IMF: In or out of the Greek program?

The difficulties that the Independent Evaluation Office (IEO) of the International Monetary Fund (IMF) encountered in an attempt to detect Fund policy failures in cases such as Greece, as covered in an October 20 New York Times piece by Landon Thomas Jr., “IMF Assessment Hints at Internal Struggles,” raises a number of questions. No, one of the main questions is not about obstacles that the IEO supposedly faced in its effort to evaluate the IMF’s performance, as the Times reporter seems to suggest. Rather, it is about the substance of the current third Greek program and, in particular, the Fund’s stance as regards Greece’s debt (un)sustainability, a view strongly at odds with what European creditors seem to believe.

However, I have the impression that even this contretemps amounts to shadow boxing too.

The IMF’s earlier stance that Greek debt was sustainable seemed to come to an end back in May/June 2014, at the time of its fifth report for the second program. The Fund rationale seems to have been that the program went off the rails due to actions of the government of Prime Minister Alexis Tsipras in the first half of 2015. In fact, a potential boost to GDP of 3 percentage points per annum for both 2015 and 2016 were lost, due to the wanton mismanagement of the economy by the current radical-left, radical-right Greek government. A new agreement was then negotiated between the Greek government and creditors with the ambitious aim of avoiding Greek bankruptcy and quickly achieving recovery.

But the IMF is now distancing itself from its earlier participation in the program, arguing that debt in particular is unsustainable and so it cannot provide financial assistance. The question that arises then, is, if the third program is supposed to be sufficiently capable of spurring an economic recovery by allowing Greece to gain access to capital markets by late 2018, how is it that the debt is at the same time, unsustainable?

As a matter of fact, how heavy a debt repayment schedule is Greece carrying? The following table shows the situation is not actually that dire. For some perspective, it is useful to compare Greece to Portugal, a peer country with about the same GDP. The table shows that, until 2025, Portugal has to make about 50 percent more repayments as a percentage of its GDP, than Greece. Ireland, Italy, and Spain are in even worse positions!

Source: EC AMeco Data elaboration by Japonica Partners. 

High interest rates are not part of the equation either—on average the rate for Greece is 2.6 percent—is the lowest by far among the five countries.

But then what is to blame for the IMF’s intransigence? A popular view supported not only by IMF but also by a vast majority of Greek politicians is that the target of a +3.50 primary budget surplus from 2018 and onwards is unrealistic and sends a signal to markets and foreign investors that Greece it is being set up to fail.

But in absolute numbers the same amount of primary surplus may be a different percentage of GDP! Three and a half percent of GDP is around 6 billion euros. The same amount of money, with a, let’s say 5-6 percent nominal growth rate represents a lower surplus in percentage, say 2.5 percent! Therefore, a dynamic view of the problem requires looking at the nominal GDP growth first and then focusing on fiscal targets and/or debt analytics.

The implementation of the third program since the summer of 2015, has once again put the burden of adjustment on the productive, private economy, simply by overtaxing it amidst a tough recovery phase. It is difficult to understand how an institution such as the IMF agreed with the Syriza government to a pro-cyclical policy prescription based on overtaxing the economy and killing the recovery, which, by the way, is indispensable both for achieving a 3.5 percent primary surplus and for debt sustainability. One would expect the Fund to ask the government to focus on growth measures and cut at least equally waste, but instead the IMF paradoxically agreed with Syriza on taxing anything that moves.

However, the result is that GDP today is extremely weak and the 1.75 percent primary fiscal surplus target for 2017 and the 3.5 percent target for 2018 seem now to be out of reach!

My conclusions are as follows:

• Debt is sustainable, so long as an economic recovery is around the corner. The Fund’s assertion of unsustainability seems to be grounded in a belief that recovery will not come anytime soon, especially as the program requires very high, pro-cyclical primary surpluses. True story, but who prescribed that policy of tax folly?
• Over-taxation is again killing the recovery. To agree to such a policy prescription and then say that high primary balances (as a percentage of nominal growth) are not realistic—and so debt is unsustainable—does not make much sense. If fiscal targets are unattainably high and then debt becomes unsustainable, please do something about that and veto any pro-cyclical, policy-killing growth!
• Facing tax folly, enterprises reduce wages and hire part-time labor to adjust. Expenditure falters and GDP stagnates. Foreign investors and markets see that the economy will not recover and that the country will soon need again some kind of debt re-arrangement. So, no money from abroad anytime soon, meaning no growth prospects at least for the next couple of years.