Greece
Fourth Review Under the Stand-By Arrangement and Request for Modification and Waiver of Applicability of Performance Criteria

This study is carried out against a backdrop of deep divisions in Greece and in Europe over how to handle the challenges now confronting Greece. Greece’s deeper medium-term policy needs and identifying ways to replace the expected market financing are discussed. Structural reforms tackled to strengthen the competitiveness and help the country integrate into the euro area. Finally, Greece has specified the policies necessary to overcome recent inertia and deliver program objectives, and a memorandum of financial and economic policies is discussed.

Abstract

This study is carried out against a backdrop of deep divisions in Greece and in Europe over how to handle the challenges now confronting Greece. Greece’s deeper medium-term policy needs and identifying ways to replace the expected market financing are discussed. Structural reforms tackled to strengthen the competitiveness and help the country integrate into the euro area. Finally, Greece has specified the policies necessary to overcome recent inertia and deliver program objectives, and a memorandum of financial and economic policies is discussed.

I. Background

1. The review took place against a backdrop of deep divisions in Greece and in Europe over how to handle the challenges now confronting Greece. Within Greece, opposition escalated to the reforms in the authorities’ program. An effort to achieve broader consensus with the opposition political parties failed, but the government was able to secure internal consensus in the governing party, after a reshuffle of the cabinet (which included the replacement of the Minister of Finance). Within Europe, confidence in the authorities’ resolve to implement the program waned, and strong opposition emerged to extending additional financing to Greece, leading to a very public discussion about options for private sector involvement (PSI). European leaders eventually reached a consensus in early July to continue supporting the authorities’ program, after program prior actions had been met.

II. Recent Developments

2. Market sentiment has taken a sharp turn for the worse (Figure 1). Open discussions of Greece’s financing challenge and euro-zone countries’ insistence on private sector involvement to resolve this have convinced markets that Greece will restructure its debt. The latest market surveys indeed suggest that about 95 percent of participants expect this outcome. As a consequence, since March, spreads on 2-year and 10-year debt over German bunds have soared to record highs, exceeding 2650 bps and 1400 bps, respectively. Rating agencies have at the same time downgraded Greece to near-default status, with current ratings now at CCC (Standard & Poors), Caa1 (Moody’s), and B+ (Fitch).

Figure 1:
Figure 1:

Greece: Financial Indicators

Citation: IMF Staff Country Reports 2011, 175; 10.5089/9781462300204.002.A001

Sources: Bloomberg; and Moody’s Creditedge.

3. Greece is adjusting in macroeconomic terms, although the deep recession is driving the process, and productivity gains are not yet apparent (Table 1):

Table 1.

Greece: Selected Economic Indicators, 2006-11

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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 (Eurostat).

Loans to corporations, up to 1 year. 2010 as of November.

Domestic credit growth of households and enterprises.

  • Indicators of economic activity suggest that the decline in domestic demand continued unabated in the first quarter of 2011. Improving net exports continue to offer some offset. The decline in output shows signs of moderating, but overall the drop amounts to some 7¾ percent from its 2008 peak. Unemployment has risen sharply, exceeding 16 percent in March 2011. Leading economic indicators have been mixed, with industrial turnover and new industrial orders from abroad as well as hotel bookings increasing slightly, while activity in the construction and services sectors is still on the decline and economic sentiment still deteriorating (Figure 2).

  • Competitiveness is improving, as nominal wage declines outstrip a drop in productivity. Nominal labor costs (both wages and non-wage labor cost) continued to decline at a fast clip in the first quarter of 2011 (-6.8 percent year-on-year). But with output still falling faster than employment, productivity dropped by ¼ percent year-on-year. Overall, the ULC-total-economy-deflated REER improved by around 6 percent in 2010 from a point of significant overvaluation (Figure 3), and has continued to fall in the first quarter of 2011.

  • Headline inflation (HICP) has been receding as the impact of early 2010 indirect tax increases dissipates. It reached 3.1 percent in May, a level very close to the Euro area average (2.8 percent). Core inflation declined to 1.7 percent (from 2.8 percent in March), while inflation at constant taxes—at 1.3 percent in April 2011—has been below the Euro area average since mid-2010.

Figure 2.
Figure 2.

Greece: Selected Indicators

(Year-on-year percent change, unless otherwise indicated)

Citation: IMF Staff Country Reports 2011, 175; 10.5089/9781462300204.002.A001

Sources: National Statistical Service; Eurostat; and IMF staff calculations and estimates.
Figure 3.
Figure 3.

Greece: Competitiveness Indicators

(Year-on-year percent change, unless otherwise indicated)

Citation: IMF Staff Country Reports 2011, 175; 10.5089/9781462300204.002.A001

Sources: Eurostat; World Economic Forum; and IMF staff calculations.1/ Includes 184 countries, estimated for 1973-2009.
A01ufig01

Headline Inflation and Inflation at Constant Taxes

(in percent)

Citation: IMF Staff Country Reports 2011, 175; 10.5089/9781462300204.002.A001

Source: Eurostat.
  • The current account deficit continues to shrink gradually (Figure 4). Data for the first quarter of 2011 show a year-over-year improvement of about 25 percent in euro terms (the trailing 12 month deficit now sits at 9½ percent of GDP). The contribution of exports has continued to grow (supported by receipts from manufactured products), while import reductions, although still sizeable, have been slowed down by rising oil prices. An increase in current transfers to the general government, mostly originating from the EU, has also been important.

Figure 4:
Figure 4:

Greece: Balance of Payments

Citation: IMF Staff Country Reports 2011, 175; 10.5089/9781462300204.002.A001

Sources: Bankof Greece; and IMF staff calculations.

4. High spreads and accelerated deposit withdrawals have placed the banking system under renewed pressure (Tables 2-3, Figure 5):

Figure 5.
Figure 5.

Greece: Money and Banking Indicators

Citation: IMF Staff Country Reports 2011, 175; 10.5089/9781462300204.002.A001

Sources: NationalStatistical Service; Bank of Greece; Bloomberg; ECB; and IMF staff calculations.1/ Scale: 1= tightened considerably; 2= tightened somewhat; 3=remain unchanged; 4=eased somewhat 5= eased considerably2/ 1= decreased considerably; 2= decreased somewhat; 3=remain unchanged; 4=increased somewhat; 5= increased considerably
Table 2.

Greece: Monetary Survey

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Source: Bank of Greece and IMF staff estimates and projections.

As of June 2010, securitised assets are no longer derecognised from the balance sheet of banks that have adopted the International Accounting Standards. The counterpart of these assets is recorded on the liabilities side as deposit liabilities to non-euro area residents.

Holdings of securities other than shares and derivatives.

Credit to domestic non-MFI residents by domestic MFIs excluding the Bank of Greece, including securitized loans and corporate bonds.

Growth rates are calculated from differences in outstanding amounts adjusted for revaluations, exchange rate valuation differences, reclassifications and any other changes which do not arise from transactions.

Rates of change based on actual net flows (i.e. adjusted for reclassifications, valuation adjustments, and write-offs).

Rates of change based on reported end-of-period stocks.

Table 3.

Greece: Banking Sector Uses and Sources of Funds

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Source: Bank of Greece and IMF staff estimates and projections.

As of June 2010, securitised assets are no longer derecognised from the balance sheet of banks that have adopted the International Accounting Standards. The counterpart of these assets is recorded on the liabilities side as deposit liabilities to non-euro area residents.

Holdings of securities other than shares and derivatives.

June 2010 reclassification related to liabilities associated with assets disposed of in a securitisation but still recognised on the statistical balance sheet.

  • Liquidity needs are acute. Steady deposit withdrawals, linked to the contracting economy, continued through April, but the pace has accelerated significantly since then, with depositor confidence undermined by the public discussions of PSI. Recent ratings downgrades have also led to a decrease of value on Greek collateral by the European Central Bank (ECB), necessitating banks to post additional collateral. Wholesale funding markets remain closed, and exceptional ECB liquidity support has grown.. Contrary to program expectations, the ECB Governing Council has not taken a decision on whether to accept as eligible collateral the proposed new €30 billion tranche of government guaranteed bank bonds.

  • Banks’ financial profiles continue to weaken (Table 4). Profitability is under strong pressure. The three largest Greek banks reported sharply lower net income for 2010 and the first quarter of 2011, with very weak domestic performance only partly counterbalanced by better profitability from operations in Southeastern Europe. Several smaller banks posted a net loss in 2010, including three partly state-owned banks and two large subsidiaries of foreign banks. Asset quality continues to deteriorate, with the system’s nonperforming loan ratio having worsened from 10.4 percent at end-2010 to 11.5 percent in March 2011 (significantly above the European average). Provisioning for bad loans increased 18 percent during Q1 2011, but notwithstanding this, provision coverage has fallen to a level below the average in a representative sample of large European banks (45 versus 57 percent). The stock of restructured loans also increased significantly, and now represents 3.7 percent of loans.

  • Banks have been reinforcing their capital levels, but their market value remains depressed due to their exposure to sovereign bonds. Contrary to expectations, no bank has required public capital support since program inception. In the wake of successful rights offerings, all large private banks have raised their regulatory Tier I capital ratio above the 10 percent bar, and the system average now stands at 11 percent (in line with the European average). In the state banking sector, ATE bank has finalized a recapitalization, which will raise its Tier I capital ratio to 11 percent (with the government injecting about €420 million net). Still, banks’ combined market value of €13 billion falls well-short of their reported Tier I capital of €30 billion, with markets discounting the value of Greek sovereign exposures in banks’ held-to- maturity portfolios.

  • There remain fragilities among small banks. One of the two small banks that was flagged as very fragile during the third review mission has been audited by external auditors and inspected by the Central Bank, has strengthened its capital to meet regulatory requirements, and is scheduled to increase it further within 12 months. Regarding the second one, its 4½ CAR falls well short of the 8 percent minimum, and it has been pursuing a merger with its major shareholder.

Table 4.

Greece: Financial Soundness Indicators

(Percent)

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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).

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

Based on revised figures from 2002 onwards.

5. Bank stress is being transmitted to the private sector. Credit to households continued to contract in the first four months of 2011, while corporate credit growth has remained marginally positive, mainly for short-term trade credits. Lending spreads on new loans have continued to increase, in particular for households. While there is no evidence of an overly rapid deleveraging, weak economic activity is relentlessly dampening demand for loans, and there is evidence that banks are increasingly curtailing new lending and rollovers of maturing loans to deal with their liquidity stress.

6. The fiscal position has stalled at a primary deficit of around 3½ percent, as progress with underlying reforms has lagged behind (Table 5; Figure 6)

Figure 6.
Figure 6.

Greece: Budget Execution up to end-May 2011

Citation: IMF Staff Country Reports 2011, 175; 10.5089/9781462300204.002.A001

Sources: National authorities; and IMF staff calculations.1/ Survey results. Data refer to end-April 2011 and include arrears predating 2010 (pure stock data). 2/ Hospital arrears include 0.1 billion of arrears not yet settled out of the total stock of 5.3 billion of arrears to suppliers known at end-2009. 3/ Social security arrears include 0.9 billion of arrears on lump sum payments to civil servant pensioners related to 2009 and 2010.
Table 5.

Greece: Modified General Government Balance for Program Monitoring

(in billion of Euro)

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Source: Greek Ministry of Finance and Fund staff projections.

Including measures taken in the context of the Medium Term Fiscal Strategy, passed by parliament on June 29, 2011.

For the personnel of the Public Power Company.

Such transfers are excluded from spending for measurement of the PCs in 2010.

Change in net financial assets. Excludes valuation changes.

Including balances of reclassified public enterprises

Cash to accrual, coverage, and other ESA adjustments.

  • Final data suggest a 5 percent of GDP fiscal consolidation in 2010. The ESA95 deficit appears to have settled at 10½ percent of GDP, ¾ percent of GDP higher than earlier estimated, but the adjustment is still impressive in the context of the recession. Accrual data, only available in March, show that ongoing weaknesses lie behind this outcome, in particular poor revenue collections for end-2010 and a weaker outturn in the social security sector. The end-2010 stock of arrears (excluding pre-2010 health arrears) reached 2.2 percent of GDP including about 2 percent of GDP accumulated in 2010 (which is already captured in the ESA outcome estimate).

  • First quarter 2011 targets were met, with the help of temporary factors. Cash revenue collections fell 0.6 percent of GDP short of expectations, reflecting weaker-than-expected retail sales. Arrears also continued to increase (to 2.6 percent of GDP excluding pre-2010 health arrears), offsetting state budget under execution of 0.6 percent of GDP. However, earlier-than-expected EU grant inflows (¼ percent of GDP) and better non-state balances—which benefited from delayed budget implementation in local governments following November elections—allowed the targets to be met. This pattern of performance has continued through end-May, with the budget running about 0.1 percent of GDP ahead of the program target.

  • Reforms of fiscal institutions are progressing, although results are materializing slowly (Table 6). Parliament passed in March tax legislation to remove several legal and administrative obstacles to effective revenue administration, and in April, the Ministry of Finance published its first comprehensive anti-tax-evasion action plan (which subsumes and extends the plans and targets of the anti tax evasion task forces set early in the year). Concerning spending controls, accounting officers have been appointed in all general government entities, and, on an interim basis, in line ministries. Commitment controls have been introduced but have been slow to take hold (in March only 35 percent of line ministries appeared to be fully reporting results from the registers, and arrears continue to climb). Delays appear to be due to capacity and organizational constraints. Fiscal and arrears reporting coverage has improved with data now covering aggregate revenue and spending data for almost all general government units, after sanctions unlocked better response rates. However, the quality of data, particularly arrears data, remains to be improved.

Table 6.

Greece: Status of Macro-Structural Reforms

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Source: Greek authorities.

Data as of June 23, 2011.