By Chr. Christodoulou-Volos

• Professor of Macroeconometrics and Finance and Chair of the Department of Economics and Management at Neapolis University Pafos

Reducing public debt is undoubtedly a goal of prudent fiscal policy. However, early repayment of public debt is not, in and of itself, an indication of sound economic management. Its effectiveness must be assessed in light of opportunity costs, fiscal constraints, and the impact on the real economy.

Greece’s recent early repayment of 2.5 billion euros to the European Financial Stability Facility (EFSF), combined with the broader plan to accelerate the reduction of public debt, brings a fundamental fiscal policy issue back to the forefront: Is it economically rational for a government to prepay its debt obligations when there are still overdue debts or significant financing needs in critical sectors of the economy?

The answer cannot be limited to the observation that debt reduction is a positive development. Economic theory calls for a more complex approach, based on the efficient allocation of limited fiscal resources and an assessment of their alternative uses.

The Opportunity Cost of Early Repayment

Every decision regarding the allocation of public resources entails an opportunity cost. Funds directed toward early loan repayment cannot, under conditions of a given fiscal constraint, be used simultaneously to settle other obligations, to finance public investments, or to boost productive capacity.

Consequently, the critical economic criterion is not the rate at which nominal debt is reduced, but rather a comparison of the marginal benefit of repayment with the marginal social and economic return on alternative uses of available resources.

If, for example, the effective cost of servicing a long-term loan is relatively low, while the repayment of maturing government obligations can immediately boost firms’ liquidity, reduce their financial burdens, and support economic activity, prioritizing early repayment is not necessarily the most cost-effective option.

Conversely, postponing productive public investments with a high expected social return may prove to be more costly in the long run than the interest savings achieved in the short term.

The Specificity of the Greek Case

In this specific case, however, a crucial clarification is needed. The repayment of 2.5 billion euros was financed by proceeds from the reprivatization of Greek banks, over which the EFSF and the European Stability Mechanism (ESM) held contractual repayment rights.

Therefore, it cannot be uncritically argued that these funds constituted entirely unrestricted budgetary resources that could be freely allocated to alternative uses.

This distinction is essential. It is one thing to make repayments arising from contractual obligations, and quite another for the government to exercise its discretion to prepay loan obligations using funds that could legally be used for other purposes.

However, this particular distinction does not negate the need for a comprehensive assessment of the public debt management strategy.

Fiscal Discipline and Maturing Liabilities

A particularly important issue is the distinction between genuine fiscal consolidation and a mere shift in liabilities.

Early repayment of loans reduces gross public debt. However, if this occurs alongside the accumulation of overdue debts to suppliers, businesses, or tax refund recipients, the overall improvement in the fiscal position may be smaller than that indicated by standard debt indicators.

Delays in government payments essentially function as a form of forced financing of the state by the private sector. They shift the financial burden onto businesses, straining their liquidity, working capital, and, ultimately, their investment decisions.

Such a practice does not constitute effective fiscal adjustment, but rather a passing on of financing costs to the real economy.

Debt Sustainability and Economic Growth

The sustainability of public debt is not determined solely by its absolute level. It depends on the relationship between the real cost of borrowing, the rate of economic growth, and the primary fiscal balance.

When the growth rate exceeds the real interest rate on debt service, the dynamics of the debt-to-GDP ratio become more favorable, provided that other necessary conditions are met.

Consequently, boosting productivity, investment, and potential output can contribute substantially to long-term debt sustainability, without requiring an unconditional acceleration of debt repayment.

This certainly does not mean that early repayment lacks economic value. Eliminating more expensive debt obligations can reduce future interest expenses, reduce refinancing risks, and strengthen the country’s credibility in international capital markets.

What should be the fiscal priority?

Effective public debt management requires a comprehensive strategy that combines maintaining creditworthiness with the consistent fulfillment of the government’s obligations and the financing of productive activities.

Early repayment is justified when the present value of its expected benefits exceeds the opportunity cost of the resources used, taking into account contractual constraints and fiscal risks.

The goal, therefore, is not to maximize the speed of debt repayment, but to maximize economic and social well-being over time, while ensuring fiscal sustainability.

A government should not be evaluated solely on the basis of the amount of loans it repays early, but also by the consistency with which it settles its obligations, the effectiveness of public spending, and the contribution of its policies to long-term growth prospects.

Because, ultimately, fiscal responsibility does not simply mean that the state pays its creditors earlier. It means managing its resources in a way that does not jeopardize the growth and prosperity of the economy it is called upon to serve.