Greece, the IMF, the EU and the Dance of Death

May 22, 2015

The dance of death between the Greek government, the EU and the IMF continues. Yet another deadline for another deal looms. But the options are narrowing.

The Troika plan for the Greek crisis has failed – completely. All the IMF growth projections have been wrong and the result of the Troika dictated austerity program has been that the Greek economy has shrunk by 25%, much of the population has been impoverished and the ratio of debt to GDP has worsened. As recently as late 2014 there was much upbeat talk from the Troika that the long delayed Greek recovery was at last beginning, that GDP was growing and that the Greek government would move into a budget surplus in 2015 allowing the scheduled debt repayments to take place as planned. In reality what was happening was that prices in Greece were falling faster than the GDP, which was still declining, and so for a brief period it appeared that GDP was actually rising. That illusion has now vanished.

It is now clear that Greece’s economy has been going backwards over the last 6 months, and that it has once more fallen back into recession. Greek GDP fell by 0.4% in the last three month of 2014, and by a further 0.2% in the Jan – March 2015 period. As a result at the end of March Greek GDP was only 0.3% above the year-earlier level. This is a lot lower than expected in IMF forecasts, and – perhaps more importantly – well out of line with what is needed to maintain the 2022 debt sustainability targets on which continuing Fund support for Greek programmes depends. In addition the tense stand off between the new Syriza government and its creditors has caused a massive capital outflow, as Greeks shifted their euros abroad in case of a sudden Grexit, and this has destroyed the liquidity of the Greek banking system, a system the Greek government is dependent on to buy its short term Treasury Bills in order to raise cash.

The Greek government has scrambled together the last of its financial resources to make the payments so far this year but it looks utterly impossible that it will be able to pay the several billion of debt coming due for repayment in the rest of 2015.

The pressure of the looming Greek default is opening up issues between the EU and the IMF. The reason is that IMF regulations prevent the Fund from continuing to make tranche payments to countries where there is a foreseeable financing shortfall during in the coming twelve months. The worsening Greek economic outlook and the consequent reduction in the revenue outlook effectively guarantee this shortfall. This means that the IMF is pressing the EU and the ECB to fund Greek repayments as those institutions, theoretically and legally, have the flexibility to do so whereas the IMF is constrained by its constitution and regulations.

Future IMF participation in any new Greek programme after June is also in doubt because without additional pardoning the debt will not be on a sustainable trajectory in terms of the objectives set down and agreed upon in November 2012. So we have nearly reached a point where ‘extend and pretend’ system has hit the proverbial fan. You can, of course, do more extend and pretend till the next time this all happens, but at this point the IMF seems reluctant to do so. On the other hand austerity-type spending cuts which only make the economy smaller and the growth path lower simply don’t help in this context, since what they give with one hand (debt reduction) they take away with the other (in the form of lower GDP).

The Greek Government Red Line: Pensions

The Greek government position is clear. In an interview with Britain’s Channel 4 this week, Varoufakis said Greece’s domestic commitments remained a priority. “If we can, on June 5, repay the IMF and pay pensions and salaries as well as the other obligations we have to our internal creditors, we shall,” Varoufakis said, referring to a 300-million-euro repayment due to the IMF in the first week of June. “If not, we will have to prioritize pensioners and public sector workers.”

Nearly 45% of Greece’s 2.5 million retirees now live on incomes of less than €665 a month which is below the poverty line defined by the EU. Over half that number fell below the threshold at the start of the crisis in late 2009. Only a fraction of the 1.4 million people out of work receive unemployment benefits. Many Greeks are opting for the security of early retirement and this means the workforce is shrinking, tax income is shrinking and pensions costs are growing.

A statement released by the office of Greece’s deputy prime minister, Yannis Dragasakis, recently declared: “After five years of recession and a ‘war-time’ cumulative loss of 25% of GDP, pensions have become the last social safety net preventing Greek society from completely falling apart. The elderly population is literally feeding the rest of the family.”

The Greek pension crisis clearly illustrates the costs and instabilities of a monetary union without a fiscal union. A poor region of the eurocurrency zone, Greece, no longer shielded by its own currency (which can no longer be devalued) and its own central bank (which can no longer print money) is encountering the full force of harsh competitive pressures from the richer regions of the eurocurrency zone and the inevitable result is severe economic contraction. And yet because there is no fiscal union this poor region is expected to pay all the costs of social welfare associated with the economic slump and at the same time pay off massive debts.

The tensions between the EU and the IMF

The debt targets for Greece were agreed by the Eurogroup with the IMF in November 2012 and which effectively made the current bail out programme possible. Given the latest recession these targets are clearly now not attainable. Greece is totally bust, so the only way the negative effects of the negotiating gridlock can be paid for is by someone else “coughing up” (or rather “pardoning” debt). This someone will need to be the Euro partners (who else is there), and the longer the stand-off goes on the higher the cost. Naturally the other alternative would be allowing Grexit, but arguably the cost of Grexit would be much higher to the Euro partners, and by a large multiple.

The issue of the growing IMF/Eurogroup divergence came to general public attention over the weekend when an IMF internal memo was leaked to Channel 4 News (UK). The key point in the memo, which is hardly news, is that Greece is running out of money. “There will be no possibility for the Greek authorities to repay the whole amount unless an agreement is reached with international partners,” referring to a series of June repayments to the IMF amounting to roughly 1.5 billion euros.

This impression is also confirmed by details of the letter that the Greek Prime Minister Alexis Tsipras wrote to International Monetary Fund Managing Director Christine Lagarde at the start of May to inform her that Athens would not be able to pay the 750 million euros due to the Fund on May 12 unless the European Central Bank allowed Greece to issue more T-bills. It appears that at the time of writing the letter (which also went to EU Commission President Jean-Claude Junker and ECB President Mario Draghi) Tsipras was not aware he could temporarily use the 650 million euros held on reserve at the Fund to make the payment, which he subsequently did. It’s not unreasonable to assume that it was the IMF itself who advised him on this.

The inter-institutional tensions are evidently reaching a critical stage, although in fact the issue has now been knocking around for some weeks, as Simon Nixon reported in the WSJ on April 22.The IMF, he said, “appears to have blinked”.

But the IMF appears to have blinked. Although its agreement with Greece is separate to that of the eurozone’s, the IMF has had to recognize that for practical purposes they are the same: The eurozone has boxed itself in and won’t distribute its funds even to alleviate an acute liquidity squeeze until Greece has reached a deal with the IMF. The IMF’s intransigence risked pushing Greece toward a messy default and possible euro exit that no one wanted. So the IMF last week agreed to streamline its demands.

This is a significant move. Greece must still agree on and implement difficult reforms, most likely including some overhauls of pensions and value-added tax. And some officials fear that even a streamlined deal may prove too much for Athens to deliver before a mid-May deadline when parliamentary approvals must begin if cash is to be disbursed before the program expires at the end of June. But the IMF has lowered the bar to a Greek deal.

It appears that the IMF is contemplating a much lower bar for agreement, and then will possibly seek disengagement from any post June programme. The Euro partners are evidently anxious to avoid this outcome, but they are caught between a rock and a hard place.

The key document snappily entitled “The Third Review Under the Extended Arrangement Under the Extended Fund Facility” explains the current dance. As long as the IMF continue to write reviews stating the Greek programme is on track then the euro area member states are on the hook to cover any shortfall in Greek debt performance in order to make the 2020 and 2022 targets (see above) achievable. This is a commitment they undertook during negotiations on the second bailout agreement.

On the other hand, if the IMF were to start producing reports stating that the programme was off-track because of Greek non-compliance, rather than for example arguing that the numbers were out of whack due to faulty macroeconomic forecasts (and of course the recent economic relapse makes those forecasts even less realistic), then the euro area member states would be off the hook from additional stepping up to the plate with the result that the IMF would end-up taking a loss.

The present recession makes it evident that those targets are even less achievable than they were previously, and that future debt sustainability analyses will have to reflect this, but the IMF has a clear interest in enabling Greece to successfully sign off the current programme (due to end in 2016) and they thus have more interest in giving the country a “pass” note than the Eurogroup ministers do.

So the upshot of all this is that the IMF is happy to kick the can down the road but that means the EU have to reach into their pockets. Even if the EU do that the same sad farce will be played out when the next tranche of payments is due, and the one after and the one after (see this post detailing the Greek repayment schedule). The Greeks have taken a lot of the pain out of the ‘extend and pretend program’, by insisting on funding their domestic social programs before attempting any repayments, and as a result have have little to lose – they are already bust. But each step of the extend and pretend program adds to the costs of the Euro group and all the time the entire unstable situation teeters on the edge of a Grexit with as yet unquantified geopolitical and contagion effects.

The politics of the situation are complex. On the one hand the IMF finds itself in a very difficult position resulting from being bounced by the EU group when the original Greek bail out was arranged in 2010. Now the EU finds itself in a position where in order to keep the IMF in the game, and the pretend and extend show on the road, it has to be lender of last resort every time the Greeks fail to have the funds to pay an IMF repayment instalment. At the same time the Syriza government by insisting on prioritising domestic social spending over making repayments, and thus be willing to play chicken in relation to a forced Grexit, has called the EU groups bluff. The EU position is that it doesn’t want to keep bailing out the Greeks, it wants to keep the IMF on board, it doesn’t want to write off any Greek debt, it doesn’t want a Grexit with costly and largely unknown consequences and it doesn’t want the Syriza anti-austerity strategy to appear to be successful in order to prevent political contagion in other indebted eurozone countries. Doing all that together and at the same time dioes not seem possible and so something has to give. So far that has not been Syriza.

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