IMF loan to Greece: an unwarranted favour

Few Indians are interested in Greece’s fiscal crisis, or the proposed IMF loan of 15-25 billion euros as part of a European rescue package. But Indians should worry. IMF resources raised for low and middle income countries are being diverted to bestow a special favour on a rich European country.

Greece’s problem is European, and should be tackled by its rich European brethren. It should not dip into limited IMF funds raised for poorer countries.

The global financial system was paralysed in September 2008. All trade credit to India vanished. So did foreign loans to Indian corporates. Foreign institutional investors, who earlier poured billions into India, pulled out $ 9 billion in 2008. The situation was worse in other developing countries. The IMF’s lending capacity of $ 250 billion proved pathetic when trillions in global finance vanished.

So, in 2009 the G-20 agreed to triple the lending resources of the IMF. Many developing countries contributed, including India, knowing they might need this in the next crisis. None dreamed that the expanded facility would be used to bail out rich members of the eurozone like Greece, Portugal or Spain.

Yet it is now clear that in a worst-case scenario, these countries will require the mother of all bail-outs. A JP Morgan economist has calculated that $ 750 billion might be needed by Greece, Portugal and Spain. Greece alone might require $ 150 billion, and might go bust even after that. Bond markets fear that Greek bondholders may lose 30% of their money.

Next in the firing line is Portugal. Its fiscal deficit is much smaller than Greece’s but it has a very large private sector debt. Also in the firing line is Spain, a big country of 47 million people. More distant but nevertheless in the line of fire is Italy, one of the biggest economies in the world.

This is a European problem, not an IMF problem. Why not? Because the IMF was created to deal only with balance of payments problems. The Eurozone countries have fiscal problems (high government deficits), but no balance of payments problems. Eurozone countries have given up their individual central banks and currencies, and instead created the European Central Bank, which issues euros in place of old domestic currencies. Banks of Eurozone countries get euros without any hurdle from the European Central Bank. So, these countries have no balance of payments problems.

But many have fiscal problems.  During the 2007-09 recession, all governments greatly expanded fiscal deficits as an anti-recession stimulus. But some European economies did not respond to the stimulus, and they now have huge fiscal deficits but no rapid growth that rebuilds government revenues. Once, government bonds of all Eurozone countries were rated triple A. But Greece’s bonds have been downgraded to junk. Portuguese and Spanish bonds are under pressure, and even Italian bonds are exhibiting discomfort.

Now, the Eurozone cannot afford to let Greece, Portugal or Spain go bust. The political and economic damage would be immense. European banks are the main holders of Greek, Portuguese and Spanish bonds, and a bond default by these countries would wreck the entire European financial system. So, European governments have agreed, reluctantly, to rescue Greece.

Why have they dragged the IMF into this European issue?  First, rather than be tough on Greece themselves, rich Europeans find it convenient to leave the disciplining to the IMF.  Second, they want the IMF to take up part of their financial burden. The IMF will lend at 3.5%, whereas the Europeans will lend to Greece at 5%, and this will provide the Europeans with an interest subsidy.

No such privilege would ever be extended to a developing country. Greece is getting a special deal because its fellow-Europeans dominate the IMF.

Poorer countries dare not stand up to Europe. But India can. It can raise a serious technical objection. The articles of association of the IMF say it can lend only for balance of payments. And Greece has a fiscal problem, not a balance of payments one. Some economists say fiscal and balance of payments are related. True, but the distinction was nevertheless made when creating the IMF.

Absent the IMF, other Eurozone countries will pick up the full rescue tab, out of sheer self-interest. They have more than enough financial muscle, and should not raid the limited coffers of the IMF.

If they need the IMF as a tough cop, let them use the IMF as a technical consultant, not a lender. Tough cops have their uses the world over, but do not usually lend to those they are disciplining.

2 thoughts on “IMF loan to Greece: an unwarranted favour”

  1. Arun Srinivas

    Very apt article sir. I hope the Indian reps in IMF and our Govt officers read this and react accordingly.

  2. In the last couple of years, the problem are with the countries who currencies are not only strong but also considered as reserve currencies like USD, Euro, pounds.

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