Why is the eurozone back in crisis over Greece?

8/2/2017

By Jim Brunsden

Athens faces another big debt payment and eurozone politics makes relief impossible

After months out of the spotlight, Greece’s international bailout programme is working its way back up bond traders’ list of worries.

Yields on Greek sovereign debt are sharply up, reflecting concerns about splits between the eurozone and International Monetary Fund over the future of the programme and the sense that in an election-heavy year for Europe, the political window for an agreement is closing.

Amid warnings from Athens that it will reject “the IMF’s absurd demands” and disagreements this week within the fund’s executive board, eurozone finance ministers are under pressure to deliver a breakthrough at their next meeting on February 20.

What is the problem?
Greece’s international creditors, namely eurozone governments and the IMF, have markedly different opinions about the country’s economic situation and how to make its debt load manageable.

The IMF has long argued the austerity demanded in Greece’s third €86bn bailout needs to be eased by lowering budget surplus targets and granting Athens substantial debt relief. But a German-led group of fiscal hawks have refused, particularly since more leniency likely means their taxpayers would have to pay more rescue loans.

Unless they resolve their differences, the IMF — which never formally joined the third bailout when it was agreed two years ago — will not fully participate in the programme. Thus far, only the European Stability Mechanism, the eurozone’s €500bn bailout fund, has been lending to Greece.

The IMF has not distributed a bailout loan in nearly three years, and it has repeatedly said it will not join the third programme without big changes. Still, eurozone leaders have always assumed that at some point it will come on board as a lender.

Why does this matter?

Berlin has never really trusted EU authorities, particularly the European Commission, to monitor Greece’s bailout and has insisted since the first rescue in 2010 that the IMF participate, arguing that only the fund had the expertise and credibility to run such a complex programme.

That demand has gradually become a political red line in Germany and other northern lenders, such as Finland and the Netherlands, where parliaments have repeatedly warned they cannot go along with a Greek bailout for long without the IMF’s imprimatur.

The fund indicated last year that it would take a decision on participation by the end of 2016 but that deadline was missed.

Should the impasse continue, it could be impossible to secure parliamentary approvals for releasing future tranches of bailout aid, throwing the whole programme into jeopardy. Wolfgang Schäuble, Germany’s finance minister, has made clear that without the IMF, the bailout in its current form is dead.

With elections imminent in Germany and the Netherlands, bailout politics in Berlin and The Hague are becoming even more fraught.

What exactly do the different sides disagree on?

The IMF sees some of the demands made by the EU in the new programme as unrealistic, notably a requirement that Athens achieve a 3.5 per cent primary surplus target by 2018 and then sustain it for the “medium term”. A primary surplus is the budget surplus when debt repayments are not counted, an important measure of a country’s ability to pay its own bills without outside help.

The fund has argued for a lower target of 1.5 per cent, but eurozone countries would have to make up the difference by granting substantial debt relief. The stance is anathema to Berlin, since at some point its bailout loans to Greece become so concessionary that they really become grants. That is politically radioactive in Germany.

The fight is not only between the IMF and Berlin, however. The IMF’s long-running war of words with Athens has worsened, too. Given its scepticism about Greece’s ability to sustain the 3.5 per cent surplus target, the fund has said that Greece should pre-legislate additional austerity measures that would be automatically triggered if Athens misses its targets.

Why do they disagree?

Underpinning the dispute is the fact that the IMF and the European Commission profoundly disagree on the outlook for Greece’s economy.

Brussels argues that the fund is being stubborn in refusing to recognise that the country is performing better than was expected both in terms of growth and primary surplus. The IMF, which was over-optimistic in economic forecasts at the start of the bailout programme, fiercely disagrees. It argues Greece will be unable to sustain its performance, and instead weaker economic output will lead its debt load to become “explosive” after 2022.

The dispute over growth forecasts has caused a rare public division within the IMF’s executive board. EU countries including France, Germany, Belgium and Sweden challenged the forecast at a board meeting on Monday, prompting a rare public acknowledgment by the fund of a split.

Why has the fight now become urgent?
Greece has enough cash to make it to July without needing further slices of bailout aid. But political reality is different: EU officials fear a scenario where prolonged uncertainty hits investor confidence in Greece, turning the IMF’s predictions into a self-fulfilling prophecy.

Also, the next meeting of eurozone finance ministers, on February 20, is the last before the Dutch general election — the first of a series of crunch votes in Europe this year.

Among policymakers, although there are doubts the matter can be fully settled at the February meeting, there is a shared sense of the need for a breakthrough. Behind the scenes, there are intense discussions aimed at finding a solution.

As one EU official puts it: “February is not formally, but [is] realistically, the time when one needs to reach political agreement.”

How could a deal be reached?
Most simply, by everyone giving some ground, although it is easier said than done. Athens would in all likelihood need to accept to pre-legislate some policy measures, the IMF would need to accept that the scale of these measures will not be as much as it originally hoped, and Berlin would need to, at the very least, moderate its demands for how long Greece must sustain the 3.5 per cent primary surplus target after 2018. Germany would also have to provide more clarity now on future debt relief.

The big question is who will have to move the most, and no one is betting on Berlin or the IMF. The stand-off has now gone on for nearly two years, with neither side budging.

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