Greece and the Euro Zone: The IMF Perspective

Speaker: Poul Thomsen (Director, European Department, IMF)
Chair: Adam Bennett (St Antony’s College)

In the midst of ongoing negotiations with Greece over a third IMF financial assistance program, PEFM had the pleasure of hosting Poul Thomsen, the Director of the European Department at the IMF. Drawing on his extensive experience as mission head for IMF teams in Greece, Mr. Thomsen presented the Fund’s perspective on the problems that continue to plague the Greek economy and the way forward.

Mr. Thomsen began by offering some comments on the prospects of the euro area as a while. Overall, the recovery is gaining momentum and cyclical unemployment is low. This is partly due to fiscal relaxation, but most of it is happening in precisely the countries with the least fiscal space, leaving them potentially vulnerable to renewed shocks. More worrying still, the euro area long-term potential is limited because of structural problems that predate the euro crisis, particularly low productivity growth that was contributing to stalled convergence. Therefore, while there are missing elements of EMU architecture that clearly needed to be added or completed, the main problems were really at the national level. In a currency union that is not a political union the ability to deal with shocks depends on policies at the national level.
Turning to Greece, Mr. Thomsen began by focusing the issue of program ownership. In a stark reminder of the political challenges, Greece has gone through ten finance ministers and the second IMF program was off-track almost 80% of the time. Despite a good start to the reforms, progress gradually eroded as there was no broad coalition in support of the necessary measures (as there was in Ireland or Portugal). In turn, this led to confidence shocks, leading to spiking government bond yields, deposit outflows, and collapse of investment that repeatedly battered output. Therefore, Mr. Thomsen argues, these confidence shocks were more important than the underestimation of fiscal multipliers in the original program design by the IMF.

Moving to the reasons for the output collapse, Mr. Thomsen argues that a focus on fiscal adjustment was inevitable in Greece. Unlike other countries, the windfall from euro adoption was used entirely for fiscal relaxation, resulting in consistent breaches of the Maastricht criteria. Thus, Greece hiked wages and pensions, while productivity only saw limited increases. The proposed fiscal adjustment in 2010 was ambitious but not unprecedented, according to Mr. Thomsen. To support it, the IMF and the EU jointly provided extremely high levels of financial assistance, which would have been substantial even if the banks had been bailed-in earlier than 2012.

This led Mr. Thomsen to focus on the current issues under discussion, starting with the quality of the fiscal adjustment. He readily acknowledged the extremely impressive fiscal adjustment in Greece, but pointed out that this has come at the expense of discretionary and capital spending that is crucial for growth. Moreover, the gap was narrowed through hiking taxes on a narrow tax base that exempts most of the middle class. This strategy was clearly not working as tax collection plummeted to less than 50% of tax due today. In addition, a relatively generous pension system with limited contributions had become an unsustainable drag on public finances as Greece needs to transfer every year 11% of GDP to cover funding gaps, compared to an EU average of 2.5%. Therefore, the IMF was seeking commitments to reform tax and pension systems through more targeted social spending that in turn would allow for the return of capital spending and a more growth-friendly stance.

Another big question remains how to deal with the sovereign debt. Mr. Thomsen explained that in 2010 strong resistance by Greek authorities and concerns about spillover effects prevented bail-in, which in turn dictated the need for large financing sufficient to take Greece out of the market for a number of years. As output continued to collapse, political instability rose, and the EU built up its firewalls, a large scale private debt restructuring was completed in 2012. It was followed by an extension of the maturity structure that halved the debt servicing costs for Greece. That stabilized the situation, but program implementation stalled again in early 2014, since when the IMF had not (to date) disbursed funds to Greece. The IMF view was that Greece’s debt is not sustainable and that whatever Greece might do in terms of reforms, it was not going to be enough to rectify this position without debt relief from the EU.

Before concluding, Mr. Thomsen returned to the necessary structural reforms in Greece. To try to regain competitiveness without devaluation, the country has implemented significant labour market reforms, particularly under the Damocles sword of Grexit for the technocratic government in 2011. However, the economy remained very closed with restrictions on professions and markets due to fierce resistance by vested interests. As labour markets were reformed without changes in product and service markets, the burden of adjustment fell too much on real wages. Therefore, Greece needs to open up its economy rather then reverse labour market reforms.

In closing, Mr. Thomsen noted that differences in ongoing talks with the Greek authorities had been narrowing notably as discussions over tax and pension reform for growth friendly policies advanced. Once there was an agreement, however, he expected the IMF to reopen debt relief discussions with the Europeans. The 7-year old saga, and the unprecedented suffering it has brought to the Greeks, was nevertheless far from over.

Ivaylo Iaydjiev (St Antony’s College)