By Tom Ellis
Lowering the interest rates at which Greece borrows money from other eurozone governments, European institutions and the International Monetary Fund is the best way to reduce the nation's debt, according to Charles Dallara, managing director of the Institute of International Finance.
In an interview with Sunday's Kathimerini Dallara described the passing of the new package of austerity measures on Wednesday as “an important step forward” and called for a “European validation of that step” at Monday's Eurogroup meeting in Brussels.
Dallara urged the IMF and the eurozone to provide “additional funding” to Greece but said he does not believe that European governments should take nominal haircuts on the amount of their exposure.
What is your assessment of where we are six months after the so-called Private Sector Involvement (PSI)?
After the agreement on the debt reduction Greece is still in my view moving forward, but not yet in a position to reap the full benefits of the PSI. I think it’s important to recall just how substantial that debt reduction was. Over 100 billion euros wiped out in one day. A reduction of debt that is equal to roughly half of GDP and an elimination of over 70 percent of the present value of the private holdings of Greek government paper, but in order for the opportunity that that created to be seized it’s crucial for additional steps to be taken and I think we are now seeing those steps unfolding, which is why I am somewhat encouraged after the elections, which obviously delayed some aspects of reforms, we’ve now had two important pieces of legislation pass relating to privatization and now relating to a broad set of reforms, which if implemented, actually can make a difference in terms of competitiveness, in terms of confidence, in terms of investment, and in terms of growth.
The first step took place, the Greek Parliament voted on them last Wednesday.
They voted for them and I think that’s an important step forward. The next step needs to be European validation of that step and European support for this revised program that needs to include the funding of this program in a clear, transparent and meaningful way. And in my view, the meeting that takes place in Brussels is perfectly timed to allow that to move forward... I think it’s important that Europe acts in part to capitalize on the momentum. What Greece has done is difficult – let’s not underestimate that passing these measures in the midst of a remarkable painful recession speaks to leadership in Greece, speaks to courage in Greece, and speaks to – I think – the willingness of the Greek people to continue to support this program even though it’s a very difficult and painful path and I think that they will need to see sooner rather than later some of the benefits of this pain. In order for that to happen I think prompt eurozone support is important, prompt recapitalization of the banks, which in my view continues to take more time than it needs and an acceleration and, if need be, a liberalization of the terms of investment funds for Greece. I don’t for example don’t know why any counterpart funds should be required. They should consider an exceptional framework for some of the European investment funds which require counterpart funds. They should look at special techniques of accelerating investment, for example in highways. Some of this however is not linked just to Europe’s own actions, but it’s linked to Greek action and it’s linked to Greek recapitalization of the banks because they need to be a partner in some of this investment fund.
If the banks are recapitalized, will they support people who are going out of their way to invest in this difficult situation or will they try to improve their capital standing?
Well I think the Greek banks are interested in getting back into the business of banking, yes; I mean we’ve worked very closely with them and I look forward to seeing some in Greece this Tuesday and obviously they have to balance capital requirements with business opportunities. There is a real question as to how much demand there is for credit today, but I think everyone understands, at least I hope they do – the government, the Greek bankers, and the European and IMF leadership – that without renewed credit flow, which can in some cases directly facilitate the investment flow, like in these highway structures, but more broadly without renewed credit flow to small and medium-size enterprises, again they can help unlock SME funding for Europe, which is poised, but they can also help generate economic activity there. I think that it’s time we turned our focus to Greece not just in terms of austerity and budget cutting, but – as was done last Wednesday – in terms of structural reform. Not enough has been done to boost growth and that in my view has to be the priority. I believe that the overall program has been too front-loaded with budget cutting. Greece has a reputation for failure to follow through, some of that in some areas including some important structural areas, unfortunately including tax collection and some of that reputation is unfortunately probably deserved. However, what is not deserved is the popular conception – which is, I would argue, a misconception – that Greece has not sufficiently tightened up. If you look over the last two to three years, you see a dramatic reduction in their budget deficit just over the last two years alone, it’s been 8-10 percent.
Actually, we’re going into primary surplus as we speak.
We are, we are. And I don’t think that Europe, or for that matter most of us, fully recognized just how substantial the adjustment of the government's physical condition is in the midst of the most painful recession that has been seen on the continent outside wartime.
What about specific measures that can take place, such as interest rate cuts?
I think that the most immediate thing they can do is to lower to the maximum extent the interest rates they’re charging on past and prospective lending both from the government and the ECB. The private creditors have postponed any principal payment due for a decade and we cut the immediate payments on what remains on the prior debt to 2 percent right now. What case is there for the European partners who are not private bankers trying to earn a profit? They are governments trying to sustain a fragile government construct, a government vision, this is what we’re told constantly: “There is a Euro vision.” What case is there not to reduce further the interest rates? I think there is very little case there. I know that they want to see Greece perform. And I think it is time that Greece accelerates privatization, accelerates structural reforms, as they have now reaffirmed their intent to do, but cutting the interest rates on prior and future lending is crucial and I would even suggest the IMF think about this as well. It’s time that we think creatively about this.
The IMF says they cannot do it based on their charter.
Look, I have been on the board at the IMF. The charter did not prevent them in the 1980s and 90s from extending credits to low-income African countries at heightened subsidized rates. Why does the charter prevent them from recognizing that Greece is as desperate as some of those African countries in the 1990s were.
An exceptional case, as German Chancellor Angela Merkel says.
I think it should be. I don’t believe that there is a constraint. They have certain rules of the game, and I respect those rules, but when I was director, I supported some special funding being set aside for African countries, which was used to take down the interest rate on lending to concessional terms and it was at the time hotly debated – we’re not a world bank – but the case was made that these countries were in exceptionally difficult circumstances, so this was not just a temporarily balance of payments crisis. Who believes that what Greece’s going through now is just a temporary balance of payments crisis?
Another argument would be for certain countries to say that Greece is a rich country, the eurozone is a rich entity, why don’t they take care of themselves?
Well, I am disappointed by some of those arguments. The IMF has been there for Latin America and for Asia at critical times and the IMF should be there for Europe today. First of all, Europe as a whole does have considerable wealth, but wealth and liquidity are very different things and we all know that. Any one of us that has any basic training in economics knows that. Right now, Europe is a region that is short of investment, short of confidence, short of liquidity. We all have to stand up and the IMF was created with a special mechanism which virtually no one in the press has written about and I don’t understand it. Why is it so much more difficult to mobilize funds from Europe today to support Greece, or Portugal, or Ireland than it is to mobilize IMF support? One simple but powerful difference is that when the IMF lends, it doesn’t get charged against budgetary outlays on any government balance sheet. Think about that. When Europe lends, it goes right to the bottom line of their budgets. We were fortunate that our predecessor created a structure in the IMF six decades ago which allows countries to feed money in there and then the IMF lends it on this concept of an exchange of assets. The fundamental point is a powerful one: that if you required every country that requires IMF support to mobilize pockets of funding from individual government budgets, I can tell you the IMF would break down overnight. But because they extend credit and in return get an equal amount on an [Special Drawing Right] term it’s a whole different political context. And therefore I would say for those who say Europe is wealthy, Europe should stand up, recognize you’ve created the perfect instrument in the IMF to fund situations like this, which can avoid creating unnecessary political tension in order to support a country.
So substantial cuts in interest rates from political partners but also the IMF.
And I would say additional funding from both, I am not among those who would argue that the governments of Europe should start taking nominal haircuts on the amount of their exposure.
Would it be enough? Would the interest rate cuts be enough?
The interest rates could provide, over the next two years, 15-20 billion, depending on how they’re done, but then, if they could augment that, maybe not immediately, but augmented it over the next six months with an additional 10-20 billion, which would allow more room for investment in the economy, that would allow maybe some continuation in the pace of fiscal adjustment here. I would recommend that all those who look at Greece take a look at Ireland and see the comparable pace of fiscal production. Weak men and women who’ve just gotten out of the hospital may try to run a marathon, but they’re certainly unlikely to win it. Ireland is moving its fiscal deficit down at an average annual pace of 1-1.5 percent per year. To me, that seems pretty reasonable. It also has helped to rebuild confidence and creditability in the markets and Ireland is well over halfway back to regaining access to capital investment markets. If you set goals for Greece, and I think they’ve done this somewhere viscidly for Spain as well, they’re so ambitious that you inevitably fall short of those goals. You create a cycle of missed targets.
Was their analysis wrong? Is there anything to be said about the program?
I don’t want to be particularly critical of the IMF or the ECB, but I think you have to look at the results to date and wonder whether or not the heavy emphasis on short-term budget cutting has really helped to sustain and stabilize the debt and lay the conditions for growth. I think one has to give quite good marks to this government to date. In two respects: One is that the prime minister stepped up and showed some leadership in the past few days, as he’s done at critical junctures over the last five months since he’s been in office. Secondly, I think that the coalition has worked better than one might have thought.
So, where do we go from here?
I think the most practical approach is for the ECB and possibly the IMF to reduce the interest rates, and then provide some additional funding. I think the problem with looking for across-the-board nominal reductions in the levels of outstanding debt – bilaterally or EFSF as ESM – would cast an unmanageable cloud over future political support for Greece and Europe's budgetary guardians and I think that one has to think practically, therefore I would much rather the voices who support Greece try to find other techniques... I think that if we get the pace of fiscal adjustment right, emphasize more of the kind of reforms that were passed yesterday rather than just belt-tightening, it will reduce it this time around. Get the structural changes made in the Greek economy, which are going to take time. I mean the barnacles that have grown to create inefficiencies in the Greek economy; those things are not going to be cleaned off the hull of the Greek economy in six to nine months. It will take five to ten years to create a more efficient, dynamic Greek economy. It doesn’t mean that growth cannot resume soon, but it will mean that we have to have some patience for the efficiency gains of reforms in the professional sectors, labor markets, reducing the scale of government, all of these things that were refrained a bit during the Papandreou time that are now being implemented. It's going to take time to play through a more attractive, efficient Greek economy.
How do we get the debt to a sustainable level?
The key to debt sustainability is not just focusing on the numerator; it’s starting to focus more on the denominator, and we need to get some growth. We wiped out a huge amount of debt, but where has it gotten us in terms of debt sustainability? Why? Not because we didn’t wipe out enough debt, not because the Europeans haven’t taken a hatchet to their debt because we cannot seem to find the recipe for stabilizing growth. We need credit, we need investments, we need confidence. And finally, we need the Europeans to reaffirm, unequivocally, their ironclad commitment to Greece remaining in Europe, remaining in the eurozone, rather than the occasional voices of doubt and ambivalence which have continued to hang over market sentiment. Secondly, if Greece could benefit from a clearer eurozone game plan for the future of the eurozone, this could also make a real difference because part of the problem in Greece today is not a Greek problem, it’s a eurozone structural set of uncertainties and I think it’s important that the Greek people and the European leaders realize that part of the cloud that hangs over Spain, Italy – all of these countries that are under pressure – Greece is a cloud that was created by the revelation that has happened over the last few years, catalyzed by Greece, but it’s a eurozone revelation that the structure of the eurozone, common currency without common fiscal policy and without a common banking framework, was not viable in the long term and therefore I would stress the importance of a unified vision by the eurozone leaders where they see fiscal convergence, not just banking, but resolution, funding, all of the elements that we, many investors, would say are key ingredients to a more compelling future of the eurozone funds.
I assume you support the mergers in the Greek banking sector?
I welcome the consolidation that is taking place in the Greek banking system today. I think again that, like with the PSI, the benefits of those are now submerged under the lack of overall clarity about the duration of the economy but those benefits are highly likely to emerge over the next years as you see the restoration of a competitive functional Greek banking system. The key here is not to be obsessed with the short-term consequences or the privatization on the government balance sheet; again, you have to focus on what’s important here and what’s important here is getting the banking system working again and a recapitalization. The focus is getting the Greek banking system working again so as to help small and medium-size enterprises, Greek corporations, and Western investors.