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The following OECD assessment and recommendations summarise chapter 1 of the Economic Survey of Greece published on 31 July 2009.
Greece has not escaped the international crisis…
The robust expansion of Greece since its entry into the euro area has slowed significantly under the weight of the international crisis. However, the economy has weathered fairly well the initial impact of the shock that plunged most of the OECD countries into a serious recession. Growth remained positive until the end of 2008 thanks to relatively buoyant exports to the Balkans and large wage increases which supported consumption. The banking sector has benefited from marginal exposure to the toxic assets which were at the root of the international storm. Even so, the impact of the crisis substantially shook the confidence of households and businesses, which are reining in spending. Furthermore, persistent structural imbalances, illustrated by the poor state of public finances and the large current account deficit, limit room for policy manoeuvre, and Greece's exposure to south–eastern Europe has increased the country's vulnerability to the crisis. In the wake of a general increase in risk aversion, the long–term sovereign interest rate spread vis–à–vis Germany widened sharply in early 2009. In line with market assessments, rating agencies downgraded the sovereign debt and credit risks of the leading Greek banks, as in a number of other European countries.
..and is unlikely to avert a recession
The OECD projects a decline in output by 1¼ per cent in 2009 followed by a slow recovery, with GDP rising by ¼ per cent in 2010. In the first quarter of 2009, real GDP contracted by an annualized rate of 4.8% over the previous quarter, but grew 0.3% year on year according to the national accounts estimates. Exports will be adversely affected this year by the plunge in international trade, including in shipping and tourism. Lower confidence, an expected rise in unemployment, and tighter credit conditions will weigh on domestic demand. Nevertheless, a number of factors should moderate the slump. The rise in household income is expected to remain robust thanks to the generous wage agreements signed in the private sector in 2008. Greece is less dependent on trade, and in particular on manufacturing, than many other OECD countries. It also continues to receive substantial EU financial support, and its growth potential is still high, even if this is likely to be weakened by the crisis. This outlook is surrounded by uncertainties, however, which tend to weigh on the downside, and if they materialise, the output projection would probably be weaker. A greater deterioration of the external environment, especially in the Balkans (which absorb almost a fourth of exports), would cut growth. The impact of the weaker economy on the financial sector could pose another risk to growth. The continuous erosion of international competitiveness, driven by the relatively rapid wage increases and a persistent inflation differential with the euro area, could also hamper the recovery more than expected, especially if the pick–up of activity remains subdued in the south–eastern European markets.
There is virtually no room for budgetary manoeuvre
Unlike many other OECD countries, Greece has virtually no room for budgetary manoeuvre to cushion the weakening of activity. Public debt is now close to 100% of GDP, and the fiscal deficit rose from 3.1% to 5% of GDP between 2006 and 2008 despite a buoyant economy. Against the background of the general rise in risk–aversion and declining market liquidity triggered by the financial crisis, repeated fiscal slippages together with the impact of ageing on the long–term budget outlook, largely explain the sharp widening of interest rate spreads with Germany. Greece is also subject to an EC excessive deficit procedure (EDP), and has six months – until October 2009 – to undertake corrective measures needed to bring its deficit back to 3% by 2010 from 5% of GDP in 2008. Under these circumstances, the government limited its crisis–related fiscal support to the most vulnerable groups and key economic sectors, such as tourism, construction and small enterprises. It has adopted a consolidation plan which, based on measures announced as of mid–June 2009, aims at reducing the structural budget deficit by 2½ per cent of GDP by 2010 according to OECD estimates. This plan includes a cut in civil service employment, a freeze in government wages, a 10% cut in “elastic” budget outlays and a one–off levy on high incomes.
Actual and underlying structural balances
Source: OECD (2009), OECD Economic Outlook 85 database.
…but automatic stabilisers should be allowed to operate and the necessary fiscal tightening needs to be carefully timed
Since the government plan was adopted, however, growth prospects have substantially weakened and the 2008 fiscal deficit was revised up. As a result, to bring the deficit below 3% of GDP in 2010, the structural fiscal adjustment would have to exceed 6% of GDP, which is more than double than that envisaged in the government consolidation plan. Given the weak economy, such an adjustment would be excessive. In the short term, the structural deficit should be reduced by at least the 2½ per cent of GDP already planned by the government over 2009–2010, and automatic stabilisers should be allowed to work beyond this. This would result in a deficit of some 6% and 6¾ per cent of GDP in 2009 and 2010 respectively, and lead to public debt above 100% of GDP in 2010.
..at the same time a strong commitment to enhance fiscal viability is indispensable
To limit any adverse impact of the higher deficit in 2009 on market confidence and interest rate spreads, the authorities should make a strong commitment to fiscal consolidation, increase credibility of fiscal policy and deal with the long–term threat to budgetary sustainability posed by population ageing. In the past, consolidation has been too dependent on temporary measures and has not yielded sufficient control over government spending. The authorities should adopt specific and concrete measures to rein in spending and improve tax collection. This policy should be buttressed by a multi–year budgetary framework, a legally binding fiscal rule that would cap expenditure and prevent structural deficits, and an independent council to oversee fiscal policy. Switzerland has gone as far as putting its fiscal rule into the constitution and this is under consideration for a new rule in Germany as well. Greece could also explore this option. To achieve fiscal sustainability, the rules should aim at reducing public debt to less than 60% of GDP by 2020–25, when the budgetary consequences of population ageing start to be fully felt. This in turn requires eliminating the budget deficit by 2014, once economic recovery is underway, to be followed by surpluses of about 1% of GDP as from 2015.
The financial sector may face pressures from its housing and emerging market exposure
Greek banks are confronting the crisis after a prolonged high growth in lending upon liberalisation of the sector since the millennium, including substantive privatization, and with no experience with recession. Although the crisis initially had little effect on banks beyond reduced liquidity, they remain vulnerable to international turbulence through their exposure in the Balkans, especially in Bulgaria, Romania and Turkey, if the economic situation in these economies were to worsen substantially. Bank claims in these countries, whether held by subsidiaries or cross–border, correspond to 17% of GDP, which is high compared to most other European countries. In these rapidly growing markets, bank groups have run substantial credit risk, exacerbated in some cases by overvalued real estate prices, and exposure to largely unhedged borrowers since half of local claims are denominated in foreign currencies. On the domestic front, banks face a large exposure to a contracting real estate sector, in which investments have dropped by over 3% of GDP since 2006. In the months ahead, the strains induced by the crisis in this sector are likely to be compounded by the impact of the projected recession on bank portfolios.
Supervisors should be prepared to deal with evolving risks
A support package was adopted to boost confidence and liquidity in the banking system. It contains measures to increase the statutory guarantees for deposits with credit institutions, aid to bolster bank capitalisation, including government acquisitions of equity, and guarantees to support bank liquidity. The measures, totalling up to €28 billion (11½ per cent of GDP), are intended to lessen the risk of a procyclical tightening of bank lending conditions. The plan appears to provide enough assistance to ensure financial stability for now, especially in view of the good initial level of bank profitability and capitalisation. However, as discussed above, significant uncertainties persist on both the domestic and external fronts. A close watch over developments in the financial sector must therefore be maintained to ensure that the support plan adequately meets the needs of credit institutions. This should be accompanied by greater efforts to disclose information about the banking system’s solidity vis–à–vis the crisis. The regular publication of Financial Stability Reports, as recently initiated by the Bank of Greece, will help reduce market uncertainty. These reports should include regularly the results of stress tests with changes in perceived risks. In the medium term, the authorities might consider changing the bank provisioning mechanisms to limit the procyclical nature of credit supply — drawing on the Spanish experience — in the context of an EU move in that direction.
Further structural reforms of labour and product markets are needed to sustain the catching–up process and boost flexibility of the economy
To sustain catch–up, Greece needs to reduce its structural imbalances and improve competitiveness with reforms that raise productivity. The sizeable difference in per capita income with the most advanced economies is mostly due to a productivity gap, although participation rates of the young and women in the labour force are also low. Low productivity is influenced by rigid product and labour market regulations. Enhancing labour market flexibility would also help prevent the expected rise in unemployment, which is already high among the young and women, from becoming structural. Further reforms in labour and product markets are needed to deal with these challenges. Minimum wages setting should better take into account the high youth and female unemployment. The government should encourage decentralised wage bargaining by avoiding administrative extensions of collective agreements to firms not directly represented in the negotiation. Significant productivity gains could be reaped from further moves towards a pro–competition regulatory stance. Specific areas where there is most scope for improvement include: reducing the number of procedures for business registration and meeting legal obligations; easing regulation of professional services; and making the regulatory framework in retailing more conducive to competition. Establishing effective competition in network industries can be achieved by further progress towards privatising public enterprises and introducing more modern regulation in the energy, communications and transport sectors. Strong and effective regulators are critical for promoting competition in all newly liberalised sectors.
How to obtain this publication
The complete edition of the Economic Survey of Greece is available from:
The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.
For further information please contact the Greece Desk at the OECD Economics Department at firstname.lastname@example.org.
The OECD Secretariat's report was prepared by Claude Giorno and Vivian Koutsogeorgopoulou under the supervision of Piritta Sorsa. Research assistance was provided by Joseph Chien.