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Emerging debt crises hold lessons, warnings for Greece

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As speculation about a Greek restructuring intensifies, investors could do worse than to look at how emerging economies have faced down debt crises.

With some 300 billion euros ($428.3 billion US) in outstanding public and private debt, a Greek workout would be unprecedented. But past credit crises suggest that restructuring, in tandem with sufficiently rigorous fiscal reform, could draw a decisive line under Greece's economic woes.

Still, successful emerging-market restructurings may not be easily replicated in Greece.

"One lesson from emerging markets is that if debt restructuring is unavoidable, it's better to do it sooner than later," said Athanasios Vamvakidis, European Head G10 FX Strategy at Bank of America-Merrill Lynch.

"But in the case of significant contagion risks and large contingent liabilities from the financial sector, it may be better to wait," he added.

A year after securing a 110 billion-euro bailout from the International Monetary Fund (IMF) and its European partners, Greece remains mired in recession and is missing fiscal targets set for its rescue.

Investors rule out an outright default but many think Greece should seek to renegotiate debt that is expected to hit 160 percent of gross domestic product next year.

BRADY CRUNCH

Wide-ranging voluntary restructuring programs such as the Brady Plan could ostensibly be a template for a solution for Greece and other indebted euro zone members such as Portugal.

Launched in 1989 to help mostly Latin American countries break out of a vicious circle of crippling debt costs and severe contraction, the Brady Plan allowed creditors to swap defaulted bank loans for a choice of new bonds, usually collateralized by U.S. Treasury bonds.

In the Greek case, the EU could offer to exchange sovereign bonds for new debt issued by its collective bailout vehicle - the European Financial Stability Fund (EFSF) or from mid-2013, the European Stability Mechanism (ESM).

Even if the terms entice enough creditors, the restructuring may not be sufficient to help drive a Greek recovery.

Over half the 17 debtor countries that took part in the Brady program between 1989 and 1997 are now investment grade but most of these are major commodity exporters that took at least a decade before attaining that credit status.

Greece's diverse investor base poses another hurdle.

"Greek debt is spread amongst a high number of investors compared with emerging markets where you could negotiate with the largest holders," said Kommer van Tright, portfolio manager at Dutch firm Robeco.

Ironically, the presence of the EU as a backstop offers creditors little incentive to take part in a restructuring.

"An incentive to take part in the Brady Plan was that it regularized payments on debt that many developing economies had simply stopped servicing," said Phil Poole, HSBC Global Asset Management's global head of macro and investment strategy.

VIENNA CALLING

Should enough creditors be persuaded to take part in a restructuring, the EU would also have to avoid fanning market fears over debt issued by peripheral euro zone countries, already heightened after EU-led bailouts for Ireland and Portugal.

Emerging markets have long laboured under the shadow of contagion risk: Mexico's declaration in 1982 that it could no longer service its foreign loans triggered a wider debt crisis for Latin America while the collapse of the Thai baht in 1997 sent Asia into a tailspin.

But the size of Greek debt together with the country's inclusion in the euro zone imply contagion from a Greek credit event would surpass anything previously seen.

Any restructuring that includes a "haircut" or forced losses on the principal would hit bondholders that include European banks and pension funds as well as the European Central Bank.

Euro zone banks hold around 154 billion euros of Greek debt, according to data from Bank for International Settlements.

If restructuring is initiated, the EU would have to provide some form of guarantee on euro zone bank deposits to prevent the run on banks seen in Argentina in 2001 when its attempt to exchange distressed debt ended in the largest ever sovereign default at over $90 billion.

Even if policymakers are willing to pay the price, Greece's inclusion in the single currency imply a debt workout would not have the same impact on growth as it has for emerging economies.

"In emerging economies, restructuring took place with exchange rate collapse and this helped the countries regain competitiveness. Devaluation is not an option for Greece," said Vamvakidis, who worked at the IMF from 1997 to 2010.

For the moment, a solution to the Greek quandary could come from the emerging economies within Europe itself.

At the height of the global financial crisis, EU policymakers moved to dissuade Western European banks from a large-scale and uncoordinated pull-out from eastern Europe under the so-called Vienna Initiative.

"What cannot be excluded...is a 'voluntary' roll-over of outstanding Greek debt...in line with the 'Vienna Initiative', said Deutsche Bank in a note.

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