June 9, 2013 5:53 pm

Hail the outbreak of honesty about Greece’s bailout

By Wolfgang Münchau

The IMF’s admission is welcome but the hard part will be acting on it

An elderly woman chants anti-austerity slogans during a protest by hundreds of pensioners in central Athens, Thursday, June 6, 2013. Elderly Greeks have faced successive pension cuts since Greece began relying on international rescue loans in 2010, and have also been hard hit by health care cuts. (AP Photo/Petros Giannakouris)©AP

It was the most honest and clear-headed analysis by an official body on the eurozone crisis yet. In just 50 pages, the International Monetary Fund produced a concise and sober analysis of what went wrong in the Greek rescue programme. This month’s report is also an outcry against the European policy consensus. Commentatorsincluding me – have been attacking this consensus for more tan three years. It is the first time an official institution has joined in.

According to the IMF, the fundamental error was excessive optimism about economic growth. The error was fundamental in the sense that it caused other misjudgments – about deficit reduction, financial sector stress, the speed of reforms and debt sustainability. Moreover, it was not an error of bad luck. The severe economic consequences of the agreed Greek adjustment were not merely visible; they were actually foreseen by many critics, as the IMF openly admits.

The other big regret expressed in this paper concerns the excessively long time it took to agree a debt restructuring for Greece. When the agreement came, most private sector investors had already pulled out.

The consequences of these accumulated errors are grave. More importantly, they make it impossible to solve the crisis within the present parameters. In a separate analysis, the IMF concluded that the debt sustainability analysis underpinning the 2012 Greek bailout is already for the birds.

It concluded that there has to be more debt relief than envisaged – some 7 per cent of gross domestic product – to meet the debt sustainability target of 124 per cent in 2020, and of 110 per cent in 2022. The 2012 agreement acknowledged a hole of 4 per cent, which has yet to be plugged. The increased estimate does not sound much but it, too, is based on positive assumptions. And it is, as ever, a minimal number.

My own expectation is that Greece will remain stuck in a vicious circle of recession and debt deflation until it either leaves the eurozone and defaults unilaterally or there is a fundamental shift in policy. The latter would require two adjustments to the existing programme.

The first would be a redefinition of debt sustainability. The target of 124 per cent of GDP is both arbitrary and illusionary. It is arbitrary because there is no economic reason for this number.

It is illusionary because investors no longer regard Greek debt as sovereign, but as sub-sovereign. Sub-sovereign entities, such as US states or German Länder, cannot sustain the same debt-to-GDP ratios as sovereign countries because they lack the ability to print their own money. A figure in the range of 60-80 per cent would be more realistic.

Second, any further debt sustainability analysis should rely on more cautious assumptions about future growth and the speed of reforms. The combination of a more realistic debt target and adjustment path is logically inconsistent with solvency. With not enough private investors left to be bailed in, this leaves official sector involvement as the only way out. Yet this is, and has remained, a taboo subject because it would be an admission that this crisis is going to cost northern Europeans a lot of money.

This is not a message the German government is keen to sell three months before the general election. I suspect it is not going to be a sellable proposition afterwards either. The only limited form of official sector involvement I can see is through debt forbearance, by which creditors and debtors agree to extend the maturity of credit and reduce interest rates. This is a form of concealed debt relief, but it is hard to see how it can be accomplished on a large scale.

Without a realistic prospect of eventual debt relief, however, Greece will have a rational economic motive to leave the eurozone once it has achieved a primary surplus and undertaken labour market reforms that enable it to benefit from a devaluation and a default. This moment has not arrived but is coming closer.

The IMF’s critical analysis is also clear-headed in the description of the political problems it faced as a member of the troika – which also includes the European Central Bank and the commission. The fund is clearly not comfortable with its relegation to the position of a junior partner, considering that it is the only organisation in the troika with any knowhow in crisis resolution.

What effect on policy will the IMF’s analysis have? The fund certainly did not apply this level of new thinking when it negotiated the bailout for Cyprus. Its prediction last month that the country would return to growth in 2015 was ludicrous – especially in view of what happened in Greece.

It is hard to escape the impression that the IMF may not be speaking with one voice here. When Poul Thomsen, mission chief in Greece, said the IMF would do it again if faced with the same information, one did not get the impression that he endorsed the message of this paper. While Washington sent its mea culpa, Mr Thomsen retorted: je ne regrette rien.

Judging from the furious reaction of Olli Rehn, European commissioner in charge of economic policy, my best guess is that eurozone policy makers will ignore the recommendations. The German government will almost certainly not accept these findings either. If the IMF is serious about its own analysis – and it should be – it should either force a policy change, or be ready to leave the troika.
Copyright The Financial Times Limited 2013

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