Greece--Conluding Remarks of 2001 Article IV Mission

November 19, 2001

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.

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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.

Greece—2001 Article IV Consultation

Conclusions of the Mission

Athens, November 19, 2001

1. The policy strategy that secured euro-area entry at the beginning of the year has continued to underpin a strong performance of the Greek economy. Over the past year, the most impressive accomplishments included a further catch-up in living standards—with real income growth remaining well above the euro-area average; and progress in consolidating the public finances—where the double-digit deficits up until the mid-1990s have given way to the prospect of fiscal surpluses. In certain areas, structural reforms have also advanced in recent years, including in financial markets and telecommunications.

2. With the economic progress of recent years, we found a widespread consensus on the large benefits of economic reforms and stabilization—and this consensus, and the political opportunities it offers, should be seized upon to broaden and deepen the reform effort. Our discussions this year focused on the content of such reforms, on the synergies that could be garnered from reforms in different areas, and on stabilization issues in the face of large economic uncertainties.

3. The global economy has weakened markedly during 2001 and this, as well as domestic factors, are affecting the economic outlook for Greece. Some indicators pointed to a deceleration in domestic activity even before the September attacks in the United States. Moreover, growth could be expected to moderate somewhat with the waning impact of lower interest rates associated with euro-area entry, and of the euro's earlier depreciation. In all, we expect economic growth to decelerate from around 4 percent in 2001, to some 3 percent in 2002—still more than twice the expected growth rate for the euro area. Notwithstanding some upside risk to growth in 2002—notably, if recent strong growth in incomes and declining interest rates sustain domestic demand—there are sizable downside risks: foremost, should a reduced willingness to fly, following the September attacks, extend into next year, the tourism sector would be severely impacted—with stronger repercussions for the Greek than for most European economies. On inflation, declining oil prices are lowering headline inflation. However, compensation increases well above the euro-area average, with the differential not fully matched by higher productivity growth, are keeping underlying inflation substantially above the area average. Prospects for further inflation declines will thus depend critically on upcoming wage settlements. Recent reductions in effective household income tax burdens should allow for some moderation in wage settlements while safeguarding real incomes. Moreover, wage settlements need to take into account increases elsewhere in the currency union and potential competitiveness implications, at a time when the external current account deficit is already larger than seems warranted by medium-term fundamentals.

4. The risks to the economic outlook need to be taken into account in designing and implementing economic policies. Against this background, our discussion this year focused on a strategy centered around two core principles: (i) a transparent, medium-term orientation; and (ii) within this framework, well-defined rules that would allow for flexibly addressing short-run challenges, including a possibly more pronounced weakening of economic activity. The medium-term orientation of policies should be particularly effective in the present environment of large uncertainty—providing an anchor to expectations and fostering growth.

5. Fiscal policy has a central role to play in promoting stabilization and growth:

  • As concerns fiscal policy's medium-term orientation, the Stability and Growth Pact's focus on strong medium-term fiscal balance and debt positions is key. For Greece, a sizable primary budget surplus could provide a useful medium-term guidepost for fiscal consolidation. A surplus above 6 percent of GDP over the cycle would meet the requirements of the Stability and Growth Pact, and lower the still very high public debt-to-GDP ratio to below the Pact's 60 percent of GDP reference value by about 2010, when the most adverse impact of population aging sets in. With declining public debt and consequently falling interest payments, this will, over time, result in rising overall fiscal surpluses—to magnitudes that have already been achieved in several other EU countries. The need for, and precise size of, these surpluses may be revisited in later years, if decisive progress is achieved on structural reforms, notably on measures to contain aging-related expenditure increases.
  • A commitment to well-specified expenditure ceilings, most effective if set for the general government level, could usefully complement the fiscal balance and debt objectives. They would provide a clear and easily monitored signal to market participants, including on the future size of government, and thus ultimately the tax burden. The government's effort to draw up multi-year budgets by ministries is a first, albeit tentative, step in this direction, and a public commitment to expenditure ceilings should be incorporated into future updates of Greece's Stability and Growth Program.
  • Credible expenditure ceilings and medium-term deficit targets can provide the framework for short-term fiscal policy responses to unanticipated shocks: they would allow the full and symmetric play of automatic fiscal stabilizers, while preserving the medium-term fiscal objectives. Of course, credibility will depend foremost on policy actions, including on reforms discussed below.

6. Applying this strategy to fiscal policy in 2001, we see little reason for a substantial deviation from the original surplus target of 0.5 percent of GDP: growth is estimated to hold up well and remain above estimated potential; and possible revenue implications of growth somewhat below the very optimistic budget assumption should be largely offset by higher-than-budgeted inflation. Moreover, sizable extra revenues that were not originally budgeted are resulting from the sale of telephone licenses. Concerning expenditures, steps should be taken, if needed, to ensure that outlays remain within budgeted amounts. In all, this should allow for a surplus close to the original overall budget target, and the so-called structural primary balance (that is, the overall budget balance, net of interest payments and temporary, cyclical effects) would rise to about 6¼ percent of GDP in 2001.

7. The 2002 draft budget, importantly, includes elements that both stay the course toward medium-term fiscal consolidation and attend to the near-term demands of stabilization. Three issues warrant, however, closer attention. First, the budget is again based on economic growth assumptions that appear on the optimistic side, in view of the weak global environment. Second, the draft budget takes as a starting point a 2001 surplus which, we hope, could be improved upon. And, third, the draft budget includes tax reductions—for the most part, appropriately targeted at equity-enhancing and distortion-reducing steps—of about ½ percent of GDP, which are not offset by expenditure cuts.

8. In all, the 2002 draft budget goes beyond the principle of allowing the full play of automatic fiscal stabilizers. This comes at a time when the macroeconomic policy mix has already eased considerably following the interest rate adjustments by the European Central Bank. For fiscal policy, the third factor above is especially relevant, as the tax reductions leave the budgeted improvement in the fiscal balance (to 0.8 percent of GDP) at somewhat less than the expected decline in interest payments. Instead, in our view, the stabilization and consolidation demands on fiscal policy would be broadly balanced if the planned additional tax reductions were matched by expenditure cuts. This would imply an overall fiscal surplus target for 2002 of about 1¼ percent of GDP, under the government's growth forecast. It is around this level that automatic fiscal revenue stabilizers should be allowed to operate. Accordingly, were growth ultimately to be stronger than projected in the budget, the additional revenues should be used to retire public debt; conversely, there would be some room for easing the surplus target, should growth weaken further.

9. In the present highly uncertain economic environment, far-reaching expenditure reforms can play a particularly pivotal role. In the period ahead, the first priority is to proceed with pension reform: establishing a sustainable and equitable pension system. We were impressed by the consensus among the social partners on the need for reform. And the emphasis on securing a social consensus for reform measures is rightly given a central role. Yet the process of consensus building must be mindful of the critical time dimension: with a broad awareness of the issues, now is the time to advance decisively, as delays could put into question the government's reform commitment more generally.

10. Concerning the overall envelope for future pension expenditure, limiting expenditure growth (in relation to GDP) to no more than the increase in other euro-area member countries may serve as a useful guidepost—as these countries, with some variation, will experience fairly similar population aging as in Greece. Incentives for a more flexible and higher effective retirement age; curtailment of sometimes excessive replacement rates; strengthened contribution compliance; and a more unified, equitable treatment of pensioners within a much less fragmented system could constitute part of a reform agenda, as could fully-funded supplementary and private pension funds. Other reform steps may also be identified in the process of forming a social consensus—a process that will, to be successful, call for strong leadership by the government.

11. In other budgetary areas, a strengthening of expenditure evaluation, monitoring, and control is urgently needed. This is particularly evident for health care, where vast room remains to also improve service delivery and quality. The planned broad reform in this sector, which has begun to be implemented over the past year, could strengthen regional responsibilities and health care quality. The implementation of better health expenditure monitoring would allow the early identification of overruns or arrears—which will need to be addressed with resolve, if the reforms are to achieve the intended results. In the public sector more generally, the planned medium-term budgets should be used to establish strict employment limits that cover all activities of the general government, as the selective interventions of the past have not prevented continuous increases of public employment.

12. We also note that sizable public expenditures are undertaken outside the general government budget. These transactions are, as we understand, in line with EUROSTAT conventions, and financed in part by privatization and securitization receipts. The premium paid on securitized debt instruments (vis-à-vis government debt) points to the relatively high cost of funding some operations, although other financing instruments, such as exchangeable bonds, may have beneficial effects for privatization. Some of the expenditure operations are also undertaken in other EU countries; obviously, they weaken the link between (measured) fiscal surpluses and public debt reduction—impeding efforts to achieve a sustainable, rapid decline of the public debt. With these considerations in mind, a careful and transparent review of all below-the-line activities should be undertaken—subjecting individual expenditures to the same budgetary oversight and assessments as other fiscal outlays.

13. On taxes, the present system is excessively complex and widely perceived as inequitable, with a multitude of distortions. These shortcomings hamper not only tax administration, but also economic performance more generally. Against this background, the planned, far-reaching overhaul of the tax system—aimed at tax simplification, neutrality, and a more equitable distribution of the tax burden—could form a further key element of a medium-term policy strategy. To underpin prospects for strong and equitable growth, it would be most helpful if the new system established a level playing field for different activities. The 2002 budget includes several steps in this direction: equity considerations are evident in the increase of the tax-exempt amounts for the personal income tax; and distortions are lowered, including with the further elimination of some stamp duties. At the same time, care needs to be taken to avoid introducing new distortions. For example, while company mergers or foreign direct investment may well be advantageous for the Greek economy, such activities are best promoted by a suitable overall business environment, rather than specific incentives. In the context of the broader tax reform, it will also be important to reassess the overall tax burden, which has increased considerably in recent years. With many of your partner countries in Europe targeting sizable tax cuts, consideration could be given to broadly similar reductions in the tax burden in Greece in coming years—with corresponding expenditure cuts securing the fiscal surplus targets.

14. Turning to the labor market, its performance remains disappointing with unemployment rates among the highest in the euro area and relatively low employment growth. Recent reforms are, in our view, unlikely to achieve a marked turnaround—which would be a necessary condition for achieving rapid convergence in living standards with euro-area partners. There remains, foremost, a need to facilitate labor market entry and to improve training. Moreover, reforms that spur employment would have positive implications for the policy needs in other areas, including for pension reform. The labor market is also an area, but by no means the only one, where substantial statistical improvements remain to be secured. As timely, high-quality data are critical for well-informed policy decisions, it will be important to provide adequate resources and managerial incentives to these tasks.

15. On financial markets, private sector credit continues to rise rapidly—a development that was largely to be expected in response to the euro-entry related decline in interest rates and banking sector liberalization. Since strong credit growth tends to increase risks—even more so for a system that has limited experience with the impact of macroeconomic weakening in a liberalized market—we were encouraged by the general awareness among supervisors and banks that these risks need to be carefully managed. Tighter provisioning rules that became effective in 2000 were a helpful step forward, also in light of the relatively high stock of nonperforming loans—indeed some banks hold provisions in excess of minimum requirements. However, these rules can not fully address the risk of future losses posed by rapid credit expansion. We welcome that the Bank of Greece is exploring ways to address this risk. Certainly, additional measures to strengthen the combination of provisions and capital should be considered if private sector credit growth remains around the high rates seen in the past two years. Furthermore, public disclosure by banks of a timely and comprehensive set of asset quality and risk indicators could enhance market discipline, thereby encouraging prudent risk management.

16. The rapid development of the banking sector has benefited from increased competition, and recent steps to reduce government control should further promote market discipline and effective cost management. Looking ahead, and given the already quite high degree of concentration in the Greek banking market, the impact of further consolidation on competition and financial system stability needs to be carefully assessed. The Competition Commission must ensure that banks' customers benefit from potential efficiency improvements arising from mergers—although these benefits may accrue only gradually, in the face of prevailing labor market practices. At the same time, the Bank of Greece as supervisor should continue to carefully address the risks that the creation of banks in control of a sizeable share of the banking system's assets and liabilities may have for financial system stability. Stability concerns also argue for strengthening the role and independence of the insurance supervisor, and intensifying its links with other financial market supervisors.

17. The deregulation and liberalization of some product markets has advanced considerably in recent years—yet, as is widely recognized, much remains to be done. Already, tangible benefits are evident in a number of areas, including in the telecommunication and banking sectors, where the ongoing process of liberalization combined with privatization has led to efficiency gains, improved services, and lower costs to both consumers and businesses. Nevertheless, more broadly-based progress will be needed to underpin continued rapid income convergence—and early steps could also help to cushion the present economic slowdown. A pivotal role falls to the Competition Commission, which has to gain the stature and enforcement commitment required to make it a true champion of competition. The government's renewed vigor in its approach to privatization should also send an important signal. Privatization by itself, however, is not sufficient to ensure competitive market outcomes, and a number of supporting structural reforms are necessary. Notably for the electricity sector, privatization and liberalization benefits may not accrue to the end-user for an extended time period, unless there is extensive divestiture of generation capacity by the dominant company and separate ownership of the national grid. In the public sector, further steps are needed to address still pervasive bureaucratic inefficiencies, as well as to forcefully implement past reforms and ease entry barriers in some sectors—steps that would also facilitate foreign direct investment. The latter should benefit from some recent initiatives, including intended privatizations in the tourism sector.


18. The mission would like to thank the authorities for their close cooperation and warm hospitality.