Today, in accordance with its Statute, the Bank of Greece submitted its Report on Monetary Policy 2011-2012 to the Speaker of the Greek Parliament and to the Cabinet. The cut-off date for the data included in this Report was 9 March 2012, when it went to press.
A new operating framework for the economy that fosters growth
The Eurogroup’s decision of 21 February 2012 was the latest and most important step in a series of actions taken by our European partners and the IMF to provide financial support to the Greek economy. These actions are tangible proof of our partners’ determination to avert a Greek default, in light of the continuous deterioration of the country's public debt dynamics over the past two years in a context of deep recession. The agreement of 21 February confirms this determination and, in conjunction with the successful completion of the PSI, creates a new operating framework for the Greek economy in the years ahead. Its main elements are:
• A reduced loan burden as a result of the debt write-down, the maturity lengthening and the lowering of the interest rates on the loans extended to Greece after May 2010 and on the loans to be extended now.
• Ensured financial support, since the Greek economy has no market access.
• A consistent and detailed programme of fiscal consolidation, based on expenditure reduction and the broadening of the tax base, as well as a specific timetable for privatisation and structural reforms in the public sector and in product and labour markets.
• Our European partners' concrete assurance that they stand ready to provide the Greek government with technical assistance for the effective implementation of reforms.
The programme's primary and ultimate objective, as expressly formulated in the Memorandum of Economic and Financial Policies and in the Memorandum of Understanding on Specific Economic Policy Conditionality adopted by the Greek Parliament on 12 February 2012, is economic growth, with three intermediate goals: fiscal consolidation, the restoration of competitiveness and the strengthening of the financial sector.
The goal of fiscal consolidation is to achieve a return to a primary surplus by 2013, with the primary surplus reaching 4.5% of GDP by 2014, so that a gradual reduction in public debt can begin, supported by privatisation. Structural reforms in the public sector will help both to reduce the fiscal deficit and to foster economic growth.
The goal of restoring competitiveness is, via a series of structural reforms, to encourage investment and export activity, ultimately contributing to employment growth.
Finally, the goal of strengthening the financial sector is expected to help support credit expansion and the provision of liquidity to the economy, thus supporting economic activity.
This policy mix is intended to bring about the start of the recovery in the course of 2013 and to put in place the conditions for sustainable growth thereafter. A high degree of certainty about the sustainability of growth is perhaps the key factor for public debt also to be deemed sustainable.
Despite progress since 2010, confidence has not yet been restored
Since the first Memorandum was signed in May 2010, there has been progress, as fiscal consolidation has made significant headway and structural reforms, which addressed long-standing weaknesses, have been implemented. However, performance in both areas –although not negligible– fell short of expectations. The policies pursued failed on the whole to convince that they would ultimately succeed, due to a lack of resolve to carry the reforms through and the absence of a clear determination to press forward in areas where we had faltered in the past. It was not adequately realised that new policy choices were absolutely necessary and would have to be made even without the Memorandum. As a result, reforms were perceived as dictated by our creditors, and not as necessary choices that could no longer be postponed without inviting dire consequences. This undermined the effectiveness of the policies that had begun to be implemented and fuelled uncertainty about whether the ambitious goals that needed to be pursued would be achieved. This amplified the negative effects of fiscal consolidation on domestic demand, exacerbated the recession and intensified the unemployment problem. The recession, in turn, made the deficit and debt targets more difficult to reach, thereby undermining confidence further.
In late 2011, as the situation worsened and uncertainty intensified, Greece’s euro area participation was called into question
As confirmed by recently released data:
• The recession in 2011 turned out to be deeper than initially forecast, with the annual decrease in GDP reaching 6.9%. The cumulative drop in GDP over the four years 2008-2011 was 13.2%, while the drop between the fourth quarter of 2007 and the fourth quarter of 2011 amounted to 17.2%.
• In 2011 the number of the unemployed has exceeded one million, total employment decreased by 6.8% and the average unemployment rate rose to 17.7%.
• The state budget deficit, in spite of the adoption of continuous fiscal measures and following a number of upward target revisions on account of the recession and delays, came to 10.6% of GDP, i.e. to a level slightly below (by €76 million) the latest revised target.
• The primary deficit of the ordinary budget was €18 million higher than in 2010.
• Budgetary slippages created the need for additional measures and necessitated the revision of fiscal targets for 2012.
• There had been strong early indications of almost all of the above outcomes, which worsened expectations and forecasts, as well as assessments of debt sustainability; thus, the possibility of default re-emerged with intensity.
• Heightened political uncertainty, right before the formation of the coalition government, worsened the situation further; this contributed to calling into question the decisions of the 26 October 2011 Summit. The issue of Greece’s exit from the euro area and a disorderly default now featured in public debate.
The consensus of political forces opened up a window of opportunity
The formation of a new government opened up a window of opportunity and was a determining factor in negotiations leading to the agreement of 21 February 2012; this agreement brought to a halt the ruinous course towards which the country had started to slide. This outcome was the most convincing proof of how important consensus and political collaboration are in the light of the historically unprecedented challenges we are facing.
The agreement of 21 February 2012 brings a halt to dangerous debt dynamics and allows for an orderly reconstruction of the economy
Following the agreement of 21 February 2012 and provided that the conditions of the programme are met on an ongoing basis, euro area Member States (through the European Financial Stability Facility) and the IMF will provide an additional official support of up to €130 billion until 2014. In addition, all Member States have agreed to an additional retroactive lowering of interest rates on the Greek Loan Facility so that the margin amounts to 150 basis points. Furthermore, the Greek authorities have reached a common understanding with private sector creditors on the general terms of their participation in the restructuring of Greek debt. This common understanding provides for a write-down of 53.5% on the nominal value of holdings to be paid back to creditors. The private sector's response to Greece's debt exchange offer recorded on 8 March was overwhelmingly positive and it is now assessed that the contributions from both the private and the official sectors will help bring Greece’s public debt ratio down to below 117% of GDP in 2020 (compared with an initial target of 120.5%) and keep it on a sustained downward path thereafter. Even though the projected debt-to-GDP ratio remains high, what is important is that the new arrangements arrest the adverse debt dynamics, which under the present circumstances of deep recession would certainly have given rise to an extremely difficult situation.
The targets of the new programme can be attained, if the programme is consistently implemented
The adoption with a strong majority of the loan agreement and the laws required for implementation by the Greek Parliament is the first positive development worthy of note. However, the success of the programme will hinge critically on its consistent implementation. Serious difficulties and problems obviously exist and need to be addressed. The bottom line, however, is that the goals are feasible and the programme can succeed.
The success of the programme will hinge upon continuity and consistency, as well as resolve from the Greek side
Success, however, will hinge upon the following:
1st. Continuity, which must be ensured at all costs. Past programmes could have succeeded, if they had been thoroughly implemented rather than shelved or watered down because of political cost considerations. This is something we can no longer afford. The programme must be implemented rigorously without deviation throughout its duration, until 2015, and beyond. An element which can support the required continuity is broad consensus across the majority of the political spectrum on the objectives of the programme. This consensus must continue to be expressed through the strict observance of the programme’s timetables. On a practical level, the decision to create a position of Secretary-General for Revenues in the Ministry of Finance with a five-year term is noteworthy. This will ensure a minimum of public administration continuity in a crucial area. The creation of similar positions will have to be considered in other key areas of public administration. The decision to enhance the capacity of the troika to provide technical assistance, as well as the presence of experts from the European Commission, can contribute to planning within a longer-term horizon.
2nd. Administrative efficiency. The success of policies depends almost exclusively on the capacity of the state and the public administration to carry them out. It is well known that in this area statist approaches and clientelism have led to distortions and rigidities; they have also nourished vested and corporatist interests, which today constitute the main obstacles to the implementation of the necessary policies. The implementation of the programme for the reconstruction of the Greek economy will fail if we don’t overcome these obstacles now. As already mentioned, the enhanced presence of the European Commission’s Task Force could contribute to making the state a more effective mechanism – a goal that will require a long and arduous effort. Such an effort must, however, begin immediately and the changes outlined in detail in the Memorandum must be accelerated.
3rd. Restoration of confidence. There is only one way to restore the shattered confidence in the Greek economy and that is to implement the commitments of the loan agreement to the letter, whilst strictly observing the deadlines. In fact, efforts must be made, wherever possible, to overperform – i.e. more than attain the quantitative targets and/or attain them sooner. The programme’s implementation must signal unquestionable resolve so as to convince the markets and the Greek people that the objectives will be met, that the exit from the crisis is possible and that the recovery will put the economy on a growth path based on sound foundations.
The key to ultimately attaining our objectives lies in bringing the economy back to positive growth rates
Bringing the economy back to positive growth rates as soon as possible is the key to ultimately attaining the targets set. Recovery and creating the conditions for sustainable growth are indeed the road to a faster reduction in the debt and deficit and to an improvement in expectations. At the same time though, fiscal consolidation is a prerequisite for growth. As shown by international experience, no country with recurrent high deficits and cumulating large debt has ever achieved sustainable growth. Nor, of course, can there be growth with the threat of a default looming on the horizon. Therefore, restoring confidence in the Greek economy is also a prerequisite for growth. Insofar as the stabilisation programme proceeds smoothly and the necessary reforms are carried out, the country’s growth prospects will improve. That is, both the fiscal and the structural measures of the programme must be implemented concurrently and effectively, so as to avert any negative side-effects.
Measures to mitigate the contractionary effects of fiscal adjustment, promote reforms and boost investment
A sustainable reduction in the deficit and the public debt requires attention to be given to the breakdown of consolidation into spending and revenue measures as well as their individual components. Expenditure cuts tend to be much more effective than revenue increases (tax hikes); just as it is advisable, on the expenditure side, to refrain –as much as possible– from cutting back on investment expenditure and, on the revenue side, to refrain from imposing tax measures that discourage saving or negatively impact on supply.
At the same time, it is important to speed up the implementation of measures –at almost no budgetary cost– that can stimulate demand and economic activity. Such measures encompass “quick-yielding” structural reforms, such as the reduction of red tape and the administrative burden (which deter investment and obstruct exports), the opening-up of closed professions and the provision of consultancy and guidance to businesses (especially export-oriented ones), as well as other measures to strengthen public and private investment and to support the supply of credit to the private sector.
Tapping into the potential at hand to favour investment and exports and to support credit
There is considerable potential at hand, which –if systematically tapped– would help accelerate the recovery. This potential includes:
• Increasing the absorption and efficient utilisation of funds available from the EU, especially for programmes directly aimed at boosting entrepreneurship and creating jobs for the unemployed. Decisions to this effect were recently announced by the Prime Minister after his meeting with the President of the European Commission on 29 February 2012. The use of funds from the National Strategic Reference Framework (NSRF), as well as the securing of funding from international organisations such as the European Investment Bank, involve the development of new financing tools; these tools could help to finance the reactivation of certain large public investment projects (e.g. motorways construction) as well as investments in the energy sector.
• The specific policy directions for growth and employment adopted by the European Council of 1-2 March 2012.
• The significant reduction in unit labour costs anticipated for 2012-13, which, in conjunction with projected price developments, leads to a major improvement in cost competitiveness, thereby contributing to an increase in exports and to import substitution. Specifically, it is estimated that by the end of 2012 the Greek economy will have regained two-thirds to three-quarters of the cumulative competitiveness loss recorded during 2001-2009, with the remaining loss likely to be regained some time in 2013. Moreover, the Report contains a projection that the current account deficit will fall from 9.8% of GDP in 2011 to roughly 7% of GDP in 2012 and should continue to decline in the following years.
• Improving the ability of banks to adequately finance the economy (after the implementation of the decision of 21 February 2012 and the recapitalisation and restructuring of banks).
• The realisation of the Helios Project for exporting solar energy to Germany and other Western European countries, which could lead to substantial investment and job creation. More generally, the faster implementation of policies for renewable energy utilisation and generation, and the exploration of possible underwater energy sources.
• Speeding up privatisation and the programme for the utilisation of public property; this would bolster both confidence and public revenue and create opportunities for foreign direct investment and the transfer of technology. The initial inflow of foreign capital as a result of privatisation could be followed by much larger second-round inflows –in total, perhaps even more than double the initial inflows– through a multiplier process arising from the additional investment needed to maximise the yield of the initial investment and potential positive externalities accruing to other businesses and sectors.
Projections for key aggregates for 2012
As stated in the Report, the recession is expected to continue in 2012 and –according to provisional projections– the average annual decline in GDP will be of the order of 4.5%, total employment will decrease by roughly 3% and the average annual unemployment rate will exceed 19%. In the course of 2013, however, it is expected that the economic recovery will begin (even though the average annual rate of change in GDP will be slightly negative, at around -0.5%), while both the decline in employment and the rise in the rate of unemployment may be halted. Moreover, inflation will continue to trend downwards in 2012, with average annual HICP inflation projected to reach 1% or lower and core inflation likely to be slightly negative (average annual level of around -0.1%). In 2013, under certain assumptions, HICP inflation is expected to ease further to around 0.5%, while core inflation will remain negative (at around -0.2%).
Strains in the banking system intensified in 2011 and continued into the early months of 2012
Greek banks came under increasing pressure in 2011 and in the first months of 2012. They continued to face a substantial withdrawal of deposits by businesses and households (approximately €35 billion in 2011) and the impairment or ineligibility of the collateral they could use for obtaining liquidity from the Eurosystem (following the downgrading, first, of the country’s credit rating, and, then, their own). Support in the face of these pressures was provided not only through the monetary policy operations of the Eurosystem, but also through emergency liquidity assistance from the Bank of Greece. A positive effect on liquidity, through the creation of eligible collateral, also stemmed from the broadening of the bank bond guarantee scheme under the package for supporting liquidity in the Greek economy (Law 3965/2011).
At the same time, the deepening of the recession made it more difficult for businesses and households to service their debt obligations on time, worsening the quality of loans across all categories, particularly consumer loans. The ratio of NPLs to total loans at end-September 2011 reached 14.7%, up from 10.5% at end-December 2010, with a further rise expected for end-December 2011. Additionally, the contraction of banking operations as a result of the economic downturn led to a further decline in banks’ operating profits (i.e. net interest and fee income). A limited positive effect on results came from the small –considering the magnitude of the challenges– cutback in costs. In the first nine months of 2011, operating expenses fell by 7.4% for banks and by 5.1% for banking groups, year-on-year. A further rationalisation of operating costs is imperative.
2012 will be a critical year for the banking system
2012 is expected to be a critical year for shaping the banking system to face up to the new economic environment. Greek banks will be required to fully overhaul their business plans, so as to be able to meet the increased challenges posed by the recession, and to strengthen their capital bases considerably by the end of the third quarter of 2012.
Any additional capital requirements for banks will be determined following the completion of the diagnostic exercise being conducted by the Bank of Greece, in cooperation with the European Commission, ECB and IMF, and based on two macroeconomic scenarios (a baseline and an adverse one). The assessment of the minimum additional capital requirements will take into account: (a) the write-down in the face value of Greek government bonds held by banks, arising from Private Sector Involvement in the debt exchange offer following the European Council decision of 26 October 2011; (b) estimated losses anticipated for bank loan portfolios; (c) provisions already set aside to cover those losses; and (d) banks’ estimated future profitability.
Recapitalisation requirements will also have to be sufficient so that banks achieve a Core Tier 1 ratio of at least 9% by the end of the third quarter of 2012 and of 10% by the end of the second quarter of 2013. These requirements also ensure that the Core Tier 1 ratio will be 7% in the three years 2012-2014 on the basis of the adverse scenario. In covering these additional capital requirements, priority should be given to attracting capital from private sector investors. Any additional capital needed may be drawn from the Hellenic Financial Stability Fund (HFSF).
The reconstruction of the banking system: a necessary condition for enhancing liquidity
Increased transparency (following the diagnostic exercise), together with recapitalisation and restructuring of the banking sector, are expected –especially if accompanied by a general improvement in sentiment– to lead, at first, to a stabilisation of deposits and, subsequently, to their gradual return. These measures are also a necessary condition for Greek banks to progressively regain access to the global money and capital markets. Once banks have strengthened their capital bases and improved their capacity to attract savings and obtain market funding, it is to be expected that the supply of bank credit will evolve more favourably. Generally speaking, improved economic activity and reduced fiscal risk will encourage banks to increase the supply of credit and will stimulate the private sector’s demand for credit. At the same time, banks will be able to gradually reduce their reliance on Eurosystem funding for liquidity support.
A historical responsibility for Greece to seize the opportunity it has been given
In the light of the Agreement of 21 February 2012, the new framework in which the Greek economy will operate in the years ahead could suffice to turn the climate and expectations around and, thereby, speed up the recovery process. However, distrust as to the ability and resolve of governments and society at large to carry the necessary reforms decisively forward remains widespread. This distrust is justified. Reform initiatives in the past had more than once come up against the illusion that a system which produced prosperity by running up deficits and debt could be maintained forever. There is no room for such illusions anymore. The truly harsh and painful losses that Greek citizens have had to endure cannot be recouped by returning to the ways of the past. Under present circumstances, such a return would result in social cohesion disintegrating and incomes plummeting.
In order to improve expectations and confidence in the future of the Greek economy, what is needed is adjustment to the new givens, implementation to the letter of all that has been agreed and a correction of past imbalances, so as to lay the foundations for the way forward. Euro-area membership and the support of our partners provide Greece with the opportunity to move forward on this path in an orderly fashion, contain the losses and shorten the difficult period of deep recession. It is up to the country, however, to assume the historic responsibility of elaborating and, more importantly, implementing a new strategy which will convincingly show that the Greek economy can be reconstructed in a way that will bring it back onto a sustainable growth path.
The full text of the Report is available here.