Room for compromise

Greece debt compromise not as hard as it looks

The possibility that a new Greek government could restructure its debt is testing a nervous market. Yet Greece and Germany, along with other international backers, will want to avoid a clash that could lead to a disorderly "Grexit" from the euro. If agreement can be reached on a reform package, financial engineering could help disguise debt reduction and save face for all.

Syriza, the party likely to lead the next Greek government, wants to cut debt so that interest is below 2 per cent of GDP, rather than the current 5 per cent. Given that most of Greece's debt is held by European state creditors, that looks hard to achieve without a big haircut. This could prove politically toxic in northern Europe, which frets about fiscal transfers between Eurozone members. It would be anathema to Berlin.

The two sides look irreconcilable. But compromise is not as hard as it looks. Syriza does not have a democratic mandate to take Greece out of the single currency. It may have to form a coalition to govern, requiring compromise even on its flagship policy. And Europe can give. Common sense dictates some debt relief: Greece's programme requires it to run an unrealistic fiscal surplus before interest payments of 4.5 per cent of GDP.

The Eurozone crisis has been a history of fudges. Taxpayers get upset about write-downs, which make losses very visible, but worry less about alterations to present value through changes to coupons and maturities. They have already taken losses by extending loans and cutting interest rates. There's still some room for more tweaking on these lines.

Another option would be to refinance the roughly euro 25 billion of Greek bonds held by the European Central Bank with cheaper long-dated loans. That would require another bailout, but still be more manageable than a haircut. Financial engineering might help too. One option would be to swap euro 52 billion of loans, currently costing Euribor plus-50 basis points, into long-dated, fixed-rate debt. That would lock in current low rates. The terms would have to be much more generous than implied by market swap rates - a backdoor subsidy.

To get any deal along these lines, a new government would need to pledge reforms, including privatisations. That may be the hardest part for a Syriza-led administration. Yet if Greece left the Eurozone, it would face similar demands from the International Monetary Fund. A deal to avert calamity should be possible.