Greece
2007 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Greece
Author: International Monetary Fund
Publication Date:
02 May 2008
eISBN:
9781451816303
Language:
English
Keywords:
ISCR; CR; deficit; IMF staff projection; adjustment path; IMF staff estimate; product market; unemployment rate; private sector; IMF staff calculation; banking system; Global
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The Greek economy showed strength supported by solid gains in employment, substantial real wage increases, low interest rates, and rapid credit expansion. Executive Directors appreciated the performance of the banking system and welcomed the Bank of Greece’s efforts to strengthen provisioning requirements and lending standards. Directors welcomed the balanced budget and product market reform and stressed the need to improve tax administration. They advised that sustained fiscal consolidation is helpful for safeguarding debt sustainability. Directors emphasized for a budget framework to guide fiscal strategy and prioritize policy objectives.

Abstract

The Greek economy showed strength supported by solid gains in employment, substantial real wage increases, low interest rates, and rapid credit expansion. Executive Directors appreciated the performance of the banking system and welcomed the Bank of Greece’s efforts to strengthen provisioning requirements and lending standards. Directors welcomed the balanced budget and product market reform and stressed the need to improve tax administration. They advised that sustained fiscal consolidation is helpful for safeguarding debt sustainability. Directors emphasized for a budget framework to guide fiscal strategy and prioritize policy objectives.

I. Background

1. The Greek economy has been buoyant for several years, and the gap in real per capita income between Greece and the EU–15 has narrowed significantly. Real GDP growth averaged 4¼ percent during 2000–06, and is estimated at 4 percent in 2007.1 Solid gains in employment and handsome real wage increases have underpinned strong consumption growth. Rapid credit expansion that followed financial sector liberalization and the drop in interest rates associated with euro adoption have fostered rising residential investment by households, while strong profitability has fueled corporate sector investment. However, the external sector has been a drag on growth; external imbalances have remained large throughout and widened (Figure 1, Tables 1 and 2).

Figure 1.
Figure 1.

Greece: Selected Indicators, 2000–08

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: IMF, International Financial Statistics; IMF, World Economic Outlook; National Statistical Service of Greece; Bank of Greece, Bulletin of Conjunctural Indicators; and Bloomberg.1/ Projection for 2008.2/ Data for 2007 as of December.
Table 1.

Greece: Selected Economic Indicators, 2001–08

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

ESA95 basis. This is not comparable to bank settlements basis data (see Box 2).

ESA95 basis.

Core prices exclude energy, food, alcohol, and tobacco.

As of November, 2007.

Domestic credit growth of households and enterprises.

Table 2.

Greece: Macroeconomic Framework, 2001–10

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Sources: National Statistical Service of Greece; Ministry of Economy and Finance; and IMF staff calculations.
uA01fig01

GDP per Capita, PPP

(Percent of the Euro area)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Source: Ministry of Finance.

2. Sustaining the strong growth momentum over the longer-term will require addressing several challenges.

  • Rising labor costs are a threat to competitiveness and may ultimately act as a brake on investment and employment growth. A substantial narrowing of the external current account deficit is needed to stabilize the net foreign asset position.

uA01fig02

Nominal Wages and Salaries, SA

(Year-on-year percent change) 1/

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: Eurostat; and IMF staff calculations.1/ Total industry and services excluding public administration.
uA01fig03

Unit Labor Costs in Manufacturing

(Percent change)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Source: OECD.

National Accounts Revisions

EU regulation stipulates that member states change the base year for the national accounts at least once every five years. For that purpose, and to resolve a number of reservations raised by Eurostat regarding previous estimates, the National Statistical Service of Greece (NSSG) carried out an in-depth revision of the national accounts with 2000 as the new base year. The revision utilized new statistical data sources—in particular, the 2001 population census; an update of the family budget survey; new surveys of enterprises in construction, hotels, retail and wholesale commerce, and transport; and new estimates of rents, capital stock, and depreciation. In October 2006, the NSSG announced a provisional increase of 25.7 percent in the GDP level. However, following a review by Eurostat, the final revision involves an increase in 2000 GDP of 9.6 percent.

While real growth rates remain roughly the same as those for the old GDP series, the composition of growth is different. In particular, gross fixed investment and private consumption are now estimated to be stronger while imports are a larger drag on growth. ESA95-basis unemployment rate is estimated to be lower in the revised national accounts framework.

Revision of National Accounts, 2000–05

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Sources: Ministry of Finace; National Statistical Service of Greece; and IMF staff calculations.

New minus old.

uA01fig04

Greece: Comparative Price Level

(EU15=100)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: Eurostat; and Ministry of Finance.

  • Inflation inertia—around 3–3½ percent in recent years—and the persistence of an inflation differential with the euro area (Figure 2), while partly driven by the convergence process, are also symptomatic of rigidities in the labor and product markets.

  • Immigration, an important source of labor supply during the past few years, has begun to wane. Employment growth will depend increasingly on the mobilization of the large unused potential labor input.

  • The current high level of government debt (93 percent of GDP) and the projected increases in pension and health care costs related to population aging will adversely affect debt sustainability. In addition, the rigidity of the expenditure structure renders the budget vulnerable to shocks that could result in a sharp growth slowdown (Figure 3).

  • The persistence of high nonperforming loans (NPLs) in the face of rapid credit growth, the rising exposure of Greek banks in southeastern Europe (SEE), and their growing reliance on wholesale funding suggest increasing exposure of banks to credit and liquidity risk. However, with household indebtedness still relatively low, strong credit growth can be expected to continue (Figure 4).

Figure 2.
Figure 2.

Greece and the euro area: HICP Inflation, 2001–08

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Source: Eurostat.
Figure 3.
Figure 3.

Greece: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: International Monetary Fund; country desk data; and IMF staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks except for the interest rate and growth shocks. The growth shock assumes that real GDP growth drops to 0.8 percent in 2008 and it recovers gradually to 3.1 percent by 2013. 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 1/4 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 2009, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).
Figure 4.
Figure 4.

Greece: Credit Developments, 2000–07

(Percent)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: IMF, International Financial Statistics; National Statistical Service of Greece; and Bank of Greece, Bulletin of Conjunctural Indicators.1/ Data for 2007 as of November.2/ Data prior to 1999 refer to public sector.3/ Data prior to 1999 refer to private sector.4/ Data prior to 2000 refers to commercial bank credit.

Private Sector Credit and NPLs

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: IMF, Global Financial Stability Report; Bank of Greece; and ECB.

3. The authorities are seeking to address some of these challenges, and will need to persevere with and broaden the reform efforts. The deterioration in the public finances in the period leading up to the 2004 Olympic Games has been reversed, in compliance with the Stability and Growth Pact’s excessive deficit procedure. The general government deficit fell by about 5 percentage points of GDP over two years to 2½ percent of GDP in 2006, and was contained at 2¾ percent of GDP in 2007 despite several unexpected one-off expenditures amounting to about 1 percent of GDP. Also, measures have been initiated under the National Reform Program for 2005–08 to strengthen tax administration and expenditure management, enhance performance of state-owned enterprises, improve the business environment and facilitate private sector development.

II. Policy Discussions

4. Against this backdrop, the 2007 Article IV consultation discussions focused on policies needed to maintain domestic economic and financial stability, through vigilance over financial sector risks, steps to ensure long-term fiscal sustainability, and reforms to tackle the structural constraints to sustained growth.

A. The Outlook

5. Economic growth is expected to moderate in the near term but should remain solid on the back of continued strong domestic demand. Although the pent-up demand for housing is anticipated to fade, the investment outlook appears positive on account of healthy corporate balance sheets, execution of projects benefiting from government incentives and public-private partnerships, and absorption of EU funds under the Community Support Framework. Consumer demand is also expected to remain robust. Thus, on the basis of the Autumn 2007 common external assumptions of the European Commission, the authorities’ baseline scenario projects real GDP growth as remaining sustained at around 4 percent during 2008–10.2 However, the subsequent deterioration in the external environment—higher oil prices, the financial turmoil and associated slowdown in main partner countries, and a stronger euro—will dampen Greece’s growth prospects. Accordingly, staff project GDP growth slowing down to 3.7 percent in 2008, and averaging 3½ percent during 2009–10 (Table 3).3

Table 3.

Greece: Medium–Term Baseline Scenario, 2004–13

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

ESA95 basis. This is not comparable to bank settlements basis data (see Box 2).

ESA95 basis.

Macroeconomic Projections, 2007–10

(Percentage changes, unless otherwise indicated)

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Sources: National Statistical Service; Ministry of Economy and Finance; and IMF staff projections.

Authorities' baseline scenario as specified in the December 2007 SGP update.

National accounts basis.

ESA95 basis.

6. The risks to the staff projections are tilted to the downside, stemming from possible persistence of the global financial turmoil. Such a persistence could result in a liquidity squeeze for banks dependent on wholesale funding and prompt them to scale back business plans (see ¶14). The persistence of the turmoil also could hit export prospects harder than presumed in the baseline scenario.

7. The authorities see ample scope for sustained growth over the longer term through reaping the benefits from Greece’s location and becoming a regional business hub. In this context, they highlight the ongoing and planned investment in infrastructure. An expansion of the Greek shipping fleet and construction of several large-scale energy interconnection projects in the natural gas, electricity and oil sectors are underway. The authorities’ strategy also entails developing ports, rail and road systems, and tourist infrastructure through private participation. They agree that realizing the investment and growth potential would require pressing ahead with structural reforms that create a conducive policy environment and improved competitiveness.

8. Inflationary pressures picked up in Q4–2007 owing to rising food and oil prices, and the risks are to the upside. The authorities, concerned about the possible emergence of second-round effects, have appealed to social partners and entrepreneurs to exercise restraint in wage and price-setting. They were encouraged, however, by the narrowing of the inflation differential with the euro area during 2007, and saw it as a sign of reduced structural rigidities. Assuming no significant second-round effects and oil prices in line with the World Economic Outlook projections, staff project average inflation to rise to 3.3 percent in 2008 and to moderate slightly thereafter.

B. Competitiveness4

9. A range of standard indicators point to a steady deterioration in competitiveness vis-à-vis trading partners. Competitiveness, as measured by Greece’s CPI-based and ULC-based real effective exchange rate, has deteriorated by about 10 percent and 17 percent, respectively, since EMU accession in 2001. Staff estimates of competitiveness based on CGER methodologies also suggest a sizable gap in the range of 30–40 percent in 2007.5

uA01fig06

REER and NEER 1/

(2001=100)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: IMF, Information Notice System; and IMF staff calculations.1/ Vis-a-vis all trading partners using weights from IMF, Information Notice System.
uA01fig07

REER (ULC-based) vis-a-vis Trading Partners 1/

(2001=100)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: OECD; and IMF staff calculations.1/ For manufacturing sector. Industrialized countries include EU15 and higher income OECD countries.

10. The authorities recognized the negative implications of the steady deterioration of competitiveness, but did not consider it an impediment in the near term. They observed that Greek enterprises were restructuring and moving up the technology ladder and that developments in employment and unemployment had been favorable. Reflecting this and the increasing diversification of trade toward the rapidly growing countries in SEE, Greece’s export market share has been broadly maintained since EMU entry in 2001. National accounts data suggest a continuation of strong export performance in 2007, though bank settlements data point to a substantial slowdown in the second half. The authorities further noted that services exports were expanding rapidly, and they saw promising prospects for sustained growth in this area.

uA01fig08

Exports by Technology Levels

(Percent of total exports)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Source: U.N., Comtrade.
uA01fig09

Exports by Labor Skills

(Percent of total exports)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Source: U.N., Comtrade.
uA01fig10

Exports by Destination

(Percent of total exports)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Source: U.N., Comtrade.1/ In value terms, excluding oil.2/ Comprises Albania, Bulgaria, Macedonia, Romania, and Turkey. Included in emerging economies.
uA01fig11

Export Market Shares

(2001=100)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: U.N., Comtrade; and IMF staff calculations.

11. Staff underscored the risks to the external outlook. The higher value-added goods are primarily exported to EU countries while exports to neighboring markets mostly include low-tech labor-intensive goods. Thus, Greek exporters are likely to face growing competition as these neighboring countries seek greater integration with other EU countries. Also, many export-oriented labor-intensive manufacturing firms are increasingly relying on outsourcing.6 Staff further noted that rising labor costs above productivity gains are adversely affecting the profitability of the tourism sector which faces intense price competition. Accordingly, staff stressed the importance of early efforts to improve cost competitiveness through wage moderation and strong productivity growth, and to create an environment conducive to investment in product upgrading.

uA01fig12

Destination of Mid-High Tech Goods 1/

(Percent of total)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: U.N., Comtrade and IMF staff calculations.1/ In value terms, excluding oil.
uA01fig13

Market Shares in Neighboring Countries 1/

(2001=100)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: U.N., Comtrade and IMF staff calculations.1/ Albania, Bulgaria, FYR Macedonia, Romania, Russia, and Turkey.

12. There was broad agreement that the current account deficit would remain relatively large in the medium term. It is assumed that, in line with recent trends, merchandise export market share will be maintained through product upgrading and geographic diversification. For its part, the shipping sector should gain market share with the expansion of the fleet. Import growth is likely to remain robust in view of the substantial investment and new ships purchases in the pipeline. Accordingly, the current account deficit is projected to remain around 14 percent of GDP during 2008–10 and fall slightly thereafter once the outlays on new ships fade away (Table 4). Thus, Greece’s already large negative international investment position will deteriorate further.

Table 4.

Greece: Summary of Balance of Payments, 2004–13 1/

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Sources: Bank of Greece; and IMF staff projections.

Bank settlements basis.

Current Account Balance, 2004–13 1/

(Percent of GDP)

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Sources: Bank of Greece; National Bank of Greece; and IMF staff projections.

Projection for 2008–13.

uA01fig14

Net International Investment Position 1/

(Percent of GDP)

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: IMF, International Financial Statistics; National Statistical Service of Greece; and IMF staff estimates.1/ IIP data for 2007 as of September. GDP in the ratio is an estimate for the entire year.
uA01fig15

External Debt

(Percent of GDP) 1/

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: Bank of Greece; National Statistical Service of Greece; and IMF staff calculations.1/ External debt data for 2007 as of September. GDP in the ratio is an estimate for the entire year.

13. In view of Greece’s EMU membership, the availability of external financing is not a concern, but the correction of cumulating indebtedness could weigh appreciably on growth going forward. While the risk of transmitting vulnerabilities to the euro area is very small reflecting Greece’s small relative size,7 large persistent current account deficits would increase the vulnerabilities to a reversal in market sentiment, leading to a corrective retrenchment of private sector balance-sheets in the face of rising indebtedness, and a possible appreciable rise in the cost of funding over time. These developments would have significant negative implications for growth.

C. Financial Stability

14. The spillover effects from the global financial turmoil on the Greek banking system have been limited thus far. Balance sheet and off-balance sheet exposures of Greek banks to the United States subprime mortgage sector are marginal. Greek banks are not liquidity providers for asset-based commercial paper conduit programs. Despite the growing reliance on wholesale funding, banks have not yet felt the impact from the global credit pressures as they had prefunded their operations up to the first half of 2008.8 However, funding and roll over risks could be heightened if the financial turmoil were to persist. The Bank of Greece (BoG, the banking supervisor) is monitoring banks’ liquidity positions closely. BoG staff indicated that while banks could temporarily bridge their financing needs through repos, they should not resort to this mode of bridge financing on a long-term basis to sustain their ongoing operations. In fact, some banks have reportedly started to scale back their business plans in recognition of the new liquidity environment and rising funding costs. Greece’s submission for the euro area lending survey suggests that some credit tightening is likely in the coming months, particularly for credit to enterprises.

Sources of Funding of Banks

(Percent of total funding, end of period)

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Source: Bank of Greece.

It includes shareholders equity and securitized loans.

Distance to Default of Banks 1/

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Sources: Bank of Greece; Datastream; and IMF staff calculations.1/ Derived from stock price data; higher values mean more stability.

Lending Standards Over the Next Three Months

Citation: IMF Staff Country Reports 2008, 148; 10.5089/9781451816303.002.A001

Source: Bank of Greece.

15. The Greek banking system remains healthy, adequately capitalized, and highly profitable, but key risks will need to be monitored closely (Tables 5–7). Continued rapid credit growth—averaging 20 percent annually—has increased banks’ exposure to credit risk and their vulnerability to swings in the economic cycle. NPL ratios have been persistently high, suggesting that banks’ risk management systems may need further improvement (Table 8). In addition, the increasing exposure in SEE, while entailing significant benefits, carries foreign exchange, credit, and country risks. Recent stress tests suggest that banks are resilient to a range of possible adverse shocks. However, staff observed that the stress tests did not take into account correlation of risks and that the underlying quality of loan portfolio was uncertain as it had not been tested through a complete economic cycle. The BoG agreed that upgrading of stress testing was necessary and indicated that steps had been taken to strengthen supervision through increasing provisioning requirements and seeking a tightening of lending standards.

Table 5.

Greece: Core Set of Financial Soundness Indicators for Deposit Taking Institutions, 2000–07

(Percent)

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Source: Bank of Greece.

Data on a consolidated basis.

2007 figures refer to end–June, 2007.

On an aggregate resident-based approach (i.e. commercial banks, cooperative banks and foreign branches).

From 2004 in accordance with IFRS.

Based on revised figures from 2002 onwards.

Table 6.

Greece: Encouraged Set of Financial Soundness Indicators, 2000–07

(Percent)

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Sources: Bank of Greece; and ICAP, Greek Financial Directory, 2008.

For 2005 and 2006, source is ICAP, Greek Financial Directory, 2008.

Principal expenses not available.

2007 figures refer to end–June, 2007.

On a non-consolidated basis; from 2004 in accordance with IFRS.

On an aggregate resident-based approach (i.e. commercial banks, cooperative banks, and foreign branches).

Spread between rate on credit lines and savings deposit rate.

Data on a consolidated basis.

Figures refer to volumes of securities traded and not numbers.