July 03, 2015
The IMF's new debt sustainability analysis for Greece is now out, and could complicate the ensuing political process in creditor countries if there is a 'Yes' vote in Greece on Sunday. The bottomline is that there is now no way for any creditors to deny the need for both a new programme as well as substantial debt relief. And the situation on the ground will be even worse than stated in the document, as the impact of the credit controls is not taken into account.
The question is how can this be tied together into a single package. The IMF's DSA is in our view the single most important official document one should read on the Greek crisis. Indirectly, it is also a narrative of just how mistaken the expectations in the past had been. For the new DSA to be realistic, it would require a lot more from Greece than the mere acceptance of a few prior actions. It would require an economic policy regime shift, both for Greece, and for the creditors as well. We are not optimistic that this can succeed.
Here is the key section:
"It is unlikely that Greece will be able to close its financing gaps from the markets on terms consistent with debt sustainability. The central issue is that public debt cannot migrate back onto the balance sheet of the private sector at rates consistent with debt sustainability, until debt-to-GDP is much lower with correspondingly lower risk premia... Therefore, it is imperative for debt sustainability that the euro area member states provide additional resources of at least €36 billion on highly concessional terms (AAA interest rates, long maturities, and grace period) to fully cover the financing needs through end–2018, in the context of a third EU program (see also paragraph 10).
Even with concessional financing through 2018, debt would remain very high for decades and highly vulnerable to shocks. Assuming official (concessional) financing through end– 2018, the debt-to-GDP ratio is projected at about 150 percent in 2020, and close to 140 percent in 2022 (see Figure 4ii). Using the thresholds agreed in November 2012, a haircut that yields a reduction in debt of over 30 percent of GDP would be required to meet the November 2012 debt targets. With debt remaining very high, any further deterioration in growth rates or in the mediumterm primary surplus relative to the revised baseline scenario discussed here would result in significant increases in debt and gross financing needs (see robustness tests in the next section below). This points to the high vulnerability of the debt dynamics."
Here are the two scenarios, the first without a new programme, the second with a programme. Note that the abbreviation GG on the left stands for "General Government", and GFN stands for "Gross Financing Needs".
The details in the report reveal why the IMF ruled itself out of further financing for Greece, its assessment now has the country's debt as highly volatile and unsustainable under each of their scenarios. What is unclear is how the IMF as part of the Brussels Group could have signed off the final tranches of the second programme without debt relief even if the Greeks had capitulated - they would then be advocating additional financing for a country whose debt was unsustainable. The process was political, pulling support would have meant the IMF admitting that they had been wrong, while the institution was unwilling to stand up to the official creditors and say this.
Based on their DSA, which we still see as too optimistic, the recommendations for further relief are breathtaking. The document suggests that one approach would be to extend the grace period to 20 years, and the amortisation period to 40 years while also providing those new loans through 2018. That's a doubling of maturities on loans from eurozone creditors. The result is detailed in the below graphic.
In the previous review debt was expected to reach 128% of GDP in 2020 and further to 117% in 2022. The concessions the IMF allowed Greece in these past reviews because it was seen as systemic are now off the table. Downside risks are taken seriously - this assessment is a far more serious attempt to understand whether and how Greece can pay back their debts. Based on new assumptions about growth paths, primary surpluses, privatisation proceeds, and interest rates (each incorporating the Syriza effect), those numbers adjust to the 150% in 2020, and close to 140% in 2022 that the IMF find in their new baseline scenario (with concessional financing to 2018). The key changes now have primary surpluses missing target by 1.5% in 2014 (which was not factored into the review in 2014), at 1% this year, which is still highly ambitious considering the latest developments, and rising to 2% and 3% in 2016 and 2017 respectively. The previous assumptions was for 3% in 2015 and 4.5% from 2016 onwards.
Although the primary surpluses make up a big part of the new-found shortfall, the IMF is more realistic about privatisation proceeds, now expected to reach only €500m over the next years rather than the previously expected €23bn from 2014-2022. The whole document is filled with this kind of "we've learnt our lesson" analysis: with reality consistently falling below what the IMF projected the fund is taking the view that downside risks need to be limited or eliminated from its analysis. Lower economic growth is another factor, which was cut by 50 basis points by the IMF in its projections due to the Syriza impact on reform commitments, now sitting at 1.5% (real).
The IMF make the important point that the burden for Greece is not servicing costs which were all but wiped out by flooring interest rates, but rather the debt burden itself - a point commentators have missed in trying to understand the debt dynamics Greece faces over the coming decades. The key issue for sustainability is when these debts fall due.
Today we also have stories on what the polls are telling us about Sunday; the state of the Greek economy mid-capital controls; why Yes means Grexit and No means Grexit; and Greece vs Puerto Rico.