The IMF and the Greek Crisis: Myths and Realities
IMF News, September 30, 2019
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- Published: September 30, 2019
Where is Greece now
- IMF assumed it would take Greece 8 years to return to pre-crisis GDP per capita levels; outcome was worse.
- Today, almost ten years later, GDP per capita is still 22 percent below the pre-crisis level.
- IMF forecast: it will take another 15 years, until 2034, to return to pre-crisis levels.
- European Commission forecast: return to pre-crisis levels by 2031.
- IMF last disbursement: mid-2014; IMF out for roughly half of the period of Greek programs due to disagreements.
The Fiscal Adjustment
- Underlying causes:
- Pensions and social transfers increased by 7 percent of GDP from euro adoption to eve of crisis.
- Public wage bill rose by 3 percent of GDP.
- Overall fiscal deficit rose from 4 percent in 2000 to more than 15 percent of GDP in 2009.
- Primary deficit in 2009: about 10 percent of GDP.
- Original program design:
- Foreseen fiscal adjustment: more than 12 percent of GDP over 3 years.
- Alternative (less ambitious) paths would have required more financing; political constraints prevented that.
- Implementation outcomes and concerns:
- Additional fiscal measures from 2011 as recession deepened; quality of measures deteriorated.
- Capital spending and recurrent spending (other than wages and transfers) cut to levels that hamper potential growth and provision of basic public services.
- Current tax collection rates fell from 65 percent in 2010 to about 41 percent in 2017.
- Pension reform rollbacks: 2016 alignment of existing retirees’ benefits with the new unified pension formula was cancelled.
- Personal income tax: exemption threshold relative to the average wage is more than two times higher than the European average, exempting well over half of wage earners and pensioners.
- 2017 broadening of the tax base pre-legislated for 2020 was scrapped when the ESM program lapsed.
- Political and perceptual effects:
- IMF often accused of advocating more austerity; IMF called for lower surpluses from 2012 onward.
- Government over-performed relative to a 3.5 percent of GDP target to convince partners it could reverse reforms, undertaking more growth-damaging austerity than even Europeans advocated to avoid reforms the Fund favored.
Reasons for the unexpected deep recession
- Acknowledged IMF under-estimation of fiscal multipliers initially; quarterly reviews adjusted multipliers and financing/time requirements.
- Deeper root causes:
- Lack of broad political support from the outset; main opposition opposed program; fragmentation culminated in SYRIZA coming to power in 2015.
- Erosion of European partners' confidence and doubts about Grexit exacerbated sentiment deterioration.
- From early 2011, program reviews had to internalize continuous deterioration in sentiments, causing flight from banking system and collapse in investments.
- Comparative example:
- Portugal’s 2011 program: similar design but negotiated with both government and main opposition, resulting in broad political support and smoother implementation.
- Design and expectation errors:
- DSA assumptions were too optimistic:
- Assumed primary surplus of 5-6 percent of GDP was unrealistic in Greek political reality.
- Assumed privatization receipts of €50 billion proved optimistic.
- Over-estimated supply response and placed excessive burden on labor.
- Labor market reforms (2012) improved competitiveness via collective bargaining reform and lower minimum wages.
- Reforms to open goods and services markets were less successful due to resistance from vested interests; increased competition and price reductions did not materialize.
- Institutional reflection:
- IMF admits being too sanguine about Greek political system’s ability to implement very large and rapid adjustment (>12 percent of GDP).
The Debt Issue
- Initial decisions and context:
- IMF supported a bail-out in 2010 due to systemic risks 18 months after Lehman and absence of firewalls to prevent contagion.
- Private Sector Involvement (PSI):
- PSI in early 2012 reduced debt-to-GDP by some 18 percentage points compared with an earlier bail-out-only scenario, but would not have been a panacea.
- PSI that occurred was tough; even tougher PSI risked being coercive with larger holdouts, litigation, and contagion.
- Official Sector Involvement (OSI) and NPV measures:
- Europeans preferred avoiding nominal haircuts; provided debt relief by reducing net present value (NPV) via lower interest rates and lengthened maturities.
- These measures gave Greece AAA interest rates averaging around 1.8 percent and the best maturity profile of any advanced country, exceeding 20 years on average.
- Interest payments fell from €12 billion in 2009 to about €6 billion or 3.3 percent of GDP in 2018.
- Market access and 2015 reversal:
- By end-2014 Greece regained some capital market access; sentiment deteriorated after SYRIZA abandoned parts of the program in early 2015, triggering the second Grexit crisis and higher projected debt-to-GDP ratios.
- 2015–post decisions and IMF position:
- IMF accepted NPV-improving OSI in 2012 but later judged that additional OSI provided in 2015 improved medium-term sustainability but left significant long-term risks.
- IMF concern: private sector unlikely to reabsorb large amounts of official debt at interest rates consistent with sustainability under current schedule.
- Result: IMF could not reach agreement and ESM program proceeded without accompanying IMF program.
- Retrospective reflections:
- Bail-out in 2010 transformed private into public debt and politicized the debt issue.
- IMF acknowledges they could have sought creditor commitments to provide debt relief if downside risks materialized and insisted on haircuts, but did not foresee the politicization degree.
Concluding remarks and outlook
- Structural political constraint: euro area is not a political union; political compromises in the Eurogroup sometimes conflict with IMF’s rules-based uniform standards.
- After iterations and politically difficult decisions by Greece and European partners, macroeconomic stability has improved:
- Modest recovery underway.
- Unemployment declining.
- Real wages recovering.
- Sovereign yields much lower.
- Capital market access slowly being restored.
- Persistent challenges:
- Pervasive rigidities still weigh on productivity.
- Very long road remains for incomes to catch up to pre-crisis levels.
- Opportunity:
- Greece now has breathing space to implement fundamental reforms needed to prosper within the euro area.
Speech by Poul Thomsen, Director of the European Department of the International Monetary Fund, at the London School of Economics, September 30, 2019.