Greece: First and Second Reviews Under the Extended Arrangement Under the Extended Fund Facility, Request for Waiver of Applicability, Modification of Performance Criteria, and Rephasing of Access Supplementary Information

Greece’s deep recession has continued unabated, with the economy struggling to gain traction against domestic political instability and weak external conditions. Stronger internal devaluation is now under way, reflecting the interaction of labor market liberalization with the already weak labor market. Current account adjustment has accelerated, notwithstanding slow progress with structural reforms. The structural transformation of Greece’s economy continues to proceed at a slow pace, and this is making Greece’s adjustment more costly. Institutional reforms continued to disappoint during 2012, again complicating overall adjustment efforts.

Abstract

Greece’s deep recession has continued unabated, with the economy struggling to gain traction against domestic political instability and weak external conditions. Stronger internal devaluation is now under way, reflecting the interaction of labor market liberalization with the already weak labor market. Current account adjustment has accelerated, notwithstanding slow progress with structural reforms. The structural transformation of Greece’s economy continues to proceed at a slow pace, and this is making Greece’s adjustment more costly. Institutional reforms continued to disappoint during 2012, again complicating overall adjustment efforts.

1. This supplement provides information that has become available since the staff report for the first and second reviews under the extended arrangement was issued. The authorities have made further progress with program implementation, and while in a few areas there was some loss of momentum, the authorities have committed to catch up by the time of the next review. Thus the thrust of the staff appraisal remains broadly unchanged.

Recent Economic Developments

2. Recent developments point to continued adjustment against a recessionary backdrop, together with a continued recovery of bank deposits.

  • The economy remains very weak. Industrial production dipped 3.5 percent year-on-year in October, in line with program assumptions, while the unemployment rate continued to climb, reaching almost 27 percent (seasonally adjusted).

  • Disinflation is running slightly ahead of expectations. CPI inflation for 2012 was 1 percent (average) and 0.3 percent (end-period), versus staff projections of 1.2 and 1.3 percent, respectively. Meanwhile, core inflation was -0.1 percent (average) and -0.9 percent (year-end) in December.

  • External adjustment continues apace. The October current account outcome was in line with staff projections. Data show continued sharp import contraction (down 11.7 percent in January–October, year-on-year) and positive but low growth of exports (up 0.3 percent).

  • The recovery of deposits has gained significant momentum. Greek banks saw an inflow of €4.9 billion (3.3 percent) in private deposits in December, with a notable acceleration following the European partners’ approval of the review. This marks the fourth consecutive month of net inflows.

Program Implementation

3. Recent policy developments point to continued progress with implementation, but a few problems with full and timely observance of benchmarks. Since issuance of the staff report, information has become available about quantitative targets, remaining prior actions, structural benchmarks, other MEFP commitments for end-2012, and adherence to conditions for the January European loan tranche.

Quantitative targets

4. Available data confirm that one quarterly performance criterion for end-December has been met, and one indicative target has been missed. The end-December performance criterion on external arrears was met. Data on the remaining end-December performance criteria are not yet available (the authorities’ Letter of Intent requests the appropriate waivers of applicability), but we expect them to have been met. Preliminary data indicate that the indicative target of €3.2 billion for privatization revenues in 2012 was missed, with realized revenues of only €6 million. As discussed in the staff report, this reflects the standstill in privatization for several months around the elections, and the absence of the Privatization Fund board for an extended period. Data on the other indicative target on domestic arrears are not yet available.

Prior actions

5. The authorities were not able to complete every subcomponent of one fiscal prior action, but they took compensating actions. One element of the fiscal prior action mandated signing an MoU between the government and owners of the merchant fleet to ensure payment of tonnage tax aimed at raising €80 million in 2013 and €140 million each year in 2014–16. The MoU has not yet been signed. However, separate legislation was passed that imposes tonnage taxes, which is expected to yield €75–80 million per year starting in 2013. The authorities expect to sign the MoU with Greek ship owners after their annual meeting on February 8. This would raise a further €60–65 million per year starting in 2014, bringing the revenues from new shipping taxes to the total envisioned in the MEFP. Since the authorities also raised the withholding tax on deposits to 15 percent in 2013 (a year earlier than envisaged), staff does not foresee a fiscal gap from the delayed completion of this measure.

Structural benchmarks

6. Parliament passed a tax bill that broadens the tax base, simplifies the tax system, and contributes towards the fiscal adjustment effort. With passage of this bill, staff considers that the authorities have also met the overdue program structural benchmark on tax reform (scheduled for end-June 2012). As noted in the staff report, there will be a second stage of the tax reform in May 2013, which will focus largely on the tax code as well as further income tax simplification. It was agreed with the authorities that this legislation would also address requirements for taxpayers to collect receipts (an activity that delivers minimum benefits while imposing significant burdens), and residual issues in the taxation of income from real estate.

7. The authorities do not appear to have met the three structural benchmarks for end-December under the program.

  • Meeting targets for key performance indicators for revenue administration. These indicators target improvements in the collection of tax debts and expansion of tax audits, among other things. Data is not yet available, but based on end-November outcomes staff considers it highly unlikely that the targets for end-December will be achieved. As noted in the staff report, lack of leadership and political commitment has taken a toll on reform efforts this year, and the authorities do not appear to have been able to catch up during the fourth quarter. The appointment on January 10 of a new head of the tax administration will address the leadership vacuum in the organization, and this can help set the stage for better performance in 2013. The authorities committed to set key performance indicators for Q1 2013 and achieve these before completion of the next review.

  • Quarterly performance indicators for public financial management. The indicators cover the adoption of commitment registers across the general government, and improvements in data reporting from commitment registers. As of end-November, only 66 percent of entities were reporting, versus a target of 90 percent for end-year. Again, it is unlikely that this ground was made up in December. However, the implementation of General Directorates of Financial Services underway in all line ministries (to improve expenditure control) is one step to improve performance in 2013. The authorities committed to set key performance indicators for Q1 2013 and achieve these before completion of the next review.

  • Screening and cleaning of existing legislation on a list of regulated professions. The authorities have taken actions to liberalize regulated professions (prior action), and as reported in the staff report, the vast majority of professions have now been addressed. However, the review of legislation for restrictions on remaining professions and economic activities is still underway. Draft legislation has been prepared that would partly implement this benchmark, and the authorities expect full implementation not later than end-March.

Other structural reforms

8. Financial sector restructuring continues to progress. The HFSF has provided bridge capital to raise core tier one ratios of the four core banks to 9 percent, using funds disbursed by Greece’s European partners in December. The resolution of Hellenic Postbank via a purchase and assumption transaction (end-January structural benchmark) is expected to be completed next week. The four core banks (three after the pending merger between National Bank of Greece and Eurobank is completed) are integrating previous acquisitions and have not been able to make acceptable binding offers for Postbank. In the event that a P&A transaction is not feasible, resolution of Postbank via a bridge bank structure may be necessary.

9. A number of other actions contained in the MEFP for end-December 2012 have been completed, although some actions are still pending. Completed actions include increases in end-user prices for low voltage electricity customers, with further increases expected in May and July that will complete the process of liberalization and cost-recovery; publication of a list of regional tax offices to be closed (to improve efficiency and governance through centralization); and the publication of the trade facilitation strategy. Incomplete actions include full staffing of the directorate of planning, management, and monitoring of reforms at the Office of the Prime Minister; and publication of a report on reducing the nontax case backlog in the courts (which was hampered by a “work to rule” strike by the judiciary). Delays in the actions will need to be overcome during the next review cycle to avoid affecting broader structural reform implementation, and in particular improvements in the business environment. Finally, several actions to support the privatization program have been delayed, although the authorities and staff agree that this need not have implications for the timing of the sales.

European support

10. The authorities have completed the actions (”milestones”) required to unlock the €2 billion disbursement of the January tranche from Greece’s European partners. The actions were passage of the tax bill passed on January 12 and the increase in electricity prices and the renewable energy levy.

Supplementary Staff Assessment

11. Greece has made further progress with reforms, but timely program implementation remains a constant challenge that will require intensive and uninterrupted efforts. On the one hand, the completion of all the prior actions (with one exception, where a substitute measure was found), and the completion of the tax reform benchmark and other end-year MEFP commitments, is evidence of the authorities’ commitment to the reform agenda under the program. On the other hand, slippages in the December structural benchmarks point to the challenges ahead in program implementation. The tasks ahead and the obstacles to successful implementation are particularly notable in the area of tax administration. As noted in the staff appraisal, reform of the tax administration is critical to the program, and it will require the full mobilization of political support to succeed.

Greece: First and Second Reviews Under the Extended Arrangement Under the Extended Fund Facility, Request for Waiver of Applicability, Modification of Performance Criteria, and Rephasing of Access--Staff Report; Staff Supplement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Greece.
Author: International Monetary Fund. European Dept.