Despite a courageous public stance by the International Monetary Fund, European officials failed again on Tuesday to deal with the critical issue of Greece’s debt sustainability. If this continues, they will undermine yet another bailout package for Greece and suffer further erosion in credibility, especially in the eyes of their own citizens. They also risk seeing another hard-fought cash infusion do little more than buy a few months for a struggling Greek population.
Greece’s problems are well documented. Years of economic mismanagement and resource misallocations have left the country with poor competitiveness, a bloated public sector, way too much debt, and bankrupt banks. To complicate matters further, the country’s short-term economic aspirations are yet to converge with the country’s inconvenient truths.
The political and social dimension is also concerning. Unlike other notable sovereign debt crises (South Korea in 1998, Brazil in 2002-3, Iceland in 2008-9, and Ireland in the past three years), Greek citizens continue to protest and disengage, showing no sign of rallying behind their elected officials in a national recovery effort.
This latest bailout package is meant to improve things: by injecting more money into an economy riddled with payments arrears and virtually no financing for working capital (let alone new plants and equipment); and by accompanying this temporary financial relief with measures to bring the budget under control, recapitalise banks and expand growth-enhancing structural reforms.
While well-intentioned, this bailout would likely fail if a major sticking point – Greece’s need for another major debt reduction – remains unresolved. The country would thus stay stuck in a recession that has ravaged the country for more than four years. Youth unemployment, already in excess of 50 per cent, would become more deeply embedded. And the social problems would continue, with a particularly devastating effect on the most vulnerable segments of the population.
When confronted with yet another failure, European officials would again point the finger of blame at the Greek government for not implementing the program in full. Greece would again blame program design. And the challenging regional environment would be lamented by all, as would the lack of responsive institutional mechanisms.
Thanks to the IMF’s willingness to speak out, a new element would now be hard to ignore: European officials’ repeated wish to brush under the rug Greece’s debt overhang.
The IMF’s insistence – at the cost of angering some of its most important political masters – is anchored by solid theory and experience.
Think of what happens when a huge dark cloud hangs over a home. Occupants will delay as much as they can any outside activities pending the passage of this menace. Same for a visibly outsized and unsustainable sovereign debt stock; in addition to draining government resources, it discourages fresh capital inflows critical for the 'four Rs' of overcoming a debt crisis: recapitalisation, rehabilitation, restructuring and recovery.
Deep inside, European officials understand this. After all, they did fund a couple of years ago a significant haircut on Greek bonds held by private creditors. Today, some are suggesting another round of such private sector involvement. But the problem no longer resides with the private debt.
The devastating debt overhang now consists primarily of debt owed to European governments, institutions and the IMF. And all that Europe seems willing to consider right now is to extend principal maturities and reduce interest rates. Explicit official debt reduction operations – or 'OSI' for official sector involvement – appear off the table.
By again refusing to take a meaningful haircut, European officials believe they are avoiding precedents that are not just politically tricky but could also fuel disruptive regional contagion. To the extent they are correct – and it is debatable – they would be winning a small battle by increasing the probability of losing the war.
Until recently, many European officials stubbornly held to the belief that "advanced countries” – and especially those that had risen to membership of such a privileged club as the eurozone – were structurally immune to "developing country debt crises.” Their outmoded mindset undercut responsive policy responses, wasting billions of euros and undermining millions of lives. By again shying away on Tuesday from meaningful official debt reduction, Europeans signalled that they still lag realities on the ground.
The IMF is right. Greece urgently needs OSI. The longer Europe resists, the greater the risks to the integrity of Greece and to the credibility of eurozone policy responses. Let’s hope that good sense prevails when European officials convene again next week.
Copyright the Financial Times 2012.