Public Debt: Lessons from Greece

HOW TO REDENOMINATE SOVEREIGN DEBT IF A COUNTRY LEAVES THE EURO? ELENA CARLETTI AND PAOLO COLLA EXPLAIN IN THEIR PAPER

The rising of anti-EU parties brought redenomination at the center of the debate. Is it possible to rename sovereign debt in Europe? Under which conditions? An answer is provided by The Price of Law: The Case of the Eurozone Collective Action Clauses, a paper co-authored by Elena Carletti with Paolo Colla, Mitu Gulati and Steven Ongena.

In order to determine whether markets value contract protections, the authors compare the secondary market yields of Eurozone bonds issued under domestic law with or without the Collective Action Clauses (CACs). The clauses were introduced in January 2013 and specify the minimum vote needed to modify payment terms. “After the Greek government-debt crisis and the famous Merkel and Sarkozy’s walk at the beach in Deauville, it was decided that the restructuring of an Eurozone State debt may take place only with private sector involvement”, Carletti says. “CACs have therefore been introduced to regulate sovereign debt restructuring”.

The paper states that investors value CAC bonds because they offer better legal protection than no-CAC bonds. The latter could potentially be harmful and subject to retroactive changes, as happened in Greece. “We found that the quality of the legal system in each country matters for the differential between CAC and no-CAC bonds. A better legal system ensures a fairer decision-making process in the event of an investor-state dispute. Renaming debt means changing payment terms. This change is subject to CACs. The latter make redenomination more difficult”.

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by Claudio Todesco