The Bank of Greece Report on Monetary Policy 2013-2014
12/06/2014 - Press Releases
Today, in accordance with its Statute, the Bank of Greece submitted its Report on Monetary Policy 2013-2014 to the Speaker of the Greek Parliament and the Cabinet.
Developments in past few months are strengthening confidence and improving the climate
In its Annual Report last February, the Bank of Greece assessed that the elimination of the twin deficits and the recouping of competitiveness would gradually restore confidence and would lead to further improvements in the financing of the Greek economy.
Developments in the months since then have been in line with that assessment:
- The capital increases by the core banks were very successful and a combined total of €8.3 billion was raised, with strong participation from foreign investors.
- The Greek government’s return to the markets was also successful, with €3 billion raised through a five-year bond issue.
- Moreover, the issuance of corporate bonds also elicited a positive response from the markets. Between December 2012 and May 2014, large Greek corporations raised a total of €4.8 billion on foreign corporate bond markets.
All of the above support the view that confidence in the prospects of the Greek economy is being restored and markets anticipate a gradual exit from the crisis. If this momentum can be maintained and enhanced, the economy is very likely to return to positive growth. However, the forecast of positive growth is subject to downside risks, relating to developments in global markets, currently characterised by ample liquidity, as well as to possible reform fatigue and a relaxation of the reform effort on the domestic front.
The turnaround in sentiment was the result of the consistent implementation of the adjustment programme. A decisive role was also played by the achievement of a primary surplus of 0.8% of GDP in 2013, above the initial forecast.
Encouraging signals from the real economy
Encouraging signals are also present in certain developments in the real economy:
- The recession has eased considerably since early 2013. If this trend continues in the remainder of 2014, GDP should grow by about 0.5%.
- Consumption, the most important component of GDP, is showing signs of bottoming out.
- A positive contribution to growth is also expected from the external balance, driven by buoyant tourism receipts and upward trending shipping receipts, reflecting an upswing in world trade.
- Moreover, industrial production shows signs of a tentative recovery, and soft data (IOBE and PMI surveys) suggest a more optimistic outlook for the months ahead.
- Lastly, encouraging indications are emerging with regard to employment, which is showing signs of recovery. However, the level of unemployment remains exceptionally high and is expected to fall only gradually.
The global economic environment is improving, while monetary policy remains accommodative
The outlook for a global recovery appears favourable, while in the EU major institutional changes geared towards strengthening economic governance are underway. Specifically, in the first half of 2014 major steps were taken towards the establishment of a Banking Union.
ECB monetary policy remained accommodative, bolstering economic activity in the euro area. The key interest rates, which had been cut twice in the course of 2013, were lowered further in June 2014, and additional non-standard monetary policy measures were adopted, aimed at supporting the flow of credit to the real economy.
Recovery in 2014 is feasible
As discussed in the report, recent developments in the Greek economy support the forecast of a gradual return to positive growth in 2014. However, recovery hinges upon, first, a reversal of the decline in investment and, second, a faster growth of exports.
Improvements in business and overall confidence strengthen the prospect of a recovery in investment as (i) firms are gaining access to alternative sources of financing, such as corporate bond issues; (ii) the absorption of EU funds has increased; and (c) the creation of a Greek Investment Fund will have a positive effect on foreign capital inflows.
The second factor expected to contribute favourably to growth is a rise in exports. As discussed in the report, the normally close relationship between export performance and cost competitiveness broke down after 2009, mainly due to heightened uncertainty about the outlook for Greece and the credit squeeze faced by exporters.
Nevertheless, the significant competitiveness gains of the Greek economy, combined with the dissipation of uncertainty, the gradual improvement in financing conditions and the rise in global demand, are expected to boost Greece’s exports of goods going forward. A positive outlook is emerging in the tourist sector as well as in shipping, which has begun to recover after several years of decline.
The positive developments leave no room for complacency - reforms must continue in order to ensure recovery
Uncertainties and risks remain, however. These could delay or even reverse the course towards recovery. Thus, the central focus of economic policy today should be to maintain and strengthen the emerging positive momentum. For this to happen, the determined effort towards the following objectives must continue:
1. An overhaul of the public sector. Progress so far has been made in downsizing and rationalising the public sector. However, there are certain areas in which there have been delays and gaps that need to be addressed promptly, if the goal of a modern state offering high-quality services without putting obstacles to business activity is to be achieved.
2. Continued fiscal adjustment over the coming years. This will secure the downward path of public debt and the country’s sustainable access to global capital markets. Over the next five years, the fiscal consolidation effort will need to be based for the most part on a rationalisation of expenditures and on improving the tax administration. Moreover, the better-than-expected fiscal adjustment achieved in 2013 paves the way to the implementation of the Eurogroup decisions of November 2012 regarding possible debt sustainability measures. This commitment from our European partners was recently reiterated in the Eurogroup statement released on 5 May 2014.
3. Reorienting the production model to ensure rapid and sustainable growth in the long term. After six years of deep recession, the Greek economy is shifting to a new growth model. In order for this shift to take place smoothly, economic policy needs to generate conditions that favour supply-side restructuring of the economy. This requires that structural reforms are stepped up to ensure the efficient and competitive functioning of product, labour and capital markets. At the same time, a recovery of investment requires a business environment with a low administrative burden for businesses, an efficient public sector and a stable tax environment that will ultimately facilitate the easing of the tax burden on businesses and individuals.
A question that arises is the extent to which this growth model will be viable on the demand side. That is, will a rise in investment and net exports offset the gap in demand as a result of the squeezed private and public consumption expenditure? As detailed in the report, such an outcome is feasible in the long run, even under conservative assumptions regarding the dynamics of exports and investment.
The results of the bank stress test exercise were well received by the markets
Important and promising developments have taken place in the banking system in recent months. At end-March 2014, the results of the stress test exercise were released, estimating the aggregate capital needs of Greek banks for the period June 2013-December 2016 at €6.4 billion under the Baseline Scenario and at €9.4 billion under the Adverse Scenario. These estimates have factored in the results of the diagnostic study as well as conservative adjustments to projections for bank profitability for the period June 2013-December 2016.
The credibility of the stress test exercise and the markets’ rising confidence in the prospects of Greek banks are evidenced by the successful capital increases by the four core banks in just two months. The increases amounted to a combined total of €8.3 billion and attracted wide participation from foreign investors. Indeed, two of the core banks were able to cover not only the capital needs identified by the stress test exercise, but also secured sufficient funds to buy back the preference shares held by the Greek State. The confidence of international investors is also evidenced by Greek banks’ regained access to global bond markets.
The banking system’s capacity to finance economic activity has now increased, as banks have started to regain access to global markets. It is estimated that the developing economic recovery, combined with a sustained and strengthening climate of confidence, will contribute to a progressive rise in deposits, thereby enhancing banks’ capacity to finance economic activity in the medium term, by relying on stable sources of funding.
The challenge of effectively managing non-performing loans
After its successful restructuring and recapitalisation, the banking sector must now optimise its troubled asset management in a manner that alleviates the burden on borrowers facing temporary difficulties in servicing their debts. In the long term, such a strategy will enable banks to unlock funds tied up in non-performing loans.
With the establishment of a Government Council for Private Debt Management and the preparation by the Bank of Greece of a framework of supervisory requirements for banks’ NPL management, as well as a Code of Conduct for the management of private sector arrears, the ground has been laid for the creation of a mechanism for resolving the non-performing loans of both businesses and households.
The banking system must contribute to the sectoral restructuring of the economy
Banks must now make their contribution to the restructuring of the private business sector and to help the new growth model gain traction. They must channel credit into truly viable enterprises, whether new or old, encourage business partnerships and support initiatives conducive to bold sectoral restructuring.
Economic recovery requires continued reform effort
The stabilisation programmes of the past years have brought about a visible improvement in fiscal aggregates, but have taken a heavy a toll on the real economy. This toll would of course have been less severe if confidence in the prospects of the Greek economy had not collapsed. Today the situation has begun to turn around: confidence is being restored and the overall climate is improving. Prospects are also benefiting from the relative optimism prevailing in global markets, as reflected in renewed risk appetite especially with regard to the euro area periphery.
If this momentum can be maintained, macroeconomic performance could exceed current forecasts and actual outcomes could improve sooner than projected. Such a path, however, is far from given and could even be interrupted. The slightest backtracking or reversal in policy could result in Greece being cut off once again from the markets and sliding back into another period of economic instability. This risk should not be underestimated. Greece’s return to global markets reflects mainly the fact that markets discount that the adjustment and reform effort will continue.
In order to avert risks, the restructuring of the economy and the reforms must continue with even greater resolve across all areas. Economic policymakers must now convince that they are not complacent and will not back track, but rather stand ready to push on to the ultimate goal: the creation of a dynamic and extrovert economy.
The full text of the Report is available here.