A craftsman in Ireland: a housing bubble led to a banking crisis in the once booming island economy (photo: Peter Muhly/AFP)
CRISIS IN EUROPE
In a packed house seminar during the global lender’s Spring Meetings in Washington, D.C., the head of the IMF’s European Department and the mission chiefs responsible for Greece, Ireland, and Portugal gave a candid assessment of the varied challenges facing these countries and the paths they are pursuing toward recovery.
“Each country’s individual economic and financial problems are very different, but there are common themes,” said Reza Moghadam, Director of the IMF’s European Department, noting how the welcome decline in interest rates that came with euro membership unfortunately also resulted in a rapid increase in indebtedness, and how competitiveness suffered.
Strategies to curb debt and boost growth
The rise in debt that followed the sharp drop in interest rates took different forms in each country. Greece’s government borrowed heavily and so did Portugal’s, along with the latter’s private sector. In Ireland, private sector borrowing boomed, especially for real estate, leading to a banking crisis when the country’s housing bubble burst and sharply rising public debt as a consequence of bailing out the banks. Large increases in debt were one problem. For Greece and Portugal, a lack of competitiveness and low growth exacerbated the fiscal challenges.
Worries about debt and growth prospects shut countries out of financial markets and stifled their economies. Working closely with the European Commission and European Central Bank, the IMF is helping Greece, Portugal and Ireland get back on their feet. “The focus of our programs has been to put in place the conditions for growth in the long run,” said Moghadam.
Each country’s program is designed to curb debt and boost growth, and provides financial help until a return to market borrowing is possible.
Hastening a return to growth in Greece
Mark Flanagan, mission chief for Greece, outlined how this has meant a focus on bringing down Greece’s very high deficits and debt, as well as measures to make Greek exports more competitive and hasten a return to growth. Given even greater challenges than initially expected, Greek officials, the IMF, and European counterparts have shown flexibility, adapting the strategy to reduce debt more aggressively—including the largest and steepest debt deal in history—and putting more emphasis on actions that will spur economic activity and employment.
“The new program had to place Greek debt sustainability on a much firmer basis, and this meant first and foremost providing a stronger underpinning to growth,” said Flanagan. Greece received two separate loans from the IMF, the first in May 2010, which was replaced with a second one in March 2012 that supports the revised strategy.
Focus on restoring confidence in Ireland
While Ireland also needed to shrink its public debt and deficits, the root cause of its problems was a banking crisis resulting from fast credit growth and poor oversight of the financial sector.
Deputy Director Ajai Chopra described how the program focused on a rigorous and transparent approach to bank recapitalization to restore confidence, and a gradual approach to fiscal savings and deleveraging by banks to cushion the impact on growth, since very high household debt will hold back private spending for some time. Chopra outlined how a solid and credible medium-term consolidation plan as well as a high degree of ownership have underpinned the country’s fiscal progress, and how further support from Europe to help break the sovereign-banking loop could make a world of difference.
Ireland received just over $30 billion from the IMF in support. Unlike Greece, competitiveness was less of a concern, and even though the external environment is difficult, exports and strong implementation of economic reforms enabled Ireland to realize modest growth in 2011.
Portugal: Addressing debt and competitiveness
As spelled out by mission chief Abebe Aemro Selassie, Portugal fell somewhere in the middle, needing to address both public and private debt as well as a lack of competitiveness, and the program focuses squarely on these challenges. Portugal’s program is the newest, with a €26 billion loan from the IMF having been approved in May 2011. So far, “implementation of the reforms by the Portuguese government has been very strong, in large part thanks to broad political consensus, including with labor unions,” said Selassie.
Challenges ahead
IMF European Department Deputy Director Poul Thomsen, who led talks on Portugal’s program for the IMF and continues to direct the IMF’s efforts on Greece, summed up experience under the Greece, Ireland, and Portugal programs. He noted how the currency union helped fuel borrowing and constrained policy options to stem the crises: exchange rate adjustment is not possible and other potential actions need to be considered carefully given potential ripple effects across the union. On the other hand, euro zone members have mobilized unprecedented amounts to help Greece, Ireland, and Portugal.
These three countries have hard work ahead, but their challenges would be much, much greater without the substantial financial support provided by the EU and ECB, in tandem with the IMF, and Thomsen reiterated the Fund’s commitment “to continue to work with these countries and adapt these programs as circumstances evolve.”
Implementation of economic reform programs will be important, and Thomsen stressed that where competitiveness and anemic growth are major concerns, “if the programs are only about fiscal consolidation and financial deleveraging, they will fail. They also need to address the structural problems.”
