Describes
the preliminary findings of IMF staff at the conclusion of certain missions
(official staff visits, in most cases to member countries). Missions are
undertaken as part of regular (usually annual) consultations under Article IV
of the IMF's Articles of Agreement, in the context of a request to use IMF
resources (borrow from the IMF), as part of discussions of staff monitored
programs, and as part of other staff reviews of economic developments.
May 3, 2013
1. Greece is making progress in overcoming deep-seated problems in the midst of a very serious and socially painful recession. The adjustment challenges facing Greece in 2010 were daunting, with fiscal and current account deficits both well into the double digits, reflecting runaway increases in public expenditures and the emergence of a large competitiveness gap in the years following the adoption of the euro.
For any country belonging to a currency union, addressing dual imbalances of this magnitude would carry very high risks to growth, as recognized at the outset. In the event, the recession in Greece has been much deeper than expected. But Greece’s achievements must also be recognized:
For any country belonging to a currency union, addressing dual imbalances of this magnitude would carry very high risks to growth, as recognized at the outset. In the event, the recession in Greece has been much deeper than expected. But Greece’s achievements must also be recognized:
- Progress on fiscal adjustment has been exceptional by any international comparison, with the primary balance set to have cumulatively improved by 10 percent of GDP by end-2013, amid a contraction in GDP of more than 20 percent.
- Greece has also made a significant dent in its competitiveness gap. Far-reaching labor market reforms have helped to realign nominal wages and productivity at the enterprise level. We estimate that the competitiveness gap as measured by Unit Labor Costs (ULC) has been reduced by close to two-thirds since 2010, while the current account deficit has come down cumulatively by about 10 percent of GDP.
- Financial sector stability has been preserved, despite large losses associated with the debt restructuring and a sharp rise in NPLs associated with the deep recession.
2. These achievements have been facilitated by unprecedented support from the international community, including €173 billion to date from Greece’s European partners. This has significantly cushioned the adjustment need, preventing what would otherwise have been much more serious social hardship, while containing negative spillover to the rest of the euro area. The achievements to date are evidence of a very strong and persistent determination on the part of Greece and its European partners to do whatever it takes to restore Greece to a sustainable situation inside the euro area.
3. However, insufficient structural reforms have meant that the adjustment has been achieved primarily through recessionary channels, with unequal distribution of the burden of adjustment. Three problems stand out:
- Very little progress has been made in tackling Greece’s notorious tax evasion. The rich and self-employed are simply not paying their fair share, which has forced an excessive reliance on across-the-board expenditure cuts and higher taxes on those earning a salary or a pension.
- While labor market reforms are causing a notable decline in nominal wages, this has only to a very limited degree been reflected in lower prices, because of failure to liberalize closed professions and more generally open up to competition. This is another reason for why too much of the burden has so far fallen on those earning wages and pensions.
- While the rebalancing of the economy has been associated with a surge in unemployment in the private sector, not least among the young, the over-staffed public sector has been spared, because of a taboo against dismissals.
Decisive corrective actions are needed in each of these areas to promote an early supply response and achieve a more balanced distribution of the burden of adjustment. The mission welcomes that the government is refocusing its program in recognition of these problems.
4. Major fiscal challenges remain. With no more room for tax increases or major cuts in discretionary spending, the government has been forced to focus on socially difficult cuts to wages and social transfers. The fiscal program for 2013–14 is unequivocal evidence of the government’s determination to meet its commitments in the fiscal area. Greece’s European partners have responded by agreeing to reduce the medium-term primary balance target from 6½ to 4½ percent of GDP and to length the adjustment period to 2016. But Greece will still need some further structural fiscal adjustment to reach its medium-term fiscal target. The key challenge is to define a way for the Government to achieve this while adhering to its promise to avoid further across-the-board spending cuts. Three key issues must be addressed:
• Tax administration reform. The government’s medium-term program assumes an improvement in tax collection by 1½ percent of GDP. Substantial technical assistance has helped give the tax administration the technical tools it needs to succeed, but this target remains very ambitious against the backdrop of the disappointing progress in this area so far. To finally deliver, deeper political commitment to tax administration reform is critical. To insulate the administration against what is still pervasive political interference, a key step over the next year will be strengthening its independence, by giving it new powers to manage its personnel and budget. Recent changes are an important step in this regard.
- Public administration reform. The plan is to primarily achieve medium-term targets for reduction in staffing levels through voluntary attrition. This is understandable. However, it is not credible without some limited mandatory redundancies. Thus, while projections suggest that attrition will be just about enough to meet medium-term staffing targets, the provision of important public services is already hampered by lack of qualified staff in key areas, like banking supervision and tax administration. Mandatory redundancies that provide room to hire new, well-qualified and motivated staff will thus need to be a key component of the plan for modernization of the public sector, and in the process lend credibility to the policy of relying primarily on attrition. The taboo against mandatory dismissals must be overcome.
- Preserving and enhancing the social safety net. The government has kept its adjustment policies progressive, but there is a need to go beyond this to strengthen specific features of the safety net, to assist those most affected by the crisis. Job training programs and income support programs for the unemployed both need to be geared up, leveraging European Community funds where available.
5. Effective financial intermediation is crucial to contribute to a strong recovery. The program’s bank recapitalization framework is set to deliver a fully recapitalized system by mid-2013, and banks should be in a position to support a gradual recovery in credit as deposits and wholesale market access returns. The reduced sovereign-bank link—banks now have little Greek government debt on their balance sheets—will also help to facilitate a return to market access. Thus, we expect that the deep de-leveraging that has taken place in recent years will soon come to a halt. However, serious policy challenges still exist in this area:
- A major concern is to ensure that the large injection of public capital does not give rise to undue government interference and attendant problems of misallocation of credit. Greece’s experience with state run banks is very poor. A reinforced governance framework, supporting strong oversight and supervision, and above all very rapid re-privatization, must be a critical objective of the strategy for the four-pillar banking system to be developed by June.
- A key priority for the banking system is to contain and reverse the mounting tide of nonperforming loans. Working out debts, within the recapitalization envelope, will help both the banks and the debtors normalize their activities faster. A more comprehensive debt resolution framework should be developed and introduced as soon as possible. In this respect, the mission welcomes the authorities’ commitment to put in place a framework for dealing with distressed household borrowers.
6. A strong recovery will need to be built primarily on deepening structural reforms. The focus should be on invigorating Greece’s export and import competing industries. This will require a more determined and ambitious effort to reduce barriers to entry into various markets, including opaque and lengthy licensing procedures. Moreover, too many assets remain in state hands. The government’s welcome public commitment to improving the business environment and accelerating privatization now needs to be matched with results. Achieving a critical mass of change will be possible only with a broad, forceful, and sustained political commitment.
7. Attempts to artificially engineer growth should be resisted. International evidence is mixed at best on the usefulness of development banks, tax-free zones, and subsidies (or tax expenditures) targeted at specific sectors. Greece cannot afford to divert resources to unproductive uses nor to devote limited implementation capacity to designing and establishing such policies. And in particular, Greece cannot afford a more complicated tax system, which would work directly against the crucial effort to improve tax collection.
8. Restoring growth remains the overarching precondition for whether Greece succeeds. Looking over the period 2010–2012, the much deeper than expected recession was overwhelmingly due to a progressive loss of confidence, culminating in acute concerns about euro exit, as political uncertainty continued to grow, making it increasingly evident that there was no strong political resolve to stand up to vested interests fiercely opposed to reforms. This led to a dramatic contraction in investments not only through poor sentiment, but directly through deleveraging and an attendant sharp credit contraction. Looking forward, two crucial considerations stand out:
- With fiscal adjustment set to remain a drag on GDP growth for several years to come, the key challenge is to generate the improvement in confidence needed for a recovery in investment to begin to more than offset this drag. This cannot happen unless Greece can secure broad domestic support for the program and the political stability that would come with this. The lessons of the recent past are that only with full and timely policy implementation and commitment to the program can the fundamentals for a recovery be put fully in place and the fear of adverse outcomes permanently put to rest.
- Greece’s public debt remains much too high, despite the restructuring of privately held bonds and recent support by official creditors. It is, therefore, very welcome that Greece’s European partners have now accepted that Greece could need significant exceptional support on below-market terms in order to restore debt sustainability and that they have committed to provide additional relief, if needed, to keep debt on the programmed path, i.e. to bring it substantially below 110 percent of GDP by 2022. With Greece’s debt now overwhelmingly held by the official sector, such a commitment is essential to assure creditors that a credible framework for dealing with Greece’s debt overhang is now in place.
9. Overall, while it will yet take some time for the country’s situation to fully normalize, the government of Greece has come a long way in its adjustment effort. Adopting the necessary policies for the next leg of the adjustment effort, which may well mark a turning point for Greece, must take priority.
The mission is grateful to the authorities for the constructive discussions.
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