The IMF and calling Berlin’s bluff over Greece

22/5/2016

If Europe wants to continue to ‘extend and pretend’ so be it. But it should be with their own money

At one level, the recurring Greek crises fit the idea from Karl Marx of history repeating itself, first as tragedy then as farce. Greece came close to a eurozone exit last summer. While it will probably come close this year, it is unlikely to leave.

But prepare for some tense moments in the next few weeks and months as Greece and its creditors struggle to agree the first review of last year’s bailout.

The International Monetary Fund has concluded that Greek public debt, at 180 per cent of gross domestic product, is unsustainable; as is the agreed annual primary budget surplus, before interest payments, of 3.5 per cent of GDP. The fund insists on debt relief, but Germany resists.

A year ago Angela Merkel, German chancellor, and Wolfgang Schäuble, her finance minister, sold the Greek bailout to their party and parliament as a loan only. They argued that once you accept a debt writedown, you turn a loan into a transfer. And once you accept the principle of a one-off transfer to Greece, you are on a slippery road to what the Germans call a transfer union, one where they pay and others receive.

In private, senior German government officials agree that Athens needs debt relief. They are not blind. But they are trapped in the lie that Greece is solvent, which is what their own backbenchers were told. Without that lie, Greece would no longer be a eurozone member. But the lie cannot be
sustained.

IMF insistence on debt relief is what could expose this lie. Christine Lagarde, managing director, last year set debt relief talks as a condition for the fund’s participation in a bailout.

Mr Schäuble reluctantly agreed yet managed to insert the words “if needed”, which give him wriggle room. But Berlin imposed another condition: the IMF must participate in the bailout, too.

This is what makes the German position vulnerable. We know IMF staff are steadfast in their opposition to being involved in a bailout without an agreement on debt relief. The trouble is that the policies are not determined by the staff but by the IMF shareholders.

The Europeans and the US are the dominant shareholders so the outcome of this battle will depend to a large extent on the view taken by Washington.

To get himself out of a hole, Mr Schäuble recently made a counterproposal: Germany accepts debt talks in principle but only from 2018.

The date was chosen with care. It is well after the next federal elections. It is not clear whether he will still be finance minister or indeed in government. I suspect the Christian Democratic Union, his party, will lead the next government; the electoral arithmetic makes other constellations improbable. Nevertheless, he is proposing to commit any successor to this course of action. Such a commitment has no credibility.

The IMF rejected his idea last week and rightly so. It wants to come clean now; or as an official recently told me it wants to regain its lost virginity. In doing so, it would restore its reputation and call Berlin’s bluff. There is, of course, a risk this stand-off would trigger another euro­zone crisis. Ms Merkel has good reason not to let the situation escalate.

A Greek debt writedown might not be popular in the Bundestag but another eurozone crisis would be a political disaster for her. It would expose the dishonesty of her eurozone rescue strategy. I see no chance of her risking a Grexit at a point when her deal with Turkey to host refugees who reach Greece is on the verge of collapse.

Many crises are looming in Europe. The idea of another summit to discuss Greece fills officials with horror.

My conclusion is that a credible threat by the IMF to pull the plug on its participation in a Greek bailout could force the Europeans, and the Germans in particular, to come clean.

If the Europeans want to continue their path of “extend and pretend”, extending the loans and pretending Greece is solvent, so be it. But it should at least be their own money they pour in. In this case they should buy out the IMF bailout loans to Athens, which means taking over the fund’s credits to Greece.

Greece would then be forever insolvent, forever in recession, but sufficiently funded and inside the eurozone. The best solution, of course, would be for the IMF to stay in and for debt-reduction talks to start.

The creditors need not even agree to a haircut, a formal reduction in the principal of outstanding debt. They could increase grace periods, lengthen maturities and reduce the interest rates towards zero. They could link some of the debt to Greek economic performance. The lower the growth, the greater the write-off. Or they could agree to turn some of the debt into equity. There are plenty of technical options to restore the country’s fiscal solvency. The combination of debt relief, a realistic fiscal trajectory and economic reforms would end the Greek crisis at a stroke.

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