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The Interim Report of the Bank of Greece on Monetary Policy 2009

20/10/2009 - Press Releases

Today, the Bank of Greece submitted its Monetary Policy 2009 Interim Report to the Greek Parliament and the Cabinet. The Bank’s Governor, Mr. George Provopoulos, delivered the report to the Speaker of Parliament, Mr. Filippos Petsalnikos. The key message of the Report can be summarised as follows:

The financial and economic crisis has brought to the fore the pre-existing big macroeconomic imbalances and structural weaknesses of the Greek economy, the most important manifestations of which are the large twin deficits (the fiscal deficit and the current account deficit) and debts (the public debt and the external debt).

Those countries which, like Greece, have twin deficits and debts face a higher risk that the exit from the crisis will be much more difficult and slower and that, therefore, they may enter a protracted period of low growth. This is why there is an urgent need for the immediate implementation of a medium-term plan that will include bold but necessary reforms. The plan’s top priority should be fiscal consolidation combined with (a) a reallocation of public expenditures in favour of those which have the biggest effect on growth and can help support vulnerable social groups; and (b) structural reforms, in particular those that entail zero or low budgetary costs but can immediately boost growth prospects.

The backbone of the plan should thus be "halt deficits – speed up structural reforms". These choices can help address effectively the dilemma of economic policy today, i.e. how to achieve fiscal consolidation in a manner that does not impair but instead boosts the growth prospects of the Greek economy – both in the short term, so as to ensure the fastest possible exit from the crisis, and over the medium- to long-term, so as to recover losses in international competitiveness and raise living standards.

A reorientation is also needed towards a multi-dimensional concept of growth that will encompass – as suggested by the most recent thinking on the subject internationally – the protection of the environment and the amelioration of the distribution of income. The Bank of Greece will systematically monitor environmental and distributional issues and has already started to take concrete initiatives in these directions.

The crisis in the Greek economy should be viewed as both a challenge and an opportunity for the comprehensive reorientation of economic policy and for the promotion of a new growth model. Society today has begun to realise the big and chronic problems that could lead to painful developments in the future, unless they are addressed properly. It is also beginning to be understood that there is no further room for delays or half-measures, if Greece is to find a way out of the current deadlock and if confidence in the prospects of the domestic economy is to be restored. The international crisis and the critical economic situation can act as a catalyst for opening a dialogue with the social partners on reforms in the functioning of the public sector (public administration, fiscal management, social security, education) and of product and labour markets; such reforms are a prerequisite for attaining the above-mentioned objectives. Conducting a dialogue that touches upon the substance of the issues would be a step towards overcoming the lack of a tradition of constructive dialogue in the country, strengthening civil society and enhancing respect for institutions, which has been insufficient up to now.

The dialogue between the social partners and the government should focus on the equitable distribution of burdens and benefits over the medium term. This would help build social consensus and win significant political backing for the implementation of the reforms. Obviously, the necessary adjustments of economic policy must be accompanied by measures that mitigate any adverse impact on the economically weaker citizens. At the same time, however, it will be necessary to overcome reactions from interest groups that take advantage of the large number and complexity of laws, red tape and lack of transparency in order to impede progress.


Α. The evolution of fiscal aggregates and the key orientations of a multi-annual fiscal consolidation plan

Fiscal aggregates have deteriorated dramatically. Fiscal consolidation is imperative in order to prevent the stalling of the country’s economic prospects. It is necessary to reduce the structural fiscal deficit by 5% of GDP cumulatively over the two-year period 2010-2011 and then by 1.5-2% of GDP per annum for a number of years.

In 2008, the general government deficit came to 5.6% of GDP (according to NSSG estimates), and this year is expected to widen much further, as clearly indicated by the rise in the central government net borrowing requirement, on a cash basis, to 9.9% of annual GDP during the nine-month period January-September (compared with 4.9% of GDP in the respective period of 2008). The general government debt will also register a strong rise this year (from 99.2% of GDP in 2008), having reached 111.5% of annual GDP already at the end of June.

The current high levels of the government deficit and debt, as well as the ongoing re-pricing of risks by investors in financial markets world-wide, call for a fast and decisive correction of deficits, in order to considerably reduce the debt-to-GDP ratio. Fiscal consolidation is also warranted in view of demographic developments and prospects, which are particularly adverse for Greece and will put additional pressure on public finances after 2015.

The huge fiscal deficit and the high and growing public debt also have broader implications. Extensive tax evasion – which is part of the fiscal problem – erodes the country’s social fabric and exacerbates social disparities and tensions. At the same time, insofar as tax evasion is easier in certain activities (usually in the services sector), it favours the gradual diversion of resources towards sectors of non-internationally tradable goods, thereby contributing to high trade deficits.

Meanwhile, the diffusion of an “easy profit” culture promotes anti-productive and anti-social standards of behaviour, which are far from the fundamental values that underlie progress in developed countries, i.e. education, productive work and healthy entrepreneurship geared towards medium- and long-term goals. Furthermore, the deregulation of the banking system and the easier access of households to borrowing, although in principle contributing to smoothing consumption over time and freeing it from dependence on short-term income fluctuations, could not in the end avoid contributing to the diffusion of a value system that encourages over-consumption and leads to the squandering of resources in non-productive uses. As a result, national saving has shrunk and current account deficits have soared. It is indicative that gross household saving has been negative for a number of years.

Given that the deficit and debt have reached very high levels, fiscal consolidation should target reductions in the structural deficit of 1.5-2% of GDP per annum from 2010 onwards. In fact, to achieve a marked and fast improvement that will inspire confidence and reverse the negative climate, even more intense efforts will be needed in the two-year period 2010-2011, i.e. a cumulative reduction in the structural deficit of 5 percentage points of GDP. Large primary surpluses are also needed in order to reduce public debt substantially within a reasonable time span.

The required multi-annual plan of fiscal consolidation must be announced publicly as soon as possible, so that markets know from the start what the authorities intend to do (and how they intend to do it). It is of vital importance to convey to the markets the message that Greece remains firmly committed to the medium-term target of a sound fiscal position. This will enhance the country’s standing in international markets and create positive expectations.

As roughly estimated, if the squandering of public funds and tax evasion can be gradually eliminated within a period of 10 years, the budgetary gains would amount to as much as 3 to 5 billion euro or 1.2% to 2.2% of GDP annually.

As shown by international experience, a fiscal consolidation strategy based mainly on cutting back and on rationalising spending is more likely to succeed. The reason for this is that such a policy implies a more efficient utilisation of public resources, leaves room for an alleviation of the tax burden, which encourages both business activity and labour supply, and enhances the overall credibility of medium-term fiscal objectives. Therefore, in the case of Greece, two-thirds of fiscal consolidation should come from the expenditure side and the remaining one-third from the revenue side (i.e. by tackling tax evasion and broadening the tax base). Meanwhile, public spending must be reallocated in favour of categories that promote economic growth, such as expenditure for education, R&D and infrastructure.

Any attempt to contain tax evasion should be focused on pulling together the tax collection mechanism. To the extent that this is achieved, it would then be possible to reduce tax rates and cope with the strong tax competition from other countries.

A favourable impact on growth could also come from the rapid promotion of reforms which entail no budgetary cost but contribute directly to improving productivity, such as reducing red tape, eliminating corruption and strengthening competition.

The reform of the social security system must also proceed at a bold step, given that, in the long term, the budgetary implications of population ageing pose an extremely serious structural problem. Addressing this issue in a timely and effective manner is necessary to achieve sustainable fiscal consolidation. In comparison with other EU countries, Greece has been rather late in adopting a comprehensive social security reform with a long-term outlook. Considering that Greece has the second highest debt and the highest expected increases in pension expenditure (in terms of GDP), its medium-term budgetary objective should be the most ambitious in the entire EU.

A well-balanced but also robust fiscal consolidation would build confidence in the economy’s medium-term prospects. This would reduce the cost of borrowing for the State (and for the private sector), as well as debt-servicing outlays, thus releasing funds needed to support vulnerable social groups and promote public investment. At the same time, quick-yielding structural reforms, which improve total factor productivity and increase the economy’s potential output, will mitigate the impact of the crisis and ensure that the recovery will start soon, proceed at a fast pace and be sustainable. Averting a fiscal deadlock and triggering a structural reorientation are both key to the implementation of the much-needed multi-annual adjustment plan.

Β. Structural weaknesses and the necessary key orientations of structural reforms

It is urgently necessary to implement a series of structural reforms in order to enhance the production potential of the economy and to foster employment. The central objectives of the structural reforms should be to steadily improve productivity and competitiveness, increase the employment rate, as well as establish conditions for lasting fiscal consolidation. In particular, it is necessary to solidly put in place conditions that would favour the setting-up of new businesses, the strengthening of exports, the inflow of foreign direct investment and the creation of new jobs in the private sector. Moreover, reforms should provide an effective support to sustainable long-term growth, which respects and protects the environment and strengthens social cohesion.

The main structural policy orientations can be summarised as follows:

• Securing the soundness and improving the efficiency of the public sector

A well-functioning public administration is essential for the effective implementation of reforms. Today, inefficient bureaucracy (compounded by the existence of numerous and complex laws) foments tax and contribution evasion, corruption and lack of transparency; it also contributes to a waste of the limited government resources, thus obstructing innovative entrepreneurship and degrading the quality of the social services provided by the state. Furthermore, the state is not organised rationally and is overgrown, in the sense that it has expanded beyond its fundamental role, which is to provide public goods and services, as well as monitor and oversee economic activities. Also, accountability is generally insufficient for large segments of the public sector.

• Enhancing the productive base through investment

The weakening of the potential rate of growth as a result of the crisis, combined with a persistently high general government deficit, a public debt that was already high before the onset of the crisis and the expected impact of demographic trends (a decline in the percentage of active population aged between 15 and 64), makes the need for structural reforms all the more pressing. It is necessary to adopt policy measures that will improve the responsiveness of supply to the changes of demand and to ongoing technological advances. The success of these measures will depend on their consistent implementation and ―given that the benefits will only become visible in the medium term― on consensus-building regarding their necessity. The perception that the state should act as a rescuer and the frequent cases of non-compliance to enacted laws (under pressure from interest groups) imply that the adoption of certain measures alone is not a guarantee for their success. The benefits from the necessary changes will be an increase in the growth rate of potential output over the medium term, and hence of employment. However, advantages are to be reaped in the short term as well, in the form of e.g. better borrowing terms for the Greek government and for private enterprises.

• Raising the employment rate and constantly improving the quality of human capital

In the labour market, the systematically high rate of youth unemployment reflects limited job creation in the private sector. The reduction in employers’ social security contributions for young workers, a practice followed in many countries, can foster the employment of young people. It is also noted that relatively looser working conditions in the public sector (shorter hours of work, no link between wages and productivity etc.) generate imbalances in labour supply, since most people tend to aim at employment in the public sector (also given the advantage of the permanent status).

The effort to maintain jobs even in enterprises with poor prospects of survival may support employment in the short term, but ultimately sentences these firms – and, consequently, the regions where they are located – to economic decline over the medium term. Job creation (of questionable advisability) in the public sector only masks the problem of limited job creation in the private sector. In any event, there is no room whatsoever for a further expansion of the already oversized public sector.

• Strengthening competition in all markets

Establishing conditions that will favour the setting-up of new businesses or the expansion of existing ones should facilitate changes in the composition of economic activity, as required by recent developments. In this respect, emphasis should be placed on eliminating barriers to competition, as well as to the movement of capital and labour shifts from declining sectors and enterprises to sectors with high value-added. This is the only way to maintain and increase incomes from employment and from healthy entrepreneurship in internationally competitive sectors and to curb structural unemployment.

Turning to the regulatory environment, certain phenomena observed world-wide during the current crisis do not support the case for increased state involvement in the economy but rather for more effective supervision of markets. For instance, insufficient financial supervision in certain countries (mostly due to breaking-up supervision responsibilities across several authorities and limiting the central bank) simply points to the need for efficient control mechanisms and for substantially upgrading the role of central banks.

The opening up of "closed" professions through the implementation of Directive 2006/123/ΕC in Greece is expected to strengthen competition and bring benefits to all citizens. Available estimates show that closed professions entail high costs to the economy and that deregulation will lead to a rise in employment.

• Changing the current pattern of energy production and consumption

A central place in the reform agenda should be assigned to strengthening “green” investment and investment connected with changing the pattern of energy production and consumption in Greece. This crucial choice, which entails a relatively low budgetary cost, can at the same time contribute to the protection of the environment and to dealing with climate change in time, strengthening competition in the energy sector, fostering the creation of new businesses and jobs, as well as to significantly reducing the country’s oil dependence and thereby its current account deficit.

As announced in June, on the initiative of the Governor of the Bank of Greece, a Committee composed of distinguished experts has been set up and has been entrusted with the task of preparing a study of the economic, social and environmental impact of climate change in Greece. The Committee will evaluate the cost of climate change for the Greek economy, the cost of possible non-action, as well as the cost of measures of climate change mitigation to be implemented within the framework of the relevant EU policies. The Bank of Greece hopes that the conclusions of this study will be useful not only as regards the issue of climate change, but also for enriching and strengthening the policy that will ensure the exit from the current economic crisis.

C. The Greek economy: overview of developments and prospects

The performance of the real economy in Greece has deteriorated under the influence of the unfavourable international environment.

The growth rate of GDP dropped sharply to 2% in 2008 (from 4.5% in 2007) and, according to provisional estimates of the National Statistical Service of Greece, it was zero in the first half of 2009. For 2009 as a whole, according to Bank of Greece estimates, the decline in GDP may be close to or above 1%. Total employment is expected to decrease by 1-1.5%, while the unemployment rate will exceed 9%. Inflation (as measured by the Harmonised Index of Consumer Prices – HICP) will fall to 1.1-1.3%; core inflation will decline at a more moderate pace (to 2.1%), remaining at higher levels than in the euro area; this results in a further loss of international price competitiveness for the Greek economy. Mainly due to the sharp fall in imports, the current account deficit is expected to narrow to 11% of GDP, still remaining among the highest in the EU-27. The decline in the deficit this year is conjunctural, while the factors driving the current account deficit to high levels in the last few years continue to be at play: these factors reflect the shortfall of national saving against domestic investment spending, the declining international competitiveness of Greek exports and the low level of structural competitiveness.

Regarding financial developments in Greece, the slowdown of credit expansion to the private sector is expected to continue over the next months, as the weakness of economic activity is dampening demand for loans, while banks' lending terms and credit standards are expected to remain tight for the period ahead. However, the supply of loans should continue to be bolstered by the ECB's enhanced credit support measures. On the side of demand for loans, a positive effect should come from the prevailing relatively low levels of bank lending rates, which keep declining. The annual rate of credit expansion to the private sector will possibly be close to 4% at the end of 2009.

D. The banking system

The stability of the Greek banking system has been preserved, but non-performing loans continue to increase in the context of weak economic activity, pointing to a need for constant vigilance. In view of the changes in the supervisory framework that are being promoted at an international level, the Bank of Greece will exercise its supervisory function even more actively.

The ratio of non-performing loans to total loans in Greece stood at 6.8% at the end of June 2009, up from 5% at the end of 2008, while the coverage ratio (provisions to non-performing loans) declined (June 2009: 41.1%, December 2008: 48.9%). Exposure to market risk also increased. By contrast, liquidity risk declined. The profitability of Greek banks and their groups dropped considerably in the first half of 2009 relative the first half of 2008, while their key profitability ratios also fell. By contrast, the capital adequacy ratio and the Tier I ratio improved significantly.

As regards the implementation of Law 3723/2008, out of a total budget of €28 billion, an amount of €11.3 billion has been utilised. The utilisation rate in Greece, at 40%, is virtually the same as that observed in the euro area (43%) and in EU-27 (40%).

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