Greece: Staff Report for the 2000 Article IV Consultation

Greece's integration into the euro area adds urgency to addressing the economic challenges. Securing stabilization gains within the Economic and Monetary Unit (EMU) will depend on labor cost developments, which need to restore an adequate level of competitiveness. Structural reforms, more equitable tax system, and public expenditure reform will be critical for securing stabilization gains. The high unemployment rate reduction will require comprehensive reforms targeted at the most affected labor market segments. An increasingly integrated and open market environment poses challenges for supervision and regulation.


Greece's integration into the euro area adds urgency to addressing the economic challenges. Securing stabilization gains within the Economic and Monetary Unit (EMU) will depend on labor cost developments, which need to restore an adequate level of competitiveness. Structural reforms, more equitable tax system, and public expenditure reform will be critical for securing stabilization gains. The high unemployment rate reduction will require comprehensive reforms targeted at the most affected labor market segments. An increasingly integrated and open market environment poses challenges for supervision and regulation.

I. Introduction and Key Issues

1. At the conclusion of the last consultation on October 20, 1999, Directors commended the authorities for the steady pursuit of stability-oriented economic policies that had yielded impressive economic results and set the stage for euro participation ( They saw the main policy challenges as securing low inflation, and enhancing medium-term growth and employment prospects. This called for balancing the euro-entry-related monetary easing with an appropriate fiscal stance; and for wage and structural policies to sustain low inflation and strengthen growth. To an important extent, these considerations also guided the 2000 Article IV consultation discussions, held in Athens during November 9–21, 2000.1

2. Imminent euro entry provided a historical opportunity for advancing living standards in Greece. Against this background, and to avert potential risks, the mission focused on:

Macroeconomic imbalances and the role of fiscal stabilization policies: There was broad agreement on the near-term fiscal surplus target, aimed also at containing inflation and a large external current account deficit. The staff argued that competitiveness needed to be strengthened, including through containing future wage increases.

Tax and public expenditure policies: The authorities planned the further lowering of marginal tax rates and a broadening of tax bases. The staff advised deeper revenue cuts, in line with those planned elsewhere in the euro area—complemented by additional primary expenditure measures.

Policies to reduce unemployment and strengthen employment growth: The staff suggested reforms aimed at the weakest segment of the labor market (i.e., job market entrants), including increased wage differentiation at the entry level and improved job market matching. The authorities thought that it would be difficult to garner broad support for these steps. And labor market institutions may hamper a needed strengthening of competitiveness.

Structural reforms: There was a consensus on the need for advancing structural reforms to reap the full benefits of monetary union and accelerate real income convergence—albeit not always an agreement on the urgency and depth of the reforms.

3. The government of Prime Minister Simitis (Pan-Hellenic Socialist movement, PASOK) narrowly won reelection in April and continues to have an absolute majority in parliament. Greece joined the euro area on January 1, 2001 (Appendix I).

II. Background

A. Recent Economic Developments

4. Greece’s economic performance improved markedly after the mid-1990s—but persistent structural weaknesses contributed to recently reemerging macroeconomic imbalances. Following a “lost decade” after joining the EU in 1981, real and nominal convergence progressed over the past five years, reflecting to an important extent stability-oriented monetary and fiscal policies. These policies, which laid the ground for euro entry at the beginning of 2001, contributed to relatively robust growth and disinflation (Table 1; and Figure 1).2 Nevertheless, the unemployment rate continued to rise, reaching the second highest level in the euro area; and, more recently, core inflation has accelerated again and the external current account deficit has widened considerably (see below).

Table 1.

Greece: Selected Economic Indicators, 1995–2001

(Percentage changes, unless otherwise indicated)

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Sources: National Statistical Service; Ministry of National Economy; flank of Greece; and Fund staff estimates and projections.


Drachma/ECU before 1999.

End-November compared with end-December.

September compared with December.

November compared with December.

For 2001, fiscal projections are based on unchanged policies.

M4N is defined as sthe sume of base money, private sector deposits in domestic and foreign currencies, repos, banks bonds, money market funds, and private sector holdings of Greek government securities with an initial maturity of up to one year.

12-month change in November.

12-month change in September.

Latest auction November 21, 2000.

Latest auction December 19, 2000.


Figure 1.
Figure 1.

Greece: International Comparisons of Macroeconomic Performance, 1990–2000

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

Source: IMF, World Economic Outlook.

Growth, Inflation, and Unemployment in Greece and the Euro Area

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Sources: WEO database; and Fund staff estimates.

5. With euro entry providing an anchor for expectations and monetary conditions turning increasingly accommodative, economic growth rose to some 4 percent in 2000. Private sector demand responded strongly to the favorable changes in the economic environment (Figures 2 and 3). With entry into the third stage of EMU viewed as more and more likely (and finally approved in June 2000), the effectiveness of relatively high official interest rates became increasingly circumscribed and private investment rose strongly in 2000. Household demand for consumer durables and construction benefited from robust income growth and also from the lower interest rate environment. Moreover, as official interest rates (and short-term market rates) declined by a cumulative 600 basis points (Figure 4), domestic demand was also supported by a strong acceleration of credit growth, with household credit expanding by around 30 percent (Figure 5).

Figure 2.
Figure 2.

Greece: GDP and Components’ Growth and Contributions, 1990–2001 1/

(In percent)

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

Sources: National Statistical Service; Ministry of National Economy; Fund staff calculations and projections.1/ Shaded areas show Fund staff projections.
Figure 3.
Figure 3.

Greece: Monetary Conditions Index, 1990–2000 1/

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

Sources: Bank of Greece; IMF, Economic Information System; European Central Bank; and Fund staff calculations.1/ Shaded areas show Fund staff projections.
Figure 4.
Figure 4.

Greece: Official Interest Rates and Differentials with Germany/ECB, 1997–2001

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

Sources: Bank of Greece; European Central Bank; and IMF, International Financial Statistics.1/ Prior to January 1, 2001, figures refer to official rates of the Bank of Greece.
Figure 5.
Figure 5.

Greece: Money and Credit Developments, 1995–2000

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

Source: Bank of Greece.

6. After converging to close to the euro-area average, consumer price inflation (including core inflation) accelerated in the fourth quarter more strongly than in the area, amid relatively high wage increases. As elsewhere, rising energy prices added significantly to headline inflation, which rose to close to 4 percent in the fourth quarter of 2000 (based on the HICP; Figure 6). And core inflation in Greece tripled since the summer of 2000, and it reached 3¾ percent by end-year—double the euro-area average. The rise in core inflation was partly due to an unwinding of indirect tax cut effects, which had facilitated meeting the Maastricht inflation criterion and were estimated to have lowered inflation by about 1 percentage point in the year to December 1999. In addition, rising nonenergy price pressure reflected a combination of strong domestic demand, unit labor cost increases above those in the euro area, and higher import prices owing to currency depreciation—the latter reflecting the weakness of the euro as well as the drachma’s roughly 4 percent depreciation during 2000 to its central parity rate. On wages, a two-year minimum wage agreement provided for raises of 4.2 percent in 2000 and 3.3 percent in 2001, with only the latter subject to an inflation catch-up clause. Nonetheless, the authorities estimated that private sector compensation growth rose to 5 percent in 2000; as this was not fully matched by stronger productivity growth, unit labor cost increases (2–2½ percent) were again above the euro-area average.

Figure 6.
Figure 6.

Greece: Evolution of Consumer Prices, 1998–2000

(Year-on-year growth rate, in percent)

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

Sources: National Statistical Service; Bank of Greece; Eurostat; and Fund staff calculations.1/ Excluding energy and sesonal food.


(12 month change, in percent)

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

1/ HICP, excluding energy and seasonal food.

7. The unemployment rate continued to rise in recent years, notwithstanding relatively rapid output growth. Although poor labor market statistics hampered the assessment and no data were available for 2000 (see Appendix II), the authorities thought that the employment intensity of economic growth was considerably lower in Greece than in other EU countries.3 With rising female participation rates and despite some earlier reforms (see below), the unemployment rate—concentrated among the young and women, and with more than half unemployed for over one year—had increased to 12 percent in 1999 (Figure 7), and little improvement was expected for 2000.

Figure 7.
Figure 7.

Greece: Labor Market Developments, 1990–2000 1/

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

Sources: IMF, World Economic Outlook; and OECD, Labor Force Statistics.1/ Shaded area shows Fund staff projections.

8. The external current account deficit widened markedly in recent years to one of the highest levels among advanced economies. With import growth fueled by strong domestic demand, staff estimates that the external current account deficit (including capital transfers) more than doubled over the past two years, reaching 7 percent of GDP in 2000 (Figure 8). About 1¼ percent of GDP of the deterioration in 2000 was attributable to higher oil prices (Table 2), while a larger portion was accounted for by strong demand for import-intensive capital goods and consumer durables. At the same time, Greek exporters benefited from a depreciating exchange rate, and robust demand among EU partners as well as new trade opportunities in the Balkans. The current account imbalance was financed primarily by foreign portfolio investment inflows. In 2000, the Bank of Greece also reduced somewhat its high foreign reserve asset position to finance the unwinding of convergence trades. The inflow of foreign direct investment (FDI) into Greece remained relatively moderate (around ½ percent of GDP), and with the internationalization of some domestic enterprises raising FDI outflows, the FDI balance turned negative in 2000.

Figure 8.
Figure 8.

Greece: External Developments, 1990–2000 1/

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

Sources: IMF, World Economic Outlook; and International Financial Statistics.1/ Shaded areas show Fund staff projections.2/ Including capital transfers.
Table 2.

Greece: Balance of Payments, 1995–2000

(In billions of Greek drachma)

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Sources: Bank of Greece; and Fund staff projections.

Includes capital transfers.

January-October 2000.

9. Fiscal consolidation continued in 2000—with staff expecting strong revenue growth to limit the general government deficit to around ½ percent of GDP—and the 2001 budget aimed at a surplus of 0.5 percent of GDP (Table 3; and Figure 9). The authorities have successively tightened their fiscal targets: for 2000, the original target of 1.2 percent of GDP was lowered to 0.8 percent in the Stability and Growth Program, which also introduced a fiscal surplus target for 2001 versus the previously envisaged deficit of 0.2 percent of GDP. The better-than-budgeted outturn for 2000—with staff expecting an even smaller deficit than the authorities—reflected buoyant revenues, due to strong economic activity and marked improvements in tax administration (helped by computerization of tax offices and cross-checking). However, current primary expenditure also exceeded the budgeted levels by a wide margin, boosted by new expenditure initiatives (including fulfillment of election promises to pay contributions to the main pension fund for minimum wage earners) and some slippages, notably on education and health care. The structural primary surplus strengthened by ¾ percentage points, to close to 6½ percent of GDP.

Table 3.

Greece: Summary of General Government Accounts, 1995–2001

(In percent of GDP)

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Sources: National Statistical Service; Ministry of National Economy; and Fund staff estimates and projections.

Ministry of National Economy projection consistent with 2000 budget.

Fund staff estimates.

Figure 9.
Figure 9.

Greece: General Government Accounts, 1990–2000 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

Source: IMF, World Economic Outlook.1/ Shaded areas show Fund staff projections.

B. Economic Outlook

10. Near-term prospects point to continued strong output growth, but also to inflation risks and continued high external current account deficits. Most indicators—such as those for retail sales and industrial production—suggest considerable momentum of domestic demand and activity, supported by the euro-entry-related easing in monetary conditions. There has, however, also been an easing of business and consumer confidence in recent months, pointing to possible downside risks to the staff’s projection of 4 percent GDP growth for 2001 (broadly in line with Consensus Forecasts—but well below the authorities’ 5 percent, predicated on double-digit investment growth). In all, downside risks to the staff’s projection relate mainly to the external side: a more rapid slowdown in world demand than currently envisaged; oil prices above those indicated in current forward contracts; or a relatively sharp appreciation of the euro, which would affect prospects for 2002 in particular. On the upside, construction but also consumer demand may accelerate more strongly than currently projected, notably if the past easing in interest rates were to lead to a considerable rise in liquidity and credit growth, as has been the experience in some euro-area countries. Greece may also benefit from an improved outlook in the Balkan region, following the normalization of trade relations with the Federal Republic of Yugoslavia (Serbia/Montenegro). Risks related to asset prices have diminished with the equity price correction since September 1999 (Table 4; and Figure 10). With continued robust output growth, there are some risks that the recent acceleration in inflation will be only gradually reversed, especially if future wage demands attempt to recoup the past oil- and import-price related acceleration of inflation (see below). Over the medium term, economic prospects will depend critically on structural reforms and competitiveness. On current policies, staff estimated potential output growth of about 3½–3¾ percent. The authorities’ higher projection (of some 5 percent) reflected foremost stronger capital stock accumulation—related to sizable effects attributed to monetary union and future structural reforms—and a sharp decline in unemployment. Should the income prospects and reform expectations ultimately be disappointed, there is a risk of potentially sizable repercussions for the external current account and economic activity—and related policy issues are discussed below.

Table 4.

Greece: Indicators of External and Financial Vulnerability

(In percent of GDP, unless otherwise indicated)

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Sources: Bank of Greece, Monthly Statistical Bulletin; data provided by the authorities; and IMF, International Financial Statistics.

Data for January-November in percent of annual output.

Public sector.

Data refer to all commercial banks incorporated in Greece. Nonperforming loans are defined as all loans with interest and/or principal payments in arrears for three months or more, and include all loans classified as doubtful by the banks themselves.

Data refer to all commercial banks incorporated in Greece. Starting in 1998, data take also into account market risks.

Figure 10.
Figure 10.

Greece: Asset Market Developments, 1995–2000

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

Sources: Bank of Greece; and Bloomberg.

III. Policy Discussions

11. The discussions in Athens took place amid a well-deserved sense of accomplishment among policymakers over Greece’s imminent euro-area entry. Notably, an extended period of stability-oriented macroeconomic policies (supplemented with heterodox anti-inflation measures) had resulted in historically low inflation and contributed to a further acceleration of investment-led economic growth. The staff noted that euro entry provided a unique opportunity for a more rapid advance of living standards in Greece, and the authorities recognized that seizing this opportunity posed substantial economic challenges, not least since there was also a need to ensure the sustainability of price stability within the new monetary policy framework. Moreover, they shared the staff’s concern—albeit not always its sense of urgency about implementing major reforms—that not addressing these challenges would, within the constraints of monetary union, risk repeating the weak growth performance that had followed EU entry. Against this background, the discussions focused on:

Stabilization policies—policies to secure sustainable rates of low inflation in the new euro environment, and to address the growing external current account deficit;

Policies to strengthen growth and accelerate real income convergence—labor market reforms to reduce high unemployment, and policies to strengthen competition and raise factor productivity; and

Policies to safeguard the financial sector—including reforms of financial sector regulation and supervision, to fully reap the benefits of monetary union.

A. Stabilization Issues and Policies

Monetary stance and inflation prospects

12. The Bank of Greece implemented relatively late the reductions in official interest rates to those of the ECB, with rates declining more than in any euro-area member in the year prior to area entry—a strategy aimed at securing the disinflation gains (Figures 4 and 11). Full convergence of the main refinancing rate was achieved only in the final week of 2000. The Bank also extended its credit controls (in the form of nonremunerated deposits for an amount equivalent to credit growth above specified rates) through the end of March 2000.4 Nevertheless, monetary conditions became increasingly accommodative in the run-up to monetary union. This reflected not only the sharp decline in short-term interest rates (by a cumulative 600 basis points during the year), but also the depreciation of the drachma to its central parity, as well as the weakness of the euro itself.

Figure 11.
Figure 11.

Greece: Entering Monetary Union — A Comparison of Monetary Conditions and Output Gaps, 1996–2000 1/

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

Sources: IMF, World Economic Outlook; International Financial Statistics; and Information Notice System.1/ Reflecting their earlier euro entry, data for countries other than Greece are lagged two years (for example, 2000 corresponds to 1998, etc.).

13. While the authorities agreed that monetary conditions were considerably more accommodative than historically observed for present cyclical conditions, they expected—compared with the staff—a more limited impact on economic activity and inflation. They pointed to several factors that were likely to contain the impact of easing monetary conditions on inflation: long-term interest rates had already converged earlier in anticipation of euro entry; the effects from rising oil and import prices were likely to wane in the period ahead; lower interest rates reduced household income—a relatively important channel in Greece in view of households’ large holdings of public debt; and the authorities thought that the output gap had probably not yet closed. Staff’s analysis suggested possibly stronger inflation pressure, in part as it estimated that the economy operated already slightly above potential; and projected important substitution effects from lower interest rates (Box 1). But the authorities and staff agreed that inflation prospects would depend critically on future wage behavior. In this area, however, labor representatives remained unconvinced that import-price-related inflation should not be incorporated into higher wages. These risks are also underscored by a long tradition of private sector wage indexation to past inflation—a practice that has been largely abandoned in the euro area, but was interrupted in Greece for only one year in 2000. If these risks were contained, inflation could end up below the staff’s projection for 2001 of an average HICP increase of 3½ percent (well above the approximately 2 percent projected for the euro area)—though inflation may remain considerably higher than indicated in the Stability and Growth Program (2.3 percent for the private consumption deflator).

The external current account: implications of monetary union

14. The authorities attributed the sharp widening of the external current account deficit largely to temporary factors related to monetary union, and to higher oil prices. Aside from the direct impact of higher oil prices, which accounted for about one-third of the worsened external performance in 2000, the widening external deficit over the past year reflected foremost strong domestic demand growth, concentrated among import-intensive investment and consumer durable goods (especially of automobiles in response to cuts in specific taxes and lower interest rates). The authorities explained that this was due in part to stock adjustments to the new monetary environment, in particular to lower interest rates, and that some of the effects would wane over time as the adjustments were completed. They also noted that competitiveness had not deteriorated; in fact—and notwithstanding some appreciation vis-à-vis the euro area (see below)—the multilateral real effective exchange rate had depreciated by about 6 percent in 2000, as the euro had weakened and the drachma in turn fell to its central parity rate.

Stabilization Challenges in the Wake of Euro-Area Entry: Lessons from First-Round Entrants

In the run-up to joining the euro, monetary conditions in Greece eased by a substantially larger amount than in any first-wave EMU entrant (see chart). For those first-round entrants that were already at a relatively advanced stage of the cycle when they experienced significant euro-related monetary easing—notably Ireland, Portugal, and Spain—the resulting impetus to demand spurred inflationary pressure and worsened external current account positions, in some cases substantially (see table).1 Although Greece differs in important respects from this group of countries—notably due to the private sector’s large interest income from government bonds—the experiences of other EMU entrants highlight the challenges and provide lessons for stabilization policy in Greece. This box focuses on two aspects—inflation prospects, in the light of other euro countries’ experience, and external current account prospects, including the extent to which a worsening may be expected in Greece due to euro-entry related changes in fundamentals.


Monetary Conditions in the Run-Up to EMU

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

Inflation and Current Account Movements in Selected Euro Countries

(In percent, unless otherwise indicated)

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HICP excluding energy and seasonal food.

Change since December 1998.

Change since 1998.

Inflation prospects and risks

Following a long period of disinflation, in which consumer price inflation fell from 20 percent in 1990 to around 2½ percent in the first half of 2000, headline inflation increased to 4 percent by late 2000. Core inflation, excluding energy and seasonal food, reached close to 3 percent, almost twice the euro-area average. Greece could be more exposed to inflationary pressure than most euro-countries on a number of counts: first, wage indexation (with compensation for inflation overruns in 2001 to be paid in 2002) raises the risk of second-round effects of recent external shocks; second, the full effects of recent monetary easing have not yet played out; and third, notwithstanding notorious difficulty in assessing output gaps, the staff estimates output in Greece to be above potential in 2000 and 2001, similar to the situation in earlier euro-area entrants that subsequently experienced a considerable pick-up in core inflation.

In assessing the inflation outlook, the staff has drawn on empirical models presented previously.2 Inflation projections based purely on econometric relationships often have important shortcomings, especially when the economic policy regime has undergone major changes and important statistical data are lacking, as is the case for Greece. Bearing that in mind, single-equation estimates suggest average inflation could rise to 3¾–4¼ percent in 2001 and 2002. The VAR-specification suggests inflation could accelerate more markedly, at least in the absence of exceptional wage moderation (see table).

Inflation Projections

(Annual average; percent)

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Model with markup related to output gap; CPI.

Based on five-variable VAR; CPI.

Stability and Growth Program, deflator of private consumption.


The experience of earlier euro-area entrants suggests that two key factors could keep inflation lower than indicated by these simulations:

(i) Monetary union: euro-membership may change the way that inflationary shocks are propagated through the economy. Indeed, this may already be happening with respect to the speed of exchange rate pass-through. In the past, depreciations of the drachma were often viewed by economic agents as unlikely to be reversed (i.e., persistent); in consequence, they quickly fed through to prices and wages. The recent depreciation of the drachma on account of euro weakness has not yet had the same effect for two proximate reasons: first, the anti-inflation mandate of the ECB has kept inflation expectations in the euro area at bay (as gauged from yields on index-linked vs. nominal bonds); and second, price-setters may not have viewed euro weakness as lasting.

(ii) Structural change: deregulation of key sectors (notably, telecommunications) as well as efforts to strengthen competition more broadly is likely to have an appreciable downward impact on prices. While Greece has been lagging behind other EU countries in this respect, the pace of reforms appears to be accelerating (see Box 3) and this could ease price pressure in the period ahead.

Staff’s central forecast for inflation, which is informed by historical relationships but not to the exclusion of other considerations, is predicated on moderate improvement on both counts listed above. Nonetheless, inflation and unit labor cost growth in Greece are projected to exceed the euro-area average in 2001–02, and by a margin somewhat above estimated Balassa-Samuelson effects.2

Monetary Union and the role of the external current account

Greece’s current account deficit (on a settlements basis) widened sharply from 3 percent of GDP in 1998 to 7 percent of GDP in 2000, the second-largest deficit among euro-area countries after Portugal. This section discusses whether euro entry may itself justify an increase in the external deficit, and what the imbalance may imply for future adjustment needs.

In the context of surveillance of other euro-area countries, staff has previously considered the policy-relevance of the external current account of individual euro-area members (as opposed to the current account of individual regions within other currency-areas).3 The analysis suggested that current account positions remain a useful, though less proximate, indicator of macroeconomic imbalances—reflecting the relatively low intercountry mobility of households (which links external debt repayment closely to national income), the absence of a supranational tax and expenditure system, and relatively limited cross-country portfolio diversification. Concerns about large external deficits may arise even when current account positions are driven by private-sector borrowing and investment decisions, as is the case in Greece. If these decisions turn out to have been based on overoptimistic expectations, incorrect information, or distorted incentives, households (and firms) will eventually have to revise their spending downwards to repay their debts, perhaps substantially.

One important channel through which Greece’s entry into the euro area may affect its current account is the reduction of risk premia (including the elimination of exchange rate risk premia). Access to capital at euro-area rates is likely to boost investment and lower saving, thus leading to a widening of the current account deficit, which is optimal from the standpoint of lenders as well as borrowers.

To ascertain the extent to which the recent current account widening may be justified by such fundamentals, the potential effects and time profile of a decline in the exchange risk premium was simulated using the IMF’s MULTIMOD. The table shows the path of the current account, savings, and investment following a decline in the risk premium of 1 percentage point (for more details, see the background study “Monetary Union Membership and Greece’s External Balance”). While it is difficult to pin down precisely the reduction in risk premia, it appears that most of the reduction in the spread of Greek interest rates over euro area rates in recent years reflected the elimination of depreciation expectations. Only a relatively small part (estimated to be in the range of 1 to 2 percentage points) reflected a reduction in the risk premium proper. Using a version of MULTIMOD calibrated to Greek data, the decline in the risk premium is simulated to raise investment as cheaper capital leads to a higher desired capital stock. Consumption is boosted through a wealth effect as asset prices rise and (higher) future incomes are discounted at a lower rate; moreover, consumption is brought forward in time as the interest rate falls. In all, the current account deficit widens by about 1–2 percent of GDP in the short run, as an improvement of the government balance (on account of higher growth) counterbalances only partly the sizeable deterioration in the private sector saving-investment balance. The medium-term current account deterioration is about ½–1 percent of GDP relative to the baseline.

Decline in Risk Premium: Simulated Effects 1/

(Deviations from baseline; percentage points of GDP)

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Simulated impact of 1 percentage point reduction in the risk premium, phased in over three years, using MULTIMOD.

Against this background, the recent widening in Greece’s external balance may not be fully explained by changes in fundamentals related to euro entry and other factors, including oil price movements. As a result, the staff estimates that—on unchanged real exchange rates and policies—Greece’s external deficit is likely to exceed a “normal” deficit by perhaps some 2 percentage points over the medium term (with the view on the “normal” deficit informed by the specific structure of the Greek economy, including relatively low per capita income compared with most other industrial countries; some of these considerations are also reflected in estimates based on the macroeconomic balance approach—see Isard and Faruqee, 1998—but other other considerations are also taken into account here, including assumptions about the impact of the decline in interest rates). The implications for wage formation and domestic policies are discussed in the main text.

1 For the initial euro-area entrants, policy issues in the cyclically advanced countries were discussed in “Cyclically Advanced Euro-Area Economies—Consequences and Policy Options” (SM/00/182, 7/27/00). For the purpose of this box, the external current account includes capital transfers.2 For further details, see the forthcoming background study “Inflation Prospects and Risks in the Wake of Euro Entry;” and Selected Issues papers for the last two consultations (SM/98/194, 7/22/98; and SM/99/255, 10/6/99).3 See “Portugal—Staff Report for the 2000 Article IV Consultation” (SM/00/219, 9/28/00); and Jörg Decressin and Piti Disyatat, “Capital Markets and External Current Accounts: What to Expect from the Euro,” IMF Working Paper 00/154.

15. The staff shared the authorities’ view that the external current account would remain a useful, though less proximate, indicator of domestic imbalances in EMU. It noted, however, that the sharp widening of the deficit raised concerns about competitiveness—and staff regretted the lack of a domestic consensus on adequate wage restraint (see Box 1; and forthcoming background paper). Earlier staff estimates had indicated that the euro-entry rate of the drachma would be broadly consistent with economic fundamentals (SM/99/244, 9/24/99). Since then, however, the drachma’s central parity has been revalued by 3½ percent; the 1999 current account deficit exceeded earlier staff estimates by 1¼ percent of GDP; and the 2000 deficit was expected to show a further sharp widening despite a considerably more depreciated euro (and thus drachma) exchange rate. Staff also noted that less than two-thirds of the deterioration in the current account since 1998 was attributable to investment, of which a sizable portion was for infrastructure and housing, with limited near-term gains in export capacity. As a result, it thought the dissipation of temporary factors relating to lower interest rates would leave the current account deficit still some 2 percent of GDP above a “normal” level, as indicated, for example, by estimates informed by the macroeconomic balance approach.5 This raised concerns about competitiveness, and the ensuing risks would be magnified if the euro were to appreciate markedly—risks highlighted by a unit labor cost appreciation vis-à-vis the euro area, reaching an estimated 6 percent since the mid-1990s (in manufacturing, adjusted for exchange rate changes).



(Cummulative change since 1998; in percent of GDP)

Citation: IMF Staff Country Reports 2001, 052; 10.5089/9781451816099.002.A001

1/ Negative number indicates increase in investment.2/ Includes statistical discrepancy between settlements- and national accounts-based current account ratios.3/ Fund staff projection.

16. The discussions also explored to what extent the financing of the external current account deficit—predominantly in the form of portfolio investment—left the economy vulnerable to sudden shifts in market sentiment. The authorities thought that these risks would, to an important extent, become limited with euro entry—a view shared by the staff, notably with respect to the near-term outlook and concerning moderate shifts in market sentiment. Nevertheless, the staff noted that the experience in other capital markets—including the United States bond market—suggested that the risk of abrupt liquidity tightening could not be ruled out, including for the euro market. This argued for caution both with respect to the size of the financing needs (and thus the current account deficit) and to the financing instruments (including their liquidity and maturity). In all, while the authorities projected somewhat smaller external imbalances, they agreed that these needed to be addressed by adequate domestic policies.

Fiscal stabilization policy and medium-term deficit targets

17. Against the background of the large monetary easing and concerns about inflation and external current account deficits, the discussions revealed a broad agreement on the need for a tight fiscal policy stance, to secure an appropriate policy mix. Following the lower-than-budgeted deficit in 2000, the authorities had accordingly tightened the budget target for 2001—aiming at a surplus of 0.5 percent of GDP versus the previous Convergence Program objective of a 0.2 percent deficit. In terms of the structural general government balance, achieving these targets would—under the staff’s macroeconomic scenario—imply a fiscal withdrawal of close to 1 percent of GDP in 2001, following a broadly similar withdrawal in 2000; the structural primary surplus would strengthen marginally in 2001 to 6.7 percent of GDP.6

Fiscal Developments and Prospects, 2000–04 1/

(In percent of GDP)

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Sources: Ministry of National Economy, Stability and Growth Program (December 2000); and Fund staff estimates.

Figures incorporate statistical revisions in the fiscal and national accounts, but exclude UMTS receipts that are expected to be realized in 2001.

Fund staff estimates.

18. With broad agreement on the fiscal deficit objectives for 2001, the discussions focused on potential risks to meeting the targets, and on corrective measures. Potential risks to the budget targets were mainly related to its macroeconomic framework and to expenditure overruns. On the framework, GDP growth was assumed to reach 5 percent (some 1 percentage point above the staff’s projection). Nevertheless, the budget’s expected growth in the nominal revenue base was broadly in line with the staff’s, reflecting the budget’s lower inflation projection. The budget also assumed some further gains from tax administration, due to additional computerization of tax offices and improved tax auditing. On the expenditure side, the authorities intended to pursue a strict incomes policy for civil servants’ wages (with base wage increases of 2.2 percent),7 and limit the growth of primary current expenditure to less than nominal GDP. Within the deficit objectives, this was to still leave room for a considerable increase in expenditure priority areas, including public investment and outlays related to the 2004 Olympics. Staff noted, however, that steps to limit expenditure growth had frequently met with little success in the past, and it welcomed the authorities’ commitment to implement primary expenditure cuts should the 2001 deficit target be jeopardized. The staff saw also room for allowing the operation of the automatic stabilizers should growth fall below its current projections. Furthermore, there was agreement that some additional expenditure tightening would be called for if signs of macroeconomic imbalances were to become more pronounced, including a further acceleration of inflation and substantial widening of the external current account deficit.

19. The new Stability and Growth Program aimed at further increases in the general government surplus, reaching the target level of 2 percent of GDP by 2003—broadly consistent with the staff’s normative scenario, although staff argued for targeting the structural primary, rather than the overall, budget balance. The authorities’ Program envisaged initially a further rise in the primary balance to 7¼ percent of GDP by 2002, but a small deterioration afterwards, with the overall balance continuing to benefit from declining interest payments. By contrast, the staff argued for maintaining the structural primary surplus at roughly the level projected for 2002 (7 percent of GDP). Over the medium term, this would result in an accelerated reduction of public debt and push the public debt-to-GDP ratio below 60 percent of GDP around 2007; in later years, this could allow some fiscal easing to cushion the most adverse impact of population aging. Provided that sufficient progress was made in addressing old-age-related fiscal pressures (see below), the staff saw room—and, indeed, a useful role—for allowing the full and symmetric play of the automatic fiscal stabilizers. The authorities preferred at this stage to stay with surplus objectives unadjusted for the cycle, which had the advantage of providing a benchmark that was well understood by the public. However, they acknowledged the potential merits of a primary target that would take into account the economy’s cyclical position—a step that might be considered after an adequate fiscal surplus had been achieved.

B. Structural Policies

20. With an extended history of, at best, relatively limited structural reforms, the authorities considered major progress in this area as pivotal for successful integration into monetary union and rapid income convergence. Product and labor market liberalization had progressed more slowly than in most EU countries and, notwithstanding some gains in recent years, Greece’s income gap vis-à-vis the EU average had essentially remained unchanged over almost two decades since EU entry. The discussions focused on several key areas—namely fiscal policy, the labor market, deregulation, and policies to strengthen competition.

Structural fiscal policies

21. The authorities explained that a fundamental review of the tax system was underway, with reform implementation expected for 2003. Expert groups were studying a comprehensive reform of a tax system that the government and market participants viewed as overly complicated and inefficient. The reforms would aim at broadening tax bases while reducing tax rates, and at aligning effective tax rates across different activities. In the meantime, the 2001 budget already incorporated several steps consistent with the general reform intentions, including the reduction of top marginal direct tax rates and elimination of many minor, but administratively costly, indirect taxes and stamp duties.8

22. While the staff welcomed the general intentions underlying the planned tax reform, it explored whether these should not also aim at lowering the overall revenue burden (in terms of GDP) in coming years, as planned in other euro-area countries (Table 6). The staff noted that the revenue burden had increased considerably faster in recent years than in any euro-area country (Figure 12), and was expected to reach the area’s average in 2001. The authorities argued, however, that surplus objectives and expenditure priorities provided little room for more decisive reductions in revenues. Moreover, they stressed the critical role of marginal tax rates, with base broadening expected to allow considerable reductions. Even so, the authorities were prepared to consider lowering the revenue burden more decisively over time, should competitive disadvantages emerge vis-à-vis the euro area. Indeed, the Stability and Growth Program, released after the consultation discussions, included more sizable reductions in the revenue burden in later years (by 1¼ percent of GDP during 2003–04).

Table 5.

Greece: Stability and Growth Program and Staff’s Medium-Term Scenario, 1999–2004

(In percent of GDP, unless otherwise indicated)

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Sources: Ministry of National Economy The Stability and Growth Programme: 2000–2004 (December 2000); and Fund staff estimates and projections.

The staff assumes that the amount of “below the line” capital injections, net of privatization receipts used to retire government debt, equals 1.7 percent of GDP, while the Greek authorities implicitly assume a larger amount.

Table 6.

Greece: Comparison of Stability Programs for 2000–04

(General government, in percent of GDP) 1/

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Sources: National authorities; and Fund staff estimates.

Figures for some years for France, Ireland, and the Netherlands were estimated or projected by Fund staff. See SM/00/48 (4/27/00) for more details on individual country stability programs; except for Greece, data for the 2001 stability programs were not yet incorporated.

GDP at PPP exchange rates weigthed average excluding Luxembourg.