14/7/15: The Brave New World of IMF Debt Sustainability Analysis

According to the secret IMF report released to the European leaders prior to the Sunday-Monday summits, "The dramatic deterioration in debt sustainability points to the need for debt relief on a scale that would need to go well beyond what has been under consideration to date - and what has been proposed by the ESM."

This is reported by Reuters here.

Per IMF report,that completes the Debt Sustainability Analysis released earlier this month (see the link to the original published report here) and that already concluded that Greek debts were not sustainable, accounting for the effects of capital controls and other recent factors, to address sustainability of Greek debt into 2020s:

1. The EU (euro area) will need to extend graced period on Greek debt repayments to the ECB and the euro area to 30 years from now, and (not or)
2. Dramatically extend maturity of debt given to Greece under previous programmes and the new upcoming programme.

Barring the above - which are not in the proposed Bailout 3.0 package - the euro area member states will have to "make explicit annual fiscal transfers to the Greek budget or accept "deep upfront haircuts" on their loans to Athens". In other words - either there will have to be direct aid or direct up front write downs to the debt. These too are not in the current proposal for Bailout 3.0.

Despite this damning analysis, the IMF continues to insist that it will be a part of the new arrangement and will have a new agreement with Greece comes March 2016 when the current one ends. In other words, political arm of the IMF (aka Madame Lagarde and national representatives of the EU) are now directly, head-on, and forcefully in a contradiction to their own technical team assessment of the situation. Madame Lagarde was present at the Sunday-Monday meetings and produced no apparent progress on the what her own technical team says will be a necessary part of any sustainable solution to the crisis.

There is an added component to all of this: IMF analysis refers to a significant deterioration in banking sector situation in Greece since the introduction of capital controls. Which makes sense - there are no new deposits coming into the system and, one can easily assume, loans due are not being serviced. This, in turn, begs a question as to how realistic are the EU-own assessments that the Greek banks will require EUR12-25 billion in capital.

How dire is the situation with Greek debt?

IMF new report projects debt to GDP ratio peaking at above 200% - which is bang on with my estimates previously - up on the previous IMF estimate of peak at 177%. By 2022, IMF estimated Greek debt will decline to 142% of GDP (that is back from the previous 'secret' report linked above). Now, the Fund says debt will stay at 170% of GDP even by 2022.

As Retuers reports, "Gross financing needs would rise to above the 15 percent of GDP threshold deemed safe and continue rising in the long term".

"In the laconic technocratic language of IMF officialdom, the report noted that few countries had ever managed to sustain for several decades the primary budget surplus of 3.5 percent of GDP expected of Greece." In other words, the holly grail of massive and continuous long-term primary surpluses - the sole pillar underpinning previous positive assessments of the Greek debt sustainability by the IMF - is now gone. Realism prevails - no country can sustain such surpluses indefinitely. Surprisingly, IMF continues to insist on 3.5% primary surpluses target.

As a reminder, IMF has called for official sector debt write downs for Greece in the past. It still insists on the same (per technical team), but does nothing from the political leadership point of view.

Conclusion: IMF is now fully torn between its political wing - dominated by the EU representation and leadership - and its technical side. Unlike a unified and functional World Bank (led by the US), the IMF has fallen into the European orbit of dysfunctional politicking and funding programmes that are far from consistent with IMF-own standards. (To see some evidence of this, read this excellent essay from Bruegel). 

IMF's role in the Greek bailout 3.0 will go down in history as a direct participation in the wilful re-writing of the European system of governance to embrace politicised leadership over calm and effective economic policy structuring. As per Eurogroup, there is no longer any doubt that the euro area leadership is wilfully incapable of resolving the Greek crisis. Incompetence no longer counts - the euro area finance ministers and prime ministers had all necessary information to arrive at the only logical conclusion: debt writedowns are needed and are needed upfront. They opted to ignore these so politics can prevail over economics and finance, allowing for subsequent consolidation of the euro area systems and institutions without a clear path for any member state to deviate from such.

Greece is just the first roadkill on this path.


Update: WSJ covers the topic of IMF dilemma.