Staff Report on Request for Stand-By Arrangement

The Greek economy is teetering owing to heavy public debt and loss of market access. Greece is adopting an ambitious comprehensive multiyear adjustment program to lower the fiscal deficit and the debt ratio, reduce domestic demand in line with capacity, and increase supply and competitiveness so that the economy can step onto a higher growth path led by investments and exports. Greece needs a strong and sustained adjustment program to lower the fiscal deficit substantially and create the basis for a declining debt ratio.


The Greek economy is teetering owing to heavy public debt and loss of market access. Greece is adopting an ambitious comprehensive multiyear adjustment program to lower the fiscal deficit and the debt ratio, reduce domestic demand in line with capacity, and increase supply and competitiveness so that the economy can step onto a higher growth path led by investments and exports. Greece needs a strong and sustained adjustment program to lower the fiscal deficit substantially and create the basis for a declining debt ratio.

I. Introduction

1. Greece entered the recent crisis with deep-rooted vulnerabilities:

  • High fiscal deficits and dependency on foreign borrowing fueled demand. Upon entering the euro area, access to low-cost credit boosted domestic demand, and growth averaged some 4 percent over the period 2000-08. Fiscal policies were pro-cyclical, with tax cuts and increased spending on wages and entitlements worsening the primary balance by nearly 7 percentage points of GDP over this period. Then, in 2009 output dropped by 2 percent and election-driven and partially-unreported spending, amid weak overall expenditure control, worsened the fiscal deficit to 13.6 percent of GDP, straining Greece’s ability to fund itself in the market.

  • High aging and entitlement costs. Mounting aging-related spending, among the highest in the EU, is a threat to long-term fiscal sustainability. In particular, spending on pensions is projected to increase by 12½ percentage points of GDP over 2010-50, while the health system is severely fragmented and its spending is projected to increase by 4½ percentage points of GDP over the same period.

  • Weak competitiveness, limited supply capacity, and a poor business environment. Inflation has consistently exceeded the Eurozone average, contributing to an estimated overvaluation of Greece’s real effective exchange rate of 20-30 percent. Competitiveness was further eroded by rigidities in the domestic economy. (Greece scores poorly on OECD and EU indicators for economic efficiency and flexibility.) Competition in internal markets is impaired, particularly in network industries (with large public sector participation) and liberal professions, but other industries have also oligopolistic features that keep margins high. Weakly contested domestic markets result in high costs and poor underlying productivity. Poor governance and regulation depress the potential for inward FDI, which is correspondingly low, while state enterprises are notoriously inefficient.

2. Thus, Greece needs a strong and sustained adjustment program to lower the fiscal deficit substantially and create the basis for a declining debt ratio, bring domestic demand in line with domestic supply capacity, and improve competitiveness so that the economy can step onto a higher growth path. The global financial crisis put a spanner in the wheels of the Greek growth model that was overly reliant on public spending. Now the dual challenge of achieving an internal devaluation and strong fiscal adjustment, amid a very difficult funding environment, is bound to weigh heavily on growth for a prolonged period. To avoid feedback loops, the soundness of the banking system needs to be safeguarded with proactive actions to stem potential liquidity pressures and preserve adequate capitalization.

3. To support their efforts to transform fiscal policies, and the economy more broadly, the authorities have requested a three-year Stand-By Arrangement from the Fund. The arrangement is in the amount of SDR 26.4 billion (3,212 percent of quota), with SDR 4.8 billion to be made available upon Board approval, and the remainder in twelve installments, subject to quarterly reviews. Program monitoring will be conducted jointly with the EC and the ECB, and Greece’s large prospective financing needs will be met by the use of Fund resources and bilateral financial support from eurozone partner countries (Box 1).

Framework for Cooperation between the Fund, the European Commission, and the ECB

Close cooperation between the three institutions is crucial in three areas:

Program design

The authorities’ program represents a coordinated framework for policy adjustment and financing supported by the EC, the ECB and the IMF. Program discussions were conducted on a quadrilateral basis between the authorities and the three institutions, resulting in a unified and consistent set of macroeconomic and structural policy parameters. These are set out in the MEFP/TMU of the IMF and the MEFP/MoU of the EC (attached for information). The MEFP focuses on macroeconomic policies and selected structural measures, while the MoU covers the full structural reform agenda agreed between the authorities and the EC.

Program monitoring

Conditionality for Fund Board reviews is based on a standard quarterly framework of performance criteria and structural benchmarks. For the EC, conditionality is based on an overall assessment of progress against the structural agenda in the MoU as well as the macroeconomic targets. The EC conducts this assessment in liaison with the ECB, and then makes a recommendation to the Euro Group committee of finance ministers, to approve the disbursement. Conditionality for both the IMF and EC is set on the basis of regular end-quarter test dates, with joint review missions consisting of IMF, EC and ECB staff and with disbursements intended to coincide to the extent possible in a fixed proportion of 3-8 between the Fund and the European financing mechanism, described next.

Financing arrangements

Bilateral support is provided by Greece’s 15 partner eurozone countries, in ratio to their shares in ECB capital. The loans will be governed by a single loan agreement between Greece and the euro countries, signed by the EC on their behalf, covering the full three years of the program. The loans will have the same maturities as the Fund purchases, and will carry floating rate interest rates (3-month Euribor) plus a spread of 3 percentage points, rising to 4 percentage points for amounts outstanding beyond three years. Each drawing is subject to a one-off service charge of 0.5 percent. Greece has undertaken to draw on the IMF and EC facilities in a constant 3:8 ratio throughout the program period.

II. Recent Economic Developments

4. Amid slowing growth and reduced global risk appetite, Greece’s heavy dependence on foreign borrowing heightened concerns over long-standing fiscal and external imbalances. A significant revision to the 2008 and 2009 fiscal deficit data shocked markets because they were twice as large as hitherto projected and revealed misreporting of official statistics (Box 2). Public debt was commensurately increased from below 100 percent of GDP to 115 percent of GDP by end-2009. Further, despite the recession in 2009, the current account deficit stood at 11 percent of GDP—evidence of significant domestic demand inflation and external competitiveness problems. When the new fiscal deficit and public debt data were revealed by the new government, markets reacted by increasing spreads on Greek bonds and lowering credit ratings.

Data Misreporting

In October 2009, the new government disclosed that fiscal data were misreported. The deficit for 2008 was revised from 5 percent of GDP to 7.7 percent of GDP. At the same time, the projected deficit for 2009 was revised from 3.7 percent of GDP to 12.5 percent of GDP. After more data became available, the provisional estimate of the deficit for 2009 now stands at 13.6 percent of GDP. The corresponding public debt figure was also corrected from 99.6 percent of GDP to 115.1 percent of GDP at end-2009. Eurostat has not validated these data, highlighting that an upward revision of the 2009 deficit (0.3-0.5 percent of GDP) and the debt (5-7 percent of GDP) are possible. Also, corrections for previous years cannot be ruled out as the Statistical Office is working on classification and methodological improvements.

Consistent with the Fund’s procedures, consultations have taken place with the authorities.1/ Staff established that the provision of inaccurate information was the result of serious institutional shortcomings (including little public accountability on the side of data producers) as well as problems with data sources. Moreover, as documented by Eurostat, there was political interference with the disclosure of some fiscal operations.

The authorities are taking remedial actions to prevent the reoccurrence of data misreporting in the future. A new law approved in Parliament grants independence to the Statistical Office. Also, the authorities have prepared an action plan jointly with Eurostat (to be endorsed by ECOFIN by mid-May 2010) to improve processes and procedures. The plan is based on 3 pillars:

  • Enhancing the institutional and governance framework of the Greek statistical system through the swift implementation of the new law establishing the Hellenic Statistical Authority.

  • Strengthening Greek statistical capacity through a comprehensive capacity building and technical assistance program with active support of the European Statistical System. As part of that program, Eurostat will provide a high-level resident expert.

  • Improving Greek fiscal data including by assigning clear responsibilities on data collection, quality checks, and data transmission processes through the adoption of memoranda of understanding among providers of data on general government and its subsectors.

1/ See rule K-1 report on breach of obligations under Article VIII, Section 5 of the Articles of Agreement (the K-1 report is forthcoming).

5. Initial attempts by the new government in January 2010 to address these vulnerabilities were not convincing. Greece was already in the Excessive Deficit Procedure of the SGP and the authorities agreed to reduce the fiscal deficit to below 3 percent of GDP by 2012. The 2010 budget targets, however, were not underpinned by sufficient measures, and the macroeconomic assumptions underlying the deficit correction program appeared too optimistic, failing to calm the market. After extensive consultations with the EC, additional measures were announced in February and March, but these also failed to instill confidence. Lastly, while the authorities took significant cumulative measures, markets were further unsettled by what was perceived to be insufficiently clear financing assurances from euro partner countries.

6. As a result, concerns about fiscal sustainability deepened and market sentiment weakened further, triggering a confidence crisis. Access to foreign funding dried up and spreads on government paper took off, threatening in the process the banking system and the economy at large with a downward spiral of unfolding risks.

7. Despite a strong capital base, the slippage of confidence in the sovereign spilled over into the banking system. Banks entered this period of heightened turbulence with a strengthened solvency position as capital buffers had been increased from €24 billion to €33 billion during 2009, as a result of the government’s banking support package in 2009 in the wake of the global financial crisis, shareholders contributions, and a conservative policy of profit retention. This resulted in an average capital adequacy ratio of 11.7 percent at end-2009 for the whole banking system. However, successive sovereign downgrades by rating agencies and market volatility put pressure on banks’ liquidity while the deepening recession caused credit to drop and loan impairments to rise rapidly with NPLs reaching 7.7 percent at year end. This caused a significant decline in profitability across all banks. Amidst increasing funding costs and difficulties in accessing wholesale markets, banks have increasingly used Eurosystem credit for their operations.

8. Concerns heightened that a worsening of the economic crisis in Greece could precipitate powerful spillovers to other countries. Immediate contagion channels include: (1) the sovereign debt and financial markets of other eurozone countries with relatively weak fiscal finances as reflected in recent week’s market volatility and downgrades; (2) foreign financial sector institutions with substantial exposures to Greek paper; and (3) depositors confidence in Southeastern Europe (SEE) where Greek banks’ subsidiaries are important. Beyond these immediate effects, contagion could become extremely unpredictable, including serious risks to the still fragile world recovery.

III. Overall Strategy

9. The authorities’ program focuses on the three key challenges:

  • Restoring confidence and fiscal sustainability: the program envisages an exceptionally strong frontloaded fiscal effort, with fully identified measures through 2013. This is to bolster confidence, regain market access, and put the debt-to-GDP ratio on a declining path from 2013.

  • Restoring competitiveness: the program includes nominal wage and benefit cuts and structural reforms to reduce costs and improve price competitiveness, which would help Greece transition to a more investment and export-led growth model. It also envisages improved transparency and a reduced role of the state in the economy.

  • Safeguarding financial sector stability: As the banking system goes through a period of disinflation, which is expected to impact profitability and bank balance sheets, tools for dealing with solvency pressures will be expanded by establishing a Financial Stability Fund (FSF). To mitigate potential liquidity pressures, the existing government banking liquidity support facilities will be extended. The ECB’s recent suspension of the application of the minimum credit rating threshold in the collateral eligibility requirements on debt instruments issued by the Greek government will also serve as a useful liquidity backstop.

10. The authorities’ exceptional efforts are envisioned to be met with exceptional financial support from the international community to allow the government time to turn the economy and the fiscal balance around. Under the baseline macroeconomic framework, strict adherence to program policies with the strong support by the international community should allow a gradual rebuilding of market access at reasonable spreads.

IV. Macroeconomic Framework

11. Transitioning toward a more sustainable model for the Greek economy will take time. Fiscal consolidation needs are large, and will have to be sustained over several years. With no recourse to the exchange rate to kick-start relative price changes, Greece needs to rely on internal devaluation—usually a long and painful process. Given the relatively closed economy, fiscal multipliers are bound to be large and the foreign sector too small to bring about a quick export-led growth response. In addition, the external environment is expected to remain weak in the short term, and structural reforms to boost the supply response will take time to be implemented and bear fruit.

12. Real GDP growth is expected to contract sharply in 2010—11 and recover thereafter. Growth is expected to follow a V-shaped pattern: the frontloaded fiscal contraction in 2010-11 will suppress domestic demand in the short run; but from 2012 onward, confidence effects, regained market access, and comprehensive structural reforms are expected to lead to a growth recovery. Unemployment is projected to peak at nearly 15 percent by 2012.

13. Inflation is expected to remain below the euro average. The needed adjustment in prices is expected to come from domestic demand tightening, both through fiscal adjustment and efforts to moderate public wages and pensions, and other costs in the economy. Demonstration from improved public wage dynamics should contribute to a moderation of private sector wages. This will help restore price competitiveness over time.

Greece: Selected Macroeconomic Indicators, 2009–2015

(Percentage change; or percent)

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Sources: Greek authorities; and Fund staff projections.

14. The current account deficit is expected to narrow gradually. As domestic demand and inflation moderate and the economy responds to structural reforms, dependence on imports should decrease and export supply improve. However, continued high interest costs on the large accumulated external debt will prevent a swifter reduction in the headline current account deficit.

15. The authorities broadly agreed with the overall macroeconomic outlook. They acknowledged that the frontloaded adjustment will dampen growth sharply in the short term but, with necessary reforms, would help engineer a faster recovery later on. They agreed that price adjustment was needed but thought adjustments in the private sector should come mainly through productivity improvements (linked to the intended reform agenda) rather than from measures to reduce private sector wages.

Greece: Selected External Indicators, 2009–2015

(Percent of GDP, unless otherwise indicated)

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Sources: Greek authorities; and Fund staff projections.

Excluding interest payments.

National accounts basis. Percentage change.

V. The Program: Policy Discussion

A. Fiscal policy

16. The authorities and staff agreed that fiscal adjustment should be frontloaded and aimed at reducing the debt-GDP ratio from 2013 and the general government deficit to well below 3 percent of GDP by 2014. This would bring the primary balance to its medium-term target of 5-6 percent of GDP, essential to secure a rapidly declining debt ratio (Annex 1). The total package of fiscal measures (11 percent of GDP during 2010-13, in addition to the 5 percent of GDP in measures already adopted in 2010) is very large, but necessary to counteract the poor starting position of very high deficits and debt, the sharp erosion in market confidence, higher interest payments, and the cyclical impact on revenue and expenditure. Moreover, structural aging-related spending pressures also add to this mix.

17. The authorities’ adjustment package of 11 percent of GDP through 2013 is based on five prongs (Box 3):

  • Frontloading and full identification of measures. The annualized effect of the new 2010 measures will account for 3½ percent of GDP, in addition to the 5 percent already in place. Strong frontloading is expected to minimize implementation risk, avoid adjustment fatigue, and rebuild confidence swiftly. All of the measures have been identified. However, staff stressed that their yield will need to be reassessed at subsequent reviews, pending progress in supporting reforms.

  • Mostly permanent measures. Of the 11 percent of GDP, only about 0.5 percent of GDP relates to measures that will expire by end-2013 (temporary crisis levies).

The Adjustment Measures

Expenditure measures are estimated at 5.2 percent of GDP. The elimination of the Easter, summer, and Christmas pensions and wages, as well as cuts in allowances and high pensions are frontloaded and will, by themselves, yield 2 percent of GDP of the 11 percent total package. Other expenditure cuts involve employment reductions, cuts in discretionary and low priority investment spending, untargeted social transfers, consolidation of local governments, and lower subsidies to public enterprises.

Revenue measures add another 4 percent of GDP to the package. This includes an increase in the standard VAT rate from 21 to 23 percent and the reduced rate from 10 to 11 percent, moving lower taxed products such as utilities, restaurants and hotels to the standard VAT rate, and increasing excises on fuel, cigarettes, and tobacco to bring them in line with EU averages. Those measures yield 2.1 percent of GDP. The remaining measures cover higher assessment of real estate; a temporary crisis levy on profitable firms; presumptive taxation; taxes and levies on unauthorized establishments and buildings; and new gaming royalties and license fees.

Structural fiscal reforms would yield 1.8 percent of GDP in 2013. This includes the results from improvements in budget control and processes (lowering expenditure), and also from improved tax administration (increasing revenue buoyancy). Because it is difficult to quantify the results from structural fiscal reforms, their budgetary effects have been reserved for the end of the program in 2013, but they could give some earlier upside adjustment potential. (Table 1 of the LOI/MEFP includes these effects as expenditure measures.)

These measures protect the most vulnerable. Through means-tested benefits, low-income retirees (nearly two-thirds of retirees of the largest pension fund) are protected from the elimination of the Easter, summer, and Christmas bonus; surcharges to high pensions apply only to the top 10 percent of pensioners; low-earners in the public sector would receive means-tested bonuses to offset the suspension of the Easter, summer, and Christmas payments; cuts in allowances are concentrated in high earners. Additionally, the increase in the basic VAT rate—which is applied to food and likely to affect all groups of the population—is only one percentage point, compared to two percentage points for the standard rate.

Greece: Composition of Measures

(Percent of GDP)

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Sources: Greek authorities; and Fund staff projections.
  • Balancing revenue and expenditure measures. On the one hand, taxes need to be increased, especially from those sectors of society who have previously not carried their fare share of the burden. On the other hand, there is a strong need to scale back the public sector, including public employment and social transfer payments, which together amount to 75 percent of non-interest expenditures. Without a balanced combination of revenue and expenditure effort, it would be difficult to achieve the large adjustment required in the fiscal accounts.

  • High quality measures. Revenue measures have been designed to broaden tax bases, improve the structure and equity of the tax system, and limit the impact on growth. Already the recent tax reform has made the system fairer and more progressive, reducing exemptions and introducing presumptive taxation for those professions that have tended to escape the tax net. Additional measures focus on consumption, green and health taxes, exploiting the previous underused property and excise taxes and imposing a heavy burden on the higher income segments of society. On expenditure measures, the reduction in public sector nominal wages and pensions is path breaking and should help improve competitiveness as the government is a wage leader in the economy. On other spending cuts, staff stressed that firm implementation of the structural reform agenda, including on public enterprise restructuring, and the important and large scale local administration reforms1 will be key to ensure that those cuts are sustainable.

  • Ensuring a fair adjustment burden sharing and protecting vulnerable groups. Revenues are made more progressive by including different elements of labor income in a single harmonized personal income tax base, and the marginal personal income tax schedule has been steepened. Further, the government is utilizing more heavily presumptive taxation to capture more of those who previously were able to stay outside the tax net. On the expenditure side, specific measures are in place to protect the most vulnerable persons in society. For instance, the lower income pension earners are shielded from the elimination of the 13th and 14th pension payment by receiving a compensatory flat annual benefit. This is also the case for low-income civil servants who would otherwise be affected by the wage cuts. Higher income pensioners and civil service have their incomes reduced by more than the average to pay for the compensation at the lower income end. Indeed, the minima have been protected.

18. The large share of upfront measures should help reduce implementation risks to the fiscal program. Nevertheless, risks remain, including lower revenue due to weaker growth, higher social transfers, additional financial sector and public enterprise liabilities, and fiscal data weaknesses. However, the program is built on cautious estimates for the yield from structural fiscal reforms, in particular from revenue administration, and the government has committed to cut discretionary spending further, if needed, to safeguard its fiscal deficit targets. Continuous technical support by the international community to strengthen institutions will be provided to minimize implementation risks. Should revenue turn out higher than projected, the authorities will save the overperformance to achieve a faster return to fiscal sustainability and debt reduction.

Greece: Medium-term fiscal strategy

(Percent of GDP)

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Sources: Greek authorities; and Fund staff projections.

19. The authorities plan a crucial pension reform in 2010. The reform will introduce a new system consisting of a contributory pension to top-up a non-contributory, means-tested pension. The new system will continue to be financed in a pay-as-you-go basis. The planned reform would contain spending by reducing replacement rates (from an average of 75 percent of wages to 60 percent), limiting early retirement (benefits will only be available starting at age 60 for all workers), increasing the normal retirement age in line with life expectancy, and indexing benefits to prices. If these measures are fully implemented, the reform would reduce the increase in pension spending over 2010-50 from 12½ percentage points of GDP to less than 4½ percentage points. Risks stem mainly from partial implementation—using more generous parameters or a slower transition—as many of the details are not yet decided (Annex 2). Therefore, staff recommended an actuarial report to be produced by the National Actuarial Authority to verify the long-term impact of the reform proposal on pension system sustainability before proceeding fully with the new system.

20. The authorities are giving priority to improving management of the health sector, especially of hospitals. The authorities acknowledged health spending has been one of the main culprits of recent fiscal slippages. Thus, following a recent IMF TA mission, they agreed on the need to close budget loopholes and force arrears to be reported to Parliament as they develop (currently they are revealed only about every three or four years, when governments tend to turn over, and no aggressive policy response is discernible). Staff urged the government to immediately start the implementation of double-entry accrual accounting in hospitals, the periodic publication of audited accounts, and the improvement in pricing and costing mechanisms. Additionally, as part of the pension reform, health funds would be separated from pension administration, including achieving a better delineation of tasks and accountability. In the medium term, health-related activities need to be unified under one ministry.

21. Further progress in revenue collections and spending monitoring is critical to the successful implementation of the program.

  • There is an urgent need to strengthen data reporting and the budgetary framework. The authorities agreed that this was critical to restore confidence in fiscal policy formulation and for monitoring the implementation of their consolidation plans. They also agreed that it was important to reprioritize some of the reforms that they already had underway, including efforts to set up an advanced system of program budgeting, which would be too far-reaching for Greece at this moment. Thus, they intend to focus more on the most urgent challenges. They acknowledged that fiscal monitoring needs to be strengthened, including through better budget preparation and approval, a top-down and medium-term focus, and improved commitment controls that are critically lacking. The authorities’ planned reforms address the key issues, and the amendment of the budget law will be timely for these reforms to become effective for the preparation of the 2011 budget. Follow-up technical assistance from the Fund and the EC will assist the authorities in the continuous implementation of these reforms.

  • Improvement in tax administration is also crucial to support fiscal consolidation. Given the wide tax evasion and corruption in tax administration, staff agrees that there is a large revenue base which should be exploited to make the tax system more equitable, efficient, and to increase collections. Effective implementation of the authorities’ recent tax collection initiatives will be key, which should be integrated within a well-targeted anti-evasion plan and reforms in tax administration. However, many of those reforms take time. With this in mind, and as noted above, there was understanding that the yield of those reforms would best be considered later in the program once they were showing material results. Technical assistance from the Fund will help the authorities in this reform process as well.

B. Structural Policies

22. Greece needs a strong program of structural reforms to restore competitiveness and growth. Greece’s price competitiveness gap reflects high administrative costs and inefficiencies, high margins in several sectors, and rising labor costs. Thus, reforms will focus on streamlining public administration and making it more transparent, improving the business climate and seeking better contested markets throughout the economy. Further, to complement public sector pay restraint, the authorities are taking measures to improve wage flexibility in the private sector. The authorities’ agenda in these areas is significantly shaped by long-term discussions and efforts with the EC, as reflected in the broad range of measures covered in the EC MoU annexed to this paper.

  • Public administration. A reorganization of sub-central governments and public entities will be implemented to reduce the number of local administrations, entities and elected and appointed officials. The authorities also plan to reduce risks stemming from state-owned enterprises through greater transparency and to enhance accountability. They further agreed it was necessary to review which state-held assets could be divested in the context of improved asset-liability management with a view to reduce the role of the state in the economy, and improve flexibility and cost competitiveness. Therefore, they intend to publish financial statements of large loss-making state companies, and also prepare a plan to divest state assets to help reduce public debt (structural benchmark for December 2010).

  • Incomes policy. The legal framework for wage bargaining and arbitration in the private sector will be reformed, and entry-level wages will be introduced below the current statutory minimum wage to assist the young and long-term unemployed to find jobs. Employment protection legislation will be revised to facilitate entry and exit in the job market, including for part-time workers, where Greece has ample potential to boost employment.

  • Business environment and competition. The authorities will move forward with a plan to cut red tape facing firms, including by establishing one-stop shops for business start-ups. They will also tackle tariff and other restrictions in important professions (including notaries, road haulage, and in legal, pharmacy, engineering, architect, and auditing professions) where distortions, tax evasion, and excessive cost burdens are known to hamper market functioning. Network industries will be progressively liberalized, the competition authority strengthened, and the EU Services Directive forcefully implemented. Improvements in the absorption of EU structural funds will help bolster the productive capacity of the economy.

C. Financial Sector Policy

23. The immediate challenge for the banks is to manage carefully the current tight liquidity conditions. Greek banks have lost wholesale market access to fund their operations since end-2009 as a result of market concerns about the sovereign debt. Maturing interbank liabilities have not been renewed, or only at high costs, some moderate deposit outflows took place during the first months of 2010, and prices of pledged collateral have fallen, putting pressure on the liquidity position of many banks. As a result, reliance on ECB liquidity has increased. To assist the banks, the government has extended the support package of early 2009 (the portion that was not used at that time), to provide a substantial €17 billion in additional liquidity and is implementing another extension of this support facility, subject to approval by the EC. The announcement by the ECB on May 3 that market debt instruments issued or guaranteed by the Greek government will remain eligible as collateral for repo transactions, independent of rating agencies grading, is anticipated to provide significant relief from liquidity pressures. In the highly unlikely case that these measures were to be insufficient, the existing Eurosystem framework also includes adequate options for national central banks to give support to temporarily illiquid, but solvent institutions against adequate collateral. If such support were given by the Bank of Greece, it would be fully guaranteed by the Greek state in a manner that is consistent with relevant ECB and EU requirements.

24. An additional safety net will be provided by the creation of a FSF. The FSF will bolster confidence in the banking sector by offering additional capital support (Box 4). Declining profitability and the possibility of losses in what could be a drawn-out recession has the potential of eroding capital bases. Thus, the authorities are establishing, through specific legislation, and in consultation with the EC, the ECB, and the IMF, a fully independent FSF funded by the government out of the resources available under the IMF/EC resources under the program (a structural benchmark for end-June). Taking into account the amounts provided by the Fund and the eurozone under the program, the overall resources available to the authorities will be sufficient to fund the FSF. The FSF will have governance arrangements in place that ensure the safeguarding of international financial resources.

25. The primary purpose of the FSF is to ensure that banks in Greece remain adequately capitalized during the downturn to preserve stability. If supervisory assessments conclude that a bank’s capital buffer might fall below adequate levels, shareholders will be invited immediately to bring additional capital or take bridging capital support from the FSF. The capital support program would provide equity to banks in the form of preferential shares that could convert to ordinary shares. When banks are not able to repay the capital support after an adequate amount of time, a restructuring process will be devised for the credit institution. Should the bank fail to meet the targets during the restructuring policies, the shares will be converted at a price in line with EU requirements for competition and state aid.

26. Resources dedicated to banking supervision will be increased to allow for increased supervision. The frequency and speed of data reporting will be increased and the framework for conducting stress-testing of financial institutions will be enhanced. Staffing will be increased both for on-site inspections and off-site review, taking into account the new responsibilities of the Bank of Greece with respect to insurance supervision. Additional flexibility will be introduced in the management of human resources, and all Bank of Greece staff will be granted strong legal protection for actions performed in good faith.

The Financial Stability Fund

Sovereign downgrades, increasing loan impairment, and the deteriorating economic outlook have undermined confidence in the Greek banking sector. The sharp slowdown in economic activity is expected to reflect negatively on banks’ profitability, with the potential of eroding capital bases. To safeguard the soundness of the financial sector, the FSF will be set up to provide banks with a safety net in the event additional capital resources cannot be found from the private sector.

The new entity would provide capital support to the banks through the purchase of preference shares. Such instruments will be convertible in ordinary shares and will have the benefit of strengthening the core capital base of banks. In this way, participation of the FSF in the shareholder base of the banks will be limited, in the first instance. By providing investors with a credibly stronger equity base, it will facilitate banks to re-access capital markets for financing and thus limit recourse to Eurosystem facilities.

After an appropriate amount of time, if the preference shares have not been repaid, the FSF would require a restructuring plan. This would be consistent with the EU legislation requirements for state aid and fair competition. The restructuring plan will be devised by the FSF specifically for the credit institution, in consultation with the Bank of Greece. Should the financial targets set under the restructuring plan not be complied with, the FSF will have the power to convert the preference shares into ordinary shares. The conversion price will be determined by applying the principles of EU legislation on state aid and fair competition.

The FSF will manage its participations in the banks with a view to sell all its holdings in a limited timeframe and to maximize sale proceeds. The FSF will have a duration limited to 7 years to de-couple it from the political cycle. It will make use of its shareholder rights to steer the board of the credit institution in a direction which would maximize its market value. Any shares remaining in the FSF at the time it ceases its activities will be transferred to the MoF.

The MoF will fund adequately the FSF from the proceeds of the IMF-eurozone credit disbursement to Greece. The amount of funds destined for the FSF will be €10 billion, which would accommodate expected losses under a stress-test scenario. The resources made available by the eurozone and the IMF under the program are more than sufficient to cover this amount

The FSF will be independent, transparent and accountable. Appointees by the Bank of Greece, the Governor of the Bank of Greece, and the Ministry of Finance will sit on the board, while the appointees by the ECB and the EC will have the right to participate in board meetings as observers. The power of the Governor of the Bank of Greece to nominate its director is expected to give it some distance from domestic treasury operations. However, the FSF will report regularly to the Greek parliament, the EC, the ECB, and the IMF staff.

27. The authorities intend to strengthen additional elements of the legal framework to promote efficient intermediation. The current proposal for the personal insolvency law will be strengthened to ensure that strong credit discipline is maintained, creditor and consumer rights are protected, and important information concerning borrower’s history is not lost.

28. The authorities will maintain close coordination with home and host country authorities within the EU framework of cross border banking supervision. A number of MOUs have been signed with host supervisory authorities to clarify and strengthen supervisory arrangements in countries where Greek banks have a significant presence, notably in SEE.

VI. Program Modalities

A. Access, Phasing, Conditionality

29. The authorities request a three-year SBA in an amount equivalent to SDR 26.4 billion, or 3,212 percent of the quota (€30 billion), with a frontloaded disbursement of €5.5 billion2; the eurozone members are expected to contribute €80 billion to the overall financing package. With this large backstopping of exceptional financing from the eurozone and the Fund, the program assumes that the government would continue to issue T-bills for the program period (keeping the stock at around €8 billion), but the rollover of medium- and long-term debt from the private sector will only be gradually restored, starting in 2012. The total external financing gap for the fiscal program is projected to be around €110 billion, within which resources for the FSF are expected to be €10 billion. In the event that the program unlocks a better-than-projected private sector response, program financing could be reduced, pari passu with eurozone countries’ assistance. Greece’s external debt service profile will give rise to a substantial need on the part of the authorities to make external payments over the program period that will be met, in part, from the purchases from the Fund.

30. The scope for increasing market access will be explored. The strength of the program and the scale of official support are expected to catalyze market access over time as the authorities demonstrate their success in adhering to the program. There may be scope to bolster this by seeking coordinated voluntary rollover understandings among creditor groups (similar in spirit to the European Bank Coordination Initiative), although the dispersion of government debt holdings may make it difficult to build a critical mass for such understandings. Prudent debt management could also help lengthen debt maturities to reduce bunching in the post program period. Banks largely rely on a traditional deposit-based model, and reliance on foreign funding, with the exception of overnight funding, is relatively low, so potential gains from coordinated rollover initiatives for the financial sector may be modest.

31. Program conditionality is focused on comprehensive monitoring of the fiscal performance. Quantitative performance criteria include ceilings on the primary deficit of the central government (or state) budget and changes in financial asset of the social security funds and local authorities in the banking system; the level of primary current expenditure; and new government guarantees. In addition, the program will seek to gain better insight in the performance of key public enterprises, beginning with publication of their financial accounts.

32. Given the large structural reform agenda with leadership of the EC, structural benchmarks for the Fund-supported SBA are set on fewer but more macrocritical reforms. They include modernizing public administration, streamlining the local authorities, improving data reporting and budget framework, reforming social security, reducing risks from the state-owned enterprises, and enhancing tax administration.

B. Exceptional Access Criteria

33. The proposed Stand-By Arrangement entails exceptional access. Staff’s evaluation of the criteria for granting exceptional access is as follows:

  • Criterion 1: The member is experiencing or has the potential to experience exceptional balance of payments pressures on the current account or the capital account resulting in a need for Fund financing that cannot be met within the normal limits. This criterion is met as heightened market concerns have led to a sharp increase in sovereign spreads and, as a result, market access is restricted to an extent that would make it impossible to cover financing needs within normal limits. Greece’s large rollover requirements on maturing foreign obligations result in significant pressures on the capital account.

  • Criterion 2: A rigorous and systematic analysis indicates that there is a high probability that the member’s public debt is sustainable in the medium term. Under the staff baseline, public debt will increase to almost 150 percent of GDP and then decline after 2013, provided that the authorities continue to implement strong and sustained fiscal and structural reforms to comply with their commitments under the Stability and Growth Pact, and Greece regains market access at favorable terms. However, significant uncertainties remain. The initial level of government debt is very high (115 percent of GDP in 2009), it may be revised upwards by 5-7 percentage points according to Eurostat, and the realization of hidden and potential liabilities may increase it further. Moreover, debt dynamics may significantly worsen under weaker economic growth, lower inflation, or higher real interest rates, in particular after the program period when gross market financing needs increase significantly. On balance, staff considers debt to be sustainable over the medium term, but the significant uncertainties around this make it difficult to state categorically that this is the case with a high probability. Even so, Fund support at the proposed level is justified given the high risk of international systemic spillover effects. Going forward, such an approach to this aspect of the exceptional access policy would also be available in similar cases where systemic spillover risks are pronounced.

  • Criterion 3: The member has prospects of gaining or regaining access to private capital markets within the timeframe when Fund resources are outstanding. This criterion is met. Greece’s reduced access to capital markets reflects heightened sustainability concerns, linked to its precarious fiscal situation and problems with fiscal data reporting, and a re-evaluation of sovereign risk following the global financial crisis. Successful implementation of a strong program, in combination with undertakings of Greece’s EU partners to stand ready to provide financial assistance, would help address market uncertainty. With improved fiscal management and structural reforms, Greece is expected to gain policy credibility and normalize access to capital markets within the timeframe when Fund resources are outstanding.

  • Criterion 4: The policy program provides a reasonably strong prospect of success, including not only the member’s adjustment plans but also its institutional and political capacity to deliver that adjustment. While Greece’s past track record of structural and fiscal reform implementation is mixed and the adjustment needed is large, a number of considerations lead staff to conclude that this criterion is met. In particular, the current government, since taking office in October, has already implemented strong measures and demonstrated its willingness to tackle the challenges ahead. Additionally, the economic reforms that would be supported by a Fund-supported SBA are backed at the highest political levels in both Greece and among its EU partners—the politically most difficult measures are being passed by Parliament before Board approval. Finally, the government’s institutional capacity to deliver the program’s adjustment will also be strengthened by ongoing technical support from the Fund and the EU.

C. Capacity to Repay the Fund and Risks to the Program

34. With disciplined program implementation, Greece’s debt is expected to be sustainable in the medium term, and its repayment capacity to be adequate. Given no outstanding use of Fund resources, the Fund’s cumulative exposure to Greece will remain manageable, albeit high, by the end of the program. Outstanding credit to the Fund is expected to peak in 2013 at about 12 percent of GDP, and debt service to the Fund as a ratio of exports of goods and services will peak at 17 percent (Table 8). However, overall debt service will rise sharply after the program: payments to both the Fund and EU would peak at 62 percent of exports of goods and service, and about 17 percent of GDP in 2015. These metrics suggest that successful access to the market will be critical for Greece’s repayment capacity to the Fund. Tapping the markets earlier and active debt management can help to smooth the repayment profile. At the same time, the risks to the Fund are mitigated by the long-standing Fund’s preferred creditor status in relation to other private and official bilateral creditors. In addition, fiscal adjustment and the resumption of growth are expected to offer powerful assistance to place the debt on a declining path from 2013 onwards.3

35. That said, there are also substantial risks to the program. Restoring competitiveness through internal price adjustment while implementing fiscal consolidation is very challenging, and the margin to respond to negative shocks is limited at this early stage.

  • Growth may be weaker than projected. Given the size of adjustment effort and still a tentative external growth environment, Greece may experience a deeper upfront contraction. While a moderate shock could be accommodated, persistently weaker growth would have a powerful negative effective on debt dynamics (Annex 1 and Annex 3).

  • The large multiyear fiscal and structural adjustment requires a decisive break from past behavior. Greece has run into fiscal problems before, which were often resolved only temporarily and by stop-gap measures. A decisive break now requires strong political will and public support. Mitigating factors include a strong mandate of the governing party and measures in the program to protect vulnerable groups.

  • Debt sustainability analysis assumes that the headline primary surplus will improve on a sustained basis by 2.9 percentage points after the end of the program, as agreed between the authorities and eurozone partners. The public debt would still decline, but at a much slower pace, with smaller primary surpluses.

  • Restoring market access. Greece’s access to private capital markets in 2012 and later years may be more constrained than has been assumed, particularly under any of the adverse shocks shown in the debt sustainability analysis.

  • Absent exchange rate flexibility, sustained wage discipline by both the public and private sectors is required to improve competitiveness. With weak growth, the needed increase in public and private savings will be challenging.

  • The side effects of the adjustment could make fiscal consolidation difficult. Wage and price deflation, and contraction in activity could lead to sharp reductions in tax revenues.

  • Financial sector conditions could deteriorate quickly, bringing with it sizable fiscal consequences. Low growth, deteriorating asset quality, and higher funding costs could all weigh on the banking sector. Potential bank solvency problems may require more public resources in resolution, which would further increase the government’s debt burden. There is also a risk of a loss of confidence in banks leading to rapid liquidity needs. The establishment of the FSF and the availability of liquidity support from the ECB and the Bank of Greece will help to manage these risks.

  • Data weaknesses continue to pose a risk. While the authorities are making strong efforts to address data reporting deficiencies,4 the accuracy and reliability of fiscal and national accounts data remain a concern, and they have continued to be revised significantly. Also, frequent revisions in the level and composition of GDP affect the calibration of the fiscal program and assessment of the strength of policies. Staff will monitor implementation of the measures in the joint Greek government and European Commission Statistical Action Plan to address these concerns. Assistance from a resident technical advisor (financed by the European partners) and close cooperation with Eurostat will help to assess and manage these data risks. The authorities have also agreed to host a Fund resident representative.

  • Coordination with EC and ECB may pose complications. To help ensure that all institutions have consistent views in assessing program performance, the joint IMF/EC/ECB team will remain in close contact between missions, so that differences of view and assessment of developments can be identified and aired early and reconciled.

36. In accordance with Fund policy, staff has initiated the safeguards assessment of the Bank of Greece, and the assessment is expected to complete by the time of the first review. IMF funds will be deposited in the government account at the Bank of Greece.

VII. Staff Appraisal

37. Mounting concerns that the authorities are not coming to grips with the entrenched dual problem of lack of competitiveness and a highly unsustainable fiscal position has led to a loss of market access. Greece has also lost access because of increasing doubts about whether its eurozone partners stood ready to provide timely and effective support.

38. The new Greek authorities have risen to the challenge by embarking on a bold multi-year program that is extraordinary in terms of the scale of planned adjustment and the comprehensiveness of reforms. Greece’s European partners, in cooperation with the IMF, are responding with an equally extraordinary three-year promise of unprecedented financial support to help see Greece through what will undoubtedly be a socially difficult period of adjustment and reform.

39. The fiscal program is impressive. The scale and the frontloading of the adjustment are unprecedented. Moreover, the decision to specify all measures for the entire full three-year period at the outset, together with the good balance between revenue and expenditure measures, adds to the program’s credibility. So does the reliance in the first two years on concrete measures that have an easily projected impact. Thus, while Greece stands to reap significant gains from reforms to tax administration and expenditure controls, such gains are invariably difficult to project, and the program’s assumptions in this regard are appropriately conservative.

40. Staff strongly welcomes the ECB’s recent decision regarding Greek government bonds. This decision in effect ensures markets that such bonds will remain eligible for repo transactions, removing a serious uncertainty that had continued to weigh on banks’ willingness to hold such bonds. With this change, the liquidity facilities available to Greek banks, including the mechanism for provision of emergency liquidity through the Bank of Greece, are in staffs view appropriate.

41. While Greek banks have weathered the global crisis well and are comfortably capitalized, the decline in economic activity that lies ahead could expose vulnerabilities. The establishment of a FSF that stands ready to inject funds in the case that a bank’s capital gets impaired is a very important precautionary measure. The management of this fund must consist of independent experts, to ensure that affected banks quickly return to viability.

42. The program’s long-term success hinges on deep and comprehensive structural reforms—to make labor markets much more flexible, to eliminate pervasive barriers to entry and unleash competition, and to reform state enterprises, among other important goals. Without such reforms, Greece would not restore competitiveness, growth and real incomes will remain stagnant and unemployment high, and the debt burden would eventually prove unsustainable. The authorities’ structural reform program is ambitious, concrete and time-bound plans remain to be fully specified in important areas. In this regard, staff finds privatization plans disappointing and is concerned that plans for reform of state enterprises are weak. While the government’s focus has understandably been on the immediate fiscal measures needed to restore market confidence, it must now focus attention on structural reforms, building on the considerable diagnostic work that already has been done in this area in cooperation with the EC.

43. The authorities feel that reforms to boost productivity will be key to restoring competitiveness and that the level of wages in the private sector is less of a problem in this regard. They, therefore, decided not to extend the elimination of the 13th and 14th wages in the private sector, or to undertake other top-down measures to lower wages. Staff agrees that reforms are crucial, but believes—considering the time that it will take for them to take hold—that it is also necessary for private sector wages to decline in order to restore competitiveness. Staff agrees that wage reduction is likely to occur without top-down measures as economic activity declines and labor market pressures ease in the coming years, but such measures should be contemplated if this were not to be the case.

44. The adjustment that lies ahead will be socially painful. While all segments of Greek society will feel the burden, staff strongly welcomes the measures to mitigate the impact on the most vulnerable groups, not least the decision to shield people with low wages and pensions from the impact of wage and pension cuts.

45. The strength and frontloading of the program creates the basis for a rapid improvement in market sentiments. A challenge in this regard is that—with no recourse to exchange rate changes and because the economy is relatively closed—the large fiscal adjustment will be associated with a notable decline in nominal GDP and an attendant contraction in the tax base, causing debt-to-GDP to rise initially from an already high level, before beginning to decline at the end of the program period. However, the sharp improvement in the primary balance—it will turn positive already in 2012 after a deficit of 8.6 percent of GDP in 2009—points to an early, rapid underlying improvement. And as reforms begin to engender a supply response, the debt-to-GDP ratio will begin to decline apace.

46. Nevertheless, the scale of the challenge facing the authorities means that it could take some time for markets to regain confidence. Should this be the case, the size of the external support implies that the authorities have 1-2 years to demonstrate resolve and built a convincing track record before they need to return to the market. The combination of strong frontloading of measures and large external support is in staffs view key to the program’s credibility.

47. Still, there are obvious risks. Fierce resistance from entrenched vested interests has stalled reforms in the past and the burden of adjustment will test the cohesiveness of Greek society. Downwardly rigid private sector wages and prices given inflexible markets are a further risk, as is the possibility of yet higher interest rates. Further, loss-making public enterprises could yet present additional pressures on the budget, and risks to banks are also acute until confidence in a strong downward path for the fiscal deficit takes firmer hold. External risks include the possibility of negative spillover from other highly indebted countries in the region. As the high indebtedness leaves little room for maneuver, the government must stand ready to take early and forceful corrective actions to make sure that the program remains on track. In this regard, the very strong measures taken by the government in early 2010—before entering into discussions on a program that could be supported by eurozone countries and the Fund—is evidence of its determination and commitment. This augurs well for the program.

48. While risks regarding debt sustainability are undeniably high, the Fund’s support is nevertheless justified given the new government’s strong initiatives and the substantial cofinancing by the eurozone countries, coupled with the systemic concerns arising from spillover effects if Greece were not given an opportunity to improve its economic policies. In view of Greece’s balance of payments needs and the comprehensive package of adjustment measures already taken and proposed by the authorities, the staff supports the authorities’ request for an SBA in an amount equivalent to SDR 26.4 billion.

Table 1.

Greece: Selected Economic Indicators

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

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

Excluding unidentified measures.

Measures fully identified up to 2013.

As of January 2010.

Domestic credit growth of households and enterprises.

Table 2.

Greece: General Government Operations, 2009–15

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Sources: Greece authorities, and IMF staff estimates.

Excludes the measures supporting the program targets, but the package of 5.2 percent of GDP in effective measures taken under the March Stability Program.

Table 3.

Greece: Public Sector Financing Requirements and Sources

(Billion of euros, unless otherwise stated)

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Sources: Ministry of Finance; and IMF staffs projections.
Table 4.

Greece: Summary of Balance of Payments, 2009–15

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Sources: Bank of Greece; and IMF staff estimates.
Table 5.

Greece: External Financing Requirements and Sources, 2009–15

(In billions of euros)

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Sources: Bank of Greece, Bloomberg, and staff estimates and projections.

Includes liabilities to Eurosystem related to TARGET (e.g. ECB repo transactions).

Includes market instruments and trade credits.

Table 6.

Greece: Core Set of Financial Soundness Indicators for Deposit Taking Institutions, 2000–09


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Source: Bank of Greece.

Data on a consolidated basis.

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 7.

Greece: Access and Phasing under the Proposed Stand-By Arrangement, 2010–13

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Source: IMF staff projections.
Table 8.

Greece: Indicators of Fund Credit

(Millions of euros, unless otherwise specified)

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Source: IMF staff projections.