Peter Boone and Simon Johnson compare Greece situation with Argentina in 2001. They say Argentina had better economics in place but still suffered hugely. Reason – lack of proper credible reforms. Same is the case with Greece.
There are disconcerting parallels between Argentina’s catastrophic decade, 1991-2001, which ended in massive default, and Greece’s recent and impending difficulties. The main difference being that Greece is far more indebted, is much less competitive in global markets, and needs a commensurately greater fiscal and wage adjustment.
At the end of 2001, Argentina’s public debt GDP ratio was 62%, while at end 2009 Greece’s was 114%. Argentina’s public deficit reached 6.4% GDP in 2001, while Greece’s was 12.7% GDP (or 16% on a cash basis) in 2009. Both countries locked themselves into currency regimes which made it extremely painful to exit: Greece has the euro, while Argentina created a variant of a currency board system tied to the US dollar. And both countries had seen their competitiveness, as measured by the “real exchange rate” (which reflects differential inflation relative to competitors) worsen by 20% over the previous decade, helping price themselves out of export markets – and boosting their consumption of imports. In 2009 Greece had a current account deficit equal to 11.2% of GDP, while Argentina’s 2002 current account deficit was a much smaller 1.7% GDP.
The solution to such crises is rarely gradual. Once financial market confidence is lost, yields on government debt soar, private capital flees, and sharp recessions occur. The IMF ended up drawing tough conclusions from its Argentine experience – the Fund should have walked away from weak government policy programs earlier in the 1990s. Most importantly, IMF experts argued that from the start the IMF should have prepared a Plan B, which included restructuring of debts and termination of the currency board regime, since they needed a backstop in case the whole program failed. By providing more funds, the IMF just kicked the can a short distance down the road, and likely made Argentina’s final collapse even more traumatic than it would otherwise have been.
Sadly, the Greeks are today in a similar situation: the government’s macroeconomic program is not nearly enough to calm markets, or put Greece’s debt on a sustainable path. By 2012 we estimate Greece’s debt/GDP ratio will rise from 114% of GDP to over 150%. The interest payments alone on this would amount to 9% of Greek’s incomes at current rates, and almost all those funds are transferred to the German, French, and Swiss debt holders.
Greece’s 2010 “austerity” program is striking only for its lack of credibility. Under that program Greece, even in 2010, does not pay the interest on its debt – instead the government plans to raise 52bn euros in credit markets to refinance all its interest while at the same time it borrows 4% of GDP more. A country’s “primary budget” position measures the budget without interest expenses — at the very least, the Greeks need to move from a 4% of GDP primary budget deficit to a 9% of GDP primary surplus – totalling 13% of GDP further fiscal adjustment, in the midst of what will be a massive recession, just to have enough funds to pay annual interest on their 2012 debt. This is under the rather conservative assumption that interest rates would settle near 6% per year, where they stand today. The message from these calculations is simple: Greece needs to be far more bold if its austerity program is to have a serious chance of success.
Despite a strong speech from Greece PM showing willingness to reform, the authors are not impressed.
Then they ask:
If they are permitted to be candid, what choices would the IMF staff present to Greece?
They list 3 choices:
- Choice 1: True Fiscal Austerity – 10% of GDP, with further measures soon
- Choice 2: Sovereign default but keep the euro
- Choice 3: The IMF’s Plan B – Debt default and exit the eurozone
For Argentina, the third options worked. It was also into a kind of monetary union with a currency board. So after giving it up and defaulting on debt, Argentina started growing after 6 months of crisis management.
The next question is: Will IMF be strong enought to propose this plan?
The answer to all this seems very clear. The IMF will agree to another program that is very likely to fail, just like they did in Argentina. There are some obvious reasons why this is likely. One reason is that it is easy to hide behind a veil of probabilities. Of course there is some chance that Greece might make it out with little change, so why not wait and see if it works? The trouble is the odds, for Greece, are slim. It is impossible to say exactly what the odds are, but suffice it to say, Greece’s external debt and current fiscal difficulties, while tied into a fixed exchange rate regime, mean that nation needs far harsher adjustments than any of the sovereign major defaulters of the last 50 years. We cannot think of one comparable example of success. The social and political divisions in Greece, along with the penchant for debilitating strikes, also reduce the odds for success.
There are also powerful personal interests that will guide these decisions. Dominique Strauss-Kahn, current head of the IMF, is primarily focused on becoming the next President of France. It will not look good – to the French electorate – if the IMF is seen forcing a Greek default, nor if it demands that the Europeans provide over a hundred billion euros of long term financing. So, he surely wants to offer a lax short term program, which is backed up by promises for “greater austerity in the future if needed”. Greece will march on, mired in recession, with its debt stock growing as the IMF and EU fund them. The private sector, as in the case of Argentina, will simply not want to touch their debt. Dominique Strauss-Kahn can then declare his candidacy in early 2011, resign from the Fund, and let his successor force the true austerity – at which time Greece will suffer ever more under any solution.
It is also in the interests of most other members of the euro zone to just “kick the can down the road”. The other debt laden periphery nations are naturally terrified of a Greek collapse that will spill over to their nations. They will now lobby hard for the IMF to be generous, and they will be satisfied with partial steps. Perhaps this will give them time to prepare, but more likely, they will just kick the can down the road themselves – as the Portuguese seem to be doing with their lax fiscal budget announced for 2010. These nations surely underestimate how much worse this may get, and they continue to suckle on the cheap credit window which the ECB has, until now, kept open to them.
So what next for Greece:
It all seems horribly reminiscent to those early days when Argentina slid towards a cruel collapse.
Need to read up IMF report on Argentina.