GREECE Staff Report for the 2004 Article IV Consultation
Author: International Monetary Fund
Publication Date:
09 Feb 2005
eISBN:
9781451816211
Language:
English
Keywords:
ISCR; CR; government; deficit; GDP; Medium-Term Program; interest rate; labor market; foreign currency; private sector; GDP deflator; Fiscal consolidation; Budget planning and preparation; Europe
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The staff report for the 2004 Article IV Consultation on Greece focuses on economic developments and policies. Rising incomes and a falling, though still high, unemployment rate underpinned strong household consumption, while increased profitability spurred investment spending, especially construction. Inflation has been above the euro area average, eroding international competitiveness and export market shares. Regarding structural policy, the authorities recognized that Greece still lags significantly behind the European Union in real per capita income despite the economic boom.

Abstract

The staff report for the 2004 Article IV Consultation on Greece focuses on economic developments and policies. Rising incomes and a falling, though still high, unemployment rate underpinned strong household consumption, while increased profitability spurred investment spending, especially construction. Inflation has been above the euro area average, eroding international competitiveness and export market shares. Regarding structural policy, the authorities recognized that Greece still lags significantly behind the European Union in real per capita income despite the economic boom.

I. Background

1. Real GDP growth in 2004 is expected to be about 4 percent for the fifth consecutive year (Table 1, Figure 1). The boom was sustained by accommodative monetary conditions associated with adoption of the euro and subsequent easing by the ECB. Fiscal policy was also markedly stimulative, with revised figures showing the budgetary situation to have deteriorated throughout the boom period. Private consumption and household confidence have been buoyant, reflecting strong wage increases, wealth effects from rising real estate prices, gains in employment and a falling unemployment rate, and deregulation of financial markets that spurred very large increases in consumer credit (Figures 2, 3, and 4). Rising profitability and, in the past two years, the Olympics have sustained investment, especially construction.

Table 1.

Greece: Selected Economic Indicators, 2000–2005

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

Data from OECD. The authorities recently revised their methodology to produce new estimates for 2003.

Latest data is for October (real effective exchange rate (consumer prices), nominal effective exchange rate); and July (real effective rate (manufacturing ULC)).

Figure 1.
Figure 1.

Greece: Output, 1998–2004

Citation: IMF Staff Country Reports 2005, 043; 10.5089/9781451816211.002.A001

Source: IMF, World Economic Outlook.
Figure 2.
Figure 2.

Greece: Cyclical Indicators, 1998–2004

Citation: IMF Staff Country Reports 2005, 043; 10.5089/9781451816211.002.A001

Sources: IMF, International Financial Statistics; OECD; and Bloomberg.1/Ratio of GDP deflator to economy-wide unit labor costs.
Figure 3.
Figure 3.

Greece: Labor Market, 1998–2004

Citation: IMF Staff Country Reports 2005, 043; 10.5089/9781451816211.002.A001

Sources: IMF, World Economic Outlook; Eurostat; and OECD.
Figure 4.
Figure 4.

Greece: Credit Developments, 1998–2004

(In percent)

Citation: IMF Staff Country Reports 2005, 043; 10.5089/9781451816211.002.A001

Sources: Bank of Greece, Bulletin of Conjunctural Indicators, and Monthly Statistical Bulletin.1/ Data prior to 1999 refer to public sector.2/ Data prior to 1999 refer to private sector.3/ Excludes banks’ holdings of government securities.4/ Data prior to 2000 refers to commercial bank credit.

2. However, years of high growth have resulted in inflationary pressures and an erosion of competitiveness, and structural weaknesses have remained largely unaddressed. There has been progress in implementing Fund recommendations in some areas (notably, the financial sector and, following recent fiscal revisions, data quality), but less has been done elsewhere (Box 1). In particular, limited progress on resolving longstanding supply-side impediments has meant that the output gap has risen and labor markets have tightened as aggregate supply has not been able to meet rising demand. Inflation and unit labor cost increases have been among the highest in the euro area, causing a sustained appreciation of the real exchange rate (Figure 5). Although about half the inflation differential may be due to Balassa-Samuelson effects, international competitiveness has eroded and the export market share has fallen. Strong domestic demand and poor competitiveness underlie large and persistent current account deficits and, in the past three years, a negative contribution of the external sector to aggregate demand.1 The size of the current account deficit and the fact that it is financed largely by portfolio flows—FDI inflows have been weak—raises issues of longer-term sustainability (Table 2). However, interest rate differentials relative to Germany remain small, reflecting Greece’s participation in a monetary union.

Figure 5.
Figure 5.

Greece: Prices and Competitiveness, 1998–2004

Citation: IMF Staff Country Reports 2005, 043; 10.5089/9781451816211.002.A001

Sources: IMF, International Financial Statistics; and IMF, World Economic Outlook.
Table 2.

Greece: Indicators of External and Financial Vulnerability, 1998–2004 1/

(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.

The interpretation of some indicators is affected by participation in EMU in 2001.

Official reserves declined in 2001 with EMU participation, due in large part to the redefinition of foreign exchange reserves and the fall in foreign exchange reserve requirements for commercial banks.

From 2001, foreign debt includes only liabilities in non-euro area currencies.

Euros per U.S. dollar from 2001.

Data provided by Eurostat.

Data prior to 2001 refer to growth of Greek liquidity measure M4N.

As from 2001, loans and deposits in euro and its national denominations are not included in foreign exchange loans and foreign exchange deposits respectively.

Data refer to all commercial banks incorporated in Greece excluding the Agricultural Bank of Greece. If Agricultural Bank of Greece is included, then the relevant ratios for the past years become 7.3 for 2002, 7.0 for 2003 and 7.1 for June 2004.

Data refer to all commercial banks incorporated in Greece excluding the Agricultural Bank of Greece. If Agricultural Bank of Greece is included, then the relevant ratios for the past years become 4.1 for 2002, 4.3 for 2003 and 4.5 for June 2004. 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 banks operating in Greece.

Data refer to all commercial banks incorporated in Greece.

Policy Recommendations and Implementation

Fiscal policy. The Fund has repeatedly called for a more ambitious fiscal stance, but consolidation stalled in recent years and revisions have revealed that deficits were much larger than reported. Had these numbers been available, staff would have advised a still stronger fiscal effort. The Fund has encouraged multi-year fiscal planning, which has not been adopted.

Data quality. The Fund has called for improvements in statistical data, as identified in the fiscal and data ROSCs. Progress has been made, notably with adherence in 2002 to the SDDS and the recent fiscal revisions, but more needs to be done (Appendix II and the ROSC updates).

Pension reform. The Fund has called for early action to address the high projected costs of population aging. Pension reforms in 2002 consolidated a number of funds, but did not address underlying expenditure pressures.

Financial sector. The Fund has welcomed actions to improve supervision and strengthen banks’ risk management, processes which have continued. A law establishing an independent insurance supervisor was passed in February 2004, but has not been implemented.

Structural policy. The Fund has called for further privatization, which continues to be a key government goal. Most recently, divestiture of the remaining stake in the National Bank was announced. Labor market reform, which the Fund has consistently advocated, has been limited.

3. Fiscal consolidation stalled during the boom, with the situation proving much worse than had been thought even as late as last spring. Restatement of the fiscal accounts by the authorities and Eurostat resulted in large upward revisions to general government deficits for 1997–2003, which never fell below the 3 percent of GDP Maastricht ceiling (Box 2 and Table 3). The general government deficit remained close to 4 percent of GDP during 2000-02 before expanding to an estimated 5½ percent in 2004; the primary surplus declined precipitously to almost zero. Olympics spending was partly responsible, adding 1 to 1½ percentage points to the deficit-GDP ratio in each of 2002-04 (Table 4). Spending overruns and revenue shortfalls raised the 2003 and 2004 deficits well beyond budget projections. Owing to the lack of fiscal adjustment, the debt-GDP ratio, officially expected to be 112 percent in 2004, has fallen little in recent years. Following these revisions, Greece was downgraded by Standard and Poor’s and put on a negative rating watch by Fitch, which however seems not to have widened interest rate differentials. In its report to Parliament and the Council, the EC announced an infringement procedure to prevent future misreporting by Greece, and raised broader issues of ensuring member-country data quality.2

Revision of General Government Accounts

From May to November 2004, the authorities and Eurostat agreed to revisions to the public accounts which substantially increased fiscal deficits for 1997–2003. The key sources of the revisions were:

  • Corrections for under-recording of military procurement, as well as a change in the method of accounting for this item from a delivery basis (preferred by Eurostat and used by the bulk of euro-area countries, but for which reliable data are not available in Greece) to a cash basis. The latter shifted the recording of some acquisitions to earlier years, but did not increase the total.

  • Corrections for over-estimation of social security and other non-central government surpluses, based on a new census of these organizations yielding up-to-date data.

  • A reversal of the decision to book January 2004 VAT receipts in 2003, a change in treatment of EU structural funds, and reclassification of a transaction with the postal savings bank from revenue to a financial transaction.

  • Debt was also revised up, mainly reflecting the capitalization of delayed interest payments and lower social security assets.

Greece: Revision of Fiscal Figures as of November 2004

(n percent of GDP)

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Source: Eurostat

For 2000-03 the figures are as of September 2004, and for 1997–99, as of November 2004.

Table 3.

Greece: Revisions to the General Government Budget Balance, 2000-03 1/

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Source: National authorities and Eurostat.

Estimates as of March 2004 versus September 2004. For 2003, the data are as of March, May, and September 2004.

Table 4.

Greece: General Government Accounts, 2000–2005

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

II. Policy Discussions

4. The discussions focused on three areas: the fiscal situation, medium-term growth, and the financial sector. Key issues were fiscal consolidation in 2005 and the medium term, and long-term fiscal sustainability in light of population aging. Policies to boost longer-term growth were also discussed extensively, as was the state of the financial sector. At the time of the mission, the new government which had taken office in March was still formulating its economic policies, although the Prime Minister’s key economic speech on September 10 provided some direction.

A. Economic Outlook

5. The authorities were more optimistic than the mission on growth for 2005. Staff projects GDP growth will slow to 3 percent, while the draft 2005 budget projects 3.9 percent, little changed from 2004.3 Since substantial wage gains and high confidence levels were expected to bolster private consumption, the key differences involved investment and the external sector. The authorities felt that business-tax reform would stimulate investment,4 the recovery in Europe would increase exports, and favorable Olympics publicity would boost tourism, offsetting the end of Olympics spending and planned fiscal consolidation. Staff argued that these latter factors would slow investment in the short run, and that losses in competitiveness would limit any advantage of stronger European growth. The authorities and the mission agreed that the key downside risks to the outlook were oil price rises5 and a large euro appreciation, which would dampen domestic demand and undercut the European recovery.

6. The authorities were also more optimistic regarding medium-term growth prospects. They judged that infrastructure investment associated with the Olympics and other projects in coming years would boost productivity and sustain growth at rates similar to those of recent years. The mission argued that the waning effects of euro adoption, correction of the cyclical imbalances built up during the boom, and the need for continued fiscal consolidation would all weigh on aggregate demand growth (Table 5). Nevertheless, quantifying potential output growth and separating trend from cycle in the recent boom are difficult, and therefore medium-term prospects remain quite uncertain. There was agreement that fundamental structural reform and improving international competitiveness, which would require wage restraint, would be key to boosting medium-term growth.

Table 5.

Greece: Medium Term Baseline Scenario, 2004–10 (Percentage changes, unless otherwise indicated)

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Source: Fund staff estimates and projections.

Assumes broadly constant ratio of revenue and primary expenditures to GDP as in 2005, and full utilization of EU structural funds.

B. Fiscal Policy

7. In the wake of the large revisions, the mission emphasized that accurate and timely fiscal data are a prerequisite for effective surveillance and for the government’s own policymaking and credibility. It stressed that the national authorities were ultimately responsible for ensuring the integrity of the data, and that data shortcomings had hindered surveillance and also policymaking (Box 3). The authorities agreed, noting that they had initiated the revision process and underscoring their firm commitment to transparency. To this end, surveys of the social security funds and local governments would henceforth be conducted every quarter and military expenditures would be recorded on a cash (instead of delivery) basis, which were judged more reliable. Revisions available at the time of the mission covered 2000-03 and for this period the authorities reassured staff that, to the best of their knowledge, there would be no further major changes. However, they did note scope for further improvements in the new quarterly surveys and the accounting practices of local governments.

Staff Advice on Fiscal Transparency in Greece

This box summarizes past staff assessment of fiscal transparency in the 1999 report on fiscal transparency, and subsequent updates, the 2003 data ROSC, and various staff reports.1 This would correspond to a loss of 0.22 percent of GDP. Using an alternative GTAP specification, a recent World Bank study1/ These documents were on the whole appreciative of the progress the authorities had made on various issues, and urged remedial action to correct remaining weaknesses. Fund staff did not identify the major misreporting issues regarding defense acquisitions and social security surpluses, but did raise questions regarding large below-the-line operations and stock-flow discrepancies.

The 1999 report on fiscal transparency, a precursor of the ROSCs, was based on a self-assessment by the authorities. Relevant recommendations were: clarifying the treatment of state enterprises; integrating ordinary and investment budgets; better reporting on quasi-fiscal activities (or eliminating such activities), and state financial assets; clarifying the accounting basis underlying the budget; bolstering oversight through parliamentary hearings on audited financial statements. Subsequent factual updates recorded improvements in transparency of the management of state financial assets and extrabudgetary funds, increased public availability of fiscal data, and initial steps to improve auditing.

The 2003 data ROSC found government finance statistics to be generally of lower quality than other areas, but was moderately positive on fiscal data integrity in the context of EU standard-setting and control. Identified weaknesses included: lack of reconciliation of fiscal and financial accounts; insufficient resources available to the statistical agency; limitations in the legal and institutional environment; methodological weaknesses; unavailability of financial flows and stocks; lack of consistency between fiscal, monetary, and balance of payments data; inability to establish internal consistency of net lending/borrowing and financing; and lack of metadata. The ROSC recommended measures to strengthen these areas.

The 2000 staff report called for improved statistics in several areas, including the fiscal accounts, to facilitate economic assessment and surveillance. The 2001 report focused on the need for greater fiscal consolidation, in particular identifying and discussing the persistent and large below-the-line entries, and noting inadequacies in the accounting of these stock-flow discrepancies. These themes were taken up in the 2003 report, which called for further improvements in transparency and accountability.

1These documents are available at http://www.imf.org/external/country/GRC/index.htm.

8. Staff urged that the integrity of the fiscal accounts be reinforced. While changes made in the wake of the review by the authorities and Eurostat resulted in major improvements, staff made further recommendations, including in the context of the fiscal ROSC update (Box 4). The authorities welcomed the mission’s proposal of a full fiscal ROSC, and have also committed to compiling fiscal financing data from 2005, which should provide an additional check on the budget figures.

Recommendations of the 2004 Fiscal ROSC Update

The report found considerable progress had been made in improving clarity and accountability, communication with the public, budget preparation, and data integrity. Regarding the last, the new survey agreed with Eurostat should greatly improve oversight of the large social security sector. However, the report also made a number of recommendations for improvement:

Clarity of roles and responsibilities would be improved by eliminating the overlap of pre-auditing, which is now done by three agencies; fully integrating all debt operations in the public debt agency; unifying responsibility for privatization; strengthening the role and mandate of the Court of Audit; and introducing performance evaluation of government activities.

Public availability of information would be improved by developing more descriptive budget documentation illustrating government objectives, policies, activities and targets. This would need to be combined with a programmatic presentation and costing of the budget itself, as has become the norm in OECD countries.

Open budget preparation, execution, and reporting would be enhanced by structuring appropriations by program, moving to a multi-year perspective, consolidating extra-budgetary and off-budget spending, including most importantly defense spending, closing special accounts, and harmonizing Greek and EU fiscal reporting practices.

Assurances of integrity could be strengthened by an independent review of budget assumptions, as well as moving the statistical agency outside the Ministry of Economy and Finance and providing it with a mandate assuring its independence.

9. The key concern, which the revisions intensified, was the need for fiscal consolidation going forward. Staff projects a general government deficit of 5½ percent of GDP in 2004, much higher than the 1.2 percent targeted by the 2004 budget, reflecting a much worse starting point in 2003, shortfalls in tax revenues and transfers from the EU, and overruns in Olympics related expenditure, social transfers, and public sector wages. There are risks of a still higher deficit: Olympics costs have yet to be finalized and revenue collection has been weak. Looking ahead, the staff’s constant-policy medium-term scenario implies little progress in deficit reduction (Table 5), and its debt sustainability analysis suggests the debt-GDP ratio will fall only gradually through 2010, and increase sharply thereafter as pension and health-care costs rise due to population aging (Table 6).

Table 6.

Greece: Public Sector Debt Sustainability Framework, 2001–50 (In percent of GDP, unless otherwise indicated)

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General government.

Derived as [(r - &3x03C0;(l+g) - g + αε(l+r)]/(l+g+π+-gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign currency-denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - n (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

Historical average for fiscal variables are for the period 2001-03 due to the unavailability of consistently defined data for earlier years.

Derived as nominal interest expenditure divided by previous period debt stock.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.