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Today’s Greek debt talks aren’t about Greek debt, but the IMF’s credibility

  • Tim Fernholz
By Tim Fernholz

Senior reporter

Published Last updated This article is more than 2 years old.

“Greece has been bailed out since 2010, and the GDP during the third quarter of this year got worse. Do you think that the program really works in Greece? Do you see it as a kind of failure for IMF?”

It’s not an unreasonable question to ask at an IMF press briefing, and it gets at the risks facing the venerable worldwide lender as it supports Europe’s efforts to rebuild a functioning financial system. After gaining credibility for quick and effective action during the 2008 financial crisis, the IMF’s role in the “troika” responsible for Greece’s financial rescue—along with the European Commission and the European Central Bank—puts it in a tight spot, one that they’ll try to resolve at meetings on Nov. 20 in Brussels.

“It’s clear the IMF was brought into this by the European nations, and a lot of what Lagarde and the fund can do is dictated by the Europeans,” says Joseph Joyce, an economist who has written a new book on the IMF. “The euro crisis is exactly that type of crisis where the principals weren’t fully able to admit how bad things were and put the IMF in a delicate position.”

As we learned in a rare public breach last week, IMF director Christine Lagarde is currently pressing European leaders to take losses on Greek loans, so that the country can reach the goal of a debt-to-GDP ratio of 120% by 2020 (it’s currently 175%). The spat comes at an awkward time, after the Greek parliament passed a controversial austerity budget—full of pension cuts, tax hikes and a postponed retirement age to save €13.5 billion—in order to unlock a new tranche of €31.5 billion in rescue funds. Those funds won’t be released until the troika figures out how to hold up its end of the deal.

The problem is that Greece’s economy is cratering, so its debt-to-GDP ratio is liable to rise as the GDP shrinks. And it doesn’t look like growth is coming back soon. As the IMF—or at least its top economist, Olivier Blanchard—recently admitted in its World Economic Outlook (pdf), its expectations that fiscal austerity would spur growth were too optimistic. (And as we recently reported, several studies have shown the same.) Now, in order to reach its fiscal goals, the IMF wants the European countries who own Greek debt to write some of it off, relieving some of the burden on the Greek people. The European countries, on the other hand, would like to kick the can two years down the road, moving the fiscal goal to 2022 in the hopes of being fully repaid.

But Lagarde and the IMF don’t want can-kicking. While politicians may only be thinking of their next election, Lagarde has to ensure that the IMF has both the resources and the credibility to back up the international financial system. In a changing economic world order, that’s been getting harder. The financial and policy-making clout a nation has on the IMF’s board of directors still reflects a somewhat outdated notion of the world’s richest countries, with emerging markets under-represented relative to the United States and Europe.

It’s in this context, trying to defend the IMF’s reputation, that Lagarde is urging European governments to take more losses on Greek debt. The IMF has already lowered interest rates on its loans and extended repayment for an additional year, but it does not control the bulk of the country’s debt. Some European leaders have urged that the IMF essentially give money to Greece at zero interest rates, loans that are made to countries much poorer than Greece.

Bail-ins—i.e., making investors take a “haircut” on the sovereign debt of fiscally floundering countries—are usually critical to ending a financial crisis. There was a fear that the modern financial system—which distributes securities to thousands of different entities, rather than a few powerful banks—would make such negotiations impossible when the Greek crisis began. One consequence of continual delay is that governments have accumulated so much Greek debt in rescue maneuvers that a restructuring is now easier, at least on paper. But Europe’s governments don’t want to be seen protecting Greek intransigence.

Lagarde’s job of selling debt relief to European ministers is, at least, is a familiar challenge to the IMF: telling governments news they are not interested in hearing. ”The ability of the fund to respond to crises is somewhat contingent on what its members can do,” Joyce says. “The IMF was active in 2008 and 2009, lent a lot of money with minimal conditions. They can come through and be very very effective—when they’re allowed to.”

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