Mission Concluding Statements
Greece and the IMF
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INTERNATIONAL MONETARY FUND
Greece—2004 Article IV Consultation
September 14, 2004
Greece has enjoyed several years of robust economic growth, even as the euro-area and global economies have struggled. As a result, employment has risen and real incomes have increased substantially. This enviable performance was capped last month by the successful completion of the Olympic Games. Yet, some of the factors that have propelled the economy forward, notably the stimulus from joining the euro area, are beginning to wane.
While growth should remain strong this year, the outlook for coming years is much less certain. Underlying fundamentals suggest the economy may slow materially in 2005. The end of spending on the Olympics is a substantial adverse shock in the short-run, especially to already weak construction activity. Relatively high inflation and wage increases will result in a further deterioration of international competitiveness. And urgently needed fiscal consolidation will sap domestic demand. On the upside, high consumer confidence and rapid credit expansion imply another brisk rise in private consumption, and the worldwide economic pickup should benefit exports, especially in the key shipping and tourism sectors. Beyond 2005, prospects depend critically on credible fiscal consolidation, policies to boost aggregate supply, and better alignment of real wages with productivity to help restore competitiveness. In the absence of strong measures, there is a significant risk of tepid growth.
The challenge for the new government, therefore, is to formulate and implement a policy agenda to secure further economic growth that will benefit all strata of Greek society. Progress has been made in several areas, including the 2002 tax reform, privatization, and financial sector supervision. Also, the infrastructure investment associated with the Olympics should help boost productivity in the years ahead. Nevertheless, much still needs to be done if Greece is to take full advantage of the opportunities offered by its membership in the European Union and, more broadly, by a rapidly globalizing economy.
Fiscal consolidation is, of course, the first order of business. The underlying fiscal situation deteriorated in recent years, even though strong economic growth provided an opportunity to strengthen the public finances. Last year, the general government deficit expanded sharply, with respect both to the previous year and to targets embodied in the budget and the Stability and Growth Program, breaching the Maastricht ceiling by a wide margin. In 2004, the deficit is expected to widen still further. These developments reflect a combination of temporarily higher spending on the Olympics, spending overruns and revenue shortfalls, and significant corrections to fiscal accounting.
The priority now is to implement a credible and clearly articulated program to restore budget balance over the medium term. Such a program is needed to ensure a rapid decline in the very large public debt, restore confidence in the ability of the public sector to manage its affairs, ease inflationary pressures built up over the past few years; prepare for the onset of population aging; and meet European Union commitments. This effort will clearly require sustained and durable measures. One-off and temporary solutions would not inspire confidence and would only necessitate larger, and probably more difficult, adjustments later. Credibility and policy formulation would be buttressed by an explicit multi-year fiscal framework laying out realistic economic assumptions, as well as fiscal objectives (spending, revenue, the balance, and the debt) and specific measures to achieve them.
The adjustment required to reach a situation of budget balance will require sustained current spending restraint, because reductions in the tax burden and continued infrastructure investment will be needed to boost long-term growth. Appropriate areas of focus include: public sector wage restraint, which would also help competitiveness by setting an example for the private sector; public-sector employment, including taking advantage of retirements and resignations in the years ahead to reduce the size of the public service; defense spending, where easing tensions in the region provide scope for cuts; health-care costs, where pressures will become particularly strong; and social programs, where there is a need to reduce costs while protecting the most vulnerable. In addition, subsidies, capital transfers, and loan guarantees should be curtailed. For 2005, the substantial savings from the end of Olympics spending should be used to make a large up-front fiscal adjustment. However, additional measures, focusing primarily on current spending, will be needed to deliver meaningful underlying consolidation. Once the required measures are in place, the automatic stabilizers should be allowed to operate and the deficit outturn will thus depend on the pace of economic activity.
A critical part of a credible policy framework is the integrity of the fiscal accounts. The authorities' recent efforts to resolve outstanding issues in this regard are commendable. A continuation of sound and transparent accounting practices and a strengthening of public expenditure management at all levels of the public sector will be key to the government's ability to assess the fiscal situation and improve policy formulation. In this light, we would urge the authorities to undertake a Fiscal Report on the Observance of Standards and Codes (ROSC) as soon as possible, to assess the Greek budgetary system against international best practice.
In the longer term, the pension and health-care costs associated with population aging pose a clear threat to the sustainability of the public finances. On current projections, these costs will rise significantly in Greece after 2010, more so than in any other EU country. If the problem is not resolved, everyone's pensions will eventually be jeopardized. The 2002 pension reform, while welcome and helpful in many respects, did not address fundamental long-term imbalances in the system. Further action is thus required, and an early start would help contain the eventual costs. At a minimum, therefore, the authorities should initiate a public debate on specific reform options in order to build social consensus on this issue. Such a discussion would benefit from experience elsewhere, as several countries have already analyzed or implemented far-reaching measures.
The banking sector appears highly profitable, well capitalized, and adequately provisioned. However, its asset portfolio is shifting sharply away from government debt toward higher-return, but more risky, consumer and business credit. This transformation is a normal part of the long-term development of the sector and is likely to continue for some years. Nevertheless, the rapid increase in private-sector lending raises possible risks in terms of credit quality, especially as it has taken place during an economic boom and banks have therefore not recently been tested by an economic slowdown or rising interest rates. Well aware of these issues, the Bank of Greece has further strengthened its supervisory capacity, increased specific provisioning and capitalization levels, and encouraged banks to enhance their risk-management procedures. These initiatives are all commendable, and should be continued, especially since banks must in any event prepare for Basel II. However, the authorities should clarify the implication for banks of their unfunded pension liabilities, since by the end of next year banks must recognize them under International Accounting Standards. Insurance supervision is a notable weak point. Priority should therefore be given to the swift establishment of the independent insurance supervisor, and to ensuring it has adequate resources. In view of the new challenges facing the Greek financial sector, we strongly recommend that the authorities undertake a Financial Sector Assessment Program (FSAP).
The key medium-term policy priority is to ensure the underlying conditions for increasing real output and living standards, which remain significantly below the average of the EU-15, an issue the authorities appropriately emphasize. In broad terms, convergence to European income levels involves four prerequisites: infrastructure investment, an improved business climate, dynamic product markets, and well functioning labor markets.
Further infrastructure investment would boost medium-term productivity and is essential for regional development. The authorities' intentions to promote infrastructure investment are welcome, but in the difficult budgetary environment they will need to take special care to choose projects with the highest economic payoffs and should explore the scope to leverage public funds through private participation.
Enhancing the business climate would increase growth potential, particularly by boosting inward foreign direct investment, which has been very weak. Reducing administrative burdens ("red tape" and excessive regulation) and simplifying tax administration, including by narrowing the discretion now available to tax inspectors, are critical. Such reforms could be implemented quickly at little budgetary cost, and should have relatively rapid impact. Tax reform also has an important role, although associated revenue losses must be offset by equivalent spending reductions. Tax policy should emphasize base broadening, simplification, and rate reductions. In this vein, the 2002 reform and the authorities' planned broad-based cuts in profit tax rates are welcome.
Product market reforms should focus on intensifying competition. All relevant EU directives on the liberalization and regulation of network industries (telecoms, gas, and electricity) should be effectively implemented as soon as possible, even ahead of the required EU schedule. The privatization program should be intensified, with the ultimate goal of government exiting all sectors where commercial forces can adequately operate. Finally, the Competition Commission should receive resources sufficient to ensure increased oversight of market structure and behavior.
Labor market reform is needed to address key weaknesses, notably low employment rates among youth and women and a high (though declining) unemployment rate. To some degree, these problems reflect mismatches between skills and demands, pointing to a need to reappraise the education and training system and the public employment service. But they also reflect impediments to employment: employment protection legislation (for example, high severance pay), which discourages hiring; limited part-time and temporary employment opportunities, which prevent some from getting vital labor-market experience; and high entry wages, which price the low-skilled out of the market.
The authorities' commitment to trade liberalization is welcome. Also welcome is the increase in ODA in recent years, to 0.26 percent of GNI in 2004, and we urge further progress toward meeting the UN target of 0.7 percent of GNI.
Athens, September 12, 2004
IMF EXTERNAL RELATIONS DEPARTMENT