Remarks delivered at the 18th Economist Roundtable with the Government of Greece by Rishi Goyal, Advisor in the IMF's European Department

July 9, 2014

By Rishi Goyal, Advisor in the IMF's European Department
Athens, July 9, 2014

Thank you for the opportunity to be with you today. Poul Thomsen sends his deep regrets. He is unable to join, owing to urgent work that came up in Washington, D.C.

I will organize my remarks as follows: I will first take stock of how far Greece has come; and then highlight three key policy priorities or challenges: in the fiscal, structural reform, and financial areas.

Starting with the stocktaking—Greece has come a long way since the crisis started.

As you recall, the fiscal deficit was in the double digits at the time. Market access was lost. In mid-2012, when the current coalition government took office, there were widespread doubts about Greece’s future in the euro zone. Deposits were leaving the banking system in droves. The economy was collapsing.

But the government’s determined policy actions since then have taken “Grexit” off the table. And we are now seeing initial signs of economic stabilization, with the potential start of a virtuous cycle. The economy contracted by its smallest amount in six years in the first quarter of 2014. Unemployment has declined slightly in recent months, though remains very high at around 27 percent. The government re-accessed markets for the first time since the crisis, and yields are down from their stratospheric levels to pre-crisis levels. With rising investor interest, market access for Greek banks and corporates has improved faster than anticipated. Deposits in the banking system have broadly stabilized, and banks have dramatically reduced their reliance on the Eurosystem for funding.

These developments suggest grounds for cautious optimism. We expect annual growth to turn positive in 2014, for the first time since 2007. Also, for the first time since the crisis, there are even signs of upside risk in the near term to the growth forecast, especially as external liquidity conditions ease and tourism rebounds.

Turning to fiscal policy, which is the first of three policy priorities that I will highlight:

The lynchpin of the authorities’ program thus far has been their fiscal adjustment. Greece has emerged from having the weakest to the strongest cyclically-adjusted fiscal balance in the euro zone in just four years, and with a primary fiscal surplus ahead of schedule. This is extraordinary by any international comparison, and speaks above all to the government’s determination to pull Greece out of the crisis.
As the government fully recognizes, the process of adjustment is not over. There is still some way to go to achieve the rising primary surplus path, reaching 4½ percent of GDP by 2016, and then to sustain primary surpluses above 4 percent of GDP for many years that will be key to bring down the very high level of public debt over the medium and long term.

Sustaining primary surpluses above 4 percent of GDP may seem daunting. In fact, there are 16 episodes among euro zone countries since 1980 of sustained primary surpluses of this level. On average, these episodes lasted for seven years. The maximum period was around 20 years—by Belgium and Ireland. Greece in the late 1990s also sustained such primary surpluses for four years. The challenge this time around is not only to reach the program target by 2016 but also to sustain it over the full political cycle for many years to come.

We agree that it is best to avoid painful across-the-board cuts in wages and pensions. But this is also why it is imperative to undertake ambitious fiscal structural reforms to build modern fiscal institutions and to overhaul the inefficient public sector. This includes enhancing the effectiveness of tax administration, where progress has lagged, so that everyone pays their fair share of taxes.

The second policy priority is on structural reforms of product and labor markets, where progress has been comparatively less. Accelerating structural reforms would boost productivity and competitiveness, lay the ground for the ongoing incipient recovery to turn to sustained and robust growth, and move Greece away from adjustment through recessionary channels.

The landmark labor market reforms of 2012 helped to bring wages closer in line with productivity. But product prices have not declined commensurately. Thus, competitiveness gains have been small if one looks at product prices as opposed to unit labor costs. The recovery of Greek exports has been notably weak relative to other “peripheral” euro area economies such as Portugal or Spain. Exports from Greece have grown by only about 1/3rd the growth rates of Portugal and Spain since the trough of 2009-10. Excluding tourism and oil, the recovery of exports has been even less over the same period.

The government is cognizant of this and is redoubling efforts to liberalize product and service markets—e.g., to lower barriers to entry for establishing new businesses, transform investment licensing to make the framework more business friendly, and open regulated professions to lower the cost of services. Moreover, the government’s commitment to address remaining excessive restrictions in the labor markets, by bringing Greece’s framework on collective dismissals and the rules on strikes (that have been extreme outliers in the EU) in line with the best practice in the EU, should lower the cost of doing business and thus contribute to more investment, growth, and jobs. The structural reform agenda is quite comprehensive. Timely implementation will be key.

The third area that I would highlight is the financial sector. In transitioning to a new, dynamic growth model, the financial sector can play a critical role—reallocating needed liquidity to growing and efficient firms and sectors. Here, the challenge is to ensure banks are adequately capitalized so that they are in a position to extend credit to dynamic firms and sectors, and not to be stuck in a prolonged slow “Japan-style” deleveraging.

After six years of recession, ongoing deflation, rising tax burdens and shrinking credit, private sector balance sheets are severely strained. The payment culture has been weakened. And the insolvency framework has been unable to deal with either the rehabilitation of viable entities or the liquidation of non-viable entities. The strains are evident in the very high nonperforming loans—over 40 percent of loans, including restructured loans that have been shown to have a very high rate of becoming nonperforming again.

To be clear, this is not an acute stability problem. Banks currently exceed prudential solvency requirements, having successfully raised around €8½ billion in capital recently.

However, we are concerned that, unless resolved upfront, resources will remain trapped in unproductive or inefficient activities and thus dampen growth. Given the constraints of currency union and the structural impediments to growth, it would be optimistic to assume that banks would simply grow their way out of the NPL problem as the economy recovers. In this regard, we see upside risk to the Bank of Greece’s capital needs estimates and think that the banking sector will likely require additional capital, if it is to deal robustly with high NPLs and pave the way for economic recovery.

Developments in this area need to kept under close review. Unless there is an early and substantial improvement, action should be taken to ensure losses are recognized on the basis of realistic assumptions of loan recovery, and banks have enough capital upfront to do so. Together with planned reforms of the framework of private debt resolution, this effort would ensure that the debt burden of households and businesses are brought in line with their repayment capacity. It would also reduce incentives, in view of the limited competition, for banks to seek to repair their balance sheets by imposing excessive spreads and fees, and thereby extracting rents from the real economy.

In conclusion, Greece has come a long way since the start of the crisis. The fiscal adjustment has been particularly impressive. The key challenge going forward is in the structural area—not least reforms of product and service markets to boost competitiveness and fiscal structural reforms. The government is fully cognizant of these challenges, and remains strongly committed to delivering on their program.

Thank you.


Public Affairs    Media Relations
E-mail: E-mail:
Fax: 202-623-6220 Phone: 202-623-7100