Today, in accordance with its Statute, the Bank of Greece submitted its Monetary Policy Report 2018-2019 to the Speaker of the Greek Parliament and the Cabinet.
Implementation of reforms to speed up growth
The present Report on Monetary Policy is submitted by the Bank of Greece at a time when the Greek economy continues to recover. Economic sentiment is positive, the liquidity situation of the banking system and the economy is improving and Greek government bond yields have been trending downward.
Nevertheless, growth rates remain relatively low and Greece’s sovereign rating is below investment grade. The economy continues to face major challenges, and significant downside risks and uncertainties arise from the external environment, such as a slowdown of global economic activity amid rising trade protectionism and geopolitical tensions. Risks also arise from the domestic environment, relating to a backtracking or cancellation of reforms, the fiscal implications of court rulings and the recent expansionary fiscal package that fuel uncertainty about the achievement of the agreed fiscal targets and the long-term sustainability of public debt and of the pension system.
In order to speed up recovery, address the risks and challenges, and consolidate investor confidence in the prospects of the Greek economy, it is essential to keep the much-needed reforms on track, safeguard fiscal stability and adopt a more growth-friendly fiscal policy mix.
Economic activity picked up in 2018 – recovery continued in the first quarter of 2019
GDP grew by 1.9% in 2018, compared with 1.5% in 2017. The economy continued to expand in the first quarter of 2019, albeit at a slower pace, with GDP seasonally adjusted and at constant prices growing by 1.3% year-on-year. The main drivers of growth were services exports, investment and private consumption. On the other hand, imports, goods exports and government consumption made negative contributions.
Available soft data and short-term activity indicators point to continued recovery in the second quarter of the year. However, export activity is expected to be affected by rising uncertainty and the global economic slowdown, amid rising trade protectionism.
2018 saw a small decline in inflation. The increase in the minimum wage and the indirect tax cuts are exerting effects in opposite directions, which are expected to some extent to offset each other, bringing the average rate of HICP inflation in 2019 to slightly lower levels than in 2018.
Positive trends in the financial sector
The liquidity situation of the banking system continued to improve in 2018 and into the first months of 2019. More specifically, deposits continued to rise, banks’ reliance on Emergency Liquidity Assistance (ELA) from the central bank decreased significantly and was ultimately reduced to zero, and access of banking institutions to the interbank market improved. These developments, together with improved confidence, enabled a further relaxation of capital controls, most recently with the lifting of all restrictions on cash withdrawals in October 2018.
The improvement in banking system liquidity and the gradual reduction of the stock of non-performing loans (NPLs), which however remains very high, led to an increase in bank credit to non-financial corporations. Furthermore, Greece’s sovereign rating has been upgraded, and Greek government bond yields have been trending downwards since the beginning of the year. These favourable circumstances enabled the Greek government to issue new benchmark bonds. It should be noted, however, that the yields on government bonds rated below investment grade are vulnerable to occasional turbulence in international financial markets.
Positive fiscal developments in 2018, still heavily reliant on taxation and on Public Investment Programme under-execution
The general government primary balance in 2018, as calculated according to the methodology of the enhanced surveillance, turned out a surplus of 4.3% of GDP, against a targeted 3.5% of GDP, thereby overachieving the programme targets for the fourth year in a row. This overachievement in recent years helps contain public debt and boosts market confidence in the commitment of the Greek authorities to the agreed fiscal targets. However, as the Bank of Greece has already stressed in earlier reports, the high primary surplus targets and their systematic overachievement mainly through tax increases and curtailment of public investment spending act as a drag on the economic recovery and adversely affect long-term potential output.
Forecasts suggest continued recovery and a primary surplus below target
According to Bank of Greece forecasts, economic activity is expected to increase by 1.9% in 2019, by 2.1% in 2020 and by 2.2% in 2021, mainly driven by private consumption, business investment and exports.
Private consumption is projected to pick up slightly in 2019 and to increase moderately in the two years thereafter, on the back of a gradual improvement in real disposable income, as a result of rising employment and wages. Investment is expected to contribute positively to growth as confidence gradually strengthens and the liquidity of the financial system is restored.
Exports of goods are expected to continue to show positive rates of change, albeit decelerating, as the impact from the Greek economy’s improved competitiveness is partly offset by the deteriorating global environment. Imports of goods and services are expected to increase, but to be slightly outpaced by exports. Thus, the positive contribution of net exports to GDP growth should be only marginal.
HICP inflation is projected to rise slightly until 2021, though still remaining at low levels, mainly reflecting the projected moderate unit labour cost growth and the assumed path of oil prices. Core inflation is projected to follow a path slightly above that of headline inflation.
As regards public finances, the Bank of Greece forecast for 2019, taking into account the recently enacted expansionary fiscal package and based on the latest available data, is that the primary surplus will come to 2.9% of GDP, against a target of 3.5% of GDP.
Macroeconomic and fiscal risks remain
The economic outlook is subject to significant downside risks, both external and domestic. Risks arising from the external environment include a stronger than expected global economic slowdown as a result of trade protectionism; a possible sharp correction in global financial markets that would increase the cost and reduce the availability of funding, the possibility of a no-deal Brexit and other geopolitical developments.
Turning to the domestic environment, delays in implementation and/or a cancellation of reforms would adversely affect the investment climate and economic activity. There are also significant downside risks on the fiscal front, relating to the Council of State Plenum rulings that earlier pension cuts were unconstitutional. Furthermore, as estimated in the European Commission’s Enhanced Surveillance Report, the recent expansionary fiscal measures will have a fiscal cost of more than 1.0% of GDP in 2019 and beyond. This poses an additional risk for the achievement of the agreed primary surplus targets. The European Commission will re-assess the impact of the measures in autumn 2019. Further fiscal risks for 2020 and 2021 arise from repealing the legislated reduction of the tax-free personal income allowance and the associated counter-measures.
On the upside, activation of the respective plans proposed by the Bank of Greece and the Ministry of Finance for tackling non-performing loans could free up resources to be channelled into productive investment projects, thereby supporting economic activity.
Bank profitability still weak – capital adequacy satisfactory
The profitability of Greek banks before taxes and provisions remains weak, as shown by the results for 2018 and the 2019 Q1 results of the four systemic banks. In terms of capital adequacy, both the Common Equity Tier 1 (CET1) ratio and the Capital Adequacy Ratio, on a consolidated basis, remain satisfactory (at 14.9% and 15.5%, respectively, for the four systemic banks at the end of the first quarter of 2019).
A decline in non-performing loans
Banks have made progress in reducing non-performing loans (NPLs). More specifically, at end-March 2019, NPLs amounted to €80 billion, down by about €1.8 billion from end-December 2018 and by around €27.2 billion from their March 2016 peak. The reduction in the stock of NPLs in the first quarter of 2019 was mainly driven by write-offs (€0.9 billion), followed by loan sales (€0.8 billion), while a significant volume of NPL sales is currently in the pipeline and is set to be completed by year-end.
The ratio of non-performing loans to total loans in March 2019 remained elevated at 45.2%. Overall, despite the improvements in the economic and institutional environment, the recoveries from active NPL management (collections, loan restructuring, collateral liquidation, etc.) remain limited, which is worrying. On a positive note, over the past few years banks have increasingly shifted to long-term NPL workout solutions. Still, an alarmingly high proportion of cured loans fall back into arrears, often just a quarter after the loan restructuring. This raises serious questions about the suitability and effectiveness of the solutions offered.
As regards the operational targets for NPL reduction, the aim is to bring the average NPL ratio down to below 20% by end-2021. Overall, there has been progress in this regard; however, the pace of NPL reduction is not sufficient to bring the NPL ratio close to the European average of 3.2% as at end-2018. The Bank of Greece sees a need for a decisive and systemic approach to the NPL issue, on top of the banks’ own efforts and has put forward a systemic proposal in this direction. The Ministry of Finance has also put forward its own proposal for NPL reduction.
The Greek economy continues to face significant challenges and legacies from the protracted economic crisis. The most important challenges are the following:
• The high stock of non-performing loans (NPLs) on bank balance sheets, which impairs banks’ ability to lend to healthy businesses and delays the recovery of investment and economic activity.
• High public debt – although its medium-term sustainability improved significantly with the measures adopted by the Eurogroup in June 2018 – creates uncertainty about Greece’s ability to service its debt in the long term, raising borrowing costs both for the public and for the private sector and hampering growth prospects.
• Maintaining large primary surpluses over a prolonged period (3.5% of GDP up to 2022) impacts negatively on GDP growth. The restrictive effect of large primary surpluses is even more pronounced when accompanied by very high taxation (including high social security contributions) and cuts in the Public Investment Programme, resulting in weaker economic recovery and expanding the informal sector.
• The still negative current account balance and the negative net international investment position.
• High long-term unemployment, high youth unemployment and low female labour force participation exacerbate inequalities, threaten social cohesion and lead to human capital erosion.
• The demographic crisis, due to population ageing and outward migration of highly skilled labour during the crisis, leads to a decline in active population and exerts downward pressure on potential growth, putting the long-term sustainability of the social security system and public finances at increased risk.
• High income inequality, coupled with the limited effectiveness of social benefits in reducing poverty risk (2017: 15.83% in Greece, compared with 33.98% in the EU). While globalisation, digitalisation, demographic change and climate change open new opportunities for growth, they also increase inequalities. Despite the State’s intervention through social and tax policies geared towards inclusive growth and lower inequalities, the results have so far not been satisfactory.
• The slow digital transformation of the economy, as evidenced by Greece’s weak performance in terms of fast broadband connectivity and basic digital skills. Based on the Digital Economy and Society Index (DESI) of the European Commission for the year 2019, Greece ranks 26th among the 28 EU countries, which implies a high risk of technological lag and digital illiteracy and of a low-productivity trap.
• The prolonged recession has left a huge investment gap, which could permanently impair the productive capacity of the Greek economy. The net capital stock of the Greek economy, including housing (at constant 2010 prices), declined by €67.4 billion between 2010 and 2016.
• Looking beyond the effects of subdued domestic demand and funding constraints, including significantly higher borrowing rates than elsewhere in the euro area, the business environment is far from investment-friendly. This is due to high tax rates, excessive red tape and legislative complexity, legal uncertainty and delays in court proceedings and enforcement of judgments and, more generally, the existence of barriers and obstacles that have proven to stand in the way of investment plan implementation, thereby worsening the business climate. In this context, it should be noted that Greece’s structural competitiveness is not only low compared to that of its European partners, but has in fact decreased in recent years, according to the ease of doing business index of the World Bank (October 2018), the global competitiveness index of the World Economic Forum (October 2018) and the global competitiveness ranking for 2019 of the IMD World Competitiveness Center.
• Finally, there is the challenge of climate change, which will require coordinated efforts to address. The Bank of Greece has been playing an active role in this area through its Climate Change Impact Study Committee (CCISC).
Prerequisites for an investment- and export-led recovery
Going forward, in view of the challenges and risks facing the Greek economy, priority must be given to the following policies aimed to facilitate the transition of the economy to a sustainable, extrovert growth model led by investment.
1st A drastic reduction in NPLs, through the activation of the plans put forward by the Bank of Greece and the Ministry of Finance, is necessary for bank lending to increase and for investment to recover.
2nd There is a need to broaden the sources of long-term financing. That is, to better utilise the financing opportunities offered by capital markets and/or alternative finance channels (such as venture capital, crowdfunding, SME-specific trading platforms, convertible bonds, etc.). Significant impetus to such alternative channels could be provided by the completion of the Capital Markets Union at the European level.
3rd A more aggressive policy for attracting foreign direct investment is warranted, as domestic savings are insufficient to match the investments needed for high growth rates. If the country is to attract more foreign direct investment, it is necessary to speed up privatisations, which mobilise additional private investment, and to focus on removing major disincentives, such as red tape; the lack of a clear and stable legislative and regulatory framework; an unpredictable tax system; weaknesses in property rights protection; limited access to financing and high borrowing costs; delays in legal dispute resolution; and the remaining capital controls restricting outgoing cross-border payments and fund transfers.
4th There is also a need to strengthen the independence of institutions and the rule of law. International experience has shown that robust economic growth is achieved by countries with strong, independent institutions and good governance that enhances public trust, as key enabling conditions for investment in physical and human capital. Any interference with public administration or with the functioning of independent authorities and especially with the justice system is incompatible with a modern state governed by the rule of law.
5th It is of the utmost importance not only to prevent any backtracking or cancellation of reforms, but also to strengthen those reforms that foster market competition. Higher competition will, in turn, motivate innovation and new investment, leading to higher productivity and employment and improving the structural competitiveness of the economy.
6th In consultation and agreement with Greece’s European partners, the primary surplus targets to be achieved up to 2022 should be lowered and a fiscal policy mix adopted with lower tax rates and social security contributions, so as to become more friendly to investment, competitiveness and growth.
A lower, more realistic, primary surplus target compared to the current one of 3.5% of GDP through 2022, if combined with more reforms and privatisations, would probably imply lower, rather than higher public debt. This is so because, with a public debt-to-GDP ratio of 180%, a 1 percentage point-higher growth rate (likely to mateliarise if the lower primary surplus target is achieved through lower taxes and social contributions, combined with more privatisations and reforms) and/or 100 basis points-lower borrowing costs (already materialised, relative to the European Commission’s baseline scenario) are 1.8 times more effective in reducing the debt ratio than an additional GDP percentage point of primary surplus. On top of this, one must also factor in the revenue from more privatisations.
7th Greater emphasis must be placed on: creating public-private partnerships; developing State-owned property, mainly through modern land-use legislation; increasing those public investments that would have a multiplier effect on the economy; and introducing international accounting standards across all enterprises and entities (above a certain size) within general government and the broader public sector. Public-private partnerships optimise total national resources, i.e. the sum of public and private resources, and offer solutions even in sectors like social security and healthcare, increasing rather than reducing available resources for citizens and improving the quality of services offered. European countries with a particularly strong welfare state, e.g. in Scandinavia, are leaders in the implementation of such schemes in social security and healthcare, whereby private funds complement public resources, and private sector involvement in these areas is subject to supervision, control and licensing by the State.
8th It is necessary to strengthen the “knowledge triangle” (education, research and innovation) through policies and reforms that promote research, technology diffusion, entrepreneurship and foster closer ties between businesses, research centres and universities. This would further contribute to increasing R&D spending and the ICT sector’s share in GDP. Overall, a strengthening of the knowledge triangle would lead to the digital transformation of the economy, an increase in the stock of knowledge and productive capital, the development of outward-oriented sectors and, more generally, to a knowledge economy and society.
9th Lastly, a key prerequisite for achieving the policies outlined above is the modernisation of public administration, with a redesigning of procedures and responsibilities, digitisation and the evaluation and development of staff capacities and infrastructures.
Since 2010, the Greek economy has achieved an unprecedented correction of its macroeconomic imbalances, improved its competitiveness in unit labour cost terms, while the banking system has been restructured and recapitalised. The economy has started to recover, albeit still at a relatively slow pace. Nevertheless, the economy continues to face major challenges, with significant risks arising on the domestic front relating to a backtracking or cancellation of reforms, as well as on the external front, such as a slowdown in global economic activity on account of rising trade protectionism and geopolitical tensions.
In order to consolidate investor confidence in the prospects of the Greek economy and ensure faster growth rates, progress with the necessary reforms must not stall or be reversed, but on the contrary needs to be stepped up. This would make Greece an attractive choice for domestic and foreign direct investment and foster the Greek economy’s transition to a new, export-oriented model, with high and sustainable rates of economic growth. In such an event, the investment gap could be closed within a reasonable timeframe and with realistic investment rates, provided that the investments are concentrated in the more productive and export-oriented sectors of the economy. Looking ahead, two things are of the utmost urgency: public investment, which had been drastically curtailed in recent years, must be increased, given its multiplier effects on the economy, and privatisations must be accelerated, as this would mobilise additional private investment.
The reaction of markets over the past weeks, with the sharp drop in the yields of Greek government bonds, augurs well for the future, on condition that the positive sentiment that has been generated is confirmed by timely economic policy action of relevance to the investment climate.
The full text of the Report is available (in Greek) here.