EU’s unraveling plans for Greek debt risks split among creditors

Greece’s ballooning debt load is casting doubt over the International Monetary Fund’s role in future bailouts.

The IMF typically needs debt to be sustainable to provide more funds and, with the economy faltering, Greece is heading in the wrong direction. Creditors preparing for talks on Greece this week have just one positive scenario and three negative ones, the most extreme of which is that the government starts paying employees in IOUs, German newspaper Die Welt reported.

The European Commission forecast last week that the country’s debt will be 174 percent of gross domestic product next year, 15 percentage points above the level projected in February. And even that assumes Prime Minister Alexis Tsipras reaches a deal to get previously agreed aid flowing.

The projection means that if there’s an agreement, the Greek leader is still going to hit bureaucratic and political resistance to longer-term support. While the euro area has denied debt relief to Greece and insisted Tsipras observe the terms of the existing bailout, the IMF has signaled its concern over the deterioration in the country’s finances.

“The uneasy relationship with the Eurogroup, which wanted IMF rigor in bailout reviews but not its debt sustainability and financing criteria, is looking increasingly unsustainable,” said Michael Michaelides a rates strategist at Royal Bank of Scotland Plc. “Just like the Greek debt.”

Asked about the implications of the Commission’s forecasts for Greece, IMF spokeswoman Angela Gaviria referred to a November 2012 statement in which Managing Director Christine Lagarde said Greece’s debt was expected to decrease to 124 percent of GDP by 2020.

IMF concerns

As Greece’s chances of hitting the target recede, it makes it more difficult for the IMF to justify extending additional funds because the Washington-based lender is prohibited by its own rules from lending to countries with unsustainable debts.

If the euro area concedes that the debt burden is not sustainable, that would add weight to Greece’s appeal for more debt relief, an offer that its creditors have dangled since 2012 as an incentive to make good on the terms of its bailout. Greece could win a cut in its interest payment and an extension of its repayment period if it sticks to the deal and delivers a primary budget surplus.

Poul Thomsen, director of the IMF’s European department, told euro-area finance ministers on April 24 that Greece will need more concessions from its creditors to achieve a sustainable debt load as it gets further from the target.

Financial reality

Tsipras has toned down demands for a writedown on Greece’s debts since his January election, as he tries to obtain aid to cover his short-term obligations. But Greece is betting that financial reality will eventually force the hand of its creditors.

“Although we know our debt is not sustainable, we aren’t pressing the issue emphatically so that we can conclude the review at this stage,” Greek government spokesman Gabriel Sakellaridis said in Athens on Thursday. “Soon, whether we want to or not, this issue won’t be hidden under the carpet.”

To be sure, the IMF has bent its debt rules for Greece before. In 2010, the fund’s executive board approved a $38 billion bailout for the country, even though an analysis by IMF staff showed Greece’s debt wasn’t sustainable. The board waived the sustainability requirement because of concerns that a financial collapse in Greece would threaten the euro area and the global economy, according to a 2013 IMF evaluation.

‘Harmonious cooperation’

For now though, European Commissioner for Economic Affairs Pierre Moscovici refuses to engage on the issue.

When presenting the forecasts last week, Moscovici said Greece has to deliver on its plan to reboot the economy and stabilize its finances before a debate on debt sustainability.

“This issue can’t be discussed until we’ve reached an agreement on the program of reforms,” Moscovici said. “We’re working on the hypothesis that we’ll be able to make progress and return to the path of harmonious cooperation.”

Zsolt Darvas, a scholar at the Bruegel research institute in Brussels, argues that if the euro area is prepared to cut the country’s interest payments and provide about 40 billion euros ($45 billion) more in rescue funds, it could still put Greece back on the path to fiscal stability without a politically difficult writedown.

“Any level of debt is sustainable if it has a very low interest rate,” Darvas said. “The real issue is how to finance the maturing debt to the IMF and ECB and if the primary surplus will be sufficient to cover actual interest payments.”

The country’s anti-austerity coalition has said that it’s willing to strive for a primary budget surplus of about 1.5 percent of GDP this year. The Commission says that as defined in the bailout program there will be almost no surplus, even assuming the government takes more austerity measures.

Under the 2012 agreement, Greece is supposed to post a primary surplus of 3 percent this year.

“Their argument, which says ‘we can’t pay, what the heck are you telling us to do?’ gets to be more powerful by the day,” David Blanchflower, a former member of the Bank of England’s monetary policy committee, said in a television interview Wednesday. “It’s not even so much now a question of won’t pay — they can’t pay.” [Bloomberg]

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