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21/12/2017 - The Bank of Greece Interim Report on Monetary Policy 2017

Today, in accordance with its Statute, the Bank of Greece submitted its Interim Report on Monetary Policy 2017 to the Speaker of the Greek Parliament and the Cabinet.

Developments and prospects: halt of the recession – positive forecasts

This Interim Report on Monetary Policy is submitted by the Bank of Greece at a time when a Staff Level Agreement for the completion of the third review of the programme has been reached with the Institutions. Progress in the implementation of the adjustment programme is having a beneficial impact on confidence, liquidity and economic activity.

The positive course of the economy is reflected not only in GDP figures, but also in several key indicators of economic activity, such as industrial production, retail sales, private sector employment flows, exports of goods and services, and foreign direct investment, as well as soft data such as the manufacturing PMI and the economic sentiment indicator. Improvements are also visible in the financial sector: bank deposits of the non-financial private sector have increased, the decline in bank credit to non-financial corporations has slowed, and banks’ dependence on central bank financing has gradually decreased.

In addition, yields of Greek government bonds have fallen and the yield curve has normalised, in line with the gradual improvement of the domestic economic environment. This enabled the Greek government to return to international bond markets, for the first time since 2014, with a new five-year issue and, towards the end of 2017, to conduct an exchange operation of PSI bonds with a view to enhancing the liquidity of the market for Greek debt. Investors’ participation in this operation exceeded 86%.

Faster growth projected for 2018 and 2019

The available data support the assessment that recovery will gain momentum in the coming months. According to Bank of Greece estimates, economic activity is expected to pick up in the medium term, with GDP growing by 1.6%, 2.4% and 2.5% in 2017, 2018 and 2019, respectively. The recovery in 2017 is due to higher exports of goods and services, as a result of Greece’s improved international competitiveness, the pick-up of global trade and the relaxation of capital controls. Higher foreign demand boosts industrial production and contributes to job creation.

Growth is projected to accelerate in 2018 and 2019, supported by exports, private consumption and investment. Consumption is expected to recover, primarily on the back of higher household real disposable income as a result of increased employment. The contribution of investment is expected to be positive, mainly due to stronger business investment, reflecting the gradual restoration of confidence and liquidity in the financial system, as well as the acceleration of privatisations. Exports are expected to remain robust, reflecting higher foreign demand and the restoration of international competiveness. These forecasts are based on the assumption that the reform and privatisation programme will be implemented smoothly and according to the agreed time schedule.

Risks and challenges

Developments in the next few months will be crucial, as they will determine the course of the economy for years to come. After eight years of painful adjustment, the current state of the economy allows favourable expectations for the future. For these expectations to materialise, however, plans will have to be made in the months ahead for a smooth conclusion of the successive adjustment programmes and a return to normality. The challenges that need to be addressed in this short period are:

• broadening and consolidating confidence, which will enable Greece to return to the markets on sustainable terms after the end of the programme in August 2018;

• implementing the programme measures without delays;

• preparing for the timely conclusion of the fourth and final review, which will mark the end of the programme;

• negotiating the re-profiling of Greek public debt and the conditions of post-programme surveillance; and

• fully abolishing capital controls as the economy improves and confidence strengthens, which will ameliorate the investment climate and help attract foreign direct investment.

Any delays or setbacks in the above matters would hamper the restoration of confidence, complicate the exit from the crisis and undermine the optimistic outlook. On the other hand, there are also a number of external risks associated with:

• a possible increase in risk aversion due to disturbances in international financial markets;

• mounting uncertainty in the European Union, mainly concerning a possible failure to form a coalition government in Germany, as well as delays in the conclusion of negotiations between the United Kingdom and the European Commission on the terms of Brexit; and

• broader geopolitical factors, such as the refugee crisis, North Korea, etc.

The banking system – Liquidity has improved and non-performing loans are being tackled

During the first ten months of 2017, the rate of change in bank credit to both non-financial corporations and households was on average less negative year-on-year. This is partly attributable to a decline in lending rates, while bank lending is also buoyed by the economic upturn.

The return of deposits to the Greek banking system continued, with redeposits of banknotes mainly by non-financial corporations and a repatriation of funds. Specifically, in the period January-October 2017 deposits by the non-financial private sector increased by €2.6 billion to €121 billion. Moreover, banks’ dependence on emergency liquidity assistance (ELA) by the Bank of Greece continued to decline. In October 2017, three banks returned to the international capital markets for the first time since 2014, with covered bond issues.

The expected strengthening of economic recovery and the confidence gains from the completion of the third review, as well as further progress in tackling the problem of non-performing exposures, which will also boost confidence in banks, will improve banks’ funding capacity by enabling them to attract retail deposits, tap the cross-border interbank market and issue debt securities.

These developments, combined with programmes co-funded from the EU budget and managed by the European Investment Bank (EIB) and other organisations, will increase the banking system’s capacity to finance the Greek economy. At the same time, demand for credit can be reasonably expected to rise, reflecting, among other things, an expected decline in borrowing costs largely as a result of narrower intermediation margins.

Banks’ results have improved

Overall, positive developments have been observed in banks’ profitability and asset quality. During the period January-September 2017, Greek banks posted marginal pre-tax profits (€287 million, an improvement relative to the same period of 2016). Loan-loss provisions increased year-on-year, while other impairment losses remained unchanged. Regarding capital adequacy on a consolidated basis, in September 2017 the Common Equity Tier 1 (CET1) ratio came to 17.1% (December 2016: 16.9%) and the Capital Adequacy Ratio (CAR) to 17.2% (December 2016: 17%).

Non-performing exposures are declining

As of September 2017, non-performing exposures (NPEs) stood at €100.4 billion or 44.6% of total exposures, having declined by 7.6% (or €8.2 billion) from the March 2016 peak. The improvement during the period January-September 2017 resulted mainly from loan write-offs, with a positive contribution also coming from sales. Sales of loans continued into the fourth quarter of the year. According to the relevant reports published by the Bank of Greece, progress towards the achievement of targets is satisfactory. It should be noted, however, that the NPE reduction targets for the next two years are significantly higher, implying that banks will need to step up their efforts and make full use of the available toolkit for private debt resolution.

Regarding business loans, the NPE ratio is considerably higher for loans to small and medium-sized enterprises (SMEs). With respect to their sectoral breakdown, higher NPE ratios are observed in trade, construction and manufacturing, which are sectors with a high share in overall business loans. In any case, banks’ accumulated provisions cover half of their total NPEs, while the other half is covered by the value of the underlying collateral, resulting in an overall coverage ratio of almost 100%.

A growth-oriented economic policy

Beyond the short-term opportunities and risks, the protracted economic crisis has left a number of stock imbalances that need to be addressed over the medium term if the Greek economy is to return to sustainable growth, most notably:

• high and persistent long-term unemployment;

• the high stock of non-performing loans;

• the investment gap;

• the public debt overhang; and

• tax evasion, which remains high.

These challenges need to be tackled in order to safeguard social cohesion, preserve Greece’s high-quality human capital, facilitate the financing of the Greek economy, entrepreneurship and foreign direct investment inflows, and strengthen the medium- to long-term potential growth of the Greek economy.

Subject to these prerequisites, the end of the adjustment programme could mark a turning point towards a growth-oriented economic policy. This policy must absolutely steer clear of past mistakes and focus on putting the enabling conditions in place for strong sustainable growth, by addressing the major challenges indicated above. This implies that, from now on, the focus of economic policy should be on the following:

1. Speeding up reforms and privatisations. Despite the progress achieved so far, there is still a lot to be done in the areas of privatisation and reforms. Privatisations which are at a mature stage need to be completed quickly. In order to attract both domestic and foreign investment, further emphasis must be placed on reforms that foster competition in the goods and services markets, such as reducing entry barriers into network industries, retail trade and professional services, upgrading the education system, improving public administration and cutting red tape.

2. Adopting a growth-friendly fiscal policy mix. More emphasis must be placed on cutting non-productive expenditure and increasing public sector efficiency, including the management of state property. This is important since, according to OECD estimates, state property in Greece is among the highest as a percentage of GDP in the OECD member states. The improvement of public sector efficiency and tax administration, so as to combat the underground economy and tax evasion and broaden the tax base, will lead to a fairer distribution of the fiscal burden and facilitate the reduction of excessively high tax rates.

3. Tackling the problem of non-performing loans (NPLs) and strategic defaulters, which constrains the banking system’s ability to finance economic growth. Moreover, banks will be facing new challenges in 2018, most notably the implementation of International Financial Reporting Standard 9 (IFRS 9), stricter treatment of loan-loss provisions, as well as the EU-wide stress test to be conducted by the ECB. Thus, in the period immediately ahead, banks need to step up their efforts to attain their operational targets for reducing their NPLs and, ideally, overachieve them now that the economy has returned to positive growth. Banks should also take advantage of the reformed institutional framework (e.g. authorisation of credit servicing firms, operation of an electronic platform for out-of-court settlement, e-auctions of real estate, etc.) and make full use of the available toolbox in order to speed up NPL reduction. In this context, they need to broaden as soon as possible the scope of the workouts they offer to borrowers and make more drastic decisions, in particular with respect to the restructuring of viable businesses, identification of strategic defaulters and implementation of definitive solutions in the case of non-viable businesses.

4. Improving the quality and ensuring the proper functioning and independence of institutions. With regard to independent authorities, it is important to strengthen their administrative and financial autonomy and ensure respect for their independence, as well as accountability towards Parliament. Well-functioning institutions improve structural competitiveness and promote economic growth because they affect incentives for people and businesses to invest in physical and human capital, technology and the organisation of production.

5. Removing various obstacles to investment. Besides improving the business environment and lowering taxation, it is necessary to decisively and definitively remove the obstacles raised by various small or large organised interests and groups, which deteriorate the business climate and stand in the way of new investment and privatisations, even those already approved.

6. Addressing the public debt overhang. Decisive and concrete actions are needed to ensure the sustainability of Greek public debt, on the basis of the Eurogroup’s decision of June 2017. The Bank of Greece has put forward a mild debt re-profiling proposal, which entails only a negligible cost for our partners and provides for, among other things, extending the weighted average maturity of interest payments on EFSF loans by at least 8.5 years.

7. Supporting the unemployed and enhancing employment and training programmes. With unemployment at very high levels, it is essential to provide immediate support to the unemployed and those marginally attached to the labour market by using active labour market policies and targeted social transfers to counter temporary income loss and shorten job transitions. In the medium term, emphasis should be placed on skill upgrading and retraining policies to get people back into work.


Today, it is urgently necessary to implement the reform and privatisation programme smoothly and according to the agreed time schedule; to promptly enact and implement the measures agreed upon in the third review; and to prepare for the timely completion of the fourth and final review, which will mark the end of the programme. These are important steps that will boost confidence and help to improve Greece’s credit rating, thereby ensuring sustainable access to the markets on favourable terms after the end of the programme. To consolidate confidence over the medium term, it is equally important to (a) specify in more detail the medium-term debt re-profiling measures, which will enable Greece’s access to bond markets on sustainable terms and, secondarily, will facilitate the inclusion of Greek government bonds in the ECB’s quantitative easing programme; and (b) clarify the form that post-programme support to the Greek economy will take.

As already known, under the EU legal framework, Greece will be under surveillance at least until it repays 75% of the official loans received from euro area countries, the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM). However, it remains to be clarified whether and on what conditions there will be a “precautionary support programme”. Such a precautionary support framework should assist the Greek economy by driving down borrowing costs, as it will provide assurance of the Greek government’s access to financing after the end of the programme in August 2018. The confidence of international investors in the medium- to long-term prospects of the Greek economy will thus be strengthened, in the knowledge that economic policy is and will remain prudent, precluding the re-emergence of imbalances.

Clarifying the form of post-programme support would be important for an additional reason, in the event that Greece’s credit rating has not improved by the end of the programme: Greek bonds would (a) continue to be accepted as eligible collateral in the ECB’s monetary policy operations; and (b) be included in the ECB’s quantitative easing programme, whether in its planned duration or during the reinvestment period.

These actions would improve the investment and business climate and attract domestic and foreign direct investment. At the same time, they would facilitate the return to financial normality, the full abolition of capital controls and the sustainable recovery of the economy after eight years of sacrifices, recession and stagnation that have exacerbated social inequalities.

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