Bank of Greece Monetary Policy Report 2022-2023
30/06/2023 - Press Releases
Today, in accordance with its Statute, the Bank of Greece submitted its Monetary Policy Report 2022-2023 to the Speaker of the Greek Parliament and the Cabinet.
Aiming at real convergence without macroeconomic imbalances
The global economy, weighed down by the fallout of the war in Ukraine, the energy crisis, high inflation and fast monetary policy tightening in response, is heading to a slowdown in 2023. The slowdown is expected to be more pronounced in advanced economies than in emerging and developing ones. The euro area is already in a technical recession, as GDP declined marginally, quarter-on-quarter, in the fourth quarter of 2022 and in the first quarter of 2023. Inflation in advanced economies started to ease in late 2022, on the back of falling food commodity and, mostly, energy prices. Although major central banks raised aggressively their policy rates, core inflation continued to trend upwards in many advanced economies until early 2023, reflecting higher energy costs feeding into the prices of industrial goods and of services. The drastic interest rate increases by central banks have helped to contain inflation expectations but, combined with other factors, have also led to lower expected growth rates and a tightening of financial conditions.
Against this background, the Greek economy has maintained much of its 2022 growth momentum through the first months of 2023. Meanwhile, headline inflation has been falling considerably, starting from the fourth quarter of last year, mainly due to a continued decline in energy prices. However, upward pressures on prices, in particular of services and non-energy industrial goods, are keeping core inflation high. Strong growth rates, high inflation and enhanced tax compliance have been key to a return to a primary fiscal surplus and a significant decline in the government debt-to-GDP ratio in 2022.
Real economy: Resilience, mild slowdown in economic activity, moderation of inflation – persistent upward trends in core inflation
In 2022, real GDP grew by 5.9%, overshooting its pre-pandemic levels, mainly on the back of rising private consumption, despite a marginal decline in household real disposable income amid strong inflationary pressures. Positive contributions to growth came also from exports of services, mainly due to the strong performance of the tourism sector, as well as from investment.
Economic activity appears to have maintained much of its 2022 growth momentum through the first half of 2023, as inflation eases and the international environment stabilises. Specifically, economic growth continued into the first quarter of 2023, but at a slower pace than one year earlier, due to a weakening in private consumption growth from the high rates seen in the wake of the pandemic. In real terms, GDP grew by 2.1% year-on-year (seasonally adjusted data), but declined marginally by 0.1% relative to the last quarter of 2022. Strong exports, as well as the increase in private consumption and investment were the main drivers of growth.
Inflation, as measured by the Harmonised Index of Consumer Prices (HICP), averaged at an annual rate of 9.3% in 2022. Underlying this development was mainly the surge in energy inflation, abetted by higher food inflation. The turnaround in HICP inflation since October 2022 stemmed from falling international energy prices, combined with strong downward base effects. By contrast, food inflation peaked in December 2022, and is expected to decline only slowly. The inflationary pressures built up in the course of 2022 as a result of soaring energy and food prices have spilled over to services and non-energy industrial goods, continuing to push core inflation upwards, which reached 8.1% by May 2023. Overall, HICP inflation has been on a strong downward path since October 2022, coming to 4.1% year-on-year in May 2023 and averaging 5.6% in the first five months of 2023.
Financial developments: Resilience of Greek bonds as a result of the upgrade of the Greek sovereign credit rating
Greek government bond yields moved in line with other euro area sovereign bond yields. Thus, following a sharp increase in 2022 due to key interest rate hikes, the yields on Greek government bonds declined in the first half of 2023, as did the yields on the other euro area government bonds. This development is also reflected in the yield spreads of Greek government bonds over other euro area government bonds. In particular, the 2022 increase in the yield spread of the Greek 10-year bond vis-à-vis the comparable German bond has been fully offset.
At the same time, the upgrades of the Greek sovereign by two rating agencies in 2022 and another one in early 2023 have reduced the distance to investment grade. Also, in March and April 2023, two rating agencies revised Greece’s credit rating outlook to positive from stable, which bodes well for investment grade being obtained soon.
Share prices on the Athens Exchange have outperformed by a considerable margin those in the United States and the euro area since the beginning of the year. The banking index performed better than the composite index, as the concerns about global banking problems were mitigated by upgrades of Greek sovereign and bank credit ratings, the resilience of the Greek economy, the significant reduction of non-performing loans and the return of banks to profitability.
Banking sector: Rising borrowing costs, falling credit and deposits
The tightening of the single monetary policy that began in 2022 has led to increases in bank interest rates by domestic credit institutions. Bank deposit rates have progressively been adjusted upwards since the fourth quarter of 2022, responding with a lag and not fully to policy rate hikes. However, the net flow of domestic private deposits was overall negative over the January-May 2023 period.
Owing to the gradual slowdown in economic activity and rising interest rates, the net monthly flow of bank credit to non-financial corporations in January-May 2023 was lower than in the corresponding period of the previous year. The outstanding amount of bank credit to households kept contracting in the first five months of 2023, with relatively stronger year-on-year rates of change than in 2022.
Banking system: Improved profitability, reduction of non-performing loans – satisfactory capital adequacy ratios
The reduction of the stock of non-performing loans (NPLs) in Greek banks led to a substantial cutback on credit risk provisions in 2022, which continued into the first quarter of 2023, thus boosting bank profitability. This development was also supported by an increase in net interest and fee income on an annual basis. The first quarter of 2023 saw a year-on-year fall in net income from financial operations and other non-interest income, which had benefited from non-recurring income in the past year.
The Common Equity Tier 1 (CET1) ratio on a consolidated basis fell to 13.4% in March 2023 (from 14.4% in December 2022) and the Total Capital Ratio (TCR) to 16.5% (from 17.4% in December 2022), both remaining below the respective euro area averages.
The stock of NPLs fell by 1.3%, but the ratio of NPLs to total loans for the banking sector as a whole rose marginally (March 2023: 8.8%, December 2022: 8.7%) due to a small decline in the outstanding amount of total loans. The significant improvement in asset quality in recent years should not lead to complacency, considering that the NPL ratio remains well above the average for euro area banks.
Projections: Acceleration of recovery after 2023, gradual decline in inflation
According to the forecasts of the Bank of Greece, the Greek economy is projected to grow by 2.2% in 2023, reflecting an expected economic downturn in the euro area and a normalisation of domestic private consumption growth. Moreover, monetary policy is expected to have a contractionary impact on economic activity in 2023, while fiscal policy is expected to be slightly expansionary, as the withdrawal of fiscal support measures is accompanied by a strong fiscal impulse from increased investment expenditure in the context of the European recovery instrument NGEU.
In the next few years, the Greek economy is expected to keep growing above potential, the level of which it has already exceeded. Specifically, the growth rate is projected at 3.0% in 2024 and 2.7% in 2025. This performance can be achieved on condition that, in the external environment, the geopolitical crisis de-escalates, energy prices fall and the Eurosystem’s monetary policy tightening has a limited adverse impact on the euro area economy. In addition, the projections rest on the assumption of continued support of international tourism to the Greek economy, progress with the implementation of investment projects and a solid growth path of the euro area economy, which is Greece’s major trading partner.
HICP inflation is projected at 4.3% in 2023, well below its 2022 level (9.3%), mainly reflecting the downward course of energy prices. On the other hand, food, non-energy industrial goods and services are expected to add to inflationary dynamics, owing to price inelasticities of these components. Non-food and energy inflation is projected at 6.1% in 2023 and is expected to remain high in 2024, being subject to strong inflationary pressures from the non-energy industrial goods and the services components. Headline inflation is projected at 3.8% for 2024 and 2.3% for 2025.
Risks and uncertainties: Risks are tilted to the downside, stemming from exogenous factors
Risks to the Bank of Greece projections are tilted to the downside. In more detail, risks to the outlook for the Greek economy include: (i) a further deterioration of the external environment; (ii) higher and more persistent inflation; (iii) a lower-than-expected absorption rate of NGEU funds; (iv) potential delays in implementing reforms, with negative effects on productivity and competitiveness; and (v) a further increase in interest rates, which could dampen growth and lead to the emergence of a new generation of NPLs. Upside risks, on the other hand, are associated with a faster fall in inflation and a better-than-expected performance of tourism.
Challenges
Investment grade: The main challenge for economic policy is to obtain investment grade and, at a later stage, exceed it. This would enhance the resilience of the Greek economy to exogenous shocks and episodes of volatility in international markets, reduce the cost of raising capital for the public and private sectors, facilitate public debt management and foster investment and economic growth.
Sustained deceleration of inflation: Tightening monetary policy is necessary in order for inflation in the euro area to continue decelerating and return to 2% over the medium term. As long as the ECB tightens its monetary policy stance in response to high inflationary pressures, the fiscal policy stance needs to remain restrictive in order to speed up the decline in inflation. In the contrary case, a further tightening of monetary policy would be required, with adverse implications for the duration and the extent of the negative effect of monetary tightening on economic activity. At the same time, both price increases in goods and services and wage growth should be consistent with the medium-term inflation target (2%), also considering that firms’ profit margins remain high.
High public debt-to-GDP ratio: Public debt as a percentage of GDP remains the highest in the European Union and the second highest in the world. In the medium term, risks to debt sustainability are contained, provided that the fiscal measures taken in response to the pandemic and energy crises are temporary and that the available European funds are effectively utilised. In the longer term, however, there is increased uncertainty, as the gradual refinancing of accumulated debt to the official sector on market terms will increase the exposure of Greek government debt to interest rate and market risk, leaving no room for relaxation of the agreed fiscal targets.
High current account deficit: Reducing the current account deficit is a major challenge, although the high deficit recorded in 2022 (9.7% of GDP) was due by about 40% to higher fuel prices and is expected to moderate to 7% of GDP in 2023. An economy which is in a process of catching up with its partners in terms of per capita GDP and which seeks to increase its share of national investment (currently 14% of GDP) to the EU average (22% of GDP) and spends on its national defence a share of GDP well above the EU average will inevitably run current account deficits. However, a deficit of more than 4% of GDP that persists over the medium term is in conflict with the EU macroeconomic imbalances procedure, but also, and more importantly, implies that national spending significantly and consistently exceeds domestic output or, equivalently, private and public investment is significantly higher than the corresponding savings.
Non-performing loans and private debt overhang: Despite its marked reduction, the ratio of non-performing loans (NPLs) is still well above the euro area average, while total private debt as a percentage of GDP remains at very high levels and hampers new borrowing and investment activity.
High unemployment and job mismatches: Despite the considerable fall in unemployment in the past few years, a number of labour market distortions persist, with female, youth and long-term unemployment rates remaining significantly above the EU averages, leading to an obsolescence of the skills of the labour force. It should be noted that the natural unemployment rate in Greece is estimated at around 13%, which is twice as high as in many EU countries, indicating the existence of serious distortions and structural problems. Moreover, the problem of job mismatches remains significant, as firms in certain sectors find it difficult to hire suitable workers to meet their needs. Major staff shortages are recorded in particular in the tourism and construction sectors.
Chronic weaknesses: Despite improvements over the past five years, the Greek economy still ranks relatively low in international structural competitiveness indicators, due to persistent inherent weaknesses. Such weaknesses, which impair competitiveness and create disincentives to investment, include delays in the delivery of justice; red tape and remaining inefficiencies in some areas of public administration (e.g. property transfers, land use planning, completion of the National Cadastre, digitalisation of public services); shortcomings in some key infrastructures; insufficient combatting of pervasive tax evasion; quasi-oligopolistic conditions in specific goods and services markets; and energy market distortions. Additional examples of inherent weaknesses include low female and youth labour force participation rates, coupled with adverse demographic trends; increased risk of poverty and social exclusion; significant regional disparities; shortcomings in the so-called “knowledge triangle” (education ‒ research ‒ innovation); and high reliance of the Greek economy on fossil fuels.
Low per capita GDP: Greece’s per capita GDP corresponds to about 55% of the per capita GDP of euro area countries, compared with about 70% before the debt crisis. Catching up requires sustained growth rates well above the euro area average. Otherwise, it could take more than 15 years for the Greek economy to regain its pre-debt crisis level relative to the euro area. This necessary continued convergence process requires the implementation of substantial investments, which must either be financed by national savings or be covered by capital inflows from abroad. However, to enhance investment, in particular to attract foreign funds, the appropriate conditions have to be in place, i.e. a business-friendly environment, highly qualified and skilled human resources, high-level infrastructure and networks. Leaving the Greek economy’s structural weaknesses unaddressed would make it vulnerable to exogenous shocks that may halt the catching-up process that has resumed in the past few years.
Policy recommendations
Taking into account uncertainties and risks associated with the international economic environment, the new and pre-existing challenges facing the Greek economy and the need to accelerate the real convergence of Greece’s per capita GDP with the EU average, the following are recommended:
1. Implementation of the reforms included in the National Recovery and Resilience Plan to enhance overall productivity, potential output growth and structural competitiveness, thereby increasing the economy’s capacity for higher (mainly investment) spending without harming the external balance.
2. Effective and rapid use of resources from the EU Structural Funds and the Recovery and Resilience Facility to boost public and private investment and narrow the investment gap. The expansion of investment should also be supported by rising domestic savings, without the contribution of which there is an imbalance between national savings and investment, which negatively affects the balance of payments.
3. Addressing the current account deficit by enhancing the competitiveness and extroversion of the economy. A condition for reducing the current account deficit is a further increase in exports, import substitution and promotion of energy autonomy to reduce energy import needs.
4. Further reduction of the government debt-to-GDP ratio. This requires a return to constant primary cyclically adjusted budget surpluses of 2% of GDP. This is necessary in the medium term as rising borrowing costs and lower growth and inflation reduce the dampening contribution of the implicit interest rate-growth differential to debt dynamics. As a result, the initially beneficial impact of inflation on the reduction of the debt-to-GDP ratio is gradually fading, and sustainable primary surpluses are therefore needed to avoid undermining the continued downward path of public debt.
5. Ensuring a further decline in inflation. This requires: First, that wage increases do not exceed productivity growth, and that secondary inflationary pressures – fed by higher wages – be avoided. Second, that actions are taken and inspections are conducted in the goods and services markets in order to prevent excessive price increases that are inconsistent with the medium-term inflation target, also considering that profit margins in many sectors are already high. Looking ahead, competition should be improved in these markets, by removing obstacles and eliminating distortions, in order to curtail oligopoly practices.
6. A further decline in the unemployment rate and addressing the problem of job mismatches. It is necessary to upgrade technical and technological education and to implement targeted training programmes. Measures are also needed to improve the work-life balance, to integrate and keep in the labour market the inactive population, with a focus on women and youth. Institutional interventions to cut or subsidise social security contributions would reduce non-wage costs and contribute, together with a stepping up of inspections, especially in sectors with increased contribution evasion, to limiting undeclared or underdeclared work.
7. Accelerating the energy transition and reducing reliance on fossil fuels. Increasing the share of renewables in the energy mix requires, in addition to new investment, also increased energy storage capabilities. In this context, it is crucial to use REPowerEU resources to improve energy efficiency and accelerate the green transition. At the same time, it should be noted that the green and digital transition of the economy requires, in addition to new investment, the existence of staff appropriately trained in new technologies.
8. A further strengthening of the banking system. The Greek banking sector has made remarkable progress in recent years and is again able to successfully continue its intermediation role and benefit from the prospects of the Greek economy and the expected return of the Greek sovereign to investment grade. However, challenges remain, related to the need to maintain strong profitability and further reduce non-performing loans. Moreover, deferred tax credits (DTCs) still make up a large part of banks’ capital.
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The Greek economy has made substantial progress since the severe debt crisis of the past decade, which built up after years of imprudent fiscal policies and competitiveness losses. As a consequence of the above changes, Greece is back on a path of real convergence with the EU average in terms of per capita GDP; the public debt-to-GDP ratio has fallen significantly, with risks to its sustainability remaining contained over the medium-term, due to the favourable profile of the Greek debt; and Greek government bonds are currently just one notch short of investment grade, which signals and confirms a return to normality.
As challenges to global financial stability remain serious, with successive crises and pervasive heightened uncertainty, economic policymakers should display responsibility and commitment to safeguard the sacrifices of the past decade and continue the progress made. This requires a prudent economic policy aiming for cyclically adjusted primary surpluses of 2% of GDP; continued reform efforts; reducing the stock of non-performing loans; stepping up the fight against pervasive tax evasion; and an efficient and timely use of the available Recovery and Resilience Facility resources to boost investment in human capital, green energy and digital technologies. These policies will consolidate Greece’s credibility in the international investor community, thereby gaining investment grade and, at a later stage, exceeding it, so as to strengthen the Greek economy’s resilience to exogenous shocks and episodes of international market volatility; lower the cost of raising capital for the public and private sectors; and foster investment, faster economic growth, real convergence and social cohesion.
The full text of the Report is available (in Greek) here.