Athens central market. Taxes should not be raised further, says the IMF (photo: Filippo Monteforte/AFP)
Greek Program
The economy is projected to shrink by about 6 percent in 2011, and unemployment has reached 16½ percent of the work force. And while competitiveness is slowly improving, the country has yet to build up a critical mass of structural reforms to reenergize growth.
“The economy is continuing to trend downwards, reflecting that the hoped for improvement in market sentiment and in the investment climate is not materializing,” IMF mission chief for Greece, Poul Thomsen, told reporters in a briefing tied to the release of the IMF’s latest report on the economy.
On December 5, the IMF’s Executive Board approved the fifth review of Greece’s economic program and released a tranche of €2.2 billion under the country’s 3-year Stand-By Arrangement. The IMF-supported program, approved in May 2010, is part of a joint package of financing with euro area member states amounting to €110 billion.
Political backing
The appointment of Lucas Papademos as new prime minister and the public endorsement of the program objectives by all the major political parties has raised expectations that Greece will now be able to make headway on important reforms. “One problem with the program has clearly been the lack of broad political support,” Thomsen said. “Now that the fifth review has been signed off by the new government, and by the three partners that are supporting this government, we are hopeful that this will help strengthen the program and the ability to implement reforms.”
No room for further tax hikes
During 2010, the Greek government managed to reduce the fiscal deficit by 5 percentage points, despite a contraction in GDP of almost 4 percent. But further progress in reducing the deficit is going to be hard without underlying structural fiscal reforms. The fiscal deficit is now expected to be 9 percent this year, against the program target of 7½ percent.
“One of the things we have seen in 2011 is that we have reached the limit of what can be achieved through increasing taxes,” Thomsen said. “Any further measures, if needed, should be on the expenditure side, and on the revenue side we have to rely on improving tax administration.”
Prospects for debt sustainability
Greece and its European partners agreed October 26 on a debt write-down by private creditors of 50 percent of sovereign bond face value as a means to help reduce Greece’s overall debt burden and restore debt sustainability. This Private Sector Involvement, or PSI, will also help secure the financing needed to help Greece implement its adjustment program. The specific details of the operation still remain to be finalized, with January now mentioned as a deadline for completion.
But sustainability cannot be restored by debt write-downs alone, Thomsen said. “What the debt sustainability analysis shows is that the outlook for debt is highly dependent on growth. That, of course, underscores the point of what this is all about: structural reform to boost productivity. If we don’t get this boost to potential growth over the medium term, the debt sustainability analysis shows that there is clearly a problem,” he said.
Preserving stability in the financial sector
The problem for Greece is that its banks are heavily exposed to Greek sovereign bonds. The PSI deal now under discussion would have a deep impact on bank capital. Recapitalization needs could be large in case of a 50 percent haircut, the IMF notes in its report.
Concerns about the banking system have led to an acceleration of deposit withdrawals, with total outflows since the beginning of the year now amounting to €32 billion, or more than 16 percent of end-year deposits.
With the banks struggling to hold onto their deposit base and economic prospects weaker, Greek businesses and households are experiencing growing difficulties in accessing credit. “Bank liquidity remains very tight. Banks are, at the same time, reevaluating credit risks, and are deleveraging, in part, because they are concerned about losses on loans,” Thomsen said.
But there are instruments in place to deal with these problems, with a process underway to strengthen the public backstop mechanism for providing capital for banks that cannot raise the necessary capital through market-based means, he said.
Critical mass of structural reforms
Structural reforms have not yet delivered expected results, in part because agreed reforms are not being implemented. For instance, two flagship reforms—on collective bargaining and liberalizing restricted professions—have yet to deliver substantial results.
“Progress has been made on many fronts but there is still a long way to go. Greece is still far away from the critical mass of reforms needed to transform the investment climate,” Thomsen said. He noted that delays in reform implementation are one crucial reason why investor sentiment has not recovered as expected under the program, and thus why the economy was weaker than expected.
Next steps
A recent staff visit to Greece focused on program implementation and the outlook for 2012. “We continue to expect to be supporting Greece. There is no formal request yet for a new program,” Thomsen said, noting that a new program would have to be evaluated by the IMF’s management and Executive Board before any negotiations could proceed.
