Parliament Budget Office: Caution necessary until bailout ends in Aug.; positive messages to markets needed

9 August 2018
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The first months that will follow Greece’s exit from the current – and third – bailout will be particularly critical, Parliament Budget Office stated on Wednesday, in a relevant report, adding that the messages that the Greek government sends will, to a great extent, affect the country’s creditworthiness in terms of followed domestic economic policy.

As such, the Budget Office said followed policy will affect interest rates offered by international lenders. The independent office recommended that risked be minimized as much as possible, especially those emanating from political pressures to expand fiscal spending and to slow reforms until the end of the program.

In a detailed report, the Budget Office states:

“Economic conditions remain favourable in the second quarter of 2018. The growth rate is positive, employment and wages are rising, the external balance is relatively balanced, the general government budget is within targets. Less favourable is the picture of unemployment and inflation, as the former did not decline in the first quarter and the latter remained low, albeit on positive territory.

During the same period, some encouraging developments were recorded in stock variables: Both non-performing exposures and overdue tax debt decreased slightly – however, social security arrears increased.

The most important development is the debt relief agreement reached at the Eurogroup meeting of June 22, 2018. The European Commission’s baseline scenario projects that debt sustainability is ensured, which is in turn a decisive step for the Greek government to secure financing from international markets under sustainable conditions. A particularly positive development is the unconditional deferral of interest and amortization of EFSF debt by a ten year period, while conditionality was limited to the reimbursement of profits on Greek bonds (ANFAs and SMPs) and the abolition of the step-up interest rate margin.

Nevertheless, the agreement reached at the Eurogroup contains an element of uncertainty regarding the long-term sustainability of debt, since it explicitly provides that additional measures will be taken, if necessary, after 2032. Taking into account these facts, the debt sustainability analysis contained in the recent IMF report finds the Greek debt sustainable until 2038 in the baseline scenario, a rather prolonged medium-term horizon of twenty years. This period is quite large, twice as long as debt sustainability analyses typically cover. However, the long-term doubts expressed in the IMF report may negatively affect markets and delay the upgrading of Greek sovereign debt by rating agencies.

Following the Eurogroup agreement of 22 June, the European Commission put Greece under enhanced surveillance with quarterly controls as provided for in Article 2 (1) of Regulation 472/2013 of the European Union. Enhanced surveillance combined with debt-relief measures and the 24.1 billion euros cash buffer that will emerge after the final disbursement by ESM, as well as the maintenance of fiscal stability and the continuation of the reform effort, are expected to strengthen investors’ confidence in the future prospects of the Greek economy and to ensure that the public sector and Greek businesses are financed from international markets on sustainable terms.

In the short term, the first months following the completion of the program will be particularly challenging for the government, as it has to signal its intentions which will in turn determine the credibility of economic policy and the level of market yields. Consequently, it is critical that the risks stemming from political pressures for fiscal expansion and for slowing down the implementation of reforms should be kept to a minimum. For fiscal policy in particular, recall that the fiscal targets from this year up to 2022 are twice as high as last year, and that these targets are set in terms of primary surpluses and are therefore unaffected by the relaxation of gross financing needs secured by the debt-relief measures. We also point out that bond issues should be well-designed and careful, given the fact that there are no urgent financing needs that require hasty moves.

We believe, however, that economic policy should now focus on the medium and long-term prospects of the Greek economy. In the medium term, the first priority should be to ensure the smooth and low-cost financing of the private sector. This will allow the gradual recovery of credit and lead to faster economic recovery. Otherwise, as international studies have shown (e.g. IMF), the absence of credit expansion leads to lower growth rates and to a more anemic recovery during which businesses, sectors and activities (e.g. investment) based on external financing are negatively affected. The most important issue in this direction is the continuation of the reduction of non-performing loans and the improvement of banking sector balance sheets which will allow banks to provide more liquidity to the economy. Additionally, it requires full use of the available European structural funds, continuation of the public property utilization program, a favourable environment for domestic and foreign investment and full removal of capital controls. Particular emphasis should be placed on investments and privatizations in which investors commit to create new jobs and generate fixed capital investment that is sustained over time.

In the long run, the most critical economic variable is labour productivity, which has dropped dramatically in our country during the crisis. Greece is a typical case where the reduction in unit labour costs during the crisis was due to wages falling faster than productivity. This development, as explained in the Special Topic, may have helped to boost exports of goods (though not services) but is certainly not sustainable in the long run. It is not viable to continue squeezing wages below a declining productivity in order to keep unit labour costs low. On the contrary, productivity must increase at a rate setting the ceiling for wage increases.

A key factor in increasing the overall productivity of the Greek economy is the modernization and upgrading of public services provided to citizens and businesses. The recent catastrophic events in Attica (floods in Mandra, fires in Eastern Attica) that led to the loss of human life suggest weaknesses in the state institutions. Apart from public management shortcomings, many of these problems are also due to the chronic shortcomings of the Greek state, such as the lack of a national cadastre and proper spatial planning. Overall, modernizing and upgrading the services of central government, first and second level local government, public enterprises, and independent regulatory authorities is a prerequisite for more efficient state and better market functioning and for enhancing the overall productivity of the economy. This will, in addition to protecting the interests of citizens, lead to a substantial increase in the long-term potential growth rate of the economy, as it is well known that the quality of governance and the efficiency of state institutions are linked to a higher level of economic growth.”

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