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Greek lessons for the IMF

Greek lessons for the IMF

The Fund has been subject to political abuse 

by Desmond Lachman

Thu 26 Feb 2015

With Greece’s longer-term adherence to the euro still in doubt, it is a good time for reflection on the lessons of the International Monetary Fund’s unfortunate Greek lending programme. Never before has the IMF lent to a single member country on the scale that it has done to Greece. And never before has a significant IMF programme produced such disappointing results.

Under normal circumstances, IMF country lending is supposed to be limited to 200% of a country’s quota in a single year, 600% on a cumulative basis. However, the past five years show that, under the IMF’s ‘exceptional access’ policy, there are virtually no limits on how much the IMF can lend. The IMF rules say it should not resort to exceptional access lending when a country’s public debt is unsustainable or when the chances of programme success are not good. Yet the IMF has managed to lend to Greece around 1,860% of its quota, more than three times the normal limit.

When US Treasury officials are questioned in Congress on whether IMF lending might put US taxpayer money at risk, they routinely point out that, in its 70 year history, no country of significance has defaulted on its IMF loans. However, since the IMF has not loaned on this scale before, history is not necessarily a guide to the future. The IMF’s outstanding loans to Greece are around $30bn, 15% percent of Greek GDP and around half its total exports of goods and services. This has to raise serious questions on whether the IMF will in the end be repaid.

An early test will come in the second half of this year, immediately following the expiry of the now-agreed four month extension of its official European borrowing arrangement. During that period, Greece has to make around $8.5bn in scheduled debt repayments to the Fund, nearly one third of the total amount it owes the IMF. Greece might have a financial incentive to repay its IMF loans, which bear an interest rate of 3-4%, more than double the rate on its European loans. But Greece might simply not have the resources to repay those loans. This would be particularly likely should the Greek economy relapse into recession and should the country’s tax performance not improve markedly from its dismal performance over the past two months.

IMF lending to a country on the recent exceptional scale might have been justifiable had such lending produced beneficial results. However, it is difficult for the IMF to make such a claim. The monumental budget austerity that the IMF imposed on Greece, within a euro straightjacket that precluded devaluation to boost exports, has reduced the country to penury and badly hit its social fabric. The IMF had supposed its lending programme would soon put Greece back on the economic growth path. In fact, it contributed to a six-year Greek depression paralleling US 1930s experience. Greek output today is 22% below its pre-crisis 2008 peak. Unemployment stands at over 25%.

A principal objective of the IMF’s programme was to restore Greece’s public debt sustainability. However, here too the IMF’s programme has failed miserably. Far from reducing Greece’s public debt to GDP ratio to 110% as planned, Greece’s public debt ratio has skyrocketed to close to 180% despite a major rescheduling of its privately-held debt in 2012. Most of Greece’s debt is now owed to official sector creditors. That makes rescheduling all the more difficult to achieve.

The greatest failure of the IMF’s programme would seem to have been that it delayed Greece’s euro exit. A basic IMF objective was to keep Greece in the euro. This reflected fear of financial market contagion that might have caused the single currency to unravel. Yet, precisely because of IMF-imposed austerity, the Greek economy now finds itself in a depression. This has caused its politics to fragment, sowing fresh seeds for exit. If unleashing austerity makes more likely the outcome that it was supposed to have forestalled, there is good cause to ask what was the point of the exercise.

One might also ask what purpose has been served by the four month extension of the European lending programme. That envisages negotiation of a new programme with much the same policy mix of budget austerity and supply-side reforms within a euro straitjacket. At a time when the Greek economy is again succumbing to recession, can we really expect the same macroeconomic policy recipe to extricate Greece from its deflationary trap, when it failed so miserably to do so before?

To its credit, the IMF has conceded that it grossly underestimated the dire economic impact of budget belt-tightening. The IMF also has conceded that it misdiagnosed Greece’s initial problem as one of liquidity rather than one of solvency. The IMF unfortunately was unable to persuade the Europeans of the need for Greece to restructure earlier its privately held debt, which would have reduced the required budget tightening.   

There is an even more important lesson for the IMF. Its exceptional access lending policy made it all too easy for the IMF’s political masters to exploit it as an opaque source of dubiously motivated multi-purpose funding to avoid necessary debt restructuring and delay exchange rate adjustment. Once the Greek imbroglio (one way or another) comes to an end, we must hope that the governments and technocrats in charge of the IMF will reform its lending access policy to make the Fund less open to abuse by its political masters, and more of the catalytic and conditional lender that it once was.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.

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