Debt crisis in Europe: Beware IMF bearing gifts

17 June 2010

The descent of Greece into a sovereign debt crisis marks the first time a country that uses the euro has gone to the IMF. The fear of adverse market reaction has now moved Europe towards greater coordination and the G20 to argue against continued fiscal stimulus.

The IMF board approved a €30 billion ($35 billion), three-year loan for Greece in early May, which complements €80 billion being lent to Greece from eurozone countries. This €110 billion is treble the amount proposed in early April, reflecting the market’s loss of confidence. Greece was unable to raise money from markets at affordable interest rates due to fears over an unsustainable debt and deficit burden. The first disbursements were made in time to stem a default on a Greek bond repayment due in mid May.

The loan is designed to keep Greece afloat for 18 months, before the country must again sell bonds to cover its fiscal deficit. With the EU-IMF loan, Greece’s debt is projected to be nearly 150 per cent of GDP by that time. The IMF loan was equivalent to 4,200 per cent of Greece’s quota in the IMF, the largest ever ratio of loan to quota size. IMF loans are typically around 300 per cent of quota. The previous largest, to South Korea in 1997, was less than 2,000 per cent of quota.

The loans are conditioned on Greece enacting a devastating austerity package (see Update 71). It prompted massive protests and public unrest throughout May, with Yiannis Panagopoulos, president of the GSEE trade union umbrella body, saying that strikes would “send a strong message of protest to the government and to the troika of the IMF, the European Central Bank and the European Commission that their neoliberal experiments on the back of Greek society are criminal.”

Hundreds of thousands of people took to the streets of Athens, the Greek capital, on 5 May, with violence and the deaths of three bank workers the result of running clashes between protestors and police. Ten days later the Greek Communist Party claimed to have brought another 100,000 people on the street to protest against the centre-left government’s austerity package. And the Greek trade unions launched a second general strike on 20 May, resulting in 20,000 people in the streets.

Greece as the next Argentina?

The Greek crisis is provoking comparisons to the Argentine collapse of 2001 (see Update 26, 24). In early May, Argentine president Cristina Fernandez said, "The recipe behind all this is almost identical. Municipal suppression, reduction in salaries and the tightening of belts, it is the eternal recipe of the international financial institutions."

High debt levels have led mainstream commentators to say that Greece, like Argentina, cannot avoid debt restructuring (see Update 71). Because of Greece’s lack of control over the European Central Bank, which issues euros, some have even likened Greece’s predicament to developing countries that are forced to borrow in foreign currencies.

A March 2010 report from the University of London’s Research on Money and Finance group argued that Greece’s difficulties were exacerbated by the eurozone. “Monetary union has removed or limited the freedom to set monetary and fiscal policy, thus forcing the pressures of economic adjustment onto the labour market.” This has resulted in trade imbalances with negtative effects on labour: “The eurozone has become an area of entrenched current account surpluses for Germany, financed by current account deficits for peripheral countries. Monetary union is a ‘beggar-thy-neighbour’ policy for Germany, on condition that it beggars its own workers first.” The report recommended that Greece exit from the euro, restructure its debt, and reorient its economic policies toward social welfare.

Argentina experienced enviable growth for years after currency devaluation and debt default. However, former Argentine finance minister Domingo Cavallo, the architect of the ultimately failed Argentine economic system in the 1990s, said the main lesson from Argentina to Greece was that currency devaluation is not the answer. He did argue for an early and orderly debt restructuring.

What European social model?

Spain, Portugal and others are also in the firing line of markets and ratings agencies, meaning early and deep spending cuts, which caused massive protests to erupt in Spain in June. While proposals for a new European Monetary Fund surfaced early in the year (see Update 70), in the end European finance ministers agreed to a more ad hoc approach to trying to prevent crises. In early May, European finance minsters agreed a €750 billion European Stabilisation Mechanism to help countries in need of funds, of which €250 billion was to be provided by the IMF. The mechanism was formally activated in early June. The minister, which was proposed by the European Commission, also discussed greater European regional control over individual member state budgets.

The IMF later clarified that there was no formal commitment to lend money, but merely an indication of its willingness to provide one-third of the resources in any operation, as it had for Greece. Assuming full utilisation of the mechanism, which includes the eurozone as well as Sweden and Poland, the IMF’s €250 billion portion would equate to about 540 per cent of the total pooled quota of the mechanism’s members.

Developing countries are worried about the availability of IMF resources, as at end May it had only about €200 billion worth available. If the Fund needed money, it would have to get it from creditors by activating the New Arrangements to Borrow (NAB, see Update 65). However only about €40 billion is available in the NAB at this moment, because though it is to be expanded to almost €450 billion, the formal consent for this expansion has not yet been given by all the participating countries. Activating the NAB implicitly gives the creditors more say over Fund decision-making, raising worries about the conservative preferences of countries like the UK and Germany and the possible consequent tightening of IMF conditionality.

The IMF support for the European mechanism can also be seen as a guide for potential rearrangements of the global financial architecture. As part of the IMF mandate review (see Update 71, 70), the Fund is rethinking its relationships with regional monetary and financial structures, including potentially lending to those regional institutions instead of directly to countries. This may open up the power dynamics between the Fund and those regional institutions, particularly those dominated by regional financial hegemons, like Germany in Europe or China in Asia. Critics have called for a reduction in the IMF’s influence and the creation of regional alternatives with more policy space for member countries than the IMF might allow (see Update 67, 65).

Other IMF programmes in Europe continue to be unpopular. Massive protests against 25 per cent wage cuts and layoffs in the public sector struck Romania’s capital Bucharest in mid May. Ukraine’s IMF programme has yet to get back on track after elections, and ministers there are threatening to turn to Russia for money if a new package cannot be agreed. The Serbian government’s reported request to unfreeze wages and pensions was rejected by the IMF at end May, which agreed to only a one-off compensation payment.

G20, IMF changing their tunes

After the Greek crisis, the risks to the global economy suddenly looked very different to G20 finance ministers, who met in Korea in early June. In their communiqué, they agreed that “The recent events highlight the importance of sustainable public finances and the need for our countries to put in place credible, growth-friendly measures, to deliver fiscal sustainability, differentiated for and tailored to national circumstances. Those countries with serious fiscal challenges need to accelerate the pace of consolidation.” This was a marked change of emphasis to the G20 communiqué issued just six weeks beforehand, as in the late April the ministers still felt that, “In economies where growth is still highly dependent on policy support and consistent with sustainable public finances, it should be maintained until the recovery is firmly driven by the private sector and becomes more entrenched.”

A number of recent reports have called for continued fiscal stimulus (see Update 71), and at a press conference in Korea IMF managing director Dominique Strauss-Kahn said that premature fiscal consolidation could shave as much as 2.5 percentage points off global growth and cost 30 million jobs. He was, however, “totally comfortable” with the G20’s call for troubled countries to quicken the pace of deficit cuts “even if it has some bad effect on growth”.