The Greek Stabilization Program Does not Appear Credible
On May 2 the International Monetary Fund and European Union made an agreement with the Greek government on a stabilization program for Greece. This program is being presented as the solution to the Greek financial crisis, but it is difficult to see how that would be the case from the details that have been published.
The program represents two substantial steps forward. First, the funding is impressive, $145 billion, which might be a sufficient amount. The other progress is that it is the right form of an agreement: a standard three-year IMF standby loan and EU cofinancing rather than a new invention. The EU has abandoned its idea of reinventing the wheel in the midst of a crisis in the form of a new EU stabilization facility.
Even so, the program does not appear credible. First, the austerity measures announced are insufficient. A gradual decline of the budget deficit to 3 percent of GDP in 2014 will not do with 120 percent of GDP in public debt. Moreover, to judge from the details made public, this is approximately the old program, perhaps with some more front-loading of the measures.
Second, the balance of spending cuts and revenue measures seems inappropriate. The spending cuts are only 5.25 percent of GDP over all three years, while the revenue measures are 4 percent of GDP. The cuts are far too small to be taken seriously, while the revenue aspirations seem unrealistically high. Revenues tend to fall rather than rise in a severe crisis. Expenditure cuts of 6 to 10 percent of GDP during the first year would have been more appropriate, as is usually done in such a serious crisis. This looks like a very weak program.
Third, this program would leave Greece with a public debt of 140 to 150 percent of GDP in 2014, which will be far more than Greece can finance. Assuming an interest rate of 6 percent per annum, this would amount to 9 percent of GDP in debt service each year. No country can manage such a burden. Greece needs a debt restructuring. It would be reasonable to write off approximately half the public debt of $400 billion—that is, $200 billion. The Greek financial crisis is not likely to be resolved until that is done. The euro countries and the IMF are simply lending into arrears, which is no good policy.
The old IMF limit was not to lend more than three times a country's quota to any country. Recently, the IMF has sensibly lifted this ceiling and lent 10 to 12 times the quota, but its Greek program amounts to 32 times the Greek quota! What will non-European nations think of the European-dominated IMF making such an extraordinary concession to one European country with an uncommonly weak stabilization program?
The European Union and the IMF have taken two steps forward, but two more steps have to be taken before the Greek stabilization program becomes credible: sharper public expenditure cuts and a debt restructuring.