IMF stays tough on debt relief as it prepares to return to Greece

International Monetary Fund (IMF) officials are once again emphasising the need for debt sustainability in any lending programme, as the fund prepares a new mission to Greece.

Lending cannot go ahead if the debt service proves too burdensome for a government to cope. "Any assessment of debt sustainability needs to be underpinned by realistic – rather than heroic – assumptions regarding future growth prospects," write Sean Hagan, Maurice Obstfeld and Poul Thomsen in a blog post on February 23. They are the IMF's general counsel, chief economist and European department chief, respectively.

The IMF and Greece's European creditors have long offered differing assessments of the point at which Greece's debts may become too crushing. Europe has pushed for a 3.5% primary budget surplus target, which the IMF says will do more harm than good.

This week, however, there were signs of a thaw in relations. "We have intensified talks in the last week and a half, to find enough common ground for the institutions to go back to Athens," said Jeroen Dijsselbloem, president of the Eurogroup, on February 20.

The emphasis will now be more on structural reforms – to tax, pensions and the labour market. "There will be a change in the policy mix, if you will, moving perhaps away from austerity and putting more emphasis on deep reforms," Dijsselbloem told a press conference.

The news means an IMF team will return to Greece "early next week", as confirmed by the fund's spokesman, Gerry Rice, on February 23. Rice called the Eurogroup agreement "good news", but added: "Let me just reiterate. For the IMF to come on board with a financing arrangement, that debt relief is equally important as the agreement on the strong policies."

It appears the IMF may have come out on top in the face-off with Europe. The fund has stood its ground on debt sustainability, and many European politicians made it clear they were not willing to continue talks with Greece without the IMF on board. Nevertheless, an agreement on budget targets and debt relief is yet to be struck.

Realistic assumptions

As Hagan, Obstfeld and Thomsen write, the IMF is prevented by its own legal framework from giving financial support if a country's debt is found to be unsustainable. They also stress the IMF must do its own analysis on sustainability and cannot delegate it to any other parties.

During the analysis, it is "critical" to make assumptions on primary surplus targets that improve sustainability over time, they say, "rather than levels that would disrupt the economy so severely that tax revenues actually fall and fiscal targets are abandoned".

Though they only mention the southern European country in passing, it is clear the analysis applies well to the Greek case. "Pretending that unpayable debts can be repaid will only sap the effectiveness of the debtor's adjustment efforts, ultimately making all parties lose more than if they had promptly faced the facts," the officials warn.