21/6/2014: IMF 'Waived' Sustainability Requirement in Lending to Euro Area Countries

IMF paper, published yesterday now fully admits that the Fund has 'waived' its own core requirements for lending under the core programmes in euro area 'periphery'. More importantly, the criteria for lending that was violated by the Fund is… the requirement that "public debt be judged as sustainable with "high probability”" under new lending programme.

The paper is available here: http://www.imf.org/external/np/pp/eng/2014/052214a.pdf

Quoting from the IMF report: "In the sovereign debt crises of the 1980s, concerted financial support from the private sector was a standard feature of Fund-supported programs, most of which were within the normal access limits. By contrast, the spate of capital account crises that began in the mid 1990s occurred at a time when the creditor base had become much more diffuse, and the Fund’s strategy sought instead to entice a resumption of private flows through programs involving large-scale Fund and other official resources. While this strategy worked well in some circumstances, it failed to play its catalytic role in cases where, amongst other factors, the member's debt sustainability prospects were uncertain." 

Thus, the Fund clearly recognised that probabilistically, extended lending can only work where there is some confidence that the borrower debts post-lending by the IMF, are sustainable. In other words, the Fund agreed that there is the need for more extensive lending (in some cases), but that such lending should, by itself, not push beyond sustainability levels of debt. Were it to do so, the Fund would have required restructuring of the sovereign debt to reduce levels to within sustainability bounds.

This is how this 'bounded' lending beyond normal constraints was supposed to work: "In response to this varied experience, and to ensure effective use of its resources, the Fund concluded that decisions to grant access above normal limits should henceforth be guided by defined criteria. These were established in the 2002 Exceptional Access Policy, [EAP] which included a requirement that public debt be judged as sustainable with "high probability.” The framework applied initially only in capital account cases, but in 2009 became applicable to all exceptional access decisions."

Now, fast forward to the Fund entanglement in euro area debt/default politics: "When Greece requested exceptional access in May 2010, the policy would have required deep debt reduction to reach the high probability threshold for debt sustainability. Fearing that such an operation would be highly disruptive in the circumstances prevailing at the time, the Fund decided to create an exemption to the high probability requirement for cases where there was a high risk of international systemic spillovers—an exemption that has since been invoked repeatedly in programs for Greece, Portugal, and Ireland."

Elaborating on this, the paper states: "An important rigidity of the EAP came to the fore when Greece requested financial support in early 2010. When “significant uncertainties” surrounding the sustainability assessment prevented staff from affirming that debt was sustainable with high probability, the existing EAP framework would call for a debt reduction operation to deliver such high probability as a condition for the provision of exceptional access. In the case of Greece, where the high probability requirement was not met, however, there were fears that an upfront debt restructuring would have potentially systemic adverse consequences on the euro area. Given the inflexibility of the EAP, and the crisis at hand, the Fund decided to create an exemption to the requirement for achieving debt sustainability with a high probability when there was a “high risk of international systemic spillovers”. Since then, the systemic exemption has been invoked 34 times by end-May, 2014 in the three EA programs for Greece, Portugal, and Ireland."

Note that the systemic exemption has been invoked 34 times in just four years, in all cases in relation to euro 'periphery'. That is a lot of 'we can't confirm sustainability of debt levels post-programme, so we won't look there' invocations. More significantly, did anyone notice these invocations in IMF country reports that repeatedly assured us, since 2010 on, that things are sustainable in these countries?

Conclusion: the Fund now fully admits that its lending to Greece, Portugal and Ireland:

1) Required (under previous conditions) deep restructuring of sovereign debt; and

2) Was carried out in excess of the already stretched sustainability bounds.

The Fund loaded more debt onto these economies than could have been deemed sustainable even by its already stretched standards of 2002 EAP.