The endgame for Greece is approaching. Eurozone policymakers appear to accept that the country is insolvent. That comes a bit late, but not too late. The eurozone now faces two formidable tasks: to quarantine Greece, and to fortify the bloc’s core, especially Italy, to reduce the risk of contagion. These require policymakers to be brave enough to make some tough choices.

How insolvent is Greece? Barclays Capital estimates that Athens would need to run a primary surplus of 7.4 per cent of gross domestic product by 2015 to restore debt sustainability, but that the maximum achievable economically and politically is 2.5 per cent. On the latter assumption, absent a restructuring, Greece’s debt to GDP ratio could reach more than 400 per cent by 2050.

A restructuring should reduce the net present value of Greece’s debt (currently about €330bn, or around 150 per cent of GDP) by at least half, and preferably to well below the eurozone target of 60 per cent. A restructuring is best done once, so that it does not have to be done again. That means getting tough with Europe’s banks. To address any insolvency, a haircut must be imposed: in the case of Greek bonds, something of the order of 80 per cent may be necessary. Much less might not be enough both to restore solvency and to allow its return to the markets.

Banks and insurers across Europe, along with their shareholders, would be hurt by such a move, but the pain would be manageable. Capital Economics estimates that the cost of solving Greece is about €140bn – or 2 per cent of eurozone GDP. Adding Ireland and Portugal to the mix – which may become inevitable as their debt is downgraded to junk status – would not take the cost beyond 5 per cent. The alternative, a broken eurozone, would be far more costly.

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