In a letter addressed to all 19 ministers sent on Thursday night and obtained by the Financial Times, Christine Lagarde, Managing Director of the IMF, says discussions with Athens to find €3bn in contingency budget cuts have gone fruitless and suggests negotiations for debt relief should start immediately for the IMF to remain in the bailout program. She also states the IMF does not expect “Greece to be able to sustain a primary surplus of 3.5 per cent of GDP for decades to come” which makes debt relief imperative.
The leaked letter puts enormous pressure on Angela Merkel for two reasons: the German parliament only agreed to do this deal if the IMF was in it and it only agreed to do this on the specific terms previously offered.
Lagarde's letter follows (bold words may be marked by the Financial Times):
Dear minister:
Program discussions between Greece and the institutions have made progress in recent weeks, but significant gaps remain to be bridged before an agreement can be reached that would include the IMF under one of our program facilities. I think it is time for me to clarify our position, and to explain the reasons why we believe that specific measures, debt restructuring, and financing must now be discussed simultaneously.
In particular, a clarification is needed to clear unfounded allegations that the IMF is being inflexible, calling for unnecessary new fiscal measures and – as a result – causing a delay in the negotiations and the disbursement of urgently needed funds.
First, together with the other institutions we have negotiated in good faith with our Greek partners on a package of fiscal measures yielding 2.5 per cent of GDP – close to being agreed – that will in our view be sufficient to reach a primary surplus of 1.5 per cent of GDP by 2018. Our assessment is based on realistic assumptions informed by Greece’s track record, the international environment, and the latest data released by Eurostat.
Second, this target falls short of what Greece promised its European partners in July last year – namely that it would achieve a primary surplus of 3.5 per cent of GDP in 2018. If the Eurogroup decided to hold Greece to this target, we could support an additional effort to temporarily reach this level, although it is higher than what we consider economically and socially sustainable in the long-run (see below).
However, let there be no doubt that meeting this higher target would not only be very difficult to reach, but possibly counterproductive. Greece’s fiscal adjustment has in the past fallen short of what was needed because of the lack of structural reforms underlying the adjustment effort. We do not believe that it will be possible to reach a 3.5 per cent of GDP primary surplus by relying on hiking already high taxes levied on a narrow base, cutting excessively discretionary spending, and counting on one-off measures as has been proposed in recent weeks. The additional adjustment effort of 2 per cent of GDP would only be credible based on long overdue public sector reforms, notably of the pension and tax system.
Unfortunately, the contingency mechanism that Greece is proposing does not include such reforms. Instead, the authorities have offered to make short-term across-the-board cuts in discretionary spending – which has already been compressed to the point where the provision of public service is severely compromised – or transitory cuts in pension and wages not supported by fundamental parametric reforms. Based on past performance, such ad-hoc measures are not very credible, but they are also undesirable as they add to uncertainty and fail to resolve the underlying imbalances. I should also add that Greece has legislated a dozen contingency-type mechanisms in the past that have largely not worked.
Third, going forward, we do not expect Greece to be able to sustain a primary surplus of 3.5 per cent of GDP for decades to come. Only a few European countries have managed to do so, carried by a strong social consensus that is not in evidence in Athens. It would be unrealistic to expect future governments to resist pressure to relax fiscal policy over political cycles stretching far into the future. The recent experience – when first a center-right and then a center-left government quickly succumbed to easing pressures once a small primary surplus was achieved – should inform us against making such exceptional assumptions in the case of Greece. In our view, maintaining a primary surplus of 1.5 per cent of GDP over the foreseeable future may be achievable in the context of a successful program and strong European budget surveillance for many years to come thereafter.
understand the urgency of the situation in the case of Greece and Europe as a whole, and our common objective is to quickly agree on a way forward. This requires compromises from all sides, and we have contributed our part by focusing conditionality on what we see as the absolute minimum, leaving important structural reforms to a later stage. However, for us to support Greece with a new IMF arrangement, it is essential that the financing and debt relief from Greece’s European partners are based on fiscal targets that are realistic because they are supported by credible measures to reach them. We insist on such assurances in all our programs, and we cannot deviate from this basic principle in the case of Greece. The IMF must apply the same standard to Greece as to other members of our institution.
Sincerely,
Christine Lagarde
Also, Greek Finance Minister Euclid Tsakalotos wrote to his 18 Eurozone counterparts on Friday, ahead of Monday’s Eurogroup gathering, to appeal for their support against demands for extra austerity that, he argued, are beyond what any elected Greek government could deliver.
As explained in the previous letter by Christine Lagarde, the IMF thinks the targets are too tough and should be lowered. But if Germany and other Eurozone countries will not ease the targets, then more austerity is needed. Euclid Tsakalotos’s letter says this more than any Greek government can bear.
Dear Colleagues,
I am writing to you before our eurogroup meeting of Monday to clarify the position of the Greek government with respect to both the closing of the first review and the discussion on debt.
There is, I think, a general recognition that my government has kept to both the spirit and the letter of our summer agreement. True the closing of the first review has taken longer than expected but this does, to a large extent, reflect the sheer bulk of the reforms carried out over the last ten months. Many of the reforms needed very complicated legislation and required the help not only of the generous technical assistance provided but also lengthy negotiations with the institutions to get the legislation right from the beginning.
But it also reflects that we have been engaged not just with fiscal adjustment but serious structural reforms that address many of Greece’s long-standing weaknesses in the financial and judicial systems, in the tax administration (including a new autonomous and independent tax revenue authority) , and perhaps most importantly of all with respect to pensions. The reform on pensions, currently in parliament, addresses in a radical way, the sustainability of the system over the long run by integrating all existing funds into one, by providing the same rule for all pensioners and by reducing replacement ratios.
We have now agreed with all four institutions the items included in the first review, not only the fiscal package of 3% of GDP, but all the structural measures as well. The latter also include the opening up of the entire NPL market, apart from some temporary protection of loans related to primary residences, and the new Privatization and Investment Fund. From our perspective we have delivered all that was promised – in certain respects more. And all this in the context of recapitalizing our banks and addressing an incredibly complex and severe refugee crisis.
However as you know there is a disagreement amongst the institutions on the impact of the fiscal package since the European institutions, and ourselves, are convinced that the package is enough to reach the 3.5% primary surplus target in 2018, whereas the IMF argues that it is only enough to reach 1.5%. This estimate, it should added, is based on the same methodology that produced an under-forecast in 2015 by a magnitude of two billion! It is important to point out that a 2% divergence for 2018 is an extraordinarily large one. And this makes the proposal for an additional 2% parametric contingent measures legislated up front very problematic.
“Firstly there is no constitutional way to vote in contingent measures in Greece, and with talks I have had with colleagues, this also is the case in some other member states. So we would just have to legislate the measures and “merely” promise that they would be rescinded in 2018 if not needed. Appealing to both your economics and political experience, can you imagine taking to parliament instead of an expected package of 5.4 billion, one of 9 billion? Indeed any package in excess of 5.4 billion is bound to be seen by both Greek citizens and economic agents, within and beyond Greece, as socially and economically counterproductive. There is no way such a package could pass the present government, or, for that matter, any democratic government that I could envisage.”
Despite the above, and at great cost to us since our proposal is a very tough one indeed, we have engaged constructively with the institutions to build on the four key words, referred to by both Christine and Jeroen, in our last eurogroup: legislative, objective, automatic, credible. We have proposed an automatic regulator to make adjustment to our budget spending – on the discretionary and non-discretionary items in each ministry with a few specified exceptions for reasons of national defence or protecting the poor – in order to provide the additional assurance required by member states that we will be on course for a 3.5% primary surplus in 2018. The European institutions have given many suggestions for improving the mechanism in line with the eurogroup decision which we have taken on board. You should have our proposal in its final form by Monday.
I see no reason why such a mechanism, together with the reform package, should not be more than enough to close the first review. Which brings me to the question of debt which is also part of our summer agreement. I consider that what Greece now needs is a clear statement, of measures now and ones to be applied in the future, which will help investor confidence that Greece has turned the corner, and that country risk has (finally!) been removed from the agenda. Investors need a clear runway, which at the very least requires a clear statement from the eurogroup that Greece is on the right path, to invest thereby helping us turn a vicious circle of fiscal measures-recession-more fiscal measures into a virtuous cycle driven by growth. And it is not only a question of investment and growth. It is also confronting the reform fatigue of the Greek people who have faced over six year of crisis and have lost 25% of their GDP. A return to growth should mitigate the need for yet another round of new fiscal measures, but more importantly it will underpin a renewed reform drive at addressing our many structural problems. This must surely be in the interest not only of the Greek people but our creditors.
The elements for closing the first review and providing debt relief are, I firmly believe, all there. Greece has since the summer carried out its promise for reform while at the same time we have provided a source of geo-political stability in a very troubled region by the way we have responded to the refugee crisis. Nobody should believe that another Greek crisis, leading perhaps to another failed state in the region, could be beneficial to anyone.
My government, and I, will continue to work for an overall solution. But such a solution must be credible not only to our creditors, and the institutions, but to the Greek people, who ultimately need to “own” the programme and be able to sustain it. I would like to think that we are so close and not have to add “yet so far”
My very best wishes