24 February 2011

The Economic Adjustment Programme for Greece - Third Review

A joint Commission/ECB/IMF mission met with the Greek authorities in Athens on 27 January – 11 February 2011. The mission assessed compliance by Greece with the terms and conditions of the second review under the economic adjustment programme and updated conditionality for the next reviews.

On 24 February the European Commission assessed measures taken by Greece to remedy the situation of excessive deficit. Subject to the approval of the Eurogroup, the overall assessment of compliance paves the way for the next tranche of loans provided by the euro area Member States.

The programme's objectives remain intact. The objectives of the adjustment programme are to preserve financial stability and adequate liquidity in the banking sector, a front-loaded reduction in fiscal deficit to restore public debt sustainability, and a change to a growth model based on exports and investment, to ensure growth and jobs and the sustainability of the external accounts. As this Compliance Report documents, these objectives remain intact. The programme is broadly on track and has made further progress towards its objectives.

The main features of the macro-economic scenario remain unchanged, but growth composition needs reshaping. Economic activity contracted by 4.5 per cent in 2010, broadly as expected when the adjustment programme was designed in May 2010. However, available data suggest that the downturn in domestic demand, mainly private consumption, was deeper than expected, while exports and non-domestic orders were strong at the end of 2010. The inflexion point of activity is estimated to sit in the last quarter of2010, while positive growth is expected to be recorded in the second half of 2011. Underlying inflation, wage settlements and unit labour costs are moderating, leading to improved competitiveness. The progressive rebalancing of the economy, supportive external demand and growth-friendly reforms are expected to move the economy back to its potential. Growth rates for 2012–14, which underlie the programme, are prudent.

Most fiscal criteria for 2010 have been met. A severe contraction in payments towards the end of the year offset large shortfalls in tax collection, thus resulting in the compliance with the cash-based quantitative criteria. The ESA fiscal deficit – which has a wider coverage and refers to underlying expenditure commitments rather than cash outflows – is estimated to have exceeded its ceiling by 1½ per cent of GDP, as already projected at the time of the previous review in November. This slippage was in part due to the revision of historical statistics in autumn.

Fiscal policy in 2011 aims to further reduce the deficit-to-GDP ratio to EUR€17 billion (7½ per cent of GDP). However, there are significant negative risks: current projections indicate a gap of ¾ of a per cent of GDP, due to base effects, as tax revenues at the end of 2010 were below previous estimates, and a downward revision for the yield of some fiscal measures. The government is committed to offset this gap. It will specify permanent fiscal measures once it finalises its medium-term fiscal strategy in end-March (adoption in early May). In the interim, to ensure to ensure compliance with the fiscal targets, it will compress expenditure – the same strategy of last year, which showed increased strains through the year as arrears built up.

The government is preparing its medium-term fiscal strategy. The medium-term strategy document will set annual spending ceilings for individual line ministries and fiscal balance targets for all general government entities. Greece is still swimming against the recession and the tide of increasing interest payments. As a result, to bring the deficit below 3 per cent of GDP in 2014, some 8 per cent of GDP in permanent measures will be needed over the period 2012-14, of which 2 per cent has already been identified in the May 2010 programme. This additional fiscal consolidation effort will require structural reforms in several key areas, tackling the root causes of Greece’s fiscal imbalances. These reforms will need to cover public enterprises, healthcare, tax policy, public employment, extra budgetary funds, investment and military spending.

Following a slowdown in momentum in autumn, a wave of structural reforms is now underway. After some important reforms adopted before the summer 2010, including a landmark pension reform and a first leg of labour reforms, structural reform efforts lost traction, and there have been delays compared to earlier policy commitments. A law to liberalise the labour market further was adopted at the end of the year, with a reform of collective bargaining and other associated measures. However, its ambition was below expectations, though time is necessary to assess its effectiveness. Several other reforms are being prepared. The removal of unnecessary hurdles to the entry and exercise of professions is a flagship reform of the whole adjustment programme; its implementation requires political determination against incumbents. The reform of the national healthcare system aims at reducing costs without endangering the quality of care. A number of business environment-related measures, such as a new investment law, a new competition law and new rules on licensing have been adopted or are approaching parliamentary proceedings. Irrespective of the urgency in adopting these reforms, it is critical to ensure the quality and ambition of legislation, as well as determined and effective implementation.

There is an intense debate on debt management operations to reduce the stock of sovereign debt. These operations could cover buy-backs, the roll-over of debt or the voluntary extension of maturities. Irrespective of the merit of those actions – which this report does not discuss – they would only provide a modest and one-off contribution to debt sustainability in Greece. Therefore, this debate and those actions, if implemented, must not reduce the political determination to, or distract the public opinion from, fiscal consolidation, privatisation and growth-enhancing structural reforms.

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