Today, in accordance with its Statute, the Bank of Greece submitted its Monetary Policy Report 2016-2017 to the Speaker of the Greek Parliament and the Cabinet.
The progress made so far forms a basis for a return to economic growth
2016 saw the completion of a long period of fiscal consolidation, with the general government balance turning to a surplus of 0.7% of GDP, from a deficit of over 15% of GDP in 2009. Equally remarkable was the improvement in the primary balance, from a deficit of 10% of GDP in 2009 to a surplus of 4.2% of GDP in 2016, under the programme definition. In practical terms, this means that nearly the entire fiscal adjustment required by the end of the current programme in 2018 has already been achieved.
This positive development would not have been possible without a fiscal policy committed to eliminating the main cause of the crisis, i.e. the very high fiscal deficits. This policy was implemented – with varying intensity – by all of the governments from 2010 to 2017, albeit through different fiscal policy mixes. This alignment on the same goal shows that, indeed, no other option was available and that fiscal adjustment was a sine qua non for Greece to exit the crisis. This is why successive governments and political parties voted in favour of fiscal consolidation measures despite their heavy toll on society. The de facto alignment of fiscal policy, placed under the overarching objective of staying in the euro area, has reduced the uncertainties and risks and ensures the continuation of growth-enhancing reforms. Against this background, any backslide, in future, to the policies of the past that had widened the fiscal deficits and brought Greece to the brink of bankruptcy should be considered unlikely. Furthermore, the commitments under the financial assistance facility agreement leave no margin for such deviation. As shown, in addition, by the Medium-Term Fiscal Strategy (MTFS) recently voted by parliament, fiscal policy will retain the same stance until the end of the programme in 2018 and beyond.
Since the start of the crisis, significant progress has also been recorded in other key areas
Apart from fiscal consolidation, the economic adjustment programmes implemented over the past years succeeded in addressing chronic structural weaknesses and distortions. The current account deficit as a percentage of GDP has been reduced by 15 percentage points. For the past two years the current account has effectively been in balance. Labour cost competitiveness has been fully restored. Price competitiveness is back at its 2002 level and can be expected to improve as the implementation of further reforms increases competition in the markets.
Meanwhile, sweeping reforms have been implemented in key areas, such as the pension and health systems, the labour and product markets, public administration, the tax system and tax collection mechanism, while a far-reaching privatisation programme is currently ongoing.
The banking system, after its recapitalisation and restructuring, has started to effectively cope with the risks of heightened uncertainty and is better equipped to address the heavy burden of non-performing loans.
The recasting of the economy continues with the Medium-Term Fiscal Strategy (MTFS) for 2018-2021
The effort to recast the economy has been scaled up with the recent enactment of Law 4472/2017, which, apart from the MTFS 2018-2021, also contains:
(a) a supplemental package of measures to guarantee the achievement of the agreed fiscal targets by end-2018;
(b) a set of measures to be implemented in the medium-term (2019-2021) including a pension reform, with reduced pension expenditure and higher social security contributions, as well as a personal income tax reform introducing a lower tax-free threshold; and
(c) expansionary measures in 2019 and 2020, contingent upon the achievement of the programme targets, geared at shifting the fiscal policy mix towards targeted welfare benefits, public investment and tax rate reductions.
This new legislation ensures the conditions for meeting the fiscal targets, but just as importantly envisages actions towards the completion of pending reforms. Therefore, its resolved implementation without further delay should help increase the growth potential, bolster confidence and boost investment.
The completion of the second review on 15 June 2017 confirms the progress achieved
The policy package introduced by Law 4472/2017 and the additional measures adopted on 12 June meet the prior actions agreed with the partners, thereby paving the way for a successful completion of the second review of the ESM programme. The Eurogroup statement of 15 June:
First, clearly expresses the partners’ positive assessment of the programme implementation, explicitly recognising that the Greek authorities have acted to meet all the requirements entailed by the agreement.
Second, paves the way to the next disbursement of funds to Greece of an amount necessary to cover the outstanding debt service and an amount to help clear the stock of government arrears to the private sector. The clearing of arrears can be expected to improve the liquidity conditions of the private sector, with multiplier effects on the real economy.
Third, reiterates in a clearer manner the lines along which further debt relief measures could be adopted after the programme’s completion in 2018.
Fourth, acknowledges the possibility of lowering the general government primary surplus target to a level equal to or above but close to 2% of GDP in the period after 2022.
Thus, the conditions have improved for Greece to successfully regain market access, with support from our partners, once the programme has been completed.
Developments – Prospects
After a mild downturn in 2015, GDP remained unchanged in 2016. The upward trend in the second and third quarters of 2016 halted in the fourth quarter. The negative carryover from the last quarter of 2016 has dampened the growth forecast for 2017, bringing it down from 2.5% to 1.6%. The weaker growth dynamics can be attributed to the long delay in completing the second review and to the consequent surge in uncertainty, which led to a considerable decline in investment. This, combined with the sharp increase in the tax burden, dampened the initial forecast. Despite the downward revision of forecasts for 2017, the medium-term growth outlook remains favourable, conditional on the continued smooth implementation of reforms. Meanwhile, the recovery is being favourably impacted by the positive economic and political developments in the European Union.
The banking system is stabilising
The gradual restoration of confidence in 2016 following the completion of the first review and the partial easing of capital controls led to inflows of deposits into the domestic banking system, especially by non-financial corporations. From the completion of the first review in June 2016 through April 2017, the stock of deposits held by the domestic private sector increased by a cumulative €3.5 billion to €119 billion. However, the first months of 2017 saw an outflow of deposits, amid heightened uncertainty related to the delays with the completion of the second review.
The contraction of credit, at least to non-financial corporations, seems to be bottoming out, while the annual rate of decline in credit to households is close to zero.
The results and overall soundness of banks developed favourably in 2016, with domestic banks reporting pre-tax profits, after several years of loss making, while the outstanding stock of non-performing loans (NPLs) declined slightly. Capital adequacy and liquidity ratios strengthened.
A small decline in non-performing exposures
The aggregate loan portfolio quality of the banking system showed a stabilising trend, as signs of improvement became visible after the first quarter of 2016. By end-December 2016, the volume of non-performing exposures on an unconsolidated basis totalled €106 billion, down from €108 billion one year earlier. This improvement resulted from loan write-offs and from the curing of certain non-performing loans following restructuring. This, together with loan repayments and liquidation proceeds, offset the formation of new non-performing exposures.
In the first quarter of 2017, non-performing exposures declined further to €105.1 billion or 45.2% of total exposures, mainly as a result of loan write-offs (especially in the business and consumer portfolios). Looking at the breakdown by type of loan, the NPE ratio came to 42.2% for housing loans, 45.0% for business loans and 54.2% for consumer loans. Among business loans in particular, for which a more detailed breakdown is available, loans to large corporations had the lowest NPE ratio (25.9%), while loans to small business and professionals (SBPs) had the highest (68.3%), followed by loans to small- and medium-sized enterprises (SMEs, 60.7%).
Turning to the action taken by banks to address NPEs, there has been growing recourse to longer-term solutions (for instance, lengthening the loan maturity and/or lowering the interest rate). In general, banks have made progress towards meeting their agreed operational targets for NPE reduction, in particular in their business loan portfolios. One matter for concern, however, is the fact that a significant share of loans subject to (mostly short-term) restructuring is now once again in arrears. In the first quarter of 2017, the default rate slowed further, but nonetheless remained above 2% and higher than the cure rate. The gap between default and cure rates is higher in the business and consumer loan portfolios. However, contrary to the trend observed in previous quarters, banks reported significant inflows of new non-performing exposures in their housing portfolios.
The provision coverage ratio for the banking system as a whole has marginally decreased, from 49.7% in December 2016 to 49.1% in March 2017. However, adding the value of collateral, the coverage ratio nears 100%.
In total, the stock of non-performing loans of all banks combined remains very high and continues, through a number of channels, to constrain banks’ lending activity. On a positive note, however, the capacity of banks to lend to the real economy is enhanced by the fact that their capital adequacy ratios remain high. More specifically, the Common Equity Tier 1 (CET1) ratio on a consolidated basis in December 2016 rose to 16.9% (December 2015: 16.2%), while the Capital Adequacy Ratio increased to 17% (December 2015: 16.3%).
The lifting of capital controls
The capital controls, imposed in 2015 to halt the capital flight fuelled at the time by the prevailing uncertainty, were a necessary emergency intervention to safeguard financial stability. They have since been gradually relaxed, as uncertainty subsides, in order to make it easier for businesses to operate. Still, the impact of the capital controls on business activity has been considerable and needs to be assessed. As part of the agreement with the partners, the Bank of Greece has undertaken to conduct a survey of this impact, currently ongoing.
Although the capital controls still in place today have clearly been relaxed, they continue to cause problems. The mere existence of policies contravening the fundamental European principle of free movement of capital is a source of uncertainty with negative repercussions on investment decisions.
Thus, it is essential to continue on the path ultimately leading to a lifting of all remaining capital controls. The steps in this direction will need to be paced in line with improvements in market sentiment and depositor confidence in the banking system.
Conditions for a transition to growth
Despite the positive developments already highlighted, the Greek economy still faces three major legacy problems from the deep and protracted recession of the past years and the decline in investment: (a) high unemployment; (b) a high stock of non-performing loans; and (c) a high public debt-to-GDP ratio. Economic policy will now have to give top priority to addressing these issues, so as to put the economy back on track to sustainable growth. More specifically:
1. Growth is the only answer to the unemployment problem. The shift of the Greek economy to a new extroverted growth model capable of generating new sustainable jobs requires a steady and consistent growth policy with the following key components:
• A growth-friendly fiscal policy mix. The excessive reliance on taxation and high tax rates needs to be reduced in favour of policies centred on containing and restructuring non-productive spending, while also improving tax and contribution collectability.
• Speeding up the privatisations that have already been agreed but have been delayed, as well as expanding privatisations through public-private partnerships.
• Rapid utilisation of the considerable idle assets of the State, especially its real estate, through appropriate legislation on land use.
• Minimisation of the considerable delays in the delivery of justice and of bureaucratic rigidities in public administration, which represent the most serious obstacles to attracting foreign investment.
• Reforms in the energy, product and service markets, and the opening-up of the remaining regulated professions, with an immediate view to raising productivity.
• On the employment front, policies and reforms are needed to facilitate the diffusion of technology and foster new entrepreneurship. This should be achieved by encouraging and providing incentives for cooperation between the private sector and higher education and research institutions, so as to boost innovation, as a prerequisite for a shift to a knowledge-based economy.
2. Addressing the issue of non-performing loans is the most pressing challenge for the Greek banking system and the Greek economy. Over the past two years, the Bank of Greece and the State have taken a number of actions to tackle the factors that have long thwarted banks’ efforts to resolve the problem. Meanwhile, the recently completed reform of the legislative framework can be expected to pave the way to a drastic reduction in NPLs by end-2019. More specifically, legislation was passed on out-of-court workout (OCW), with a view to enabling coordinated action between the banks and other creditors, including the State and social security funds. Legislation has been adopted to provide legal protection for bank and public officials involved in debt restructuring as long as they follow due process, and to establish a platform for electronic auctions.
More specifically, the activation of the OCW mechanism is expected to have a decisive impact, as it offers several major advantages, such as a holistic approach to NPLs, whereby all elements of debt are considered as part of the restructuring plan; the promotion of voluntary negotiations between creditors and debtors; a compact time frame for reaching a workout solution; an electronic OCW platform, etc. The advantages of this mechanism should contribute to a swift, effective and transparent global settlement of business debt towards the private sector and the State (e.g. tax authorities, social security funds), while the information requirements for participating in the mechanism prevent its use by strategic defaulters.
Meanwhile, favourable results are expected from the development of a platform for the electronic auctions of real estate, together with the amendment to the institutional framework governing NPL management companies, with a view to facilitating market entry. So far, four such companies have been authorised.
Looking forward, banks must step up their efforts to achieve their NPL operational targets. In this context, they must identify those businesses that are viable, and encourage and actively support investment in innovative activities and strategic sectors of the economy, especially the ones that are export-oriented and make use of Greece’s strategic advantages. In cases such as these, banks must implement long-term solutions, thereby rewarding responsible entrepreneurship. At the same time, though, they need to deal with strategic defaulters and take non-viable businesses off life support.
3. Debt relief would facilitate Greece’s sustainable return to the markets. At its meeting on 15 June 2017, the Eurogroup commended Greece for delivering on its prior action commitments under the agreement and gave a clearer outline of the debt relief measures that could be envisaged once the programme is completed (deferral of EFSF interest and amortisation by between 0 and 15 years). The Bank of Greece has repeatedly stressed the need for such measures, based on currently available estimates and projections, in order for the debt to be manageable. Accordingly, the outlines given at the Eurogroup meeting of 15 June 2017 could lead to the sustainability of public debt if the interest payments on EFSF loans were to be deferred by more than 8.5 years.
The economic adjustment programmes implemented during the past seven years have succeeded in addressing chronic weaknesses and distortions in the Greek economy. The correction of macroeconomic imbalances and the competitiveness gains create positive prospects for the future of the economy. As the root causes of the crisis have been rectified, Greece must now create the proper conditions for rapid economic growth in order to tackle the crisis legacy problems, namely the high rate of unemployment, the large public debt ratio and the high stock of non-performing loans.
To this end, economic policy must now focus on growth, in particular on: a consistent and determined implementation of the reform and privatisation programme; action to effectively address the issue of non-performing loans; lowering the tax rates through measures that improve the collectability of taxes and social security contributions; and further cutting non-productive spending in the broader public sector. Returning to a sustainable growth path would gradually reduce unemployment, enable households and businesses to repay their debt and generate the funds necessary for Greece to service and gradually lower its debt-to-GDP ratio.
However, the Greek economy will need help in order to reduce its high public debt. Thus, the partners’ commitment to medium-term debt relief measures to ensure medium- to long-term public debt sustainability in the period after the end of the current programme needs to be specified. This would improve the economic climate and facilitate Greece’s return to the markets in 2018, if not sooner. Letting this pending matter drag on poses potentially serious risks and might even foreshadow the need for a new financial assistance agreement post-2018, something that neither Greece nor its partners would want.
The inclusion of Greek government bonds in the ECB’s quantitative easing (QE) programme and the ensuing improvement in financing conditions would enhance market confidence in the Greek economy and support a sustainable return to international markets.
All of the above, if they materialise in a timely manner, would speed up the return to financial normality and signal Greece’s exit from the crisis.
The full text of the Report is available (in Greek) here.