Free Lunch: The IMF's big stick

Foreclosing on the ECB?

Few have great hopes that an agreement between Athens and its creditors will be struck at the eurogroup meeting in Riga today, though some reports suggest Angela Merkel is coming around to the need not to push Greece into more austerity (h/t Eurointelligence).

The focus on intra-European quarrels, however, distracts attention from the IMF. As Simon Nixon has pointed out, Washington matters as much if not more than Brussels, Berlin and Frankfurt. That is not just because Berlin is hiding behind the IMF, as Nixon says. It is also because the financial facts give the IMF the whip hand over the eurozone.

It is reasonably well known that Greece is now paying its way - its only need for continued support is to refinance maturing debt, and most of this is to the IMF itself or the ECB. (Many think that Syriza's amateurism has already squandered the primary surplus. But the latest numbers show that by the end of March, public finances had caught up with the revenue shortfall recorded early in the year. The surplus is actually €2bn ahead of the forecast, though that is because of spending arrears. Dan Davies usefully spells out what this means for Greece's possible next steps: the hard deadline for Athens to decide what it wants is the July 20 payment to the ECB.

A less well-known fact is that of the almost €20bn left in the current rescue programme, virtually everything comes from the IMF. Only one last €1.8bn tranche is set to come from the EFSF, after which (if it ever comes to that) the end of the affair is entirely IMF-funded (except for about €2bn in profits the ECB has made on Greek bonds which the eurogroup has promised to return to Athens, which is still waiting). Add to that the IMF's status in the international community, which makes it the last creditor Greece would ever default on. So, you might ask, who are these pesky Europeans to decide on what conditions an IMF-only funded programme should continue or not?

The only reason for Athens to want a deal at all is of course the money. So if the IMF really wants one to happen, it will, and if it really doesn't, it won't. What if the IMF wants one and the eurozone baulks? The IMF's rules stop it from lending to governments that have imminent financing gaps. But if the IMF wants a deal with Greece, there is only one place such a gap arises. Not in Athens' primary budget because it has a surplus, one big enough to cover modest interest expenses as well. Not because of principal repayments to the IMF, which can be fully covered by the remaining IMF loan tranches themselves (if you think this is a stupidly roundabout way to organise things, you are right). So the gap would come from other maturing debts. The only ones of any size for the next few years are bonds held by the ECB.

It is within the IMF's power, therefore, to strike a bilateral deal with Greece which eliminates the financing gap by another round of "private sector involvement" - a restructuring of Athens' remaining sovereign bonds, in particular those held by the ECB. Before shooting this down as utterly unrealistic, consider the following:

First, the restructuring could be value-enhancing - ie Athens could offer a debt exchange swapping imminently maturing bonds for new ones with longer maturity but somewhat higher interest rates. It would in effect be a repayment extension with an interest bonus. The primary surplus makes this possible; the amounts are small. It's just the timing that is too lumpy.

Second, this need not hurt private lenders who were already restructured in 2012 or those who trusted Athens by buying new bonds in 2014. The former were given very long-term bonds so are not due repayments any time soon. The latter can be protected by limiting the restructuring to debt maturing in the next two years. That largely means bonds held by the ECB.

Third, it is simply wrong to say that the ECB cannot agree to a debt swap because this would amount to monetary financing of governments. A debt swap is exactly what it did a few weeks before the March 2012 restructuring to avoid being hit by it. If the swap is value-enhancing, this increases the ECB's profit. That's hardly monetary financing; if anything it reduces any monetary financing that has already taken place. The ECB's exposure was always in the form of tradable securities, to give the ECB the ability to sell if the price was right. The IMF can ensure that it is.

This won't happen. But a clear realisation that it is possible could make a difference. In particular, it could focus European minds on agreeing a collaborative solution in order to avoid an uncollaborative one.

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