Germany Blinks on Giving Debt Relief to Greece….or Did It?

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Germany and Greece’s other creditors, facing the threat of the IMF sitting out the so-called “third bailout” of Greece, which needs to be in place by early July to stave off default, made what is being touted by Greece and some media outlets as a big concession, as in being willing to entertain debt reduction. In fact, reading between the lines, it is the IMF, and not Germany and the creditors, that have given ground. The IMF was insisting on actual debt reduction for Greece, as in principal haircuts. The Financial Times reports that the IMF has offered what amounts to an extend and pretend program:

On debt relief, ministers examined some basic options outlined by the IMF and the European Stability Mechanism, the eurozone’s bailout fund.

Governments have firmly and repeatedly rejected any formal writedown of their holdings of Greek debt, leaving them to look at other options, such as longer grace periods and extended payment timescales.

An ESM paper, seen by the FT, outlines a range of options including 5-year maturity extensions, capping annual loan repayments at 1 per cent of gross domestic product until 2050 and capping interest rates at 2 per cent. One more radical move mentioned is to buy out the IMF with cheaper and more long-term ESM loans.

This is a change in the IMF position that had gone curiously uncommented on by the press. Even before updating its forecasts for Greece to show it will not earn a primary sur this year, the IMF had taken the position that Greece needed debt reduction, not mere debt “relief”. And indeed, in an environment of zero going to negative interest rates in Europe, extending maturities, which already extend to 30 years with interest rate deferrals in the early years, is not going to provide much help in net present value terms.

In fact, while the willingness to talk about debt relief for Greece is shift in Germany’s position, it isn’t that much of one. The IMF had made it clear that it regards the concessions that Germany is willing to make as inadequate. And the two sides (the IMF versus the other creditors) are far apart, and the Greeks are still not on board with what cuts are to be made either. Moreover, the principals won’t get together to try hash things out until May 24, and then things are on hold till after the Brexit vote of June 23.

That means if they don’t resolve their large differences, they have only a very short runway before a Greek default.

And there does not appear to be a route for a short-term fudge to extend the negotiating timetable, that is, patch together a few weeks of financing without the IMF involved which would hopefully roll into a longer-term deal with IMF support. Three countries, Germany, Finland, and the Netherlands, have had their parliaments stipulate IMF participation as a condition for new lending.

One of the peculiar elements of the negotiation is the way the players have lined up. The Greek government is bizarrely insisting that it can meet the punitive fiscal sur targets of 3.5% of GDP for 2018 and later years. The IMF, based on its recent work, projects that Greece will have a primary deficit, not a sur for 2016 and regards a fiscal sur of 3.5% as unattainable in general for anything more than a short period of time, and not a realistic target for Greece. The IMF wants a less deranged (but let us operate under no illusions, still harsh) primary sur target of 1.5%. And if you go with the IMF’s projections of what Greece could conceivably do in the way of primary sures, it’s clear that there is no way the outstanding debt can be paid in full. And there’s no way to reduce its value in economic terms enough with more extend and pretend, like pushing out maturities and lowering interest rates. The IMF is insisting on reductions in the principal amount.

So why did Greece savage recent IMF moves to shake some sense into the other creditors, like leaking a memo that made clear that the IMF thought the 3.5% target was nuts and given the Brexit vote break, they didn’t see how there was enough time to resolve differences, meaning make the other creditors realize the IMF was serious about the Greek debt levels being unworkable?

Just as Germany is laboring under the delusion that it can wring more blood out of Greece, Greece seems to believe that if it carries on enough, it can get the IMF out of the picture. It would much prefer to have the European Commission in charge of the next bailout, since it believe the EC would cut it plenty of slack and the EC would love to play a bigger role. But the Germans want someone tough and independent in charge. It isn’t simply that the IMF is the better gaoler than the EC by virtue of expertise, experience, and temperament. It’s also that they need the optics of an outside, technocratic-looking organization behind which to hide. But now Germany is finding itself hoist on needing the IMF. The Greek bailouts have done nothing but damage the IMF’s image, and have also upset the developing countries that constitute half the organization’s board, who correctly contend that the IMf is devoting far too much in the way of funding and staff to Greece. The mission of the IMF is to aid developing countries that are having currency crises (which usually turn rapidly into debt crises).

But while the IMF seemed to have the whip hand, the odds that the creditor countries will give Greece debt haircuts are close to nil. Even though the IMF has been willing to threaten walking from the bailout unless its conditions were met (and its conditions are based on its analysis, which is still place misguided faith in austerity), it would be political suicide for any political leader in one of the hawkish countries (Germany, Finland, Latvia, the Netherlands, and Spain. for starters) to back debt reduction for Greece. Under the peculiar Eurozone budgetary rules, they’d need to recognize losses now (although there might be a fix via one of the Euro-alphabet-soup facilities to defer or spread out loss recognition). Given how the Germans, Finns, and Latvians in particular have demonized the Greeks, it would take a major propaganda campaign to turn opinion around. There isn’t remotely enough time for that.

But even with the IMF having backed off from requiring debt reductions, it isn’t clear that the remaining large differences will be resolved. The impasse over the IMF’s 1.5% versus the German and other ultras’ 3.5% primary sur target is a gaping chasm.

That background will hopefully make it easier to read between the lines of :

The political space for a deal was opened on Monday by the readiness of Wolfgang Schäuble, Germany’s finance minister, to explore ways to ease Greek debt repayments. He had, until then, strongly resisted such talks as unnecessary, putting IMF participation in the programme in doubt.

Ministers said they would seek an agreement at a meeting on May 24. The package would require Greece to prepare “contingent” budget cutting measures to be enacted if its public finances failed to sufficiently improve, as well as parallel commitments from eurozone nations to deliver on promises of debt relief, covering the short, medium and long term.

The talks framed the discussion around options, such as interest payment holidays or extensions of debt maturities, while deferring the hard political battle over what is actually needed.

Yves here. You can see this is not about the hard issue of resolving the difference over the targets and then seeing what that means about making the expected payments from Greece match the debt paydown fantasy. This is discussing the acceptability of various fudging, um, bridging devices and how far each might be pushed.

And if you’ve been following the details of the arm-wrestling, the “contingent payments” are a bright idea by the creditors to punish Greece further if it does not meet its targets. This would be one way to punt on differences between what Greece says it can do versus creditor skepticism: “OK, we can try it your way, but when that fails, these other cuts kick in automatically”.

On the one hand, this approach can be defended as a classic negotiating approach, “Let’s work on the easy stuff first so as to create a climate of cooperation before dealing with the nasties.” But on the other, this can be viewed as a device by Schauble to not concede ground yet or at all on the primary sur targets (the contingency measures could bridge that gap) on the hope that the IMF either does not really dare to abandon the third bailout or that Lagarde can be muscled into place through the IMF board. But while that would ordinarily be a decent assumption, Lagarde faces an organization in revolt. Unusually, there are good odds that the staff would sabotage any capitulation, either via leaks or by resignations. So she might not make additional concessions.

The IMF has made clear that these proposals don’t go far enough:

This may not go far enough to satisfy the IMF, whose managing director, Christine Lagarde, reiterated in a letter to EU ministers last week that Greece’s budgetary targets were unrealistic and that any effort to meet them should be based around deep economic reform rather than arbitrary, and potentially damaging, cuts.

[Greek Finance Minister] Mr [Euclid] Tsakalotos told the Financial Times that the IMF was still “sceptical” about Greece’s approach but that the organisation was also “engaged to make it better”.

He added that, according to budgetary projections backed by the EU, “this mechanism may well not be necessary at all” for Greece to reach its targets.

Yves again. You see Greece and the EU united in the perverse desire to preserve the 3.5% primary sur target fiction: the EU, to pretend that the deal is on track until it isn’t; the Greeks, presumably out of the recognition that they are trapped, and the misguided belief that if they get the money they need, they can fuss about shortfalls later, since in the end Europe has always coughed up more. The problem is that as the long-suffering Greek population knows, each bailout comes with more blood-letting and amputations. How much more can Greece take before it becomes a failed state?

Put more simply: last year, it was Greece and its creditors playing a game of chicken over the Greek bailout. This year, it was Lagarde (or more accurately, the head of the European program team, Poul Thomsen) and Schauble playing chicken. While the press is playing up the German concession, it was widely anticipated last year (and signaled in the German press) that the creditors would be willing to give maturity extensions and more interest rate reductions as “debt relief”. We’ll know more as reports and leaks progress whether the IMF willingness to consider debt “relief” as opposed to reduction was a device to look cooperative and keep talks moving, or as a careful reading of Financial Times account indicates, a real concession. It is possible that the IMF and the other principals thought it was important to show progress, particularly with Brexit vote looming, and that the IMF may return to insisting on debt haircuts if the other creditors refuse to budge on the lunatic 3.5% primary sur targets. But at this juncture, in this year’s game of chicken, it looks like it was the IMF, not Germany, that blinked.

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    1. Yves Smith Post author

      Aiie, my name dyslexia again, I do this all the time and it drives me crazy. The FT report referred to Dutch….and God only know how my fingers turned that into Denmark. Fixed.

  1. RabidGandhi

    Yves, the ostensible hammer here is that if a deal is not made, Greece will enter into default (again). But my question is: how much of a real problem is that for the creditors/Troika? I have always thought that the threat of default was more of a way to keep debtors in line than a problem for creditors. If Greece defaults again, yes there is a delay in payments, yields on Greek bonds go up, the media get to continue their mischaracterisation of the Greeks as deadbeats, Schauble’s narrative is reinforced… Is the threat of default really that much of an impetus for the IMF and Germans to cede their positions?

    1. NotTimothyGeithner

      The political fallout is on their minds too. I’m not certain a Greek default or Grexit would help Merkel’s political standing and by extension the Troika. Europe would become paralyzed. “Money for Erdman but not for Greece” will be everywhere.

    2. James Levy

      I thought a default meant, “You’re not getting your money.”

      To me, this should be the old saw about how if you owe the bank 15,000 you’re in trouble but if you owe the bank 150,000,000 the bank is in trouble. For reasons I’m sure Yves has laid out (but it all gets too Byzantine for me, honestly) this isn’t so, but exactly why seems to be theoretical and psychological more than material.

      Oh, Dog that didn’t bark in the night question: with millions of Greek-Americans in this country, why do we never hear from them? If Ireland or Israel was in danger of having people die in the streets for lack of medicine because they couldn’t pay for imports, we’d hear from those communities. Any thoughts?

      1. Alejandro

        The presupposition in your “dog that didn’t bark in the night question” is that this is about ethnicity. While there may be something to this neatly taxonomized (monolithic communities) narrative, if the ears are unplugged, “we” may hear the dog barking-“its class war”. It’s about the lop-sided power of creditors to “create new realities” and shape society to their benefit and OUR detriment. As reminded recently, “the vile maxim of the masters of mankind”, and these “masters”, have “discovered” finance. In this sense, don’t have to “be” “Greek-American”, to feel Greek and “bark” on OUR behalf.

        Should the power of creditors extend to creating a failed state?

        I ‘believe’ it was Santayana that said-“The empiricist … thinks he believes only what he sees, but he is much better at believing than at seeing”…and I would add-“much better at believing than at listening”.

      2. Me

        Actually Greece isn’t owing that much. Several politicians, that are certainly not Tsipras friends, suggested already, that one should simply accept, that Greece will never pay anything back and be done with it. Greek representatives totally were agains this, probably fearing other forms of backlash, e.g. regarding support by the EU. Greece gets about 2.7% of GDP in net payments from the EU (Money spend by the EU in Greece minus what Greece pays the EU). This is roughly the same amount Greece pays in interest for its debt to various European institutions. Not getting net payments from the EU and having debt at zero no credibility at the money markets at all probably is a net negative for Greece. Otherwise I would guess they had long declared bancruptcy.

        1. Yves Smith Post author

          Huh? The FT has reported Greece as owing €3.5 billion in July. I see higher payment per this Wall Street Journal chart from last year, so I wonder if some of the Treasury bill maturities have changed due to some refinancings. The chart shows the Greek payments in July are mainly to Treasury bill holders, as in rolling over maturing debt, of €3.0 billion total. It also has $400 million to pay to the IMF and $800 million to the ECB. I need to get more current information. I do recall reading about an early July deadline, so the date for the first Treasury bill refinancing, July 8, looks to be the binding constraint.

          If it can’t pay maturing debt, it will have to pay very high interest rates to sell any new debt to keep running the government, as in paying pensions and payrolls. Not getting a bailout means in short course that the government defaults on its citizens too.

          An IMF arrearage is not fatal, but it gets the IMF very upset and embarrassed and gives the IMF a good excuse to abandon the program, which means Germany etc can’t fund Greece unless they go through tons of hoops to figure out who would run the program and then get parliamentary approval for that. That is months while Greece really falls apart (go read the coverage of what happened during the two week bank holiday last year. Food and pharmaceutical supplies were running thin and shortages were starting. Greece is not self-sufficient in food, petroleum or pharma. so if its payment system isn’t operating, it quickly becomes close to impossible to import). Similarly, not paying the ECB means the ECB would not extend any support to its banking system under the ELA. The ELA is only a two week program and has to be renewed by the voting members of the ECB board (who gets to vote rotates). The last time the ECB lowered the hammer, the Greek economy came close to a standstill (see parenthetical above) and a lot of small businesses failed. Greece is still making very heavy use of the ELA, although down from the peak in 2015:

          To put it another way, you can drown in six inches of water as well as six feet…you are dead either way.

    3. Chris Wagner

      I see it differently. The deadbeat “leaders” have been deceiving both, parliament and voters. Merkel assured them that every penny would be repaid bla bla. Moreover, she has hidden the awkward fact that Greece has grabbed more than 100 bn Euros through Target 2. No collateral, no green light needed. It’s strictly DIY cowboy self-help financing. Italy just grabbed 250 bn and you haven’t heard about it? Guess why!!

      The lying will have to come to an end. The ECB is sick in its double role as regulator of Greek banks.

      1. Yves Smith Post author

        Please check the Target 2 balances. They are now below 70 billion euros. And the ELA loans were and are collateralized. In fact, one of the issues last year was that regardless of how the bailout talks went, Greece was running out of runway with the ECB because its banks were going to run of eligible collateral.

        I agree that the longer the pretense goes on (in terms of needing to take writedowns) the worse the outcome will be. But don’t make stuff up.

  2. No one in particular

    Beg to differ slightly. The IMF might have conceded on debt “reduction”; however, my only source provides an additional angle – the W A Y in which the IMF will “participate” in the third bailout, which it currently does not. Apparently – see link below – the IMF will only take an “advisory” role, and not provide any new cash to the program.

    Which – in itself – will be an anathema for many German MP’s – because without new money, Schaeuble will have a heck of a time to get the necessary approval – and the German press is mute on the issue.

    However, there was a report in DWN today (link, German only) – about delays with the last pillar of the banking union, i.e. the mutual use of the national deposit schemes to bail out banks, possibly to the detriment of Northern Europeans to save, first and foremost, Italian banks.

    [pinch of salt material – not sure how reliable the source is]

    And one last point, not entirely unrelated – you may have heard of the government crisis in Austria, the chancellor resigned over the refugee crisis, and they possibly will have new elections, which will possibly a right-wing government…. which is sending shock waves through Berlin and Paris (were Hollande had to use the emergency rules to push through labor market reforms against the majority in parliament).

    To which extent this will influence the wiggle room for all concerned regarding the Greece tragedy….. we will see.

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