In the context of

sovereign debt crisis A sovereign default is the failure or refusal of the government of a sovereign state to pay back its debt in full when due. Cessation of due payments (or receivables) may either be accompanied by that government's formal declaration that it wil ...

, private sector involvement (PSI) is, broadly speaking, the forced contribution of

private sector The private sector is the part of the economy which is owned by private groups, usually as a means of establishment for profit or non profit, rather than being owned by the government. Employment The private sector employs most of the workfo ...

creditors to a

financial crisis A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with Bank run#Systemic banki ...

resolution process, and, specifically, to the private sector incurring outright reductions ("haircuts") on the value of its debt holdings.

History

The term "private sector involvement" was introduced in the late 1990s in the context of the discussions on bond restructurings and

capital account In macroeconomics and international finance, the capital account, also known as the capital and financial account, records the net flow of Foreign direct investment, investment into an economy. It is one of the two primary components of the balan ...

crises. Previously, the term used to broadly denote any kind of private-sector participation in an existing government program, such as, for example,

family planning Family planning is the consideration of the number of children a person wishes to have, including the choice to have no children, and the age at which they wish to have them. Things that may play a role on family planning decisions include marit ...

,"Private Sector Involvement in Family Planning"
the Family Planning and Reproductive Health Indicators Database or

health care Health care, or healthcare, is the improvement or maintenance of health via the preventive healthcare, prevention, diagnosis, therapy, treatment, wikt:amelioration, amelioration or cure of disease, illness, injury, and other disability, physic ...

. Since then, it has come to signify specifically the private sector's participation in the losses taken in cases of

sovereign debt A country's gross government debt (also called public debt or sovereign debt) is the financial liabilities of the government sector. Changes in government debt over time reflect primarily borrowing due to past government deficits. A deficit occ ...

write downs.

Justification

The private sector involvement covers measures such as the rescheduling, re-profiling, and restructuring of the state-debt holdings of private creditors, in the context of the resolution of a sovereign debt crisis. According to the

International Monetary Fund The International Monetary Fund (IMF) is a major financial agency of the United Nations, and an international financial institution funded by 191 member countries, with headquarters in Washington, D.C. It is regarded as the global lender of las ...

, the measures of the private sector involvement process are appropriate in order to "have the burden of crisis resolution shared equitably with the

tate Tate is an institution that houses, in a network of four art galleries, the United Kingdom's national collection of British art, and international modern and contemporary art. It is not a government institution, but its main sponsor is the UK ...

sector," as well as to "strengthen market discipline."

Implications

ECB Executive Board member Lorenzo Bini Smaghi warned in 2011 that the enforcement of private sector involvement in resolving a financial crisis inside the

Eurozone The euro area, commonly called the eurozone (EZ), is a Monetary union, currency union of 20 Member state of the European Union, member states of the European Union (EU) that have adopted the euro (Euro sign, €) as their primary currency ...

would incur "a series of problems": The taxpayers of the creditor countries would suffer in any case; patient investors, who have stuck to their investment, would be punished; the measure would destabilize the financial markets of the Eurozone by creating incentives for short-term speculative behavior; and it would delay the return of the debtor nation to the markets since market participants would be unwilling to start reinvesting in the country for a long period. This, Smaghi stated, would oblige the state sector to eventually increase its financial contribution.

Context

Although the term used to denote any kind of private-sector participation in an existing government program, such as, for example,

, or

, it has come to signify the private sector's participation in the losses taken in cases of

write downs, and, more specifically, "any kind of...contributions of the private sector in the context of sovereign financial distress." In the view of the

, private sector involvement "in the resolution of financial crises is appropriate in order to have the burden of crisis resolution shared equitably with the official sector, strengthen market discipline, and, in the process, increase the efficiency of international capital markets and the ability of emerging market borrowers to protect themselves against volatility and contagion." The Fund claims that "a broad consensus has emerged among IMF member countries on the need to seek PSI in the resolution of crises." According to William R. Cline, “'PSI' has been the 1990s equivalent of 'bailing in the banks' in the 1980s."

Greek sovereign-debt crisis

The most prominent case of PSI occurred in the process of the sovereign-debt restructuring of

Greece Greece, officially the Hellenic Republic, is a country in Southeast Europe. Located on the southern tip of the Balkan peninsula, it shares land borders with Albania to the northwest, North Macedonia and Bulgaria to the north, and Turkey to th ...

, after a significant

haircut A hairstyle, hairdo, haircut, or coiffure refers to the styling of hair, usually on the human head but sometimes on the face or body. The fashioning of hair can be considered an aspect of personal grooming, fashion, and cosmetics, although ...

"Haircut: A reduction in the

face value The face value, sometimes called nominal value, is the value of a coin, bond, stamp or paper money as printed on the coin, stamp or bill itself by the issuing authority. The face value of coins, stamps, or bill is usually its legal value. Ho ...

of a troubled borrower's debts
BBC
2015); a reduction of the amount that will be repaid to creditors

2015) of it was agreed, in early 2012. The so-called "world's biggest debt-restructuring deal in history""How the Greek debt puzzle was solved"
Reuters, 29 February 2012 affecting some €206bn of bonds, occurred in February 2012, when the

Eurogroup The Eurogroup is the recognised collective term for the informal meetings of the finance ministers of the eurozone—those member states of the European Union (EU) which have adopted the euro as their official currency. The group has 20 members ...

finalized a second bailout package for Greece.Statement
by the

, 21 February 2012 EU member-states agreed to a new €100 billion loan and a retroactive lowering of the bailout interest rates, while the

would provide "a significant contribution" to that loan. Part of that deal was the agreement for private-sector involvement (PSI), whereby private investors were asked to accept to write off 53.5% of the face value of the Greek governmental bonds they're holding, the equivalent to an overall loss of around 75%. If not enough private-sector bondholders were to agree to participate in the bond swap per the PSI requirement, the Greek government threatened to retroactively introduce a

collective action clause A collective action clause (CAC) allows a supermajority of bondholders to agree to a debt restructuring that is legally binding on all holders of the bond, including those who vote against the restructuring. Bondholders generally opposed such cla ...

to enforce participation."Das Rettungspaket kommt, die Zweifel bleiben"
("The bailout comes, the doubts remain"), ''

Süddeutsche Zeitung The ''Süddeutsche Zeitung'' (; ), published in Munich, Bavaria, is one of the largest and most influential daily newspapers in Germany. The tone of ''SZ'' is mainly described as centre-left, liberal, social-liberal, progressive-liberal, and ...

'', 21 February 2012, (in German) Eventually, private-sector involvement reached 83,5% of Greek bond holders. The

Bank of Greece The Bank of Greece ( , ) is the national central bank for Greece within the Eurosystem. It was the Greek central bank from 1927 to 2000, issuing the drachma. Since 2014, it has also been Greece's national competent authority within European ...

, in its 2011–12 report, commented that "the successful completion of the PSI, creates a new operating framework for the Greek economy in the years ahead." The PSI was proclaimed a "great success", justified as providing the Greek economy with breathing space, although it hit the value of Greek holders of debt paper, as well as the reserves of Greek pension funds, most severely penalizing small private bondholders (i.e. private individuals holding less than 100k face value), whose losses were not even recognized for a

tax deferral Tax deferral refers to instances where a taxpayer can delay paying taxes to some future period. In theory, the net taxes paid should be the same. Taxes can sometimes be deferred indefinitely, or may be taxed at a lower rate in the future, particular ...

. (The law 4046/2012, article 3, paragraph 5, only recognized losses of corporations for tax write-offs). At the same time, Greek sovereign bonds held by the ECB and other EU central banks as a result of the SMP Programme (and ANFAs operations) were excluded from the PSI step through a secretly agreed swap agreement between the ECB and the Hellenic Republic in February 2012. During the following years, Eurosystem central banks were subsequently paid back at face value, generating a substantial 18 billion euros of profits, which were partly retroceded to the Greek government.

Legal aspects

Certain official measures executed during Greece's state

debt restructuring Debt restructuring is a process that allows a private or public company or a sovereign entity facing cash flow problems and financial distress to reduce and renegotiate its delinquent debts to improve or restore liquidity so that it can continu ...

process and the subsequent private sector involvement were not covered by existing ISDA provisions for CDS contracts, as the

conceded. Therefore, according to the IMF, the typically expected credit event was not officially triggered, the negative contingencies to private holders of state debt were increased, while the credibility of the sovereign- CDS market was undermined. The measures undertaken included the "persuasion"Quotation marks in the original. of certain Greek debt-holders to accept large

haircuts A hairstyle, hairdo, haircut, or coiffure refers to the styling of hair, usually on the human head but sometimes on the face or body. The fashioning of hair can be considered an aspect of personal grooming, fashion, and cosmetics, although ...

under a supposedly “voluntary PSI" agreement. Accordingly, Greece achieved a "very high creditor participation" of 97 percent of debt held, despite the restructuring being preemptive and, as assessed by the IMF, having a "very large" target of a 70 percent

of the bonds'

.In terms of

net present value The net present value (NPV) or net present worth (NPW) is a way of measuring the value of an asset that has cashflow by adding up the present value of all the future cash flows that asset will generate. The present value of a cash flow depends on ...

Notes

References

External links

*{{cite journal , last= Xafa , first= Miranda, author-link=Miranda Xafa , date=January–March 2013 , url=https://www.mirandaxafa.com/mediaupload/articles/life_after_debt.pdf, title=Life after Debt: The Greek PSI and its aftermath , journal=World Economics, volume=14, issue=1 , pages=81–102 Government finances Investment Public economics