Germany, the IMF, and Aid for Greece

The latest agreement is only an interim solution—another debt haircut appears unavoidable

29/11/2012 five questions to Claudia Schmucker

Five Questions, November 29, 2012

Category: Economy and Finance, IMF, Europe, Germany, Greece

Even public creditors will have to waive part of their outstanding payments. Otherwise, the target that eurozone finance ministers and the IMF have now agreed to—a lowering of Greece’s public debt to 124 percent of GDP by 2020—will not be attainable, says DGAP economic expert Claudia Schmucker. But the German federal government will avoid an unpopular debt write-off before the 2013 federal elections.

How far off are the IMF and Germany from each other regarding debt relief for Greece?

From the beginning, the IMF set a goal to lower Greece’s debt level to 120 percent of GDP by 2020. It had to adhere to this figure during negotiations because its credibility would have suffered otherwise. The majority of IMF executive directors actually criticized the organization’s strong engagement in Europe, above all in Greece.

In order to reach the 120 percent target, a debt haircut for public donors would have already been needed, a move that was opposed by a number of countries, particularly Germany. In the run-up to the 2013 federal elections, the German government does not want Greece to renounce its credit claims.

Donors ultimately agreed to a debt level of 124 percent of GDP by 2020. In order to accommodate the IMF, it was also agreed that Greece’s public debt would have to sink to under 110 percent by 2022.

How long will the current agreement hold?

This week’s agreement is only a temporary solution. Political actors hope that it will send a signal to markets and thus strengthen trust in Europe and Greece.

Even though Greece has made a lot of progress on the macroeconomic level, it will need even more support in the future. Another debt haircut will certainly be a part of this.

Why did the IMF ultimately give in?

Developing nations within the IMF had significant reservations about financial aid for Europe. They have criticized double standards in lending. That is why IMF Managing Director Christine Lagarde has long held to the original goal of reducing Greek debt levels to 120 of GDP by 2020 despite the fact that German, Finnish, and Dutch opposition has made clear that Greece will not be able to achieve this target.

But if an agreement on further aid had not been reached, this would have seriously upset trust in financial markets. This is why the IMF agreed to the compromise. But in return, it managed to preserve the 2022 target of lowering Greek public debt below 110 percent of GDP. Christine Lagarde can sell this as a success to the IMF’s executive directors. Such a compromise between member states and the IMF was foreseeable.

What kind of financial relief will Athens actually receive?

The bailout package for Greece contains a reduction of interest rates, loan extensions, as well as a buyback of debt. The reduction of interest rates and the loan extensions provide financial relief for Greece, but the majority of debt relief will come from the debt buyback program.

But there is a large amount of uncertainty here that could endanger the program’s success. Eurozone finance ministers decided that the price for Greek government bonds cannot exceed the price at the close of the market on Friday. It is thus uncertain that enough private investors will take part.

Has Germany already lost money in the bailout for Greece?

Germany has so far profited from the programs for Greece. It has first profited from the interest paid by Greece on its bonds. The European Central Bank (ECB) holds a large number of Greek government bonds and receives profit from the interest that is paid back. These profits have been distributed from the ECB to eurozone central banks, including Germany. For the current deal, it was agreed that the ECB’s profits will be reimbursed to Greece. Germany also profits from historically low interest rates—some of which are even negative—for the issuing of state bonds, as the country has been seen as a safe harbor throughout the euro debt crisis.

But a number of difficulties remain. The biggest problem is how to proceed with Spain and Italy, the third- and fourth-largest economies in Europe. Spain will need to refinance over 200 billion euros for 2013 and 2014. It can be seen as positive that Greece’s acute borrowing needs have been taken care of for a while, even though a sustainable solution does not yet exist. A small improvement in the world economy—which is expected next year—could make upcoming reforms and adjustment steps easier for periphery states.

Claudia Schmucker recently commented on this situation for the New York Times.