Wednesday, February 8, 2017

The IMF Staff Has It Right On Greece

By Mohamed A. El-Erian
The Bloomberg View
February 8, 2017

When the International Monetary Fund’s board met Monday to discuss Greece, it was heartening to read that “most Executive Directors” agreed with the staff’s view that the country’s debt, at 179 percent of gross domestic product at the end of 2015, was “unsustainable.” Yet “some directors had different views on the fiscal path and debt sustainability.” This division within the board also applied to what Greece still needs to do with its budget. With the medium-term primary fiscal surplus heading to 1.5 percent of GDP, “most Directors agreed that Greece does not require further fiscal consolidation at this time.” But, again, “some Directors favored a surplus of 3.5 of GDP by 2018.”

Despite the backing of a majority of the board for the staff’s technical assessment that Greece does not need to tighten its budget screws further but does require debt reduction, the institution is still unable to break a deadlock that harms the country, undermines the integrity of the euro zone, and puts the IMF’s own finances at some risk. Understanding why sheds light on the outdated governance that still plagues the IMF’s good functioning, dents its global standing and weakens its effectiveness.

Facing an acute debt problem, Greece embarked on a massive fiscal adjustment program that saw its budgetary imbalance, as measured by the primary balance, swing from a deficit of 15 percent in 2009 to a slight surplus last year -- one of the largest fiscal swings in the history of IMF programs. But because of a dreadful collapse in output, the country’s debt-to-GDP ratio continued to march relentlessly higher during the period.

The debt crisis, and what the IMF itself called an “impressive” fiscal adjustment that followed, came at a large cost to Greek citizens. From 7.8 percent in 2008, close to the euro-zone average of 7.4 percent at that time, the country’s unemployment rate soared to 27 percent in 2013, more than twice the average for the euro zone as a whole. It improved thereafter, but only marginally, amounting to around 23 percent at the end of 2016. Meanwhile, the poverty rate is at a worrisome 35.7 percent.

Youth unemployment is even more alarming: It peaked at almost 60 percent and now still stands at 46 percent. With many of the young lacking gainful employment for prolonged periods, they risk going from being unemployed to becoming unemployable, thereby threatening a lost generation with consequences that would extend to future generations.

What Greece has lacked, and still does, is high and inclusive growth. Delay in implementing pro-growth structural reforms was a contributor, but it is only part of the story.

Throughout the period, Greece has been laboring under a crushing weight of debt whose consequences go well beyond the diversion of funds for debt servicing. The resulting “debt overhang” serves to discourage the engagement of new capital, thereby withholding the fresh oxygen that the country’s economy desperately needs. The situation has been made worse by a change in the composition of liabilities that reduces the scope for debt operations -- that is a shift away from private creditors and in favor of official debt from “senior creditors.”

Some of us warned very early on about the excessive debt burden when Greece embarked on its adjustment program. And some steps were taken to reduce the burden, including an outright reduction of obligations to private creditors and securing better maturity and interest-rate terms on debt owed to European government. But, because of the steadfast opposition of official European creditors, Greece has been unable to achieve the needed critical mass reduction in its debt overhang.

Recognizing the significant headwinds to growth, the IMF staff has -- rightly -- become increasingly vocal about the need for Greece’s European partners to agree to reduction of official bilateral debt. What started out as private advocacy has, over the last couple of years, spilled onto the public domain. And in the last few months, the staff has weighed in, including via blog posts. Its assessment is particularly important as the IMF guidelines prohibit the institution from lending into a situation where medium-term debt sustainability is not within reach.

The staff’s policy position on the budget and debt is reinforced by the board’s implicit recognition of a series of analytical and operational slippages made on this sad country case. As a result, in their meeting on Monday, “Directors emphasized the importance of developing realistic forecasts and targets, securing adequate financing and debt relief, undertaking fiscal adjustment through high quality measures at a pace consistent with the country’s implementation capacity, and adopting well-sequenced structural reforms based on strong ownership and parsimonious conditionality.” In the Fund’s technical language, this is quite a mea culpa.

In an economically rational world, such a multifaceted assessment that is supported by the majority of the IMF’s 189 members should be sufficient to deliver a better outcome -- and particularly when the organization itself, together with European governments and institutions there, has been a major lender and an anchor for the adjustment programs. But this is not the case here, as staff and management find themselves in a Mexican standoff with their European political masters.

The longer European governments oppose debt reduction for Greece, the harder it will be for the country to recover from the devastating collapse in output and living standards. The longer this persists, the greater the fuel for anti-establishment parties that attack the euro zone’s ineffectiveness and spotty accomplishments. The more this goes on, the higher the probability of concerns about the integrity of this important and historical regional project whose implications extend well beyond economics and finance.

The IMF also is worse off. Having been pressured strongly by its European members to make loans it shouldn’t have made (and wouldn’t have made) had management at that time stuck to the institution’s own guidelines and practices, the IMF is now being frustrated from righting the wrong. With that comes renewed doubt about attributes that are key to its effectiveness and credibility -- from uniformity of treatment to its technocratic excellence and its ability to be an honest and trusted adviser to countries and the international community. And all this casts an even brighter spotlight on the costs and unintended consequences of outdated governance and uneven practices.


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