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At the conclusion of annual Article IV bilateral discussions with the authorities, and prior to the preparation of the staff's report to the Executive Board, the IMF mission often provides the authorities with a statement of its preliminary findings.
Greece—1999 Article IV Consultation Discussions

Preliminary Conclusions

June 28, 1999

1.  The stability-oriented economic and monetary policy that has been steadily pursued over the past years has succeeded in placing Greece squarely on the road to joining EMU by the target date of January 1, 2001. Although observance of all the Maastricht criteria (notably on inflation) is not yet secure, a positive outcome of Greece's drive to EMU participation is now widely anticipated. This is a momentous accomplishment. The policies that have made it possible are bearing their fruit with a pace of economic growth that, in recent years, has finally outstripped the EU average. This has been accompanied by a sharp decline in inflation and a moderation of wage settlements, suggestive of an incipient culture of stability that will be essential in monetary union.

2.  At the same time, it is also evident that, on the remaining route to EMU, Greece faces both macroeconomic policy challenges and a need for further structural changes. First, the macroeconomic policy mix will need to undergo a fundamental rebalancing, with fiscal policy being called upon to move to center stage in the disinflationary effort as the effectiveness of monetary policy will diminish and monetary conditions will ease substantially. This will require a significant strengthening of current fiscal plans. On the structural front, there has been appreciable progress in several areas, and it is beginning to reveal the economy's substantial potential for growth when freed of its shackles. But, given Greece's starting conditions, much remains to be done. The continued dominant presence of the public sector in key economic activities, the inefficiency of an overmanned public administration, and the persistence of labor and product market rigidities combine to hamper competition, entrepreneurship, and technical progress. Employment performance has been lackluster and the country has been largely overlooked as a destination for foreign direct investment. The efforts of the past years have laid the groundwork for a turnaround in this performance, and a continued impetus in the pace and scope of structural reform stands to yield substantial benefits to the economy.

3.  We welcome your statements that policies will remain firmly focused on keeping the EMU process on track and on persisting with the structural reforms required to prepare the economy for the demanding competitive environment of monetary union. Our recommendations are framed consistently with these statements. Having come this far, and given the high stakes at hand, the country would be ill-served by any pause in either its macroeconomic stabilization or structural reform efforts.

4.  In the remainder of 1999 and in 2000, macroeconomic policy will need to be centered, first, on securing outcomes that will ensure a positive EMU decision and, second, on establishing the conditions that will make for a smooth transition and a positive performance upon entry. From this angle, the main challenge is that of achieving and sustaining price stability. Last year we considered that an immediate post-devaluation tightening of the fiscal stance—with the active pursuit of a better-than-budgeted outcome—represented the best option to return inflation durably to the ambitious path required for EMU. The official view was rather that fiscal tightening beyond the original deficit target for 1998 risked being too uncertain an instrument to reduce inflation rapidly by year-end. With post-devaluation inflation remaining stubbornly high through September, recourse was made to indirect tax cuts and other administrative measures. This approach remains in our view second-best, even if, by limiting the adverse second-round effects of wage catch-up clauses, it contributed to the deceleration of wage increases.

5.  The inflation outlook remains of some concern. On current trends, and barring further measures, it is likely to average close to—or slightly above—the likely Maastricht reference value. Furthermore, inflation is projected to rise for technical reasons in late 1999-early 2000, as the one-off impact of the indirect tax cuts of late last year dissipate. Given the need to contain inflation within a certain reference period, administrative measures may again be called upon to intervene. But such measures, by their nature, have transitory effects on inflation. To counter the prospect that Greece will enter EMU with inflation on the rise, other policy instruments—notably fiscal, wage, and structural policies (given the constraints posed on an already tight monetary policy)—must be fully harnessed to the task of securing a sustainably competitive inflation performance in monetary union.

6.  The tight monetary policy stance adopted to date, centered on high interest rates and a strong drachma, has been central to the disinflation effort. The Bank of Greece's objective of achieving price stability by end-1999, and on a sustainable basis thereafter, implies the maintenance of a tight stance as long as is feasible. In this setting, interest rate cuts will need to await clear evidence of lower actual and expected inflation on a sustained basis. Such a stance is also entirely appropriate in light of the economy's cyclical position and other related developments, such as the boom in credit, financial, and real estate markets.

7.  However, there are evident limits to this approach in the run-up to EMU. The high level of interest rates is inducing capital inflows, while the ability of interest rate policy to curb credit growth is being eroded by the public's widespread perception that interest rates will per force decline in the coming period, by firms' recourse to alternative sources of finance, and by intense competition for increased market shares in the banking system. These factors were cause for understandable concern, inducing the Bank of Greece to adopt measures to limit credit growth; given the distortive nature of such measures when maintained over time, we welcome their temporary nature. The approach to EMU can only exacerbate the pressures noted above, thus progressively constraining the ability of monetary policy to control inflation.

8.  Looking forward, the eventual alignment of domestic interest rates with those in the euro area and the depreciation of the drachma to its central ERM parity—which we view as broadly appropriate from a medium-term perspective—will entail a substantial relaxation of monetary conditions next year. Although the easing implied by lower interest rates is in part diminished by its dampening effect on household incomes, the influence of this channel should not be overplayed. Given the conditions currently prevailing in Greece, the change in monetary conditions is set to be much larger than that experienced by the economies that joined EMU in the first wave. In the countries that experienced large interest rate reductions prior to EMU entry, inflation rates have been appreciably above the euro area average.

9.  Against this background, it is incumbent on fiscal and other policies to offset the effect of monetary easing on inflation. The fiscal targets of the 1999 budget and of the convergence program fall short of this requirement. For 1999, adherence to the budget targets would imply a broadly neutral fiscal stance, with no change in the general government primary surplus from 1998. We are, however, encouraged by the apparent scope for overperformance on the revenue side, where the sustained tax administration efforts of the past years are yielding tangible results. We urge that the larger-than-budgeted revenues be fully devoted to deficit reduction, bringing within reach a general government deficit in 1999 around the target set for 2000 in the convergence program. Below-the-line equity increases to public enterprises should also be contained to well under their budgeted level of 1.6 percent of GDP, as indeed was partly done in 1998.

10.  Looking beyond 1999, we would in the first instance counsel caution in contemplating tax reduction initiatives. While we appreciate the need, for reasons of equity, to adjust the level of the minimum tax-exempt income, we see it as inadvisable to go beyond this. Not only is fiscal policy in 2000 called upon to rebalance the policy mix, but it is far too early—in a country where the culture of price stability is still fragile—to provide the public with a signal of relaxation, particularly when the negotiations for a new wage agreement will be resuming. It is also premature to hand back the hard-won revenue gains of improved tax administration; in order to avoid revenue losses from the announced abolition of the objective criteria, we urge a further strengthening of tax assessment and control capabilities. At all events, any measure that would reduce revenues must be made contingent on a prior, clear identification of specific offsetting cuts in current primary expenditure. In this respect, the track record to date shows that very hard work is required merely to contain the rise in the ratio of such expenditures to GDP—despite undoubted efforts over the period, current primary spending rose from 29.6 percent of GDP in 1994 to 30.9 percent of GDP in 1998. Indeed, this ratio is unlikely to decline appreciably until social security reform takes hold; it is in the context of a social agreement on this issue that an alleviation of the tax burden, particularly of taxes on labor, as well as other initiatives to enhance job creation, could best be discussed and contemplated.

11.  In formulating the 2000 budget, it must be recognized that, given the possibility (and desirability) of a better-than-budgeted performance this year, and a considerably sharper decline of the interest bill than envisaged in the convergence program, the targets of the latter are now superseded. The convergence program recognized that it was deliberately conservative in its calculation of the interest bill, and developments in market conditions would confirm a substantial overestimation of the interest burden in 2000-01. In these circumstances, therefore, adherence to the convergence program's target of a deficit of 1.7 percent of GDP in 2000 would not only imply no improvement in the overall deficit relative to the outcome within reach for 1999, but would also entail a marked deterioration in the primary surplus (from around 7 percent to some 5 percent of GDP). Together with the concomitant monetary easing, and strong projected growth in the seventh year of the current expansion, such fiscal relaxation would not bode well for inflation in the year prior to EMU entry and the early period in monetary union. However, we understand that the authorities maintain their caution about future developments in the interest bill.

12.  We would advise that, rather than aiming for the convergence program's superseded targets for the overall deficit (or marginal improvements thereupon), the government should, at a minimum, commit to observing the program's targets for the primary balance in 2000 and 2001 (a surplus of about 7 percent of GDP in both years). This is not a tall order: first, it corresponds to the objectives that the government had set for itself a year ago for a magnitude that it can directly affect; and, second, it implies no further primary adjustment from the projected outcome for 1999. Indeed, in the cyclical and policy mix circumstances that are likely to prevail, a sharper fiscal contraction might well be required, and we would urge you to monitor the situation carefully and stand ready to raise the sights further from the minimum noted above when elaborating the 2000 budget. Requirements will also need to be assessed in light of developments in the course of 2000, and corrective action promptly undertaken if needed.

13.  Turning to a more medium-term perspective, we would note that a primary surplus of the order of 7 percent of GDP would lead relatively rapidly to fiscal balance or a small overall surplus. While this is more than would be required to ensure Greece's observance of the Stability and Growth Pact (SGP), we feel that a proper assessment of the fiscal requirements depends also on a careful evaluation of the medium- and long-term outlook for both the assets and liabilities of the broader public sector. To this end, we see benefits in developing a balance sheet/net worth approach to fiscal policy-making and reporting, in line with trends in other OECD countries, and have prepared some preliminary suggestions to this effect during our visit. Taking this perspective, a number of considerations argue for an ambitious medium-term fiscal target, beyond that required by the SGP. While Greece can count on comparatively large privatization proceeds, it is burdened by a high government debt ratio, the highest level of unfunded pension liabilities in the OECD (a primary surplus of 7 percent of GDP would still leave the debt ratio at above 60 percent by 2005, when the number of pensioners is set to begin rising steeply), significant contingent liabilities, and a large debt accumulated by its chronically loss-making public enterprises. These issues need to be tackled directly, but they are also likely to entail budgetary pressures.

14.  During our mission, we reviewed and discussed extensively Greece's self-assessment against the IMF Code of Good Practices on Fiscal Transparency—Declaration of Principles. We take this opportunity to express our appreciation for your readiness to undertake this exercise: it is noteworthy that Greece now ranks among the few Fund member countries that have completed such a self-assessment. The assessment indicates that significant steps have been taken toward improving fiscal transparency in recent years, and also acknowledges some remaining weaknesses and areas where further steps are to be taken. From a fiscal policy perspective, it would, inter alia, appear useful to prepare periodic reports on fiscal sustainability covering a long-term (40 to 50-year) horizon, along the lines of what is being done in some other industrial countries.

15.  Wage moderation has played an important role in the deceleration of inflation. It is crucial that this not be undone in the new national agreement to be negotiated next year, and early indications appear encouraging. In their negotiations, employers and employees need to appreciate fully the consequences of the regime change implied by monetary union. We already noted last year, but it bears repeating, that the loss of the exchange rate instrument definitely closes the door to one-off nominal solutions to the cost competitiveness problems that have periodically plagued Greece. Should such problems re-emerge, they would show up in higher unemployment. In deciding wage increases, the social partners should look to unit labor cost developments in the euro area as a guidepost, a practice already adopted in some other countries. Furthermore, in the environment of price stability that is to prevail in monetary union, the role of wage catch-up clauses becomes obsolete.

16.  The structural reform agenda is by definition a broad one; we focus here only on a few selected items where we feel that significant breakthroughs would make a major contribution to preparing the economy for the exigencies of monetary union, and promote a much more rapid and employment-intensive catch-up process—an imperative for a country that stands to enter the euro area with one of the lowest GDP per capita in the EU. If sufficiently bold, the structural reform agenda can relieve the burden placed on macroeconomic policies.

17.  The government's privatization and flotation program has been steadily implemented, despite recurring difficulties. The sales have contributed significantly to debt reduction and enhanced competition in the banking system—but not appreciably so elsewhere, including in key economic sectors that remain dominated by public enterprises. We look forward to an expansion of the program's reach in its new elaboration, and welcome initial indications to this effect. However, with majority sales in public utilities not on the agenda, we would stress the benefits, including for disinflation, that can be obtained from allowing new entrants into these markets, and—more broadly—from a strengthening and refocusing of the activities of the Competition Commission. We endorse the recommendations of the latest OECD survey on public enterprise reform, including its call for an effective reduction of surplus personnel and a more rapid liberalization than allowed under EU directives and derogations when feasible—the telecommunications sector would appear a prime candidate in this respect. In the electricity sector, we welcome the recent proposals to deal with the Public Power Corporation's (DEH) unviable pension system and look forward to early progress on this long-standing issue. Furthermore, much preparatory work remains to be done to meet the deadline of February 2001 for the liberalization of the electricity market, and we would urge a stepped up effort.

18.  There is another dimension to the privatization effort and to the state's relations with public enterprises that merits attention. This regards both the below-the-line capital injections to such enterprises (projected in the public investment program to average 1.6 percentage points of GDP annually between 2000 and 2004, an amount that adds substantially to the public debt stock) and the operations of DEKA. Irrespective of the statistical treatment of these items, we would stress the need for more effective monitoring and analysis of the medium- and long-term effects of these transactions on the government balance sheet, as well as the importance of providing more information on these operations and their returns in the annual budget report. Finally, we would reiterate our call that privatization proceeds be used only to redeem public debt, notwithstanding the discretion in the use of these funds afforded by the law setting up the recipient agency DEKA.

19.  The performance of the Greek labor market and of employment has not materially improved since our last visit. The experience of the past year highlights the need for a quantum leap to a significantly bolder approach. The measures taken in August 1998, while intended to address some key rigidities (the inflexibility of working time, the lack of adequate wage differentiation, the ineffectiveness of job matching mechanisms under a public monopoly), were subject to a web of implementation difficulties that have rendered them not only ineffective but, indeed, unapplied. Thus, for example, there is no evidence that firms have availed themselves of the possibilities offered under the annualization of working time, there are no concrete cases of opt-outs from sectoral wage accords in areas of high unemployment, and the bulk of job placement activities remains in the hands of the public bureaucracy. This year's National Action Plan for Employment marks a notable improvement from that of 1998: its elaboration entailed a broad coordination and stock-taking of the many facets of employment policy, thus providing a previously unavailable overview of the government's initiatives and plans in this area. We note, however, an emphasis on employment subsidy programs and a continued reliance on state-run organizations for training and placement services—on the basis of other countries' experiences, we are skeptical about the public sector's ability to perform these functions effectively. Looking forward, and in order to enhance employment performance, we would urge breakthroughs in particular on two key fronts: reducing the high effective entry wage for first-time job-seekers (who account for almost half of the long-term unemployed) and significantly improving the quality and job-relevance of vocational training. As experience matures, it will also be important to monitor closely the cost effectiveness of the "Young in Active Life" program, the "Stage" program for university graduates, and other similar initiatives.

20.  There is by now a broad recognition and an ample body of analysis with regard to the need for a deep-seated reform of Greece's social security system. But, despite this recognition, the window of opportunity for action is rapidly narrowing—the prospective financing difficulties are not at all distant. While we were positively impressed by the scope for appreciable savings and increased efficiency arising from the 1998 "mini-package," as well as by the plans to overhaul the organization of IKA, there remains a pressing need to proceed with the envisaged "second phase" of broad reform that would address the system's basic structure so as to ensure its long-term viability. Social security reform implies major changes in the social fabric of a nation, and a broad debate in a nonpartisan spirit would be desirable, so as to permit the expeditious enactment of reform legislation.

21.  A final important area of structural reform concerns the public administration. Here again, though significant steps have been taken (e.g., hiring based on merit and a new civil service code), much remains to be done to endow Greece with a truly modern, efficient, and responsive state apparatus, and we would urge an intensification of efforts in this direction.

22.  In closing, we would note that the achievements to date are impressive, and have allowed Greece to approach the threshold of joining its EU partners in the historic process of European integration represented by EMU. With continued and resolute action across the broad spectrum of economic and structural policies covered above, Greece will be able to embark on monetary union in a strong position and fully reap its benefits.

Athens, June 28, 1999