This (Greece) Is What the IMF Was Made For
Lorenzo Bini Smaghi:
Only a full IMF programme can save Greece from default: When discussing Greece, some policy officials and market participants have suggested that ‘the markets are now better prepared to deal with a default’. When was the other time such statements were being made? Probably in mid-September 2008, a few days before the collapse of Lehman Brothers.
If there is one thing to learn from the past five years, it’s that financial contagion operates in unexpected ways, especially after a major shock such as the failure of a major financial institution or the default of a country.
Even if markets have prepared for the possibility of a default by Greece, the practical consequences of such an event can be of a much higher order of magnitude.
First, Greece would most probably have to exit the euro, as it would have no other way of financing its current expenditures other than to print its own money. Capital controls, bank holidays and nationalisations would be required to try to counter a run on the banking system. Litigations between creditors and debtors would rise exponentially. The social and political stability of the country would be in grave danger.
Second, the political crisis would spread to European institutions because of their inability to solve the problem….Third, creditors would be further discouraged from investing in the eurozone, given its inability to manage its debt problems. Contagion could extend to the core of the euro system. Fourth, the financial tensions around the euro would produce a serious blow for the economic recovery not only of Europe but also the US and Japan, and possibly in emerging markets….
So what should be done to prevent such a scenario from occurring?
Greece does not suffer from a typical balance of payment problem that can be dealt with short to medium-term adjustment and financing. It has a major structural problem that can be resolved only through a combination of macroeconomic, structural and social measures. It also needs prolonged technical assistance….What is required is much more similar to the kind of programme that the International Monetary Fund applies to low-income countries, under the Poverty Reduction and Growth Facility (recently renamed Extended Credit Facility), with official financing provided for several years, at concessional terms to ensure debt sustainability. Strong conditionality has to be implemented, in line with the IMF practice for this type of programme, but not under the threat of continuous default that alienates the political support in Greece for the right policies and fuels instability in financial markets.
This avenue raises three fundamental issues. First, it is costly…. Second, other debtor countries may be tempted to seek the same concessional conditions as those granted to Greece. But European authorities have stated that Greece is unique. They should stick to that commitment….Third, at this stage of the negotiation, it might be too late to introduce such a game changer. But it’s never too late to try to avoid a disaster.
