general public showed a preference for investing their savings abroad.

Then because of severe mismanagement of the revenues, inflation rose and exacerbated the 1982 oil crisis. Oil prices plunged, world interest rates soared and the government defaulted on debt. Developed countries reacted on this by providing more loans. The crisis was treated as a liquidity problem and not as a solvency problem (Vásquez, 1996). Mexico had to start a far-reaching process of structural reform that period (as well as other middle-income countries with high debt in the region). The US Secretary of Treasury at that time, James Baker, called upon the international community to start a close cooperation to help these countries.

One important thing to know is that before Baker came with his initiative the collaboration among different parties was difficult. The different parties involved were the indebted countries, international private banks, the governments of industrialized countries, the national central banks and the international financial organizations. They were talking about resolving debt, but it was not very successful. There was no collective sense of responsibility, because all parties were pointing fingers at each other. The indebted countries asked for some concession from their creditors, which were banks and governments of industrialized countries. The banks tried to leave it for the governments and the international organizations to resolve. The governments were not very eager to allow any concessions. Finally, the international organizations did want to play a special role in the debt crisis, but refused to be the main creditor by itself (De Beaufort Wijnholds, 1989). In short, there was a strong need for coordination and joint action.

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3.2 The Baker Plan

At the end of 1985 James Baker succeeded in convincing other countries that a closer cooperation is needed to aid indebted countries. He made it clear that the only way the world economy was to recover was by recognizing the debt crisis for what it was: a long term economic and political barrier to development that is slowly strangling world economic growth (Bogdanowicz-Bindert, 1986). All parties had to contribute. Another $20 billion was asked from the commercial banks over a 3-year time span for 15 heavily indebted countries. And also the World Bank was called upon by Mr Baker to provide more assistance. The Bank would increase their part to a total amount of $9 billion along with a role in streamlining all operations and providing direct assistance to the private sector of indebted countries. Baker also added two specific clauses: 1) The World Bank had to give guarantees for direct investment in developing countries and 2) Debtors had to promise strong reforms and commitments. The final goal was to bring back economic growth (De Beaufort Wijnholds, 1989). If you believe that countries can grow out of their debt, then providing liquidity is a good way of attacking the problem. But it is known that the Baker Plan did not work out. Important to know is why it did not work out.

In total 15 countries were included in the Baker Plan. But in reality, Mexico was its prototype (Vásquez, 1996). Baker had convinced the IMF about the importance of the Mexican agreement. It would give a signal to the world market that commercial banks are willing to help in a debt problem situation and that they are prepared to bear the risks. After all, it is in everybody’s interest to strengthen confidence and credibility (Montagnon, 1986). In addition, it would be very convenient for the US to help Mexico (being their third largest trading partner) and gaining prestige for future negotiations with other indebted countries. That point of view did not came unnoticed and people worried that political considerations would become more important than healing the market (Rogoff, 1993).

The major elements of the Mexican restructuring package were loans from commercial banks and the World Bank. Only after reviewing research people found out that there should have been more guarantees for the Plan to work. The Bank only guaranteed the final amount at maturity but not (all) the interests. The commercial banks were afraid of not getting back their full investment so they lend the country enough new money so that they could pay their interest back on time. By that, the

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commercial banks created the financial illusion of generating income these countries do not have. This even resulted in a net payback to the banks. It became clear that finding a long-term solution for the debt crisis was not the primary objective of many banks. The goal was to protect their balance sheets and income statements in the short term (Bogdanowicz, 1986).

Slowly came the awareness that the Baker Plan was about to fail. The plan should have involved outstanding debt reductions and concessions on interest rates. Providing restructuring time and breathing space should have been the goal. The Baker Plan could not provide the right incentives (Vásquez, 1996). Instead the banks chose for themselves, which really shows the mix up between collective and personal interest. The next US Secretary of Treasury was Nicholas F. Brady and he knew that without some real debt relief a number of countries would not be able to get back up. Besides, as long as their debt is growing faster than their net export proceeds, they will simply never catch up and still be stuck with their debt overhang problem. He learned that the debt problem was to be handled on a case-by-case basis between a country and its creditors. And he also learned that the IMF and the World Bank should always be supervising when the terms of debt are under discussion (Sachs, 1989).

3.3 The Brady Plan

In 1988 Mr Brady became US Secretary of Treasury and acknowledged the Baker Plan’s failure. That is, Mexico did some extensive trade reform but growth failed to appear. No wonder, every time only short-term rescheduling and new-money commitments came out after intense negotiations full of twists and turns. Because it were only short-term agreements the international market could not provide enough time to breach the gap between the costs that were made and the benefits harvested in the future. To fire up an economy you will need at least a medium-term framework for the private sector to gain confidence. Otherwise they do not have any certainty that current policies will continue. Until such uncertainty is resolved private savers will get biased towards more liquid assets, including foreign ones (Van Wijnbergen, 1986). To take the uncertainty away Brady made debt relief an option by legitimizing it in 1989. From then the negotiations for the debt package could really take shape. The ultimate goal was very simple; restructure the banks’ loans in such a way that

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interest payments would be reduced, principal forgiven, and the maturities lengthened (Arslanalp and Henry, 2005).

By that time Mexico had an external debt of $100,4 billion (111,6% of GDP), mostly held by commercial creditors and the other part mostly held by official creditors like the IMF and the World Bank (World Databank, via Van Wijnbergen, 1991). Estimated gross financing needs for a pre-set growth goal of 4% was around $50 billion (according to Van Wijnbergen’s and Mundial’s (1990) econometric macro model). Looking at their options for financing sources they were short on another $23,5 billion creating a huge financing gap. Plus, this amount was very sensitive for fluctuations in oil prices and national interest rates. The oil company Pemex was still state-owned and a decrease in world price of Mexican oil costs Mexico $0,5 billion in forgone export revenues per year. Similarly, an increase of the international interest rate with 1% would increase the current account deficit of Mexico almost by $6 billion. This implies potential profit gains for Mexico for fixed-interest debt instruments.

3.4 Mexico’s strategic call for help

Having considered all the different kinds of proposals eventually it left Mexico with only one option: Exit-bonds schemes and cash flow oriented measures (Van Wijnbergen, 1991). Exit bonds are bonds that will be free from future calls for new-money commitments. For significant debt alleviation these exit-bonds would require guarantees of principal and interest payments. The answer came from the use of old loans refinanced at lower interest rates. The discounted value of the future payments then falls and the public sector does not need to buy anything upfront. It provides short-term cash flows because of reduced interest payments and no fiscal problems for the public sector. Putting this into practise and trying to reach the biggest debt relief possible would require Mexico to offer its creditors a menu of choices. But because they knew all parties’ preferences and demands they would talk to the creditor parties one-by-one in a specific order.

Negotiations started with the IMF and the World Bank, both supporting Mexico publicly that its debt reduction was necessary. To some, the IMF credit was seen as a “seal of approval” on countries for banks and governments to supply more resources (De Beaufort Wijnholds, 1989). The banks and countries could use this in to

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their advantage. Others were less enthusiastic, claiming that the debt forgiveness was too small (Sachs, 1989) especially from official lenders (Rhodes, 1990), and that the IMF should be more of a coordinator rather than a lender (Vaubel, 1983).

So first the IMF confirmed a lending package of Special Drawing Rights (SDR’s) worth around $4 billion. SDR’s are potential claims on freely usable currencies of IMF members, a short of debt paper within the IMF system. Shortly after that the World Bank agreed upon a loan of $0.5 billion per year for three years and another lending programme of $2 billion in the period of 1990-92. After the commitment of the IMF and the World Bank Mexico had to look for institutions that could grant the desirable guarantees, which they knew commercial creditors would ask for. It would stimulate the voluntary part of the deal (Sachs, 1989). So they turned to the Paris Club, covering $2.6 billion of principal and interest payments from 1989 until 1992 and rescheduling old loans to longer maturity. After completion with the Paris club Mexico sent an inquiry to the commercial creditors (more than 600 banks). Luckily they find a way to shrink the negotiation formation to 15 representatives of creditor banks, a Bank Advisory Committee. The deal was not clear-cut, Mexico asked for a 55% debt relief and the committee offered only 15% at first. After a few months of bargaining it all resulted in a 35% debt relief. In total the restructuring would take on $48,9 billion of Mexico’s external debt. Eventually they were able to set up a menu for the way the commercial banks could participate.

3.5 Choosing from the menu

There were three choices (Van Wijnbergen, 1991). First, old claims could be converted into new claims with a LIBOR interest rate of 13-16% and a 35% decrease of the former principal. Second, old debt could be exchanged for new instruments at par with a fixed interest rate of 6,25%. For both instruments applied that they would have a very long maturity of 30 years and an escrow place in de Federal Reserve Bank in New York. In addition, there was also an escrow on the first year and a half interest payments in the package for the first two options. Third, there was the option of exchanging old debt for new debt at par and market rates. But then the following three years the bank would have to make additional loans equal to 25% of the amount of this option without any collateralization of the principle or interest payments. Finally there was also a complementary debt service reduction option bound to the oil

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price after 1996. The boundary was set at $14 per barrel and 30% of the extra revenue would be available for the creditors who chose this option. The only restrictions were a maximum amount of percentage of the old debt brought into the deal and the amount is scaled depending on the distribution of options among creditors. As a final note, all the escrows were backed by the contributions the IMF and the World Bank made earlier, own reserves and a loan from Japan.

Initially, the result was postponed due to the complexity of the problem, but also due to the uncertainty about the consequences of each option. They all waited for the end of the year to pass on their decision. Eventually among all creditors, almost half of them chose the par bonds (49%) and the discount bonds (41%) followed closely as the second-best alternative. The option for new money (10%) was the least favourite (Vásquez, 1996). Reason for this was that the par bonds and the discount bonds were worth more on the secondary market. The only difference was the use of market interest rates or fixed interest rates. Another reason was that the new money option was probably presented as a junior debt, which comes down to a much lower valuation on the secondary market. Remarkably, among the Mexican creditors the new money option was actually very popular, but their portion of the debt was only small. In the end there was no way for any creditor to avoid an agreement, because Mexico made it clear that all old claims were denied after a certain date. By the end of January all banks had decided on their preference and on February 4th 1990 the agreement was officially signed.

Now, looking back more than 30 years ago the Brady Plan was subject to a lot of revision. During that time people thought of a lot of different ways to review Mexico and its Brady Plan. Many believe the Brady Plan was a success, but others refute this. In the next section arguments from both sides are discussed.

3.6 Arguments in favour of the Brady Plan

With such an amount of money used to help Mexico with their debt restructurings, one would ask the eminent question whether they used the money in a proper and efficient way to improve economic performance. The easiest way to look for this result is to compare the gross benefits with the gross costs. This will bring us a real rate of return. On the benefits side are included the old flow of debt service since the old claims have been terminated. Also the interest earnings on and the face value of

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the collateral accounts are taken into account. Then the new money imbursements and the back payment of excess amounts before the moment the deal were retroactive are added up to the benefits. As for the gross costs you have the debt service instruments and the new money instruments. Finally, also the various collateral accounts that were guaranteed by the financial institutions had to be paid back. Overall, you then get a real rate of return of 36% (Van Wijnbergen, 1991). This result indicates a very efficient use of the enhancements funds by Mexico.

What you can see in the graphs (#1 and #2, see Appendix) is that the different indicators also show an improvement of Mexico’s situation. Vásquez (1996) even stated that Mexico has moved aggressively towards the free market and has begun attracting impressive levels of finance again from the international capital markets. The graphs speak for themselves. Here we look at two of them: Some visualization of their debt (total amount of debt rescheduled, total exchange of external debt stocks and their loans with the MF) and the Real GDP growth. As can be seen they all indicate a substantial improvement as a consequence of the reforms and debt restructurings. Especially, where the Baker Plan could not trigger the start of economic growth in Mexico the Brady Plan did. Mexico received more money for their reforms, but at least it was medium/long term debt instead of short term. The difference is that the maturity lies further in time, which gives Mexico time to increase economic performance. In addition, some secondary effects are considered that came along with the debt package.

The debt relief, obviously, was a reduction of the net transfer that Mexico had to pay to its creditors. But this also meant there was less pressure on the exchange rate. Moreover, because all the deals had a medium-term maturity or longer, this also had effect on other variables like future exchange rate, taxation and other financial regulations. All this, in its turn, reduced fluctuations in public debt (related to the Peso) and, following from that, influenced expectations of domestic interest rates. In general, it relieved Mexico from its vulnerability and regained them credibility. The whole package, also, caused a strong response in the market for private investment and private capital inflows. Not to mention the satisfaction of the IMF, the World Bank and the Government of Japan for achieving their objective of helping Mexico. Overall, a very positive opinion about the Brady Plan dominates the public debate. However, some counterarguments seem plausible and legitimate.

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3.7 Arguments against the Brady Plan

Although the Brady Plan worked for Mexico to get them out of debt overhang, one must be cautious to simply duplicate it on another country. The Brady Plan covered 14 other countries as well and not all countries got the same result. In Mexico’s case the main focus laid on restructuring and exchanging commercial debt. This would make the Brady Plan an irrelevant framework for other countries whose debt is predominantly held by official creditors. And even if the country is suitable to implement the restructurings, the domestic government also needs to be strong willing implement all the reforms. Because some restructurings can be very tough and if the domestic situation is too fragile the Plan will not work or even collapse.

A few other objections against the Brady Plan were that people complained about the taxpayer becoming the real victim here. Thinking that the Mexican taxpayer was expected to pay the bills (Sachs, 1989). Obviously that is not true, their contribution was only a small proportion of the whole Brady deal. And besides, the Brady Plan was by all means a better proposal than the Baker Plan. The World Bank actually stressed the need for an outward-oriented regime so that Mexico did not have to cut down on the domestic market too much.

Some economics reforms are essential and if the domestic government cannot push it through, the credit received from official financial institutions will go to waste. Even worse, the money could go to commercial creditors or the very policies that caused the whole problem are continued. Intuitively, this would jeopardize the creditworthiness of the official institutions. Rogoff (1993) suggests that some commercial banks actually have the intention to benefit in that way in the first place. Hoping for countries to fail in restructuring and thereby expect to receive more back from their initial credit. It is certain that the Brady Plan will not work in a country that cannot get the domestic situation ready and fit for restructuring. But either way the Plan does, in any case, bring along a fruitful negotiation environment where debt relief can be acquired.

3.8 Banco De México

The Banco de México (Banxico) is the central bank of Mexico. To ensure the stability of the domestic currency’s purchasing power their main function is to provide

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domestic currency to the Mexican economy. By constitutional mandate, it is autonomous in both its operations and management. Furthermore, they are responsible for supporting the sound development of the financial system and promote the optimal functioning of the payment systems (Banco de Mexico, 2014).

Throughout history the exchange rate regimes changed a lot in Mexico. The exchange rate change can be seen in graph #3 (See Appendix). In this paper we specifically look at the period of August 5 1985 until November 10 1991 (Banco de Mexico, 2009). Previous years the exchange rate already appreciated heavily, but it was nothing compared to the massive appreciation in this specific period. At that time there was a regulated float regime and Mexico’s Central Bank controlled it by accumulation and selling of foreign currencies (Ten Kate, 1992). At the beginning of this regime the USD/MXN was $282,30 (coming from $50 in 1982), at the end of the financial crisis it had raised to $3.068,90. After that, in 1994, they decided to introduce a “New Pesos” with a 1:1000 ratio holding it now around $13. But with an exchange rate appreciation of this magnitude one can imagine the impact on the interest rates and credibility of a country.

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4. THE GREEK DEBT CRISIS

As we saw in the previous chapter the Brady Plan worked out very well for Mexico. Together they got Mexico out of their debt overhang problem and through some tough restructurings. Interesting to see was what let them slide into a crisis and what aspects were involved. It is also very interesting to see what the conditions were for the Brady Plan to work. Because what we already lifted out was that the Brady Plan (constructed for 15 different countries) did not work for all cases. Of course every crisis is different, but now it is time to have a look at what the Brady Plan could do for the current Greek crisis. Greece is now struggling for a couple of years and one might think that the solution that the Brady Plan brought Mexico (debt relief and restructurings) could work, or is even necessary, for Greece. First the preceding years before the Greek crisis are worked out. Especially what their conditions were before and at the beginning of the crisis. One major factor that plays a role in the Greek crisis is their EMU membership. Some downsides of that membership are discussed, but the European tranche in this crisis is also talked over a bit later in this chapter. Also some other characteristics are observed that let some less developed countries be more vulnerable for a crisis, which are also spotted in Greece’s profile. After that the start of the current Greek crisis is taken into account, including but not limited to the different parties that played substantial part in the whole situation. Next, the dynamics of the Greek and the EU-IMF debt restructuring packages are examined. Some sanction and solutions came already into force, but some did not. These different plans are explained. Finally, a small part about the Bank of Greece (BoG) is discussed. But because Greece is in the EMU, their policy is less radical and decisive in the matter.

4.1 Pre-crisis

Although Greece entered the European Monetary Union (EMU) in 2001 the country had much difficulties meeting the formal restrictions and conditions with respect to debt sustainability. Greece has always had a relatively high debt to GDP level, but they were allowed to become a member anyway. The high current account deficits originated from the mismanagement back in the 80s and 90s. One might say that you could have saw it coming, but there were no worries because Greece enjoyed a large

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growth rate since their EMU entrance (Graph #4, see Appendix). The spreads on Greek bonds have always been low and close to the German bonds (Arghyrou, 2010, and graph #5, see Appendix) so the financial environment was supporting. It even grew more than the rest of the euro area, inflation stayed low and unemployment rates fell. The prosperity masked their vulnerability, which came to a halt when the sub-prime crisis came over from the US.

Unfortunately, competitiveness did fall when Greece entered the EMU. Although they benefitted from being in a monetary union (open trade, etc.) Greece also experienced that things would be cumbersome within this system. Wages were very inflexible and did not adjust downwards when needed, because there was not an exchange rate that could compensate for it; there was a notorious bureaucracy; disproportionate tax evasion; low stable inflation; and unnecessary high expenditures (Alogoskoufis, 2012). And no wonder, joining the euro area meant lower interest rates and easier access to credit, because they could raise funds from international markets (Lane, 2012). But, if you looked at the overall EMU current account deficit around 2007 it was close to zero. So stronger economies like Germany compensated with large surpluses for the Greek deficits. With so many different interests and different economic states the ECB needed to choose the overarching policy very delicately. In the end, Greece was very eager to enjoy their prosperity and was not about to tighten their fiscal policy. But when the crisis came over from the US they found out that their economy was not stable enough.

4.2 Characteristics for an easier victim

Fact is that Greece was struck much harder than other countries. It is well known that other countries like Portugal, Ireland, Italy and Spain (the other components of PIIGS) were also very much influenced by the crisis, but Greece’ crisis was more intense. Gourinchas and Obstfeld (2011) argue that Greece was more vulnerable because of lower institutional quality. Intuitively, this seems quite right, looking at the size and the speed of all the current restructurings. In addition, this low quality causes foreign lenders to disengage. They become suspicious and there is a lack of confidence that their investment is safe. Without new investment Greece cannot pay her short-term debt obligations and soon or later this can even cause default.

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When it comes to the speed of adjustment the rigidity of prices and wages also contribute on this point. The state of the economy needs certain flexibility, especially during a recession, but the adjustment mechanism takes too long. This originates from another cause and that is the hard peg of a country’s currency. In the case of Greece, of course, this is not a hard peg but an Optimal Currency Area (OCA) with the euro as their currency. Ironically, when a country wants to regain competitiveness they should devaluate their currency. But in an OCA the country is trapped and there is no exchange rate that changes appropriately. So now the adjustments need to be done via the domestic price level and wages.

For an OCA to function properly the countries involved must have a significant amount of trade with each other. Secondly, there should not be significant asymmetric shocks that hurt only one or a few of the countries in the OCA while the others are booming. But when it does happen flexibility is required for both labour and wages to adjust and for capital to run from the booming countries to the countries that were hit by the shock and vice versa. As explained before, in the Greek case only the first requirement was met. Labour mobility was underperforming and the wages were sticky due to labour unions. In fact Kar (2011) showed that capital funds were actually floating from weaker to stronger countries, instead of the other way around.

Imagine a deflation and all the costs that it brings along with it. For instance, all investments will be delayed because people will know that they will get more for their money when the price level is back up again. In addition, firms will be forced to cut back on costs due to lower income. And this in turn affects wages and even job losses (less employment). Taking it even further, these job losses will then increase social welfare payments and will lower overall output. It also has an effect on the country’s debt, because a deflation will result in a higher real value of their existing debt. Of course, deflation lowers prices, which will make a country more competitive and will increase a country’s net export. But being in a debt overhang problem situation the amount of debt is big enough that it will take too much time to overcome it. Finally, considering real interest rate is the nominal interest rate minus the inflation, a deflation will bring along a positive effect on the real interest rate. Throughout history it showed that it is difficult to keep the nominal interest rate below zero. So an expansionary monetary policy, stimulating investment, with low real interest rates and dealing with deflation is very hard to conduct. These are some consequences for being in an OCA, so it seems. This sounds all very hypothetical, but

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it shows how limited a country can be in such a situation. Here a small side step is made to discuss the actual requirements for a beneficial OCA and hard peg.

4.3 Start of the Crisis

So underneath the surface there was more for Greece than met the eye during those times. And when the crisis came over from the US in 2007 it would become the first major test of the Eurozone area (Arghyrou, 2010). The reason for the crisis was that ‘subprime’ mortgages were gathered, chopped, and through securitization sold in packages of different risk levels. Foreign investors from all over the world bought these packages and thus everyone got infected. Almost every large bank and insurance company had these packages on their balance sheets, resulting in an intertwined fate of many financial markets. When the bubble snapped this mortgage crisis evolved into a banking crisis. Because all the banks had to amortize these risky parts, they lost a lot of money. And because they all bought and sold these opaque subprime mortgages to/from each other there raised a lot of uncertainty about the banks’ balance sheets. Nobody would lend each other any more money. This lack of faith had great consequences and the interbank trade completely came to a halt. When Lehman Brothers was the first to fall, the fear for a domino effect was increasing and governments nationalized some major important banks. This was the beginning of what would become a dreadful crisis for Greece and nowadays (in the year 2014) we can look back and distinguish three guilty parties responsible for the worsening case of Greece.

4.4 Three parties to blame

When the crisis reached Greece, their vulnerability was exposed. 10-year Greek government bond yield started ascending more and more, hitting its peak in 2009. Beetsma (2011) states that Greece already admitted in 2004 that they joined the Eurozone with wrong and deluded deficit numbers. But in 2009 Greece again announced that their deficit was larger than expected. After a landslide victory, the new government announced that the previous government’s prognosis for the Greek budget deficit was more than double the amount (from 6% to 12,7% of GDP). Then after a few months another announcement was made, admitting that the Greek budget deficit was revised to an even greater amount of 13,6% of GDP. (Graph #6, see

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Appendix) After this, on 23 April 2010, the Greek authorities formally requested the activation of the EU/IMF rescue mechanism (Arghyrou, 2010). Clearly, the lack of transparency and the huge mismanagement of fiscal and macroeconomic policy over the years have done a great deal of harm. So in the first place it was Greece’s own fault, having an unstable. But at the same time, after some delay of payments, the financial markets and credit agencies started to notice and react determined.

At the end of November 2009, parallel to Greece’s budget deficit revision, Dubai asked for a delay of payments. The financial markets reacted with a strong increasing risk aversion and it waked up the credit rating agencies. De Grauwe (2010) accused the rating agencies of two shortcomings: 1) the agencies systematically failed to see crises coming and 2) after the crisis erupted, they systematically overreacted, thereby intensifying it. After founding out about Dubai’s postponement of payment the agencies downgraded Dubai’s bonds. But they also started searching for other possible sovereign debt crises, knowing that they failed so scandalously. Obviously, Greece was a natural target. And soon more southern European countries were examined and the rating agencies started the downgrading process. Government bond rates increased significantly and Greece had to go through the “Fisher paradox” (Fisher, 1932). For the private sector to reduce its debt the governments needs to be willing to increase its own debt. But the credit rating agencies force the government to deleverage their own debt levels. They cannot reduce their debt both at the same time, otherwise neither of them will succeed. It turns into self-defeating dynamics, which pulls the economy down into deflation (De Grauwe, 2010). Concluding remarks, the credit rating agencies did not take action when needed and overreacted afterwards.

As a third responsible party, a fair portion of blame can be allocated to the ECB and Eurozone governments. Here credit rating also plays a role in the matter. As discussed earlier in this chapter an OCA, like the EMU, has its rigidities. In the case of Greece the ECB and Eurozone countries reacted far too late. They failed to give a clear signal to the market that they were willing to provide political and financial support to whichever country was facing financial problems (Kouretas, 2010). Two reasons can be found for this delay: First it has got to do with the no bail out clause signed in one of the EU treaties. The Maastricht Treaty states with a no-bail-out clause that the European Union shall not be liable for the debt of governments, i.e. the governments of the Union cannot be forced to bail out a member state. (Article 103, section 1) A misinterpretation is at hand here, because another clause in the Treaty

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(article 100, section 2) states that when a member state is seriously threatened by exceptional circumstances beyond its control, the Council may grant financial assistance to the member state concerning. Obviously they can only do this with a qualified majority on a proposal by the Commission and under certain conditions. If they had figured out earlier that by helping Greece they were not breaking any clauses and had not discussed about it so long, Greece would have been helped faster. Secondly, there was a major disagreement on the actual appropriate response to the Greek crisis. Europe faced a lack of political union and created ambiguities about whether Greek government debt was accepted as collateral in liquidity provision (De Grauwe, 2010). And here the credit ratings come in again.

The ECB relies on ratings by the same American credit rating agencies to determine suitability of government bonds as collateral. Before the crisis the ECB agreed upon a minimal rating of A+ for bonds to be eligible. But when the banking crisis occurred the ECB temporarily lowered this to BBB- to support out the banks. At the end of 2009 the ECB publicly declared going back to their pre-crisis minimal rating from the start of 2011 on. For Greece this was at the very moment of weakness and the market participants holding Greek government bonds saw their holdings become extremely illiquid. The same was true for many other countries and this worsened the crisis.

4.5 The dynamics of the Greek restructurings

Today (in the year 2014) a lot of restructuring has been done in Europe. What started in Greece has affected many countries in Europe and the first signs of improvement are showing. The last couple of years a few solutions have been brought to the stand in the public debate and some are carried through as we speak. Although Greece is the main subject of this paper, the crisis is also tackled on a European scale and thus this will also be discussed. The Greek government responded to the crisis with the Greek Stability and Growth Programme and the trinity named the “Troika” (consisting of the ECB, EC and IMF) have brought the EU-IMF Fiscal Consolidation Package to help Greece back up (Kouretas, 2010). Both programmes are looked at into more details.

The Greek Stability and Growth Programme was submitted in January 2010. It consisted of five points on the revenue side and five points on the expenditure side to reduce government spending (Kouretas, 2010). First, the tax collection and evasion

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were at troublesome levels, which would gain around 1.2 billion euro. Second, the social contribution evasion needed to be lowered and the age of retirement had to go up; this was also estimated on a 1.2 billion euro raise. Third, profitable companies received a special levy accounting for 0.87 billion euro. Fourth, faster progressing EU receipts for a public investment programme. This would raise another 1.4 billion euro. Finally, several indirect taxes were increased like on alcohol and oil. Then on the expenditure side first salaries were lowered with 10%, saving around 0.65 billion euro. Second, a recruitment freeze in the public sector was set into motion. Expected to save 0.15 billion euro. Third, implementing a 5:1 retirement/recruitment ratio for employees in the public sector. The estimated savings will be 0.12 billion euro, but it will cost around 8000 people their jobs. Fourth, the amount of the budget used for social security and pension funds is lowered with 10%. This will save Greece an amount of 0.54 billion euro. Finally, other measures in the public services that can help save more money. In total these ten targets can save up to almost 3% of GDP.

In addition to these ten targets some other conditions played a role. In a meeting in July 2011 many loans’ maturity were extended, interest rates were lowered and the private sector was addressed to participate. Private banks were asked to partly absolve their loans to Greece with the aim to lower the Greek government debt to GDP below 100%. The Greek parliament also approved a law that made the firing of civil servants possible. And in 2012 they also agreed on an arrangement with private creditors; almost all bonds where interchanged for bonds worth around 50% of their previous value. Of course these restructurings had influence on the Greek economy and market. Wages declined 15% on average in the public sector and with 30% at state-owned companies. Pensions were lowered with 10% and almost 10% of all government employees lost their job. The Greek unemployment level rose to above 25% (Graph #7), which started a lot of protesting of the Greek people. Because much Greek debt is owned by Greek banks further debt relief is risky. Although it would lower the pressure on the Greek government, debt relief might cause the Greek banks to default. Moreover, this would mean that all creditors will not receive back all their money and many countries will not allow this. They are afraid that domestic tax is used to pay for this debt relief.

Then for the EU-IMF fiscal consolidation package there were also some conditions that needed to be met before or during the process of restructuring. In March 2010 they reached a three-year programme agreement for bilateral loan from

Greece and the Brady Plan