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Tuesday, January 5, 2010

The IMF Is Ready To Help Greece If Asked - So Why Not Ask Them?

by Edward Hugh: Barcelona

"The EU should create a mechanism to help out countries which found themselves in Greece's shoes. But one has to believe Greece will solve its problems by itself." This is the view expressed by Marek Belka Director of the IMF's European Officein an interview with Reuters last week. Asked whether the IMF would be ready to help bail out Greece, Belka said: "Yes, we are ready. But it depends on whether the EU or Greece will request it."

In a separate interiew with IMF Survey Magazine (worth reading in its entirety) Belka cites Ireland and Spain as “good examples” of countries with “homemade imbalances” based primarily on “real estate and asset price bubbles”. As he points out, Ireland and Spain (unlike Greece) entered the financial crisis with “relatively low levels of public debt”, something which has enabled them “to react to the crisis by using the fiscal space that they had accumulated in good times”. “Now of course, both countries have been forced to start fiscal consolidation". And since, “In a monetary union, depreciating your economy out of the crisis is not an option...countries must rebuild their competitiveness through factory-price adjustment, which often means unfortunately, cutting wages.” He thus essentially reiterates the central point that Paul Krugman, I and numerous others have been making about this situation.

No Clear Decision Taker

So, as members of the ECB and EU delegations board their plane on the way to Athens tomorrow, they will have plenty of things to be thinking (and worrying) about. Basically, what seems to be going on here is a huge poker-style game of brinksmanship, with none of the various parties (the Greek government, the EU Commission, the IMF, and the Credit Ratings Agencies - to name but a few - really absolutely clear about what the others are up to, or what they really want. You could even add-in more "stakeholders" (in terms of parties who will have to assume ownership of any final agreement) if you want, the French and German governments, for example, the EU Finance Ministers, the Greek Socialist Party, the Greek Trade Unions, the list, in fact, is well nigh endless.

This is really far from a desireable state of affairs for a team of people who collectively are going to have to try and solve one of the most complex problems to have emerged from the recent economic and financial crisis, and do it quickly, since there is a clock ticking away in the background. Evidently the Greek government should be having to negotiate with everyone else, but the others should have one common voice, and this is far from being the case, which is what leads to all the confusion, and is why Belka says the EU needs to put a mechanism in place to handle this kind of situation - a uniform mechanism which treats all EU members - whether inside or outside the Eurozone - fairly, and where the rules and procedures are clear to all. This mechanism, should, as I have suggested, include powers for the EU Commission to intervene over the heads of national parliaments (a need which is already evident in the Latvian case), and implement hard and unpopular solutions when they are in the interest of the entire community of Europeans. We cannot have one minority interest after another playing themselves off against the rest, it makes the Union harder to manage than a "hung" parliament.

Timing As Well As Content Will Be Important

Problems and confusion at this point abound. In the first place, we still have no clear indication of what the final 2009 fiscal deficit number is going to look like. There has been a lot of speculation in the press, and little in the way of denial, so it seems to be the case that it will be above 12.7%, but exactly how much above may be just what those EU representatives are on their way to discuss.

In principle Athens submitted the first version of its budget report - known as its Stability Programme - to the European Commission yesterday (4 January), and it will be the content of this report that the ECB and EU Commission representatives will be travelling tomorrow to discuss. At this stage what the Commission have is a draft version for negotiation (there seems to be some doubt that this draft was even sent, but then some documentation must have gone to Brussels for them to talk about on Wednesday) and ammendment. The final plan will more than likely be submitted at the end of the month, after being discussed by the Greek cabinet on January 15 and put to the Greek Parliament on January 20.

According to the web portal Capital.gr there are three measures that both the European Commission and the European Central Bank seem to be insisting on: increasing VAT by one or two points, increasing the age limits for retirement and a continuing wage freeze until the deficit is brought below 3%. But according to the website, none of these is included in the Greek Stability Programme that was sent to Brussels. According to their report, "Greek officials will meet in Athens with EU executives to agree on the starting point, that is on the deficit level for 2009... Eurostat in January will also decide on the height of the deficit", which seems to suggest that the report I cited yesterday that even the 2009 deficit level (we are now in 2010 remember) forms part of the negotiations, a hypothesis which the ongoing silence from the Greek authorities only add credibility to.

In principle the eurozone finance ministers will discuss the outcome of the negotiations at their regular monthly meeting on 15-16 February, but apparently EU President Herman Van Rompuy has just "upped-the-ante" by calling an extraordinary meeting of Europes leaders for 11th February with the only topic - Europe's economy - on the agenda. This evidently on adds to the pressure on Greek Prime Minister Papandreou, since the purpose of the meeting is to allow the various countries to present their exit strategies from the crisis.

The Greek government is increasingly under siege, and the latest indication of this is their decision today to cut the adjustment period from four to three years, and reduce the country's deficit below 3% by the end of 2012. Obviously such decisions are not trivial, and not taken lightly, since the correction involved is rather large - basically the decision means that the Greek Finance Ministry will now need to “pull” between 24 and 25.5 billion euros out of the economy in three years. No mean feat this, even for a Herculean politicians like Papandreou. But the core quest still remains unresolved: it is not the velocity of the fiscal correction which is at issue, but its depth (in terms of structural character), and the fact that it should be associated with a substantial economic correction, capable of putting economic growth back on a sound footing.

Too Much To Do And Too Little Time To Do It In

Let's look now at why what is being proposed is likely to be quite hard. In the first place the Greek economy - before entering a direct body slam with the global economic crisis - had been growing at an average rate of something like one percent a quarter (or around four percent a year). Which looks like a pretty good performance, until you start to think about how they did it.

As can be seen in the following chart, the steady rise in Greek output was being fuelled by a surge in government spending (see chart below) and this gave the impression that the impact of the global crisis was slight, which it was initially, due to the massive support the government was providing, unsustainable support if you look at Greece's overal growth and debt dynamics.

In addition this extra demand being provided by the Greek government was doing nothing to resolve the underlying problem - which is the lack of competitiveness of Greek industry -and was simply sucking in imports to fuel the country's large current account deficit.

But the other part of the equation here is that Greek private consumption has also been losing momentum in recent years - a not infrequent phenomenon in countries with ageing populations, and thus it is unlikely that the Greek economy is going to see any strong internal impetus from this source in the years to come.

In fact bank lending to households, after growing at an rate of around 20% per annum over an extended period, is now down to an annual increase of only 3.9% (in October) and is still falling (see chart).

This is not due to s shortage of liquidity, since liquidity is now abundant in the Eurozone, but due to a lack of demand and unwillingness on the part of banks to risk lending to people with the kind of employment and income profile to be found among those asking for credit at this point in time (ie people with debts, or unemployment, business problems etc). On the other hand, since Greek government bonds are, at least at this point, effectively guaranteed by the Eurosystem, lending to government has naturally boomed.

So here is the problem. The Greek government is going to rein-back some 20 billion euros plus in spending over the next three years in a way which will only fuel the existing contraction. Consumer demand is unlikely to revive, and capital spending and foreign investment are likely to continue to remain weak (see chart below). So everything will depend on exports, and on how long it takes to return competitiveness to the Greek economy. If other countries who have embarked on this path in the last couple of years are anything to go by, results will not be quick in coming, which means the economy will contract, and prices will deflate, while at the same time debt to GDP will surge. This is why the Greek economy will need to be wrapped in cotton wool in the coming years, and why the name of the IMF continues to be mentioned.

Mixed-Signal Mix-up

The big issue in the whole current Greek melodrama, is the one highlighted in the quote by Belka at the start of this post - the EU still lacks clear mechanisms to handle a situation like the present one, and this only leads to more and more confusion, as the name of the IMF gets constantly being invoked.

Obviously the excess deficit process is clear enough. Greece is currently up to the point outlines Art. 126(8) of the Excessive Deficit Procedure (most other countries still being in the Art.126(7) antechamber - for once Greece could be described as being in the vanguard). For Greece to avoid sanctions, it must present a set of credible measures aiming at correcting the deficit, early in 2010, which in theory are as outlined in the draft programme that should have been submitted today and then discussed before the 15th of January. Should an agreement fail to be reached, Greece would then move on to Art.126(9), which is the last injunction before sanctions are triggered. In the hypothetical eventuality that agreement is not reached the sanctions could be things like a) the publication of additional information before issuance of bonds and securities, b) a revision of the ECB policy regarding its loans to the country, c) the requirement of a deposit to be placed with the European Community, and c) ultimately, fines. But really, not of these are either appropriate or desireable in the present situation, although (b) is obviously a possibility, even if it would need to be used as a form of pressure to achieve some other kind of outcome - like Greece voluntarily going and asking for help from the IMF.

But basically this is a measure of last resort, since I am sure all parties want - at this point - to keep this as an "in house" affair. But we in the EU still lack mechanisms, which is why the IMF route cannot be totally discounted.

But it is this uncertainty about just how much the EU has in the way of teeth, and how far it is willing to go in using those teeth that causes part of the problem. It is clear that both the ECB and the EU Commission are convinced that some sort of serious intervention in the Greek economy is essential. The problem is how they convey to Papandreou and Pasok that they are convinced, and how they demonstrate - to Greece, other EU countries and the financial markets - just what their level of conviction is.

On the other hand, even though the ECB is currently talking tough, no one really knows how far they are prepared to go. The ECB is currently accepting bonds which at least one agency rates at BBB- or above, but this is a crisis measure set to expire at the end of 2010 when the previous threshold of A- will be reinstated. ECB Vice-President Lucas Papademos has insisted that the ECB will not hold back on the decision to return to the old collateral standards for the sake of just one country, but at this point few analysts seem convinced, and indeed the only think that really will convince them is if they do eventually implement their threat.

Another way of thinking about the situation is to work back from the end point to the present. If Greece is going to have a really hard time keeping that last A- rating (or A2 in the case of Moody's), and if the ECB really is serious about reintroducing the old collateral standards, then a rubicon is going to have to be crossed in 2010, since while the Eurosystem could undoubtedly cope with a situation where Greek bonds were not acceptable as collateral, this would not be a situation to be welcomed with open arms. So why not take decisions now which will avoid it. That is to say, I find it hard to believe that the Greek government is in any position to refuse the final offer the EU authorities will make to them, so why not include in the list of requirements that the Greek government go to the IMF to seek help. This would give a much tighter handle to the EU on what the Greek government actually gets up to, as well as getting them off the hook about the ratings issue - since Greece would effectively be guaranteed by the Fund, and hence an exception could be made. This is not a perfect solution, but it may be the best we have currently available. What we need to do is put that mechanism together, and do it fast, but in the meantime, let the words of Marek Belka not be lost: "Yes, we are ready. But it depends on whether the EU or Greece will request it."

Other background posts to this situation are:

That "Staggering" Greek Deficit Continues To Stagger Onwards and Upwards

Why The Ratings Agencies Are Right And George Papaconstantinou Is Wrong

Europe Needs Action Not Words From The Greek Finance Minister

So What's It All About, Costas?

The Velocity Of Modern Financial Crises

That Which The ECB Hath Separated, Let No Man Join Together Again!

It's All Greek To Me