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This could be Greece’s last chance to save itself

Nasos Koukakis, special to
Wassilios Aswestopoulos | NurPhoto | Getty Images

Despite decisive action proposed by the International Monetary Fund to ease Greece's financial burden, more turbulence lies ahead for the debt-ridden European nation, reveals the latest IMF report, which was delivered to the Fund's board members for consultation. CNBC has received the report through a close source to the IMF.

According to IMF deputy spokesman William Murray, the report will be discussed at the IMF's board meeting on Feb.6.

Among the reforms they are pressing are further cuts to pension programs and an increase in income taxes.

Without a substantial pace of reforms, Greece will be unable to narrow the gap in its real per-capita income relative to the euro zone and remain prosperous and competitive. This has prompted the euro zone's finance ministers to demand that Greece proceed with these necessary reforms until Feb. 20 or risk the IMF dissolving support of the Greek financial program.

The new, stringent rules

In the latest report, the IMF claims the Greek banks have a weak capital structure and are exposed to the risk of nonperforming loans. The Greek banks' current strategies require a reduction in the aggregate nonperforming loans ratio to 48, 42 and 34 percent by 2017, 2018 and 2019, respectively, but these backloaded NPL reductions "do not appear consistent with the Greek authorities' ambitious investment and growth assumptions."

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Among the measures included in the IMF report is the push to rebalance the policy mix toward growth-friendly and equitable policies and to lower the threshold of tax-free income. "Greece's revenue yields lag behind peers as high marginal tax rates applied on narrow bases encourage tax evasion, discourage labour participation in the formal economy and provide incentives for firms to relocate to low tax neighbouring countries," the IMF report said.

In addition, the IMF supports a further reduction to Greece's pensions, which in recent years have fallen by 40 percent. The report stresses that "while recent pension reforms have helped address expected long-run pressures from population aging, pensions for current retirees remain unaffordably high." At this point, the IMF is very critical, claiming that "the Greek authorities did not see a need to reduce pension spending or the income tax credit."

Debt is projected to be ‘explosive’

The IMF is hardening its stance not only against Greece but also across the euro zone countries seeking greater debt relief for Greece.

Yet even with with full implementation of policies agreed to under the ESM program, a debt sustainability analysis included in the report reveals that Greece's public debt is "highly unsustainable." It further emphasizes that Greece's public debt and financing needs will become "explosive" in the long run if Greece is unable to replace highly subsided official sector financing with market financing at rates consistent with sustainability.

The IMF projects Greek debt will reach 170 percent of GDP by 2020 and 164 percent of GDP by 2022 but will rise thereafter, reaching around 275 percent of GDP by 2060. (This is based on the cost of debt rising over time as market financing replaces highly subsidized official sector financing. It should more than offset the debt-reducing effects of growth and the primary balance surplus. )

The country's gross financing needs (defined as the sum of budget deficits and funds required to roll over debt that matures in the course of the year) will be higher: a 15 percent of GDP threshold by 2024 and a 20 percent of GDP threshold by 2031, reaching around 33 percent by 2040 and about 62 percent of GDP by 2060.

The IMF argues that although the Eurogroup — the finance ministers of the euro zone — committed to additional debt relief for Greece, some measures "are not specific enough to enable a full assessment of their impact on debt sustainability."

Additional proposals for relief

The report confirms that "a substantial restructuring of the terms of European loans to Greece is required to restore debt sustainability under IMF's baseline scenario." The IMF is proposing the following guidelines:

  • Extending grace periods for existing debt until 2040.
  • Extending maturity until 2070.
  • Further deferring interest payments on all European loans until 2040.
  • Locking in the interest rate (not exceeding 1.5 percent) of all EFSF andESM loans amounting to around 200 billion euros (US$214 billion) at low levelsfor 30 years.

"While the Eurogroup has agreed to lock inthe interest rate on some European loanS, the scope of the measurescontemplated is likely much less that what is required to ensure sustainabilityunder IMF's baseline scenario," notes the IMF report.

The authors ofthe analysis stress that "if policies were weaker than expected, resulting in a lower primarybalance (stabilizing at 1 percent of GDP), debt sustainability would no longerbe ensured even under IMF's restructuring proposal.

To ensure sustainability according toIMF's criteria, the interest on both EFSF and ESM loans would need to bereduced to 0.25 percent for 30 years.

By Nasos Koukakis, special to

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