Not again, moan the Germans! What do they need it for? Enough is enough. Kick them out! That is what you would expect by now as the public reaction in Germany. However, public opinion is not unanimous anymore, otherwise there would not be demonstrations for debt relief throughout cities in Germany, and Europe, in solidarity with Greece. So to understand whether another 50 be should be advanced, let us examine the issue a bit further?
So firstly, is the money actually needed?
And then, secondly, let us determine whether the IMF is right to say that only EU and IMF can provide the funds? What are the alternatives?
(1) Does Greece need additional money?
It is true
Financing needs add up to over €50 billion over the three-year period from
October 2015 to end–2018.
This is what the IMF says in its latest report on Greece. It adds:
It is unlikely that Greece will be able to close its financing gaps from the markets on
terms consistent with debt sustainability.
That basically means that the EU and the IMF will have to advance the money, as Greece cannot come to the bond market to get further debt. The interest rates on the bond market are too high.
This is, of course, the 50bn which German Finance Minister Schaeuble offered US Treasury Secretary Lew to throw into the pot, if the US were keen to help Greece. This was reported a couple of weeks ago, so we all know now, where Schaueble got the 50bn from.
Now this 50bn money is of course not new money which Greece needs. Let us state once more loud and clear. Greece runs a primary surplus at the moment, and intends to do so over the next years. That means that apart from debt servicing charges, Greece raises enough money from taxes to pay for its government expenses.
So all new money Greece needs is always only for debt servicing charges.
What is all the excitement about the 50bn about then, how did the IMF derive at that figure?
Maybe the following analogy might help:
Let us pretend, three years ago Michael got a 150,000 loan to refinance a boat and a house with one mortgage under the under the following condition.
100,000 to be repaid over 30 years time.
10,000 to be repaid from the sale of the boat in 3 years time
40,000 to be refinanced from another lender in 3 years time
Well, now, three years are up, and Michael finds that other lenders will only lend to you on very high rates, and the bottom has fallen out of the boat market. Naturally, Michael does not want to sell the boat. In addition, rather than the pay-rise Michael was planning on, he was laid off and had to take on a lower-paid job.
Unsurprisingly, there is now a financing requirement of 50,000. It looks like new money needs to be found, but it the total amount of debt is the same, and due to Michael’s lower income virtually unpayable. But no other lender will take on 50,000, Michael’s bank is stuck with the loan.
That is exactly the position the IMF and EU find themselves in. They cannot get Greece to sell its assets (airports, public utilities), which it is reluctant to do in a recessionary market. As the IMF puts it
The fourth SBA review in July 2011 projected €50 billion to materialize through end–2015. Actual receipts through the first quarter of 2015 were €3.2 billion, about 94 percent below the target.
Only 3.2bn of assets were sold, not 50bn!
But just as Michael’s total indebtedness has not gone up, the total indebtedness of Greece will also stay the same.
So no new 50bn money is needed by Greece. The Germans can relax.
What the IMF should have said in its report, our assumptions were unsustainable optimistic, and therefore we are stuck with the Greek debt a bit longer than we thought. That is basically what they say in the relatively candid report. How optimistic were the assumptions? The IMF is scathing (as scathing as they can be) here about its own IMF department which obviously made the first set of assumptions.
There is a substantial weakening in the delivery of structural reforms and in the reform commitments. This has made untenable the assumption until the last review that Greece would go from having the lowest average TFP [total factor productivity] growth in the euro area since it joined the EU in 1981 to having among the highest TFP growth, and that it would go to the highest labor force participation rates and to German employment rates
And Greek Finance Minister Varoufakis, in his own blog, puts it succinctly. Commenting on the realism behind the IMF assumptions, he says:
Pigs would, of course, sooner fly!
The IMF goes now through a number of more realistic scenarios in the report, testing the viability of the Greek debt under various conditions. But only under the most optimistic assumptions the debt is viable, just.
But if expected growth does not materialise, or other unexpected problems hit, Greece will have a problem. And the assumptions are made that Greece does not repay its loans in the first year 20 years, and the repayment period stretches to 40 years. In effect stretching out the current loan agreement by a factor of 2. Even then, giving market rates are much higher, it seems unlikely that the debt can ever be repaid.
The IMF come to the conclusion that some part of the debt has to be written off. It suggest 60bn, to get to the point where they thought they would be after the previous debt restructuring in 2012.
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.
More than 30% of GDP would amount to 60bn. Yesterday we suggested 120bn debt relief to reduce the debt to GDP ratio to 110%, just under the 120% debt sustainability ratio, to allow Greece to grow quickly and sustainable.
(2) Now, does Greece need to go to the IMF/EU? Can Greece not get its funding elsewhere?
(2.a) Default each time debt repayments due
Default is always an option. We said that Greece should default on its loans and get debt reduction by stealth, it could of course do so, and just live frugally from its own taxes. In which the 50bn would just not be repaid when they are due. In this case the lenders, mainly the IMF and the EU would have to write off the 50bn loan.
(2.b) Are there alternative ways of financing Greek debt?
Greece might believe it is in the long term interest to come to an agreement with its creditors and not default, if at all possible. What else could Greece do?
The IMF rightly says the route to the market is barred, as interest rates for Greek debt will be too high to issue government bonds.
What other options are there? What would ideal state financing instrument look like under these conditions?
Professor Richard Werner, Finance and Banking Professor at Southhampton university has also thought about this, here are his views for the ideal government financing instrument:
But is it possible to design a funding instrument with all these desirable features, namely that it is
non-tradable and would not need to be marked to market by investors, but instead could be kept on their books at face value;
cheaper, requiring a lower interest rate, than the crisis-period bond market yields;
available without rating from the credit rating agencies and hence also not affected by potential ratings downgrades;
available domestically, hence not requiring borrowing from abroad, thus resulting in lower total debt and greater fiscal and financial stability domestically and in the eurozone;
generating returns for the domestic banking sector, allowing organic growth of reserves and capital buffers;
boosting domestic demand, delivering overall economic growth, and hence lower deficit/GDP and debt/GDP ratios by increasing the denominator; such reliance on domestic demand would be superior to the reliance on external demand of IMF-style packages, as foreign demand is an exogenous factor.
available without the conditionality of required deep fiscal tightening, asset sell-offs and deflationary structural reform?
Given how utopian the wish-list may already appear, one might as well add another, even taller-sounding feature, which would be the most attractive of all: The ideal alternative funding source would also
be available on demand by being created ex nihilo domestically, without the need for any capital by the lenders.
Should such a debt instrument or funding source exist, it would be the most attractive source for the sovereign borrowers concerned, and not utilising it would be negligent. To find it, one could ask the debt origination experts at a leading international bond investment bank whether it could be designed. But securities firms could hardly expect to earn money on such an instrument. Fortunately, they will not be needed to design such an instrument: It already exists.
It is one of the oldest and simplest debt ‘products’ in existence: a bank loan contract.
So Professor Werner believes that countries should borrow domestically from their own commercial banks, using normal bank loans, at low interest rates. Banks would benefit, as they have certain income. Countries would not be beholden to the bond markets and rating agencies, and money would stay in the economy, in its own country.
That last point is not a trivial point. That is of course what the whole discussion about the primary surplus is all about. The IMF wants the interest to be sent to Greece’s creditors abroad, itsforeign lenders.
The Greek government says rightly these primary surpluses will lower GDP in Greece. (Money goes out of the country for these interest payments, as it would with an import of a car, that will lower GDP, unless exports will make up for it!)
That drop in GDP will not happen, of course, if Greece borrows form its own banks, then the interest goes to the domestic bank. If Greece had all its government borrowing at its own banks, an estimated at 2% of GDP per year would stay all in Greece. Or two thirds of the 17.2bn which the IMF says will now go to foreign lenders in the next three years will stay in Greece.
Greece would be approximately 12 bn Euro better off in 3 years time, just by borrowing from its own banks, rather than from the EU and IMF.
So, if Greece does not want to default, it should say to the IMF:
We are quite happy to finance the 50bn shortfall over the next three years..
We will borrow the money needed from out own commercial banks at the same rate the ECB charges on its refinancing of Greek liabilities. Plus a 0.3% interest margin on top, which will give the Greek banks much needed income, while keeping Greek financing costs well below the current rates paid to IMF and EU. The IMF and EU loans will reduce, making European tax payers happy.
A win-win-win situation for Greek banks, the Greek government and the Greek creditors.
But Greece should also say that there must be a condition to this deal, namely that there must be debt forgiveness. Because only then is Greek debt sustainable, as stated by the IMF. Only then will the ECB allow Greece to add the government debt to its commercial banks balance sheets. Only then will money be repatriated to Greece from accounts in Germany and Switzerland, to start investment in Greece again. And only then will there be hope for Greece.
No matter whether is 60bn or 120 bn, a substantial debt write off for Greece will have to happen.
Germany will have to understand that this is the price Germany, and Greece’s other creditors will NOW have to pay for regulatory failure of the Euro if the Greek crisis is to end. The European politicians and institutions, by continuing to deny joint responsibility for the disaster, will only prolong the crisis. by refusing to admit to a rational way forward.
All the politicians in the Eurozone, not just the Germans, who are denying reality, are destroying not only Greece, but the European spirit of cooperation. Demonstrations throughout Europe are for Greek debt relief, not against it. Politicians in Europe should take note!