A year ago, I wrote an article about what an IMF bail-out would look like. At the time I was a lone voice as the scenario seemed unlikely. In the past few weeks the IMF has often been mentioned. I dusted off my article and am re-publishing it so that everyone can understand the implications of an IMF Bail-out.
I thought it useful to look at Greece as an example as I visited the country in 2018. The more I researched, the more I felt like I was reading a Greek tragedy.
The Greek crisis started in the aftermath of the Global Financial Crisis of 2007/08 after revelations that Greece entered the EU, and maintained its membership, by using fake economic data. In other words, they lied about the size of their debts. This news triggered credit rating downgrades to junk, capital flight and bond yields spiking to unsustainable levels. Basically, 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 ECB and the IMF, bearing gifts. They offered help in the form of loans but with stringent conditions attached, including severe austerity measures, structural reforms and 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 US$375 billion. Loans came in drips and drabs, subject to regular reviews of the implementation of reforms.
There were dramatic scenes as people protested, the government changed, banks closed for a while, terms were renegotiated over and over again (from lowering of interest rates to increasing the term of each loan), private bond holders were forced to accept a 50% cut on their investments and state assets were sold to insiders at rock bottom valuations.
But the biggest toll was borne by the Greeks 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 since 2010.
And the effect? After the first loan was implemented Greece suffered the longest recession of any advanced economy since the Great Depression, lasting for five years. The economy shrunk by 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 debt reduced from the original 300 billion euros to 226 billion euros, its debt-to-GDP ratio 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 massive tax evasion, 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 will face an uphill battle in managing its debts, sustaining economic growth and supporting the rising number of the poor. Greek banks are weak, as are the private sector balance sheets. Some capital controls remain in place. And although the economy is growing, it is still only three-quarters of its pre-crisis size.
So, what can we learn from this riveting drama? It’s simple. An IMF-imposed austerity damaged economic growth, deflated wages, increased unemployment and reduced tax receipts, making it harder to pay debts and run a country.
South Africa must beware – here be dragons.
Magda Wierzycka is the CEO of Sygnia.