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15/06/2016 - Bank of Greece Monetary Policy Report 2015-2016

Today, in accordance with its Statute, the Bank of Greece submitted its Monetary Policy Report 2015-2016 to the Speaker of the Greek Parliament and the Cabinet.

The completion of the first review has a positive effect on confidence and enhances the growth prospects

The Eurogroup decision of 24 May, recognising the full staff-level agreement reached between Greece and the institutions and paving the way to the completion of the first review, marks an important step in the implementation of the current programme. This decision has direct and indirect benefits, including:

• The disbursement of successive loan tranches totalling €10.3 billion by autumn 2016, of which €6.8 billion will be used for public debt servicing and €3.5 billion will be used to settle part of general government arrears. This should have a positive impact on liquidity and economic activity in the second half of 2016.

• The anticipated decision by the ECB Governing Council to reinstate the waiver for Greek government bonds, enabling Greek banks to obtain low-cost financing from the European Central Bank (ECB).

• The ability of Greek government bonds to be included in the ECB’s quantitative easing programme. This, together with the reinstatement of the waiver for Greek government bonds, should have a sizeable beneficial effect, potentially amounting to €400-500 million, on banks’ results. Even greater, however, would be the indirect benefits, through e.g. upgrades of the credit ratings of the Greek sovereign and Greek banks.

• The reasonable expectation that the yields of Greek government bonds as well as of bonds issued by Greek non-financial corporations in international markets will decline at a fast pace, as is already happening.

The above developments are expected to encourage a return of deposits to the Greek banking system, which will allow an easing and ultimately lifting of capital controls. This, along with a more effective management of non-performing loans, will contribute to a reduction in borrowing costs and will gradually increase the lending capacity of Greek banks, with positive effects on the financing, hence the growth performance, of the Greek economy.

In general, the positive review is expected to have a favourable impact on the Greek economy, as it will strengthen confidence and remove the uncertainty that has weighed heavily on the economic climate and has led to a postponement of investment decisions. What is urgently needed now is a shift of policy focus towards reforms and privatisations, which will bolster growth and counterbalance the recessionary effects of high taxation. For if we fail to achieve positive and rising rates of GDP growth soon, the targets set will become much more difficult to attain and the positive effects will fade away.

Hesitant decisions by the Eurogroup on public debt

The successful completion of the first review is accompanied by a commitment of our partners to take action to reduce the Greek debt burden. The Eurogroup statement of 25 May describes the timeframe and outlines a number of actions to be implemented, if deemed necessary, in order to bring the gross financing needs of the general government down to more manageable levels, i.e. below 15% of GDP in the medium term and below 20% in the long term.

The Bank of Greece takes the view that, in the first place, the expressed will of our partners to provide debt relief strengthens confidence in the future of the Greek economy. However, the measures included in the Eurogroup statement have not been specified or quantified, and the relevant timeframe does not signal a decisive and frontloaded approach to public debt sustainability. Thus, the public debt problem is not dealt with today, in the current favourable environment of very low interest rates, but rather is postponed to be re-examined in the post-programme period. The final decisions on debt are conditional on (i) a positive final assessment of programme implementation; and (ii) the outcome of an updated debt sustainability analysis to be produced in 2018.

Public debt sustainability is feasible even with a lower medium-term primary surplus target

The Bank of Greece considers that there are important reasons to act now. First, global interest rates are at historical lows and the term structure is relatively flat, implying that, at the same cost, debt relief now could be much more beneficial to Greece than a few years down the road, when global interest rates might be higher. Second, debt relief now will contribute to improved confidence of international investors in the country, hence, to lower risk premia, lower cost of financing, stronger investment and improved growth prospects for the Greek economy.

Sensible debt relief measures may include (a) extension of maturities; (b) smoothing of interest payments over time; (c) restoration of transfers of ANFA and SMP profits; (d) swap of IMF loans with ESM loans.

On the basis of an analysis presented in this report, debt relief measures should be accompanied by a lower medium-term fiscal target. Specifically, the final target for a general government primary surplus of 3.5% of GDP could be reduced to 2% of GDP after 2018, enabling a faster return of the Greek economy to robust and sustainable growth rates. Besides, past experience has shown that only few countries have been able to maintain high primary surpluses of 3.5% of GDP for relatively long periods, as required in the case of Greece from 2018 onwards.

Public debt sustainability scenarios explored by the staff of the Economic Analysis and Research Department of the Bank of Greece show that primary surpluses of 2% of GDP from 2018 onwards are consistent with public debt sustainability assuming (a) an extension of loan maturities by 20 years and (b) smoothing of capitalised deferred interest payments over a 20-year period.

Moreover, the easing of fiscal targets will allow a lowering of taxation, which is currently high. This would alleviate the consequences for the real economy, thereby strengthening growth in the medium-to-longer term, which could speed up the reduction of public debt.

Prospect of recovery in the second half of 2016, but risks remain

In the first months of 2016 economic activity was negatively affected by capital controls and by long delays in the completion of the first review of the new programme, which was initially expected in the fourth quarter of 2015. Against this background, financing under the new programme froze, government cash management came under strain, with government arrears accumulating, and uncertainty about the economic outlook was rekindled. These developments, coupled with the negative carryover effect from 2015, caused GDP to contract for a third quarter in a row. In particular, economic activity declined in the first quarter of 2016, both year-on-year (-1.4%) and relative to the previous quarter (-0.5%).

As discussed in the present report, the completion of the first review is expected to restore confidence and boost liquidity and should improve the investment environment in the second half of 2016. According to Bank of Greece estimates, for 2016 as a whole the GDP growth rate should turn out marginally negative, at -0.3%, as the positive growth rates expected for the third and fourth quarters of 2016 should partly offset the negative outcome of the first half of the year.

Nevertheless, risks to the outlook of the Greek economy remain. The greatest risk relates to the excessive − as the Bank of Greece sees it − emphasis on tax increases as decided in the context of the first review in order to cover the fiscal gap of 2016-2018: a stronger than expected recessionary effect from the higher tax burden could imply, as an indirect impact, a shortfall against revenue targets.

Furthermore, any delay in the implementation of reforms and privatisations envisaged in the programme would dampen economic growth, thereby refuelling uncertainty, undermining confidence and weakening the prospects of a definitive exit from the crisis. In addition, an exacerbation of the refugee crisis could hurt tourism and trade, slowing economic recovery. At the same time, risks and uncertainties about the course of the global economy and the outcome of the upcoming British referendum still exist, which could slow the recovery of the Greek economy.

A prospect of liquidity improvement as a result of the completion of the first review and ECB initiatives to stave off deflation in the euro area

The completion of the review would largely dispel the remaining uncertainties. Combined with the anticipated exit of the Greek economy from the recession onto a path of sustained growth as adjustment and reforms bear fruit, reduced uncertainty should lead to a return of deposits to Greek banks and improved access of domestic credit institutions, as well as of healthy extrovert Greek businesses, to international financial markets.

Moreover, the completion of the review would trigger a decision to accept Greek government securities as eligible collateral for open market operations, through which the Eurosystem refinances euro area banks on highly favourable terms. Until recently, Greek credit institutions participated in regular monetary policy operations and targeted longer-term refinancing operations (TLTROs), although the eligible collateral available to them was relatively limited and consisted almost exclusively of European Financial Stability Facility (EFSF) notes. Notably, it was not before April 2016 that Greek banks were allowed to sell EFSF notes (which they had acquired from the EFSF as part of their earlier recapitalisation) to the Eurosystem, under its asset purchase programme.

The monetary policy accommodation measures introduced since 2014 have contributed to increased credit flows from banks to the real economy in the euro area, a general improvement of financing conditions across the Monetary Union, as well as to a depreciation of the effective exchange rate of the euro, thereby strengthening the international competitiveness of the euro area (hence aggregate demand in the euro area) and dampening downward pressures on domestic prices.

Still, economic recovery in the euro area remains fragile. Of course, the readiness of the Eurosystem to adopt appropriate standard and non-standard monetary policy measures has averted the worst, as also evidenced by a pick-up in the GDP growth rate in the first quarter of 2016. However, on the back of successive falls in international commodity prices, inflation is well below 2%, i.e. the medium-term objective in order to consolidate price stability, while core inflation remains very low.

In March 2016, the ECB Governing Council reduced key interest rates again, in order to counterbalance the negative impact of a worsened external environment on the return to price stability in the euro area. In particular, the interest rate on the main refinancing operations was lowered for the first time to zero and the interest rate on the deposit facility to -0.40%. Furthermore, the ECB Governing Council decided to expand the asset purchase programme. First, the monthly purchases from private or public issuers were expanded from €60 billion to €80 billion. Second, bonds with a residual maturity of 6 months to 30 years issued by non-financial corporations established in the euro area were also included in the programme. Third, in the context of the public sector purchase programme, the issuer and issue share limits for securities issued by eligible international organisations and multilateral development banks were increased from 33% to 50%.

Finally, the ECB Governing Council launched a series of four TLTROs, to be conducted on a decentralised basis by national central banks during the period from June 2016 to March 2017. By participating in these operations, counterparties (mainly commercial banks) can obtain funding with a four-year maturity at zero or negative interest rates.

The Governing Council of the ECB closely monitors price developments and, as it has noted in the past, stands ready to use any additional monetary policy measures within its mandate as necessary to secure a return of the rate of inflation in the monetary union to levels close but below 2% in the medium term.

The new institutional framework will enable a more efficient management of non-performing loans

The major problem facing the Greek banking system today is the high stock of non-performing loans in bank portfolios. Tackling this problem, together with the recent recapitalisation of the domestic banking system and the expected increase in liquidity following the completion of the review, will enhance the ability of credit institutions to provide financing and thus support economic growth.

Indeed, in 2015 Greek banks had to set aside considerably higher provisions for credit risk and, as a result, their losses rose to €9 billion. The quality of loan portfolios of domestic credit institutions worsened, with the ratio of non-performing exposures to total exposures rising from 39.9% in December 2014 to 44.2% in December 2015. This ratio, on the basis of provisional data, rose further to 45.2% in March 2016, although this seems to stem mainly from a lower denominator, as the creation of new non-performing loans is showing signs of weakening.

On a positive note, however, the provision coverage ratio slightly exceeds 50%, and capital adequacy ratios for the Greek banking system as a whole, following the recapitalisation, increased to more than 16% in 2015.

Meanwhile, a number of improvements have been introduced recently to the regulatory framework, which promote a more efficient management of banks’ troubled assets. Important legislation has also been adopted aimed to speed up enforcement procedures and, more generally, court proceedings, to address the issue of overindebted households and to simplify the resolution and special liquidation of businesses.

The initiatives planned for the next months are seen as crucial for the structure of the Greek banking system and the restructuring of domestic banks. More specifically, the following initiatives must be implemented soon:

• developing a secondary market for loans (performing or non-performing), in order to increase the number of participants and benefit from expertise in bad loan handling;

• reforming the out-of-court debt settlement framework to ensure fast, effective and transparent settlement of debts to private creditors and to public sector entities;

• improving the infrastructure of the judicial system and the specialised know-how of judges;

• addressing long-standing issues relating to the tax treatment of loan write-offs and provisioning for both borrowers and lenders;

• introducing provisions to engage shareholders in the efforts of banks to restructure firms.

The Bank of Greece adheres to its commitments, among other things by amending the Code of Conduct on the management of non-performing loans (NPLs) and loans in arrears and by implementing a framework of operational targets and monitoring of NPL resolution strategies for all Greek banks.

At the same time, there is a need for a more active NPL management policy on the part of banks, one that would place more emphasis on long-term arrangements, including multi-creditor workouts, and on the restructuring of viable businesses. In this regard, the achievement of the targets to be mutually agreed with the Bank of Greece and the ECB in the near future will play a crucial role in the fast reduction of the large volume of non-performing loans in bank portfolios.

Key requirements for a return to growth

Based on actual developments in the real economy and the expected positive impact of the first review, it is reasonable to predict that the end of the recession is close and that clear signs of recovery will become visible in the latter part of 2016. Moving on from this recovery to sustainable and strong growth will require a number of tangible and concerted actions, aimed to restore a “growth environment”. These actions are the following:

1st. Consolidation of confidence and strengthening of the view that the Greek economy has returned to normality and there will be no backtracking. To achieve this, reforms have to be implemented consistently and constantly.

2nd. Utilisation of public property. As suggested by the Bank of Greece long ago, together with the implementation of necessary reforms, putting idle public property into good use and speeding up privatisation processes are the strongest tools to boost investment activity and achieve sustainable growth, but also to support fiscal adjustment, insofar as they help to reduce public debt.

3rd. Tackling the high stock of non-performing loans, which is the greatest challenge facing the banking system. Addressing this problem will not only alleviate the burden on cooperating borrowers, but will also enable banks to free up funds that could be channeled into more dynamic and extrovert businesses, thereby contributing to a comprehensive restructuring of the economy in favour of tradable goods and services, which could lead to a rise in productivity and potential output, even in the short run.

The actions described above, along with an exit from the recession and a gradual recovery of the economy, will bring about a stabilisation and, subsequently, a decline in the NPL ratio, with beneficial effects on the economy as a whole.

4th. Reforms to support extroversion. The implementation of reforms in the markets for goods and services and in the functioning of the public sector will lead to an increase in investment and employment, while it is also expected to encourage innovation and the introduction of new technologies by increasing competition. In turn, these developments will improve the quality of Greek exports and expand the export base and overall competitiveness of the Greek economy. This will ensure that the decrease in the current account deficit is sustainable, while also at the same time it will increase potential output in the medium-to-long term.


The completion of the first review creates positive prospects for the recovery of the Greek economy in the second half of 2016, a development already anticipated by markets as reflected in falling Greek government bond yields. At the same time, the commitment of our European partners to take action in order to ensure the sustainability of public debt in the short and medium-to-long term is a positive step forward. However, the issue of public debt is not dealt with decisively and in a frontloaded manner in the context of the current very favourable environment of very low global interest rates, but is postponed to be re-examined in the future.

Against this backdrop, the Bank of Greece is of the view that the envisaged measures for the management of public debt need to be specified, quantified and frontloaded. This would lead to a further decline in the country’s risk premium in the course of the current year and improve the credibility and acceptance of the policies pursued, thereby further enhancing confidence and strengthening economic recovery.

Moreover, the Bank of Greece believes that a return of the Greek economy to realistic and sustainable rates of growth would be further supported by a lowering of the medium-term fiscal target for a primary surplus of 3.5% of GDP from 2018 onwards to 2% of GDP, without affecting public debt sustainability prospects. This would allow for lower taxation and free up resources to support economic activity.

From now on, the Greek authorities should turn their attention to the crucial issues that constrain the country’s growth potential and feed the vicious circle of recession. In this respect, the following are necessary:

• implementation of reforms included in the programme;

• acceleration of the programme of privatisations and utilisation of public property;

• drastic action to deal with banks’ non-performing exposures;

• alleviation of the tax burden with simultaneous cuts in the non-productive expenditures of the general government.

These actions will attract foreign investment and set in motion a virtuous circle that would signal the definitive exit from the crisis and a sustainable increase in total productivity of the Greek economy over the medium-to-long term.

The full text of the Report is available (in Greek) here.