Greece: Fourth Review Under the Extended Arrangement Under the Extended Fund Facility, and Request for Waivers of Applicability and Modification of Performance Criterion

This paper discusses Greece’s Fourth Review Under the Extended Arrangement under the Extended Fund Facility, and Request for Waivers of Applicability and Modification of Performance Criterion. The economy is rebalancing, but it continues to do so through recession, not productivity-enhancing structural reform. Domestic demand continues to fall albeit at a moderating pace, and import compression has resulted in a further shrinking of the current account deficit. The large output gap and high unemployment rate are exerting downward pressure on wages, and the competitiveness gap in unit labor cost terms has narrowed further. Product prices are also easing. Sentiment indicators have improved, but the political crisis has had a dampening effect.

Abstract

This paper discusses Greece’s Fourth Review Under the Extended Arrangement under the Extended Fund Facility, and Request for Waivers of Applicability and Modification of Performance Criterion. The economy is rebalancing, but it continues to do so through recession, not productivity-enhancing structural reform. Domestic demand continues to fall albeit at a moderating pace, and import compression has resulted in a further shrinking of the current account deficit. The large output gap and high unemployment rate are exerting downward pressure on wages, and the competitiveness gap in unit labor cost terms has narrowed further. Product prices are also easing. Sentiment indicators have improved, but the political crisis has had a dampening effect.

Context

1. Greece has made important progress in rectifying pre-crisis imbalances. The country entered the crisis with one of the highest fiscal and external imbalances in the euro area. With unprecedented European and international support, steadfast fiscal adjustment by the Greek authorities since 2009 delivered an improvement in the cyclically-adjusted primary balance of over 15 percent of GDP. The country is now at the cusp of achieving primary balance—a remarkable achievement. External imbalances have also been reduced sharply. However, this adjustment is due principally to recession (import compression), not productivity-enhancing structural reform.

2. The ongoing correction of imbalances has come at a very high cost. The economy is in the sixth year of recession. Output has fallen by nearly 25 percent since its peak in 2007. The unemployment rate is about 27 percent, and youth unemployment exceeds 57 percent.

3. The high adjustment cost reflects in important part the delayed, hesitant and piecemeal implementation of structural reforms (see Greece: Ex Post Evaluation of Exceptional Access under the 2010 Stand-By Arrangement and 2013 Article IV Consultation). Amidst recurrent domestic political crises, vested interests opposed to reforms have been increasingly emboldened. Thus, reforms have fallen well short of the critical mass needed to transform the investment climate. The onus therefore remains on delivering rapidly on structural reforms to unlock growth and create jobs, which would lessen the pain of further adjustment.

4. The review took place against the backdrop once again of domestic political tensions that culminated in a cabinet reshuffle. The closure of the public broadcasting company (ERT), as part of the public administration reform of the government, led the smallest partner (Democratic Left) to withdraw from the governing coalition. Consequently, the government’s majority in parliament was reduced to a slim margin.

Recent Developments

5. Recent macroeconomic developments are broadly in line with program projections.

  • The output contraction is slowly decelerating (Table 1; Figures 1 and 2). Real GDP declined by 5½ percent y/y in Q1 2013 (compared to -5¾ percent in Q4 2012). Fiscal adjustment and falling incomes further reduced public and private consumption, while investment appears to have stabilized at a depressed level. The contribution of the external sector disappointed as exports weakened, reflecting soft global demand. But a number of indicators—e.g., economic sentiment and higher tourism bookings—point to a milder contraction in Q2 than in Q1.

  • Ample spare capacity is lowering wages and prices (Figure 3 and 4). Unemployment continues rising (from 26.4 percent in December 2012 to 26.9 percent in April 2013), although the pace of increase is slowing, with a modest pickup in hiring. Spare capacity in industry has stabilized at an elevated level. The output gap has precipitated large wage adjustments (nominal wages declined by 11 percent during 2010–12), which have also finally started to be transmitted to lower prices—the CPI and the GDP deflator are declining.

  • External adjustment is continuing largely through import compression (Table 2 and Figure 56). Besides soft global demand, weak exports reflect sluggish improvements in price competitiveness (the ULC-based REER depreciated by over 8 percent y-on-y in Q1, but the CPI-based REER remained broadly stable y-on-y in June) and limited availability of trade financing. The 12-month current account deficit through Q1 2013 reached 2¼ percent of GDP (compared to 3½ percent at end-2012). But the underlying external position remains relatively unfavorable, with the structural current account deficit estimated at about 6 percent of GDP in 2012, implying an overvaluation in the CPI-based REER of about 10 percent (see External Sector Report).

  • Liquidity and financial market conditions are mending slowly (Figure 78). Since mid-2012, deposits have recovered and reliance on Eurosystem funding has declined sharply. In the last two months, deposit movements have stabilized, and access to Eurosystem funding now stands at around €85 billion. The injection of bridge capital at year-end allowed ELA to decline sharply, but further reduction will be constrained by the pace of deposit inflows, given banks’ limited ECB-eligible collateral. Interest rates remain elevated, and the recent political uncertainty and expectations of tighter monetary policy in advanced economies have led to an increase in sovereign spreads to around 900 bps (from around 700 bps after the upgrade by Fitch in May).

Table 1.

Greece: Selected Economic Indicators, 2009–14

article image
Sources: Elstat; Ministry of Economy and Finance; Bank of Greece; and IMF staff projections.

Based on Labor Force Survey.

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

Data for 2013 as of May.

Includes securitized or otherwise transferred loans from 2010 onward.

Figure 1.
Figure 1.

Greece: Demand Indicators, 2007–13

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Sources: Elstat; Bank of Greece; and IMF staff estimates.1/ Interpolated monthly.2/ Deflated by PPI excluding energy.3/ Deflated by CPI.
Figure 2.
Figure 2.

Greece: Supply Indicators, 2007–13

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Sources: Elstat; Eurostat; and IMF staff estimates.1/ Interpolated monthly.2/ Over past three months.3/ Over next three months.
Figure 3.
Figure 3.

Greece: Labor Market Developments, 2007–13

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Sources: Elstat; Eurostat; Haver; and IMF staff calculations.1/ Includes wholesale and retail trade, transportation and storage, and accomodation and food service activities.
Figure 4.
Figure 4.

Greece: Inflation Developments, 2005–13

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Sources: Elstat; Eurostat; Haver; and IMF staff calculations.1/ Excludes food, alcohol, tobacco, and energy.2/ Private sector business economy. Interpolated monthly from seasonally adjusted data.
Table 2.

Greece: Summary of Balance of Payments, 2010–18

article image
Sources: Bank of Greece; and IMF staff estimates.

Includes debt of the monetary authority.

Figure 5.
Figure 5.

Greece: Balance of Payments, 2010–13

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Sources: Bank of Greece; and IMF staff calculations.
Figure 6.
Figure 6.

Greece: Competitiveness Indicators, 2005–13

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Sources: Haver; Eurostat; IMF, Direction of Trade Statistics; and IMF staff calculations.
Figure 7.
Figure 7.

Greece: Financial Indicators, 2007–13

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Sources: Bloomberg; InTrade; Moody’s CreditEdge; and IMF staff calculations.1/ Simple average of National Bank of Greece, Alpha Bank, EFG Eurobank, and Piraeus.2/ Simple average of Coca-Cola Hellenic Bottling, Hellenic Petroleum, Hellenic Telecom, OPAP, and Titan Cement.3/ Current 1-year EDF calculated by Moody’s Analytics. EDF is the probability of default is defined as the failure to make a scheduled debt payment. The EDF is driven by both asset volatility and market leverage.
Figure 8.
Figure 8.

Greece: Money and Banking Developments, 2007–13

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Sources:Bank of Greece; and IMF staff estimates.1/ Nonperforming loans exclude restructured loans.
uA01fig01

Contributions to GDP

(Percent)

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Sources: Elstat; and IMF staff calculations.
uA01fig02

Economic Sentiment, SA

(Percent balance)

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

uA01fig03

Production Slack, SA

(Percent balance)

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Sources: Elstat; Eurostat; and IMF staff calculations.1/ Interpolated monthly.2/ Private sector business economy.
uA01fig04

Wages and Prices

(Y-O-y percent change)

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

uA01fig05

REER

(2007 = 100)

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Sources; European Central Bank; Eurostat; Haver; and IMF staff calculations.
uA01fig06

External Trade, SA

(Billions of euros)

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

uA01fig07

Bank Deposits and Eurosystem Borrowing

(Billions of euros)

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Source: Bank of Greece; European Central Bank; Haver; and IMF staff estimates.1/ Interest rate for nonfinancial corporations2/ Agreed maturity up to oneyear.3 /Revolving accounts up to one million euros floating or up to one year maturity.
uA01fig08

Greece-Euro Area Interest Rate Spread 1/

(Percent)

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

6. The recession is continuing to strain balance sheets.

  • Credit conditions remain tight (Tables 34). Overall, the deteriorating asset quality is hampering the flow of credit to the private sector, and the contraction in credit has worsened slightly (to -3.7 percent y/y in May) in line with staff projections.

    • For the household sector, the rising liabilities-to-income ratio (at 109 percent in Q4 2012), prospects for further nominal income adjustment, and falling house prices (-30 percent cumulative from its Q3 2009 peak to Q1 of this year) have contributed to a simultaneous tightening of credit conditions and a reduction in the demand for new loans in the last two quarters (as confirmed by survey results). With falling wages, rising unemployment, and tax increases all cutting into disposable income, the already high household NPLs increased further to above 27 percent in Q1. Traditionally low savings rates, which remained close to zero in Q4 2012, have made households vulnerable to income shocks (Figure 9).

    • For the corporate sector, NPLs are rising (to 31 percent in March), credit is shrinking, and the financial position of SMEs is weak owing to falling domestic demand. Survey results point to weak demand for loans and some further tightening of credit conditions in the last two quarters (banks maintain that good investment projects from SMEs remain rare). But the sector as a whole generates substantial surpluses (8 percent of GDP in Q4 2012). Some large corporations tapped the international market, raising about €2 billion through May 2013 largely to roll over debt falling due, albeit at high yields of around 8 percent (Figure 10).

  • The process of recapitalizing banks is complete, but cleaning up balance sheets is yet to begin (Box 1; Table 5). Private sector participation in the recapitalization was stronger than envisaged (amounting to €3.1 billion, in addition to about €3 billion coming from the recapitalization of subsidiaries by foreign banks that have since exited the country), and three out of the four core banks have retained their private sector management. One small non-core bank also managed to meet its capital needs through private sources and remains operating. On July 12–13, it was announced that the two HFSF-owned bridge banks—TT New Hellenic Postbank and Nea Proton Bank—are being sold to Eurobank.

Table 3.

Greece: Monetary Survey, 2010–14

article image
Sources: 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.

Projected growth rates are calculated from differences in outstanding amounts and do not take into account write-offs, valuation changes, or reclassifications.

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

Table 4.

Greece: Monetary Financial Institutions (excl. BoG)—Uses and Sources of Funds, 2010–16

article image
Sources: 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.

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

Projections do not take into account write-offs, valuation changes, or reclassifications.

Figure 9.
Figure 9.

Greece: Household Balance Sheet, 2007–13

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Sources: Bank of Greece; Eurostat; European Commission; European Central Bank; and IMF staff estimates.1/ Over past 12 months.
Figure 10.
Figure 10.

Greece: Corporations Balance Sheet, 2007–13

Citation: IMF Staff Country Reports 2013, 241; 10.5089/9781484350911.002.A001

Sources: Bank of Greece; Bloomberg; Eurostat; European Commission; European Central Bank; and IMF staff estimates.1/ Financial and nonfinancial corporations.
Table 5.

Greece: Core Set of Financial Soundness Indicators for Deposit-Taking Institutions, 2009–13

(Percent, unless otherwise indicated)

article image
Source: Bank of Greece.

Data on a consolidated basis. For end-2011 and 2012Q1, C.A.R. ratios are affected by the PSI and include only the first tranche of €18 billion HFSF recapitalization. In addittion, C.A.R. ratios are affected by the negative supervisory own funds of two banks (ATEbank and TT Hellenic Post Bank).

From 2004 in accordance with IFRS.

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

Based on revised figures from 2002 onwards.

Spread between rate on credit lines and savings deposit rate.

There are no specialised life insurance companies in Greece. General insurance companies offer general insurance and life insurance products.

7. Fiscal adjustment is broadly advancing albeit with some slippages (Tables 69), but progress on fiscal institutional reforms has been slow (Tables 1011). These latter reforms are key to enhance the efficiency and effectiveness of the public sector and ensure a more equitable distribution of the adjustment burden.

Table 6.

Greece: Modified General Government Cash Balance, 2012–16 1/

(Billions of euros)

article image
Sources: Ministry of Finance; and IMF staff projections.

Calculations based on program definitions as outlined in the TMU.

Arrears clearance going forward is modelled below the line.