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Mohamed El-Erian: ‘The IMF Is Right About Greece’

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What to do with Greece? It’s a question that will likely be remembered for dominating discussion in 2012.

“Despite a courageous public stance by the International Monetary Fund, European officials failed again on Tuesday to deal with the critical issue of Greece’s debt sustainability,” PIMCO chief Mohamed El-Erian begins in an op-ed in Financial Times on Wednesday.

If this continues, he notes, they will undermine yet another bailout package for Greece and suffer further erosion in credibility, especially in the eyes of their own citizens.

“This latest bailout package is meant to improve things: by injecting more money into an economy riddled with payments arrears and virtually no financing for working capital (let alone new plants and equipment); and by accompanying this temporary financial relief with measures to bring the budget under control, re-capitalize banks and expand growth-enhancing structural reforms.”

Though well-intentioned, El-Erian writes that this bailout would likely fail if a major sticking point—Greece’s need for another major debt reduction—remains unresolved.

“The country would thus stay stuck in a recession that has ravaged the country for more than four years. Youth unemployment, already in excess of 50 per cent, would become more deeply embedded. And the social problems would continue, with a particularly devastating effect on the most vulnerable segments of the population.”

When confronted with yet another failure, he adds, European officials would “again point the finger of blame at the Greek government for not implementing the program in full. Greece would again blame program design. And the challenging regional environment would be lamented by all, as would the lack of responsive institutional mechanisms.”

But there’s help form an unlikely source—the IMF, and its willingness to speak out.

“A new element would now be hard to ignore: European officials’ repeated wish to brush under the rug Greece’s debt overhang. The IMF’s insistence—at the cost of angering some of its most important political masters—is anchored by solid theory and experience. By again refusing to take a meaningful haircut, he adds, European officials believe they are avoiding precedents that are not just politically tricky but could also fuel disruptive regional contagion. To the extent they are correct — and it is debatable — they would be winning a small battle by increasing the probability of losing the war.”

Until recently, he concludes, many European officials stubbornly held to the belief that “advanced countries” – and especially those that had risen to membership of such a privileged club as the euro zone – were structurally immune to “developing country debt crises.”

“Their outmoded mindset undercut responsive policy responses, wasting billions of Euros and undermining millions of lives. By again shying away on Tuesday from meaningful official debt reduction, Europeans signaled that they still lag realities on the ground.”