Category: Economics and Banking

As negotiations go down to the wire, the IMF is once again being cast in the role of dictator. It is the enforcer of controversial structural reforms to a country experiencing severe economic distress, the social consequences of which have been disastrous over the last seven years. In many ways, however, the IMF is used as a scapegoat for promoting unpopular policy choices by the elected politicians and unelected bureaucrats of the eurozone who are well aware of the organisation’s fundamental commitment to favouring fiscal consolidation.

As the June 30 deadline approaches for Greece’s €1.5 billion debt repayment, here are the five key things to know about the IMF’s position.

1. Keeping the eurozone in tact

Keeping the eurozone together is a paramount concern for IMF negotiators. They will therefore almost certainly not recommend that Greece consider taking the nuclear option of abandoning the euro, which would be the likely result of defaulting on its debts.

This is because of the risk of systemic instability. And also because of the potential for eurozone rules to act as an external constraint on future economic policy choices in Greece – which the IMF has long seen as in need of further structural reforms and greater fiscal discipline.

Plus the organisation has a long history of exhibiting a status quo bias whenever it has been faced with the possibility of regional monetary distintegration, such as in the case of the ruble zone during 1991-93.

2. Reputational costs

The IMF is acutely aware of the reputational costs it faces if it is blamed for a sovereign default by Greece – let alone if Greece is eventually forced out of the euro. Here, the stakes involved with the terms of the Greek bailout, and whether or not Greece remains in the euro, differ markedly for the IMF compared with its “Troika” partners, the European Central Bank and the European Commission.

After the IMF took the lead in coordinating a multilateral response to the Asian financial crisis in 1997-98 it shouldered most of the blame for policy mistakes that inflamed the crisis. This motivated many countries to shun the organisation over the next decade until the onset of the global financial crisis in 2008.

There can be no real winners from the high stakes poker match between Greece, the EU, and the IMF that has been running since the Syriza-led coalition came to power in January. But how the IMF’s reputation fares in the aftermath of the eurozone crisis will have a significant impact on its future crisis management role, both in Europe and beyond.

This is one of the reasons behind the IMF’s decision in 2013 to publicly admit to making notable errors in underestimating the damage that the initial round of austerity policies in 2010-11 would do to the Greek economy. This acknowledgement helped to place a small amount of distance between the IMF’s position and the apparent commitment of EU leaders to austerity-at-any-cost, while reducing the potential for the IMF to be used as the scapegoat for mistakes also made by its Troika partners.

A concern with protecting its reputation is also why the IMF has been at pains to emphasise in press briefings that it has pushed for “social fairness and social balance” in the design of reforms to the Greek pension system.

3. Greece’s commitment to structural reform

How flexible the IMF will be in reaching a compromise with the Greek government depends in large part on how they assess Greece’s commitment to implementing structural economic reforms.

Over the five months since it was elected, the Syriza government has demonstrated little or no political will for implementing major overhauls of the pensions system and the tax system, which are key concerns for the IMF.

A broader issue here is the IMF’s principle of “uniformity of treatment” for borrowers. There will inevitably be internal debates over how much the IMF should compromise with Greece over its bailout terms. But this principle constrains how flexible the organisation can be seen to be for any individual country, to avoid future borrowers also demanding softer loan conditions such as through looser policy targets or a slower pace of structural reforms.

4. Views on tax reform

The IMF’s long-standing views on tax reform also limit its flexibility towards Greece’s recent proposals for tax rises. Here, as in other countries, the IMF is seeking a substantial broadening of the tax base through the expansion and simplification of consumption taxes.

It is concerned that tax increases alone cannot plug the fiscal gap in a country with a notoriously leaky tax system. Though much of Syriza’s proposed changes may increase tax revenue in the short-term, the IMF is more interested in structural reform of the tax system that can help in shaping long-term policy.

In the meantime, cutting public spending in Greece, from the IMF’s perspective, is both easier for the government to achieve as a stopgap solution and is a better indicator for the country’s creditors of the government’s political commitment to implementing painful reforms.

5. Leadership

During the four years that former French finance minister Christine Lagarde has served as the IMF Managing Director, her public comments on Greece have gradually moved towards recognition of the need for debt relief. This is a significant shift from the organisation’s official position in 2010-11, and has expanded the negotiating space available to the IMF. Meanwhile it has placed pressure on its Troika partners to deliver some form of debt relief down the track.

Yet despite growing acknowledgement that debt relief will need to be part of any long-term agreement to achieve fiscal stability in Greece, this is only likely to be formally placed on the negotiating table after the government first agrees to a comprehensive package of structural reforms.

The end game

As the negotiations over Greece’s economic future enter the end game, the chasm between the debtor country and its creditors remains both wide and deep. The carrot of debt relief is only likely to materialise once substantial progress is made on implementing the structural reforms that have been deemed unacceptable by Greece’s Syriza government.

It is hard to imagine how a workable long-term solution can be fudged at this stage of the process. This would need either the creditors relaxing their demands for continued austerity or the government caving in and accepting the structural reforms it campaigned against in the election in January. The former is highly unlikely, given the signal this would send to other economies. The latter seems equally unlikely and if it happens might result in the collapse of the government and fresh elections, starting the messy process of muddling through negotiations all over again.

Greece will hold a referendum on July 5 on whether the country should accept the bailout offer of international creditors. The government’s decision to reject what was on offer and call the referendum is ultimately an attempt to take charge of its domestic policy and reaffirm its credibility with voters.

Although Greece is hard strapped for cash this is clearly a political decision with profound consequences for the future of the European Union. It is also the right one.

This is not merely useful as a negotiating tactic for obtaining a better deal with its creditors, as many commentators might suggest. The coalition of the left, Syriza, had no choice but to oppose further measures that would lock its economy into a deflationary spiral, the trappings of which are destroying Greek society.

The Greek position

Elected with the mandate to end the savage austerity policies already imposed, Syriza could hardly accept the further cuts demanded. These include cuts in income support for pensioners below the poverty line and a VAT hike of up to 23% on food staples. Even more onerous was the demand that Greece should deliver a sustained primary budget surplus of 1% for 2016, gradually increasing to 3.5% in the following years when its economy has already been contracting for six years.

By most counts the austerity policies imposed by Greece’s creditors in 2010 in exchange for the bailout money (of €240 billion) have been an abject economic and moral failure. The International Monetary Fund itself has acknowledged “a notable failure” in managing the terms of the first Greek bailout, in setting overly optimistic expectations for the country’s economy and underestimating the effects of the austerity measures it imposed.

The former IMF negotiator, Reza Moghadam, has acknowledged the fund’s erroneous projections about Greek growth, inflation, fiscal effort and social cohesion. The debt is now almost 180% of Greece’s GDP, up from 120% when the bailout program began. And this is mainly due to the fact that GDP has contracted by 25%, rather than the significantly lower projections by the IMF. The shrinking of the economy and rising unemployment levels have exceeded those that hit the US in the financial crisis of the 1930s.

The human and social costs have been even more staggering in Greece. Incomes have fallen by an average of 40%, and the unemployment rate reached 26% in 2014 (and higher than 50% for youth). With hundreds of thousands of people depending on soup kitchens, and thousands of suicides in the years 2010-2015, the moral case for debt forgiveness seems just as strong as the technical one based on economics.

The creditors’ offer

Yet in the terms presented to Greece by their creditors there is no commitment to reducing Greece’s crippling debt (which all commentators acknowledge is unrepayable). Nor is there any tangible proposal for rebuilding the Greek economy.

Germany, France, and the EU, aided by the IMF and ECB, continue to insist on implementing policies that have so manifestly failed Greece. They do so to avoid having to justify the massive bailouts of their own financial systems – shifting the burden from banks to taxpayers – if Greece fails to make the repayments. The leading EU partners must not be seen to act leniently towards Greece as this might encourage anti-austerity parties Spain and elsewhere.

Broken Europe

But the social and political costs of these policies have put the legitimacy of the entire European integration project in question. By being locked into austerity policies, Europe is tearing itself apart.

This brings to the fore the faulty institutional framework that has exacerbated these issues. European integration was conceived by a set of elites, while many EU citizens have never fully embraced the idea: the EU tends to be regarded as an economic entity rather than a cultural or social one. The “ever closer union” remains an aspiration, while EU institutions patch up compromises between its most powerful members.

The ill-thought and haphazard implementation of the common currency is perhaps the most costly compromise of all. The Greek government is therefore right to ask for generous debt relief to allow the economy to have a fresh start in exchange for reforms that will address the perennial problems of corruption and inequality that bedevil Greek society.

The right decision

Greece has many problems – including unfair taxation (64% of taxes are paid by salaried employees and pensioners), corrupt elites who have governed the country for at least four decades with fellow European governments repeatedly turning a blind eye to their flouting of rules, and the oligarch-owned media which are neither independent nor free. But accepting the bailout would only feed into the system that got Greece into this crisis.

Meanwhile, the newcomer to Greek politics, Syriza, has been told it will only receive the funds agreed under the previous bailout terms if it is ready to implement further policies that will decimate the poor and impoverish the middle class even more. Cutting pensions, many of which are already below the eurozone average when almost one in two of them are facing poverty, would be a mistake.

So would conceding to the firing of an additional 150,000 public sector workers when their overall headcount has already been reduced by 161,000 since 2010 – a 19% reduction, according to the IMF.

Contrary to popular belief, the number of public sector employees as a percentage of the workforce in Greece is 14% below the OCED average, but austerity has had an even more disastrous impact on employment in the private sector, with an estimated 400,000 businesses closing down in the past five years.

No country has ever succeeded in emerging from financial crisis by means of austerity. Further austerity would have made the impossibly bad situation that Greece is in worse still. In rejecting the creditors’ further demands, the Greek government stands for the working people of Greece – and Europe too.

Author: Marianna Fotaki, Network Fellow, Edmond J Safra Center for Ethics, Harvard University and Professor of Business Ethics at University of Warwick,

Since our last episode, the crisis in Greece has escalated further. Negotiations between the government and its creditors collapsed over the weekend, and restrictions on bank withdrawals will now follow.

The next step is for the government to issue the equivalent of IOUs to pay salaries and pensions. The country is seemingly on the slippery slope to exiting the euro.

Many of us doubted that it would come to this. In particular, I doubted that it would come to this.

Nearly a decade ago, I analyzed scenarios for a country leaving the eurozone. I concluded that this was exceedingly unlikely to happen. The probability of a Grexit, or any Otherexit, I confidently asserted, was vanishingly small.

My friend and UC Berkeley colleague Brad DeLong regularly reminds us of the need to “mark our views to market.” So where did this prediction go wrong?

Why a euro exit didn’t make sense

My analysis was based on a comparison of economic costs and benefits of a country exiting the euro. The costs, I concluded, would be severe and heavily front-loaded.

Raising the possibility, however remote, of exit from the euro would ignite a bank run in said country. The authorities would be forced to shutter the financial system. Economic activity would grind to a halt. Losing access to not just their savings but also imported petrol, medicines and foodstuffs, angry citizens would take to the streets.

Not only would any subsequent benefits, by comparison, be delayed, but they would be disappointingly small.

With the government printing money to finance its spending, inflation would accelerate, and any improvement in export competitiveness due to depreciation of the newly reintroduced national currency would prove ephemeral.

In Greece’s case, moreover, there is the problem that the country’s leading export, refined petroleum, is priced in dollars and relies on imported oil, which is also priced in dollars. So much for the advantages of a depreciated currency.

Agricultural exports for their part will take several harvests to ramp up. And attracting more tourists won’t be easy against a drumbeat of political unrest.

What went wrong?

How did Greece end up in this pickle? Some say that the specter of a bank run was no longer a deterrent to exit once that bank run started anyway due to the deep depression into which the Greek economy had sunk.

But what is remarkable is how the so-called bank run remained a jog – it was still perfectly manageable until the Greek government called its referendum on the terms of the bail out deal offered by international creditors, negotiations broke down and exit became a real possibility.

Nonperforming loans — ones that are in default or close to it — were already rising, to be sure, but the banks still had all the liquidity they needed. The European Central Bank supported the Greek banking system with emergency liquidity assistance (ELA) right up to the very end of June. Only when Greece stopped negotiating did the Central Bank stop increasing ELA. And only then did a full-fledged bank run break out.

So I stand by the economic argument. Where I need to mark my views to market, however, is for underestimating the role of politics. In particular, I underestimated the extent of political incompetence – not just of the Greek government but even more so of its creditors.

In January Syriza had run on a platform of no more spending cuts or tax increases but also of keeping the euro. It should have anticipated that some compromise would be needed to square this circle. In the event, that realization was strangely late in coming.

And Prime Minister Alexis Tsipras and his government should have had the courage of its convictions. If it was unwilling to accept the creditors’ final offer, then it should have stated its refusal, pure and simple. If it preferred to continue negotiating, then it should have continued negotiating. The decision to call a referendum in midstream only heightened uncertainty. It was a transparent effort to evade responsibility. It was the action of leaders more interested in retaining office than in minimizing the cost to the country of the crisis.

A hard lesson learned

Still, this incompetence pales in comparison with that of the European Commission, the ECB and the IMF.

The three institutions opposed debt restructuring in 2010 when the crisis still could have been resolved at low cost. They continued to resist it in 2015, when a debt write-down was the obvious concession to Mr Tsipras & Company. The cost would have been small. Pretending instead that Greece’s debts could be repaid hardly enhanced their credibility.

Instead, the creditors first calculated the size of the primary budget surpluses that Greece would have to run in order to hypothetically repay its debt. They then required the government to raise taxes and cut spending sufficiently to produce those surpluses.

They ignored the fact that, in so doing, they consigned the country to an even deeper depression. By privileging their own balance sheets, they got the Greek government and the outcome they deserved.

The implication is clear. Never underestimate the ability of politicians to do the wrong thing. I will try to remember next time.

Author: Barry Eichengreen, Professor of Economics and Political Science at University of California, Berkeley