piraeus bank group


Reverse Engineering and Phoenix Miracles

The publication of the ex-post evaluation, and (indirect) self-criticism of the IMF regarding its role and decisions on the 1st Economic Adjustment Programme implemented in Greece from May 2010 to March 2012, has been the cause of extensive comments and discussions. Although one may not agree with many of the IMF’s conclusions (and to agree in even more), one has to acknowledge that they were the only one of the involved parties that – rightly or wrongly, fairly or unfairly – entered into a public process of self-examination and validation of their policies and proposals.

Bearing that in mind, our objective is not to retrospectively criticize a programme established within tight timeframes and in an extremely uncertain and volatile economic and social environment. The real challenge is to be able to draw the right conclusions that will help us chart a better path from hereon in. Most of our criticisms focus on this issue.

One of the main concerns about the programme so far is the fact that all its forecasts concerning the level and the duration of the recession have been way off the mark. The official sector’s justification of this failure is that the severity of the recession has been systematically underestimated because Greece failed to stay on track with timelines for required milestones and was unwilling to implement crucial structural reforms. Certainly there is some truth in this claim. However, perhaps in its next review the IMF will also recognize another cause of failure. In Greece, the official sector has been forced to operate under two very important constraints: i) that the level of available funds for Greece is fixed at €246 bn and ii) that Greek public sector debt needs to be seen as sustainable. It is therefore highly likely that the official sector’s forecasts regarding key programme variables, such as GDP, inflation, deficit, privatizations revenues, etc include a certain degree of reverse engineering so that these two constraints are always satisfied.

The application of reverse engineering is evident in both the debt sustainability analysis (projections for both a fiscal surplus of 4.5% of GDP, that will be used exclusively for debt servicing needs, and at the same time for GDP growth of 3.7%) and the official sector’s forecasts for a moderation in the pace of the recession (from -6.4% in 2012 to -4.2% in 2013). The official sector’s rationale for this moderation is especially telling. Looking at the components of GDP, it is clear that consumption (public and private) will continue to shrink and that the external sector has very little potential to contribute to economic output. Therefore, the only way to mitigate the recession is through investment, the decline of which, according to the official forecasts will decelerate from -19.2% in 2012 to -4% in 2013. But, while experience from previous crises teaches us that, in times of recession, public investments support the recovery, in the case of Greece, these investments will have to come from the private sector, as there are no available additional resources for public investment projects. The problem with the implementation of reverse engineering though is that it cannot explain the way in which the private sector will expand its investment projects in an environment of declining demand for goods and services, high real interest rates and credit contraction. In an effort to somehow support this argument the recent IMF report includes a study which shows that Greek firms could finance their investments through their own funds and retained earnings. Examples of creditless recoveries are known in the academic literature as “Phoenix Miracles”. However, in Greece we know that the Phoenix was a "mythical" creature.