The IMF recently released an internal self-critical report on how it constructed the adjustment program for Greece, thus sparking a debate on why the original, 110 billion euro, May 2010, adjustment program with the IMF, the European Commission, and the ECB — the “troika” — went off-track.
The Fund now says that it should have restructured Greece’s debt from the start, but that the ECB was opposed to that idea. As a result, the restructuring was delayed until March 2012. The IMF also says that its assumptions about the depth of the contraction were overly optimistic. Between 2008 and the end of last year, real GDP contracted by about 20 per cent; it will likely contract somewhat further this year.
My own assessment is as follows:
1. The May 2010 adjustment program had 4 main pillars — fiscal consolidation, structural reforms, privatization, and improved tax collection.
2. Only the first pillar was implemented, and that was implemented the wrong way — it placed extensive emphasis on tax increases and not enough emphasis on expenditure cuts. For the first 2 years of the program, essentially nothing was done to fulfill Greece’s agreements with the troika on privatization, tax collection, and structural reforms, except for an overhaul of the pension system.
3. For the first 6 months or so after the May 2010 agreement, fiscal consolidation, based on revenue hikes, took place. At the same time, the Greek Parliament passed a number of measures relating to structural reforms. The financial markets liked what they saw. As a result, 10-year sovereign spreads relative to Germany dropped from 1,000 basis points in May 2010 to 500 basis points in October.
4. But the markets noticed that while Greece was good at passing reform legislation, it was very poor at implementing. Spreads began to rise. Greek banks, which held large amounts of Greek sovereigns, suffered huge losses. What started out as a sovereign crisis, spread to the banking system, creating a second crisis area — the banking system.
5. The depth of the contraction was exacerbated, because the troika underestimated the size of the fiscal multiplier. The troika has recently admitted that it had underestimated the size of the fiscal multiplier in Greece. In January 2012, the Bank of Greece Governor published an article in The Financial Times, in which he stated that the fiscal multiplier had been underestimated.
6. All of this was compounded by politicians who failed to tell people why Greece found itself in a crisis to begin with, and what would be needed to get out of the crisis. Instead, politicians fought amongst themselves. They gave the impression that painful measures were being imposed on Greece by unsympathetic foreigners.
6. To date, there has been very little done in Greece in terms of structural reforms, improving tax collection, and privatization. Recent fiscal consolidation, however, places emphasis on expenditure cuts.
7. The bottom line: the adjustment program went off track because Greece failed to implement. What Greece needs to do is implement its commitments. It appears that the present 3-party coalition is determined to implement its agreements. Consumer confidence in Greece is at a 5-year high.
