Working Magic – Approval in Principle

The Greek saga continues – not as the time bomb threat of the summer of 2015 but still as a story that seems never to end. It is a saga where in which the authors dedicate time, money and most important political fantasy and even magic. Think about a friend who is in dire need of money. You are somehow willing to help, but then you are limited by rules of your budget that allow you only under certain circumstances to bail out your friend. As a result, you tell your friend that his demand is approved in principle but that you can’t provide financial resources at this point. Assume further, that you are not the only one to whom your friend turned for support. The other friend of your friend also would like to help but only under the condition that you help, too. This seems like a classical catch-22. And yet, the solution is simple. You create in writing an Approval in Principle (API), and this interprets the friend of your friend that you are on board. Money flows and life is good again.



That’s what happened with Greece, the EMS and the IMF the other day. The IMF created an API, and ECOFIN was happy to give the green light in principle for de-icing the next trench of the Greek rescue package.

The repayment schedule for Greece is impressive regarding time and size. Time-wise, it is clear that Greece has to deal with at least 20-25 more years with payments for the accrued debt. Size-wise, the repayment constitutes a burden for the Greek economy. Latter is at least the perspective of the IMF that declared Geek debts utterly ads not sustainable, and thus wants to provide money to Greece only in the case the largest creditor of Greece, the EMS, is willing to cut a substantial part of Greek debts. The EMS and the largest creditor under the leadership of Germany see a partial debt cancellation as politically impossible. The IMF uses two methods to evaluate debt sustainability, where the second one is relevant for Greece as it looks a situation where debt has a long maturity and low-interest rates. Under those circumstances, the IMF asks whether the country’s annual financing needs for covering gross payments of interest and principal as well as its primary fiscal balance is compatible with the expected economic development. The current rescue program for Greece asks for an annual primary budget surplus of 3 .5% of GDP, and this over a very long period. The IMF sees such a surplus possible but only for a few years and not for a long period as it would run into serious legitimization problems, i.e. there are social limits for a longer lasting period of high primary budget surpluses. As a consequence of such an analysis, the IMF demands a far-reaching debt haircut and a lower budget surplus target of 1.5 % that would give any Greek government some breathing room. Still, the IMF continues to demand harsh and serious reform, in particular in regards to effective taxation as Greece continued to be a weak effective tax state.

The creditors and in particular Germany is not willing for a serious debt cut. However, to bring the current tranche through the Bundestag Schaeuble and Co need the participation of the IMF in the rescue mission. Latter only can participate if there is a debt cut. API is the tool to overcome this circle. Both, the IMF and Germany keep their face, and the game can continue. Given the relatively good news from the Eurozone when it comes to the growth of GDP and the rate of unemployment in combination with its external position, the postponement of the Greek saga is no longer disturbing or even risking the existence of the Eurozone. This relative stability works against Greece as its creditors now feel much stringer than in summer 2015. Sure, small concessions will come after September when Germany’s elections will be over. However, the concession will be a far cry from the debt cut the IMF is asking for.