IMF and EU policy Responses to Greece Economic Crisis - Case Study Example

IMF and EU policy Responses to Greece Economic Crisis Name College Course Tutor Date Prior to Greece economic crisis, which started on fall of 2008, the government of Greece accessed substantial loan from abroad to fund the current account deficits and the budget. Between 2001 and 2008, Greece economy recorded a robust performance of 5 percent compared to other Eurozone economies which struggled at a paltry 2 percent. During the year 2009 Greece operated a budget deficit in the region of 9 percent. Studies points that successive Greece governments spent heavily on non-development projects resulting in current account and budget deficits. The double deficit, both the budget deficit and current account deficit forced the Greece government to borrow from international markets, which by 2009 plunged the country’s economy into a massive debt of 116 percent of GDP. According to Maastricht Treaty, a country’s permissible budget deficit should by 3 percent of GDP and external debt is 60 percent of GDP.As at that time Greece was not alone, as other 25 countries had exceeded that limit. Greece debt crisis has sucked I.M.F and EU into domestic politics and geopolitics hence threatening to tear the European economic relationship. IMF and AU recommendations on the Greece recovery has proven futile. Greece fiscal policy is pro-cyclical; the Greece government has been adopting budget cuts whenever the economy slips back into recession. For example in 2010-2011, the Greek government cutback its expenditure by 8.7 percent of GDP. The strategy was not able to solve the economic crisis instead the economy shrunk therefore the taxman was unable to collect sufficient revenue to resuscitate the economy. The Stand-By Arrangement by IMF and Greece upon review in 2010 showed that the projections was underestimated by 6.9 percent. The drop of two thirds took place between the fourth and Fifth Review under five months in December 2011. The IMF in 2012 adjusted its strategy towards increasing revenue streams for Greek economy hence shifting the gears in 2013-2014 by cutting spending and this exacerbated the recessionary situation. The IMF projection assumes that privatization revenues will be 22 percent of Greek GDP by 2017.In the past two years privatization revenue has not be able to jumpstart the Greek economy as the projections indicate that by 2020 the actual debt/GDP ratio will be 138 percent instead of a reduced target of 120 percent. The policy recommendation by IMF was jeopardized by unresponsive Greek economy coupled with sluggish Eurozone economy. Greek economy experienced a robust growth in 2000-2009 of 4 percent real GDP growth compared to 2 percent of Euro area and the growth was attributed to unsustainable drivers. Greece upon admission into Euro area, credit availability meant that the Greece government borrowed to finance huge wage increments, which had a bearing on increased consumption. There was also increased public spending. Instead, the Greece government had an option of spending in development projects that would have yielded returns to the economy. According to European Commission(2010) the Greek uncompetitive economy and perpetual fiscal imbalances coupled with the global credit crunch of 2008 made the economy susceptible. The classification of Greek bonds as “junk” by rating agencies was subjective and it deepened the Greek economic crisis. The Greek request for bailout was subjected to conditions, which bordered on political interference by both the EU and IMF. Opponents of interventionists policies by IMF argues that funding by IMF was morally hazardous as it has limited impact on the economy in terms of recovery. Research studies indicate that IMF intervention as a matter of fact exacerbated lending and borrowing as implicit assurance given by IMF makes countries like Greece not to struggle to avoid mistakes hence remain solvent (Döbeli and Vanini, 2004 and Vaubel, 1983). Greece’s initial bailout was about restoring confidence and ensuring financial stability (European Commission, 2010) an objective, which was not achieved. On the other hand, some researchers argue that the IMF intervention does not constitute a moral hazard since the resources provided does not have a significant impact in the economy(Lane and Phillips 2000, and Zettelmeyer, 2000). IMF Managing director press release on Greece’s first major bailout stated that “the success of Greece’s recovery program will depend, first and foremost, on the commitment of its government and people” (IMF Press Release 10/176. May 2, 2010). The statement meant that IMF assistance was laced with the geopolitics and domestic politics. Greece citizens took to streets to protest against a raft of measures proposed by EU and IMF on Greece government. The points of contention among the Greece citizenry was job cuts , reduction in public spending among other measures that was geared to reducing costs but which proved to be costly political mistake. European community considered Greece as a valuable member due to its strategic location. The Greece location presented opportunities for expanding western influence further, which in their mind could curtail communism and Soviet expansionist policies. According to Tsinisizelis& Michael(2008) Greece integration and continued stay in the European Union was political. The AU standards for a country to be its member is contained in the Maastricht Treaty, which sets the criteria for a country to be eligible for admission into European Union. First, the annual deficit of the government must not exceed 3 percent and debt ratio should not be more than 60 percent of GDP at the end of the preceding year. Secondly, a country must have membership in Exchange rate mechanism and the prospective member country should not have devalued its currency for a minimum two years before admission into the AU. Thirdly, inflation rate the inflation rate must not go beyond one and half times in terms of price stability that of the best three member states. Fourthly In terms of price stability, the nominal long-term interest rate must not go beyond 2 percent points that of best –performing three countries. Therefore, Greece admission and continued stay in the European Union was political. Measures frequently devised by European Union and IMF was laced with political undertones. According to Verney (2009) Greece economy did not meet the criteria set by the Maastricht Treaty in the first place. The adoption of IMF guidelines on recovery strategies since 2010 popularly known as ‘’ the Troika’’ .The terms are decided by the European Commission, European Central Bank and IMF with consultation with the Greek government. The opaque terms proposed used by these institutions as structural reforms that they allege to change the downward spiral of Greece economy is seen experts to be political. The implementation of this structural reform programs has made the economic situation to be worse. The IMF’s standby Arrangement that was under fifth review in 2012 and Greece economy was under recession for the fifth year. Reinhart& Rogoff(2009) compares the economic losses of 14.4 percent of GDP in 2007 to projected downward trend, to the worst financial crises in 20th and 21st centuries. The unemployment projections by IMF an important economic indicator shows that IMF was off the mark as shown in Figure 2 as projected job losses are enormous than projected. The social cost of IMF recovery strategies has been unprecedented job losses, which is projected to be 17 percent in 2016 compared to pre-crisis rate of 7.7 percent. EU perceives the Greece as creditor .EU also has vested political and ideological interest in Greece and their recommendations towards improving the Greece economy borders on dictating the general direction of Greece politics. The EU has all along recommended lean government in Greece with limited regulation and having lean labour force and weaker labour unions. On the other hand, IMF in its recommendations downsizing the public sector. To that extent it is crystal clear ideological and political is a priority to the AU and IMF rather than real economic recovery of Greece. This is because the downsizing has not been able to solve the issue of underperforming economy and it could lead to worst suffering of Greece citizens. Real GDP Projections Source: IMF, Various and Hellenic Statistical Authority. FIGURE 2 Source: IMF, Various. To some extent, some programmed policies by IMF and EU of devaluing the Greek currency are justified since it makes the economy more competitive and at the same time efficient. To the contrary the raft of measures recommended by IMF and EU shows that the Greek economy did not respond and where positive responses were noted it was because of the overall improvement of world economy. Troika’s myopic views of micro-economic impacts of their policies which are pro-cyclical has continued to baffle researchers. Troika’s recommendation towards resuscitating the Greece economy has always resulted in negative deviations, which they attribute to Greek government failure to institute structural reforms. IMF in its record acknowledged that the targeted programs entered into difficult phase at some point because investor confidence could not be regained since the structural reforms taken assumed a slower phase. The explanation offered by IMF was not plausible since the economy was deficient of demand due to tightening of budget, leaving many Greece citizens with little money to spend. The projected Greek economic growth has been painfully slow for these reasons. Despite policy guidelines and exertions by EU and IMF on Greece government, the economy is unlikely to respond positively and in fact, economists predict that the structural programs might make Greek economy to default in their obligations thereby making the economy to sink even further. IMF and EU should adopt genuine and practical measures towards rescuing Greece economy. Non-partisan approach should have been adopted. EU and IMF can bail out the Greek economy almost in an instant by writing-off its debt rather than negotiating an additional loan with little interest. They can also allow the Greece government to adopt fiscal stimulus hence facilitating quick recovery. The European Union even with the foregoing circumstances in Greece are not willing to climb down from their positions. They are unwilling to let go of debts which Greece government owe. In the light of situation at hand, the rigidity has led to questions on the rationale behind their position. With this continued impasse, the likelihood of default of Greece government defaulting in its foreign debt is real. . References 1. Árvai, Z., K. Driessen and I. Öther-Robe (2009),'Regional financial interlinkages and financial contagion within Europe', IMF Working Paper 09/6. 2. European Commission (2009i), The return to viability and the assessment of restructuring measures in the financial sector in the current crisis under the State aid rules, 2009/C 195/04. 3. Gulati, Mitu and Lee C. Buchheit. 2010. “How to Restructure Greek Debt.” Duke Law Working Papers. No. 47. http://scholarship.law.duke.edu/working_papers/47/ 4. Hellenic Statistical Authority. Online Database. Accessed February 2012. http://www.statistics.gr/portal/page/portal/ESYE 5. IMF (International Monetary Fund). 2011a. “Greece: Fifth Review Under the Stand-By Arrangement, Rephasing and Request for Waivers of Non-observance of Performance Criteria; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Greece.” http://www.imf.org/external/pubs/ft/scr/2011/cr11351.pdf 6. IMF (International Monetary Fund). 2011b. “Greece: Fourth Review Under the Stand-By Arrangement and Request for Modification and Waiver of Applicability of Performance Criteria.” http://www.imf.org/external/pubs/ft/scr/2011/cr11175.pdf 7. Reinhart, Carmen and Kenneth S. Rogoff. 2009. “The Aftermath of Financial Crises.” National Bureau of Economic Research Working Paper No. 14656. http://www.nber.org/papers/w14656. 8. Reinhart, C. and K. Rogoff (2008), 'Is the 2007 US Sub-Prime Financial Crisis So Different? An International Historical Comparison', American Economic Review 98(2), 339–344. 9. Spiegel, Peter. 2012. “Greek Debt Nightmare Laid Bare.” Financial Times. February 21. http://www.ft.com/intl/cms/s/0/b5909e86-5c0f-11e1-841c- 10. Tsinisizelis, Michael (2008). Greece in the European Union: a political/institutional balance sheet. About Greece 145-158. 11. Verney, Susannah (2009). Flaky Fringe? Southern Europe Facing the Financial Crisis. Southern European Society and Politics. 14:1, 106. Read More