External debt is Greece’s perennial Achilles heel, economists warn

Greece has been through many cycles of debt, default and bailout in its history, and it is the composition of its sovereign debt as well as the level is to blame, according to a new research by economists Carmen Reinhart and Christoph Trebesch.

"The evidence we present reveals striking historical parallels between the past and the present," they say in a paper that studies a range of crises since the country gained independence in 1829.

Greece has been bailed out "many times", with "heavy conditionality" and externally imposed adjustment processes. Each crisis was characterised by a reliance on external debt, and while creditors initially held out, they were always eventually forced to accept haircuts, the economists say.

Reinhart, a professor at the Harvard Kennedy School, and Trebesch, an assistant professor at the University of Munich, stress the importance of Greece's reliance on external debt in their paper, published by the National Bureau of Economic Research.

Over the past 200 years, Greece's reliance on external debt has made the country vulnerable to sudden stops in capital flows, the authors say. They note this serves as a "broader precautionary note" for other countries "addicted" to external debt.

Indeed it is an issue that may well afflict other economies. The Bank for International Settlements warned in its latest quarterly review that emerging markets are heavily reliant on US dollar-denominated debt, raising the prospect of a sudden reversal in capital flows if the Federal Reserve was to raise rates.

Reinhart and Trebesch draw a parallel in particular to countries in Latin America, many of which have been "chronically dependent" on external borrowing, and went through "repeated" boom-bust cycles over the past 200 years.

By contrast, countries such as Japan and India that focused on domestic borrowing have "barely witnessed" sudden stops and defaults in their history.

'Dire consequences'

Reinhart and Trebesch note that external borrowing is alluring for its low interest rates and ready availability. "But these potential advantages of external borrowing may come at a high cost, given the fickle nature of foreign saving," they say.

Greece's first external borrowing came in 1833, from Britain, France and Russia, with high taxes and public spending cuts attached as conditions. Similar adjustment programmes were a condition of loans in 1898 from the International Finance Commission, in 1923 from the League of Nations and in 2010 from the Troika, the authors say.

In all four episodes, the authors document rising interest rates and "strong balance sheet effects", which are signs of a sudden stop in capital flows. Falling exchange rates and central bank reserves resulted in shortages of foreign exchange.

Crisis resolution processes were "protracted", characterised in particular by a refusal to grant debt relief that caused economic difficulties to persist over many years.

"Arguably, the most costly legacy of external debt is the loss of political control that comes with it during crisis times," they say.