Still working it out.

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IMF Would Be Other Casualty of Greek 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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All sides are working hard to prevent Greece from defaulting on its debt obligations to the International Monetary Fund -- and with good reason: Such an outcome would have dire consequences not only for Greece and Europe but also for the international monetary system. 

The IMF's "preferred creditor status" underpins its ability to lend to countries facing great difficulties (especially when all other creditors are either frozen or looking to get out). Yet that capacity to act as lender of last resort is now under unprecedented threat.

Preferred creditor status, though it isn't a formal legal concept, has translated into a general acceptance that the IMF gets paid before almost any other lender. And should debtors fail to meet payments, they can expect significant pressure from many of the fund's other 187 member countries. That's why instances of nations in arrears to the fund have been limited to fragile and failed states, particularly in Africa.

Greece's Fiscal Odyssey

The IMF has been able to act as the world's firefighter, willing to walk into a burning building when all others run the other way. Time and again, its involvement has proved critical in stabilizing national financial crises and limiting the effects for other countries.

Not long ago, it would have been improbable for the IMF to engage in large-scale lending to advanced European economies (the last time it did so before the euro crisis was in the 1970s with the U.K.). And it would have been unthinkable for the fund to worry about not getting paid back by a European borrower. Yet both are happening in the case of Greece. Moreover, compounding the unprecedented nature of the Greek situation, other creditors (such as the European Central Bank and other European institutions) are in a position to help provide Greece with the money it needs to repay the IMF. Yet that would only happen if an agreement is reached on a policy package that is implemented in a consistent and durable fashion.

If Greece defaults to the IMF, it would find its access to other funding immediately and severely impacted, including the emergency liquidity support from the ECB that is keeping its banks afloat. The resulting intensification of the country’s credit crunch would push the economy into an even deeper recession, add to an already alarming unemployment crisis, accelerate capital flight, make capital controls inevitable and, most probably, force the country to abandon Europe’s single currency.

The IMF also would be worse off. A Greek default would be the largest case of nonpayment since the institution was created in 1945. It would fuel both internal and external criticism that the fund had been co-opted by European politicians, adding to longstanding worries about the slow progress in reforming its outmoded governance, representation and some of its practices (including the “tradition” that the head of the institution always be a European). And it would make the IMF more hesitant to lend aggressively in other crises.

Fortunately, such a fate can still be avoided if Greece and its creditors succeed in completing what have been painful negotiations for all involved. If they don't, we would have to add the IMF's reputation to the casualties of a crisis that already has inflicted horrific suffering on millions of Greek citizens.

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