amorgos34
CHIAGNI & FOTTI SRL
Greece: Why the IMF Debt Sustainability Analysis is wrong
Yesterday, the IMF published its Preliminary Debt Sustainability Analysis for Greece (link below). Although the document does not incorporate the impact from the recent imposition of capital controls and heightened political uncertainty, it makes for grim reading. It is a tale of missed budgetary targets, structural reforms not undertaken, growth undershoot, and increasing financing needs. And it is unsurprising that what has grabbed the headlines is their statement that the debt sustainability now requires both significant new lending alongisde easing of lending terms on the existing debt to official sector creditors, which means the rest of the Euro area.
Greek Finance Minister Varoufakis stated yesterday that he would “cut his arm off” rather than sign a deal which did not include some form of debt relief. PM Tsipras has, predictably, seized on the IMF document as support for his argument that without immediate debt relief any package cannot work, so one should vote “no” on Sunday. Meanwhile, the poll published by Bloomberg this morning suggests that the outturn of the referendum hangs in the balance.
The debt sustainability disagreement, again
The IMF and the rest of the region have different views about the relevance of the debt sustainability analysis. For the IMF, the debt sustainability analysis is part of the machinery through which it justifies its lending decisions to the Fund’s stakeholders. Hence the usual requirement is that debt sustainability is established with high probability before IMF funds are disbursed. One can see how such an approach is appropriate when the IMF is the only major official creditor available to offer a country in financial difficulty, and a return to market access needs to be achieved in a short time frame. However, things are decidedly more complex when another official sector creditor is part of the story. The Euro area is sui generis - unlike anything that has come before it.
The IMF is clearly aggrieved that the Eurozone has, more than once, suggested that debt restructuring of some form would be forthcoming so that debt sustainability could be demonstrated ex-ante. Indeed, the gap between IMF and Eurozone perspectives on this issue is one the Greek authorities have tried to exploit. We find ourselves surprised that, given the importance of this issue, the Eurozone and IMF have not made more of an effort to get on the same page.
The Eurozone’s approach has been that the demonstration of debt sustainability ex-ante is less important than the IMF believes. This reflects a number of forces, but we highlight four. First, as currently constituted, European Treaties make face value debt reductions very difficult to undertake without being open to legal challenge. Second, those Treaties partly reflect the current political reality that, among the creditor countries, tolerance for overt transfers within the currency union is low. Face value debt reduction, for example, is simply too overt to be able to command parliamentary support. Third, the region recognizes that under most vaguely “positive” scenarios it will be providing financing for Greece within the Euro area for the long haul. As a result, the terms of that financing will partly reflect the extent of political integration and attitudes toward risk-sharing through time. With a following wind, there will come a point in the future when attitudes toward “forgiving” Greek debt may make that possible.
Finally, and perhaps most importantly, the Eurozone sees the granting of debt relief in any form as not something to be handed out at the beginning of a program, but as part of the incentive mechanisms for the Greek authorities to undertake difficult policies. Debt relief, in the form of maturity extensions and lower rates, has always been on the table for a Greek administration that delivered on its program commitments, but not in advance of that delivery. The reason that debt restructuring has been withheld (to the IMF's dismay) is because Greece has not undertaken the measures that the region geneuinely believes are necessary for the country to prosper. That is as much about product market, tax collection and governance reform as it is about "austerity".
We have tended to be more sympathetic to the Eurozone’s approach to this issue than that of the IMF. Many argue that the Eurozone’s approach (“trust us, and we will work out the debt sustainability through time”) does not provide enough certainty to allow investment to occur and confidence to return. But we are heavily influenced by two things. First, in our view, experience through 2014 suggested the Eurozone approach could work: the economy grew, markets were re-accessed, and budgets outperformed targets for a while. All that happened with the “unsustainable” debt burden in place. Second, we think the region’s desire to use debt relief as a bargaining tool is almost inevitable given the political configuration of the region currently. And this is where yesterday’s document from the IMF is, in our view, misguided. A large part of the additonal financing need for Greece the IMF identify stems from the fact that they have lowered their forecasts for potential growth because structural reforms have not been undertaken. So the IMF's suggestion is that, because of the absence of such reform, debt should now be restructured up-front. Then on page 13 of the document, we read the following statement with a degree of incredulity:
“A debt operation on official claims will not generate adverse market spillovers. On the contrary, by allowing debt to be assessed as sustainable with high probability, such action will have a catalyzing effect in restoring full market access.”
This statement is contained in a document published on June 26th – before the Greek referendum was called. But even at this stage, one can envisage plenty of “debt operations” which would be hugely destabilizing for the Euro area markets as a whole. Let’s imagine that, somehow, the Eurogroup proposed a 30% face value write down of Greek debt (for example). The reaction in German and other Northern European electorates and parliaments would be severe. That would call into question the willingness of such parliaments to support the programs necessary to allow any other countries to access OMT, if needed. It would suggest to any other country that comes under a program or has debt outstanding to the rest of the region that conducting the discussions in a manner akin to the current Greek administration is a recipe for “success”. The German Constitutional Court has effectively been told by the European Court of Justice not to fight their ruling on ECB OMT on the grounds of defence of the German Constitution. We should not pretend the German Constitutional Court will comply under all circumstances.
There are good reasons why the Eurozone wants the IMF’s technical expertise at the table as it designs economic support programs in the Euro area. But the IMF faces internal political pressures of its own. Assuming we get a yes vote on Sunday in Greece, the nature of the support being provided to Greece is going to have to be fundamentally reconsidered. And at the same time, the need to stabilise the situation is urgent. This will be complex. Perhaps one way forward for the creditors would be for the ESM to “buy out” the IMF’s part of the program, leaving them as a “technical” consultant with minimal “skin in the game”. The European authorities should then make it clear that the ex-ante demonstration of debt sustainability is far less important than establishing a functioning working relationship with the Greek authorities premised on a secure expectation that they stay in the Euro. The publication of the IMF’s June 26th document does not, in our view, contribute toward such an outturn.
Yesterday, the IMF published its Preliminary Debt Sustainability Analysis for Greece (link below). Although the document does not incorporate the impact from the recent imposition of capital controls and heightened political uncertainty, it makes for grim reading. It is a tale of missed budgetary targets, structural reforms not undertaken, growth undershoot, and increasing financing needs. And it is unsurprising that what has grabbed the headlines is their statement that the debt sustainability now requires both significant new lending alongisde easing of lending terms on the existing debt to official sector creditors, which means the rest of the Euro area.
Greek Finance Minister Varoufakis stated yesterday that he would “cut his arm off” rather than sign a deal which did not include some form of debt relief. PM Tsipras has, predictably, seized on the IMF document as support for his argument that without immediate debt relief any package cannot work, so one should vote “no” on Sunday. Meanwhile, the poll published by Bloomberg this morning suggests that the outturn of the referendum hangs in the balance.
The debt sustainability disagreement, again
The IMF and the rest of the region have different views about the relevance of the debt sustainability analysis. For the IMF, the debt sustainability analysis is part of the machinery through which it justifies its lending decisions to the Fund’s stakeholders. Hence the usual requirement is that debt sustainability is established with high probability before IMF funds are disbursed. One can see how such an approach is appropriate when the IMF is the only major official creditor available to offer a country in financial difficulty, and a return to market access needs to be achieved in a short time frame. However, things are decidedly more complex when another official sector creditor is part of the story. The Euro area is sui generis - unlike anything that has come before it.
The IMF is clearly aggrieved that the Eurozone has, more than once, suggested that debt restructuring of some form would be forthcoming so that debt sustainability could be demonstrated ex-ante. Indeed, the gap between IMF and Eurozone perspectives on this issue is one the Greek authorities have tried to exploit. We find ourselves surprised that, given the importance of this issue, the Eurozone and IMF have not made more of an effort to get on the same page.
The Eurozone’s approach has been that the demonstration of debt sustainability ex-ante is less important than the IMF believes. This reflects a number of forces, but we highlight four. First, as currently constituted, European Treaties make face value debt reductions very difficult to undertake without being open to legal challenge. Second, those Treaties partly reflect the current political reality that, among the creditor countries, tolerance for overt transfers within the currency union is low. Face value debt reduction, for example, is simply too overt to be able to command parliamentary support. Third, the region recognizes that under most vaguely “positive” scenarios it will be providing financing for Greece within the Euro area for the long haul. As a result, the terms of that financing will partly reflect the extent of political integration and attitudes toward risk-sharing through time. With a following wind, there will come a point in the future when attitudes toward “forgiving” Greek debt may make that possible.
Finally, and perhaps most importantly, the Eurozone sees the granting of debt relief in any form as not something to be handed out at the beginning of a program, but as part of the incentive mechanisms for the Greek authorities to undertake difficult policies. Debt relief, in the form of maturity extensions and lower rates, has always been on the table for a Greek administration that delivered on its program commitments, but not in advance of that delivery. The reason that debt restructuring has been withheld (to the IMF's dismay) is because Greece has not undertaken the measures that the region geneuinely believes are necessary for the country to prosper. That is as much about product market, tax collection and governance reform as it is about "austerity".
We have tended to be more sympathetic to the Eurozone’s approach to this issue than that of the IMF. Many argue that the Eurozone’s approach (“trust us, and we will work out the debt sustainability through time”) does not provide enough certainty to allow investment to occur and confidence to return. But we are heavily influenced by two things. First, in our view, experience through 2014 suggested the Eurozone approach could work: the economy grew, markets were re-accessed, and budgets outperformed targets for a while. All that happened with the “unsustainable” debt burden in place. Second, we think the region’s desire to use debt relief as a bargaining tool is almost inevitable given the political configuration of the region currently. And this is where yesterday’s document from the IMF is, in our view, misguided. A large part of the additonal financing need for Greece the IMF identify stems from the fact that they have lowered their forecasts for potential growth because structural reforms have not been undertaken. So the IMF's suggestion is that, because of the absence of such reform, debt should now be restructured up-front. Then on page 13 of the document, we read the following statement with a degree of incredulity:
“A debt operation on official claims will not generate adverse market spillovers. On the contrary, by allowing debt to be assessed as sustainable with high probability, such action will have a catalyzing effect in restoring full market access.”
This statement is contained in a document published on June 26th – before the Greek referendum was called. But even at this stage, one can envisage plenty of “debt operations” which would be hugely destabilizing for the Euro area markets as a whole. Let’s imagine that, somehow, the Eurogroup proposed a 30% face value write down of Greek debt (for example). The reaction in German and other Northern European electorates and parliaments would be severe. That would call into question the willingness of such parliaments to support the programs necessary to allow any other countries to access OMT, if needed. It would suggest to any other country that comes under a program or has debt outstanding to the rest of the region that conducting the discussions in a manner akin to the current Greek administration is a recipe for “success”. The German Constitutional Court has effectively been told by the European Court of Justice not to fight their ruling on ECB OMT on the grounds of defence of the German Constitution. We should not pretend the German Constitutional Court will comply under all circumstances.
There are good reasons why the Eurozone wants the IMF’s technical expertise at the table as it designs economic support programs in the Euro area. But the IMF faces internal political pressures of its own. Assuming we get a yes vote on Sunday in Greece, the nature of the support being provided to Greece is going to have to be fundamentally reconsidered. And at the same time, the need to stabilise the situation is urgent. This will be complex. Perhaps one way forward for the creditors would be for the ESM to “buy out” the IMF’s part of the program, leaving them as a “technical” consultant with minimal “skin in the game”. The European authorities should then make it clear that the ex-ante demonstration of debt sustainability is far less important than establishing a functioning working relationship with the Greek authorities premised on a secure expectation that they stay in the Euro. The publication of the IMF’s June 26th document does not, in our view, contribute toward such an outturn.
