The future of the Greek economy

The Greek crisis was the result of major macroeconomic imbalances accumulated over a long period of time, leading to the sovereign debt crisis in 2010. To a large extent, these imbalances have now been addressed, although major challenges remain.

Over the past eight years, Greece has implemented a bold economic reform and adjustment program that has fully eliminated fiscal and external deficits and improved competitiveness. In more detail:

– The general government balance turned into a surplus of 0.5 percent of gross domestic product in 2016 from a deficit of 15.1 percent of GDP in 2009. The primary surplus reached 3.8 percent of GDP in 2016 (program definition), from a deficit of 10 percent of GDP in 2009.

– The current account deficit has fallen by 15 percentage points of GDP since the beginning of the crisis, with the current account effectively being in balance over the last three years.

– Labor cost competitiveness has been fully restored and price competitiveness has recorded substantial gains since 2009.

– The reforms implemented cover the pension system, the health system, labor market, product market, the business environment, public administration, the tax system, and the budgetary framework.

As a consequence, openness has improved substantially and the economy has started to rebalance towards tradable, export-oriented sectors. The share of total exports in GDP increased from 19 percent in 2009 to 33.1 percent in January-September 2017. Exports of goods and services, excluding the shipping sector, have increased by 47 percent in real terms since their trough in 2009, similar to euro area exports.

The banking system has been restructured, consolidated and recapitalized and is among the best capitalized in Europe. Provisions cover half of banks’ nonperforming exposures (NPEs), while the other half is covered by the value of the underlying collateral, resulting in an overall coverage ratio of almost 100 percent.

Significant institutional reforms have been implemented, aiming at providing banks with a variety of means of reducing nonperforming loans (NPLs), including the authorization of credit servicing firms, operation of an electronic platform for out-of-court settlement, and electronic auctions of real estate.

Banks have set operational targets to reduce the stock of NPEs by 37 percent by end-2019 and progress toward the achievement of targets is satisfactory. In September 2017 NPEs stood at 100.4 billion euros or 44.6 percent of total exposures, having declined by 7.6 percent from the March 2016 peak. The improvement in 2017 resulted mainly from sales and loan write-offs.

Short and medium-term outlook

Progress in the implementation of the adjustment program and in particular the completion of the third review is benefiting confidence, liquidity and economic activity. The economy is recovering. This is reflected not only in GDP figures, but also in several key indicators of economic activity.

Improvements are also visible in the financial sector: Bank deposits of the private sector have increased and credit to corporations has stabilized. Nevertheless, financial conditions remain tight and bank lending rates are high compared to other euro area countries.

Yields of Greek government bonds have declined to pre-crisis levels and the yield curve has largely normalized. The government has returned to international bond markets and earlier this month, despite market turbulence, it issued a seven-year bond through which it borrowed 3 billion euros at a yield of 3.5 percent. Moreover, yields on corporate bonds have fallen, while share prices rose, reflecting a gradual recovery of investor confidence in connection with steady progress in the implementation of the economic adjustment program.

On the fiscal front, in January-November 2017, the general government cash primary surplus improved, reaching 4 percent of GDP, compared to 3.7 percent in the same period last year. The 2017 primary balance target of 1.75 percent of GDP is expected to be reached with a significant margin. For 2018 the primary balance target of 3.5 percent is considered achievable.

According to BoG estimates, economic activity will pick up in the medium term, with GDP growing by 1.6 percent, 2.4 percent and 2.5 percent in 2017, 2018 and 2019, respectively, supported by exports, recovering private consumption and investment.

Risks and challenges

The above is based on the assumption that the reform and privatization program will be implemented smoothly and by the agreed time schedule. The recovery of the economy remains fragile, and subject to risks and vulnerabilities, both internal and external. Delays or backtracking on reforms would weaken the positive outlook and impact negatively on investors’ confidence.

Stock disequilibria – such as the high public debt, the high burden of NPLs and high unemployment – persist or have even increased during the years of the crisis, acting as a drag on long-term growth.

To address the above challenges the focus of economic policy should be on the following:

1. Addressing the public debt overhang. The BoG has put forward a mild debt reprofiling proposal, which entails only a negligible cost for our partners and provides for extending the weighted average maturity of interest payments on EFSF loans by at least 8.5 years.

2. Implementing the remaining reforms and improving the quality of institutions. Particular emphasis should now be placed on improving public administration, implementing the land registry, strengthening institutions and the autonomy of independent authorities, cutting red tape, lowering the regulatory burden and ensuring the predictability and stability of legislation, reducing entry barriers into network industries, retail trade and professional services as well as on enhancing judicial efficiency.

3. Adopting a growth-friendly fiscal policy mix. The overperformance relative to the fiscal policy targets over the past three years strengthened fiscal policy credibility, but it came at a cost, i.e. lower economic growth. This is due to the high reliance of the fiscal policy mix on tax policy measures and tax rate hikes. The mix is not sustainable and must change. More emphasis has to be placed on cutting nonproductive expenditures, increasing the public sector efficiency, including the management of state property and improving tax administration.

4. Tackling the problem of NPEs and strategic defaulters. The NPE reduction targets for the next two years are ambitious compared to 2017, implying that banks will need to step up their efforts and make full use of the available toolkit for private debt resolution.

5. Improving further the business environment and the insolvency framework to enable faster reallocation of productive factors to more productive opportunities.

6. Promoting innovation, education and knowledge-based capital. Policy must focus on improving the quality of labor (i.e. skills), attracting investment in new technologies and improving the quality of capital through the creation of an institutional framework that supports innovation.

7. Speeding up privatizations to attract foreign direct investment. Conditions should be established to attract FDI by quickly completing privatization projects which are at a mature stage, as well as stepping up the pace of the overall asset utilization program.

8. Supporting the unemployed and enhancing employment and training programs.

A major issue in the coming months is the consolidation of confidence and the improvement of the country’s creditworthiness, which will allow the return of the Greek sovereign to financial markets on sustainable terms. The steps in this direction are the implementation of the reform and privatization program and preparation for the timely conclusion of the fourth and final review; the specification of medium-term debt reprofiling measures; and the complete lifting of capital controls, in connection with the improvement of the economic outlook and depositors’ confidence in the Greek banking system.

New bond issuances, while still in the European Stability Mechanism program, coupled with the forthcoming ESM disbursements could be used to build up a cash buffer.

However, it is important to clarify the environment in which the economy will move after the end of the program. Under the European Union legal framework, Greece will be under surveillance at least until it repays 75 percent of the official loans received. Therefore, it remains to be clarified, first, the form of supervision in the conduct of economic policy and, second, whether and on what conditions precautionary financial support from the partners will be available after the completion of this program.

According to the BoG, such a precautionary support framework could assist the economy by further driving down borrowing costs, as it will provide assurance of access to financing after the end of the program. It will also allow the ECB to maintain the waiver on Greek government bonds after the end of the program and eventually include them in its asset purchase program.

I am confident that the actions I have described will improve Greece’s creditworthiness, boost the investment and business climate, facilitate the return to financial normality, and contribute to the sustainable recovery of the economy after many years of recession and stagnation.

Yannis Stournaras is the governor of the Bank of Greece. This text is from a speech at a recent event organized by the Hellenic Spanish Chamber of Commerce in Athens.