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Analysis

Why creditors should heed IMF advice

Debt crises in Greece and Puerto Rico

by Desmond Lachman in Washington

Wed 5 Apr 2017

US and European policy-makers differ on many economic issues but have at least one thing in common: they have learned little from the Greek sovereign debt crisis. Europe has already been stymied by the impasse over Athens’ debt burden. The US may find the same thing happens in its policy interactions with a territory that, in the American context, bears some resemblance to Greece: Puerto Rico.

The International Monetary Fund, to its credit, seems to have learned from the major mistakes that it made during its initial years of handling the Greek crisis. The Fund has recognised it was counterproductive to demand excessive budget adjustment from an economy stuck in a monetary union without a currency of its own to depreciate. In the end, as the IMF now acknowledges, budget cuts produced a deep economic decline that lowered tax receipts and increased debt.

The IMF should have insisted, as a precondition for its involvement, that Athens secured, as long ago as 2010, a significant reduction in its debt with private bondholders. This would have led to a much less severe economic programme that would not have sunk the economy.

I can only hope that the US authorities will take on board the IMF lessons from Greece and adapt policies accordingly to the worsening circumstances in Puerto Rico. Greece appears politically to have reached the limits of how much budget adjustment it can bear.

However, like its European counterparts, the oversight board that the US Congress created last year to help resolve Puerto Rico’s financial crisis has learned little. Apparently oblivious to the Greek experience, the board is demanding excessive budget cuts. A more sensible policy would call for restructuring the island’s debt to a level consistent with a reasonable amount of budget adjustment. However, instead the board is suggesting that Puerto Rico take revenue and expenditure measures over the next 10 years to reduce its budget deficit by around 10% of GDP.

This would have a devastating effect. The 2-3 percentage points of budget adjustment that the oversight board seems to be seeking in each of the next two years is likely to cause the Puerto Rican economy to contract by 3-4% a year. Already, in the last decade, the economy has shrunk by more than 10%, and more than 10% of the population has emigrated. A further decline would generate more dislocation, more migration, and less capacity for Puerto Rico to service its debt.

The Puerto Rican economic crisis is likely to reach a head after 1 May, when a creditor moratorium ends. There will be a similar reckoning in Greece in July, when Athens must make a large bond redemption to the European Central Bank. Both events will concentrate the minds of creditors and debtors alike.

I hope Steven Mnuchin, US Treasury secretary, and Wolfgang Schäuble, German finance minister, consult on how they might find a way out of the debt trap in which both Greece and Puerto Rico find themselves. If IMF advice can be brought to bear, there may still be hope that wisdom will prevail.

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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