Squaring the troika triangle

Markets have learned to approach meetings of EU leaders with very low expectations, but this week’s offering even managed to fall short even of these. Markets are right to be worried. The disagreements emerging between the IMF and the EU are disturbing because they could mark the beginning of the end of the troika that has backed the bailout programs to date. That would spell disaster for the ability of the eurozone eventually to emerge from the other side of the sovereign crisis.

The presence of the IMF has been crucial from the beginning. It has bought expertise in constructing and monitoring adjustment programs and has acted as an external arbiter. For countries receiving assistance, it is a politically a less contentious bank manager to report to than the EU. What is surprising is that it has taken this long for the cracks to emerge.

For its part, the IMF has a reputation to maintain. It has not lost money on a lending program. When it has undertaken other programs, it has more often than not imposed losses and restructured borrowing at the beginning to put debt onto a sustainable footing. With Greece, private sector debt- holdings were eventually restructured, more than a year after the initial bail-out. But even then, the IMF was doubtful that the 120% of GDP target would be met by 2020. Even if it were achieved, this would still be double the level regarded as sustainable by the EU under the fiscal compact (and its predecessor).

The priorities of both sides are diverging. The IMF wants to ensure that Greek debt is on a sustainable footing. Increasingly an official-sector involvement (writing down ECB holdings, loans made via EU) would have to be part of this, in the IMF’s view. The EU, for its part, does not see this as an option, not least because it would be seen as violating the treaties under which the single currency operates. Furthermore, each leader has its own domestic electorate and Merkel knows that writing down German lending to Greece would spell electoral disaster.

Either the IMF is going to step back from further involvement (e.g. with Spain), demand more if it does engage or make further involvement conditional on the EU dropping its steadfast refusal to consider official-sector write-downs. Of course, this does not automatically translate into a negative factor for the euro, but if the IMF does step back then investors will rightly struggle to retain their faith in the remaining institutions.

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