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The Bank of Greece Interim Report on Monetary Policy 2015

04/12/2015 - Press Releases

Today, in accordance with its Statute, the Bank of Greece submitted its Interim Report on Monetary Policy 2015 to the Speaker of the Greek Parliament.
The present Interim Report on Monetary Policy is submitted at a time when negotiations between the government and our partners are going smoothly and the recapitalisation of the four significant Greek banks has been successfully completed. These factors support reasonable expectations that the agreement will be a success, ensuring a return to economic growth. Such an outcome, however, presupposes a climate of political stability and consensus, which will enable the unobstructed implementation of the agreement, thereby opening the way for discussions on further debt relief.

It should be recalled that the previous report of the Bank of Greece on Monetary Policy 2014-2015 was submitted to Parliament on 17 June 2015. At the time, negotiations with our partners had reached a standoff and all possibilities were open. In its report, the Bank of Greece had warned about the consequences of a fallout with our partners and argued that “striking an agreement with our partners is a historical imperative that we cannot afford to ignore”. A few days later, on 28 June, amid protracted uncertainty, it became necessary to introduce a bank holiday and capital controls in order to safeguard the stability of the banking system and protect deposits. Capital controls further exacerbated uncertainty and took a toll on the real economy.

The agreement of 12 July and the broad consensus reached halted the adverse and uncertain course of the economy

The adverse and uncertain course of the economy was halted at the Euro summit of 12 July 2015, with the Greek authorities committing to an agenda of measures that would need to be passed by Parliament, as prior actions for the negotiation of a new programme with the European Stability Mechanism (ESM). The agreement reached on 12 July 2015 was ratified by Parliament on the morning of 14 August, after an all-night session, with an unprecedented majority.

As a follow-up on the agreement, a number of legislative measures were enacted in the ensuing months, concerning structural reforms in government finance, public administration and the pension system. More recently, the law on bank recapitalisation was adopted, once more by a large majority. All four significant Greek banks managed to raise sufficient private funds to cover the gap identified under the baseline scenario of the stress test, with two of them fully covering their capital needs exclusively through private funds. At present, the negotiations for the first review of the programme are ongoing.

It now appears safe to presume that the present government has opted for a path of cooperation and mutual understanding over one of confrontation with our partners. This fundamental choice is also backed by the overwhelming majority of the opposition, which remains committed to Greece’s European orientation. Therefore, a strong pro-European consensus base is effectively in place, which can reasonably be expected to guarantee the consistent implementation of the agreement and foster political stability as an essential condition for the programme to succeed, especially given that most of the adjustment has already been completed in the period since 2010 and that only little ground remains to be covered.

In this regard, it should be pointed out that the remaining fiscal adjustment should not rely on tax or contribution rate increases that would undermine competitiveness, growth and employment. Instead, the emphasis should be on cutting non-productive government spending including of the broader public sector, reducing tax expenditure, eliminating any remaining exceptions from general tax and social security provisions, as well as on a privatisation programme, aimed in particular at maximising the value of idle State-owned property. Action to rein in non-productive spending could involve overhauling the structures of the broader public sector and reassessing the need for maintaining the hundreds of entities, reallocating human resources to pivotal functions (for instance, tax auditors) or understaffed areas (for instance, guards at museums), thereby increasing total productivity across the broader public sector. Furthermore, idle property belonging to the State or to legal entities in public law still holds largely unexploited potential, which, if tapped into, could help resolve many economic problems.

It is also important to underline that a climate of political stability and consensus forms the cornerstone for returning to economic and financial normality. The ability to achieve strong growth rates crucially hinges on the restoration of confidence, the acceleration of reforms and privatisations, the exploitation of State-owned property and substantial investment. Banks, for their part, now face the major challenge as well as the opportunity, after their successful recapitalisation, of managing their non-performing loans (NPLs) and reducing them to the levels prevailing in the rest of the euro area. This serious problem calls for determination and innovative solutions, drawing on the experience of other countries. A return to normality in the financial sector, too, would encourage the return of deposits and thus enable the lifting of capital controls.

The new agreement is focused on strengthening the economy’s growth potential

Apart from its key role in averting adverse developments, the agreement contains provisions that are definitively steps in the right direction, built around the four main pillars that address the current and future needs of the economy. These pillars are: restoring fiscal sustainability; safeguarding financial stability; promoting growth- and competitiveness-enhancing structural reforms; and modernising the State and public administration.

Also, the agreement provides for the establishment of a new independent fund, whose overarching objective will be to manage valuable assets and to protect, create and ultimately maximise their value, which will then be monetised through privatisations and other means. Such monetisation will provide one of the main sources for financing investment and for repaying part of the new ESM loan.

Changes are also envisaged that will ensure the sustainability of public debt, thereby helping to contain the government’s financing needs at manageable levels. This would initially free up resources that could be rechannelled to investment, thus boosting employment. Further, public debt sustainability would improve sentiment, with multiple positive effects: new investment, inflow of foreign investment, return of deposits to the banking system.

Overall, apart from ensuring fiscal sustainability, the new agreement is geared towards expanding the country’s growth potential, as it envisages reforms which, if implemented effectively, will deliver considerable benefits over both the medium and the short term.

With the elimination of macroeconomic imbalances, a shift to growth is now possible

As stressed above, the agreement with the ESM can serve as a launch pad for an economic policy geared towards the fastest possible return of the Greek economy to a growth trajectory. It should, however, be mentioned that the agreement with the ESM and the focus on growth-enhancing reforms would not have been possible – at least not in this particular form – if the previous years had not seen the macroeconomic imbalances of the Greek economy addressed: large fiscal and external deficits, loss of competitiveness, labour market rigidities and constraints. In these areas, the two previous programmes accomplished their goals, albeit at the cost of a longer and deeper recession. However, there were delays in the implementation of growth-friendly reforms, i.e. structural changes to the functioning of the public sector and product and services markets. This is one of the many reasons why the recession was deeper than expected.

Protracted uncertainty is weighing on growth prospects

The delays in implementation of structural reforms under the previous programmes meant that there was a lag before the benefits of the adjustment became visible, unlike its costs which were felt immediately. Thus, the benefits only emerged in late 2014-early 2015: GDP growth of 0.7% in 2014 and positive year-on-year growth rates in the first two quarters of 2015. This recovery could have gained traction and the overall outcome for 2015 and 2016 would have been positive (in line with the initial projections), if they had not been undercut by heightened uncertainty since the last months of 2014. This period saw two elections, one referendum with acute confrontations and a protracted negotiation process with conflicting messages. Uncertainty and the ensuing impact on the real economy peaked with the bank holiday and the imposition of capital controls.

The capital controls – at least during the initial phase – had an immediate and visible impact on domestic and international transactions, which is easing up as the controls are gradually relaxed. The distortions caused to the capital and product and services markets have had far-reaching repercussions that cannot be accurately assessed, although it goes beyond saying that they have continued to weigh on economic activity in the second half of 2015. On the other hand of course, the capital controls halted the capital outflows and – as a collateral benefit – encouraged the use of electronic money.

In addition, the first half of 2015 was marked by a freeze in financing under the economic adjustment programme (including ANFA and SMP returns), soaring borrowing costs and a shortfall of tax revenue relative to budget targets. These circumstances along with the debt payments falling due at that time put huge strains on government cash management, leading to the postponement of payments to general government suppliers and to short-term borrowing from general government entities for servicing debt to the IMF and other international creditors.

Despite growth falling back into slightly negative territory over 2015, a recovery in the second half of 2016 is within reach

As discussed in the present report, despite the strong headwinds of the past months, the economy has displayed resilience, which is likely to mitigate the negative impact previously expected. According to the latest data, developments seem to be turning out better than in the pessimistic projections of last summer. In particular, despite the initial shock caused by the bank holiday, the impact on the economy from the capital controls has proved more muted than expected. This can be attributed to the fast scaling back and improved management of capital controls, as well as to a rational behaviour on the part of consumers.

However, as suggested by preliminary data for the third quarter of 2015 reflecting the impact of capital controls on the supply of credit to the economy and the increased tax burden on households, activity is expected to decline in the second half of the year, driving the economy into recession. Still, the recession, according to all available indications, is expected to be moderate for the year as a whole.

For 2016, real GDP growth is expected, at least in the first half, to remain in negative territory, owing to a strong carryover effect from 2015. The course of economic activity in 2016 hinges crucially on the pace of implementation of reforms under the new agreement, as well as on the ownership of the programme. The necessary conditions for the economy to gradually recover, after the successful recapitalisation of the significant banks, are the further relaxation of capital controls and ultimately their removal, an improvement in the liquidity situation of the banking system and the restoration of confidence.

To sum up, despite showing remarkable resilience in the first half of 2015, the economy has slid back into recession in the second half of the year. However, as uncertainty dissipates, capital controls are further relaxed and, most importantly, the terms and conditions of the agreement are consistently implemented, the recession should moderate, thereby making a recovery in the second half of 2016 more likely.

The global environment appears to be favourable, despite heightened risks

Α rapid implementation of the agreement will allow Greece to benefit from the favourable international economic environment and from the liquidity-boosting initiatives of the ECB. More specifically, the global economy continues to register positive, albeit moderate, growth rates and the outlook is favourable overall, although subject to high uncertainties, associated with the significant slowdown of growth in emerging market economies and with geopolitical risks.

Moreover, heightened uncertainties and risks have recently emerged due to two major developments: the mass inflows of refugees into Europe – mainly via Greece – and the surge in terrorism as evidenced by the recent Paris attacks. Policy responses to address these issues may involve restrictions on the free movement of persons and goods, with serious implications for the real economy and the investment climate. In Greece in particular, the thousands of marooned refugees would put additional strain on the country’s already overstretched economy and society.

The ECB has taken important initiatives to stave off deflation and boost liquidity in the euro area

In order to prevent deflationary conditions from taking hold in the euro area, the Eurosystem has pursued an accommodative monetary policy. On 3 December 2015, the Governing Council of the ECB decided to cut the interest on the deposit facility by 10 basis points to -0.30%. At the same meeting, the Governing Council decided to extend the euro-denominated asset purchase programme, conducted since March 2015, by six months. The programme is now expected to continue until March 2017 or beyond, if necessary, until a sustained adjustment in the path of euro area inflation is reached, consistent with the aim of achieving inflation rates below, but close to, 2% over the medium term.

Greek credit institutions and the Greek economy in general are benefiting from ultra low interest rates, which also alleviate public debt servicing costs. In addition, a weaker euro as a result of the very accommodative stance of the single monetary policy helps increase the international competitiveness of Greek exports.

Greek credit institutions continued in 2015 to cover a significant part of their liquidity needs through the regular monetary policy operations of the Eurosystem, as well as through extensive recourse to targeted longer-term refinancing operations (TLTROs). The reason why Greek credit institutions cannot raise more funding at low cost – which would have enabled them to supply more credit to the real economy – is that securities issued or guaranteed by the Greek State are not accepted as collateral by the Eurosystem in its regular open market operations. These securities are, of course, used for access to the emergency liquidity assistance (ELA) provided by the Bank of Greece, but at a significantly higher cost, in accordance with the terms and conditions set by the ECB Governing Council for all the Member States.

Before the ECB Governing Council can issue a decision reinstating Greek securities as eligible collateral, there must be progress with the further implementation of the agreement, certified by a positive review by Greece’s international creditors. A positive review would also make Greek securities eligible for the asset purchase programme, resulting in an immediate and significant boost to Greek banks’ liquidity and lending capacity.

The recapitalisation of the banking system was necessary

The rekindling of uncertainty during the negotiations with our international creditors in the first half of 2015 triggered mass deposit outflows, despite the fact that GDP was growing. The outflows were halted with the imposition of a bank holiday in late June and the introduction of capital controls, restricting cash withdrawals and fund transfers abroad. Uncertainty drastically abated once the agreement between the Greek government and European partners was signed in mid-July, paving the way for a gradual return of deposits to the banking system in the months ahead. Indeed, after July there was an increase in corporate deposits, alongside a net inflow of banknotes from circulation to the Bank of Greece and a repatriation of funds.

Nevertheless, the protracted negotiations, the outflow of deposits and the constantly increasing ratio of non-performing loans (NPLs) against the backdrop of a worsening economic climate necessitated another recapitalisation of the Greek banking system, on top of the recapitalisation of 2014. The ECB conducted a comprehensive assessment of the four significant Greek banks and a stress test which identified an aggregate capital shortfall of €4.4 billion under the baseline scenario and of €14.4 billion under the adverse scenario, i.e. amounts far lower than the €25 billion foreseen in the new Financial Assistance Facility Agreement.

The four banks submitted their respective capital plans to the ECB, detailing how they intended to address their capital shortfalls. Out of these plans, capital mitigating actions amounting to €0.6 billion were approved. After the relevant law was passed by Parliament, the recapitalisation process was completed successfully, with substantial participation by foreign investors, who placed around €5.3 billion in the four significant banks. An additional €2.7 billion was covered through liability management exercises (voluntary bond swap offers to bank bondholders). The necessary additional funds for the two banks that did not fully cover their capital needs from private sources (€5.4 billion) were drawn from the Hellenic Financial Stability Fund (HFSF).

Addressing the problem of non-performing loans

The recapitalisation process has resulted in the creation of prudential buffers at the four significant banks. These capital buffers will improve the resilience of their balance sheets and their capacity to withstand potential adverse macroeconomic shocks, as well as the impact of the recognition of losses from the resolution of NPLs. Following recapitalisation, the Capital Adequacy Ratio of the four significant Greek banks currently stands at an estimated 18.1%, one of the highest in the EU (compared with an average of 16.7% for a representative sample of significant banks across the EU at end-June 2015).

The high accumulated stock of NPLs poses the most pressing challenge for the banking system. The adoption on 19 November of the law setting out the conditions for foreclosure protection for primary residences paves the way to addressing the problem of households’ non-performing exposures. The next two months will, in addition, require the establishment of a licensing and operational framework for NPL management companies, the undertaking of actions to promote multi-creditor workouts, as well as improvements in the out-of-court settlement procedure for corporate NPLs. Furthermore, by end-February 2016, the Bank of Greece, in consultation with the banks and the HFSF, will need to have set targets for the resolution of NPLs, and by end-March 2016 to have revised the Code of Conduct, laying down the debt restructuring guidelines for groups of borrowers on the basis of concrete loan segmentation criteria.

As the implementation of the programme progresses and uncertainty dissipates on a more lasting basis, the cost of financing will decrease further, while the liquidity situation of the Greek economy will improve. Renewed confidence will open the way for the return of deposits, while also allowing credit institutions to regain access to international money and capital markets.

The successful completion of the first review will lead to Greek securities becoming eligible once again as collateral in Eurosystem monetary policy operations and will allow Greek government bonds to be included in the ECB’s asset purchase programme. Such an outcome, in tandem with the completion of the banks’ recapitalisation and the more efficient management of their troubled assets, will help to ensure lower borrowing costs and to boost the lending capacity of Greek credit institutions, despite the adverse effect of the ongoing economic recession (on loan demand, credit risk, etc.).

The prerequisites for moving on to sustainable growth

As already mentioned, despite the difficulties, the Greek economy showed remarkable resilience in the first half of 2015 and its productive capacity was less severely impaired than anticipated. This, combined with the growth-enhancing provisions of the agreement, now allows for a policy shift towards creating adequate conditions for the quickest possible recovery and the achievement of sustainable strong growth looking forward. Attaining these objectives will require the following:

- Addressing the issue of NPLs, following the recapitalisation of the Greek banks. Addressing this problem will ease the burden on cooperating borrowers, while also enabling banks to unlock funds tied up in troubled loans that are unlikely to be repaid.

- Fast implementation of reforms in the goods and services markets so as to improve the business environment and competitiveness.

- Actions to boost job creation and reduce unemployment. Particular emphasis must be placed, in the short term, on active employment policies, targeted re-training programmes and, above all, reforms to the education system focused on skills and employability.

- Maintaining the primary surpluses, as required by the agreement.

- Parallel actions for increasing public sector efficiency. Modernising the tax administration is an overriding priority, as it would help to curb tax evasion and corruption, while also fostering healthy competition.

- Enhancing the capacity of the public sector to implement the necessary structural reforms, by streamlining the institutional environment.

- Increasing investment, the most important prerequisite of all for laying the foundations for sustainable growth, in order to bridge the gap between Greece’s investment-to-GDP ratio and the euro area average.

- Maximising the value of State-owned real estate and speeding up the privatisations envisaged in the agreement are the most powerful tools not only to revive investment and growth, but also to achieve fiscal sustainability, by reducing public debt. First, privatisations, if accompanied by a strong commitment for future investment (as in the case of the regional airports), would spur an inflow of badly-needed investment, thereby boosting aggregate demand and, ultimately, output. More importantly, however, maximising the value of State-owned real estate and implementing the privatisation programme as planned would send a strong dual signal to the markets: first, that the Greek government is firmly committed to implementing the agreement and, second, that the participating investors are confident of the Greek economy’s upward trajectory and of positive returns on their investments. In other words, the rapid realisation of privatisations and the utilisation of public real estate will, on the one hand, contribute quantitatively to the recovery and, on the other hand, mark a decisive step towards restoring confidence. This in turn will improve the investment climate and attract additional foreign direct and domestic investment. If, over and above all that is laid down in the agreement, public real estate utilisation is rapid and efficient, it could not only contribute to a further alleviation of the public debt, but also support the sustainability of the social security system. It should be pointed out in this respect that privatisations involving idle public real estate have a zero opportunity cost and therefore a high growth multiplier effect.


In conclusion, a return to normality and sustainable growth hinges upon two essential conditions: First, the government must implement the Agreement negotiated with our partners and take the necessary initiatives, beyond the ones already envisaged in the Agreement, to improve the economic and investment climate, building on the recent positive response of private investors to the recapitalisation of the significant Greek banks.

Second, Greek Parliament, after steadily supporting the adjustment effort and the rescue of the Greek economy since 2010, can reasonably be expected to pass all the legislation implementing the Agreement, especially given that most of the adjustment has been accomplished since 2010 and that only little ground remains to be covered.

The Bank of Greece has, on numerous occasions in the past, stressed the need for political and social consensus in tackling the major problems facing the country. Now that this consensus has been built, which is by all means an achievement, it must not be allowed to disintegrate. On the contrary, it must be preserved in order to safeguard political stability, to support a definitive exit from the crisis and to pave the way to growth.

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





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