The Troika is dead

August 16, 2015

'Greece’s debt has become unsustainable. Greece cannot restore debt sustainability solely through actions on its own.' Christine Lagarde, the IMF’s Managing Director (channelling Yannis Varoufakis)

The European creditor nations and Greece have reached an agreement on a third bailout in five years.The bailout, which was approved by Greece’s Parliament includes the familiar details, in return for an infusion of 86 billion euros Greece has promised to increase taxes, cut spending and enact measures to make its economy function more efficiently. The deal is economically brutal and is just more of exactly the same sort of policies that have all but destroyed the Greek banking system and impoverished much of the Greek population. It will almost certainly not work. Nevertheless, it has been celebrated as a breakthrough.

Greece has also agreed to a very detailed timetable for numerous and specific milestones and targets, and it has agreed to very close supervision by the EU institutions of every step of its legislative and administrative compliance. Greece is now effectively being run by the EU institutions.

The one institution that is not part of the new bailout is the IMF. The Troika is no more because the IMF has refused to take part in the new program because it says that the Greek debts are unsustainable and that without some major and significant debt restructuring the new program will fail.

The IMF reaches breaking point

The partnership of the IMF and the EU institutions began to break down in June, as representatives of European countries and the IMF gathered at a private meeting at the European Union’s headquarters in Brussels to devise a plan to keep the country in the eurozone.

Poul Thomsen, the Danish fund official who served as the IMF point person in the Greek talks, had since early in the spring, been arguing that while Greece needed to follow through on tough economic measures, its debt was out of control. Europe, however, insisted that the Greek government had only to enact tough austerity measures to set itself on a prudent financial path and all would be well.

Now the Europeans wanted to present an analysis based on their own view of Greece’s debt prospects at a crucial meeting of the creditor countries’ finance ministers the next day. And in doing so they took the IMF’s conclusion, that Greece could no longer repay its debt and that Europe might have to face losses on its exposure there, and relegated it in their presentation to one throwaway sentence, presenting Greek debt unsustainability as being a long-shot scenario.

For the IMF it was a breaking point. Not only were officials frustrated that Europe was not accurately reflecting their view, but they also wanted to make sure that their non-European shareholders, many of whom had become very critical of the fund’s aggressive lending in Greece, got the full picture of how their analysis had changed. So, in a highly unorthodox move, they decided to make their disagreement public. They released their full analysis, a 23-page document, a week later. That action meant that the IMF could at last publicly change its fundamental position and ever since then then the fund has been adamant: Europe must provide significant debt relief in order for the IMF to provide cash toward the next Greek bailout.

TheTroika is dead

The IMF began to publicly shift its position back in June when it published a Preliminary Debt Sustainability Analysis, which said this (my emphasis):

“At the last review in May 2014, Greece’s public debt was assessed to be getting back on a path toward sustainability, though it remained highly vulnerable to shocks. By late summer 2014, with interest rates having declined further, it appeared that no further debt relief would have been needed under the November 2012 framework, if the program were to have been implemented as agreed. But significant changes in policies since then—not least, lower primary surpluses and a weak reform effort that will weigh on growth and privatisation—are leading to substantial new financing needs. Coming on top of the very high existing debt, these new financing needs render the debt dynamics unsustainable. This conclusion holds whether one examines the stock of debt under the November 2012 framework or switches the focus to debt servicing or gross financing needs. To ensure that debt is sustainable with high probability, Greek policies will need to come back on track but also, at a minimum, the maturities of existing European loans will need to be extended significantly while new European financing to meet financing needs over the coming years will need to be provided on similar concessional terms. But if the package of reforms under consideration is weakened further—in particular, through a further lowering of primary surplus targets and even weaker structural reforms—haircuts on debt will become necessary.

The IMF issued an update to its Greek Preliminary Public Debt Sustainability Analysis on the 14th of July 2015 which taking into account the damage done to the Greek economy by six months of uncertainty and a banking crisis, concluded the following – again, my emphasis:

“Greece’s public debt has become highly unsustainable. This is due to the easing of policies during the last year, with the recent deterioration in the domestic macroeconomic and financial environment because of the closure of the banking system adding significantly to the adverse dynamics. The financing need through end-2018 is now estimated at Euro 85 billion and debt is expected to peak at close to 200 percent of GDP in the next two years, provided that there is an early agreement on a program. Greece’s debt can now only be made sustainable through debt relief measures that go far beyond what Europe has been willing to consider so far.

What exactly does the IMF mean by “far beyond what Europe has been willing to consider so far”? The document accompanying the press release quoted above identifies several options:

  • Dramatic extension of debt maturity on the entire stock of European debt, including new assistance. The IMF suggests a grace period of 30 years, which implies that maturity would be considerably longer. A century, maybe?

  • Explicit transfers to the Greek budget from creditor countries to enable it to meet its obligations towards those same creditor countries.

  • Deep up-front haircuts – i.e. writing off some of the debt.
    Although any one of these proposed measures, or a combination of any of them, would have more or less the same financial affect in delivering some debt relief, they would each have different political implications in terms of how they can be spun and presented to electorates and political elites in places like Germany that are deeply hostile to any notion of debt relief. But whatever particular mix of those proposals were to be adopted the IMF’s overall position is quite clear, no debt relief, or relief that is insufficient to make Greece’s debt sustainable, is not an option. Not if the creditors want the IMF to contribute.

    The IMF means what it says. Since this was released, IMF representatives have on six occasions reiterated that extensive debt relief as well as evidence of reform commitment is a pre-requisite for IMF financial assistance, including twice in the last week. On Wednesday August 12th, Delia Velculescu of the IMF’s staff team participating in the Greek negotiations had this to say:

    In the period ahead, we look forward to working with the authorities to develop their program in more detail and for Greece’s European partners to make decisions on debt relief that will allow Greece’s debt to become sustainable.

    And on Friday August 14th, Christine Lagarde, the IMF’s Managing Director, made an exquisitely timed intervention just as the EU and Greece were announcing agreement on the new bailout program:

    “However, I remain firmly of the view that Greece’s debt has become unsustainable and that Greece cannot restore debt sustainability solely through actions on its own. Thus, it is equally critical for medium and long-term debt sustainability that Greece’s European partners make concrete commitments in the context of the first review of the ESM program to provide significant debt relief, well beyond what has been considered so far.”

    The refusal of the IMF to participate in the new program is major problem for the EU because Germany has repeatedly stated that without the IMF there is no deal and Germany has also stated that there can be no debt restructuring for Greece.

    Finland’s Finance Minister, Alex Stubb summed the situation up nicely: “The IMF wants to be involved only if there is debt relief; we want the IMF to be involved but we don’t want debt relief. Some kind of solution will have to be found,” he said. In short, there is now a stand-off between the EU and the IMF.

    The response of the Eurogroup (the grouping of eurozone finance ministers) has tried to brush over the problem of the IMF stand on debt relief by kicking the can down the road. Its statement refers in passing to the need for agreement on debt relief in order to bring the IMF on board, but blithely assumes away the obstacles to achieving this:

    “The Eurogroup considers the continued programme involvement of the IMF as indispensable and welcomes the intention of the IMF management to recommend to the Fund’s Executive Board to consider further financial support for Greece once the full specification of fiscal, structural and financial sector reforms has been completed and once the need for additional measures has been considered and an agreement on possible debt relief to ensure debt sustainability has been reached. Resulting policy conditionality will be a shared one as the policy conditionality underlying the ESM macroeconomic adjustment programme is developed in parallel to the one of the IMF. Once approved, the full re-engagement of the IMF is expected to reduce subsequently the ESM financing envelope accordingly.”

    In other words although the new finance in the new third program is at highly concessionary rates that reduce its effective burden there will be no up-front debt relief for the large quantities of old debt. Instead possible future debt relief will be dangled as a carrot which may be possibly offered at some future date when Greece has delivered on its promises. The problem is that Greece cannot deliver on its promises because they are impossible.

    The primary surplus targets in the new program are almost certainly unachievable due to the poor condition of the Greek economy, precisely the point made by the IMF in its Debt Sustainability Analysis update.The notion that the utterly wrecked Greek economy can simply transition as of now into generating a growing budgetary surplus and then sustain it for decades is utterly foolish. Even if Greece does by some miracle manage to achieve and sustain a primary surplus sometime soon there is a clear incentive for creditors, reluctant to offer debt relief, to declare that Greece’s progress on other reforms as being inadequate, whatever it does, and therefore refuse any debt relief. There is an equally clear incentive for Greece to soft-pedal on reforms in the certain knowledge that if no debt relief is offered and the IMF refuses to contribute, creditors stand to lose their shirts. And there is a further incentive for a relaxed approach by Greece: after all, if you suspect that nothing you do is going to be good enough, why bother to implement all this destructive austerity nonsense?

    It is very clear that Wolfgang Schäuble, the German Finance Minister, wants Greece out of the Euro but failed in the recent cliffhanger negotiations in achieving that ambition, blocked primarily by a French led coalition. Now it is Schäuble that is saying that both debt restructuring is impossible (he actually always describes it as being ‘illegal’) and that a program without the IMF is impossible (in the knowledge that the IMF has ruled out participation without debt restructuring). The new program will unravel, the Greek crisis will reignite and Schäuble may get his wish to eject the Greeks from the Euro. If he does then he can focus all his attentions on the country he most wants to restructure and reform, which is France.

    Previous post:

    Next post: