Greece: Default is no soft option

The head of the European Central Bank once again said today that a Greek default "would not happen". Every G20 official - in or outside the eurozone - will tell you the same thing: with markets as fragile as they are, it is unthinkable that a sovereign government would be allowed to default. Investors and experts are thinking about it all the same.

In fact, looking at the economic programme the Greek government has signed up to, many veterans of past debt crises would say a debt restructuring was only a matter of time. But it's worth asking how - and when - it is done. And how it would help.

As you'd expect, there's no rule book for countries seeking to default on their debt. It's not something the international system likes to encourage. But it's not as if it has never happened. There have been 40 defaults by sovereign governments in the past 20 years alone, and more than 70 since 1980.

Many of those governments were able to borrow again quite soon after - sometimes in a matter of months. But only when they were able to do a deal with all - or nearly all - the bond-holders on how much of the debt would get repaid - and over how long.

Russia took less than two years to restructure its foreign debt after declaring a moratorium in August 1998. Creditors lost about half of the value of the principal. A similar deal was done over the same period for Ukraine and its debt. But as we know, Argentina in January 2002 was different: messier and much more drawn-out. Offered only 30 cents on the dollar, some bond-holders are still holding out, eight years later. Only now is the country able to talk about borrowing again on international capital markets.

Research by IMF economists (The Costs of Sovereign Default, Working Paper October 2008) suggests the long-term cost of default for countries can be quite low: after a few years, governments don't even pay much of a premium on world markets. But the short-term cost to the economy can be huge. That would certainly apply to Greece today.

Imagine the Greek government stopped paying interest on its debt tomorrow. It would still have a primary deficit - excluding interest payments - of more than 8% of national income, and it might not have anyone to borrow that money from. That could mean more austerity, not less, especially if the country remained in the euro.

There would also be the collapse of the domestic banking system to consider, Greek banks being the largest holders of Greek sovereign debt. And that's before you get even to the costs of contagion for other countries, as investors wondered who would be next.

Many investors now think a Greek default - or debt restructuring - is inevitable at some point. They may be right. But it's no soft option. There are good reasons why European officials will keep saying it is unthinkable for as long as they possibly can.