Is There Hope for a Recovery of the Greek Economy?

GREECE Athens Parliament Building and Greek Flag in the foreground
GREECE Athens Parliament Building and Greek Flag in the foreground

After five years of a deepening economic recession and growing unemployment in Greece, one may wonder whether there is now hope ("elpida") for an end to the Greek fiscal and debt crisis, the restoration of the country's competitiveness, and a sustainable recovery of growth and jobs. A number of prominent academics and media pundits have noted that Greece has recently gained some breathing space; but they still foresee only meager prospects for success of the Greek reform program, which was adopted with the support of the euro group and the IMF in May 2010 and revised in March 2012. On their part, Greek opposition parties have been waging a vigorous fight for the abandonment of this program and its replacement by a strategy that would put an end to austerity, increase social transfers, and demand a far-reaching restructuring of the public debt. Yet, while conscious of the pains imposed by the requisite austerity measures on much of the population, the Greek governing coalition which took office in June 2012 has been taking resolute actions to reinvigorate the reform program and promote an early economic and financial recovery in cooperation with the country's partners.

It should be recalled that the Greek reform program went significantly off track last spring, triggering great fears of an imminent Greek exit from the euro zone. To a large extent, this was due to substantial slippages in policy implementation, particularly in the area of structural reforms, and these slippages were exacerbated by the political uncertainties surrounding the national elections in May and again in June 2012. With the serious weakening of Greece's policy credibility, public fears spread, the outflow of bank deposits accelerated, and domestic liquidity virtually dried up. Although justifiably disappointed with this turn of events, the country's foreign lenders tended to place all program shortfalls on Greece's door-step, leaving aside (until recently) their own responsibility for a number of program design weaknesses (including an underestimation of the so-called "fiscal multipliers"). Furthermore, recurring pronouncements by some European officials questioning Greece's position in the euro area tended to undermine confidence in the economy. As a result, economic conditions continued to deteriorate, with the decline in real gross domestic product (GDP) now estimated to have amounted to 6.0 percent in 2012, compared with 4.8 percent envisaged in the program, while the rate of unemployment surged to almost 27 percent (in October), as against a programmed annual average of 19 percent. The larger-than-programmed contraction of national output and the delays in policy implementation thus worsened the already doubtful outlook for the sustainability of the public debt.

In this environment, the new Government faced enormous challenges to put the program back on track, and the negotiations with Greece's partners proved very difficult and protracted. But the Government persevered, providing the necessary leadership for reform, despite the strong opposition of vested interests and a generally unfavorable public sentiment. Finally, after almost six months of deliberations, understandings were reached on an updated and recalibrated program, leading to the completion of the reviews of the medium-term arrangement with Greece's euro area partners and the IMF. This unlocked loan disbursements to Greece of as much as 34.3 billion euros (about $45.6 billion) from the euro group in mid-December 2012, as well as some 3.3 billion euros from the IMF in January 2013; and an additional 14.8 billion euros of program loans are to be disbursed by the end of March, subject to the implementation of agreed measures.

In view of Greece's spotty track record, there are doubts of course that "this time things will be different," i.e., that the program will indeed be rigorously implemented and the economic crisis will recede. Nevertheless, some key aspects of the Greek authorities' strategy and changes in approaches of their partners (all designed to render the program more realistic and manageable) augur well for an economic turnaround. The updated program envisages a decline in real GDP of 4.2 percent in 2013, followed by an increase of less than 1.0 percent in 2014 and more rapid growth thereafter. Clearly, 2013 will be another very difficult year for Greece; but for the reasons noted below, which offer grounds for cautious optimism, a recovery could begin to be felt toward the end of 2013, especially if there is a pick-up in growth in the European Union as a whole.

The first and most important reason for cautious optimism is that the Greek authorities have given high priority to restoring the country's policy credibility through a strong commitment to reform and important upfront actions; these actions have largely attenuated if not eliminated the prevailing fears of a Greek exit from the euro zone, which have had a pernicious impact throughout the economy. In this context, the Government adopted a reasonable fiscal policy package for 2013-14, placing greater emphasis on expenditure cuts and savings rather than new revenue measures (that weighed heavily in the initial program). The new package includes some socially difficult cuts in pensions, wages and social benefits, while carefully targeting these cuts to protect the most vulnerable groups; improved budgeting and monitoring rules; and corrective mechanisms to safeguard the achievement of the fiscal and privatization targets.

However, as a weak revenue performance remains the "Achilles heel" of the reform effort, I believe that decisive and unwavering measures will be needed to improve tax collections; otherwise, further painful reductions in government outlays (notably wages and pensions) may be unavoidable. To this end, high priority should be given to strengthening tax administration and vigorously combating tax evasion (especially by the wealthy and the self-employed). Also, the broader tax overhaul that is under preparation should seek to establish a simpler and fairer tax system, including a rationalization of property taxation and some cutbacks in value-added tax rates. Furthermore, strong efforts will be required to achieve a leaner and more effective public administration to better serve Greek society, especially its poorest members.

Second, in agreement with their partners, the Greek authorities have stretched out the time frame for realizing their fiscal objectives by two years, or from 2014 to 2016. This will help to cushion the impact of the requisite austerity measures, give the country more room for maneuver, and facilitate a faster economic recovery. Based on the progress made toward the end of 2012, Greece is now expected to bring its primary fiscal accounts (excluding interest payments) into balance in 2013, representing a major achievement relative to the deficit of 10.4 percent of GDP in 2009. It will then progressively generate a primary fiscal surplus of 4.5 percent of GDP and largely eliminate the overall fiscal deficit by 2016.

Third, progress is now being made on structural reforms. Recent actions to reduce both wage and non-wage labor costs have been significant. But in my view, in order to close the remaining gap in the country's competitiveness, it will be important to enhance productivity, as well as liberalize product and service markets so as to ensure that reductions in costs are adequately reflected in lower prices. The restoration of competitiveness will help boost the growth of output and exports of goods and services, notably in agriculture, manufacturing and the key tourism industry. Also, in light of the disappointing record on privatization so far, there will be need to revitalize the privatization and development program of public assets so as to achieve if not exceed the lower targets recently established; this is critically important not only for mobilizing much-needed financial resources but also for enhancing economic efficiency and potential growth.

Fourth, the updated program seeks to unleash a virtuous cycle of reforms and growth that would tend to reinforce each other. After more than two years of extremely tight liquidity conditions, with a build-up of large cross-arrears in the economy, the program now provides for substantial injections of liquidity in the system that would help speed a recovery. Importantly, a major recapitalization of Greek core banks is expected to be completed in the coming months, thereby restoring their solvency and facilitating the extension of credit to the real economy. The clearance of government payment arrears to domestic suppliers is also expected to play a crucial role, as these suppliers would be able in turn to settle their own overdue obligations, with salutary chain effects across major sectors of the economy. Concurrently, the authorities are restarting or accelerating the execution of a number of infrastructure and other projects that can be financed almost entirely by available European structural and cohesion funds; and they have recently concluded agreements with the European Investment Bank to guarantee lending to small and medium enterprises, as well as support infrastructure and energy sector investments. Finally, steps are being taken to expedite the implementation of the already approved fast-track and other procedures designed to improve the business environment and attract foreign direct investment. The convergence of these measures, if combined with the dismantling of bureaucratic hurdles, would help revive growth and begin to reduce unemployment.

And fifth, following the large "haircut" of the country's privately held sovereign debt in early 2012, euro area countries have undertaken significant initiatives aimed at contributing to the sustainability of Greece's public debt. With the strong encouragement of the IMF, the euro group agreed last December to reduce interest rates under the Greek Loan Facility; extend maturities on official loans and defer some interest rate payments; and transfer to Greece profits earned by the European Central Bank on Greek bond holdings. The Greek authorities also carried out in December a voluntary buyback of Greek government bonds from the private sector at a substantial discount. With these and other debt relief measures expected down the road, and contingent on progress in fiscal consolidation, it is now projected that Greece's public debt ratio will be progressively reduced from a high of about 178 percent of GDP in 2013 to 124 percent of GDP in 2020 and substantially below 110 percent of GDP by 2022. Although uncertainties remain regarding the debt dynamics, a further lowering of the country's debt burden may still be needed; but this can be achieved only through continued close cooperation with creditors and an effective implementation of the program.

These key elements should be coupled with a broader set of institutional reforms that would enhance social cohesion in support of the program and improve its prospects for success. The most important of these reforms are promoting transparency and accountability in government operations and the political system; combating corruption and cronyism in all their aspects; ensuring a speedy and equitable prosecution of justice; reforming the education system with a focus on practical learning; and fostering research and development to encourage productive initiatives.

In conclusion, judging from the authorities' political commitment to reform and their recent upfront actions, there is reason to believe that Greece can meet its major challenges of restoring fiscal and debt sustainability, promoting competitiveness, and ensuring a recovery of growth and jobs over the medium term. Already, there are some signs of improving confidence in the economy, including a narrowing of long-term interest rate spreads and a reflow of deposits into the Greek banking system; but major downside risks remain, especially a possible flare-up of political difficulties and disruptive labor strike actions. Going forward, international support, particularly European solidarity, will be critical for Greece; but key to success will be the rigorous and sustained implementation of the updated program, notably in the areas of tax collection, public administration, privatization, and the liberalization of product and service markets.

* Evangelos A. Calamitsis is an economist and former director at the International Monetary Fund (IMF).