Greece: Staff Report for the 2005 Article IV Consultation
Author: International Monetary Fund
Publication Date:
06 Jan 2006
eISBN:
9781451816235
Language:
English
Keywords:
ISCR; CR; government; deficit; investment expenditure; fund staff estimate; foreign exchange; exchange rate; tax administration; economic growth; interest rate; Fiscal stance; Current spending
Download PDF (686.5 KB)

This 2005 Article IV Consultation highlights that economic growth in Greece has been strong for several years, underpinned by a large fall in interest rates owing to adoption of the euro and subsequent European Central Bank easing. In 2005, the authorities implemented substantial fiscal consolidation, reducing the budget deficit to 4.6 percent of GDP on IMF staff calculations. Economic growth in 2006 and beyond is likely to be moderate compared with the high rates enjoyed in previous years, though it should remain comfortably above the euro area average.

Abstract

This 2005 Article IV Consultation highlights that economic growth in Greece has been strong for several years, underpinned by a large fall in interest rates owing to adoption of the euro and subsequent European Central Bank easing. In 2005, the authorities implemented substantial fiscal consolidation, reducing the budget deficit to 4.6 percent of GDP on IMF staff calculations. Economic growth in 2006 and beyond is likely to be moderate compared with the high rates enjoyed in previous years, though it should remain comfortably above the euro area average.

I. Background

1. Real GDP growth has been very strong for several years, but economic imbalances have also developed, notably a sharply deteriorating fiscal position (Figure 1, Table 1). Growth has been underpinned by a sharp fall in interest rates due to adoption of the euro and subsequent ECB easing, rapid increases in private-sector credit following financial sector liberalization, procyclical fiscal policy, and, most recently, spending on the Olympics games. In addition, strong capital formation, high labor productivity growth, and significant immigration have all contributed to an expansion of aggregate supply. Despite this favorable economic backdrop, the fiscal deficit has widened, reaching 6.6 percent of GDP in 2004, the primary surplus turned into a deficit, and public debt stood at 111 percent of GDP (Table 2).1 The key reason for the fiscal deterioration was spending: in 2000–04, real primary expenditure grew by 5.9 percent a year on average (5.1 percent excluding the Olympics) in 2000–04.

Figure 1.
Figure 1.
Figure 1.

Greece: Selected Indicators, 1998–2005

(Cont.)

Citation: IMF Staff Country Reports 2006, 004; 10.5089/9781451816235.002.A001

Sources: IMF, International Financial Statistics; IMF, World Economic Outlook; National Statistical Service of Greece; Eurostat; Annual Macroeconomic Database (AMECO); OECD, Economic Outlook Database; and Bloomberg.
Table 1.

Greece: Selected Economic Indicators, 2000-06

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

Annual averages. Figures for 2004 not fully comparable with those for previous years because of new sample as of 2004.

Staff estimates for 2006 exclude the impact of planned additional revenue measures which are as yet unspecified. If the authorities’ estimate of the impact of these meaures are included, the deficit would be 2.7 percent of GDP.

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

Table 2.

Greece: General Government Accounts, 2000–06

(Baseline Scenario)

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

Staff estimates exclude the impact of planned additional revenue measures which are as yet unspecified. If the authorities’ estimate of the impact of these meaures are included, the deficit would be 2.7 percent of GDP.

2. In 2005, growth is expected to slow to 3½ percent, still well above most other euro-area countries. The end of Olympic spending and, to a lesser extent, rising oil prices moderated domestic demand, although private consumption remained robust. Export growth fell somewhat, notwithstanding strength in the key shipping and tourism sectors, but import growth also fell after the Olympics-related surge in 2004, leaving, unusually, a very slight positive foreign balance contribution.

3. The government, in its first budget, implemented substantial consolidation. This year, staff estimates the deficit will fall to 4.6 percent of GDP, a reduction of 2 percentage points, associated primarily with the end of Olympics spending (accounting for 1¼ percent of GDP, including a sharp fall in public-sector investment), lower interest costs (½ percent of GDP), and lower growth of public sector wage costs and pensions.2

Greece: General Government Expenditures, 2000-05

(Percentage change)

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

4. Inflationary pressures persist and competitiveness continues to erode. A persistent inflation differential vis-à-vis the euro area and high unit labor cost increases, due to a positive output gap and a tightening labor market, have resulted in a steady appreciation of the real exchange rate, more than reversing an improvement in the run-up to joining the euro. As a result, export growth has been weak and export market shares have fallen by some 17 percent since 2000. Inward FDI has been chronically weak, suggesting a reticence to invest in Greece.

uA01fig01

EXTERNAL INDICATORS

Citation: IMF Staff Country Reports 2006, 004; 10.5089/9781451816235.002.A001

Source: IMF, World Economic Outlook.

5. The Greek banking system has been transformed in the past decade, as private-sector intermediation has displaced holdings of public debt. Commercial banks have benefited from liberalization, privatization, and buoyant economic growth to extend credit aggressively to new clients—particularly households and SMEs (Figure 2). They have also moved into southeast Europe, hitherto relatively underbanked. Rapid credit expansion has raised concerns, however, since the resilience of the system has not been tested by a sharp economic slowdown in growth or higher interest rates. The nonbank financial sector is small and plays only a limited role in financial intermediation.

Figure 2
Figure 2

Greece: Credit Developments, 1998–2005

(In percent)

Citation: IMF Staff Country Reports 2006, 004; 10.5089/9781451816235.002.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.
uA01fig02

CREDIT/GDP RATIOS

Citation: IMF Staff Country Reports 2006, 004; 10.5089/9781451816235.002.A001

Source: Bank of Greece, Bulletin of Conjunctural Indicators.

Greece: Policy Recommendations and Implementation

Fiscal policy. The Fund has called for significant consolidation, and the deficit is being reduced significantly this year and next. A comprehensive fiscal ROSC was done earlier this year. To strengthen fiscal management, the authorities have established task forces to examine the recommendations of FAD technical assistance missions on expenditure management and tax administration.

Pension and health care reform. The Fund urged public dialog to lay the groundwork for early action to deal with the fiscal costs of aging. The government has raised the public profile of this issue, but will not implement reforms in this term of office. Steps have been taken to control hospital spending.

Data. The Fund has for some time called for improvements in data quality, and efforts in this area continue. Nevertheless, historical budget estimates are still under discussion with Eurostat, data for the financing side of the budget are not yet available, and the quarterly national accounts data are of poor quality.

Financial sector. Both banks and the supervisor have strengthened risk management, in line with longstanding Fund recommendations. However, the new insurance supervisor is still not operational. In line with Fund advice, the authorities undertook an FSAP in 2005.

Structural policy. The Fund has urged greater flexibility to improve competitiveness, and significant steps were taken this year in both product and labor markets. The authorities plan further measures in the years ahead.

6. Structural reform, after languishing for some time, is now underway, and political support for reform appears to be strengthening. In recent months the government has introduced a number of important measures, including reductions in the corporate tax rate; unified and extended shopping hours; more flexible overtime arrangements; a new law to better integrate immigrants; a new competition law that brings Greece into line with EU standards; a stronger competition authority; further gas and electricity liberalization; and simplification of business licensing procedures, first for industrial companies and subsequently for the commercial sector. While opposition to specific measures remains, the successful implementation of these initiatives suggests increasing public acceptance of the need for reform. Reflecting this mood, the Prime Minister’s annual policy address in September and the National Reform Program both emphasized the need to further improve productivity and competitiveness if Greece is to achieve the Lisbon objectives and close the income gap with western Europe.

II. Policy Discussions

7. Policy discussions focused on three areas: fiscal consolidation to ensure sustainability, the financial sector, and competitiveness and medium-term growth.

A. Economic Outlook

8. There was broad agreement on estimated growth in 2005, but the mission was somewhat less optimistic than the authorities for 2006 and beyond. For 2005, the authorities emphasized that the Greek economy had continued to outperform the euro-area by a significant margin, despite fiscal consolidation. For 2006, the authorities project a small increase in real GDP growth to 3¾ percent, while the staff projects a mild slowdown to 3¼ percent. Both the authorities and staff expect private consumption to remain strong and investment to rebound from its post-Olympic slump. However, the staff was more cautious regarding the contribution of the external sector, where lost competitiveness could take a toll, and the strength of domestic demand, which could be weakened by faltering confidence (Figure 3) and the full-year effect of high oil prices. Beyond 2006, the authorities were optimistic about medium-term growth, pointing to implemented and planned structural reforms and infrastructure improvements. Staff projects a gradual decline in growth to its potential rate of 3 percent 3—which is still high by comparison with most European countries—as the effects of euro entry and financial liberalization wear off and competitiveness erodes further.4

Figure 3
Figure 3

Greece: Cyclical Indicators, 1998–2005

Citation: IMF Staff Country Reports 2006, 004; 10.5089/9781451816235.002.A001

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

9. It was recognized that there are significant risks on both sides of these projections. Investment could rebound more strongly than expected from its Olympics-induced ripple, although higher interest rates could dampen activity. Growth would also be affected by changes in oil prices or EU economic growth, and by developments in tourism (which has rebounded strongly from two weak years, but is still vulnerable to security concerns) and shipping (also strong, but inherently volatile). The mission raised two medium-term issues: that the erosion of competitiveness might cut potential growth more than already incorporated in the medium-term projections; and that the end of the boom following euro adoption might prove much sharper than anticipated, as occurred in Portugal.5 The authorities viewed their structural reform agenda as addressing the key issue of competitiveness. Regarding the Portuguese experience, the authorities conceded resemblances, notably very high credit growth and procyclical fiscal policy during the boom, but stressed important differences, including a much lower ratio of private debt to GDP and the fact that Greece is in a position to benefit from the rapid economic development of southeast Europe.

uA01fig03

HOUSEHOLD DEBT

(in percent of GDP)

Citation: IMF Staff Country Reports 2006, 004; 10.5089/9781451816235.002.A001

Source: National authorities.

B. Fiscal Policy

10. The authorities have made deficit reduction their top priority. In the context of the EU excessive deficit procedure (EDP), they are committed to lowering the deficit below 3 percent of GDP in 2006, but were concerned to avoid substantial adverse effects on economic growth or social cohesion. For 2005, budget implementation has been strong on the spending side, but revenue collection fell well short of expectations because of a surge in tax evasion, perhaps associated with reforms to the tax inspectorate, designed to curb corruption, which included replacing many employees. The authorities reported that they had begun to take corrective measures, but in the meantime they planned to securitize tax arrears (but see footnote 2) to ensure adequate progress toward the EDP commitment.

11. The authorities plan further significant consolidation in 2006, although they are relying in part on temporary measures and, at the time of writing, policies for a significant portion of the adjustment were not specified. The authorities target a deficit of 2.6 percent of GDP in 2006, with measures including a previously announced reduction in the corporate tax rate, the introduction of a VAT on real estate transactions, restraint of the public sector wage bill, and tighter control on the spending of public enterprises and hospitals. However, consolidation also depends heavily on increases in unspecified tax and non-tax revenues, some of which are to be temporary, and in lower infrastructure investment. Staff’s baseline estimate for 2006 assumes spending targets are met but excludes the unspecified revenue measures. Together with a lower growth projection, this yields a projected deficit of 3.8 percent of GDP. By contrast, if the measures yet to be announced yield the revenue assumed by the authorities, staff projects a deficit of 2.7 percent of GDP.

Staff Fiscal Projections, 2006

(In percent of GDP)

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Source: Staff estimates

12. The mission supported the large fiscal consolidation in 2005-06, but argued durable measures would be needed. In this context, the mission was critical of securitization and other temporary measures, which do not improve the underlying budget position, and of past resort to tax amnesties, which undermine compliance. Net of temporary measures and adjusted for the cycle, staff projects the deficit would still be about 4¼ percent of GDP in 2006. In the absence of further measures, the outlook is for little narrowing of the deficit in coming years (Table 3). Given very high levels of public debt, such an outcome would expose the Greek economy to continued risks to debt sustainability in the event of significant interest rate increases and, especially, should economic growth decline sharply (Figure 4).

Table 3.

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.

Staff estimates for 2006 exclude the impact of planned additional revenue measures which are as yet unspecified. If the authorities’ estimate of the impact of these meaures are included, the deficit would be 2.7 percent of GDP.

Figure 4.
Figure 4.

Greece: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2006, 004; 10.5089/9781451816235.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks.Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent ¼ standard deviation shocks applied to real interest rate, growth rate, and primary balance.3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2006, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

13. The mission also argued for continued consolidation to achieve structural budget balance by 2010, since the costs of population aging are projected to begin to rise steeply shortly after that. This would require structural deficit reductions of about 1 percent of GDP a year, on average (Table 4). Front-loading of consolidation would be desirable to take full advantage of currently buoyant economic growth and because the electoral cycle will make restraint increasingly difficult in 2007-08. Given the authorities’ policy to sustain public investment and implement tax reform, priorities supported by staff, current primary spending growth would have to be held to levels well below rates earlier in this decade. Nevertheless, there would still be room for real primary current spending to rise in real terms if the economy grows as in the staff projection and revenue collection remain strong.

Table 4.

Greece: Medium-Term Staff Policy (Adjustment) Scenario, 2002–10

(In percent of GDP)

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

14. The authorities agreed that further, durable measures would be needed in 2007 and beyond to ensure strong public finances. They emphasized, however, that the 2005-06 deficit reduction was very large and that it would take time to develop and implement more structural measures. Next year, a key focus would be greater control of state-owned enterprises, with a view to reducing the need for subsidies and loan guarantees (see Section D, below). In addition, the authorities were reinforcing tax collection through electronic cross-checking of VAT returns, and planned to step up absorption of EU funds.

15. The mission also recommended that spending be clearly prioritized, which would be facilitated by a multi-year adjustment strategy and tax and expenditure reform. Broad areas of possible saving (some of which are in train) include: continued restraint of public sector wages, which have risen rapidly in recent years; taking advantage of retirements (estimated by the authorities at about 7000 a year) to slim the public service; better control of spending by state-owned enterprises, transport companies, and hospitals; and scaling back high military spending. Ultimately, however, consolidation will require decisions on which programs to contract. Discussion on this point was informed by the results of the TA mission on expenditure management and tax administration and the fiscal ROSC, which identified weaknesses in the current budget system—including a focus on spending lines rather than program objectives, ineffective audit and accounting controls, and lack of transparency—and offered recommendations for improvement (Box 2). The authorities welcomed these initiatives and have already established high-level task forces to review the recommendations. In view of the sweeping nature of the suggested reforms, the mission urged that the task forces be given strong political backing.

uA01fig04

MILITARY EXPENDITURE, 2003

(in percent of GDP)

Citation: IMF Staff Country Reports 2006, 004; 10.5089/9781451816235.002.A001

Source: OECD, National Accounts.

16. The authorities plan further tax reform, with a view to stimulating economic activity. The corporate tax rate is to be cut again, to 25 percent, and a real estate tax is under consideration. Reforms to the personal income tax (PIT), to be implemented in 2007-10, are being formulated which provisionally involve reducing the number of brackets, lowering the top rate, and raising the basic exemption. The mission supported such reforms, provided deficit reduction objectives were not compromised. Regarding the PIT, it warned against expecting a very large revenue boost from the elimination of tax brackets, and argued that major gains would arise instead from the simplification of deductions, which would dovetail with tax administration reforms. The authorities concurred, noting that they intended to strictly limit revenue losses from the PIT reform, although the relevant calculations had not been completed.

Greece: Key Recommendations of ROSC on Fiscal Transparency, and Technical Assistance on Public Expenditure Management and Tax Administration

  • Fully consolidate budget, including the ordinary and investment budgets, and execute through a more transparent treasury single account.

  • Move to programmatic budgeting and a medium term budget framework, supported by comprehensive mid-year reviews and fiscal sustainability analyses.

  • Extend management systems to the entire general government, with better defined responsibilities and more complete reporting at the sub-national level and pension funds.

  • Begin to move to full accrual accounting.

  • Make quasi-fiscal activities more transparent.

  • Streamline expenditure controls with greater emphasis over commitments.

  • Strengthen the internal financial management in budget institutions to promote accountability.

  • Move to ex-post, value-for-money audits, increasing the relevance of the Court of Audit’s annual reports and the effectiveness of parliamentary oversight.

  • Introduce modern system of self-assessment in tax administration supported by risk-based enforcement, and reduce degree of discretion.

  • Return to periodic filing of VAT returns.

  • Introduce stronger measures to collect tax arrears.

  • Improve accounting and budget management through more effective information technology.

17. The authorities and the mission agreed that, in the absence of corrective measures, pension and health-care costs threaten longer-term fiscal sustainability. Spending on these items is set to rise by 10½ percent of GDP between 2010 and 2050, according to 2001 EC estimates (which are in the process of being updated), which would result in an explosive debt-GDP ratio in the absence of corrective action. The authorities stand by an election commitment not to act in its current term of office, but have begun to prepare the ground by referring the issue to the Economic and Social Council for discussion by social partners. The mission agreed that building political support was a prerequisite to reform. Staff noted that time was running short, however, especially since pension reforms often became fully effective only long after implementation, and urged that a more visible and comprehensive dialog be begun soon. A key part of such a discussion will be updated estimates of aging costs. The National Actuarial Authority has been charged with this task, but has fallen far behind schedule, and the mission therefore recommended that additional resources be provided immediately, including by outsourcing the work. On health care, the authorities have recently improved financial monitoring and procurement systems, while recognizing that additional measures will be needed, including better pricing and costing mechanisms and improved auditing.

uA01fig05

AGING AND OVERALL DEFICIT

(in percent of GDP)

Citation: IMF Staff Country Reports 2006, 004; 10.5089/9781451816235.002.A001

Source: IMF staff estimates and projections.
uA01fig06

DEBT DYNAMICS WITH NO REFORM

(in percent of GDP)

Citation: IMF Staff Country Reports 2006, 004; 10.5089/9781451816235.002.A001

Source: IMF staff estimates and projections.

18. The mission also laid out a number of reform options, based on experience in other countries.6 Such policies include reducing high replacement rates, running budget surpluses beyond 2010 to reduce public debt more rapidly, raising the effective retirement age, streamlining the highly fragmented system and further unifying entitlement conditions, developing a clear vision on an adequate (but affordable) level of minimum protection, and strengthening sustainability assessments.

C. Financial Sector

19. The FSAP concluded that the banking system appears profitable and well capitalized, and offered a number of recommendations (Box 3). Capital positions are strong and returns on assets and equity have risen so far this year (Tables 5, 6, and 7). However, bank credit to the private sector has grown very rapidly for several years, raising potential challenges in managing associated risks. Nonperforming loans exceed European averages and are high for the current stage of Greece’s economic cycle. Stress tests revealed that bank soundness is not threatened by market risk, but also that banks carry significant unhedged equity and interest rate risks on their banking books. Greek banks have high cost structures and, since profitability is supported by high spreads for consumer lending, intensified competition will pose challenges. In addition, as deposit growth falls short of rapid credit growth, banks are increasingly tapping new, more costly sources of funding. Larger banks are raising funds in euro-area capital markets, but access is limited for smaller banks with lower credit ratings. Finally, the introduction of IFRS may result in one-time capital charges, as the new standards have tighter rules on assessment of impaired assets, asset valuation and hedging, and recognition of employee benefits (including pension obligations).

Table 5.

The Core Set of Financial Soundness Indicators for Deposit Taking Institutions

(1998-June 2005 unless otherwise indicated)

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June 2005 figures refer to Greek quoted banks only unless otherwise indicated.

June 2005 figures refer to all banks.

Data on a consolidated basis.

This figure does not include ATEbank (formerly known as the Agricutlural Bank of Greece). If ATEbank were included, then the relevant ratios would become 26.5 for 2004 and 25.9 for June 2005.

This figure does not include ATEbank. If ATEbank were included, then the relevant ratios would become 7.0 for 2004 and 7.5 for June 2005.

September 2005 figures refer to all banks on a non-consolidated basis (i.e. commercial, cooperative and foreign branches).

Table 6.

Greece: The Encouraged Set of Financial Soundness Indicators

(1998-June 2005 unless otherwise indicated)

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Source: Bank of Greece.

June 2005 figures refer to Greek quoted banks only.

Data on a consolidated basis.

September 2005 figures refer to all banks on a nonconsolidated basis (i.e. commercial, cooperative and foreign branches).

Data on a nonconsolidated basis.

Provisional data for the series 1998–2004.

Table 7.

Greece: Financial System Structure

(1998-Q3 2005)

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Source: Bank of Greece.

Provisional data.

Number of institutions with 75 percent of total assets (of all credit institutions operating in Greece).

Euro billion.