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GDP- linked bonds: Act III – does the Greek tragedy finally reach its catharsis?

During the past months, media’s attention on the crisis in the Eurozone gradually decreased. However this does not imply that all is to the best. The stress test for European banks could expose large deficits in own capital, unemployment is fairly high and economic growth has almost come to a standstill while Government budget deficits increase. In this context the Greek emergency loans will yield maturity and have to be refinanced. There are signs that the European creditors are willing to give the Greek government’s demand for another haircut. But can this be the best tool for all parties? Herein we will discuss a potential alternative that doesn’t partially waive Greece of its debt and is linked to Greece’s economic development. Greece’s economic situation is not at its best. Since 2008 economic output has decreased by about one quarter while unemployment rose to 27%;,public deficit is at a horrendous 175% of GDP of which most is debt held by public (foreign) institutions.


Some argue that the crisis management was terrible and the haircut of 2012 was long due before. This delay has led to financial contagion of other countries instead of preventing the spread. Both programs by the EU and the IMF did not force the Greek government to take any self-responsibility, as the threats of punishment the programs were conditioned or were not credible. The programs contributed to an increasing separation of Europe as the change in voting patterns toward more radical parties and photomontages of German politicians dressed in Nazi-uniforms show.

This year the second economic adjustment programme for Greece will expire and the Greek prime minister Antonio Samaras is openly demanding a financial cut, longer maturities, lower interest rates and furthermore a grace period of several years. For the German government it would be ridiculous to meet Samaras’ demands. Not only would it impose huge costs to German taxpayers but it also would not solve Greece’s problem of public debt. The IMF forecasts that in order to reduce Government debt to a still high 128% until the year 2020 Greece would have to record annual growth rates of above 3% and a primary surplus of around 3-4% annually. However in the past Greece fell already short on the growth estimates that were estimated to be recorded under both Troika-programmes.

On the other hand there is not enough operational leeway given for the required relief. The duration of loans of European creditors for the first program is 30 years, the term of the second program even 40 years. The actual average interest rate is 1.5 per cent and the repayment of the second program is scheduled to begin only in 2023. Therefore, it is negligent to believe that another financial alleviation would sustain the debt situation of Greece, which is likely to call for further concessions during the next 2-3 years. Accordingly, this would mean a debt cut in installments.


It is therefore urgent to rethink monetary policy – a sustainable solution requires an acceleration of reforms and more self-responsibility on part of the Greek government. A new study of by the by the German Institute for Economic Research (Deutsches Institut für Wirtschaftsforschung – DIW) in Berlin suggests to link the interest rate to Greek economic growth in alternative to a cut in debt. Until now, the interest rate is linked to EU economic average growth. Hence, if Greece’s yearly growth rate is smaller than a rate, which has to be determined in advance, interest rates decline and in the opposite case they would increase. Consequently, interest payments would move in step with the growth rate and therefore automatically take into account Greece’s capacity to pay. Such a linkage already exists for a minor part of the restructuring of debt from 2012.

Furthermore, full indexing of European credits to the domestic GDP would have many advantages. On one hand it would improve Greece’s financial solvency and therefore reduce the default risk for (German) taxpayers. In long term, a higher variability of interest payments might appear which can be compensated by no loss of interest for the creditors. On the contrary, this would reduce the risk premium and improve solvency as well as lead to an economic relaxation.

Even Greece could be tempted to deliberately reduce economic growth to avoid higher interest payments; simulations of the DIW Berlin estimate this risk to be very low. GDP- linked bonds would provide incentives for Greece to assume responsibility for their own reforms and therefore increase their chances of success. The relationship between Greece and its creditors, especially Germany, could return to normal even it would be important to closely monitor Greek’s decisions and actions.

The Greek government couldn’t blame Europe any longer for their own mistakes and would ultimately realize that the responsibility of the counties future lies in their own hands. It is about time to solve the Greek government debt crisis once and for all. Financial assistance programmes of the past did not achieve what they were supposed to. Politicians on both sides –creditors and debtors- should learn from past mistakes and be open to alternative approaches. Additional financial aid programmes should make sure that Greece finally takes responsibility for their own acts and reforms. It would be a big step toward ending the inner European conflict and the European crisis.

Student Numbers: 685 & 656



Author: studentnovasbe

Master student in Nova Sbe

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