The Bank of Greece Interim Report on Monetary Policy 2013
17/12/2013 - Press Releases
Today, in accordance with its Statute, the Bank of Greece submitted its Interim Report on Monetary Policy 2013 to the Speaker of the Greek Parliament and to the Cabinet.
In its previous Report on Monetary Policy in May 2013, the Bank of Greece, based on indications existing at the time, had assessed that the Greek economy was on track for stabilisation.
An easing of the recession in 2013, the economy on track for stabilisation
Today, those indications have become stronger and it is now reasonable to forecast that 2014 will see the end of the recession and the start of recovery.
This more favourable outlook is supported by the following developments:
• Fiscal consolidation, now in its fourth year, has made remarkable headway, and a primary surplus is expected for 2013 after a protracted period of large deficits.
• For the first time, the current account balance will show a surplus in 2013. This development is largely due to a decline in imports, but buoyant tourism receipts and higher exports of goods have also played a significant role.
• The pace of recession in 2013 is expected to moderate (to roughly 4%) relative to 2012 and to the rate projected early this year.
• Domestic and foreign expectations have improved, and confidence is gradually taking hold. Favourable developments have begun to feed into the real economy.
• The privatisation programme is making progress after significant delays in previous years.
• Prices have started to respond to weak demand and lower labour costs, a development conducive to an improvement in real disposable income.
• Restructuring on the supply side of the economy has been slow. However, it is encouraging that developments in relative prices provide an incentive for a shift of resources from the non-tradables sector to the tradables sector, where productivity is much higher. This trend, if it continues and intensifies, will lead in the medium term to higher total productivity, improved competitiveness and job creation, in other words to sustainable growth.
• The recapitalisation of credit institutions has been completed and the structure of the banking sector has changed radically, with the creation of fewer banks that are more resilient and better positioned to exploit economies of scale. The restructuring and consolidation of the banking system was smooth, without a single depositor having incurred a loss on their savings, in other words without any disruption to financial stability.
The macroeconomic data support the forecast of a recovery in 2014
The above factors lead to the forecast that 2014 will be the first year of positive growth, after six consecutive years of recession. Recovery will be underpinned by:
(a) a slower decline in consumption, as real disposable income is expected to stop falling;
(b) a positive contribution from foreign demand, bolstered by the exports of goods and tourism services;
(c) a small increase in non-residential construction, as shown by a relative improvement in investment demand indicators;
(d) a faster utilisation of EU funds and resources available from the European Investment Bank, for the financing of infrastructure investment and small- and medium-sized enterprises; and
(e) a stepping-up of privatisations.
The recovery will have a favourable impact on employment, and the average annual unemployment rate in 2014 is expected to decline.
International conditions are also more favourable
Developments in the global and particularly in the European economy, as recorded in late 2013, are shaping an environment that could be supportive to the recovery of the Greek economy. The euro area economy, after six quarters of falling output, is now posting positive growth rates for the second and third quarters of 2013, with GDP growth projected to be 1% in 2014, compared with -0.4% in 2013, and inflation expected to remain at low levels.
At an institutional level, important steps were taken in 2013 towards the establishment of a banking union in the euro area, including:
- The adoption of legislation on the establishment of the Single Supervisory Mechanism, which will have become fully operational by November 2014. The launch of the mechanism means that from late 2014, the ECB will assume its banking supervision responsibilities.
- The agreement on the directive establishing a framework for the recovery and resolution of credit institutions and investment firms, as well as the consultations on a Single Resolution Mechanism.
Finally, a positive impact is also expected from monetary policy, which, after the ECB’s recent lowering of its key interest rates, has become even more accommodative.
Uncertainties and risks remain
However, whether the above-mentioned favourable prospects for 2014 will actually materialise and how the future course of the economy will play out are still subject to considerable uncertainty.
In this respect, a major element of uncertainty is the political climate, often marked by polarisation and open confrontation, at a time when what is needed is the exact opposite: the coming together of social and political forces for a national policy for exiting the crisis and returning to growth. There is, therefore, some cause for concern that in 2014, an election year, political confrontation could be aggravated and polarisation could peak, making compromise, a prerequisite for a national policy, even more difficult to achieve. Such an outcome would lead to heightened uncertainty and undermine the elements currently underpinning the favourable forecasts for 2014. Against this background, it is crucial, at the current phase, for economic policy to remain focused on the implementation of structural reforms.
Moreover, the ability to consolidate confidence and give impetus to recovery will also hinge upon the successful completion of the upcoming negotiations with our partners on the issue of Greece’s public debt in line with the Eurogroup decision of 26-27 November 2012.
Economic policy must seize the objective opportunities that exist
As discussed in the Report, the objective conditions for an end to the protracted recession are in place. However, in order for the positive expectations to materialise, economic policy must seize these opportunities in the first instance to foster recovery in 2014 and then to lay the groundwork for stronger and sustainable growth in the period ahead.
For this to happen, economic policy must:
• rigorously pursue the fiscal adjustment programme, meet the targets set and ensure sustained and rising primary surpluses;
• speed up the restructuring of the economy through structural reforms that will support a shift of resources and employment to the tradables sector, i.e. a change of the growth model.
Major progress with fiscal consolidation
2013 marks a milestone for fiscal adjustment, as a primary surplus at the general government level appears to be within reach for the first time since 2002. Taking into account the effect of the ongoing, albeit gradually easing, recession, the Bank of Greece estimates that the structural primary balance will have improved by 18.6 percentage points of potential GDP over the period 2010-2013, yielding a surplus of around 4% of potential GDP by end-2013. This improvement is not only a major achievement, but is also one of the biggest fiscal consolidations ever achieved at the global level.
It should, however, be noted that the fiscal consolidation effort has relied disproportionately on tax increases, thereby putting a considerable burden on taxpayers and squeezing disposable income. From the outset, the Bank of Greece had argued that the fiscal consolidation effort should focus primarily on cutting expenditure and on increasing revenue by expanding the tax base and curbing tax evasion.
The fiscal consolidation effort will have to be pursued with the same determination in 2014. This will boost confidence in the economic prospects and help stabilise and then gradually reduce the debt-to-GDP ratio. Meanwhile, the economic recovery is expected to help in achieving the primary surpluses and, more generally, to facilitate sustainable fiscal adjustment.
Creating the necessary conditions for easing the tax burden on those who already pay taxes
Meeting the fiscal targets crucially hinges upon further expanding the tax base. However, this must be achieved by curbing tax evasion rather than by imposing new taxes or by continuously increasing the tax burden on those who already pay taxes. Improving the efficiency of the tax administration and the tax collection mechanism, through the establishment and empowerment of an independent General Secretariat for Revenue, will prove key to curbing tax evasion and fostering a climate of social equity, where everyone contributes to the fiscal consolidation effort according to their tax-paying capacity. Progress in this direction would make it possible to ease the tax burden on those who already pay taxes, as this burden has increased substantially in the last few years.
Intensifying the effort to streamline the public sector
Progress has been made in streamlining the public sector, but has been far slower than the pace of fiscal adjustment, and major reforms regarding the functioning of the state are still pending. Therefore efforts must now be stepped up to restructure and consolidate the public sector, giving priority to:
• Eliminating or merging public organisations and enterprises and speeding up the administrative reform that will deliver expenditure savings and a better level of services.
• Tightening the control of expenditures of the National Organisation for Health Care (EOPYY) and social security funds with the goal of ensuring the viability of the social security system.
• Reforming and modernising the judicial system to ensure speedier delivery of justice.
• Upgrading the tax administration and the tax collection mechanism in an effort to curb tax and contribution evasion and to foster a climate of social equity.
Finally, particular emphasis must be placed on speeding up the privatisation process, so as to make up for the shortfalls from target of 2013 and strengthen the business environment, thereby helping to attract foreign investment.
A new banking landscape has emerged following the recapitalisation and restructuring of the banking system
The past few months have seen important developments in the banking system. Recapitalisation and restructuring in the sector have shaped a new landscape, comprising fewer but stronger banks with a greater capacity to supply credit to the economy in the medium term. This occurred despite the fact that the Cypriot banking crisis in early 2013 rekindled concerns and uncertainties about Greece’s banking system and overall economy. The truly great risks were successfully avoided thanks to the swift, coordinated and effective response of the Government and the Bank of Greece.
Obstacles to credit expansion in the short term
In the short term, new lending remains limited, as banks’ lending capacity continues to be constrained by several factors. One of the most important constraints is the accumulation of non-performing loans, which makes banks more reluctant to extend new loans and deprives them of income from principal and interest payments that could otherwise have been recycled into new loans. Non-performing loans also pose the risk of a potential impairment of the capital base of banks, thereby forcing them to tie up more capital for loan-loss provisions.
Meanwhile, credit demand remains weak, as investment activity has declined, households’ demand for credit has been dampened by high unemployment, wage cuts and the downward trend in real estate prices and borrowing costs remain high.
Normalising credit expansion would require:
(a) improving the overall climate
The ongoing improvements in macroeconomic conditions and in the microeconomic business environment, together with growing confidence in Greece and its banking system, are expected to lead to a normalisation of credit expansion in the medium term, as they will: enable Greek banks to gradually regain access to the international interbank market; encourage the flow of deposits back to banks; generate demand for credit; and help reduce credit risk.
(b) bank initiatives for the management of non-performing loans
Credit supply conditions would also benefit from improved management of non-performing loans and from proactive measures to prevent further non-performing loans. There is considerable room for improvement in bank policies in this regard.
In order to ensure the effective management of their loan portfolios, banks have submitted their strategies for troubled asset management to the Bank of Greece. In this way, the Bank of Greece and the banks will be able to work out together alternative ways of handling the troubled assets and the most viable long-term solution. In fact banks, thanks to the consolidation in the sector, have already begun to adopt a more centralised management approach to their problem loans. As for the problem loans of banks under liquidation, an independent special committee has been set up and has already started functioning, to ensure the coordinated and consistent management of these loans as well.
Financing and economic recovery
The forecast recovery of the economy will need to be driven by business investment focused on export-oriented sectors of activity. However, for as long as the household saving rate remains negative, putting pressure on the banking system’s deposit base, banks’ capacity to finance such investments will, at least in the short term, remain limited, despite the aforementioned anticipated upturn. Thus, in order to support economic recovery, the flow of bank credit to the real economy will have to be complemented in the short term with alternative sources of financing, such as the following:
Alternative sources of financing
First, debt financing from corporate bond markets. The revision of the legal framework governing corporate bond issues in Greece could foster the development of a domestic corporate bond market for smaller businesses with limited access to international markets.
Second, equity financing. As investor confidence in the prospects of the Greek economy grows, domestic companies will increasingly gain access to markets for financing.
Third, resources available from the EU Structural Funds. Over the period 2000-2008, Greek businesses have absorbed funds equivalent to 1.6% of GDP per year to finance investment. In 2013, resources from the EU Structural Funds are estimated at €4.2 billion (2.3% of GDP).
Fourth, resources available from the European Investment Bank (EIB). In 2013-14 the EIB is expected, via domestic partner banks, to co-finance loans to small- and medium-sized enterprises (SMEs) amounting to €1.4 billion. According to estimates from the domestic partner banks, SME loans totalling €635 million will have been extended by end-2013, with the remaining €805 million expected for 2014.
In total, resources from EU Structural Funds, bond markets, the stock exchange and the EIB can cover a significant part of the economy’s financing gap. Part of this financing (National Strategic Reference Framework and EIB support) will be channelled through banks and will underpin bank lending, especially to small- and medium-sized enterprises. Foreign direct investment will serve as an additional source of financing.
Tomorrow’s banking system and its role in the restructuring of the economy
As a next crucial step, the banking system will have to develop a sustainable business model. It is clear that each bank has a different starting point, but the key elements of the model will need to be the same for all and focus on: the rationalisation of operating costs and, more generally, higher internal capital generation via operating profits; shedding non-core business; redesigning foreign business; the active management of troubled assets; and sound pricing policies for banking services.
Action along the lines described above will enable the banking system to play an enhanced role in establishing and supporting the new growth model of the economy. This calls for a new framework for credit supply and risk management, in order to avoid the distortions of the previous decade, when credit was largely used for residential investment and consumption. Instead, new credit should be allocated to dynamic and export-oriented enterprises with strong growth potential (e.g. in the sectors of infrastructure, food, energy, technology, health and tourism). In the same vein, the strengthening of businesses through mergers and acquisitions should be encouraged, where possible with support from the banks involved.
Diagnostic assessment of banks' loan portfolios
In compliance with the obligations and commitments arising from the Memorandum of Understanding, and following a tender procedure, the Bank of Greece engaged BlackRock Solutions in July 2013 to conduct a diagnostic assessment of banks’ loan portfolios. The results of the assessment, together with the restructuring plans already submitted by the banks, will be taken into account during the current stress test exercise, expected to be completed soon. It should be recalled that, if the stress test results identify a need for capital increases, the Hellenic Financial Stability Fund has a buffer of over €8 billion. Meanwhile, the banks have been requested to submit quarterly funding plans, to be evaluated by the Bank of Greece. These plans detail the actions to be taken by banks to diversify their funding sources and thereby gradually reduce their reliance on Eurosystem financing.
The recovery will require continued and stronger efforts
2013 marks the fourth year of the effort to avert a full-blown crisis in the Greek economy and to establish the conditions for a return to growth. During these four years, the recession has been deep and the price that Greek citizens have had to pay has been high. However, this downward course can now be halted, since, in spite of delays and shortfalls in meeting targets, there have been significant achievements: the twin deficits − fiscal and external − have been eliminated, the losses in competitiveness recouped, the major inefficiencies in the social security system addressed, the banking system restructured and confidence restored.
The effort, however, has yet to be completed and the emerging stabilisation of the economy is still fragile. It is imperative to safeguard all that has been accomplished at such tremendous cost, to prevent any backsliding and to cover the remaining distance in order to consolidate the country’s growth prospects.
The full text of the Report (in Greek) is available here: