The Bank of Greece Interim Report on Monetary Policy 2020
14/12/2020 - Press Releases
Today, in accordance with its Statute, the Bank of Greece submitted its Interim Report on Monetary Policy 2020 to the Speaker of the Greek Parliament and the Cabinet.
The second wave of the pandemic is heightening uncertainty and delaying the recovery
The COVID-19 pandemic continues to adversely affect the global and the Greek economies. Having developed into a worldwide health crisis with major economic and social consequences, it has driven the Greek economy into a deep recession and into deflation and has led to increases in credit risk and the fiscal deficit, while non-performing loans are also expected to rise.
The extensive and coordinated support measures taken at a national, European and international level concerning fiscal and monetary policy but also the banking system have to some extent mitigated the impact of the pandemic on economic activity and alleviated the labour market risks.
Nevertheless, the resurgence of the pandemic worldwide and in Greece has, since September, compounded uncertainty. Several European countries have taken additional confinement measures in order to curb the exponential rise in infections and ease the mounting pressure on their healthcare systems. The Greek government, after a number of local lockdown measures, announced a new general lockdown, effective from 7 November. This decision is expected to lead to a deeper recession for 2020 and to weaken the recovery anticipated for 2021, but was warranted by public health imperatives.
The pressure on the public healthcare system from the pandemic is expected to continue through the winter, leading perhaps to an extension of lockdown measures at a local or national level. Therefore, heightened uncertainty about the course of the pandemic and the negative impact on GDP are expected to continue into early 2021 and until effective vaccines and treatments for COVID-19 become available to the general public. According to the medical community, noteworthy progress has been made in this area and tangible results are expected in the first half of 2021. Until then, macroeconomic forecasts will remain subject to considerable uncertainty. Consequently, the competent national and European institutions can only provide projections based on alternative scenarios.
The pandemic has driven the Greek economy into a deep recession
The pandemic has halted the recovery of economic activity that had begun in 2017. In January-September 2020, Greek GDP contracted by 8.5% year-on-year, driven mainly by the negative contribution of services exports. The fall in private consumption has also had a negative contribution, whereas the decline in imports of goods and services has dampened the recession.
The fiscal measures taken by the Greek government to support businesses and workers and the unprecedented interventions from European institutions − consisting of fiscal, monetary, supervisory and structural policies − have mitigated the adverse effects on the Greek economy.
Financial developments
Bond market developments have been positive, as shown by the recent upgrade of Greece’s credit rating by Moody’s and a decline in Greek government and corporate bond yields. A decisive factor behind this development was the inclusion of Greek government bonds in the ECB’s Pandemic Emergency Purchase Programme (PEPP) and their eligibility as collateral in Eurosystem refinancing operations.
Bank deposits of the non-financial private sector have continued to increase as a result of higher precautionary saving, a postponement of consumer and other spending, direct State aid credited into corporate accounts in order to support liquidity, and the use of moratoria on loan and tax obligations.
Bank credit to non-financial corporations, especially large firms, increased in 2020, reflecting the measures taken by the Greek government to expand loan guarantee and co-financing schemes, as well as the favourable monetary policy measures of the ECB and the supervisory flexibility provided by the Single Supervisory Mechanism (SSM).
Projections: Deterioration of macroeconomic and fiscal data in 2020 – A positive outlook for 2021-2022
In the conditions generated by the pandemic, macroeconomic forecasts are surrounded by high uncertainty. Therefore, the present report examines three scenarios: a baseline and two alternatives, i.e. one milder and one more severe – based on different assumptions regarding the course of the pandemic and the overall duration of the containment measures taken. Under the baseline scenario of the Bank of Greece, economic activity is expected to contract by 10% in 2020. A recovery is anticipated in 2021 and 2022, with GDP growing by 4.2% and 4.8%, respectively, driven by a significant pick-up in both domestic and external demand.
Based on the mild scenario, which assumes a faster lifting of the containment measures and a relatively short transition to normality, GDP is expected to contract by 9% in 2020 and to rebound to 4.8% in 2021 and 5% in 2022. The severe scenario assumes that the impact of the pandemic will be stronger and that the economy will have greater difficulty recovering, with GDP declining by 11% in 2020 before growing by 3.2% and 4.5%, respectively, in 2021 and 2022.
In the baseline scenario, the contribution of private consumption is estimated to have been negative in 2020, reflecting a deterioration in labour market conditions and a decline in disposable income, as well as a postponement of consumer spending due to the lockdown measures and increased precautionary saving. In the next two years, the gradual recovery of the labour market will contribute to an increase in private consumption at a relatively moderate pace.
Total investment is estimated to have declined considerably in 2020, reflecting a drop in business investment, whereas housing investment is estimated to have increased. In 2021-2022, investment expenditure is expected to pick up, supported by an improving investment climate, utilisation of funds from the Next Generation EU (NGEU) recovery instrument and an acceleration of privatisations.
Total exports are estimated to have declined significantly in 2020, reflecting the impact of the pandemic and of the containment measures adopted worldwide on tourism receipts. Exports of goods and services are projected to post robust growth in 2021, as well as in 2022, in tandem with rebounding foreign demand. Imports are expected to develop in line with domestic demand and exports over the entire projection horizon.
Inflation, as measured by the Harmonised Index of Consumer Prices (HICP), is expected to remain in negative territory in the period ahead, mainly on account of low international oil prices and services prices, and to return to a positive, albeit low, rate by 2022. Core inflation is expected to follow a path close to that of the headline index in the period 2020-2022.
According to the revised forecast of the Bank of Greece, in 2020 the general government primary balance, monitored in the context of the enhanced surveillance, is expected to deteriorate relative to the June forecast, turning out a deficit of 7.3% of GDP, due to a larger contraction of economic activity and the additional fiscal support measures.
Despite heightened uncertainty about the course of the economy and fiscal aggregates during 2020-2022, risks to the sustainability of public debt remain contained until the early 2030s, owing to the composition of debt, 80% of which is held by the official sector, and to the favourable repayment profile, as arising from the agreed medium-term debt relief measures. Hence, the projected increase in the ratios of public debt and gross financing needs to GDP is not expected to undermine the medium-term sustainability of public debt, provided that the fiscal measures in response to the pandemic are temporary and that macroeconomic equilibrium is soon restored.
The forecasts are subject to increased risks associated with the evolution of the pandemic
As regards the risks surrounding the baseline scenario of the Bank of Greece, the major downside risk relates to the recent resurgence of the pandemic, which would delay the return to normality. A further escalation of the pandemic, accompanied by an extended duration of restrictions on economic and social activity could have a stronger and more persistent impact on the real economy, in particular on the services sector, most notably tourism. In addition, an increase in non-performing loans as a result of the recession would divert resources from productive investment.
The risks from the external environment are mainly associated with uncertainty about the duration and severity of the pandemic, and the possibility of a slower and weaker than anticipated recovery of the global and European economies. Risks also stem from a worsening of geopolitical tensions in the South-Eastern Mediterranean and from a no-deal Brexit.
On the other hand, upside risks are associated with a faster roll-out of effective coronavirus vaccines in early 2021. Also a faster and more efficient absorption of NGEU funds could further boost the growth prospects of the Greek economy.
Banks: Losses reported in the first nine months of 2020 – Satisfactory capital adequacy, but deferred tax credits remain a challenge
Taking into account the increased provisioning against credit risk, due to the impact of the pandemic, and the loss from the sale of a large volume of NPLs by one systemic bank, the banking system posted a loss after taxes in the first nine months of 2020. In terms of capital adequacy, the Common Equity Tier 1 (CET1) ratio and the Capital Adequacy Ratio on a consolidated basis remained at satisfactory levels (14.6% and 16.3%, respectively) at end-September 2020. With a fully phased-in impact from International Financial Reporting Standard 9 (IFRS 9), the CET1 and the Capital Adequacy Ratio came to 12.1% and 13.9%, respectively.
However, it should be noted that more than half of bank capital is accounted for by deferred tax credits (DTCs). This is an issue that needs to be addressed, especially given that DTCs as a percentage of total bank capital are expected to rise under the current NPL reduction strategy.
Decline of non-performing loans in 2020, but a new inflow of NPLs is expected due to the pandemic
Non-performing loans (NPLs) came, on a solo basis, to €58.7 billion at end-September 2020, down by €9.8 billion from December 2019 and by €48.5 billion from their March 2016 peak. The NPL-to-total loan ratio remained high in September 2020 at 35.8%. It should be noted that the high percentage of performing loans benefiting from moratoria until end-December 2020 contained the inflow of new NPLs. Still, it should be pointed out that non-performing private debt remains high, irrespective of the reduction in NPLs on bank balance sheets via transfer to non-bank entities.
2020 saw substantial reforms aimed at resolving the issue of NPLs. These involved the securitisation of NPLs through the activation of the “Hercules” scheme and the enactment of Law No. 4738/2020 which improves several aspects of insolvency law. Nevertheless, NPLs will remain high, and considering that there will be a new inflow of NPLs due to the pandemic, other solutions complementary to the “Hercules” scheme need to be implemented.
Challenges
The coronavirus pandemic has significantly exacerbated some of the problems that Greece was facing as a legacy of its ten-year debt crisis. More specifically, Greece is experiencing a sharp contraction of GDP, deflation, postponement of investment decisions, a halt in the downward course of unemployment, while a new generation of NPLs is expected to compound the already high stock of NPLs. The necessary fiscal measures adopted to support businesses and households worsen Greece’s fiscal position and increase the already high public debt-to-GDP ratio.
The above-mentioned problems add to the challenges already faced by the Greek economy before the outbreak of the pandemic, namely low structural international competitiveness and the public sector’s low efficiency, despite a recent improvement in Greece’s ranking in the IMD World Competitiveness Index. Furthermore, despite the progress made during the pandemic, the digital transformation of the economy remains slow, as shown by Greece’s performance in the European Commission’s Digital Economy and Society Index (DESI). The Greek economy continues to be weighed down by chronic weaknesses: the high level of tax evasion and the projected demographic decline due to population ageing. Meanwhile, climate change has highlighted as a new challenge the need for a transition to cleaner forms of energy.
Prerequisites for addressing the impact of the recession and speeding up the recovery
The measures to support the European economy should be continued
Drawing on the experience from previous crises, including the debt crisis, the European authorities responded proactively, decisively and effectively in order to support the European economy and to give the medical-scientific community time to develop effective coronavirus treatments and vaccines. The expansionary fiscal policy, in conjunction with an accommodative single monetary policy stance, has supported the European and the Greek economy, mitigating the negative impact of the pandemic on economic activity.
The measures to support the European economy should be continued, as their premature withdrawal could delay the recovery and lead to a sharp rise in bankruptcies, in non-performing loans and in structural unemployment and to a decline in investment and in labour productivity. Such negative developments would drive Europe into stagnation and deflation. Thus, the combination of expansionary fiscal and monetary policies should remain in place until the recovery gains traction and euro area inflation returns to levels close to, but below, 2% on a steady and sustainable basis.
Furthermore, the establishment of the new Next Generation EU recovery instrument should not be a one-off policy but rather a permanent fiscal instrument of macroeconomic stabilisation through the issuance of safe bonds.
Medium-term policy priorities: utilisation of NGEU funds, continuation of reforms and fiscal consolidation
In the medium term, a return to positive growth will require the continuation of structural reforms and an increase in investment. This would facilitate the transition to a sustainable growth model, one that would speed up digitalisation, incorporate the principles of green and circular economy and rely on continuous investment in human capital. To this end, crucial will be the timely and efficient utilisation of NGEU funds available for the period 2021-2026, totalling €32 billion in constant 2018 prices for Greece, of which €19.3 billion in grants and €12.7 billion in loans. The available funds will need to be targeted at growth-enhancing high value added projects in the areas of energy saving, the transition to green energy, the digital transformation of the public and the private sector, as well as at strengthening the healthcare sector. Furthermore, substantial funds will need to be allocated to education, as an increase in expenditure for education aimed at broadening and deepening human capital skills can be expected to have significant multiplier effects on Greek GDP and employment and to foster the digital transformation of the Greek economy.
Utilisation of NGEU funds will crucially depend on effective action planning and coordination, public administration efficiency, and the achievement of economies of scale through the participation of domestic and foreign large firms that are highly extroverted and have managerial and financial knowhow. It is along these lines that Greece’s draft National Recovery and Resilience Plan was published, drawing on the medium-term roadmap suggested by the Pissarides Committee. The proposed actions under the Plan are consistent with the respective policy recommendations from the Bank of Greece, as outlined in its regular reports.
In an economy like Greece’s, with high public debt and limited fiscal space, fiscal expansion should remain targeted and temporary in nature, so as to safeguard debt sustainability and prevent the pandemic crisis from turning into a debt crisis. Furthermore, the cash buffer should be preserved at high levels, as it contributes to maintaining investor confidence and thereby to reducing the debt refinancing risk.
Once the pandemic is over, fiscal policy should once again focus on the gradual reduction of deficits and on fiscal consolidation, in order to safeguard the long-term sustainability of public finances. The withdrawal of government support will need to be timed with a gradual return to strong positive growth rates, in order to mitigate the risk of secular stagnation and deflation.
Notwithstanding the need for budgetary consolidation in the years ahead, fiscal policy could still remain supportive to growth under an appropriate policy mix. For instance, further cuts to tax and social security contribution rates would support employment and economic growth and serve as a disincentive to tax evasion and undeclared work. Furthermore, given the Greek economy’s large investment gap, fiscal policy will need to be strongly investment-oriented by increasing growth-friendly public expenditure, which is complementary to private investment and can have significant and lasting growth gains.
Despite important institutional changes, such as the activation of the “Hercules” scheme and the reform of insolvency law, and the significant reduction of the high stock of NPLs already achieved, non-performing loans remain a major issue, which is in fact expected to worsen once the pandemic-related support measures are withdrawn. In this regard, the Bank of Greece has submitted a proposal to the government for the establishment of an asset management company to undertake the management of a substantial share of NPLs, while the proposal also addresses the issue of deferred tax credits (DTCs). Comprehensive and immediate action on the issue of NPLs would free Greek banks of their costly and time-consuming management, create favourable conditions for banks to achieve sustainable core profitability and enable them to more effectively take advantage of the accommodative monetary policy measures, and the liquidity support measures adopted by the Greek government, in order to provide credit to the economy. This would have other positive effects, including an effective improvement in the investibility of Greek banks and in Greece’s credit rating.
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The coronavirus pandemic has driven the global and European economies into deep recession. The coordinated emergency monetary, fiscal and supervisory support measures taken by European governments and EU institutions have to some extent contained the severity of the recession.
The recent resurgence of the pandemic has heightened uncertainty about the scale of the recession and the recovery prospects of the European economy. Fiscal and monetary policy should therefore remain expansionary, until the euro area economy returns to a solid growth path. A premature withdrawal of the support measures would delay the recovery.
The Greek economy has been hard hit by the health and economic crisis, despite the domestic and European actions taken to mitigate the impact of the pandemic. The second wave of the pandemic and the new general lockdown measures to safeguard public health have further weighed on economic activity and increased uncertainty about the course of the economy in the period ahead. However, in the medium term the prospects of the economy appear to be more benign, given the encouraging news about the production and roll-out of effective coronavirus vaccines, as well as the funds available under the NGEU.
The pandemic has had severe health, social, economic and fiscal repercussions. However, NGEU funds open up the possibility of turning the crisis into an opportunity for the modernisation, green transition and digital transformation of the Greek economy and the adoption of a sustainable and extrovert growth model. The nation’s political forces should ensure that this opportunity is not lost and that, in the medium term, once the economic recovery is on solid ground, fiscal sustainability is safeguarded.
The full text of the Report is available (in Greek) here.