How a kinder, gentler IMF austerity stance came too late to save Greece

A woman celebrates at Syntagma Square in Athens on July 5, 2015 after the first exit-polls of a referendum on austerity measures.
A woman celebrates at Syntagma Square in Athens on July 5, 2015 after the first exit-polls of a referendum on austerity measures. PHOTO: AFP

WASHINGTON (BLOOMBERG) - A growing recognition by IMF economists since the global financial crisis of the dangers of imposing too much austerity on cash-starved countries may have come too late to help the fund's biggest client: Greece.

From 2008 to 2013, the International Monetary Fund became more accepting of fiscal measures to aid expansion around the world and began to recommend nations with limited room for stimulus make a more-gradual return to budget surpluses, according to a 2014 analysis of IMF research by Cornel Ban, an international-relations professor at Boston University.

Even though the IMF had been pushing for debt relief for several years, as the junior partner to European creditors its message largely failed to break through until Thursday, when the fund published an analysis detailing how much longer the nation would need for repayment. The IMF also suggested the Europeans would have to accept a principal writedown if Greek reforms were watered down any further.

The decision to release the analysis may have played into the hands of Greek Prime Minister Alexis Tsipras. Greeks agreed with him and voted resoundingly in a referendum Sunday to reject proposals from the IMF and European creditors to unlock more bailout funds.

"What the IMF is saying is the Europeans have to provide Greece with debt relief, and that debt relief will mean there's less of a fiscal adjustment," said Desmond Lachman, a former IMF official and now a resident fellow at the American Enterprise Institute in Washington. "They're softening their position, but it's a little late in the day."

The referendum came five days after Greece failed to make a debt payment of 1.5 billion euros (S$2.24 billion) to the IMF, the largest missed payment in the fund's seven-decade history, freezing the lender's biggest bailout program.

The fund decided to release the debt analysis last week in an effort to be transparent about Greece's financial situation, an IMF official told reporters on a conference call Thursday, when asked if the institution was concerned the analysis might influence the referendum's outcome. The official gave the briefing on condition of anonymity.

As a member of the so-called troika of creditors that included the European Commission and European Central Bank, the fund's hands were tied from the start, even as it tried to be more flexible.

Worried that a Greek default might trigger a European banking crisis, the fund's board agreed in 2010 to waive a cornerstone of IMF bailouts which required that Greece's debt be sustainable.

An internal review in 2013 would conclude that the IMF should have pushed earlier for a restructuring of Greece's debt, which would have eased austerity and limited the economy's contraction. As it turned out, Greece plunged into a much deeper recession than anticipated, with unemployment surging to about 25 per cent in 2012.

The IMF now recognizes that an earlier restructuring of Greece's debt would have helped the country's recovery, said a person familiar with the fund's program in Greece. IMF officials also accept that their assumptions underestimated the extent to which spending cuts would impede growth, according to the person, who asked not to be identified.

Still, Greece had no choice but to narrow its budget deficit to restore confidence in the economy, the person said. The fund also faced a Greek government that repeatedly failed in delivering on reform promises, completing just one of 16 benchmarks in the last year and a half, according to the person.

By the time Christine Lagarde took over as IMF managing director in July 2011, the fund was recalibrating its broader position. In an opinion piece in the Financial Times that August, she warned that "slamming on the brakes too quickly" on fiscal stimulus around the world would threaten the global recovery.

In March 2012, the IMF approved a new US$36 billion loan program for Greece, around the same time private bondholders agreed to take a writedown on the value of Greek debt. Even so, the IMF said euro-member states would probably have to offer further debt relief.

The fund's World Economic Outlook that October said policy makers may have been underestimating the effect of fiscal measures on economic growth since the financial crisis. The implication for Greece: Public spending cuts may have caused more economic pain than first thought.

More recently, with Greece's government balking at terms for aid from the IMF and European creditors, much of the criticism leveled at the IMF on Greece is misguided, said Jacob Funk Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington. The other four European loan programs the IMF offered since the crisis - Ireland, Portugal, Cyprus and Iceland - turned out well, he said.

During the Asian financial crisis in the late 1990s, the IMF's prescriptions for tight monetary policy and restructuring in the banking sector fueled resentment in countries such as Thailand and Indonesia.

"The IMF has actually been better than it was back in those old days, but the IMF is in a more difficult position" because of its membership in the troika, said Joseph Stiglitz, the Nobel laureate and longtime critic of the IMF, in a phone interview before the referendum.

"When you have a debt crisis, there needs to be a quick and deep restructuring, and if you don't do that the overhang lingers and the economic recession or depression continues," Stiglitz said.