Greece -- 2003 IMF Article IV Consultation, Conclusions of the Mission

February 10, 2003

Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
February 10, 2003

1. Strong economic growth has continued in Greece and some further progress has also been made in advancing structural reforms. The resilience of growth is particularly remarkable amid a global economic slowdown, with the Greek economy benefiting from the decline in interest rates associated with monetary union and from the preparations for the Olympics. In the structural area, noteworthy recent steps included, among others, a tax reform, additional privatization, and some steps to strengthen transparency.

2. However, risks to the durability of the present economic expansion have also emerged. Fiscal consolidation has slowed, at a time when the public debt remains very high; the external current account deficit has widened to one of the largest deficits among industrial countries, raising foreign indebtedness; and domestic credit and private sector indebtedness continue to rise rapidly, albeit from low levels. On structural reforms, the agenda remains far from complete-to some extent understandable, given the relatively late start of reforms in Greece compared with other EU countries.

3. Our discussions this year focused on policies to sustain strong, equitable growth in living standards. This calls for taking advantage of the present economic expansion and addressing emerging macroeconomic imbalances; fiscal and structural reforms will be essential if Greece is to compete successfully within monetary union and integrated world markets. This would also argue for steps to raise employment growth in the formal economy and reduce unemployment-an area where developments have remained disappointing. There is a risk that if the needed adjustments are not implemented in a timely manner, growth will wane and the required fiscal and structural adjustments would have to be undertaken under much less favorable circumstances.

Economic prospects

4. For the near term, domestic growth prospects continue to be favorable and most indicators point to GDP growth above the euro-area average also for 2003-04. Official data suggest growth reached close to 4 percent in 2002, and with the expected acceleration in public investment, preparations for the Olympics, low interest rates, and the projected gradual pickup in economic activity elsewhere in Europe, we expect broadly similar growth rates over the coming two years. The projections are subject to considerable downside risks: a war in Iraq could further raise oil prices and weaken in particular the tourism sector; an additional euro appreciation would erode competitiveness; and adjustments to the macroeconomic imbalances noted above could also slow near-term growth. Inflation has remained well above the euro-area average, owing in part to divergent cyclical conditions and factors related to Greece's real income convergence. However, sizable external sector imbalances raise also concerns about competitiveness. This argues for a determined effort to narrow the inflation differential vis-à-vis the euro area: aligning wage increases more closely with those in the area, and strengthening competition, especially in the service sector.

Fiscal policy: consolidation and reform

5. Following a remarkable fiscal adjustment ahead of monetary union, progress has stalled and, in 2002, the deficit declined only marginally. Overruns on current noninterest expenditures, including for new civil service hiring and wages, continued to plague budget execution. In the end, a widening of the deficit was only prevented by two temporary factors: unbudgeted revenues of about of €0.8 billion (0.6 percent of GDP), owing to the clearance of tax arrears for previous years; and a cutback in investment spending relative to budgeted amounts, related in part to slower-than-anticipated EU project approvals.

6. Looking ahead, the fiscal policy strategy will have to address three important concerns: first, proceeding with fiscal consolidation, focused on a sufficiently rapid reduction of the high debt (still above 100 percent of GDP, among the highest in the EU)-to prepare for spending pressures related to population aging and to alleviate interest rate risks; second, redressing the emerging macroeconomic imbalances-in particular, freeing up resources for the tradable sector and spurring durable growth; and, third, improving in a broad sense the quality of public sector services-raising accountability and transparency, and strengthening public expenditure planning, efficiency, and control.

7. The 2003 budget addresses some of these concerns-yet its targets are, in view of strong economic growth and macroeconomic challenges, insufficiently ambitious. The budget aims at a reduction in the fiscal deficit from 1.1 percent of GDP in 2002 to 0.9 percent in 2003. However, netting out the positive revenue effects of the economic expansion on the budget, the (structural) deficit would remain unchanged: the budget does not take advantage of the forecasted strong growth and low interest rate environment to proceed with underlying fiscal consolidation. As a result, the planned fiscal stance would help little in addressing the concerns outlined above, and consideration should be given to strengthen the target, reducing the structural deficit by about ¾ percent per annum through 2006, the horizon of the Stability Program. The resulting rise in public saving would facilitate a narrowing of the external imbalances; and it would put the fiscal accounts on a path to reduce the public debt to about 60 percent of GDP by 2010-the government's target in the previous Stability Program, which remains appropriate.

8. Aside from whether the budget targets for 2003 are sufficiently ambitious, there is a risk that the targets will be missed by a considerable margin. With the tax reform expected to result in sizable revenue losses (above ½ percent of GDP), the budgeted deficit reduction counts on expenditure restraint in several areas. However, there are risks that wage expenditures could once again exceed budget targets, absent steps to sharply curtail public sector employment; and measures that would secure the envisaged decline in real (and sometimes even in nominal) expenditures in many other areas still need to be identified. These risks have to be addressed early and decisively, lest they lead to a substantial increase (rather than the needed reduction) in the fiscal deficit in 2003.

9. Successful fiscal adjustment will require restraint in all major expenditure areas. In this regard, it would be useful to revive earlier intentions and set specific, binding expenditure ceilings, extending over a multiyear horizon and covering all levels of the public sector. This would facilitate efficient expenditure planning and provide a framework for strengthened budgetary control-an area where progress has remained limited. These considerations should be incorporated into the planned "Code of Fiscal Stability." The Code could be an important step forward, provided that it tightly limits borrowing, encompassing all levels of government and public sector entities.

10. On specific expenditure areas, our discussions focused on:

· Civil service: Inflexible employment arrangements have hampered cost effective service delivery in many areas of the general government sector, shortcomings that could be addressed to some extent by the planned introduction of part-time employment. Care is needed to prevent an expansion of overall staffing; on the contrary, there remains room for reducing employment, taking full advantage of attrition and redeployment to areas of greatest need. These steps should also free resources for more competitive pay for strong performers in the civil service-and consideration could be given to broader reforms in this direction.

· Defense: Taking advantage of easing tensions in the region should allow, over time, a significant reduction in Greece's relatively high military spending.

· Subsidies and capital transfers: Recent accounting revisions highlighted the sizable and frequent financial support for public enterprises. Savings in this area depend on utilizing the room for efficiency gains and improving cost recovery (for example, on railways and urban transport). By contrast, plans to provide above-market rates of return on "popular saving bonds" run counter to the general direction toward market-oriented reforms.

· Health: A far-reaching reform of the health care system has begun with increased decentralization, performance-oriented contracts for regional managers, a strengthening of auditing procedures, and expanded flexibility in primary care provision. Looking ahead, measures are to focus on forceful implementation of these reforms, and plans to improve service quality and establish a more cost-efficient procurement system are also welcome. It will be important to ensure that staffing needs of the more decentralized system are met by reallocating freed-up resources within the sector, and that all payment obligations are settled in a timely fashion.

Greece and EU: Estimates of Public Pension Expenditures, 2000-50

(In percent of GDP)








Greece prereform







Greece postreform














Sources: Ministry of Labor and Social Security; and EU.

· Pensions: The pension reform adopted in 2002 entailed important positive steps, including a consolidation of funds, an extension of the contribution period for determining pension benefits, disincentives for early retirement, and a legal framework for private pension funds. However, the reform largely failed to address the projected rapid rise in public pension expenditure over the longer term (see text table). Based on the government's projections, pension expenditures, already relatively high in relation to GDP, would almost double over the coming decades-by far the largest increase projected for any EU country. This is clearly not sustainable. While we recognize that the present circumstances are not conducive to further reforms, the issue needs to be addressed at an early stage-and with sufficiently decisive steps to provide a stable framework for old-age pensions that allocates sufficient minimum incomes to the most needy among the pensioners.

11. A rapid reduction of the high public debt is only achievable with public expenditure restraint in all areas, including those that affect the public debt but not the Maastricht-based fiscal deficit. Recent statistical clarifications by Eurostat brought some of these expenditures into the fiscal deficit. Still, the recourse to expenditures that are not recorded in the deficit (but raise the debt) has remained large-with the Stability Program indicating an associated impact on the public debt ratio of around 4 percent of GDP in 2002 (net of privatization receipts). Current plans to reduce these outlays sharply in 2003 would be an important step forward and need to be implemented forcefully, including by strictly limiting state guarantees and ending the repeated recourse to capital support for public enterprises. Any remaining spending in these areas should not exceed privatization receipts, so that the public debt will fall at least as rapidly as indicated by the general government balance. Moreover, it would further improve transparency if more detailed information were published on the underlying transactions at the general government level.

Public sector efficiency, transparency, and tax reform

12. We found a widespread consensus that public sector efficiency remains wanting and that administrative hurdles, while reduced, continue to hamper investment and interfere with activities in many areas. Several steps were taken to lower administrative hurdles, including simplifications of some licensing and the creation of both citizen service and investment centers. Still, Greece's low foreign direct investment receipts is only one indication that more remains to be done to successfully implement previous and initiate further reforms in this area. Reducing unwarranted public sector interference is critical in this regard, but it bears repeating that improving service delivery of the public sector is also important.

13. We were struck by the intense public debate about transparency and accountability-areas that are of critical importance for longer-run growth and welfare-but have also seen important progress. Concerning progress, we note the adoption of international accounting standards for 2003 (ahead of EU requirements) and of a new corporate governance law, as well as plans to strengthen auditing procedures. Further reducing the room for discretion by public authorities, noted above, would also be helpful, and consideration could be given to a broader public campaign that stresses the importance of these issues and addresses decisively all areas of misconduct.

14. To a significant extent, the recent tax reform addresses evident shortcomings in terms of transparency, simplicity, and the rule of law in the public sector. Tax relief-including the increased tax-free threshold for the personal income tax, which benefits a broad segment of the population-was another element of the reform. But probably more important were steps toward a transparent system. In particular, the reform simplified a range of major taxes and eliminated many, although not all, stamp duties. It is hoped that these measures become part of an ongoing process toward a more simplified, equitable tax system-accompanied by actions to strengthen the integrity of the tax services.

Financial sector

15. Household and enterprise indebtedness-still low by international standards-have increased rapidly in recent years and banks' capital ratios have declined, albeit from high levels. The credit expansion reflects at least in part the decline in interest rates, related to monetary union, and financial liberalization. As in other countries, the banking sector was negatively affected by the sharp decline in equity prices in recent years-but has also remained resilient under these circumstances. While capital ratios have fallen, they remain well above regulatory minima and also above euro-area averages, helped by relatively favorable cyclical conditions in Greece. The share of nonperforming loans has generally shown a declining trend, yet it marginally increased in the first half of 2002 and remains relatively high.

16. The evolving challenges facing the financial sector-including risks in the event of a future economic downturn, which the newly liberalized banking sector has not experienced-warrant added supervisory vigilance. This concerns in particular the adequacy of capital and provisioning, and the recent strengthening of the latter is welcome-to be followed by a review of banks' internal risk management systems. In these and some other areas, we note that a further upgrading of supervisory expertise has continued; steps have to ensure that a sufficient number of high quality staff is recruited to address evolving supervisory demands. To strengthen market discipline, an important role could be played by increased disclosure of asset quality and other risk indicators, where requirements are considerably more extensive in several industrial countries. We also found broad agreement that bankruptcy procedures are unduly protracted, affecting the quality of bank portfolios and the efficiency of financial intermediation. Consideration should be given to judicial reforms that would facilitate loan recovery or workouts, steps that could also improve contract enforcement more generally.

17. In the insurance sector, financial performance has deteriorated markedly and adds urgency to the need for strengthening supervision. The deterioration in the sector mirrors in part international trends and requires forceful surveillance, a challenge that is not adequately addressed within the existing framework. Measures should be adopted promptly to rectify the extensive shortcomings from international best practices-concerning in particular issues of timely supervision, supervisory independence, and disclosure. Moreover, the demands of increasingly integrated financial services and markets call for strengthening formal coordination among all financial market supervisors.

Labor market and structural reforms

18. Structural reforms in labor and product markets will be pivotal for convergence in living standards. Unemployment rates, although declining, remain among the highest in the euro area and employment gains in the formal economy have remained small, despite strong output growth. Moreover, the high unemployment rate among the young is indicative of a mismatch between educational achievements and the needs of the labor market. Recent education reforms hold out the promise for improvements: for example, expanded educational services (pre-school and full-day schools) may facilitate increased female participation rates, while some new courses at the secondary level and vocational training could address skill mismatches. But increased resources are spent on these activities without corresponding savings in other areas-and we look forward to the review of these activities to draw lessons for more effective resource allocation. Concerning other labor market issues, Greece's relatively extensive employment protection may warrant a careful reappraisal: it hampers activity in the formal sector (and probably deters some investment), while keeping workers in the informal sector, where they are afforded no social protection and safety net.

19. On competition, the successful advances over recent years should form a strong impetus for further progress. The Competition Authority still has to play a more active role as a guardian of competition, and a determined effort is needed to recruit a sufficient number of competent staff. Concerning specific sectors, the case of telecoms is a good example of the benefits that can accrue from increased competition within an effective supervisory framework. In the electricity sector, the commitment for further market liberalization at the retail level is welcome. However, to introduce in the near term effective competition for power generation would require divestitures by the dominant firm, a step that could also facilitate the needed expansion of generation capacity; in addition, consideration should be given to strengthen the regulator's independence, notably for tariff decisions. Privatization advanced in 2002 amid difficult market conditions. While not without setbacks, the determination in this area was also indicated by the easing of some earlier sales limits; indeed, the largest competition and efficiency gains could be expected if the state were, over time, to fully divest itself of all interests in commercial activities.

20. Considerable progress was made over the past year in strengthening the quality and timeliness of statistical data, and Greece became a subscriber to the IMF's Special Data Dissemination Standard. This should substantially improve the assessment of economic developments and timely decision making-areas which would be further helped, in Greece as in other countries, by collecting intrayear data on general government activities.

21. Greece has benefited greatly from its integration into European and global markets. We hope that the current EU presidency can further advance external trade liberalization, in particular for exports from developing countries.


22. Monetary union has afforded clear economic benefits and a window of opportunity to move forward with economic reform. We are hopeful that this opportunity is seized to its fullest, securing strong, equitable growth well beyond the near-term horizon.


February 10, 2003


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