Greece: no news is good news? (Notes)

Abstract :

• After being hit hard by the sovereign debt crisis, Greece has seen its macroeconomic fundamentals improve at the cost of drastic reforms.
• The European bailout program will end in the summer of 2018, and the authorities will have to continue their efforts.
• Greece’s public debt remains the most sensitive issue for long-term development.
• Non-performing loans have reached historic levels, but the banking sector is showing positive indicators.

Less in the media spotlight, Greece is slowly emerging from several years of recession that have hit its economy. This article takes stock of the state of the Greek economy today, drawing on the chronology of the crisis to better put into perspective the economic challenges facing the Greek authorities.

GDP fell by 25% in volume between 2007 and 2015, public debt has stood at 180% of GDP since 2014, unemployment has almost tripled, peaking at 28% of the working population in 2013 (58% for youth unemployment), public spending that has contracted by 30% in order to restore budgetary balance (a deficit of 19% in 2009): these have been the consequences of the financial crisis for Greece since 2008. After successive changes of government, swinging from one end of the political spectrum to the other, fierce negotiations with international bodies and the implementation of heavy structural reforms, Greece is back on the path to growth (1.4% in 2017) and employment (unemployment has fallen by nearly 7 points since 2014).

A quick look back at the timeline of the Greek crisis :

• Before the financial crisis, Greek public debt was already high (over 100% of GDP), while the public deficit stood at over 6% of GDP.
• The crisis first hit the banking system (decline in activity, increase in the cost of capital and increase in bad debts, loss of confidence). The Greek government carried out a major bailout operation, which led to a worsening of the public finance situation.
• The new prime minister, George Papandreou, presented the public with the reality of the state of public finances, which had been glossed over by the previous government. In 2009, he launched an initial austerity plan worth €2.5 billion (wage freeze, tax increases, privatizations, etc.). However, as this first plan was not sufficient, a second austerity plan was launched in spring 2010, worth €4.8 billion (increase in VAT and taxes on certain products).
• In May 2010, the European Commission, the European Central Bank, and the IMF (forming the Troika) agreed to provide financial support to Greece by granting it a loan of €110 billion (of which €80 billion came from the European side). The quid pro quo for this loan was the continuation of the austerity measures already underway (with a target of saving EUR 30 billion by 2015). As part of the bailout plan, the austerity measures continued in 2011, sparking violent anti-IMF and anti-EU protests.
• In view of the deteriorating economic and financial situation, a new international aid plan was put in place in 2011 (and took effect in 2012) with 1) a new loan of €140 billion and 2) debt relief (just over 50% of private bank debt, or €107 billion according to the IMF). Papandreou resigned.
• From 2012, new austerity measures were introduced. This was followed by new aid packages, restructuring, debt write-offs (€40 billion in 2012) and new austerity measures (eight austerity plans in total, with a total target of nearly €100 billion in savings since 2010), and changes of government (successively Antonis Samaras, from the right, then Alexis Tsipras, considered to be radical left).
• The debt thus amounted to €312 billion in 2015, of which more than €130 billion was held by the European Financial Stability Facility, created in 2010 to provide financial assistance to eurozone countries in difficulty, more than €50 billion was held by EU member states, €27 billion by the ECB, and €25 billion by the IMF.

1) The Greek economy today

The Greek economy is improving. After eight years of recession between 2008 and 2016 (with the exception of 2014), GDP grew by 1.4% in 2017. This increase was driven in particular by a 9.6% rise in investment, combined with a 6.8% rebound in exports (according to OECD data). The unemployment rate remains high, at 21.5% of the working population, but is on a downward trend (27.8% in 2013). Public finances are now balanced, with a public surplus of 0.5% of GDP in 2016 (and 0% in 2017), while the primary surplus (excluding debt interest) stood at 3.7% over the last two years. After falling by 33% between 2009 and 2016, public spending stabilized in 2017, while revenues contracted slightly this year (-0.8% year-on-year).

Source: IMF

The challenge now is to maintain this trend. The catch-up effect of Greek economic activity should not be underestimated, as GDP is still far from its pre-crisis level (EUR 187 billion in 2017 compared to EUR 251 billion in 2007, at constant prices). Total investment remains marginal compared to pre-crisis levels (27% of GDP in 2007 and 12% today). It is therefore important for the Greek authorities to continue the efforts they have made so far. This is all the more important given that Greece has been operating under various European Stability Mechanism (ESM) programs since 2011. The first program granted Greece loans of €52.9 billion in 2011, while the second program amounted to €141.8 billion between 2012 and June 2015. The third program began in August 2015 and is expected to end in August 2018 (for a total amount of €51.5 billion). The next step will be to maintain the recovery without relying on this financing.

This is why public debt management remains the main challenge. Currentlyrepresenting nearly 180% of GDP (EUR 328 billion at the end of 2017), Greece’s public debt is sustainable for the time being. This is because it consists mainly (80%) of European loans from the three post-crisis aid programs, with an average maturity of 18 years and an average interest rate of 1.8%. In anticipation of the end of the ESM program, the Greek authorities are currently preparing an official return to the capital markets (an initial €3 billion was raised on the bond market in August 2017 with a five-year maturity, the first since 2014). Conditions are improving, with the yield on 10-year sovereign bonds falling from 7.9% at the beginning of 2017 to 4.2% in April 2018 (compared with yields of over 25% in 2015). With no further aid programs on the agenda, Greece will have to finance its debt more independently on the financial markets in the future. This will also enable the Greek government to avoid the reforms that accompany aid packages. However, while Greece is currently able to service its debt, this could become unsustainable in the medium to long term.

The crisis destroyed productive capacity and permanently removed many people from the labor market. Investment contracted by 65% between 2008 and 2015, which now requires new investment to revive production in the long term. This contraction has led to a decline in the capacity utilization rate, which fell to 64% in 2015 (compared to 77% in 2008), although it has risen slightly since last year. At the same time, the labor force has shrunk by 1 million people, a decline of 22%. Unemployment rose from 7.8% of the labor force in 2008 to 27.5% in 2013, before reversing and reaching 21% in 2017. The number of people at risk of poverty or social exclusion also rose, representing 36% of the population in 2014 compared to 28% in 2008, before falling back to 37.8% in 2018. Productivity has been driven down (from $72,000 per worker per year in 2008 to $67,000 in 2018, according to the ILO), accompanied by a decline in real wages.

The banking sector. In 2016, non-performing loans (NPLs) accounted for nearly 50% of total loans (outstanding), partly due to the 30% drop in production and the lack of effective control by the authorities during the bank credit expansion phase. However, Greek banks remain well capitalized overall[1]. As a reminder, an agreement was reached at the end of 2015 with European creditors to recapitalize Greek banks. Nearly EUR 10 billion in equity capital was injected (under an agreement signed with the EU and the IMF) into the country’s two main banks, while others managed to raise private funds (notably Eurobank, the country’s third-largest bank). In terms of liquidity, the crisis of confidence had prompted Greeks to withdraw their money from banks on a massive scale (EUR 80 billion is said to have left the country between 2010 and 2015), forcing the government at the time to introduce capital controls, which took the form of a limit on withdrawals of EUR 60 per day and restrictions on transfers abroad.

Source: Bank of Greece

2) Reforms undertaken to restore the economy

The reforms have begun to bear fruit and the Greek authorities are continuing their efforts to maintain economic recovery. To this end, and in order to improve the investment climate, a new law on investment incentives and a new growth strategy are pursuing the objectives of better governance, reducing informality and corruption, and regulating productive markets.

In terms of public finances,improvements have been made in the registration of self-employed workers, tax collection through the modernization of payment methods and procedures, and cooperation between the judiciary and the tax authorities. However, despite efforts to collect taxes, the system is based on very high tax rates on a low tax base, largely due to tax evasion and the informal sector. In order to maintain the budget surplus, efforts in these areas should be continued, alongside a debt restructuring plan. This is why, in its scenario, the OECD suggests:

1)furthering the reforms already underway (e.g., raising the retirement age by 4 years instead of the 3 years planned by 2030, reducing the growth of family allowances, which remain very high in Greece, to 0.25 pp by 2020 and then 0.08 pp each year until 2025 to bring them into line with the European average of 0.8% of GDP, etc.) and;

2)restructuring debt by locking in fixed interest rates over a long period (otherwise, official concessional loans will be refinanced from 2030 at market rates, estimated to be 1.1 percentage points higher than concessional rates).

In the banking sector. Banks’liquidity has improved significantly, and they are sufficiently capitalized. Nevertheless, net of provisions, NPLs still represent 175% of banks’ capital. The Prime Minister presented his plan last May to eradicate this phenomenon by supporting the banking sector through better governance and the lifting of certain restrictions (particularly on cash withdrawals and capital transfers abroad). To reduce the level of NPLs, the authorities have adapted the regulatory framework to facilitate their management, notably by setting up a dedicated department in each bank and introducing better legal protection for banks. In this regard, liquidation procedures have also been simplified and accelerated, while NPL reduction targets have been set (under the supervision of the Bank of Greece). In addition, banking governance has also improved thanks to the single supervisory mechanism, set up in 2014 to supervise banks in the eurozone, and the Hellenic Financial Stability Fund, a shareholder in the country’s main banks, which is developing a strategy to align governance indicators with the best international standards. There are also plans to create a « bad bank » that would take over a large portion of the NPLs currently held by banks.

In addition, certain public assets have been privatized in order to find sources of financing (notably regional airports, the port of Piraeus, and rail networks), bringing the total amount of assets sold to €1.5 billion, or 0.8% of GDP. The Hellenic Corporation of Assets and Participations ( HCAP) was created at the end of 2016 to manage state assets. HCAP’s objective is to contribute to reducing public debt while supporting the growth strategy. To this end, it is expected to publish its strategy shortly, which will link the state’s strategic investments to socio-economic objectives. Other privatizations, as part of the aid programs, are in the pipeline, such as: Athens International Airport, Hellinikon Airport, DESFA (national gas distributor), etc.

In the labor market, many workers’ rights were suspended during the crisis years (particularly between 2010 and 2013). Collective agreements were frozen, allowing companies complete flexibility on employment and wages, while the minimum wage was reduced (from €877 to €684 in 2013 and has remained stable since then). At the same time, eligibility requirements for unemployment benefits were tightened and the authorities launched a project to revise the labor code in order to simplify it. In addition, in order to combat poverty, pension spending was reduced in favor of a more equitable redistribution, notably with the introduction of a social solidarity income program and a single agency for the management of social pensions.

3) Economic outlook

For the next two years, the 2019-2022 economic framework established by the Ministry of Finance forecasts growth of over 2%(above the European average), thanks in particular to the recovery in domestic demand, driven by investment but also by private consumption, whose contribution to GDP is likely to double by 2019 due to the increase in real wages (+0.5% per year) and employment (unemployment estimated at 14.3% in 2022).

However, the economy’s momentum remains sensitive in the long term to the level of public debt and NPLs. Once the ESM program ends (on August 20, 2018), Greek debt will be dependent on market conditions. It cannot be ruled out that an exogenous shock (rise in hydrocarbon prices, changes in the dollar, Brexit, migration crisis, etc.) could push up the cost of servicing the debt. This is why international bodies (notably the OECD and IMF) are calling on creditors (particularly the European Commission) to restructure Greek debt so that it remains sustainable in the long term.

The restructuring of Greek debt is seen as the main challenge currently facing the European authorities and the IMF. That is why, at the Eurogroup meeting on June 21, 2018, it was decided to restructure part of the debt held by the ESM (EUR 96 billion). Interest payments will now begin in 2032 (instead of 2023 as initially planned) and the maturity of this tranche has been extended by 10 years (from 2059 to 2069). In the medium term, this will make it possible to link the financing requirements targets (set at a maximum of 15% of GDP by 2023 and 20% until 2060) with the sustainability of public debt. However, the IMF points out that in the long term, further debt relief will probably be necessary, especially given the optimistic assumptions for growth (2.2% by 2022 and above 3% thereafter) and primary surpluses (3.5% of GDP by 2022 and 2.2% of GDP between 2023 and 2060). It estimates that if a large-scale debt restructuring (or even write-off) plan is not put in place by creditors, Greek debt could become unsustainable by 2040.

In addition, certain short-term risks cannot be overlooked, such as: high taxes and contributions on household income (which could hamper consumption); poor management of NPLs; and exogenous risks such as political upheaval in Italy and Spain, the consequences of Brexit, rising oil prices, and Trump’s trade policy.

Conclusion

Greece has paid the price for the crisis for many years, but thanks to numerous reforms and negotiations with its creditors, it has been able to return to economic growth driven by solid macroeconomic fundamentals. Public spending has been reduced, allowing public accounts to be rebuilt, while the banking sector has been strengthened. However, many challenges remain, particularly the management of the enormous public debt incurred in recent years.

Dialogue will be necessary with the main creditors, particularly Europe, to enable both timely debt servicing and the continuation of the reforms undertaken. In addition, the high level of non-performing loans continues to weigh on banks’ balance sheets, although they are now sufficiently capitalized. There is also the challenge of the labor market, with high unemployment and a widespread informal sector, exacerbating tax revenue shortfalls and poverty, which has increased during the crisis. Greece has come part of the way, but efforts and caution must not be neglected in the future.