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The Bank of Greece Report on Monetary Policy 2010-2011

15/02/2011 - Press Releases

Today, in accordance with its Statute, the Bank of Greece submitted its report on Monetary Policy 2010-2011 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 report takes into account economic developments and relevant data up to 8 February, when it went to press.

One year of economic adjustment: what risks have been averted and what has been achieved. The cost of the adjustment reflects the price of past inaction.

In two and a half months, a year will have gone by since the initiation of the Economic Adjustment Programme. The Economic Adjustment Programme averted the collapse of the Greek economy by securing the necessary funding when the cost of market financing had become prohibitive; furthermore, it sped up a number of major improvements which had been delayed for decades. This proves that the financial support agreement did not only act as rescue in the present difficult circumstances, but has also been a strong driving force towards changing obsolete structures. Additionally, a very important contribution at this critical juncture came from the ECB, with its provision of liquidity to Greek banks, its bond purchases and its acceptance of Greek government securities as collateral, regardless of their rating.μWhat has been accomplished during this time is indeed considerable:

¬Developments that could have spun out of control, causing explosive problems for the economy and society and entailing costs many times higher than what we are called upon to pay today, have been averted.

–The country has recovered credibility in the international arena.

– The first steps have been taken in the long but necessary effort to put the Greek economy on a sound and healthy track.

This great effort will undoubtedly entail costs, reflecting the price of past inaction. Back then, when conditions were much more favourable, the necessary changes could have been made gradually and at a far smaller cost. Today, we have to pay this price under adverse circumstances and within tight time limits.

Developments in GDP, employment, incomes, inflation and the balance of payments. The prospects for 2011.

GDP is estimated to have declined by slightly more than 4% in 2010 (after contracting by 2.3% in 2009), while international organisations project that the recession will continue into 2011, at a weaker pace. It is projected that GDP will fall by approximately 3% in 2011, with a possibility of a slightly larger decline. The recession is hitting consumption and, much more strongly, investment. Factors such as uncertainty, the increased tax burden, a slump in demand and tight credit have caused investment to fall at a rate likely to have exceeded 18% in 2010. Considering that investment had declined significantly in 2009 as well, it becomes clear that the productive capacity of the economy – i.e. its potential growth rate – has shrunk significantly. Of course, the potential growth rate is expected to pick up in the future, as structural reforms yield results and the country’s credibility improves, contributing, among other things, to inflows of foreign direct investment.

The recession has had a direct and strong impact on employment and unemployment. Employment fell by an estimated 2.5% in 2010, which translates into 100,000 jobs lost. The job losses contributed significantly to a rise in the number of unemployed. The rate of unemployment is estimated to have exceeded 12.5% of the workforce in 2010 and is expected to remain on an upward path in 2011.

Incomes have also declined. Real average earnings of employees in the total economy are estimated to have fallen by 9% in 2010 and are projected to decline further by almost 5% in 2011. The 2010 fall in real incomes also reflected a rise in inflation to 4.7%, mainly due to the increase in indirect taxes and the surge in oil prices. In 2011, the average annual rate of headline inflation is expected to drop markedly to around 2.2%, while the average level of core inflation should fall below 1%.

The current account deficit (based on Bank of Greece data) as a percentage of GDP, after declining appreciably in 2009 due to the recession, is estimated to have shown an only marginal decrease in 2010. By contrast, positive developments were the recovery of exports of goods in the second half of 2010, the significant drop in imports of goods, as well as the big rise in shipping receipts. The rebound of exports of goods reflected mainly the recovery of global demand and, secondarily, the improvement of Greece’s cost competitiveness in 2010, which is expected to continue this year. In 2011, the current account deficit as a percentage of GDP is expected to decrease further.

The decrease in the fiscal deficit is a positive development, but constitutes only the beginning. The biggest challenge now is the radical overhaul of the state.

In the critical area of fiscal consolidation, there has been visible progress. The state budget deficit was reduced to 8.4% of GDP, from 13.1% in 2009 (based on Ministry of Finance data). This was certainly an important achievement, but constitutes only the beginning. The deficit reduction was mainly achieved through across-the-board measures, such as wage and pension cuts and tax increases, without any improvement of substance as far as the size and the inefficient operation of the public sector are concerned, i.e. the areas where deficits are initially generated and then swell to huge proportions. The necessary interventions in this field must be radical, far-reaching and persistent in order to produce lasting beneficial effects on expenditure, which must continue to decrease steadily. Decreasing the deficits and creating sufficient primary surpluses are, after all, the first step required in order to effectively deal with the high debt-to GDP ratio. The second and equally decisive precondition for reducing the debt-to-GDP ratio and mitigating the effects of the crisis is the recovery of the economy and, once this is under way, fast-paced growth.

The upcoming changes in the European environment call for vigilance and stronger efforts.

Persevering in the policy of fiscal consolidation in the years ahead is also warranted in view of upcoming developments in the international environment and, particularly, the initiatives taken both in the EU and in the euro area to improve economic governance and draw up a comprehensive European solution. The EU is currently seeking to deal with the situation through a comprehensive response, in part by introducing new, stricter regulation that will effectively prevent fiscal and macroeconomic crises in the future. The environment that is being shaped by these initiatives and in which the Greek economy will be expected to function, will require all countries to step up their efforts to restore conditions of economic stability. This new institutional environment will be supportive for those economies that adhere consistently to a course of economic adjustment, but will make the situation more difficult for those countries that lag behind. For Greece, the developments underway in the EU and the euro area are a clear message that the country needs to step up the effort it has begun. If this is accomplished, the EU will continue to provide essential help. If, however, the comprehensive European solution is misinterpreted as leaving room for complacency and a relaxation of efforts, the Greek economy will come against additional difficulties.

The first leg of the strategy for addressing the debt dynamics: faster fiscal adjustment. Structural reforms in the state must be carried forward with resolve and lean on broad social consensus.

After the first year of implementation of the Economic Adjustment Programme, economic policy must now turn to a fundamental overhauling of the state, so as to reduce spending and increase the efficiency of the public sector. Such a task is obviously much harder to achieve than the one-off, across-the board measures already taken, since it is likely to meet with strong resistance.

Today, structural reforms in the state must be carried forward with resolve and lean on the broad consensus of society, which understands that the "old regime" can no longer continue.

The government has already committed to present, by March 2011, its comprehensive action plan and an implementation timetable for the reforms needed to reduce the deficit in the medium term. The plan will identify the additional fiscal measures (of a structural nature), equivalent to over 5% of GDP, that will bring the general government deficit down to 2.6% of GDP by 2014. It would be particularly welcome if the fiscal consolidation process could be accelerated in the coming years and if a deficit reduction was achieved by 2014 larger than the one currently envisaged. Such an outcome is feasible, if the deficit reduction plan focuses on the following:

Reducing the expenditure of general government entities and agencies, by means of organisational and structural changes, i.e.: reform of loss-making public enterprises, eliminating unnecessary public sector entities and merging others, reforming public administration by rationalising the pay system and the human resources management of general government agencies, examining the possibility of further cuts in defence expenditure.

Upgrading the operation and improving fiscal institutions, with an emphasis on more effective expenditure control, greater transparency and improved budgeting. In this context, the adoption of numerical fiscal rules concerning the level and the rate of change of key budgetary aggregates would be of particular importance.

Speeding up privatisation, which could be facilitated by a reliable recording of real property belonging to the state, and increasing revenues from its better use.

Curbing tax evasion, through effective enforcement of the law. This would require comprehensive computerisation, in conjunction with a simplification of the tax system.

The second leg of the strategy for addressing the debt dynamics: speeding up growth. The more quickly and efficiently these structural reforms are pushed forward, the sooner growth will come.

Growth is now the main desideratum for the Greek economy. The exit from the recession and the rapid return to positive GDP growth would mitigate the negative impact on employment and incomes, while also making things easier for the strategy of reducing the debt-to-GDP ratio. Growth, however, will come as the end result of a number of factors acting in synergy to improve productivity and competitiveness and to create a business-friendly environment. Accordingly, growth policy will have to positively influence all these factors in order to be effective. At present, the necessary preconditions for growth include:

A faster reduction of deficits, not only for fiscal/budgetary, but also for growth purposes. Given, for one, that deficits induce higher borrowing rates and that deficit funding deprives an economy of resources that could be channelled towards productive activity, and, secondly, that the continuous enlargement of an inefficient public sector “crowds out” entrepreneurship and innovation, deficit reduction, in the case of Greece, is a first and necessary step needed for the economy to return to an upward path. Stabilisation is a growth policy.

Targeted growth-enhancing policies on the basis of a binding, comprehensive Action Plan for Growth, as the Bank of Greece has proposed.

Sweeping structural reforms that would do away with obsolete structures and improve competitive conditions in the economy. These reforms include measures aimed at enhancing labour market flexibility and increasing job opportunities, upgrading the education system, simplifying licensing procedures, opening up closed professions, fostering competitive conditions in the markets, removing the obstacles to a business-friendly environment. The more quickly and efficiently these structural reforms are pushed forward, the sooner growth will come.

Active policies to boost investment, based on the new laws on investment incentives and on the Hellenic Fund for Entrepreneurship and Growth (ETEAN), on faster absorption of EU funds available through the National Strategic Reference Framework and on encouraging saving via an appropriate taxation policy.

The banking system: 2011 will be a year of major and complex challenges, so banks must remain vigilant. The rate of credit expansion this year will depend on the ability of banks to access money and capital markets and on the improvement of depositors’ confidence.

The banking system, as with other sectors of the Greek economy, has come under a lot of pressure on account of the overall economic and fiscal conditions in the country. The profitability and efficiency of Greek banks and banking groups decreased further, the quality of banks’ business and household loan portfolios deteriorated, and bank funding essentially relied on refinancing from the Eurosystem. An encouraging development, of course, was the fact that capital adequacy remained relatively high. The difficulties facing the banks did not originate from any wrong choices of their own; rather, they were the result of the major fiscal crisis that brought about the downgrades of the credit rating of Greek sovereign debt, leading to corresponding downgrades for Greek banks. Therefore, in order to eliminate the problems faced by banks, the factors that caused them in the first place must cease to exist. This, of course, does not relieve banks from their responsibility to take concrete steps to mitigate the impact that the fiscal crisis has had on them, especially considering that 2011 will be a year of major and complex challenges. This year, banks will have to deal with the expected further deterioration in the quality of their portfolios of loans to households and businesses, the need to gradually reduce their reliance on the Eurosystem for funding, the rationalisation of their business models and operating costs, and their gradual adaptation to the requirements of the new international regulatory framework.

Credit to the domestic private sector, based on existing data, is expected to register zero or negative growth rates in 2011. The weakening financial condition of businesses and households continues to constrain their access to borrowing and reduces their willingness to take up debt. On the other hand, the recent extension of the liquidity support plan is expected to have a positive effect on private sector financing. The rate of credit expansion this year will depend on the access of Greek banks to money and capital markets and on the improvement of depositors’ confidence.

Changes have so far been made that would have been unthinkable a few months ago. This shows that the radical overhaul of the Greek economy is feasible. This effort can produce positive results. However, many changes are coming up against rigidities and reactions that undermine the overall effort.

Fiscal adjustment has made a good start, coming close to the targets set for 2010. More specifically, the targets for the state budget cash deficit were met, whereas the initial target for the general government deficit was not, due to a reclassification of certain public enterprises and because of shortfalls in revenue. Fiscal adjustment must now be stepped up, in order to overshoot the projections and achieve large and sustainable primary surpluses as soon as possible. The key to success lies in the radical reform of the public sector with changes that will slash its operating costs, increase its efficiency and generate a business-friendly, growth-fostering environment.

So far, changes have been carried out that would have been unthinkable just a few months ago. This goes to show that a radical overhaul of the Greek economy is feasible and that this effort can produce results. On the other hand, several of the reforms are coming up against rigidities and reactions that undermine the overall effort. The Annual Report of the Bank of Greece released in April 2010 pointed out that the Greek crisis was, amongst other factors, due to the prevalence -- for decades -- of attitudes and practices that eventually led to an impasse. That Report also noted: "We can no longer rely on recipes of the past, i.e. a selective and at will compliance with laws and regulations, a shifting of responsibility onto others, refusal to make the slightest effort towards consensus-building, dogmatic misinterpretations of reality, efforts to perpetuate our vested interests at the expense of the society at large.”

Much of the above survives to this day in a part of society, triggering negative attitudes, a stubborn insistence on defending self-interests, as well as the delusion that the previous situation could have gone on indefinitely, without any change. At the same time, the impression is given that the measures announced and implemented are dictated by the “Memorandum of Understanding” and not by the objective situation of the economy.

This climate needs to change and to give way to active support of the effort to create a modern Greece with positive prospects. A prerequisite for this is to give an accurate portrayal of the situation, without embellishments and omissions, and to present the real facts, the reasons that brought us to the brink of bankruptcy, the necessity of reforms, the multi-year nature of the effort already underway and, of course, the expected result – i.e. the benefits compared to the costs.

It is also necessary:

● to realise that it is impossible for us to continue to operate as we did in the past. Quite the opposite: today, mistakes made over many decades must be corrected within a few years. This comes at a serious price, which certainly must be distributed equitably across society;

● to make clear that the changes are not imposed by the “Memorandum of Understanding”, but form part of a long-term effort to overhaul the Greek economy. The course will be a long one, and today we are still at the beginning. A successful outcome will require: resolve, vigilance in the management of changes, long-term targeting and perseverance in the pursuit of the objectives that have been set;

● to deal effectively with the phenomenon of negative attitudes, which creates a rift in the rule of law and, if allowed to spread further would undermine social cohesion and economic progress;

● to stress, as clearly as possible, that the ultimate goal is growth and a prospering society in a modern European environment.

The full text of the report is available here.












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