Greece: 2009 Article IV Consultation: Concluding Statement of the IMF Mission
May 25, 2009
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.
After years of strong growth, the Greek economy is entering a downturn. During the upswing, per-capita incomes approached the euro-area average. This occurred in an unusually benign global environment with ample liquidity and low interest rates. However, with limited reforms and insufficient policy adjustment, competitiveness deteriorated. Consequently, catching up was largely financed by debt, generating large fiscal and external imbalances. The current global crisis has started to affect Greece and marks a turning point in economic conditions going forward. Necessary policy adjustments are inevitable to correct the imbalances. Delaying adjustment could lead to extended slow growth.
The outlook remains uncertain but a slowdown is underway
1. Prospects are sobering. The mission projects growth between -1 and -2 percent in 2009 with a recovery beginning late in 2010. Consumer and business confidence, industrial production, and retail sales have dropped sharply as in other euro-countries. But Greece has felt the downturn with some delay due to high real wage growth and reliance on small and medium-sized enterprises that have responded sluggishly to the global shock. Nevertheless, Greece is highly integrated with the euro area, which is experiencing a sharp recession. Thus, decoupling is unlikely as the effects of the global financial crisis spill over to the domestic economy and trade remains weak. Compounding these effects, high wage growth that provided support upfront is further eroding competitiveness. The balance of risks remains on the downside.
2. Medium-term recovery will likely be tepid in the absence of significant reforms. Greece is entering the downturn with large imbalances. High public sector debt has crowded out the private sector. Inflation persists above the trading partners’ average and structural rigidities imply costs that have contributed to the large current account deficit. These factors increase the likelihood of a prolonged period of slow growth.
3. Thus, Greece needs a comprehensive medium-term policy program to bolster confidence and boost potential growth. Key elements are: maintaining a sound banking system to support credit as demand revives; reducing pressures from public debt and deficits to create space for the private sector, while being careful to protect the poor with an adequate safety net; and lowering costs in bureaucracy, product, service, and labor markets to bolster competitiveness and speed up the recovery.
The banking system’s challenge is to manage well the growth slowdown
4. Greek banks have shown resilience, but also felt the effects of the crisis. The banking system as a whole has weathered the global financial crisis well, due to its traditional retail business models and lack of toxic assets. Nevertheless, banks experienced an increase in funding costs (compressing margins) as liquidity tightened in late-2008 while loan applications dropped when the private sector began deleveraging. The downturn in foreign and domestic economic activity raised impaired loans. In response, banks increased provisioning and profits declined.
5. The authorities’ response to the financial crisis has been appropriately pro-active. Greece was early to implement bank assistance, consistent with the EU framework:
• Deposit insurance per person per bank was increased from €20,000 to €100,000.
• Capital adequacy was boosted as banks could sell €5 billion (already substantially committed) of 5-year preference shares to the government with one state representative in the Board. The payout of ordinary dividends has been restricted to bolster capital further.
• Liquidity assistance was offered with €8 billion in special 3-year zero-coupon government bonds that can be collateralized for liquidity operations with the ECB.
• Debt guarantees were offered up to €15 billion.
In addition, supervisors have intensified monitoring and contacts with banks’ managements so that additional steps are implemented to further minimize risks, as appropriate.
6. The banking system appears to have enough buffers to weather the expected slowdown. Systemic risks appear contained and the profits of banks, capital cushions, and stepped-up provisioning should provide enough resources to absorb increased impaired loans (in Greece and Southeastern Europe (SEE)). Liquidity policies of the ECB are supportive, debt and interbank markets are slowly opening up, and there is still substantial room under the banking package.
7. Nevertheless, near-term operating conditions for banks could remain challenging, and vigilance is warranted. The operating environment is expected to be difficult as the world goes through the recession. Moreover, Greece could experience prolonged slow growth, and financial tightening could return. Thus, domestic credit quality may deteriorate further than envisaged, and portfolios in SEE could face pressures as local economies slow and their exchange rates shift. These risks need to be managed cautiously.
8. The mission’s policy recommendations are:
• Bank assistance: the package bolstered confidence. However, the government’s bank involvement should remain at arm’s length. To maintain sound lending, the state representative at the Board should refrain from advocating directed lending. While the take-up of the package has been moderate, it should be kept in place preemptively.
• Liquidity: the ECB’s provision of liquidity will not last indefinitely. Banks need to prepare an exit strategy to unwind positions as conditions improve.
• Cross-border issues: Greek banks have opportunities in SEE. But the region is now passing through a difficult adjustment, and commitment is needed to stay involved. All countries, including Greece, should avoid financial nationalism (indeed, all protectionism). The authorities are encouraged to continue developing strong relationships with Central Banks and supervisory colleagues in all SEE countries and to conduct crisis-management exercises with partner countries.
• The crisis resolution framework: the authorities should remain prepared to act if systemic pressures arise. Market solutions should be sought first (e.g. merging banks), and if public support for individual banks is required, this should minimize government involvement and spell out clear exit strategies.
• Financial Stability Report: we welcome the report now being prepared. We encourage this to become a regular feature, informing the public about the health of the financial system, and recommend the issuance of a simultaneous version in English and an update of the report at mid-year.
Fiscal consolidation cannot be postponed
9. The mission projects the headline deficit to widen and public debt to increase sharply. With current information and the growth outlook, and if no further measures are taken, we estimate a deficit of at least 6 percent of GDP in 2009, rising to over 7 percent in 2010. This “no-policy-change projection” includes measures to date but not potential future ones. The debt-to-GDP ratio would continue rising for many years, leading to difficult-to-manage fiscal pressures. This was reflected in spiking spreads on government bonds—and high funding costs for the country as a whole—as liquidity in financial markets tightened. Spreads are now easing, but a return to the low levels prior to the crisis is unlikely and risks of new spikes remain if policies are not strengthened.
10. We welcome the deficit-reducing measures of early 2009 and encourage further steps without delay. Durable measures taken so far, including moderating incomes policy, cuts in nonessential expenditure, and higher excises, could yield over 1 percent of GDP in saving—a welcome reduction in the underlying structural deficit.
11. The mission’s policy recommendations are:
• There is no room for fiscal stimulus. The government’s response to the crisis has rightly included protecting the most vulnerable groups with assistance to the unemployed and poor. But we advise against income transfers to high income groups. Measures such as subsidizing car sales or providing cash grants to new self-employed professionals do little for growth, but further increase the debt.
• Greece needs a coherent multiyear fiscal plan to place debt on a downward path. This cannot be done in one year, nor should it be, to avoid deepening the recession. But further measures are needed, which must be consistent, durable, of high quality, and forward looking, to lower underlying deficits and debt. This plan, assisted with progress in program budgeting and containing ambitious but realistic measures, should be well-communicated to the public and offer monitorable high-frequency milestones to establish a confidence anchor. With strong confidence, fiscal adjustment can be expansionary.
• The mission recommends annual adjustment of about 1½ percent of GDP in permanent measures beginning in 2010. This adjustment is required to place the debt ratio on a downward path by 2012. Automatic stabilizers can be allowed to operate around this adjustment path. The authorities should resist pressure to grant favors to special interest groups or specific sectors, which may become stronger with weak economic conditions.
• Measures must be of high quality:
Ø Tax effort: Efforts should focus on income that escapes taxation, which contributes to the weak public finances, and to spread the tax burden more fairly. Measures could include: (i) broadening tax bases by reducing exemptions and deductions; (ii) moving ahead decisively with taxing the self employed and the informal sector by using information cross-checking and presumptive taxation; (iii) increasing further selected excise taxes to the euro-area average; and (iv) suspending the corporate and personal income tax rate cuts of 1 percent a year through 2014 until the deficit is confirmed to be below 3 percent of GDP.
Ø Incomes policy: The wage bill is growing fast and the authorities need to increase efforts to moderate it to create room for the private sector. Thus, we recommend to: (i) continue wage moderation (extended to pensions)—through a signaling effect, such policy would help moderate wage and pension growth in the private sector as well and help restore competitiveness; and (ii) continue restrictive hiring policies to shrink payroll. From 2010, the government plans to implement a new wage-policy system for new hires, which should re-enforce expenditure containment.
Ø Social security reform: Social transfers are putting growing pressure on the budget, and the pension system is not actuarially balanced, requiring further policy action. (i) The reform just begun (merging 133 into 13 funds) is a welcome step in the right direction and can generate short-run savings if implemented tightly through issuing and requiring social security numbers for all citizens and services; cross-checking data for revenue enhancement; and accelerating the implementation of the new IT and accounting systems. Targets for this reform need to be quantified and published, so that the public can monitor progress. To address long-run pressures in social security associated with population aging, (ii) the Actuarial Authority should be provided with resources and data to prepare annual actuarial reports for all funds as an input for drafting the next year’s government budget. This report should be published so that citizens can monitor the status of social security. (iii) In parallel, the authorities need to prepare parametric reforms in dialogue with social partners, with quantified targets. Pension payments need to be brought in line with contributions to ensure that pensions of the next generation can be paid. This reform should not be postponed, considering that it can only be introduced gradually.
• Public enterprises. The authorities need to set a 5-year deadline to eliminate the public-enterprise operating deficits, which constitute an off-budget source of debt.
Structural reforms can help Greece reach its full potential
12. Structural reforms need to assist the recovery and boost the economy’s growth potential. Above euro-average inflation reflecting high administrative costs (captured by government), high margins (captured by employers), and high labor costs (captured by workers) has resulted in a significant competitiveness gap, with negative-sum gains for society as a whole. Restoring competitiveness requires ambitious and comprehensive reforms in all three areas, which will take time, commitment, and bold initiatives to build credibility and momentum. Key for success is a dialogue with social partners to increase buy-in and ownership of the agenda.
13. The mission’s policy recommendations are:
• The public administration should be streamlined and made more transparent. While progress has been made, including through selling the state airlines and restructuring the railway system, more ambitious and swift actions are needed to: (i) cut entities, reduce staffing, and limit political appointees to lower costs and increase the efficiency of the public sector; (ii) accelerate privatization of public enterprises to limit losses and public indebtedness; and (iii) place greater trust in the public by publishing more information, including financial statements of state enterprises and hospitals, to increase public acceptance.
• Product and service markets need to be further liberalized, by: (i) rationalizing legislation and accelerating actions cutting administrative burdens to facilitate a more efficient business environment; (ii) completing reforms and unbundling of network industries, which provide vital inputs to the entire economy; and (iii) ambitiously implementing the EU Services Directive to liberalize professional services, retail trade, and other activities that can significantly lower production costs.
• Labor market reforms are key to achieve lower unit labor costs. More government spending cannot compensate for high labor costs and solve the problem of unemployment. The authorities are encouraged to: (i) promote a tri-partite social contract between employers, unions, and the public sector, aimed at more cooperative bargaining to favor employment growth over income growth at this time, requiring understandings on wage moderation in return for investment and employment promotion; and (ii) facilitate more part-time work to boost participation of youths and women in the labor force.
The mission thanks the authorities and other interlocutors for their cooperation, extensive discussions, and hospitality.