OECD warns euro periphery debt unsustainable

City A.M. Reporter
Debt levels in Greece, Ireland and Portugal are unsustainable if market interest rates remain high – but policy options for restoring the countries to health carry big risks, the OECD has said.

The Organisation for Economic Cooperation and Development said the three countries faced huge challenges even if they met the targets set their in EU/IMF rescue packages.

"Even if the governments are more or less on track to meet their fiscal targets, their fiscal positions would not be sustainable if market interest rates were to remain for long at their current level," the OECD said in its twice-yearly economic outlook.

The report mapped out three rescue options for the countries but stopped short of endorsing any of them and highlighted hefty risks involved.

It first proposed continued funding from the European Union and International Monetary Fund at interest rates well below those in the market.

"However, if eventually any of these countries were unable to repay their debts at the interest rate on offer, such continued assistance would only have postponed the resolution of unsustainable positions," the OECD warned.

While continued assistance could calm markets in the short term, the OECD said, it could also drive up debt yields if official loans were seen to have senior status.

"Unless such senior assistance reduces the probability of default significantly, it thus translates into higher risk premia," the OECD said in the report.

A second option would be to reschedule the existing debt stock, but this would have to be done over a "very extended period" and at low interest rates to restore fiscal sustainability.

The third option would be reduce government liabilities through a more far-reaching debt restructuring.

"In practice, however, the use of this option is severely circumscribed by the need to find adequate answers to three issues: how to avoid a breakdown of domestic financial sectors, which would have calamitous effects; how to address spillovers to other countries through the financial system; and how to prevent contagion effects from one country to others," the OECD said.

A disorderly debt restructuring could spark contagion to the core of the eurozone financial system, heightening risk aversion globally, it said.