All Shall Be Well - Goldman's Latest Perspectives On Greece

From Erik Nielsen

Delegations from the IMF, European Commission and ECB – a reported total of 20 people – are arriving in Athens today to start negotiations on the macro conditionality of the rescue package.  Its been indicated that the IMF loan could be a 3-year Stand-by worth up to €12-15bn, co-financed by a €30bn package of bilateral loans from the other 15 Euro-zone members disbursed during the next 12 months.  Meanwhile, markets are reacting very negatively although– to my knowledge – there are no new news.

Please find below my answers to the most frequently asked questions related to the negotiations and the rescue package from investors in recent weeks:

1. What are the conditions for disbursement of the loans from the IMF and the Euro-zone, and how long time will it take before money can be handed over to the Greek government?

For the IMF loan to be activated the Greek government will need to agree to a set of macroeconomic policy conditions; negotiations with IMF staff begins today.  When agreed, staff will submit the draft agreement to IMF management and when approved it will be sent to the IMF Board for consideration.   The IMF staff is expected to spend the next week and a half or so in Athens, which means that formal approval and disbursement should be ready in time for the government’s May 19 amortization payments, assuming that it can be fast-tracked through management and the Board.  (Approval by IMF management and board can be considered a formality at that stage.)  The European governments need to get their bilateral loan offers approved by their national parliaments, a process that is about to get under way now.  French finance minister Lagarde presented to the cabinet this morning an allocation of €3.9bn for this year (out of the total French contribution of €6.3bn.)  The French government plans to present it to the National Assembly for a vote on 3-4 May and at the Senate on 6-7 May.   I suspect the other governments will have broadly similar time schedules, although, reportedly, the German government will not present the bill to parliament until Greece has officially requested the loan.  Once approved by the parliaments, Greece needs to make a formal request for the whole package followed by a unanimous decision by the 15 governments to disburse.

2. What will the IMF conditionality look like, and will the Greek government agree to it?

We expect the IMF to focus on three areas: (1) Fiscal contingency plans for 2010; i.e. if implementation of this year’s budget were to fall short of the expected cut in the nominal deficit of 4% of GDP then there will be pre-agreed additional measures implemented. (2) Fiscal measures for 2011 and 2012 to secure the necessary further reduction in the deficit down to 3% of GDP in 3 years.  I suspect that the IMF will require tougher measures than presently envisaged by the government because their medium term fiscal plan suffers from some of the same optimism that caused the protracted policy adjustments for this year; and (3) structural measures to restore competitiveness and hence growth in the medium term.  In other words, I am pretty sure that the IMF’s objective at this stage is to restore debt sustainability via policy adjustments, and not via a forced debt restructuring.  One would hope that the government will agree to such measures because they are required to restore medium term debt sustainability.  However, PM Papandreou’s statements in the Greek press yesterday leave me somewhat concerned, particularly with respect to structural reforms and the restoration of competitiveness.  If this becomes a major issue, then I suspect that the IMF might settle for a smaller and shorter program to help them through the May payments, but for investors this ought to be a major concern.

3. Can anything go wrong in these processes?

Sure, but it’s unlikely when it comes to securing the payments through May.  The IMF loan could be held up if the Greek government does not agree to the necessary conditionality, but as indicated above, I think the IMF might then try to settle for something less to help them over the imminent liquidity crisis.  Needless to say, this would be a major concern with respect to longer term sustainability.  On the European side, one or several parliaments could refuse to approve the loans.  If that were to happen in a small country, I suspect that the others would simply go ahead without them, and the package would be proportionately smaller.  If it were to happen in one of the four big countries we would have a major crisis on our hands, but here I think the Euro would be the single biggest casualty, as discussed under (4).

4. Are the IMF and European loans conditional upon each other being disbursed?

No, not legally, but while the IMF certainly could go ahead without the Europeans, I think it would be very difficult to see the Europeans go ahead without the IMF because (1) the link to the IMF was made explicitly in the statement from the summit, and (2) it would imply that macro-conditionality would not be sufficiently robust from the IMF.

5. Will the IMF and Europeans be senior to private creditors?

There is a long standing gentlemen’s agreement that the IMF is senior to others, but it is unclear whether the Europeans would claim the same status.  Historically, bilateral loans have not been senior to commercial loans, but we do not have a comparable precedence for such a tight linkage between the two sides to tell what would happen in this respect in the event of a future debt restructuring .  Unless explicitly stated otherwise, I would think it wise to assume that this rescue package is senior in its entirety.

6. If all goes well and the total €45bn (or so) package gets agreed and committed, are we then out of the woods?

No, unfortunately not.  The Greek government faces a financing gap of about €51bn during the next 12 months, and the IMF-EU deal would disburse “only” about €40bn (the first year’s share of a front loaded 3-year IMF program plus the EU money); and assuming that all conditionality is met every quarter.  This leaves more than €10bn to be financed mostly via short term T-bills to the Greek banks which will then repo it all at the ECB.  This is do-able, but it does not address the issue of sustainability.  To restore sustainability, the Greek government will need to pull off significant fiscal tightening of more than 10% of GDP (some 7%-8% of GDP on the primary fiscal balance) over the next 3 years, while raising about €150bn to pay debt redemptions and interest payments.  At the same time, growth needs to be restored to generate the necessary base for the tax collection, and for that to happen competitiveness will need to be addressed, including via a reduction in nominal wages of maybe 15% or more.

7. What to look out for? – Conditionality and a voluntary debt restructuring!

Since I continue to believe that the present liquidity crisis will be resolved (but watch the parliamentary proceedings), I’ll pay particularly attention to the macro conditionality now being negotiated, and the government’s commitment to carry it through.  This is critical for the longer term debt sustainability.  As mentioned above, I do not think we are about to cross into the territory of forced debt restructurings, but I would certainly look out for signs that the government might offer a voluntary debt restructuring arrangement sometime over the next few months to address the payment humps in 2011-2014.  Clearly, a large multi-year official rescue package combined with a voluntary debt restructuring would create a much longer breathing space for the government to undertake the necessary reforms.  This is important because the size of the necessary adjustments suggests that this really isn’t a three year operation; a ten-year undertaking seems much more realistic.  To me, this is probably the best-case scenario for how this will all pan out.  Shortfalls on policy conditionality, official financing and/or voluntary smoothing operations for existing payment obligations would likely end in tears.

Stay tuned