I have long argued that Greece is a hopeless case as long as it has to use the euro as its currency. It cannot now and will not ever be able to compete with the more efficient eurozone members (Germany, Austria, and the Netherlands). It appears the IMF is starting to understand this. There is also evidence of disagreements between the IMF and the strong euro countries about next steps. In what follows, I briefly review the Greek case and what it means for the other “Weak Sisters” (Portugal, Spain, Italy) and world markets in the weeks ahead.
Greece – How Grim Can It Get?
So far, Greece has received €20 billion from the IMF and €60 billion from euro countries. The money is doled out in tranches, the idea being that Greece has to meet certain performance targets before getting each tranche. It recently failed to achieve its targets but still got the latest tranche (€2.2 billion from the IMF and €5.8 billion from euro countries because of just how desperate the situation is.
In the meantime, lenders are being asked to take a 50% “haircut” (for more on when a default is not a default, see my earlier article). The talks are not going well. There is a lot of money betting on a complete default. What will happen? How many have to sign up for the 50% haircut? I quote from the latest IMF Greek Standby Review:
“Should the debt exchange only reach 50 percent participation, instead of the near universal participation assumed so far, debt would peak at 179 percent of GDP, and begin to stall at around 145 percent of GDP post-2020. Even if the EFSF [euro countries] covered the financing gap created by lower PSI [Greek creditors] participation, the debt would end at around 130 percent of GDP by end-2030 ... this level is already above what might be considered sustainable and moreover showing an only limited downward trend.”
The “haircut” talks have broken off. And on “haircuts,” there is one other point worth noting: the Greek banks. They hold a lot of Greek sovereign debt. Again, from the IMF Review:
“Current bank portfolios of Greek government bonds (GGBs) have a nominal value of about €45 billion (€39 billion book value after June 2011 impairments), compared to an aggregated core capital of €22 billion.”
Most of the domestic GGB holdings are with the six largest Greek banks (97 percent). In short, a write down/haircut on Greek sovereign debt of 50% would effectively bankrupt the six largest Greek banks.
The IMF–Mandated Reforms for Greece
When the IMF operates on its own, it goes into a country and figures out has to be done to turn things around. This will normally involve reducing the government deficit, reducing the rate of increase in the money supply, and various other policy changes). It then fashions a “standby agreement” with the country whereby it can get money from the Fund in tranches for the achievement of stated progress targets. In the case of Greece, the IMF focused on what Greece would have to do to become competitive using the euro as its currency.
In all the years I have been covering the IMF, I have never seen such a long list of policy changes being demanded of any country. The general categories include: fiscal reforms, pension reforms, health sector reforms, Social Security reforms, government performance reforms, and economic system reforms. In order to achieve these objectives, the Greek government has agreed to foreign technical assistance in more than 20 different fields. Ok. So maybe if Greece did everything on the IMF list, they could stay in the eurozone and compete with the Germans. But don’t hold your breath. This will not work.
The IMF Got It Badly Wrong
The IMF is aware that austerity policies cause unemployment to grow. Its own research concluded that a fiscal consolidation of 1% of GDP results in an increase of .3 percentage points in the unemployment rate. But take a look at what has happened in Greece. Things have gone terribly wrong. As Table 1 indicates, things are bad and getting worse. Just look at the revised projections for unemployment and growth.
Table 1. – IMF Projections and Reality
I can imagine discussions going on among professional staff within the IMF. Some realize this effort is not going to work and are extremely angry that they got roped into this effort with the euro countries. Others, the statesmen/diplomats of the Fund, are trying to hold things together. But the anger and frustration are growing.
Evidence of Friction
Last weekend, Andy Dabilis wrote a story documenting growing friction between the IMF and euro countries over the Greek program. The Fund is apparently upset that Germany and other strong euro countries has focused almost completely on getting Greece to reduce its government deficit. The IMF is now saying this one dimensional approach has failed. The IMF is upset that Greece is not being pressured by its euro partners to go after tax evaders and implement the myriad of policy reforms discussed above. Dabilis reports that the IMF was “attempting to distance itself from a ‘counterproductive set of austerity measures’ imposed on the country under the insistence of the EU.”
Meanwhile, Christine Lagarde, the managing director of the IMF, is telling the euro countries that the size of the second bailout for Greece needs to be increased by “tens of billions of Euros”.
In short, everyone is pissed, recriminations are rampant, and the Greek program has failed.
Implications for Other Weak Sisters’ Stabilization Programs
Not clear. Germany will probably continue to insist on reducing government deficits, but the IMF will be looking far more closely at the impact of such austerity measures on unemployment and GDP growth. Recognize that Spain’s unemployment rate is already 23% and much higher for younger workers.
What will be the ripple effect of eurozone problems be globally? Hard to tell. There is much more bad news to come. But some indication of the effect already comes from the downward revisions of GDP growth. In Table 2, I compare IMF growth estimates made in September 2011 with ones made in April 2010.
Table 2. – IMF: Revised Growth Estimates
Sadly for the global economy, things will get worse in Europe before they get better.