Greece: Taking stock - economic and financial changes since the onset of the global and euro area crises

Francisco Torres (Santander Visiting Fellow, St Antony's College, Oxford)
Jonathan Scheele (ESC Visiting Fellow, St Antony's College, Oxford)

On 17 February Eleni Dendrinou-Louri, Deputy Governor of the Bank of Greece, spoke at a SEESOX seminar organised in association with PEFM. The session was chaired by Max Watson, PEFM Director, and Francisco Torres, Santander Visiting Fellow, was discussant

On the economy and economic adjustment, she characterised the pre-crisis period from 2001 to 2008 as a low inflation and low interest rate environment, with negligible spreads vis-à-vis German government bonds but large and growing fiscal and external imbalances.

On the fiscal front, the deficit was almost continuously above 5% of GDP, worsening considerably from 2007 onwards. At the same time, those fiscal imbalances were structural, given the unfunded pension system, the lack of budgetary controls in healthcare, the weak tax administration and poor collection rates, the large underground economy and the clientelist political system.

On the competitiveness front the situation was no better, with Greece losing competitiveness by about 30% against its trading partners between 2001 and 2009. The current account deficit widened significantly between 2001 and 2008 and the relative price of non-tradables increased substantially. Greece ranked worst in the euro area as regards its twin deficits – budget and current account. Thus ‘the debt crisis was an accident waiting to happen’. Spreads sky rocketed and gave rise to self-fulfilling debt dynamics, resulting in a debt-GDP ratio of 176.2% in 2013.

The first adjustment programme focused on fiscal adjustment (its first pillar), while the other pillars (structural reforms of labour and product markets, combatting tax evasion and privatisation) were only partially implemented. Moreover, most of the fiscal consolidation was also achieved through tax increases (60%) rather than expenditure cuts (40%). As a result, real GDP contracted by 25% and unemployment rose from 8% to 27% between 2008 and 2013.

Things had been improving dramatically in the last two years. Fiscal consolidation has been striking, with a positive primary balance achieved in 2013. However, the gap between fiscal effort and outcome reflected the high level of the fiscal multiplier (due to a low savings rate, the closed nature of the economy and liquidity constraints).

On the external adjustment front, the current account adjustment had been mainly the result of a decline in imports. Wage adjustments did not lead to a considerable fall in prices, as other factors were more significant. Competitiveness was also being promoted by structural reforms. Labour market reforms, reduced bureaucracy and market liberalisation were all contributing to the shrinking of the non-tradables sector.

There were reasons for optimism in the medium to long term: rising economic sentiment (above 90 since early 2013) and rising PMI and new export orders indexes. Positive growth was likely to return in 2014 as the fiscal drag would decline and competitiveness gains would further affect export performance, while liquidity constraints were likely to be loosened and the supply-side effects of structural reforms become evident. Increasing the openness of the economy, reducing the size of government and improving institutional characteristics (public administration, bureaucracy, and the like) would all contribute to a higher long-term potential growth rate, estimated to be of 3-3.5% per annum.

On the Banking System, the pre-crisis sector was sound and healthy. There was a comparatively low level of private debt, the banks did not hold toxic assets and therefore they were not affected by the subprime crisis; however there was exposure to Greek sovereign debt.

With the sovereign debt crisis, Greek banks were hit by a series of downgrades and deposit withdrawals, losing access to international capital markets and obliging the Eurosystem to provide (expensive) ELA via Bank of Greece; this was now declining. Banks experienced significant losses due to the Private Sector Involvement (PSI) (€43 bn), the rise in non-performing loans (30% in 2013) and rising deposit interest rates needed to keep depositors.

As a response to these developments, banks deleveraged (13% reduction in private sector credit 2010-2013), thereby contributing to economic contraction, and creating negative feedback loops between the financial and the real sectors. At the same time, liquidity problems turned into solvency problems, putting at stake the stability of banking system, with implications well beyond Greece. Still, thanks to the provision of the necessary liquidity, tight banking supervision, and efficient cash management, all depositors were protected and there were no bank runs.

Bank recapitalisation focused on strengthening viable banks and winding down non-viable ones. This was done through an assessment of capital needs (about €40.5 bn) and an assessment of viability based on regulatory and business performance criteria. Four core/systemic banks – National Bank of Greece, Eurobank, Alpha Bank, and Piraeus Bank – were eligible for state support through HFSF; the rest were left to seek private capital or external purchasers. The crisis was a catalyst for consolidation and a reduction in the number of financial institutions: from 65 to 39, with the big four controlling 92% of total assets. Three of the four remained in private control while one (Eurobank) stayed under HFSF. In spite of a partial return of deposits and a reduction of Eurosystem dependence on funding, some challenges remained: the still low net interest margin, banks continuing to make losses and NPLs still rising. Much depended on changes to Euro area governance, notably the setting up of a banking union, a stronger budgetary framework and economic governance and a stronger economic union.

Despite predictions to the contrary, there has been no Euro Grexit. Progress continued in eliminating Greece’s fiscal imbalances, making the economy more competitive internationally and further improving external balances, and completing the restructuring of the banking system. At the same time there were continuing efforts to complete the monetary union.

As the process of overhauling the Greek economy continues, economic growth would return, with Greece becoming increasingly attractive for foreign investment.