LET EUROPE PAY FOR ITS POLICY FAILURES / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

July 19, 2011 11:22 pm

Let Europe pay for its policy failures

By Alan Beattie

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And so the circus moves on. On Thursday the eurozone authorities, for want of a better term, will be meeting in Brussels for the thousandth iteration of their response to the Greek crisis.

The run-up to the summit, which was supposed to design a second and much larger bail-out for Greece, has been sadly typical of Europe’s shambolic and convoluted policy process. The European Central Bank has continued a high-volume but confused row with the eurozone finance ministers about writing down Greek sovereign debt and what does or does not constitute a default.

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Watching, with a mixture of resignation and despair, is the institution that parachuted on to the battlefield at the beginning of the bail-out in May 2010, the International Monetary Fund. Anyone who still believes that the IMF is an organisation of sinister omnipotence should take a look at its current situation – and start to think, as some in Washington are, about how the IMF can disengage from a situation where the risk to its reputation is beginning to outweigh the benefit from its presence.

It was a good idea for the IMF to get involved in Greece. That it did reflects the diplomatic skills of its now departed managing director, Dominique Strauss-Kahn. Its participation meant overcoming resistance from truculent Europeans including Jean-Claude Trichet, ECB president, who wanted to sort out the problem themselves.

The IMF brought expertise, credibility and cheap lending. Reasonable people – a category that on this occasion probably even includes most economists – will argue that right from the beginning, Greece was never likely to turn round its public finances without a debt restructuring. But restructuring or no, Greece still needed to turn a primary fiscal deficit into a surplus, and was always likely to find that easier when supported by the IMF.

But partly because of mulish European pride and partly because of the size of the economies involved, the IMF contributed less than a third of the €110bn rescue package announced in May 2010, €30bn to the eurozone’s €80bn. This was a new departure: although it had co-financed rescue programmes before, with EU money supplanting its lending in eastern Europe in 2008-09, the fund had in effect operated as the senior partner or had almost complete unity of purpose with the other lenders.

By itself, this junior role may not have mattered too much as long as the fund acted as a credibility gatekeeper, taking a leading role in negotiating and enforcing loan conditionality with the borrower, Greece. But it turns out that what it really needed was to enforce conditionality on its dysfunctional co-lender, the eurozone.

All things considered, the Greek government has had a reasonable shot at implementing a very tough combination of heavy fiscal tightening and structural changes. The real failure is the chaotic babble of eurozone policymaking. It is that discord, as much as a failure of political will in Greece or even the prospect of a debt restructuring per se, that has blown out Greek bond spreads and now infected Italy and Spain with the panic virus.

The IMF now no longer bothers to hide its frustration with European bickering and dithering, and the possibility that the fund will disengage from Greece is increasingly under discussion in Washington. Last week, when it agreed its latest tranche of funding for Greece, the fund made clear that only the wider continental – and possibly global – ramifications of a disorderly Greek default allowed it to continue lending into such an uncertain situation. The main problem was not anything Greece had failed to do, but whether medium-term eurozone funding would be guaranteed, given that private lending, default or no default, is likely to be very slow to return.

Stopping disbursements under the lending programme already agreed would be a nuclear option. But when it comes to augmenting its commitment under a second bail-out, the IMF might be wise to look at the chaos of the European policymaking machinery that underlies it, and say: no thanks. It should refuse point-blank to increase its commitment if that means endorsing any programme such as the voluntary debt rollover plan recently proposed in Paris, which would make the long-term debt problem worse by offering bondholders sweeteners to participate. If the fund declining to add more lending to its current plans causes market disruption, so be it. The IMF is supposed to be there to smooth over liquidity problems, not to pour good money after bad by lending to insolvent governments. If the eurozone wants to follow a boneheaded rescue strategy, let it pay for it.

In an important and disturbing sense, the IMF’s insistence on substantial long-term eurozone financing may become a form of self-preservation. At some point, it is inevitable that the countries underwriting the eurozone rescue effort, notably Germany, will have to write off some of their own losses or in some other way effect a fiscal transfer to Greece. The IMF will not: it is a crisis lender, not a benevolent uncle for delinquent rich countries, and it needs to be clear that there will be enough eurozone cash coming in that it can get its money back.

The IMF needs to think hard about the company it chooses. Mr Strauss-Kahn rightly took a calculated risk and got the fund into the thick of the capital markets firefight in Greece. Christine Lagarde, his successor, might well be the one to organise it being airlifted out.

Copyright The Financial Times Limited 2011.