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—2007 Article IV Consultation; Preliminary Conclusions of the Mission

December 10, 2007

1. The Greek economy has recorded strong economic growth for several years, and the gap in real per capita income between Greece and the EU-15 has narrowed significantly. Domestic demand has been the main engine of growth—supported by solid gains in employment, handsome real wage increases, low interest rates, and rapid credit expansion—while the external sector has been a drag on growth. The strong performance of the Greek economy appears likely to continue for some time.

2. However, there are significant downside risks to the medium- to long-term growth and employment prospects on account of major economic imbalances. The imbalances include: (i) a steady erosion of competitiveness, manifested in a widening of the external current account deficit; (ii) rigidities in the product and labor markets that have contributed to the persistence of inflation differential with the euro area; and (iii) a high level of government debt which is expected to rise further owing to increases in pension and health care costs related to population ageing. The authorities recognize these vulnerabilities and are seeking to address some of them, especially on the fiscal front. However, they will need to persevere with and broaden the reform efforts. The prevailing buoyant economic environment may create a sense of complacency about the need for reforms, but it provides an ideal opportunity to make significant progress and avoid painful adjustments later. The longer the imbalances are allowed to accumulate, the more difficult it will become to correct them.

Growth outlook

3. Economic growth will continue to be driven by domestic demand in the coming years. The investment outlook appears positive on account of the acceleration of the absorption of EU funds, a large number of infrastructure projects in the pipeline, the execution of projects benefiting from government incentives, and the still unsatisfied demand for housing. Consumer demand is also expected to remain robust. The authorities believe that there is ample scope over the longer term for promoting trade in goods and services and reaping the benefits from Greece's location. However, realizing this potential requires a conducive policy environment. The mission would also like to note that there are downside risks to growth in the near term because of a likely tightening of lending standards by banks, higher oil prices, and the negative impact on export demand on account of the envisaged slowdown in the euro area and the strength of the euro. The mission will prepare a fully fleshed out macroeconomic framework once the details of the revised national accounts become available.


4. Competitiveness is a source of concern, notwithstanding the recent pick up in exports. A range of standard indicators point to a steady deterioration in competitiveness, reflecting rising relative unit labor costs and persistent inflation differentials with the main trading partners. Estimates of real exchange rates based on CGER methodologies1 suggest a sizeable competitiveness gap in the range of 10-30 percent in 2006. The improvement in export performance is a reflection of a move up the technology ladder in exports to the EU and the increasing diversification of trade toward the rapidly growing countries in Southeastern Europe and other emerging markets. However, going forward, there are risks that the favorable export developments may not be sustained, as Greece appears to be losing market share in the established neighboring markets and export-oriented labor intensive manufacturing firms are increasingly relying on outsourcing. Moreover, rising labor costs are adversely affecting the profitability of the tourism sector which is subject to intense price competition. The major challenges are to improve cost competitiveness through wage moderation and to invest in product upgrading in both goods and services.

Fiscal policy

5. Fiscal imbalances have been significantly reduced since 2004 in compliance with the European Commission's excessive deficit procedure, and the authorities are appropriately pursuing further fiscal consolidation with the aim of achieving a balanced budget by 2010. Indeed, the mission believes that further fiscal adjustment to a surplus position after 2010 is necessary in view of the prospective large ageing costs. Achieving a progressive improvement in the fiscal position will be challenging. The 2008 budget envisages a substantial increase in revenue from a broadening of the property tax base and efforts to combat tax evasion through administrative measures, incentives, and restructuring the taxation of fuel oil. The mission considers the revenue target to be ambitious, and the authorities will need to undertake considerable efforts to achieve it. The authorities should ensure that budget implementation during the year is in line with the achievement of the overall deficit target. The mission is also concerned that the quality of expenditure adjustment in the 2008 budget falls short of what is needed to ensure sustained consolidation. The saving in expenditure comes mainly from the elimination of the one-off expenditures incurred in 2007. Meanwhile, social transfers inexorably will continue to increase as a ratio to GDP and the wage bill is slated to rise as well, making the expenditure structure more rigid. In the mission's view, achieving budget balance by 2010 will require further revenue enhancing measures and determined efforts to better control primary current spending.

6. Given that Greece's tax-to-GDP ratio is relatively low by EU standards and that tax evasion is firmly entrenched, a key priority is to continue with efforts to simplify the tax system, broaden the tax base, and to strengthen tax administration. The mission would encourage the authorities to phase out distortionary exemptions for all major taxes and simplify the rate structure of personal income tax and the VAT. On the tax administration front, the recent strengthening of procedures—in particular, more intensive auditing and cross-verification—has produced some positive results, but much remains to be done. The mission believes that the incentives offered to taxpayers under the new law on tax evasion will have only a small impact on overall compliance. The mission would recommend that the National Council focus attention on increasing tax compliance through simplifying tax laws and regulations, improving taxpayer services, streamlining basic tax procedures, adapting organization structure to the business needs, further intensifying risk-based auditing, and providing training for tax officials.

7. Efforts to strengthen expenditure management should continue and their scope broadened. Further reform should seek to extend the coverage of the budget, strengthen the effectiveness of expenditure control, improve cash management, and put in place an appropriate financial management information system. The development of a medium-term budget framework would help to prioritize policy objectives and promote fiscal discipline. The pilot initiative in program-based budgeting should be extended to all line ministries and this approach should be fully integrated into budget preparation and execution. Potential saving also could come from reducing over-staffing and tightening recruitment procedures in the budgetary sphere.

8. The mission strongly supports the government's plan to introduce greater transparency and accountability in the operations and finances of local governments, public hospitals, and the pension funds through the adoption of standard budgeting and monitoring frameworks. Greece's health expenditure efficiency score ranks rather low among OECD countries. Thus, early efforts are needed for improving pricing and costing mechanisms, introducing better controls on procurement, and upgrading management of public hospitals. However, legislative and administrative initiatives alone are not sufficient. Focus on effective implementation is crucial. Public enterprise reform initiatives have not yet resulted in visible improvements in enterprise performance. The net operating balance of state-owned enterprises is estimated to have deteriorated further in 2007. Decisive steps to reduce these losses are necessary.

9. The authorities are right to give high priority to pension reform. Unless the social security system is fundamentally reformed, the long-term costs of population ageing are expected to threaten the sustainability of the public finances. The authorities are focusing on obtaining efficiency gains through mergers of pension funds, tightening the provisions for early retirement (the list of "heavy and unhealthy" occupations and the disability pension code would be reformed toward this end), increasing the incentives for people to stay employed longer, and tackling contribution evasion. While these are steps in the right direction, in the absence of an assessment of the cost savings, it is not clear to what extent they will suffice to restore the pension system to financial viability. The mission's perception is that the authorities are pursuing a gradualist approach to pension reform and would recommend a more ambitious and comprehensive strategy. A gradualist approach will need deeper and more painful adjustments later, skew the tax burden toward future generations, and require larger fiscal surpluses to achieve debt sustainability. Stimulating a public debate to build social and political consensus for pension reform is essential. Toward this end, the authorities should prepare and publish comprehensive and realistic projections of the cost of population ageing in accordance with EU methodologies, and explain how the reform measures under consideration will close the financing gap. The mission understands that staffing constraints and bureaucratic procedures have been key impediments to data collection and the required analysis. These problems should be urgently redressed.

Structural reform

10. Broader labor market reforms are essential for regaining lost competitiveness and reducing the unemployment rate (which still remains among the highest among OECD countries) further. Notwithstanding recent initiatives—easing overtime restrictions, reducing the disincentives to accept employment, and improving the targeting of active labor market policies—the Greek labor market remains relatively rigid by international comparison. In the World Bank's latest Doing Business report, Greece is ranked 142 among 178 countries with regard to the regulation of employment, and the rigidity of employment index is almost twice as high as the OECD average. Therefore, the authorities should review employment protection legislation, especially on temporary employment, with the aim to ease its restrictiveness. Despite a commendable wage restraint in the public sector, (real) wage increases in the private sector have been too large and exceeded productivity growth, with adverse implications for preserving international cost competitiveness. The mission would therefore urge the social partners to enhance the flexibility of the wage setting system and exercise wage moderation. In particular, consideration should be given to decoupling minimum wage and average wage increases, and eliminating the administrative extension of collective agreements to enterprises not represented in the negotiations. At this juncture, when inflation has surged because of hikes in energy prices, it would be important to ensure that wage settlements in the next round of collective bargaining do not validate a second round of price increases.

11. Product market reforms are key to reducing price rigidities and promoting robust productivity growth. Greece fares poorly on the ease of doing business, with a rank of 100 among 178 countries. This is also discernible from the chronic weakness of foreign direct investment inflows. The mission therefore welcomes the new bankruptcy code and the plan to introduce legislation in early 2008 aimed at lessening bureaucracy in setting up of businesses and sharply reducing business start-up time. A major challenge is enhancing competition in the network industries and in the transport sector. Unbundling of the operations of the incumbents in the electricity and gas markets and opening the transport market to new entrants should help achieve this. The authorities should also ensure that the Hellenic Competition Commission is effectively organized and staffed to tackle price rigidities in the product market.

Financial stability

12. The Greek banking system remains healthy, adequately capitalized, and highly profitable, but some developments will need to be monitored closely. Continued rapid credit growth has increased banks' exposure to credit risk and their vulnerability to swings in the economic cycle. The increasing exposure in Southeastern Europe (SEE), while entailing significant benefits, carries foreign exchange, credit, and country risks. Spillover effects from the turmoil in mature financial markets have been limited thus far. Bank of Greece (BoG) data indicate that Greek banks' reliance on external financing is relatively small. However, in the event of a prolonged credit crunch in mature markets, an increased use of such finances would heighten the role of strengthened supervision. Although stress tests suggest that banks are resilient to a range of possible adverse shocks, the BoG has appropriately taken steps to strengthen supervision through increasing provisioning requirements, and seeking a tightening of lending standards and upgrading of stress testing to take into account correlation of risks. It is also welcome that the BoG has taken the initiative to foster cooperation with SEE supervisors on Basel II implementation, crisis management and money laundering, and to harmonize regulation and supervisory practices.

13. It is welcome that the Private Insurance Supervisory Committee will become operational in January 2008. It would be important to proceed quickly with the necessary staffing and changes in legislation so that there are no supervisory gaps. The mission is pleased to learn that a risk-based approach to supervision will be applied to the insurance sector. The mission would urge the authorities to intensify efforts to fully address the deficiencies identified during the FATF assessment in relation to the legal and regulatory/supervisory frameworks for anti-money laundering and combating financial terrorism.

The mission would like to thank the Greek authorities for their close cooperation, generous hospitality, and stimulating discussions.

1 See Methodology for CGER Exchange Rate Assessments, IMF, 11/8/06


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