Germany Blinks on Giving Debt Relief to Greece….or Did It?

Germany and Greece’s other creditors, facing the threat of the IMF sitting out the so-called “third bailout” of Greece, which needs to be in place by early July to stave off default, made what is being touted by Greece and some media outlets as a big concession, as in being willing to entertain debt reduction. In fact, reading between the lines, it is the IMF, and not Germany and the creditors, that have given ground. The IMF was insisting on actual debt reduction for Greece, as in principal haircuts. The Financial Times reports that the IMF has offered what amounts to an extend and pretend program:

On debt relief, ministers examined some basic options outlined by the IMF and the European Stability Mechanism, the eurozone’s bailout fund.

Governments have firmly and repeatedly rejected any formal writedown of their holdings of Greek debt, leaving them to look at other options, such as longer grace periods and extended payment timescales.

An ESM paper, seen by the FT, outlines a range of options including 5-year maturity extensions, capping annual loan repayments at 1 per cent of gross domestic product until 2050 and capping interest rates at 2 per cent. One more radical move mentioned is to buy out the IMF with cheaper and more long-term ESM loans.

This is a change in the IMF position that had gone curiously uncommented on by the press. Even before updating its forecasts for Greece to show it will not earn a primary surplus this year, the IMF had taken the position that Greece needed debt reduction, not mere debt “relief”. And indeed, in an environment of zero going to negative interest rates in Europe, extending maturities, which already extend to 30 years with interest rate deferrals in the early years, is not going to provide much help in net present value terms.

In fact, while the willingness to talk about debt relief for Greece is shift in Germany’s position, it isn’t that much of one. The IMF had made it clear that it regards the concessions that Germany is willing to make as inadequate. And the two sides (the IMF versus the other creditors) are far apart, and the Greeks are still not on board with what cuts are to be made either. Moreover, the principals won’t get together to try hash things out until May 24, and then things are on hold till after the Brexit vote of June 23.

That means if they don’t resolve their large differences, they have only a very short runway before a Greek default.

And there does not appear to be a route for a short-term fudge to extend the negotiating timetable, that is, patch together a few weeks of financing without the IMF involved which would hopefully roll into a longer-term deal with IMF support. Three countries, Germany, Finland, and the Netherlands, have had their parliaments stipulate IMF participation as a condition for new lending.

One of the peculiar elements of the negotiation is the way the players have lined up. The Greek government is bizarrely insisting that it can meet the punitive fiscal surplus targets of 3.5% of GDP for 2018 and later years. The IMF, based on its recent work, projects that Greece will have a primary deficit, not a surplus for 2016 and regards a fiscal surplus of 3.5% as unattainable in general for anything more than a short period of time, and not a realistic target for Greece. The IMF wants a less deranged (but let us operate under no illusions, still harsh) primary surplus target of 1.5%. And if you go with the IMF’s projections of what Greece could conceivably do in the way of primary surpluses, it’s clear that there is no way the outstanding debt can be paid in full. And there’s no way to reduce its value in economic terms enough with more extend and pretend, like pushing out maturities and lowering interest rates. The IMF is insisting on reductions in the principal amount.

So why did Greece savage recent IMF moves to shake some sense into the other creditors, like leaking a memo that made clear that the IMF thought the 3.5% target was nuts and given the Brexit vote break, they didn’t see how there was enough time to resolve differences, meaning make the other creditors realize the IMF was serious about the Greek debt levels being unworkable?

Just as Germany is laboring under the delusion that it can wring more blood out of Greece, Greece seems to believe that if it carries on enough, it can get the IMF out of the picture. It would much prefer to have the European Commission in charge of the next bailout, since it believe the EC would cut it plenty of slack and the EC would love to play a bigger role. But the Germans want someone tough and independent in charge. It isn’t simply that the IMF is the better gaoler than the EC by virtue of expertise, experience, and temperament. It’s also that they need the optics of an outside, technocratic-looking organization behind which to hide. But now Germany is finding itself hoist on needing the IMF. The Greek bailouts have done nothing but damage the IMF’s image, and have also upset the developing countries that constitute half the organization’s board, who correctly contend that the IMf is devoting far too much in the way of funding and staff to Greece. The mission of the IMF is to aid developing countries that are having currency crises (which usually turn rapidly into debt crises).

But while the IMF seemed to have the whip hand, the odds that the creditor countries will give Greece debt haircuts are close to nil. Even though the IMF has been willing to threaten walking from the bailout unless its conditions were met (and its conditions are based on its analysis, which is still place misguided faith in austerity), it would be political suicide for any political leader in one of the hawkish countries (Germany, Finland, Latvia, the Netherlands, and Spain. for starters) to back debt reduction for Greece. Under the peculiar Eurozone budgetary rules, they’d need to recognize losses now (although there might be a fix via one of the Euro-alphabet-soup facilities to defer or spread out loss recognition). Given how the Germans, Finns, and Latvians in particular have demonized the Greeks, it would take a major propaganda campaign to turn opinion around. There isn’t remotely enough time for that.

But even with the IMF having backed off from requiring debt reductions, it isn’t clear that the remaining large differences will be resolved. The impasse over the IMF’s 1.5% versus the German and other ultras’ 3.5% primary surplus target is a gaping chasm.

That background will hopefully make it easier to read between the lines of the update at the Financial Times:

The political space for a deal was opened on Monday by the readiness of Wolfgang Schäuble, Germany’s finance minister, to explore ways to ease Greek debt repayments. He had, until then, strongly resisted such talks as unnecessary, putting IMF participation in the programme in doubt.

Ministers said they would seek an agreement at a meeting on May 24. The package would require Greece to prepare “contingent” budget cutting measures to be enacted if its public finances failed to sufficiently improve, as well as parallel commitments from eurozone nations to deliver on promises of debt relief, covering the short, medium and long term.

The talks framed the discussion around options, such as interest payment holidays or extensions of debt maturities, while deferring the hard political battle over what is actually needed.

Yves here. You can see this is not about the hard issue of resolving the difference over the targets and then seeing what that means about making the expected payments from Greece match the debt paydown fantasy. This is discussing the acceptability of various fudging, um, bridging devices and how far each might be pushed.

And if you’ve been following the details of the arm-wrestling, the “contingent payments” are a bright idea by the creditors to punish Greece further if it does not meet its targets. This would be one way to punt on differences between what Greece says it can do versus creditor skepticism: “OK, we can try it your way, but when that fails, these other cuts kick in automatically”.

On the one hand, this approach can be defended as a classic negotiating approach, “Let’s work on the easy stuff first so as to create a climate of cooperation before dealing with the nasties.” But on the other, this can be viewed as a device by Schauble to not concede ground yet or at all on the primary surplus targets (the contingency measures could bridge that gap) on the hope that the IMF either does not really dare to abandon the third bailout or that Lagarde can be muscled into place through the IMF board. But while that would ordinarily be a decent assumption, Lagarde faces an organization in revolt. Unusually, there are good odds that the staff would sabotage any capitulation, either via leaks or by resignations. So she might not make additional concessions.

The IMF has made clear that these proposals don’t go far enough:

This may not go far enough to satisfy the IMF, whose managing director, Christine Lagarde, reiterated in a letter to EU ministers last week that Greece’s budgetary targets were unrealistic and that any effort to meet them should be based around deep economic reform rather than arbitrary, and potentially damaging, cuts.

[Greek Finance Minister] Mr [Euclid] Tsakalotos told the Financial Times that the IMF was still “sceptical” about Greece’s approach but that the organisation was also “engaged to make it better”.

He added that, according to budgetary projections backed by the EU, “this mechanism may well not be necessary at all” for Greece to reach its targets.

Yves again. You see Greece and the EU united in the perverse desire to preserve the 3.5% primary surplus target fiction: the EU, to pretend that the deal is on track until it isn’t; the Greeks, presumably out of the recognition that they are trapped, and the misguided belief that if they get the money they need, they can fuss about shortfalls later, since in the end Europe has always coughed up more. The problem is that as the long-suffering Greek population knows, each bailout comes with more blood-letting and amputations. How much more can Greece take before it becomes a failed state?

Put more simply: last year, it was Greece and its creditors playing a game of chicken over the Greek bailout. This year, it was Lagarde (or more accurately, the head of the European program team, Poul Thomsen) and Schauble playing chicken. While the press is playing up the German concession, it was widely anticipated last year (and signaled in the German press) that the creditors would be willing to give maturity extensions and more interest rate reductions as “debt relief”. We’ll know more as reports and leaks progress whether the IMF willingness to consider debt “relief” as opposed to reduction was a device to look cooperative and keep talks moving, or as a careful reading of Financial Times account indicates, a real concession. It is possible that the IMF and the other principals thought it was important to show progress, particularly with Brexit vote looming, and that the IMF may return to insisting on debt haircuts if the other creditors refuse to budge on the lunatic 3.5% primary surplus targets. But at this juncture, in this year’s game of chicken, it looks like it was the IMF, not Germany, that blinked.