Greece's Debt May Not Be So Daunting

11 JUL 20, 2015 3:13 PM EDT

By Leonid Bershidsky

Bloomberg

Greece's debt burden has taken on mythological attributes and questions about the dominant narrative have become a form of heresy. I, too, have repeated the line that "even the IMF considers Greece's debt unsustainable." Yet that is a half-truth and it has the potential to distort policy.

The assertion comes from a June 26 International Monetary Fund document that Greece's former finance minister, Yanis Varoufakis, called a "fascinating read." In his bombastic style, he went on to assert: "Never before has a veritable institution advocated policies that clashed so mercilessly with its own research. Never before has the IMF agreed, on economic analysis, with a government it sought to devastate."

But the IMF research paper didn't agree with the economic analysis of Prime Minister Alexis Tsipras's government. What it said was that the actions of this government, and the previous one, drove the 2012 bailout program off track and increased Greece's financing needs.

"If the program had been implemented as assumed, no further debt relief would have been needed under the agreed November 2012 framework," the IMF document read. In fact, it claimed Greece would have achieved better-than-projected debt-to-gross-domestic-product ratios by 2020 and 2022. "However, very significant changes in policies and in the outlook since early this year have resulted in a substantial increase in financing needs," the IMF went on. Greece wasn't collecting enough taxes, privatization stalled and growth lagged.

Varoufakis and Tsipras shouldn't try to co-opt IMF analysts as allies, even if they end up calling for debt relief. The IMF is operating by a different logic, though it also is easy to question.

As Julian Schumacher and Beatrice Weder di Mauro of the University of Mainz pointed out, the templates the IMF uses for its debt sustainability analyses are available to the public and can be tested. There are two frameworks: one for relatively rich countries with market access, the other for poor ones that cannot borrow on the financial markets. For Greece, the IMF used the rich-country one, which focuses on nominal debt levels. From that point of view, Greece looks horrible: Its debt, the IMF says, will peak at about 200 percent of GDP in the next two years if its financing needs are met.

The problem with that approach is that the rich-country model no longer is relevant to Greece. Sure, its per capita GDP remains high -- almost $26,000 in 2014, taking into account purchasing power parity, making it 44th in the world -- and the poor-country framework is only applied to really low-income nations with per capita GDP below $1,200. It could be argued, however, that Greece, with 25.5 percent unemployment (and more than 60 percent of young people out of work) and with capital controls that allow a bank depositor to withdraw only $420 a week, may no longer qualify as a first-world country because it has neither the economic wherewithal, nor the market access. Greece may not recover these for years.

Also, it shares an important feature with the countries to which the IMF applies the low-income framework: most of its debt -- 79 percent -- is held by public-sector lenders. Most of the rest is in long-term bonds that banks and funds received during the 2012 debt restructuring.

Schumacher and di Mauro point out that because of that profile, the low-income country framework, centered on the present value of debt, may provide a more accurate picture. Using the IMF and World Bank's 5 percent discount rate, they calculated that the net present value of Greek debt is 93 percent of GDP, 281 percent of exports and 213 percent of government revenue.

The first two numbers are terrible. World Bank calculations (for gross national income, a measure close to the GDP, and for exports) show similar ratios for countries such as Jamaica and Liberia, and that also includes private debt. Such data send strong distress signals: This is a country that needs debt relief.

However, even at 213 percent, the present value of Greek debt relative to budget revenue is below the IMF's danger threshold.

What that means is that, by IMF standards, Greece's debt is not really an unbearable burden on the country's government, which is supposed to be repaying it, even though it looks too big for the underlying economy.

But Greece, of course, isn't an economic outsider like Liberia, and developing-world standards shouldn't apply. It is an emerging special case that, according to Schumacher and di Mauro, needs a different debt sustainability model, preferably one that all the creditors and the government could accept.

For the moment, no one, not even the IMF, has any idea of whether Greece's debt is sustainable. That may explain why the German Finance Ministry rejected the IMF analysts' suggestion of extending maturities by "say, 30 years on the entire stock of the European debt" -- a strangely imprecise phrasing for the institution. It also may be why German Chancellor Angela Merkel hasn't explicitly responded to the possibility of debt restructuring as a reward for compliance with policy guidelines imposed by the creditors. What is clear is that Greece has a liquidity problem and that its economy needs to start growing again. With luck, that's being fixed. In the meantime, economists at the IMF, the European bailout fund and the European Central Bank should take another look at sustainability frameworks, agree on one they like and suggest a solution. There's still time.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:

Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:

Max Berley at mberley@bloomberg.net