By Dimitris Kontogiannis
The Greek economy has made its first step towards stabilization and recovery by registering a smaller-than-expected contraction last year. Whether this will lead to a gradual return to normalcy depends largely on political developments and market perceptions about the effectiveness of expected debt relief measures to be decided by the EU authorities. But the IMF and the EU clearly disagree on the best way to make Greece’s debt sustainable. One way to resolve this issue will be for the IMF to exit the Greek program in the second half of 2014. Some think market participants will rejoice, pushing Greek bond yields lower and helping the country fill the funding slack via a precautionary credit line from the ESM.
The role of the chief auditors of the EU, the IMF and the ECB, the so-called troika, in the eurozone debt crisis has come under scrutiny and has been criticized by members of the European Parliament in recent weeks – a bit too late, some may say, since Ireland exited the rescue program at the end of 2013 and Portugal is likely to do the same a few months from now. But this development is important for Greece, which is still struggling to meet high fiscal targets and to implement a host of structural reforms under its program. Also, an increasing number of Greek officials appear happy to point out the overly optimistic targets set in the first Greek bailout program back in May 2010 and the troika’s complete change of heart, which led to pessimistic estimates accompanied by proposed policy measures last year.
Even Finance Minister Yannis Stournaras, widely regarded as a technocrat who is on good terms with the troika, has criticized it in public, saying that the government would have done great damage to the economy if it had accepted the troika’s policy proposals last September to take additional austerity measures to close the estimated fiscal gap in 2014. Stournaras’s criticism may reflect exasperation with some policy demands deemed counterproductive and politically insensitive.
While criticism of the troika is mounting both in the EU and Greece, the time is approaching for the Eurogroup to give the green light for much-discussed debt relief measures. Athens appears confident revenues will exceed expenditures excluding interest payments on public debt to meet one of the prior actions, but the ongoing review of the adjustment program has yet to be concluded. It is reasonable to expect both sides to reach some kind of an agreement in the next month or so to open the road for loan disbursements ahead of the May expirations, amounting to more than 8 billion euros.
Still, the return of the Greek economy to growth for the first time since 2008 remains the most important challenge with the prospect of political uncertainty hovering and the debt overhang looming. History suggests that huge debt can undermine GDP growth and may destabilize a country. The Greek debt-to-GDP ratio is huge by any means and is seen exceeding 170 percent of GDP in 2013, standing at more than 315 billion euros. This debt overhang can have detrimental effects on growth via various channels.
It is well known that Germany and others in the EU disagree with the IMF’s proposal for a Greek debt write-off to make it sustainable and opt instead for interest rates cuts and a 20-year maturity extension of the bilateral loans. But the EU‘s preferred type of OSI (Official Sector Involvement) would have little impact on the debt-to-GDP targets in 2020 and 2022 set out in the DSA (Debt Sustainability Analysis) of the IMF, although it reduces the net present value (NPV) of the Greek debt according to analysts. But the EU and some analysts question the usefulness of DSA. They say it is a theoretical construct based on assumptions about variables such as GDP growth, interest rates and primary budget surpluses well into the future, and that even a small change in one of the variables can lead to large changes in the debt-to-GDP ratio.
This is more so in the Greek case since the biggest chunk of the debt, i.e. more than 240 billion euros, will be held by eurozone countries and institutions which have no interest in bankrupting the country and undermining the euro project – especially after Greece’s unprecedented fiscal effort and the almost certain delivery of a primary surplus in 2013 as well as the implementation of more than 80 percent of required structural reforms by the end of March or so. In this regard, the DSA of the Greek debt may have to be given up but the IMF is unlikely to accept this since it funds countries with sustainable debt based on its own method and calculations.
Given this fundamental disagreement between the EU and the IMF, the Greek government’s reported increasing malaise with the policy proposals of the IMF auditors and the objections of some emerging market countries to the IMF’s funding of Greece, the time may come for the IMF to leave the Greek program. Of course, this means somebody else will have to cover the resulting gap since IMF financing to Greece is projected to end in the first quarter of 2016. This could be Greece itself if the EU decides to back it by offering a precautionary credit line via the ESM. This would come on top of the projected financing gap of 11-15 billion euros for the 2014-2016 period which largely stems from the Greek debt buyback at end-2012 demanded by the EU and the IMF. Is it possible? Time will tell but some traders are willing to bet that markets will celebrate the IMF’s departure, pulling Greek yields down.