Greek Economy at a Crossroads
IMF Survey online
December 17, 2010
- Program broadly on track, signs of improving competitiveness
- More reforms needed to boost potential growth
- Economy projected to turn around in latter part of 2011
The IMF’s Executive Board approved December 17 the disbursement of about €2.5 billion to Greece as part of the three-year lending arrangement that was agreed in May 2010. The IMF loan is part of an international rescue package worth €110 billion, of which the European Union is providing €80 billion and the IMF the remaining €30 billion.
The Greek government has made good progress on its reform agenda. After six months of intense reform efforts, there are signs that competiveness is improving, helped by a slowdown in underlying inflation and wage growth. Budget measures implemented since the start of the program have reduced the deficit by an estimated 6 percent of GDP in 2010 alone. On top of that, the pension reform approved in July implies large long-term fiscal benefits and improved labor supply.
But market sentiment toward Greece remains volatile. The economy is still adjusting, and unemployment is rising. A key test will be the implementation of additional structural reforms to boost growth and create new jobs.
In an interview, Poul Thomsen, head of the IMF’s team, discusses the challenges involved in restoring the overall health and competitiveness of the Greek economy.
IMF Survey online: What does Greece need to do in the months ahead?
Thomsen: Greece has made a good deal of progress, completing a first wave of fiscal adjustment and reforms, including a landmark pension reform. The economic program is now at a crossroads. Increasing tax rates and cutting expenditures was necessary, but these steps cannot be intensified further to secure the full fiscal adjustment that is needed. That’s why reforms to strengthen control over government spending are needed—improving, in particular, revenue administration, state enterprises, and the way the health sector is run.
In addition, a second set of reforms aimed at promoting growth and opening up the economy is now being prepared. When these reforms are implemented, they will begin to deliver dividends.
IMF Survey online: Why are these reforms such priorities in the near future?
Thomsen: Structural reforms can help Greece become more competitive, which is key to restoring growth, creating new jobs, and improving incomes. At the same time, reforms that reduce fiscal imbalances will also bring down interest rates and reduce the pressure on public services and tax rates. Let me elaborate a little.
A near term priority is opening up professions in the highly regulated service sector. These reforms will focus in particular on lawyers, notaries, engineers, architects, auditors, and pharmacists―professions that play an important role in the economy. More competition will lower substantially the cost of such services, which will benefit consumers and companies alike. Companies and individuals that use these services will gain by making their own products that much more competitive.
Healthcare and state enterprise reforms are important because they will help achieve fiscal adjustment as well as efficient public services. The Greek people have been paying much higher prices for healthcare than necessary, and have had to foot the bill for costs in state enterprises that are out of line with international norms. So measures will focus on reducing costs through better administration, lower spending on drugs, reduced hospital expenditures, and reducing high wages in state enterprises.
I want to emphasize in particular the importance that we and the government attach to strengthening Greece’s revenue administration. It is important that everyone pay their fair share in taxes, particularly those high-income earners who have managed to evade taxes in the past. We cannot expect wage earners, pensioners and the poor to shoulder most of the burden of adjustment.
IMF Survey online: Why is legislation to allow firm-level wage agreements so important? Will this lead to massive wage cuts?
Thomsen: The way the Greek labor market was operating contributed to a disproportionate increase in wages over the last decade and a loss of competitiveness. So wages need to be brought more in line with productivity. Over the medium term, wage developments in Greece will be governed by productivity improvements. A more open and dynamic labor market will offer more and better employment opportunities as the business environment improves, investment increases, and the economy expands.
"We cannot expect wage earners, pensioners and the poor to shoulder most of the burden of adjustment. "
IMF Survey online: Are Greek banks too dependent on financing from the European Central Bank?
Thomsen: The ECB’s measures to support liquidity in the Greek banking system have been very effective. The challenge going forward will be for banks to regain access to interbank and wholesale markets, and to transition out of the temporary arrangements in an orderly manner. We expect this to happen over time, as the government implements its reform program. So far, a few banks have been able to re-access markets on a limited scale.
Developments concerning banks’ capital needs have also been encouraging. They have been able to raise significant capital through market transactions. Also, the Financial Stability Fund that was set up as part of the economic program has not had to be activated.
IMF Survey online: When do you expect the IMF to extend the repayment terms on its financing?
Thomsen: The IMF’s Managing Director has said he is willing to propose a conversion of Greece’s present Stand-By Arrangement (SBA) into and Extended Fund Facility (EFF) to the IMF’s Executive Board. This would lengthen the loan repayment period from 5 to 10 years. For this to be effective, the euro area partner countries would have to agree to a similar extension of the repayment period for their portion of the loans to Greece.
IMF Survey online: Many groups in Greece are expressing discontent. When will the situation improve?
Thomsen: The government’s program is ambitious. Far-reaching changes have happened quickly and under difficult circumstances. It is understandable that there is discontent and opposition. But the government designed the economic program with a strong sense of fairness in mind. The measures protect the most vulnerable groups. These considerations will continue to guide the effort going forward.
No doubt this is a tough period for Greece and its people, but we expect the economy to stabilize at the end of 2011. The fiscal situation will improve as the deficit declines, and the benefits of the structural reforms in the public sector should become apparent as services improve.
IMF Survey online: What’s the next milestone?
Thomsen: The next review of the economic program will be in March and we expect to discuss with the government and our European partners the next steps to ensure a successful continuation of the program.