IMF report predicts long, painful road ahead for Greece's recovery

By Howard Schneider
Washington Post Staff Writer
Wednesday, May 12, 2010; A11

ATHENS -- An internal International Monetary Fund assessment paints a dour picture of Greece's path to economic recovery, with years of high unemployment rates, slow growth and political bickering threatening to undermine a recently approved international rescue program.

In crafting a $140 billion, three-year bailout for the indebted country, IMF and European officials praised the Greek government for the budget cuts and tax increases it has enacted, and for its plans to further overhaul one of the continent's least competitive economies.

But a detailed staff assessment, released after the IMF board approved the rescue program, describes both the depth of the social shock in store for the nation and the substantial risks that could push Greece back to insolvency.

There are global implications: The rescue program for Greece was approved to stop a "contagion" from undermining confidence in other highly indebted European countries, eroding the value of the euro and weakening banks, and possibly throwing the world economic recovery off course with a new financial shock.

Plan at risk

The risk that the joint IMF-European Union rescue plan will come unwound is "undeniably high," said the IMF staff report, which detailed how variations in the fund's assumptions about growth, inflation, interest rates, restructuring and other variables could leave Greece's debt load climbing despite the efforts to bring it down.

Indeed, the report suggested, the effort to aid Greece was justified as much by the "systemic concerns" posed for the world economy by a Greek default as by the likelihood that the program will succeed.

The level of concern that Greece's problems might spill over to other countries became clear last weekend when European finance ministers and the IMF approved a separate, near-trillion-dollar effort to support other indebted European nations if they run into trouble.

The program was considered an emergency measure, and markets around the world rose Monday, although the euro fell Tuesday as U.S. markets remained flat. But its success is far from guaranteed, requiring some of the same difficult political choices in other parts of Europe that Greek society is trying to navigate.

The IMF staff report described in unvarnished terms the pressures that are likely to mount.

After years of growth fueled by low-interest borrowing available after Greece adopted the euro, the country must now go through years of "internal devaluation" -- falling wages, rising unemployment rates and stunted growth. As a member of the 16-nation European Monetary Union, the country does not have its own currency. But using local economic conditions, the IMF staff estimated that the country's "effective exchange rate" was overvalued by as much as 30 percent -- an excess that will have to be squeezed out of the economy in a "long and painful process."

The first round of adjustment is already underway in the form of government spending cuts and tax increases equivalent to more than 8 percent of the country's economic output.

Though intended to make the economy more productive in the long run, the size of those initial steps will first serve as a drag, keeping the country in recession for at least another year and helping drive the unemployment rate to near 15 percent in 2011.

The rate is projected to remain near that level for perhaps five years.

"The burden of adjustment will test the cohesiveness of Greek society," said the IMF staff report, which envisions "fierce resistance from entrenched vested interests" that may try to block reforms.

Prime Minister George Papandreou has pushed initial changes through the Greek parliament and is now working on a pension reform plan that the IMF says is critical to bringing the country's social spending into line by raising retirement ages and cutting benefits.

Going far enough?

Throughout the document, the IMF staff expressed confidence in the current government's willingness to follow through with promised changes, and Papandreou has been blunt in telling Greeks about the severity of the country's problems.

But the staff report also cited areas in which Papandreou was not willing to go as far as the IMF felt was needed -- rejecting some proposed changes that would drive down wages for employees of private businesses, for example, and not detailing which of Greece's long list of state-owned companies should be sold.

Despite the difficult steps already taken, the IMF staff said, some of the harder political choices -- ones that involve narrower and potentially influential constituencies in the government and the private sector -- have not been made.

The program's success "requires a decisive break from past behavior," the report said, and "hinges on deep and comprehensive structural reforms. . . . Without such reforms, Greece would not restore competitiveness, growth, and real incomes will remain stagnant and unemployment high, and the debt burden would eventually prove unsustainable."

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