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Greece’s Worst Option: IMF Default

Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”
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Finance Minister Yanis Varoufakis's surprise decision to meet with International Monetary Fund Managing Director Christine Lagarde in Washington on Sunday added to the suspense over whether Greece would make its April 9 debt payment to the fund.

QuickTake Greece's Fiscal Odyssey

This is a consequential question because defaults on loans from the IMF, one of the world’s few “preferred creditors,” are extremely rare. When they have occurred, the debtors have tended to be fragile or failed states in the developing world and not advanced countries, let alone members of the euro zone, one of the world’s elite economic groups.

The very fact that the 450 million euros (almost $500 million) payment is in doubt reflects the extreme economic, financial and socio-political circumstances facing Greece. It is hard to imagine any outcome to this predicament that would improve Greece's lot.

Having struggled to restore economic growth, and with an unemployment rate of 26 percent, Greece isn't generating enough revenue to meet all of its obligations. Even though the economic logic mostly works in its favor, Greece's ability to mobilize additional funding from abroad has stalled due to both mismanaged negotiations and creditor intransigence.

Meanwhile, Greece's domestic socio-political context makes it difficult for the government to make payments to the IMF, especially as it struggles to pay salaries and finance basic social services.

Nonetheless, the payment to the IMF needs to be made.

Countries that default on their IMF obligations often experience widespread disruption to their cross-border financial relations. In the case of Greece, such a default would hinder the flow of funds from the European Central Bank, currently a lifeline for the country’s banks. And it would accelerate the outflow of deposits from banks, increasing the probability that a slow bank jog will turn into a destabilizing bank run. 

Realizing that, it is likely the Greek government will find a way to make the payment to the IMF by April 9 (or shortly thereafter within the allowable grace period) -- and after the meeting in Washington on Sunday, Lagarde said she had received "confirmation" from Varoufakis that the payment "would be forthcoming." But doing so may just be the least-bad option for Greece in a lose-lose situation.

The payment to the IMF wouldn't necessarily make it easier for Greece and its creditors to better work collaboratively to restore the country’s growth and financial viability with the euro zone. Sadly, it is more likely to exacerbate tensions and even increase the probability of a “Graccident” (that is, some type of economic/financial/political disruption that pushes Greece out of the euro zone against the wishes of all major players).

Even though Greece has undergone one of the largest fiscal adjustments in history, the continuing hemorrhaging of funds due to capital flight means that it can ill-afford a $500 million net transfer to one of its official creditors. If the outlay isn't matched rapidly by new funding from its creditors -- which has been mostly halted since August -- this highly visible depletion of funds could accelerate the withdrawals from domestic banks.

The government will also struggle to maintain its credibility with those who had been its most ardent political supporters -- people who bought into the electoral rhetoric of putting Greek interests ahead of those of foreign creditors. As a result, if the payment is made, the government may find it even harder to get legislative approval for the structural reforms the country needs. Concurrently, it would be expected to secure greater concessions from creditors, including a meaningful relaxation of austerity and significant debt forgiveness.

The uncertainty over this week’s payment to the IMF is just the latest episode of a multiyear tragedy for Greece and its creditors as they try to navigate a situation that has been managed too timidly for too long. Unless the two sides collaborate more effectively toward more decisive outcomes, it is a matter of time before one of these episodes becomes the ultimate catalyst for a Graccident that all are eager to avoid.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Mohamed A. El-Erian at melerian@bloomberg.net

To contact the editor on this story:
Max Berley at mberley@bloomberg.net