Too Little, but Perhaps Not Too Late

Author: Uri Dadush
Originally published by European Voice

“A week is a long time in politics”, a British prime minister once said. Indeed, just weeks ago, a bail-out of Greece was said to be illegal under EU treaties, and the involvement of the International Monetary Fund (IMF) was deemed “unthinkable”. But last Thursday night in Brussels, eurozone leaders agreed not only to take precisely those steps, but also on a formula for burden-sharing based on each country’s share in the European Central Bank (ECB), implying that Germany—the bail-out’s most outspoken critic—would carry the largest burden.

A thin veil was deployed to provide legal cover, stating that loans to Greece would not come at subsidised interest rates. But why, then, are EU and IMF loans needed?

The markets’ refusal to accept anything less than a 300 basis point spread on Greek debt, despite assurances that help was forthcoming, forced this remarkable 180 degree turn. At these spreads, with debt at well over 100 percent of gross domestic product (GDP) and with GDP in an austerity-driven freefall, Greece is headed directly to the bankruptcy courts—and, in the process, the problems of Portugal, Spain, Italy and others facing a similar plight, including counties outside the eurozone, will intensify.

The euro has enjoyed a rally. But it remains to be seen whether the agreement goes far enough to bring Greek spreads down to a manageable level in the coming weeks. I fear that it will not, for four reasons.

First, it failed to specify the size of the loan pool, and the rumoured figure of €20-25 billion would not go nearly far enough. It would barely cover Greece’s funding needs over the next few months, and represents some 11-13 percent of Greece’s GDP. By way of comparison, loans from the EU and the IMF to Latvia represent 46 percent of its GDP—and Latvia has brought wages down around 17 percent as part of its loan programme, while in Greece riot police are busy quelling protests over cuts that are a small fraction of that. The smaller the support package, the tougher the austerity measures Greece must take.

Second, the conditions for disbursing the loans—‘ultima ratio’ or as a last resort—are nebulous and will require a unanimous decision by the 16 members of the eurozone. This holds the bail-out hostage to as many separate legal processes, beginning with Germany’s and its constitutional court, and involving assorted parliaments.

Third, the agreement does not specify who is in charge of leading the bail-out. It states only that the ECB and the European Commission will decide on the conditions and loans subject to agreement by leaders, and that the IMF will be involved. Will the IMF, the only institution that has the instruments, expertise and track record to evaluate whether and how much Greece can pay and what steps Greece can realistically take to fix its problems, be free to operate? Most importantly, will the IMF be allowed to conduct an objective analysis of whether Greece needs to restructure or reschedule its debt?

Fourth, the agreement lacked any mention of EU-wide changes in macroeconomic policy that are needed to deal with the problems of the vulnerable countries.

In a standard IMF rescue, countries have the capacity to make changes in fiscal, structural, monetary and exchange-rate policies. Because individual members of the eurozone have no control over the latter two, they will be forced into even greater austerity and more rapid structural adjustment. But the eurozone as a whole can—and should—deploy a more expansive monetary policy over the many years that such policy will be needed, and countries with a surplus can help stimulate demand across the zone as a whole.

A credible recovery plan must include these measures, and it implies a lower euro, but enacting them would require a different mindset at the ECB and a degree of collaboration across states that we have yet to see. And, in any event, the IMF’s capacity to influence its largest shareholders is limited, at best.

Until these questions are answered, markets will withhold judgment on the credibility of the whole rescue package, and continue to demand higher yields.

The Brussels meeting did have one positive outcome: the temporary shelving of expensive distractions, namely the proposals to form a European Monetary Fund and other arrangements to build European safety nets. These ten-year projects, which require treaty changes, will be delegated to a task force.

The Brussels agreement is clearly a case of ‘too little’, but perhaps not one of ‘too late’. There is still a little time for politicians to act.