Interview with the Governor of the Bank of Greece, Yannis Stournaras at AXIA Ventures Roundtable
15/11/2022 - Articles & Interviews
1. Does the recent rise in market interest rates affect in a significant way the fiscal situation in Greece?
The sovereign debt crisis in Greece in 2010 has led, among other things, to a favourable public debt restructuring following the implementation of three Adjustment Programmes in agreement with Greece’s debtors. As a result: (a) the weighted average residual maturity of public debt is 19.8 years (at the end of June 2022); (b) the weighted average (implicit) interest rate of public debt is 1.3% (at the end of 2021), lower than many other euro area high-debt countries; (c) the share of fixed interest rate liabilities in total public debt approaches 100% (at the end of June 2022); (d) the weighted average time to debt refixing is almost 19 years (which means that the current low debt servicing costs will remain fixed for a long time, thus insulating Greek debt from market turbulence); and (e) almost 75% of public debt liabilities are to the official sector (mainly the EFSF/ESM). As a consequence, the interest rate risk from the increase in current bond yields is rather limited for the public sector.
However, the gradual refinancing of the accumulated debt under market terms is expected to increase (in the medium term) the market rate risk of Greek public debt. Hence, it is a welcome development that the Government Budget for 2023 envisages a primary surplus of 0.7% of GDP, while in the following years it is envisaged that the primary surplus will be close to the net interest payments on public debt.
2. Do you expect Greece to achieve investment grade in the first half of 2023? Or incoming national elections are an obstacle to that? How effective has the Recovery and Resilient Fund (RRF) been for Greece?
The achievement of investment grade will be an important factor contributing to the reduction of the borrowing costs for the public and the private sectors (including banks) in Greece. If Greece surprises positively in (a) fiscal developments in 2022 and (b) GDP growth in 2022, continuing in parallel the implementation of its structural reform programme, I see no reason why incoming national elections could be an obstacle to achieving investment grade.
According to available evidence, Greece has achieved considerable progress in reaching the relevant RRF benchmarks and is ahead of the initial timetable regarding disbursement applications. In particular:
(a) In terms of grants, Greece has already received nearly one quarter of scheduled RRF funds. In addition, investment projects amounting to 13.5 billion euros have been approved, out of which 1.7 billion euros have already been disbursed to the project owners.
(b) In terms of loans, the European Commission has up to now disbursed to Greece 3.5 billion euros (more than one quarter of the total), whereas applications for RRF loans sum up to 2.8 billion euros.
Overall, Greece has shown a clear commitment and dedication to the timely and successful implementation of the reform program, positively signaling the capital markets and the rating agencies regarding the credibility of the reform effort.
The positive effects of RRF on investment are already felt in the Greek economy. Private investment has increased substantially over the past two years and the investment to GDP ratio is currently at levels last seen before the onset of the sovereign debt crisis in 2010.
According to Bank of Greece research, RRF is expected to lead to significant gains in GDP and employment, but also in terms of productivity and competitiveness. However, in order to make these gains permanent, Greece has to carefully implement all the structural reforms related to RRF.
3. The overall asset quality of the Greek banking system has improved significantly, with NPL ratio moving close to 10% as per BoG’s last report. However, this is the result of the clean-up exercise for the 4 systemic banks as the NPL ratio of the smaller players is still c. 50%. As the governor of the BoG, what would be your priority to ensure that smaller players that do not qualify for government guarantees can clean up as well? Would you see consolidation of smaller players or is there a better course of action?
It's true that the NPL ratio in the LSIs (Less Significant Institutions) sector is much higher than the one of the four significant banks and the cleanup of their balance sheet is on top of our list with the supervisory priorities. Contrary to their systemic peers, the LSIs couldn’t use the domestic Asset Protection Scheme (the so-called Hercules plan), which by design was practically not applicable to the smaller banks. To give you an idea on how important is the absence of a systemic tool: since December 2019, when Hercules was adopted by the Greek government, the total reduction in the stock of NPLs at system level reached 53.7 bn euros. So the vast majority of the reduction was not achieved by loan restructuring, liquidations or collections, but through sales of loans (and to a lesser extent write-offs). Now on the LSIs; as you may be aware of, the two largest LSIs (Attica and Pancreta) are taking actions to significantly strengthen their capital base and be in a position to effectively manage their legacy book (through direct sales, NPL securitizations without government guarantees, loan restructurings, etc.) and to grow. Both Attica and Pancreta have completed successfully a share capital increase (Attica is to execute a second one in the coming months as per its capital plan), whereas Pancreta has agreed to merge with Chania bank and absorb the HSBC branch network in Greece. Effectively, the two banks (together with Chania) will hold more than two thirds of the LSI sector in Greece, which is one of the most concentrated in the euro area. At the moment we don’t see the need for further consolidation in the Greek LSI sector but we cannot rule out actions by very small players beyond Attica and Pancreta.
4. In your latest Bank of Greece Financial Stability report, you discuss about the future management of NPLs currently sitting with the servicers and not the banking system. Are these NPLs an opportunity, as long as they become cured and re-performing, for the Greek banks to grow faster than expected in the upcoming years, or do you identify them more as a risk during this part of the cycle?
First, I would like to reiterate our position that the role of NPLs servicers is significant for the financial stability in Greece as they should effectively manage these obligors that are currently outside the banking system. They should provide effective restructuring solutions to the viable obligors or, for non-viable ones, manage the idle collateral which will become productive again. Having said that, I believe that there are significant investment opportunities in these NPLs, as long as they become cured and re-performing, as you rightly point out. We wouldn’t object to a re-onboarding of these customers on banks’ balance sheets upon certain conditions. This will assist domestic lenders to achieve their goals for credit expansion.
5. The HAPS scheme expired at the end of October, even though there are some securitisations that are approved but not completed as of yet. Do you expect that we would see HAPS renewed for another term?
For three securitizations (Frontier 2 by NBG, Sunrize 3 by Piraeus and Solar, the combined securitization by all four systemic banks) there has been an application to enter the scheme but none of them has been yet approved by the relevant HAPS committee. Personally I don’t see the need to extend the scheme for another term. All four significant institutions have reached a single-digit NPL ratio and the plan is to cover the remaining distance to the EU average organically or through direct sales outside HAPS. At the same time, in a baseline scenario the impact from new NPLs due to the worsening economic situation will be manageable. Of course, it is up to the Greek government to decide on the extension.
6. In the latest Bank of Greece Financial Stability report, issued before 9M22 results, you bring up the issue that Greek banks are still not very profitable considering that cost of risk could grow. After seeing the 3Q results, and the higher profitability of Greek banks (ranging from 7-11.5% RoTE), do you feel more comfortable?
After many years in a row, all four significant institutions have returned to profitability. The financial fundamentals of Greek banks have been significantly improved compared to the past. Being supervisors, we always like to take a step back and have a more prudent view on the financial results and prudential indicators. For instance, and while we are still digesting the 3rd quarter results, we see that there are still some areas of improvement, such as the reliance of operating income on non-recurring profits, the reduction in net fee income following the disposal of cards acquiring business, the income from NPLs that is set to decline upon the further reduction of the legacy book. At the same time, banks have taken significant cost containment actions, whereas they benefit from mild credit expansion and a sharp reduction in the cost of credit risk. Looking forward, the achievement of the banks’ plans for double-digit RoEs depends on the headwinds coming from the macroeconomic environment that clearly affects all banks in the euro area but also some Greek-bank-specific issues such as the need to issue several billions of MREL instruments in the coming years. Still, we remain optimistic about the future profitability prospects of Greek banks.
7. Regarding asset quality, it is true that Greece still has higher NPL ratio (c. 10%) vs. EU average (1.8%). However, recent trends show that Greek banks are converging to the EU, with lower NPL ratio, higher coverage and also a declining percentage of Stage 2 loans. Would you say that this could continue, and therefore the Greek gap vs. EU average could close further?
Our expectation is that Greek banks will further converge to the EU average in terms of asset quality indicators. In a baseline scenario and according to banks’ own strategies, the gap will close significantly by 2024. Having said that, I would like to stress that we see risks ahead for all banks in the euro area stemming from the combined shock of rising interest rates and high energy prices to some vulnerable borrowers, especially those who were on a recovery mode from the pandemic. To this end, we suggest caution and awareness to all stakeholders, to avoid the creation of a new generation of NPLs.
8. On ECB Monetary Policy Normalization: what has been achieved so far and what are the next steps?
We have made substantial progress in monetary policy normalization. Not only did we start raising rates in July, but even before then we had taken normalization measures with regard to the purchase programmes, the phasing out of collateral easing measures and the ending of the very favourable terms of the TLTROs III.
With the latest interest rate adjustment on October 27, we have raised our key interest rates by a cumulative amount of 200 basis points.
Interest rates are on a track which will allow us to achieve our inflation target of 2% in the medium term, taking into account the current path of inflation and output. I would avoid using technical concepts such as the ‘neutral’ interest rate or the ‘target-consistent terminal rate (TCTR)’. The estimates of these interest rates are based on unobservable elements and, therefore, subject to large uncertainty. The concept of neutral rate was briefly discussed at our latest monetary policy meeting and was found “not necessarily helpful”.
Having said that, we will continue to base the pace of our interest rate rises on the evolving outlook for inflation and output, following our meeting-by-meeting approach.
9. Do you foresee a recession in the Euro Area? What is the impact of higher energy prices? Have you detected signs of second-round inflationary effects? Has the ECB taken these factors into account?
Clearly, there are increasing risks that the euro-area could be headed into a recession. These risks are mainly the result of the rise in energy prices which occurred this year. Both the high inflation experienced so far, which reached 10.7% in October, a figure that is much too high, and the risks of a recession have the same underlying cause – the series of supply-side shocks, including higher energy prices.
The latest forward-looking indicators of economic activity are signaling contractions across all euro area countries (the Commission’s Economic Sentiment Indicator, the Ifo Business Climate Index and the ZEW Indicator of Economic Sentiment). Notably, the PMI registered in October the biggest contraction in almost two years. This was also verified by hard data, given the latest flash estimate of 0.2% GDP q-o-q growth for the third quarter of 2022. The energy shock is going to impart a strong recessionary impulse to the economy. The weakening in our economies, but also in the US and globally, will lead to a further contraction of demand. The risks are already on the downside and we will know by the time of our December meeting on monetary policy if we are in what was called the downside scenario in our September projections.
The ECB’s monetary normalization has taken these factors into account. That is why the ECB’s normalization came later and has been more gradual than that of the Federal Reserve, which, in the past few years, has had to contend with considerable demand-driven inflation resulting from a highly expansionary fiscal policy.
In light of these remarks, I agree that a prudent pace of adjustment is warranted in the euro area. We need to bring down inflation without contributing to a recession.
Presently, second-round effects and inflation expectations remain contained. We will continue to carefully monitor wage negotiations and developments so that we can achieve our price stability objective.
Also, despite the very encouraging recent fall in fuel prices, especially in gas prices, energy markets remain volatile and uncertain, until at least substantial targeted measures manage to shield the economy from the impact of high energy prices. To a large extent, these developments warrant continued and close monitoring in the view of our forthcoming December macroeconomic projections.
10. At which level do you expect the key ECB interest rates to peak? When do you expect this to happen?
In the present state of high uncertainty, it is very hard to predict the level and the time of the interest rates peak. There is no hard evidence at the moment for an end to the terrible war in Ukraine, which, apart from the human tragedy it entails for Ukraine, is also a major shock to the economy of the Eurozone. There are significant risks for price, economic and financial stability. Based on current evidence, there is some ground to cover until we see the peak of the interest rate hike. As I said, however, the pace and the ending level of our interest rate path will depend on evolving conditions for inflation and output, which will be assessed in a meeting-by-meeting approach.
11. Is fiscal policy in the Euro Area consistent with the monetary policy stance?
Being a large net energy importer, the Eurozone is facing an acute supply-side (imported, energy-driven) inflation problem. This implies, among other things, that monetary policy faces an acute policy trade-off in its effort to tame inflation. It needs the assistance of fiscal policy (as well as energy policy, at least for the period that energy prices are being weaponized in the Ukraine war). Discretionary fiscal support measures should be targeted, trying to insulate the most vulnerable income groups; temporary, without altering the overall restrictive fiscal stance; and tailored to motivate and facilitate a more efficient energy consumption. Governments should be committed to bringing down public debt ratios and reducing fiscal deficits, while structural policies should be designed to increase the Eurozone’s growth potential. The timely implementation of the investment plans and structural reforms under the Next Generation EU programme is an important supplementary instrument to these goals. Also, the proposed RePowerEU investment plan would enhance the resilience of the European economies against the current or any future energy crisis.
12. When do you expect quantitative tightening (QT) to start? Are there any risks associated with QT?
We will actually discuss the prospects of future steps in this direction in our December Governing Council meeting. Any such steps should be cautious and gradual, as quantitative tightening reinforces interest rate increases across the yield curve.
In fact, in a recent Bank of Greece Working Paper (“A global monetary policy factor in sovereign bond yields” by Dimitris Malliaropulos and Petros Migiakis, July 2022), the authors found that global central banks’ large-scale asset purchases have contributed to significant and persistent declines in long-term yields globally, ranging from around 330 basis points for AAA-rated sovereigns to 800 basis points for non-investment grade sovereigns. Hence, tightening monetary policy by scaling down central banks’ balance sheets to pre-crisis levels may lead to sharp increases in sovereign bond yields globally and widening spreads of vulnerable sovereigns, with severe consequences for financial stability and the economic prospects.
In the euro area, we stand ready to use the Transmission Protection Instrument, to the extent needed, to counter unwarranted, disorderly market dynamics that pose a threat to the transmission of monetary policy across all member countries.