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29/05/2013 - The Bank of Greece Report on Monetary Policy 2012-2013

Today, in accordance with its Statute, the Bank of Greece submitted its Report on Monetary Policy 2012-2013 to the Speaker of the Greek Parliament and the Cabinet.

The economy is rebalancing

In recent months there have been stronger indications, both at home and abroad, that the economy is rebalancing. These indications can be summarised as follows:

- The possibility of a Greek exit from the euro area is now remote, as widely acknowledged by analysts and international organisations.

- Confidence in Greece’s economic prospects is gradually being restored, as shown by the sharp decrease in the yield spread between Greek and German ten-year government bonds.

- The Greek banking system has weathered the storm and proved resilient to the severe crisis; it is currently undergoing a process of restructuring on new, healthy foundations. This is the first crucial step towards restoring normal financing conditions in the real economy. It is worth noting that the stability of the banking system was shielded from the tangible risk of a spillover from the Cyprus crisis. Thus, the peak in uncertainty triggered by the developments in Cyprus proved short-lived, putting a halt to the outflow of deposits observed in April 2013.

- The twin deficits (fiscal and external) have declined considerably: fiscal consolidation has made remarkable progress, and a primary surplus seems likely to be achieved in 2013, while the external balance has also improved substantially.

- The implementation of the stabilisation programme is judged to be well on track, and disbursements under the loan agreement are continuing smoothly.

However, output continues to contract and unemployment is still rising

These indications are decidedly positive and, if sustained, herald a future improvement in the real economy. However, the recession and the rise in unemployment continue. Adjustment has taken a heavy toll in terms of output, employment and disposable income -- the reason being that it was necessary to address, within a short space of time, accumulating chronic problems and imbalances that, if left unchecked, would surely have led to a default and an exit from the euro area. In the end, the default was averted thanks to substantial progress in the area of fiscal adjustment, which made possible the continued financial support from our partners. The extent and duration of the recession could nevertheless have been lessened, had structural reforms to promote the efficient functioning of the public administration and markets been pursued more energetically and boldly.

An economic recovery is possible in 2014 if the improvement in economic sentiment takes hold and structural reforms are speeded up

If the implementation of structural reforms can be speeded up and the improvement in economic sentiment takes hold, it is plausible to expect that the results will soon be felt in the real economy as well. A prerequisite for recovery is the continued steadfast and faithful implementation of the stabilisation programme.

According to the Report, GDP is expected to contract at a rate of close to 4.6% this year, and unemployment to stabilise at around 28%. A return to positive growth is anticipated for 2014, while unemployment should start to decline in 2015.

Inflation is projected to turn out at about -0.3% in 2013 and core inflation at -1.1%. At the same time, it is estimated that the loss of competitiveness over the period 2001-2009 will be more than recovered by end-2013.

Finally, based on available evidence, the current account deficit is expected to narrow further to below 3% of GDP in 2013 and to hover around 2% in 2014.

The banking system has proved resilient to the crisis

Until recently, the banking sector had been facing serious problems with liquidity, loan portfolio quality and capital adequacy. These problems, though still present, are gradually being mitigated. It is particularly worth noting that, despite the extremely adverse conditions, the government and the Bank of Greece took effective action and succeeded in safeguarding financial stability and fully protecting depositors. This was confirmed again recently when, starting in late March, Greek banks had to tackle the negative fallout from developments in Cyprus. Following swift and effective action on the part of the Greek authorities, the risk that shocks from the Cypriot banking system would be transmitted to the Greek financial system was minimised, as deposits with Greek branches of Cyprus banks were fully excluded from the bail-in imposed on deposits in Cyprus. The former Cypriot bank branches operating in Greece continued to serve their customers smoothly after their acquisition by a domestic bank. The risk of contagion from the Cypriot to the Greek banking system was thus nipped in the bud.

The recapitalisation of core banks will soon be completed

Following the transitional recapitalisation of the core banks by the Hellenic Financial Stability Fund (HFSF) in May and December 2012 using EFSF debt securities, recapitalisation is nearing its completion within the specified timeframe.

Recapitalisation will mark the starting point for a restructuring of the banking system based on a comprehensive long-term strategy. A noteworthy number of mergers and acquisitions have already been completed, while the consolidation in the banking system has also been supported by the bank resolutions that took place without any disruption to market stability and with full protection of all depositors.

In the months ahead, the banking system will face new challenges. Once banks’ capital base has been strengthened, they will be expected to manage their new entities with a focus on achieving the maximum possible synergies, in the context of the regular (quarterly) funding plans that they are required to submit to the Bank of Greece for assessment. At the same time, banks will need to prepare for the new stress test exercise to be conducted by the Bank of Greece by end-2013. Special attention will be given to the more efficient management of non-performing loans. Moreover, by end-September 2013, the institutional framework of cooperative banks must be aligned with the best international practices.

The return of deposits, the fall in funding costs, as well as the completion of the restructuring and recapitalisation of the banking system (both of which are structural reforms of crucial importance), will all contribute decisively to the restoration of confidence in the prospects for the Greek economy and are prerequisites for economic recovery. The Bank of Greece will continue to take action with a view to maintaining the stability of the financial system, protecting depositors and creating a sustainably sound and well-capitalised banking system; these goals are a sine qua non for supporting the real economy.

Uncertainties and risks still remain

These encouraging developments, however, leave no room for complacency, as risks and uncertainties still remain which could jeopardise stabilisation and undermine the prospects of economic recovery:

- Despite progress in several areas, the functioning of public administration remains weak. This weakness leads to shortfalls as regards the implementation of measures previously passed by the Greek Parliament and effectively delays reforms that could mitigate the intensity of the recession.

- The protracted and deep recession, combined with the lack of liquidity, could increase the number of – essentially viable – businesses that are forced to shut down.

Policies to support the recovery

Nevertheless, the climate is more favourable today for the speedier pursuit of policies aimed at translating the improvement in expectations into real economic activity. For this to happen, there are a number of prerequisites:

First, to press ahead with the fiscal consolidation programme, fully adhering to the timetable and targets set. Meeting the budgetary targets both fully and on time is the first and essential condition for the continued smooth disbursement of funds under the loan agreement. Top priority should be given to achieving a primary surplus in 2013. Achieving the budgetary targets would bolster confidence in the Greek economy, while also eliminating the need for additional across-the-board measures. In fact, the progress made so far with fiscal adjustment has been crucial to ensuring continued financial support to the Greek economy.

Second, to accelerate structural reforms, especially in the public sector. In particular, emphasis should be given to:

- finalising the tax reform agenda, which should create the conditions for reducing the tax burden of those who already pay taxes. This requires a broadening of the tax base, through the effective curbing of tax evasion;

- improving the efficiency of tax administration, in order to boost public revenue. Of major importance in this respect is the upgrading and effective functioning of the General Secretariat of Public Revenue Administration;

- taking steps to rationalise the functioning of the public sector, by utilising the opportunity for staff renewal opened up by the recent decision to replace some 15,000 civil servants who are expected to leave service under mandatory exits by 2014. New recruitments should be strictly merit-based and targeted to cover pressing needs in key areas (e.g. tax administration, health).

Third, to carry through the privatisation agenda with greater resolve and at a faster pace, assessing each privatisation in terms of its potential to create jobs and foster a shift in the Greek economy’s growth model.

Fourth, to urgently address the issue of unemployment, by inter alia strengthening active labour market policies. This can be achieved by making more effective use of resources available from the Structural Funds to support social cohesion.

Fifth, to complete pension reform in practice, by developing the occupational and private life insurance pillars, which, under certain conditions, could help offset the declines in main, first-pillar pensions. This would require eliminating existing obstacles and rigidities.

Sixth, to enhance liquidity in the short term, by accelerating: (i) the payment of public sector arrears to the private sector; and (ii) the utilisation of available resources of the National Strategic Reference Framework (NSRF) and the European Investment Bank to support investment and relaunch infrastructure projects.

Key to restoring normal liquidity conditions will also be the strengthening of the banking sector, which – along with the completion of structural reforms – will help to rebuild confidence in the economy and increase both the supply and demand for bank financing.

In the long term, however, given that domestic savings are not sufficient to finance growth via bank lending, alternative sources of financing the economy need to be tapped, complementing bank credit and EU funds. In this respect, as the economic and business outlook improves, Greece must seek to attract foreign direct investment through privatisations and to take advantage of the opportunities offered by the corporate bond market.

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The full text of the Report is available here.