The economic adjustment programme agreed last weekend between Europe, the International Monetary Fund and Greece will be considered, and approved, by the IMF’s executive board soon. Early satisfaction with the programme has given way to serious market doubts about it. These doubts are rational because the fiscal arithmetic simply does not work. For the IMF, this programme represents a squandered opportunity because it could have been ahead of events and designed a much better programme, specifically by facilitating orderly debt restructuring. Instead, we could end up with a programme that is inequitable, perverse and unsuccessful, with much greater costs all around.
When the Greece saga began, the mantra of the German government and many purists in Europe, including the European Central Bank, was: ‘no default, no bail-out, no exit’. European private-sector holders of Greek debt would be spared any pain (no default). The European taxpayer would be protected (no bail-out). And European companies would be shielded because Greece could not devalue its currency (no exit). That left one and only one policy measure that could be brought to bear on the problem, namely a fiscal austerity programme, with the average Greek citizen bearing all the burden of adjustment. Europe, in short, had defined this to be an exclusively Greek problem.
The recently negotiated IMF programme changed that situation in one important way: the burden of adjustment is now being spread to include European ($105bn) and international ($40bn) taxpayers. China, India, Brazil among many others will contribute — which is as it should be — given their growing economic status and the co-operative nature of the endeavour. But there will still be no contribution from European banks that hold large amounts of Greek debt. That taxpayers in much poorer countries should contribute so that rich financial institutions can get away with reckless lending seems unfair and perverse. One might call this ‘immoral hazard’: heads the banks win, tails much poorer taxpayers thousands of miles away pick up the tab.
What is worse is that this bail-out of European financial institutions increases the already high odds of failure of the IMF programme. Greece’s fiscal predicament requires not just adjustment and financing but devaluation and debt restructuring. And with devaluation being achieved through painful deflation, the case for restructuring looks only stronger. Substantial debt write-offs are necessary and will probably remain so even if Greece exits the eurozone.
Consider the prerequisites for a successful programme. First, Greeks must acquiesce in the sharp decline in living standards over the next three years. Second, after three years of the programme, Greek debt will be much greater than today’s 115 per cent of GDP. At that point, markets will have to think it plausible that Greece is on a path toward reasonable debt levels because it is able to grow fast enough and maintain the fiscal belt-tightening for some considerable time. Doubts on the part of markets on any of these scores will lead to higher costs of borrowing for Greece and put it back into the viciously self-sustaining fiscal debt dynamic in which it has found itself recently, except that the starting point in terms of debt levels will only be worse. This might well prove to be the (unlucky) 13th labour of Hercules.
Why then has the IMF gone along with this arrangement? A generous reading is that the IMF has to work with governments, and if Greece and Europe have strong preferences, then those must be respected. A less charitable reading is that the IMF is a Euro-Atlantic Monetary Fund, where its management does the bidding of its richer shareholders. It is true that, in this instance, the IMF has imposed tough conditions on the borrower, but it has done so because Germany would have it no other way. It has gone along with bail-out of the banks because the major players, including the ECB, wanted it that way.
All this is a pity because Greece could have been a real opportunity for the IMF to regain durable legitimacy. Insisting on contributions from all parties — not just the Greek citizen and international taxpayer — would have led to a programme that was fair, avoided ‘immoral hazard’ and the perverse incentives associated with rewarding reckless financial sector behaviour, and would have maximised chances of success. The IMF could have set a precedent for an orderly debt resolution programme by rehabilitating the spirit if not the specifics of the proposal on sovereign debt restructuring made by former IMF First Deputy Managing Director, Anne Krueger. Debt restructuring will happen, but it will be disorderly and messy with all the actors reacting to rather than shaping events. So, for now, we must continue to watch this unfolding Greek tragedy whose essence is not just sadness and pain but their inevitability.
The writer is senior fellow at the Peterson Institute for International Economics and Center for Global Development.
A version of this article appeared in the Financial Times last week
