We need to return to primary fiscal surpluses
The Covid-19 pandemic has shown the benefits of complementarity between monetary and fiscal policies at times of crisis. The simultaneous monetary and fiscal loosening helped to shore up the economy against the impact of the pandemic.
However, the return to normalcy entails challenges that could affect the interaction between the two policies. The tightening of monetary conditions that is already under way could slow economic growth and, more importantly, put upward pressure on borrowing costs for both the public and the private sectors and affect the sustainability of public and private debt.
The explicit reference to Greece in the European Central Bank’s December 2021 announcements is a strong message of confidence in the Greek economy and helps to mitigate some of these risks. Effectively, the ECB’s decisions will provide support to Greek bonds, until they obtain an investment grade rating, via three channels: (1) their continued eligibility for purchase during the PEPP reinvestment period, which was extended until the end of 2024; (2) the flexibility of PEPP reinvestments, including the purchase of debt securities in excess of the redemption amounts; and (3) a possible resumption of net purchases under the PEPP, if deemed necessary. Moreover, the fact that Greek bonds will continue to be purchased during the PEPP reinvestment period until the end of 2024 suggests that they would also remain eligible as collateral for the Eurosystem refinancing operations over the same period.
The recent rise in Greek government bond yields is a generalized phenomenon and is largely due to the common shock of changing global financial conditions. However, given the lower credit rating of Greek bonds, their yields are more sensitive to international market volatility compared with other sovereign bonds. Therefore, part of the increase in the spreads of Greek government bonds (vis-a-vis comparable German bonds) is attributable to the fundamentals of the Greek economy.
According to debt sustainability analyses carried out by the Eurosystem, Greek public debt, despite its high level, is resilient to various adverse macroeconomic and fiscal scenarios. In particular, Greece’s debt-to-GDP ratio is stabilizing and is projected to reach its pre-crisis levels earlier than the ratios of other highly indebted countries, marking the largest drop by 2030, both in the baseline and in the various alternative scenarios.
The resilience of Greek debt dynamics is due to the following factors:
(i) The specific characteristics of Greek public debt, which ensure relatively low interest rate and refinancing risks over the next 10 years. The three MoUs agreed upon after the 2010 debt crisis implied the full refinancing of public debt at a very low weighted average (implicit) interest rate (1.4%), an extension of the weighted average maturity of debt to about 20 years, and a structure where most of the debt is held to maturity by official sector creditors (sovereigns and international organizations).
(ii) Greece’s fiscal position, as a result of structural fiscal surpluses. After the lifting of the pandemic-related emergency support measures, and in the absence of new expansionary fiscal measures, Greece will return to structural primary surpluses, which will reinforce the downward trajectory of public debt. This feature is a result of the significant structural fiscal consolidation achieved in previous years, which must be preserved.
(iii) The positive contribution of the “snowball effect” – i.e. the impact from the difference between the nominal GDP growth rate and the implicit borrowing rate. The snowball effect is a key driver of the rate of change in the debt-to-GDP ratio and reflects, inter alia, the impact of the macroeconomic environment on debt dynamics. Compared with other countries, the contribution of this effect to debt reduction is expected to be more than double in the case of Greece, given its much higher debt level (implying a stronger impact from the interest rate-growth differential), as well as the anticipated large GDP gains from the utilization of the Recovery and Resilience Facility resources.
Against this backdrop, an increase in debt refinancing costs, even if due to the idiosyncratic features of the Greek economy, such as the lack of an investment grade rating, would have limited impact on debt sustainability. Specifically, since only a small proportion of Greek public debt is refinanced on the markets, higher borrowing costs would lead to relatively small increases in interest payments, and the impact on debt dynamics would be limited (smaller than in other countries). There is no doubt, however, that rising government bond yields push upward the overall cost of borrowing for the private sector as well, including banks and businesses.
Despite these favorable characteristics of the Greek public debt, improving its sustainability by faster debt reduction should be a priority for fiscal policy in the coming years, in order to avoid both a recurrence of the past debt crisis in the future (more than 10 years ahead) and an increase in the private sector’s borrowing costs.
Besides, the long maturity of the support mechanism loans (over 30 years) calls for a long-term perspective on the sustainability of the Greek public debt, well beyond the medium-term horizon of 10 years. It should also be taken into account that the stock of public debt is projected to increase after 2032, when the deferral period for interest payments on the EFSF loan expires. In order to address these problems, we must bring the future into the present, so that appropriate policy measures can be taken in a timely manner.
The main reason behind the focus of fiscal policy on accelerating debt reduction is that the debt’s resilience to future negative shocks will be comparatively weaker, despite its projected lower level. More specifically:
(i) The current favorable characteristics of Greek debt are not of permanent nature. In coming years, debt held by the official sector (which is not marketable and thus not exposed to market volatility), which has long maturity and low interest rates, will be gradually replaced by marketable debt to the private sector, with shorter maturities and higher interest rates. So, despite the expected drastic decline in debt as a percentage of GDP, the factors that currently make it resilient to adverse shocks will gradually unwind over the next 10 years, as a growing part of the debt will become subject to market risk.
(ii) Annual gross financing needs play an important role in assessing debt sustainability. In the case of Greece, where the bulk of the debt has not been accumulated on market terms, but rather through official sector low-interest loans with a very long repayment period, a grace period and a multi-year deferral of interest payments, an exclusive focus on the debt-to-GDP ratio would be misleading. Instead, fiscal sustainability should also be assessed in terms of annual gross financing needs over a horizon extending to the year 2060, namely with regard to the established benchmarks of 15% of GDP in the medium term and 20% of GDP in the long term. Although the debt ratio is projected to steadily decline in the coming years, the gross financing needs are expected to remain significantly higher in the medium term as compared to pre-pandemic levels. Under the burden of additional borrowing during the pandemic, any scope for an easing of the agreed targets for permanent primary surpluses of 2% of GDP has been exhausted. Primary surpluses of this size are also necessary in order to ensure interest payments on public debt.
(iii) The debt-reducing contribution of the snowball effect is expected to decrease over time. The key factors underlying this development will be both the changing macroeconomic environment, with more moderate growth and higher borrowing rates expected in the long term, and the mechanical effect of progressively falling debt levels. Accordingly, in the long run, fiscal policy will face growing pressure to contribute more to debt reduction by achieving primary surpluses.
Greece should take advantage of the emerging favorable macroeconomic environment, which facilitates a fiscal consolidation that can remain countercyclical and credible. The conditions are suitable for Greece to catch up with other euro area countries and no longer be an outlier in terms of debt-to-GDP ratio. In this light, the country must gradually return to its pre-pandemic sound fiscal position in order to avoid wasting the sacrifices made in the context of the fiscal consolidation that was achieved in the past decade for the benefit of future generations.
Yannis Stournaras is governor of the Bank of Greece
