Are The IMF and the EU at Loggerheads Over Greece?

Everything has a cost, or so the story goes, especially time. In the Greek case we now know an additional item on the mounting bill: the country is back in recession. The issue is who - apart of course from the long-suffering Greeks themselves - will pay the extra costs of  the latest imbroglio.

The Cost Of Not Finding A Solution

 

It is now clear that Greece's economy has been going backwards over the last 6 months, and that it has once more fallen back into recession. Greek GDP fell by 0.4% in the last three month of 2014, and by a further 0.2% in the Jan - March 2015 period. As a result at the end of March Greek GDP was only 0.3% above the year-earlier level. This is a lot lower than expected in IMF forecasts, and - perhaps more importantly - well out of line with what is needed to maintain the 2022 debt sustainability targets on which continuing Fund support for Greek programmes depends.

Indeed "Greece is so far off course on its €172bn bailout programme that it faces losing vital International Monetary Fund support unless European lenders write off significant amounts of its sovereign debt", Peter Spiegel wrote in the Financial Times on 4 May 2015. The reason for this is obvious: IMF regulations prevent the Fund continuing to make tranche payments to countries where there is a foreseeable financing shortfall during in the coming twelve months. The worsening in the Greek economic outlook and the consequent reduction in the revenue outlook effectively guarantee this shortfall.

But the sort of debt write-off the IMF is demanding of its European partners goes much deeper than that. Future IMF participation in any new Greek programme after June is also in doubt because without additional pardoning the debt will not be on a sustainable trajectory in terms of the objectives set down and  agreed upon in November 2012.  So you reach a point where extend and pretend hits the proverbial fan. You can, of course, do more extend and pretend till the next time it happens, but at this point the IMF seems reluctant to do so. On the other hand austerity-type spending cuts which only make the economy smaller and the growth path lower simply don't help in this context, since what they give with one hand (debt reduction) they take away with the other (in the form of lower GDP).

The background to the current stand-off is to be found in the debt targets the Eurogroup agreed with the IMF in November 2012 and which effectively made the current programme possible. Given the latest recession these targets are clearly now not attainable. On the other hand Greece is totally bust, so the only way the negative effects of the negotiating gridlock can be paid for is by someone else "coughing up" (or rather "pardoning" debt). This someone will need to be the Euro partners (who else is there), and the longer the stand-off goes on the higher the cost. Naturally the other alternative would be allowing Grexit, but arguably the cost of Grexit would be much higher to the Euro partners, and by a large multiple.

The issue of the growing IMF/Eurogroup divergence came to general public attention over the weekend when an IMF internal memo was leaked to Channel 4 News (UK). The key point in the memo, which is hardly news, is that Greece is running out of money. “There will be no possibility for the Greek authorities to repay the whole amount unless an agreement is reached with international partners," referring to a series of June repayments to the IMF  amounting to roughly  1.5 billion euros.

This impression is also confirmed by details of  the letter that the Greek Prime Minister Alexis Tsipras wrote to International Monetary Fund Managing Director Christine Lagarde at the start of May (see details in this Kathimerini article) to inform her that Athens would not be able to pay the 750 million euros due to the Fund on May 12 unless the European Central Bank allowed Greece to issue more T-bills. It appears that at the time of writing the letter (which also went to EU Commission President Jean-Claude Junker and ECB President Mario Draghi) Mr Tsipras was not aware he could temporarily use the 650 million euros held on reserve at the Fund to make the payment, which he subsequently did. It's not unreasonable to assume that it was the IMF itself who advised him on this.

The inter-institutional tensions are evidently reaching a critical stage, although in fact the issue has now been knocking around for some weeks, as Simon Nixon reported in the WSJ on April 22.The IMF, he said, "appears to have blinked".

The general impression being given is that the IMF is contemplating a much lower bar for agreement, and then possibly disengagement from any post June programme. The Euro partners are evidently anxious to avoid this outcome, but they are caught between a rock and a hard place.

On Or Off The Hook? 

 

In order to understand what is going on between the Eurogroup and the IMF it is necessary to go back to a 2013 document entitled: The Third Review Under the Extended Arrangement Under the Extended Fund Facility (what a mouthful that is, henceforth the Third Review). In particular the following paragraph in that document off a key:

The macroeconomic outlook, debt service to the Fund, and peak access remain broadly unchanged and euro area member states remain committed to an official support package that will help keep debt on the programmed path as long as Greece adheres to program policies. Capacity to repay the Fund thus depends on the authorities’ ability to fully implement an ambitious program. It continues to be the case that if the program went irretrievably off-track and euro area member states did not continue to support Greece, capacity to repay the Fund would likely be insufficient.

Now all of this may sound - at least to the uninitiated - like a load of old bureaucratic mumbo-jumbo, but actually there are a number of key statements here which may help to put the current internal Troika tiff in some sort of broader and more intelligible perspective.

The cited paragraph talks about three issues: the macroeconomic outlook, the commitment of euro area member states to support Greece and keep the debt on the programmed path as long as Greece adheres to the programme's requirements. It also warns of the danger that should the programme go "irretrievably off track", and euro area member states not give the necessary support then the country's capacity to repay the Fund would clearly be insufficient - ie the IMF would be left holding the can, and Fund employees would be faced with the complicated task of explaining to its non-European members why losses had been incurred.

Crudely put the position is this - as long as the IMF continue to write reviews stating the Greek programme is on track then the euro area member states are on the hook to cover any shortfall in Greek debt performance in order to make the 2020 and 2022 targets (see above) achievable. This is a commitment they undertook during negotiations on the second bailout agreement.

On the other hand, if the IMF were to start producing reports stating that the programme was off-track because of Greek non-compliance, rather than for example arguing that the numbers were out of whack due to faulty macroeconomic forecasts (and of course the recent economic relapse makes those forecasts even less realistic), then the euro area member states would be off the hook from additional stepping up to the plate with the result that the IMF would end-up taking a loss.

Well the present recession makes it evident that those targets are even less achievable than they were previously, and that future debt sustainability analyses will have to reflect this. Bottom line: the IMF has a clear interest in enabling Greece to sign successfully off the current programme (due to end in 2016) and they thus have more interest in giving the country a "pass" note than the Eurogroup ministers do.This is why, in Simon Nixon's words, they are blinking, to the great discomfort of the Eurogroup partners.

Bottom Line: When You're Bust, You're Bust

 

A lot of attention is being paid at the moment to the idea that Greece is running out of money, and indeed there is a lot of chuckling about just how much grasp Yannis Varoufakis actually has of game theory. But at the end of the day it is also true that when you have lost everything (in the bankruptcy sense) you have relatively little still to lose. To some extent the idea that the Greek government might be deploying this strategy - known technically as coercive deficiency - was explored by Jacques Sapir back in February.  In my humble opinion far too much energy may have been wasted on laughing at Mr Varoufakis (which might precisely have been his intention) and far too little invested in trying to think through what he might have been up to.

If delays in negotiations mean a large bill is run up on your credit card (figuratively speaking) at the end of the day you can't pay it, so someone else will have to. This is the situation Greece is now in. If non performing loans start to rise with the new recession eventually these will have to be written off, and the bank recapitalization costs will go on someone else's account.

 The IMF memo in fact draws attention to this issue, and states that “non-performing loans are at very high levels and – going forward – the system might suffer from important stress." Indeed they go further and point out how "staff also noted a dramatic deterioration in the payment culture in the country”. This is what you would expect to find in a country steadily, and day by day, going bankrupt.

It's no longer clear that even if progress was made in the next two weeks towards some sort of fudged compromise deal - the so called "quick and dirty outcome" that the IMF oppose - that this would be able to get the necessary agreement from all EU parties and the IMF before the June payment. That is not necessarily an insurmountable issue, but it does highlight just how near to a potential brink (or "accident") we are, and it also serves to draw attention to the point that the longer all this goes on the greater the cost for Eurogroup members. Reforms will bring a bit more growth, but only in the longer run. Whatever the package of structural reforms the Greeks sign on to it won't do that much to mitigate the effects of the hit the Greek debt sustainability profile just took.

But then there is the other alternative - just allow the momentum of the present impasse to carry Greece straight out of the Euro Area. That would solve the problem of getting a deal, but the cost, when you come to think of EFSF and IMF loans plus ELA would hardly be negligible, not to mention the as yet unquantified geopolitical and contagion effects.

Whatever way you look at it, the next few weeks are certainly likely to be interesting.

If Greece Had Not Existed, Europe’s Leaders Would Have Had to Invent It

δεῖ δ’ αὐτὸν ἐς φάρμακον ἐκποιήσασθαι - He must be chosen from among you as a scapegoat. Hipponax

One of the more intriguing aspects of the whole modern Greek drama is the tragicomic way the country seems to be constantly condemned to live out well known themes which come from its own mythology. The latest example is the way what was once the cradle of European civilization has allowed itself to be converted into the role model for everything its fellow Europeans are not. Or at least, this is the story we are supposed to believe.

Greek culture and historiography is replete with references to a figure - the pharmakos, or scapegoat – who needed to die that others might live. In fact, the pharmakos ritual is probably as old as human experience itself. In classical Greece it was the custom in times of crisis for some poor unfortunate to be singled out to serve as a whipping boy, the one whose chastisement served to make the wounded demos whole.

The unlucky victim, according to the texts, was first beaten with fig branches, and then ceremonially led through the assembled community to receive a bout of verbal abuse prior to the execution of sentence, which invariably meant being either sacrificially killed or permanently banished. The whole process has normally been interpreted by anthropologists as the means of purifying the group of some kind of perceived pollution, some sort of plague or great misfortune which has inexplicably befallen them. The source of the evil is first accumulated in the victim - the scapegoat - who is then sacrificed in order that it may in this way be extirpated and the city cleansed.

According to the nineteenth century British classicist Jane Harrison the pharmakos was viewed as an “infected horror”, even to the extent that the kindest thing might be “to put an end to a life which was worse than death”. The resonance of all this with the recent history of the Euro Area should not be hard to discern. For many Greece has come to incarnate all that is bad within the monetary union. Due to its own laxness it has been transformed into the rotten apple that endangers the rest of the barrel. It needs to be set apart, if need be even expelled. Hypocritically or otherwise some even go so far as to suggest it would be in the country’s best interest to meet this fate, to have Grexit forced on it as an act of kindness, in a way which is all too reminiscent of the arguments used to justify terminating the scapegoat’s suffering . Such a life was, after all, "worse than death".

The line in the sand that has been drawn around the country is slowly but surely becoming an impermeable frontier. The logical step for the country to take now is "capital controls", or so we often hear, as if such a measure were to help the country remain inside the currency whereas in reality it is the obvious stepping stone on the road to exit.

Extraordinarily those who are most praised for being "not like Greece" often turn out, on inspection, to be only milder versions of the same. They have debts which are almost as unsustainable as the Greek one (Italy or Portugal), they run far higher fiscal deficits (Spain), they need more labour and pension reforms just like Greece, and without doing more are surely stuck in similar kinds of “growth traps”. Yet far from the others being subjected to harsh austerity and pressure for “tough love” reforms, they are big beneficiaries – without any kind of conditionality – of central bank bond purchases, a backstop for guaranteeing ultra-low interest rates and the kind of market access from which the transgressor country remains frustratingly cut off from. Given that Greece is so obviously the weakest member of the group, what kind of bizarre logic leads the EU’s leaders to impose the most difficult of conditions, especially given how much is at stake for all of us?

Looked at from a suitable distance it isn’t that hard to argue that if Greece hadn’t existed it would probably have been necessary to invent it. Amongst so many squabbling parties Greece’s presence has served to unite, to let the others know who they are by enabling them to say who they are not. Whatever his shortcomings, the fact that Finance Minister Varoufakis found himself in an 18 to 1 minority in Riga speaks volumes: Greece is the tie that binds.

So Greece has suffered greatly so that Europe might save itself. And this has now happened twice.

The first occasion was when the country’s debt was consciously not restructured in 2010, provoking an impossible fiscal adjustment which was inevitably followed by an ultra-deep recession. This decision, as is often noted, allowed Europe’s banks to be saved, while at the same all the other struggling countries had their economies talked up, simply on the basis of their not being "Greece". Indeed the much vaunted European Banking Union is very much a by-product of the Greek travails, as was Draghi’s currency-saving promise. Without the threat of contagion from Greece to support the case for it would this have ever been made? And now, before our eyes, history is being repeated. The second time is just as much a tragedy as the first one was. Greece is being starved of cash, while everyone else is receiving substantial debt support and enjoying seeing their interest payments reduced to extraordinarily low levels by ECB QE bond buying. Fiscal deficits targets in countries like France, Spain, Italy and Portugal have been relaxed, and in any event no longer attract the investor attention they once did. Everyone wants to ride the Draghi wave, not push back against him. And how exactly was QE pushed so easily through an otherwise deeply divided ECB governing council? It couldn't possibly be because those who were most opposed to it were also those most in favour of forcing Grexit, could it?

Could there have been some kind of "unholy alliance" between hawks and doves at the central bank since QE put in place the essential "cordon sanitaire" firewall, even while many were busy denying there was any real deflation risk. Naturally it is the presence of this QE firewall which would be absolutely essential to the existential well-being of the common currency should the worst come to pass in negotiations with the new Greek government. How can it be, at the end of the day, that those who are deemed strongest get most support, while those who are weakest are left exposed – like frail babies in a world long past – to wolves and inclement weather, just to test if they are strong enough to survive before being fed?

The First Bailout Enabled a Firewall to Be Built

Greece undoubtedly suffered as a result of the delay in accepting that the country’s original debt dynamic was unsustainable. In fact technical staff at the Fund were convinced of this from the outset, but EU leaders were opposed and from the Greek vantage point critical time was lost. As the IMF explain in their review of the first bailout programme; “An upfront debt restructuring would have been better for Greece, although this was not acceptable for the Euro partners.”

It would have been better for Greece since it would have enabled the IMF to lend over a longer period, which would have meant that the rate of reduction in the fiscal deficit could have been slower. In plain language the austerity applied would have been less severe, and the economic adjustment more manageable. This is the philosophy being pursued at the present time with the Spanish and French deficits. These two countries are being given longer to bring the overspend down below the critical 3% of GDP stipulated in the Maastricht Treaty, and there is a consensus that this is a good thing.

An earlier recognition that Greece was insolvent would certainly have helped the Greeks, but it would not have been welcomed by other EU governments who would have had to help their banks – the ones who had been financing the excesses in the first place. "Contagion from Greece was a major concern for euro area members,” the IMF explain, “given the considerable exposure of their banks to the sovereign debt of the euro area periphery.”

So a programme where there were serious doubts about long term debt sustainability was adopted due to the risk of contagion elsewhere in the Eurozone. The result was that Greece's correction had to be carried out more quickly (or an attempt had to be made to do so) resulting in a much steeper than absolutely essential recession. This way of doing things is not desirable, but even less desirable is to do it, and then fail to accept responsibility for having done so.

The objective of the line of argument being laid out here is not to support the world view of Syriza or the current Greek government, rather it is to suggest that mistakes made earlier are what has produced a climate in which Syriza-type arguments prosper. Simply to blame the Greeks for this is a travesty. Europe's leaders need to look beyond the current Greek government, and think about the long term interests of the Greeks themselves. Starving the Greek government of cash and crashing the economic recovery - which will only foment more radicalism later - is not the way to do things.

How Serious Is Recession Risk Now In Greece?

Getting hard data on Greek economic performance since February is still difficult, since all the important developments are far too recent. However, what information we do have all points in the direction of serious weakening in the economy. Economic sentiment has been falling in recent months, and April's drop was particularly pronounced. The economy contracted in the last three months of last year, and it has surely contracted again in the first three months of this one, making a new recession well nigh a certainty.

The Greek Parliament Budget Office declared at the end of April that in its opinion Greece was at risk of a new recession. “An agreement with creditors is urgent because the country is in danger of falling into deep recession and the government’s lack of strategy harms the economy”, they say in their latest quarterly report. In fact the economy is almost certainly relapsing and has been in a recessionary trajectory since the last quarter of 2014. Bank deposits have dropped by 26 billion euros since then and outstanding debts to the state have risen by almost 3.5 billion euros in the first quarter of 2015.

Most businesses are having serious financial problems and huge difficulties with foreign suppliers and clients. Non-performing loans are increasing and the retail sector is suffering, while new investments are almost non-existent. The economy has reached a point where even healthy businesses are in danger, the report says. Some evidence to back this view has also come from the Greek Commercial Register which reported a 21.8% annual drop in new business creation in the first three months of the year. As the Parliament budget office notes, the economy is starting to suffer from a shortage of cash and liquidity. The banks have suffered a severe deposit loss, and although much of this is covered by emergency liquidity assistance (ELA) obtained via the ECB the fact of the matter is people will be holding on to their hard currency Euros just in case Grexit occurs. This in itself slows activity down.

But in addition the Greek government itself is short of cash, which means it is not paying suppliers punctually, if at all. Those suppliers then need short term working capital loans from banks who themselves are short on capital, and so on. Basically the economy is suffering a severe cash and credit crunch and it is hard to see how this won't have a severe negative effect on economic activity. The lasts EU Greece forecasts recognizes this state of affairs, and lowers the 2015 GDP growth forecast from 2.5% to 0.5%. More ominously it also raised the debt outlook for this year from 170.2% of GDP to 180.2%. Since Greece is effectively bankrupt this inevitably means more debt pardoning from the country’s Euro Area partners if it is to remain in monetary union. A point which is picked up by the IMF in signs of growing tensions within the Troika itself over how things are being handled.

Under existing bailout targets, Athens was supposed to run a primary surplus — government receipts net of spending, excluding interest payments on sovereign debt — of 3 per cent of GDP in 2015. But according to the Financial Times, the IMF Greek representatives Poul Thomsen told EU Finance Ministers in Riga that initial data showed Athens was on track to run a primary budget deficit of as much as 1.5 per cent of gross domestic product this year.

As the FT’s Peter Spiegel puts it: “With the large surplus now turning into a sizable deficit, Greece’s debt levels would begin to spike again. This would force either Athens to take drastic austerity measures or Eurozone bailout lenders to agree to debt write-offs to get Athens’ debt back on a sustainable path. Officials said Mr Thomsen specifically mentioned the need for debt relief during the three-hour meeting.”

The Politics of Fear

The question is, what will be the longer term political consequence of crashing the economy again? The sharp growth in support for Syriza over the last couple of years can be seen as the one of the side effects of an overly deep recession/depression. Sending the Greek economy down further is only going to complicate the political scene even more, and make finding consensus even more difficult.

Too much EU policy emphasis has been placed on "defeating" Syriza, rather than securing the long term stability of Greece, and its people. Too many EU politicians have even been playing games, using the specter of Syriza to fight domestic populism at home. Naturally the cases of Spain and Portugal come immediately to mind. But does this lack of flexibility serve the long term interest of Europe? Greece's problems are still long term, and can't all be resolved in negotiations between now and June. Releasing bailout money to pay the IMF and the ECB - or rather paying it direct - would have made sense, using these payments as a way of pressuring Syriza by strangling the Greek economy doesn't.

While growth returned in 2014, it was very modest growth in relation to the fall which preceded it. In addition the country's economy is still suffering from deflation, with consumer prices falling by 1.9% in March over a year earlier, the 24th consecutive month of negative inflation. What the country needs from the EU and the IMF is not a bed of nails, but rather support in moving the economy back onto the path of stronger growth momentum. Rather than treating the country as a scapegoat, as an example of what not to do, Greece badly needs the kind of positive support Portugal, Italy and Spain have been receiving in order to start to attract some constructive investment. All have to serve, but not all are being forced to serve as an example.

What is needed is not a lesson in morality - from either side - but some plain old fashioned pragmatism. If Greek GDP really does constitute a negligible part of Euro Area GDP where's the big deal? Do US politicians make such a fuss about states like Alabama, or similar? It's in everyone's best interest, and you know it makes sense.

Greece has already made a very substantial adjustment to its fiscal and external balances. On the fiscal side Paul Krugman estimates it amounts to around 20% of GDP between spending cuts and tax hikes. What a pity if for want of the final nail the whole kingdom were to fall. Greece's has now lost less competitiveness than Finland since the year 2000. This doesn't mean that the one is more competitive than the other, Finland was a lot more competitive at the turn of the century, but it does suggest that the country has made a lot more progress than the anti-Syriza bias in statements on Greece is giving its citizens credit for at the moment.

 Naturally the country "cheated" on its partners, and sacrifices were inevitable but surely a more pragmatic and equitable solution could have been found. Simply punishing a country for what is perceived to have been "wrong doing" on the part of its elected representatives accomplishes little and may put a great deal at risk, including amongst those not directly involved.

It's Baaack: Looming Greek Elections Threaten To Re-ignite the Euro Crisis

If at first you don't succeed, try, try again......  aka third time unlucky.

The Euro crisis has all the signs of being back amongst us, and this time it may be here to stay. After two earlier false alerts - one in July around the collapse of the Portuguese Banco Espirito Santo, and another in October over the state of the Greek bailout negotiations - the announcement in early December that the Greek presidential selection process was being brought forward to the end of the month sent  markets reeling off into a complete tizzy.

In a development reminiscent of the heady days of 2012 yields on Greek 10yr bonds surged over a percentage point in the two days following the announcement, while the stock market fell by the most on a single day since 1987. 5yr CDS on Greek debt were also up sharply, and even more significantly, the yield curve inverted with 3 year debt started to move above that on ten year debt. Yield inversion on sovereign bonds is often seen as a symptom of potential default as investors demand ever more for holding short term debt.

And the chaos continued all week with 10 yr bond yields rising above 9% and stocks falling another 7.35%, taking the total drop in equities to over 20% (chart from Mike Bird at Business Insider).

 The reason for the market panic is obvious, since investors didn't need long to study the Greek constitution and realise that should the current government be unable to summon sufficient votes for their candidate to be approved in the final vote on 29 December, then general elections would become inevitable.

With yesterday's vote this possibility has now become a reality and elections are to be held on 28th January 2015. What's more there is a significant possibility that the radical left coalition - Syriza - will win, and in that eventuality some sort of confrontation or stand-off with the EU Commission and the Troika would become inevitable.

What is worrying investors most is not the fact that Syriza have renegotiation of the country's debt in their programme - with government debt at over 175% of GDP and the economy in deflation some sort of restructuring is inevitable - but the kind of economic programme the new government would try to implement since it would surely be based on a kind of "anti Troika" formula - higher salaries, higher pensions, more government employees, and repeal of the new labour law, just for starters - and these kind of "reverse reform" measures would be hard for Europe's leaders to swallow.

Formally the party do not seek to leave the Euro, their aim is rather to run an alternative economic model within the Euro structure, based on the assumption that faced with the threat of Greek exit Europe's leaders would back down and become more flexible. Investors are nervous since they fear that they may not do so, and that Greek exit may actually ensue.

Long Term Depression

Despite the fact Greece's economy grew by 1.6% over a year earlier in the 3 months to September (making for the third straight period of quarterly growth) this welcome "green shoot" comes on the back of six years of contraction during which time the economy fell by around 25%. The country - and it's citizens - is a lot poorer now than it was then, not to mention the fact that it has been burdened with a lot more debt.

So while growth has returned, it is very modest growth in relation to the fall which preceded it. In addition the country's economy is suffering from deflation, with consumer prices falling by 1.2% in November over a year earlier, the 21st consecutive month of negative inflation. The IMF now forecast that Greek GDP will grow by 0.6% in 2014, but prices will fall by 0.8% meaning that nominal (non inflation adjusted) GDP will be stationary. And this kind of situation could go on for years and years as the country exists a horrendous recession only to enter an extended period of secular stagnation.

Despite the timid, but much applauded, recovery, the macroeconomic data is far from being encouraging, as this screenshot taken from the statistic office website illustrates.

Industrial output is back where it was in 1976, and was down 1.7% over a year earlier in October.

 Greece's current account has made huge strides in the right direction, and the balance was even positive in 2013, but this improvement has largely been the result of a reduction in imports (and living standards) and not due to export growth.

As a result the country still runs a sizable goods trade deficit.

So Greece isn't having an export lead recovery, which is what the country really needs. In fact massive sacrifices have been made, many people's lives have been made a misery, yet there is really very little to show for it all. Which is why Syriza is doing well in the polls. With 26% unemployment continuing, surely (the thinking goes) anything would have to be better. Why not try a long shot in the dark?

Whom The Gods Would Destroy They First Make Mad

The horrid little secret about the common currency experiment is that it provided a structure wherein it was very easy to get into trouble (cheap interest, good credit ratings, no current account supervision) but desperately hard to get out of it (no currency to devalue). The big problem for Greece now is to find a way to get the country back to where it was before they got into the current mess while staying inside the currency union? Some would say quite simply they can’t and the conclusion to be drawn is that they should leave the Euro. This isn’t as easy or as obvious a solution as it seems, and in addition many of the other member countries are effectively counter-parties on much of the large external debt that has been accumulated, so in the event of non-payment part of the problem would simply change hands. Any decision by a member country to cut loose from the Euro is unlikely to be welcomed by the creditor nations, making the idea of a voluntary, negotiated departure pretty unlikely, particularly after Mr. Draghi made his promise. The exiting country would have to do so unilaterally, and face the consequences on debt default and sustained lack of access to international capital markets.

It would be a very messy affair, and in some ways not a decision a person applying a rational calculus would be likely to arrive at. There are so many losses to offset against the gains. Under these circumstances the only conceivable way a deliberate decision to leave could credibly be envisioned would be as a result of one or more of the respective agents being effectively driven “insane” by the constant painful efforts involved in trying to carry out the very large competitiveness correction required while remaining within the currency union. This indeed was the argument I advanced in my essay submission to the Wolfson Prize: a procedure for orderly exit is essentially a worthless document since if anyone does leave the affair won't be orderly, but bitter and fraught with conflict. And this phenomenon of growing political instability was what characterized Argentina before it went careering off the tracks in December 2001.

So just because many might question the rationality of such a decision doesn't mean it won't happen, or couldn't happen as an unwanted side effect of a conflict which gets out of control. Economies on the southern periphery are not recovering (in any normal sense of that word), they are condemned to either frequent recessions or one very long depression, depending on how you classify things, together with protracted deflation and unacceptably high levels of unemployment. The degree of lost competitiveness that was inflicted during the early years of the century - and which is as much an institutional and reputational issue as it is a price one - imply that a decade or more may pass before daylight is seen.

If it ever is. This outcome is proving very painful for the respective populations. Too long and too painful, which is why we are now seeing a surge in support for organizations like Syriza, or Podemos in Spain, or the 5star movement in Italy. Confidence has steadily eroded in the old political elites, who were trying to convince voters that pigs really could fly (while in many cases lining their own pockets in the process) and more radical political movements are emerging. It isn't that hard to understand. This was always going to happen.

Some, like the FT's Kerin Hope, try to draw comfort from the idea that Syriza may be moderating as the responsibility of holding power looms.

"....the recent market panic belies the fact that Mr Tsipras has softened his rhetoric since Syriza came first in May’s European elections, cementing its lead over the governing New Democracy party in opinion polls. He professes devotion to the euro while his economic team now holds regular international conference calls in an effort to reassure fund managers that a leftwing government would be able to tackle Greece’s debt problem and would not oppose foreign investment."

But this may be mistaking tactics for strategy. These movements are not about to get incorporated in the mainstream. And the key issue is not likely to be the debt one. As I explained (here) in the summer of 2013 formulas exist for handling this question. What is most likely to divide Athens and Brussels if Syriza win the elections is the nature of the economic model the country will adopt. In this sense Ambrose Evans Pritchard has this one right.

As matters stand, it is more likely than not that a defiant Alexis Tsipras will be prime minister of Greece by late January. His Syriza alliance vows to overthrow the EU-IMF Troika regime, refusing to implement the key demands. A view has taken hold in EU capitals and the City of London that Mr Tsipras has resiled from these positions and will ultimately stick to the Troika Memorandum.... But the fact remains that he told Greek voters as recently as last week that his government would cease to enforce the bail-out demands “from its first day in office”.

 In fact they go further, describing Troika representatives as "criminals" who work to convert the periphery into "German colonies". If you listen hard enough you can hear Podemos leaders saying similar things in Spain.

As Ambrose also points out, Mr Tsipras will be banking on the idea that the EU leaders will back down, and talk turkey. But what if they don't? Their room for manoeuvre on this front is far more limited than it is on the debt one, since others in the south would surely want to follow a similar path if they thought they could. Grexit may be something that no one actually wants to happen, but sometimes things no one wants to happen do.

 Postscript

The above arguments are developed in detail and at far greater length in my recent book "Is The Euro Crisis Really Over? - will doing whatever it takes be enough" - on sale in various formats - including Kindle - at Amazon.

Greek Re-entry (or Grentry) Not The Game Changer Many Think It Is

There is no doubt that Greece's recent bond sale was an exciting and even invigorating moment for many people. The WSJ's Simon Nixon, for example, called it "a symbolically important moment for the euro crisis". Reuters' Marius Zaharia suggested the speed of the come back could even be a game-changer for the heavily indebted southern European country. Certainly there can be little doubt that, as Nixon puts it, the turn round in market fortunes was a remarkable achievement, illustrative of just "how far market sentiment toward Southern Europe has changed". 

 "For the country at the center of the crisis to draw €20 billion ($27.77 billion) of foreign demand for a five-year bond yielding under 5% shows that the market now believes Greece will stay in the euro zone, that it won't collapse into chaos and that any further debt relief will be provided by official rather than private lenders."

The pace of the fall in Greek bond yields has been little short of astonishing, and Nixon is surely right, market participants now believe that the country isn't about to collapse into chaos (although we'll have to wait and see just how far this belief survives any further evidence of increasing support for Syriza). Possibly more importantly, they are now convinced that future debt relief will come from the official and not the private sector. So swift has the turnaround been, that it is now quite probable that Antonis Samaras's promise the country would wind-up its bailout process in 2014 may well be fulfilled.

In fact, it is hard to understand the present turnaround in Greek financial fortunes outside of the context of (i) the widespread belief that the ECB will eventually be forced into a sovereign bond buying QE programme; and (ii)  the agreement by the country's Euro Area partners (pressurized by the IMF - see this post) to meet any shortfall on the country's debt reduction programme over and above 110% in 2022 provided it fulfills ongoing EU Commission reform  requirements. Following publicaton of the latest EU report in April the FT put it like this:

Under a hard-fought deal reached in November 2012, Greece’s lenders agreed to provide additional debt relief after Athens achieved a primary budget surplus – which excludes interest payments. Jeroen Dijsselbloem, head of the eurogroup of finance ministers, said these talks were set to begin after the summer. The EU official declined to speculate on how eurozone governments would help to lower Greece’s debt levels, insisting this discussion was not part of the just-completed review. 

What this basically means is that the Greek headline Eurostat sovereign debt figure of 175% of GDP is a very misleading one. 40% of this debt is in the hands of the European Stability Mechanism (ESM) on very favourable terms -  capital repayments are not due for 25 years while interest payments have a waver till 2023. As Klaus Regling, head of the  (ESM) put it in an interview with the Greek newspaper To Vima, "There's no debt sustainability problem for the next 10 years. This is very good news for investors."

Greece's public debt currently stands at about 320 billion euros, or 175 percent of GDP. About 80 percent of it is in the hands of the European Union and the International Monetary Fund, at very low interest rates and on a long repayment schedule.

Regling's ESM, which holds about 40 percent of Greece's debt, is charging Athens about 1.5 percent to cover its own financing costs. ESM rescue loans to Greece have a 25-year repayment schedule and Athens starts paying interest on them 10 years after they are disbursed. The EU and the IMF have so far extended 218 billion euros of bailout loans to Greece over the past four years and Athens stands to get 19 billion euros more by the end of the year.

In other words, investors, irrespective of whether or not the ECB introduce QE, can safely buy new Greek debt without worrying too much about whether they are going to be paid back. Between now and 2023 there is no real problem in that department given the de facto Euro Partners guarantee. As I point out elsewhere (On The Trail of Italian Debt) Greek and Portuguese sovereign debt issues are comparatively small beer, and will not threaten the common currency, but the same cannot be said for Italian, or ultimately Spanish, debt. So Greek debt, even at current interest rates looks, frankly, attractive. Doesn't Mario Draghi constantly advise investors not to underestimate the determination of EU politicians to hold the Euro together. Well, there you are.

Real Economy Hits Bottom But Muted Rebound Ahead

Life is rather different, though, within the typical Greek "oikos" (or household). While Greece's economic slump is now hitting the bottom and while, following a pattern seen elsewhere on the periphery, there has been a great boost for the financial sector, there has been relatively little in the way of real gains for the country's hard pressed population at large. Bond yields have fallen sharply, shares are up (or here), and banks are even able to sell bonds (for an example of what they then do with the money see this NYT piece from Landon Thomas), but little of this has trickled through to participants in the real economy.

The economy was down by 1.1% in the first three months of the year when compared with 2013,  the lowest inter-annual  Q1 drop since 2010. The economy is now something like 25% than it was at the q1 peak in 2009. Since the Greek statistics office STILL don't produce quarterly seasonably adjusted data (is that a measure of the progress they have made?) we don't know for sure, but it does look like the economy actually grew from December to March on an sa basis.

But there is little improvement visible in either retail sales or industrial output.

Unemployment has clearly peaked, but so far only fallen marginally.

A lot of the external correction has now taken place, and the current account balance was positive in  2013.

Exports turned positive on a year on year basis in March, but the country country still runs a sizeable goods trade deficit.

Credit gowth remains negative.

So, it is important to bear constantly in mind that the fact the economy has stopped contracting is not at all the same thing as it returning to growth. On that front we will need to wait and see, but there is little that is especially encouraging to date. The problem with having the Euro as a currency was never how to stop the economy contracting. It was always the difficulty which would exist in subsequently returning the economy to growth. Italy and Portugal pre-crisis didn't see their economies shrink, but they did remain stuck in low growth.

The most serious problem facing Greece right now is evidently deflation.

Inter-annual inflation has now been negative for 14 months. Curiously, in the Greek case the main problem with deflation is not going to be that debt levels are pushed up, since as we have seen above excess Greek debt is now effectively guaranteed by the Euro Area partners. A deflationary debt spiral this isn't likely to become the problem it could be in non-debt-guaranteed countries like Spain or Italy.

Deflation will, most likely, push up the level of non performing loans in banks, but even these can be recapitalized and some of the cost passed on to the common currency partners. The real problem in the Greek case is that people will constantly feel that the amount of money in their pockets is shrinking, which it will be (turnover can be down while sales volume is up). This creates a very important mismatch between the positive discourse about  economic improvement coming from the government and the official sector generally and the amount of money people see in their tills and wage packets. Naturally, deflation in this sense is not conducive to political stability, and it is here the main risk to the Greek recovery is to be found. In the meantime, a two tier Euro divided between those who have acquired some sort of implicit debt guarantee and those who haven't has effectively been created, yet few have so far seen fit to notice the fact. As the IMF stated in their latest (eleventh) Portugal Program Review:

"While staff considers public debt to be sustainable over the medium term, this cannot be asserted with high probability. However, systemic risk from contagion to other vulnerable euro area countries, should the sovereign fail to service its debt, continues to justify exceptional access......Nevertheless, commitments by euro area leaders to support Portugal until full market access is regained—provided the authorities persevere with strict program implementation—give additional assurances that financing will be available to repay the Fund".

The Second Battle Of Thermopylae

According to legend and some historians, by making a stand in the Thermopylae pass 300 brave Spartans valiantly saved the day for the entire Greek army in the face of a Persian force of overwhelming strength and manpower. More than 2,000 years later some 11 million Greeks might be considered to have carried out a rather similar operation by single handedly facing-off a massed horde of frantic global speculators on behalf of the entire Euro Area population - at no mean cost to themselves in terms of wealth, employment and general well-being. Or at least that is the conclusion which could be drawn from reading through the latest self-critical review issued by the IMF dedicated to the lessons which can be learned from the to-date handling of  the country’s deep economic and social crisis.

The document, entitled Ex Post Evaluation of Exceptional Access Under the 2010 Stand-By Arrangement (henceforth referred to as the Evaluation Document), does not mince its words, and suggests that Greece suffered a worse than necessary recession due to the reluctance of Europe's leaders to agree on debt restructuring from the outset. The reason for this reluctance is obvious with hindsight, the Euro Area was institutionally ill-prepared for the kind of crisis which was unfolding while the interconnection of the European capital markets and the banking sectors meant the financial systems of a number of other European countries were at risk.

Contagion from Greece was a major concern for euro area members given the considerable exposure of their banks to the sovereign debt of the euro area periphery. 

 Earlier debt restructuring could have eased the burden of adjustment on Greece and contributed to a less dramatic contraction in output. The delay provided a window for private creditors to reduce exposures and shift debt into official hands. This shift occurred on a significant scale and left the official sector on the hook.

An upfront debt restructuring would have been better for Greece although this was not acceptable to the euro partners. A delayed debt restructuring also provided a window for private creditors to reduce exposures and shift debt into official hands. As seen earlier, this shift occurred on a significant scale and limited the bail-in of creditors when PSI eventually took place, leaving taxpayers and the official sector on the hook. - IMF Evaluation Document

The contents of the Evaluation Document were widely reported on in the press (see for example here), and produced a swift response from EU Commission representatives, including an "I don't think it's fair and just that (the IMF) is trying to wash its hands and throw dirty water on European shoulders," from Economic and Monetary Affairs Commissioner Olli Rehn. The little phrase that caused all the problems was the report's assertion that "An upfront debt restructuring would have been better for Greece although this was not acceptable to the euro partners."  Obviously, when a dispute becomes as public as this, something, somewhere is going on. Trying to fathom what it was I couldn't help noticing that the publication of the  Evaluation Document coincided almost exactly in timing with the issuing of the Fund's latest report on the current (rather than the initial) Greek programme - The Third Review Under the Extended Arrangement Under the Extended Fund Facility (what a mouthful that is, henceforth the Third Review) - where curiously the international lenders let slip the significant little detail that next year Greece is expected to have a funding shortfall of some 4 billion Euros. Almost immediately denials that any kind of talks were ongoing about any kind of  forthcoming debt pardoning for the country started to surface in Germany, (or see here).

In my case the light dawned when reading more thoroughly through the Third Review document I came across the following paragraph:

The macroeconomic outlook, debt service to the Fund, and peak access remain broadly unchanged and euro area member states remain committed to an official support package that will help keep debt on the programmed path as long as Greece adheres to program policies. Capacity to repay the Fund thus depends on the authorities’ ability to fully implement an ambitious program. It continues to be the case that if the program went irretrievably off-track and euro area member states did not continue to support Greece, capacity to repay the Fund would likely be insufficient.

Now all of this may sound - at least to the uninitiated - like a load of old bureaucratic mumbo-jumbo, but actually there are a number of key statements here which may help to put the recent internal Troika tiff in some sort of broader and more intelligible perspective.

Sometimes in order to get to grips with a highly complicated argument thread it helps to go to the endpoint and then work your way back. It also helps to bear in mind that the recent Evaluation Document is as much about the future as it is about the past - and in particular the scenario which will come into play in 2020 and 2022 when the current programme's debt to GDP targets are expected to be achieved.

The cited paragraph talks about three issues: the macroeconomic outlook, the commitment of euro area member states to support Greece and keep the debt on the programmed path as long as Greece adheres to the programme's requirements, and the danger that should the programme go "irretrievably off track", and euro area member states not give the necessary support then the country's capacity to repay the Fund would clearly be insufficient - ie the IMF would be left holding the can, and Fund employees would be faced with the complicated task of explaining to its non-European members why losses had been incurred.

So now I understand the nervousness a bit better. Crudely put the position is this - as long as the IMF continue to write reviews stating the Greek programme is on track then the euro area member states are on the hook to make up any shortfall in Greek debt performance. This is a commitment they undertook during negotiations on the second bailout agreement.

On the other hand, if the IMF were to start producing reports stating that the programme was off-track because of Greek non-compliance, rather than for example arguing that the numbers were out of whack due to faulty macroeconomic forecasts (some of them from the EU Commission itself), then the euro area member states would be off the hook from additional stepping up to the plate with the result that the IMF would end-up taking a loss.

Complicated isn't it? That is why the rule of starting out from the assumption that nothing is ever exactly what it seems to be is normally a good one to work by.

What is obvious from reading through the documentation is that the IMF is keen to highlight the guarantees given by Greece's euro area peers at the time of setting up the Extended Fund Facility (2012) that "adequate support" would be provided to bring Greece's debt down below 110% of GDP in 2022 (ie that there would be some form of debt pardoning) should the country comply with the terms of its programme and the debt dynamics still not turn out right. Since we now have a track record on all this, and since staff economists at the Fund have also recently conducted a debt sensitivity analysis which came up with the finding that given slight under-performance on GDP and inflation outcomes the debt could still be as high as 147% of GDP come 2022 , the issue is no mere trifle.

This is, in my opinion, why so much emphasis is now being placed in Washington on the fact that Greece's short term interests were to some extent sacrificed for the greater good of the eurozone, a justification which may make the bitter pill of Euro-partner losses on their loans to Greece easier to sell to their respective electorates.

Well, since nothing is really valid in this world until it is tested (like the June 2012 commitment to mutualise some of Spain's bank losses), and since 2020 is still a relatively long way away, it isn't hard to understand why the good folks in Washington might want to see the commitment in Europe tested a good deal sooner, which is where, I think, next year's 4 billion euro funding shortfall comes in. I cite the latest review document (my emphasis):

The program is fully financed through the first half of 2014, but a projected financing gap of €4 billion will open up in the second half of 2014. Thus, under staff’s current projections, additional financing will need to be identified by the time of the next review, to keep the program fully financed on a 12-month forward basis, and the Eurogroup has initiated discussions already on how to eliminate the projected 2014 gap. In this regard, the Eurogroup commitment made in both February and November 2012 to provide adequate support to Greece during the life of the program and beyond, provided that Greece fully complies with the program, is particularly important.

Again the essentials are hard to-get-through-to for all the bureaucrat-speak, but the last sentence says it all - "The Eurogroup Commitment...to provide support to Greece....is particularly important."

A Deeper Than Necessary Recession?

Greece's recession has been one of the deepest peacetime recessions ever experienced in industrialized economies, and bears comparison with the great depressions of the 1930s in the US and Germany (see chart prepared by the IMF below). Overall, the economy contracted by 22 percent between 2008 and 2012 and unemployment rose to 27 percent; youth unemployment now exceeds 60 percent. As domestic demand shrank across all areas, net exports provided support largely through shrinking imports. Indeed as opposed to other countries on Europe's periphery exports actually shrank in Greece in both 2011 and 2012.  The issue this raises is was such devastation really necessary in a country participating in a currency union which could have expected support from other participants?

Naturally the country "cheated" on its partners, and sacrifices were inevitable but surely a more pragmatic and equitable solution could have been found. Simply punishing a country for what is perceived to have been "wrong doing" accomplishes little and may put a great deal at risk, including amongst those not directly involved.

As the IMF points out in the Third Review, Greece was forced into one of the largest fiscal adjustments seen anywhere  to date (see chart below).The primary adjustment in 2010–12 amounted to 9 percent of GDP, and was much higher (15 percent of GDP) in cyclically-adjusted terms. The same outcome could have been achieved over a slightly longer period of time had a more constructive attitude been taken. On the other hand the IMF take the view that some sort of rapid fiscal adjustment was unavoidable (but how rapid?) given that the Greece had lost market access and official financing could be considered to have been  as large as politically feasible. They conclude:

It is difficult to argue that adjustment should have been attempted more slowly. The required adjustment in the primary balance, 14½ percentage points of GDP, was an enormous adjustment with relatively few precedents, but was the minimum needed to bring debt down to 120 percent by 2020. Moreover, despite the starting point being slightly worse than thought to be the case when the 2010 Stability Program was drawn up, the SBA-supported program had already extended the period over which the Maastricht deficit target would be achieved from 3 to 5 years. Since the program only ran through mid-2013, the last part of this adjustment would occur after the program and the conditionality had ended. Moreover, debt would still be increasing when the program ended.

One of the key points to note here is the observation that the program only ran through mid-2013. This is a knock-on consequence of the type of program originally set up (the so-called Standby Arrangement - or SBA). SBA's are by their very nature designed and intended for short term liquidity support prior to a reasonably rapid return to market access. But Greece's needs, as is now obvious, were longer term and involved solvency issues. Had a decision been taken at the outset to set up an Extended Funding Facility (the 2012 program is of precisely this type) then the time horizon could have been longer, but part of the reason an EFF was not chosen was because the solvency issue was not recognised and debt restructuring was not on the table, so the argument at this point becomes somewhat circular. That is to say, had the will been there at the outset to use an Extended Funding Facility and had the realistic view (recognized with hindsight) that debt restructuring was inevitable been taken, then the Greek fiscal correction would still have been significant, but more extended in time, and with less overall damage to the economy's private sector.


And the damage was severe. The employment loss was dramatic (see chart) and as in other countries who have suffered a similar, if more benign, fate (Spain, Portugal) it is hard to see how earlier levels are ever going to be recovered given anticipated future growth rates.

The social and economic consequences of the over ambitious fiscal correction  have gone well beyond the downsizing of the country's bloated public sector, and no part of Greek society has been spared. Among Greek households the fall in disposable income between 2009 and 2011 nearly doubled the previous debt-to-disposable-income ratio (which rose to 96 percent - higher than the peak observed in Latvia). Falling property prices have raised mortgage loan-to-value ratios from around 70 percent on average before the crisis (lower than in European peers) to close to 90 percent in 2012 (currently higher than even in Spain). House prices fell by 11.8% in the year to the end of March, according to the residential price index published by realtors Knight Frank following a 9.8% drop a year earlier. For a country which didn't really have a property boom before the crisis this is very striking.

In the non-financial corporate sector the decline in profits has affected firms’ ability to service debt, with the interest coverage ratio dropping from 24 percent in 2001 (one of the highest in Europe) to 2.4 percent in 2012 (higher only than Portugal). As a result Non-performing loans in both the household and corporate sectors have risen sharply (see chart below for the corporate case) and in 2013 are expected to pass the 30% of total loans mark.

All this distress and impairment naturally creates problems where previously few existed. The Euro firewall building process meant that most of Greece's sovereign debt risk was transferred from other European banks to Greek ones, with the consequence that when the debt restructuring finally did come these banks all needed recapitalizing by the state leading the country to have to borrow yet more money to pay for this. Now that the only external imbalance correction process is what the IMF calls the "recessionary path" (rather than a more comprehensive internal devaluation - see below) these same banks are being faced with substantially more losses on their general loan books, possibly leading to the need for yet more recapitalization, and so on.

Divergences Within The Troika On Deflation?

"Deflation is a protracted fall in prices across different commodities, sectors and countries. In other words, it is a generalised protracted fall in prices, with self-fulfilling expectations. Therefore, it has explosive downward dynamics. We do not see anything like that in any country". Mario Draghi answering the question "do you see any risk of deflation in some countries in the euro area?" at this months ECB press conference

"Macroeconomic developments are broadly as expected. The economy is rebalancing apace: the current account deficit is now shrinking fast, by 6½ percent of GDP in 2012; the competitiveness gap has been reduced by about half as last year’s labor market reforms are facilitating significant wage adjustment; and deflation is finally setting in". - IMF Third Programme Review (my emphasis).

Leaving aside a small quibble about the definition of deflation Mario Draghi selects for himself - for self-fulfilling expectations about an ongoing fall in prices to set in prices first need to start falling - there is no doubt that in the case of Greece prices are now falling, and the arrival of this crude kind of deflation (rather than what we could call the Draghi variety) in any country is surely an issue which most of the world's central bankers beyond the confines of the ECBs governing council are certainly not blasé about, if only because unless it is handled properly it can transform itself into the kind Mr Draghi so rightly fears . According to the IMF Third Review

In response to Greece’s now high output gap, headline HIPC inflation fell to 0.3 percent at end-2012 (from over 2 percent at end-2011) and turned negative in March (-0.2 percent) and April (-0.6 percent). Core inflation (excluding energy and unprocessed food), which has been negative for some time, fell further to -1¼ percent in March. The GDP deflator also turned negative in 2012 (-¾ percent).

The striking thing, leaving aside the issue of definition,  is that the IMF actually seem to welcome the fact deflation is finally arriving in Greece - due to the competitiveness impact it will have on the Greek price level. But it is here I think that one can discern some sort of difference of opinion within the Troika itself. It seems likely that the IMF would actually agree with Mario Draghi that Japanese-style deflation is probably not on the cards in Greece at the moment (although given the depth of the country's problems and the fact that the countries workforce has now started shrinking - due to demographic shifts and emigration - who the hell really knows, I certainly wouldn't put my hand in the fire one way or the other on this one).

But the IMF are concerned about an ongoing fall in wages and incomes in the context of continuing increases in the price level, and hence welcome the drop in prices as part of an internal devaluation which is seen as essential to restore international competitiveness.

The far-reaching labor market reforms put in place in early 2012 have contributed to deeper wage corrections than in other recent crisis cases and substantial adjustment in the ULC-based REER. Less encouraging has been the weak and delayed response of prices to wage reductions, owing largely to product market rigidities. This asymmetry in price adjustment has led to a substantial erosion in real incomes and demand, and placed a disproportionate burden on wage earners relative to the self employed and the corporate sector. It has also left the CPI-based REER overvalued in 2012 by about 9 percent (Box 2). With the headline inflation now in negative territory and a widening inflation differential with the euro area, the extent of overvaluation is gradually reducing and relative prices between the tradable and nontradable sectors are adjusting. - IMF 2013 Article IV Consultation

So why might the other parts of the Troika - the EU Commission and the ECB - be more nervous about the consequences of this drop in the price level? They are concerned about the impact on Greek debt dynamics is the obvious answer. This drop in prices is now seen as essential and inevitable by the Fund, but is still to some extent being resisted in  Brussels and Berlin. Again, the reason for the reticence is obvious, "we're on the hook" - remember, if Greek debt is above the 110% of GDP target in 2022, or reaches levels in the intervening years that make this level obviously unattainable, for reasons of lower than anticipated GDP or price growth then the Euro Area peer countries are committed to making up the difference.

The chart below shows the results of a Debt Sustainability Analysis carried out by Fund economists during the period of the first bailout. What is clear is that the two main risk items for debt snowballing are lower than anticipated GDP growth and deflation. As the IMF itself observes in the Evaluation Document: Since the shocks considered were fairly mild, this sensitivity analysis demonstrated the precariousness of the debt trajectory. For example, the deflation shock considered in the DSA (3 percent more) would not have made much difference to the internal devaluation, but would have caused debt to jump to 175 percent of GDP.

In the Third Review the Fund goes even further on the basis of a new Debt Sustainability analysis - "If nominal growth averages 1 percent lower than the 4 percent baseline projection, debt will be 134 percent in 2020 with an only modest declining path thereafter". That is to say, if the sum of GDP growth and inflation is 1% less than forecast in the baseline scenario debt will rise substantially.


So Whither Greece? Is Grexit About To Become An Option Again?

According to Citi's Chief Economist Willem Buiter, the man who coined the term Grexit, the possibility of Greece exiting the euro zone has receded "markedly" in recent months. "We still believe that there is a fairly high risk of Grexit in coming years, but no longer put it in our base case at any particular date," Citi said in a research note co-authored by Buiter published in May. Reading this assessment at the time of its publication the argument seemed reasonable to me. But after 48 hours of poring over IMF documentation on the country I am no longer so sure that this conclusion is as solid as it seems.

My feeling now is that, despite Buiter's recent pronouncements, Grexit may well come rapidly back on the agenda after the German elections. I think markets are soothing themselves with an overoptimistic expectation of how committed German politicians are to moving towards banking and fiscal union - Draghi bond buying at the ECB is another issue, but the Greeks by and large don't have bonds to sell, they just have debt obligations to the official sector. Put another way, as Wolfgang Munchau argues in this week's Financial Times, “The OMT is not designed to address the solvency problems of various private and public entities in the eurozone”, and Greece's coming problems are surely of the solvency and not the liquidity kind.

 The key issue really hangs around the obligations the Euro partners entered into with the IMF last December to fund any shortfall in Greek funding and debt-reduction needs as long as the IMF continues to give the country a pass mark during the ongoing reviews.

 Looking over and over again through the numbers the IMF put forward it is clear to me that there is really very little wiggle room left on Greek debt dynamics, and that the IMF are fully aware of this as their Debt Sustainability exercises demonstrate, hence initial attempts to distance themselves from EU institutions in the Evaluation Document. The move reminds me of one of Leo Messi's attempts to lose his markers while languishing near the edge of the penalty box. One swift lunge and its in the net.

Now one possibility which lies before us is obviously that the IMF gives the country a red flag in a review. That wouldn't be so difficult given the way Greece works. Yet actually, for reasons discussed in the introductory section to this piece, the Fund has precious little interest in doing this, since the country's Euro peers could then simply walk away from their funding obligations and the IMF would be last man standing on the debt, a situation they repeatedly stress they are anxious to avoid. Nonetheless, let us assume they do throw up a red flag, what would be the consequences?

Well, not another EU backed aid programme surely. The red flag would mean the issue of possible Grexit would be directly back on the table, since core Europe would surely be extremely reluctant to accept politically unpopular losses for a country that wasn't complying, and it is hard to see what the solution to ongoing funding shortfalls coupled with non-compliance would be if it wasn't euro exit.

So now let's assume that the country gets a series of continuing green flags, but that nominal GDP performance is less than projected in the programme's baseline scenario - it may not be politically correct to say this, but it is hard not to get the impression that the inflation and growth numbers for 2015 to 2018 (showing nominal GDP growth of around 4.7%) have been devised explicitly to bring Greek debt into the region of 120% by 2020, at least on paper. The probability of under-performance is thus high.

Cognizant of this looming difficulty the Fund seem to be already attempting to force the issue by looking for a 4 billion Euro down-payment on their commitment from the Euro partners in 2014. Then, supposing they wanted to accelerate the Euro partners Greek bail-in process they would only have to revise down their post 2014 inflation and GDP forecasts to make even more money needed quite quickly. But, if we think about it a bit,  the political logic for ongoing debt pardoning in Greece by other EU member states isn't especially clear given that Italy, Portugal, Ireland and Spain could all easily have debt levels over 110% of GDP come 2022. So how can you justify making Greece a special case in the positive sense? I think the more likely outcome is that core Europe will try to wriggle out of its obligations following the German elections, and that this move will lead to a surge in uncertainty about Greece's future, with Grexit once more becoming an openly discussed option.