BackGreece needs a haircut; even IMF knows this
It is no longer possible to 'extend and pretend' for Europe and for Greece
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In 2013, The Wall Street Journal (WSJ) published the leaked minutes of the May 2010 meeting of the International Monetary Fund (IMF) on the first Greek bailout. The minutes show that several IMF officials, especially those from emerging economies, were very sceptical about the impact of the austerity programme forced on Greece. WSJ cited India’s executive director at the IMF, Arvind Virmani, as saying, “The scale of the fiscal reduction without any monetary policy offset is unprecedented…(It) is a mammoth burden that the economy could hardly bear. Even if, arguably, the program is successfully implemented, it could trigger a deflationary spiral of falling prices, falling employment, and falling fiscal revenues that could eventually undermine the program itself. In this context, it is also necessary to ask if the magnitude of adjustment…is building in risk of program failure and consequent payment standstill…There is concern that default/restructuring is inevitable."
Virmani’s comments proved to be prophetic but, of course, the advice fell on deaf ears.
The Greek economy continued to contract, unemployment rose to a quarter of the population and the IMF programme was a failure, with government gross debt rising from 145% of gross domestic product (GDP) in 2010 to 177% in 2014.
And, remember, this happened in spite of the loosest possible monetary policy and ultra-low interest rates.
The Brazilian executive director hit the nail on the head when he said the IMF programme, “may be seen not as a rescue of Greece, which will have to undergo a wrenching adjustment, but as a bailout of Greece’s private debt holders, mainly European financial institutions."
The Swiss executive director asked: “Why has debt restructuring and the involvement of the private sector in the rescue package not been considered so far?"
The representatives of Egypt, Iran, Russia and Argentina all proposed the restructuring of Greek debt. They were all ignored.
After that agreement unravelled, in 2012, an accord was reached with some private sector creditors to cancel half their debt, but many foreign private creditors had already been paid and it was the Greek financial institutions, including their pension funds, which had to take the brunt of the write-downs. The result was that the Greek government had to borrow even more to bail them out. The upshot is that now, Greek debt is owed mainly to the Troika—IMF, the European Union member states (Germany as the largest creditor) and the European Central Bank.
Cut to the present. A few days ago, the IMF unveiled an extraordinary document, a “preliminary draft debt sustainability analysis" on Greece. Reuters reports that the EU members wanted to keep this IMF analysis secret, but it was released under pressure from the US. The document is dated 26 June, but was released on 2 July. It is, of course, dead in the water, because, with the breaking off of the talks, the default to the IMF and the referendum, events have moved rapidly beyond it.
What does the IMF document say?
It assumes Greek GDP growth of 2% in 2016 and 3% in 2017 and 2018. Those assumptions are in startling contrast to the growth rates of -5.4%, -8.9%,-6.6%, -3.9% and 0.8% for 2010 to 2014. That’s not all—the IMF says real GDP growth since Greece joined the EU in 1981 has averaged 0.9% per year. Under the circumstances, the IMF growth projections appear rather heroic.
Just how heroic? Total factor productivity (TFP) has averaged a mere 0.1% per year since Greece joined the EU. If that average rate of growth continues, then, the IMF study says, Greece would have an average growth of -0.6% per annum. If, instead, it carried out structural reform, if labour force participation increased to the highest in the euro area, unemployment fell to German levels, and TFP growth reached the average in the euro area since 1980, real GDP growth would average 0.8% of GDP. Clearly, the IMF projections are not just heroic, they are positively Herculean.
Similarly, against a primary surplus (surplus excluding interest payments) of 0% of GDP in 2014 and a hoped-for primary surplus of 1% this year, the IMF projects primary surpluses of 2% next year, 3% in 2017 and 3.5% of GDP thereafter. These high growth and primary surplus projections are the IMF’s baseline case for Greece. They do not recommend debt forgiveness and, instead, insist on even more austerity, despite the failure of the previous bailouts. As for the EU, their short-sighted leaders seem perfectly willing to betray the idea of a united Europe for thirty pieces of silver.
What if the IMF’s unrealistic assumptions are not met? In that case, the IMF study says, “A lower medium-term primary surplus of 2½% of GDP and lower real GDP growth of 1% per year would require not only concessional financing with fixed interest rates through 2020 to cover gaps as well as doubling of grace and maturities on existing debt but also a significant haircut of debt, for instance, full write-off of the stock outstanding in the GLF (Greek loan facility—€53.1 billion) or any other similar operation."
The point is, once you abandon those heroic assumptions for more reasonable ones, the conclusion is that a sizable amount of debt forgiveness is called for. For Europe and for Greece, it is no longer possible to “extend and pretend". And this is true irrespective of the outcome of the referendum.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at capitalaccount@livemint.com
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