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26/10/2010 - The Bank of Greece Interim Report on Monetary Policy 2010

Today, in accordance with its Statute, the Bank of Greece submitted its Interim Report on Monetary Policy 2010 to the Speaker of the Greek Parliament and to the Cabinet.

The Economic Adjustment Programme is a foundation for reshaping the economy

The Greek economy is going through its most difficult time in recent decades, after hesitation for many years to address the problems while they were still manageable. With the advent of the global financial crisis, the dead-end became visible to all and the country’s position in international markets was shaken.
The activation of the financial support mechanism for Greece established by euro area countries and the International Monetary Fund, based on the agreed Economic Adjustment Programme, served to avert the catastrophic outcome which seemed inevitable in April 2010. At the same time, banks in Greece benefited from the non-standard measures, taken by the European Central Bank.

The Programme secures financing for Greece from the euro area countries and the IMF for a period of three years, under conditions where the cost of market funding has become prohibitive. Furthermore, it sets out the general guidelines of economic policy for the years to come, mainly in the area of public finances, as well as regarding the implementation of structural reforms in the broader public sector and the functioning of markets. The Programme is a consistent medium-term plan of economic adjustment; it includes a specific timetable for its implementation and compresses into a three-year period changes and reforms which should have been carried out when conditions were more favourable and the associated costs would have been lower.

To be assessed properly, the cost of the Programme must be compared with the cost of non-implementation. The medium-term benefits of the Programme are substantial

The cost of reform appears high and is spread throughout the economy. The cost is mainly reflected in wages and pensions, particularly in the public sector, an increased tax burden for enterprises and individuals, as well as a downturn of activity which affects incomes and employment across all sectors of the economy.

In the first half of 2010, GDP fell by 3% compared with the corresponding period of 2009, while for the year as a whole it is expected to decline by about 4%. Unemployment is projected to exceed 12%; average real wages, partly reflecting high inflation, will decline by 8% in the total economy and by 17% in the public sector.

Recession was of course expected for this year; it is also expected to continue in 2011, albeit at a weaker pace. In order to address the current serious problems, the economy has to adjust to lower levels of activity, until it starts to recover driven by a more active contribution of the private sector.

The above paints a broad picture of the immediate, already visible, cost of adjustment. It should be noted however that a proper assessment of this cost would entail a comparison with the cost of non-implementation of the programme. The big difference made by the programme lies in the following:

1. Developments which would not be controllable were averted and there is now room for policies that can limit the duration and depth of the recession. The programme is binding as regards fiscal targets, but in the area of growth there exist numerous possibilities for intervention, which should be exploited as soon as possible.

2. If the programme is implemented consistently, the final outcome which can be envisaged will include:

• Greece remaining an active member of the euro area, rightfully participating in the processes shaping the future of the EU and of our country.

• The Greek economy doing away, once and for all, with the obstacles of the past and operating more efficiently.

• Limiting the privileges and exemptions which were hampering growth and nurturing social inequality.

• A strengthening of potential growth, thereby making it feasible to achieve higher and sustainable levels of income and employment.

A complete restructuring of public administration and continuity of implementation are prerequisites for the success of the Programme

A first, sine qua non, condition for the success of the Programme is the adequacy and effectiveness of the mechanism needed to implement it, namely public administration. In this respect, important changes are already under way and must be carried through rigorously and without delays. However, these are not enough. What we need now is a comprehensive and complete rebuilding of the state on new foundations, so that its operation will encourage rather than hinder creative initiative.

The second necessary condition is ensuring continuity in the implementation of the Programme. One of the main reasons that led to the current crisis is that similar stabilisation programmes launched in the past were never completed, as they soon lost their momentum and were eventually abandoned. As a result of such vacillation, any benefits that had been achieved would disappear a few months after the interruption of a programme and the economy would return to its initial level or an even lower one.

Fiscal adjustment is a necessary condition for growth

In order to limit the depth of the recession and speed up recovery, it is necessary to encourage private business activity, which is currently being suppressed by low demand, low competitiveness, the slowdown in credit expansion and the increased tax burden.

As regards the tax burden, there is no room for further increases in tax rates for businesses and individuals; policies to achieve the necessary increase in public revenues should be geared towards broadening the tax base and combating tax evasion. Further increasing the burden on those who already pay taxes would not only intensify the recession but would actually prove counter-productive, bringing about a decline instead of a rise in revenues.

The settlement of tax arrears is not the ideal option for increasing revenue. In the present context, however, this policy can prove useful, provided it is accompanied by a thorough modernisation and restructuring of the tax system and the implementation of new practices and effective methods for curbing tax evasion. At the same time, given that the tax environment has been highly volatile over the recent past, having been subject to major changes, there is an urgent need to create a credible tax environment that entails stable tax rates and efficient tax collection mechanisms.

For fiscal consolidation to produce better results over the next years, it must rely mainly on expenditure cuts. Admittedly, a large reduction in expenditure has been achieved since the start of the Programme. However, this reduction has predominantly relied on cuts in wages and pensions, whereas large margins exist for achieving substantial expenditure savings by addressing and eliminating the structural weaknesses in the public administration, which generate chronic deficits and debts. Fiscal consolidation must now proceed at a much quicker pace, through a drastic reduction in the waste of funds in the broader public sector and through merging or closing down public sector entities which are not really productive. Fiscal consolidation will be sustainable and successful only if it stems from a radical restructuring of the state at all levels.

During the first year of the Programme, fiscal consolidation has made remarkable headway. However, risks to the adjustment path remain high. Adding to these risks is the imminent revision of the 2009 general government deficit, which may also affect the deficit-to-GDP ratio in 2010.

More generally, in view of the new information, it is self-evident that there must be a stronger effort to cut public expenditure and increase revenues in line with the Programme targets. This will involve, among other things, curtailing discretionary spending and improving the efficiency of the tax collecting mechanism. Moreover, the successful implementation of the Programme crucially requires that fiscal policy be planned on the basis of alternative scenarios and be prepared to take corrective action in the event of deviations from targets.

A binding Action Plan for Growth

A prerequisite for the economy to enter a new virtuous circle is a steady evolution of the fiscal adjustment process at a pace that -- if possible -- would overshoot the one envisaged in the Programme. This would have a positive effect on the economic climate, improve market confidence earlier and favourably affect the availability and cost of financing. The Programme sets out the actions that are absolutely necessary to address the current crisis. The strict implementation of the Programme is of the essence, but it is no substitute for the broader responsibility of economic policy to address the major issue of growth and to speed up policies aimed at reviving the economy as soon as possible.

The Programme is a good start that mitigates risks and gives the economy the time required for its reshaping on new foundations. However, the road will be long and arduous: growth is not just around the corner. Until improvement is visible, there will be some deterioration for a while. Thus, what is required, in parallel with the fiscal adjustment, is to draw up a detailed “road map” for vigorously reviving the growth process – based this time on solid foundations. In other words, we need a binding and coherent Action Plan for Growth, which will operate side-by-side with the fiscal adjustment process, complement and/or elaborate on policies which are already being adopted and suggest new policies which will favour growth without jeopardising the achievement of the fiscal targets.

Such an Action Plan, together with the promotion of reforms already planned and a smooth evolution of the fiscal adjustment effort, will send out a strong signal to the markets – namely that the Greek economy is in the process of reinventing itself, becoming outward-looking, opening up to entrepreneurial initiatives and taking advantage of the opportunity provided by the support mechanism in order to achieve a speedy recovery. What is needed is a focus on growth, a common objective as regards what we want to achieve over the coming years and a clear choice of the instruments that will take us there.
An Action Plan for growth should include the following:

1. The exploitation of the country’s comparative advantages and concrete medium-term plans with clear policy targets and instruments to pursue an outward-looking growth strategy – i.e. one that places emphasis on exports and on attracting foreign direct investment. This means that priorities must be set with respect to (a) the allocation of public resources to public investment and to the support of private investment; and (b) the upgrading of infrastructure, e.g. in the key sectors of transport and energy.

2. The identification, codification, specification and fast implementation of the “horizontal” reforms that are expected to have a favourable effect on the economy’s growth potential. This effort mainly aims at the creation of a business-friendly environment, through an effective improvement in the regulatory and institutional framework. If tangible results are obtained soon in this respect, it will be easier to attract foreign and domestic capital to finance the necessary investment.

The key areas in which structural changes are urgently needed – and in some cases are already underway – include:

– Modernisation and transparency of public administration.

– Enhanced flexibility in the labour market.

– Strengthening competition in the markets for goods and services.

– Better absorption of Community funds through the National Strategic Reference Framework (NSRF), the promotion of investment and an enhanced export orientation of the economy.

– A more effective education system.

A sine qua non for growth is to boost business activity

By implementing the structural changes outlined above, economic policy will create an appropriate environment – a business “ecosystem” – that will enable enterprises to operate more efficiently. This system must be characterised by stable rules on competition and taxation, a drastic reduction in administrative obstacles and costs, an unambiguous regulatory framework for the functioning of markets, well-defined and fast procedures relating to land use/location and licensing for business start-ups, as well as a vigorous fight against corruption.

However, adjustments are also required on the part of enterprises, which must become far-sighted, expand their time horizons and immediately take investment initiatives. The pursuit of maximum possible gains in the shortest possible time is no longer an option. The global economic crisis has brought about fundamental changes to approaches to valuing stocks, shifting the emphasis from short-term returns to long-term business planning. The necessary process for the adjustment of enterprises would involve: increasing their size; developing synergies and joint projects; improving productivity – including through on-the-job training – thereby contributing to lower costs; strengthening their export orientation by looking for new markets and working jointly with other firms; and adopting eco-friendly practices.

Challenges for the banking system

Unlike the case of many other countries, where the crisis originated in the banking system and then spilled over to the real economy, the Greek banking system, which has solid foundations, only began to face liquidity constraints when the severe fiscal imbalances led to successive credit rating downgrades of the Greek sovereign and in turn of Greek banks, thereby restricting bank access to sources of finance and raising their borrowing costs. This development, coupled with the tendency of domestic deposits to decline in the first half of the year, inevitably affected banks’ liquidity, and hence the supply of credit.

At the same time, recession, which weighed on the financial situation of non-financial enterprises and households, caused credit demand to decline. These factors led to a deterioration in the quality of the banks’ loan portfolios and a fall in their profitability. On account of these developments, on both the demand and the supply side, the annual rate of credit expansion declined, whilst still being positive.

Capital adequacy remained relatively high. However, the particularly adverse macroeconomic conditions imply that banks should keep their capital adequacy ratios at levels well above the regulatory minima for precautionary reasons. A positive development in this direction is the successful completion of the recent share capital increase of the National Bank of Greece.

It is important to note that banking sector aggregates will not change for the better without a correction of the factors that exert pressure on banks’ credit ratings and thereby on their ability to raise funds from money and capital markets. In other words, an improvement in the macroeconomic environment is necessary. This improvement will make a positive contribution towards mitigating not only banks’ liquidity risk, but also their credit risk, enabling them to continue to accommodate the demand for bank credit.

At the same time, banks should be more far-sighted in adjusting to the new economic and regulatory environment. They need to take into consideration that, even after economic activity has recovered, the growth rate of banking will still fall short of pre-crisis levels. Moreover, the ECB’s non-standard measures still in place will eventually be phased out and banks may continue to face difficulties in tapping the international markets, as governments, banks and non-financial enterprises will be in strong competition for funding. Finally, banks have to prepare themselves for the gradual implementation by 2018 of the new international regulatory framework “Basel III”.

These reasons make it necessary for banks to review their business models, seeking to maintain high capital adequacy and liquidity levels by setting aside sufficient provisions for credit risk and by rationalising their cost structure. Strategic alliances and mergers will certainly contribute to the achievement of these goals, because of the resulting synergies.

The aim is to restore confidence in the economy

The arduous effort that the country is making today aims at restoring confidence in the future of the economy, i.e. in its ability to overcome its fiscal difficulties and become more creative, outward-looking and open to business initiatives and investment.

Confidence, however, cannot be restored overnight or automatically. Today, five months after the activation of the financial support mechanism, markets still treat Greek bonds with cautiousness, although the climate has lately started to improve. One of the challenges for Greece is to show continuity, consistency and perseverance in implementing the Programme. These traits must be continuously confirmed in practice. Market cautiousness is also fuelled by analyses that consider debt restructuring to be unavoidable, as they anticipate that growth rates will be too low to ensure the servicing of the large public debt.

Such scenarios have already been refuted by the IMF, which in a recent analysis concludes that debt restructuring is unnecessary, undesirable and unlikely. Statements by EU and ECB officials are in the same vein. In any event, however, it is up to us to answer with our actions – in two ways: First, by achieving the targets of the Adjustment Programme, and – wherever possible – by overshooting them, thereby sending a clear signal that fiscal consolidation is proceeding at a fast pace. Second, by drawing up and swiftly implementing a coherent Action Plan for Growth, which will convincingly show that, as a beginning, the Greek economy can recover soon and, subsequently, can grow strongly, standing on new and sound foundations.

If we manage not only to achieve the important fiscal targets but also, over the next two-and-a-half years, to establish the conditions for boosting exports and attracting foreign investment that will enhance growth, we can convince the markets that the debt dynamics will be reversed. The Greek economy has immense growth potential. The situation is already improving, but the road ahead is long and there is no room for complacency. Today’s crisis can and must act as a catalyst for reshaping the economy, enhancing the country’s competitiveness and prosperity within the euro area. This is what is at stake for Greece.


Apart from analysing economic developments and prospects, the Report includes an extensive chapter (Chapter VII) on issues related to a more effective implementation of the fiscal adjustment programme and fiscal structural changes. In this context, six “Special features” deal in depth with : (i) Directions for further reducing primary public expenditure; (ii) Tax evasion, tax administration and measures to upgrade the tax collection mechanism; (iii) Options for the more effective utilisation of public sector real estate; (iv) Structural changes in the health system aimed at controlling costs, reducing spending and upgrading services; (v) Privatisations in the period 1996-2009 and loss-making public enterprises today; (vi) Dealing with climate change and “green” tax policies.

The full text of the Report (in Greek) is available on the website of the Bank of Greece