As Greece knows all too well, beware the IMF dragons

Austerity Programme

An IMF bail out is often mentioned as the “dark scenario” facing SA if we do not get our finances in order. I thus thought it useful to look at what an actual IMF bail out looks like, choosing Greece as an example, probably because I visited Greece in July. The more I researched, the more I felt like I was reading a Greek tragedy.

The crisis started in the aftermath of the global financial crisis of 2007/2008 after revelations that Greece entered the EU, and maintained its membership, by using fake economic data That is, they lied about the size of their debt. This news triggered credit ratings downgrades to junk status, capital flight and bond yields spiking to unsustainable levels. If Greece wanted to borrow more money to fund running the country and the repayment of existing debt, it would need to pay unaffordable interest rates. This meant existing creditors faced a very real risk of Greece defaulting on all its existing debt obligations.

In 2010 three players entered the scene the European Commission, the European Central Bank and the IMF bearing gifts. They offered help in the form of loans but with stringent conditions attached, including severe austerity measures, reforms and the privatisation of state assets. Eventually one loan was not enough. There were three series of loans, in 2010, 2012 and 2015, ultimately amounting to about $375bn. There were dramatic scenes as people protested, the governing party was voted out, banks closed, private bondholders were forced to accept a 50% haircut on their investments and state assets were sold to insiders at rock bottom valuations. But the biggest toll was borne by the Greek people themselves. Pensions and wages were cut, the public sector was dramatically reduced, taxes rose and the power of trade unions was greatly diminished by the abolishment of collective bargaining agreements.

All in all, the government enacted 12 rounds of tax increases, spending cuts and reforms after 2010. And the effect? After the first loan was implemented Greece suffered the longest recession of any advanced economy since the Great Depression, lasting five years. The economy had shrunk 26% by 2014, while the unemployment rate rose from below 10% to over 25%. By 2014, 44% of Greeks lived below the poverty line and 20% lacked money to buy food. By 2017, although Greece’s overall debt had reduced, its debt-to-GDP ratio had shot up from 127% to 179%, the world’s third highest after Japan and Zimbabwe. In response to a shrinking economy the government doubled taxes.

Personal income tax rose to 70% and VAT to 23%. This encouraged tax evasion a problem before the crisis, perpetuating the recession. Many firms relocated abroad, while over half a million skilled Greeks, out of a population of 10.8 million, left. By mid 2017 things seemed better. But this was temporary. Further credit lines were needed, further austerity commitments were made, including more changes to labour laws, a cap on public sector employment and a reduction in pension and social security payments. Greece trumpeted exiting the bail out programme on August 20, 2018. But the IMF has warned that it faces an uphill battle in managing its debt, sustaining economic growth and supporting the rising number of poor.

Greek banks are weak, as are private sector balance sheets. Some capital controls remain in place. Although the economy is growing again, it is three quarters of its pre-crisis size. So, what can we learn from this riveting drama? An IMF imposed austerity programme damaged economic growth, deflated wages, increased unemployment and reduced tax receipts, making it harder to pay debts and run the country. SA beware – here be dragons.

Publication: Business Day (Late Final)
Date: Wednesday, October 10, 2018
Page: 7