29 May 2013

Bank of Greece: Report on Monetary Policy 2012-2013

Confidence in Greece’s economic prospects is gradually being restored, as shown by the sharp decrease in the yield spread between Greek and German ten-year government bonds. The Greek banking system has weathered the storm and proved resilient to the severe crisis; it is currently undergoing a process of restructuring on new, healthy foundations. This is the first crucial step towards restoring normal financing conditions in the real economy. It is worth noting that the stability of the banking system was shielded from the tangible risk of a spillover from the Cyprus crisis. Thus, the peak in uncertainty triggered by the developments in Cyprus proved short-lived, putting a halt to the outflow of deposits observed in April 2013.

The twin deficits (fiscal and external) have declined considerably: fiscal consolidation has made remarkable progress, and a primary surplus seems likely to be achieved in 2013, while the external balance has also improved substantially. The implementation of the stabilisation programme is judged to be well on track, and disbursements under the loan agreement are continuing smoothly.

If the implementation of structural reforms can be speeded up and the improvement in economic sentiment takes hold, it is plausible to expect that the results will soon be felt in the real economy as well. A prerequisite for recovery is the continued steadfast and faithful implementation of the stabilisation programme. According to the Report, GDP is expected to contract at a rate of close to 4.6 per cent this year, and unemployment to stabilise at around 28 per cent. A return to positive growth is anticipated for 2014, while unemployment should start to decline in 2015.

Until recently, the banking sector had been facing serious problems with liquidity, loan portfolio quality and capital adequacy. These problems, though still present, are gradually being mitigated. It is particularly worth noting that, despite the extremely adverse conditions, the government and the Bank of Greece took effective action and succeeded in safeguarding financial stability and fully protecting depositors. This was confirmed again recently when, starting in late March, Greek banks had to tackle the negative fallout from developments in Cyprus. Following swift and effective action on the part of the Greek authorities, the risk that shocks from the Cypriot banking system would be transmitted to the Greek financial system was minimised, as deposits with Greek branches of Cyprus banks were fully excluded from the bail-in imposed on deposits in Cyprus. The former Cypriot bank branches operating in Greece continued to serve their customers smoothly after their acquisition by a domestic bank. The risk of contagion from the Cypriot to the Greek banking system was thus nipped in the bud.

Nevertheless, the climate is more favourable today for the speedier pursuit of policies aimed at translating the improvement in expectations into real economic activity. For this to happen, there are a number of prerequisites:

First, to press ahead with the fiscal consolidation programme, fully adhering to the timetable and targets set. Meeting the budgetary targets both fully and on time is the first and essential condition for the continued smooth disbursement of funds under the loan agreement. Top priority should be given to achieving a primary surplus in 2013. Achieving the budgetary targets would bolster confidence in the Greek economy, while also eliminating the need for additional across-the-board measures. In fact, the progress made so far with fiscal adjustment has been crucial to ensuring continued financial support to the Greek economy.

Second, to accelerate structural reforms, especially in the public sector. In particular, emphasis should be given to:

• finalising the tax reform agenda, which should create the conditions for reducing the tax burden of those who already pay taxes. This requires a broadening of the tax base, through the effective curbing of tax evasion;
• improving the efficiency of tax administration, in order to boost public revenue. Of major importance in this respect is the upgrading and effective functioning of the General Secretariat of Public Revenue Administration;
• taking steps to rationalise the functioning of the public sector, by utilising the opportunity for staff renewal opened up by the recent decision to replace some 15,000 civil servants who are expected to leave service under mandatory exits by 2014. New recruitments should be strictly merit-based and targeted to cover pressing needs in key areas (e.g. tax administration, health).

Third, to carry through the privatisation agenda with greater resolve and at a faster pace, assessing each privatisation in terms of its potential to create jobs and foster a shift in the Greek economy’s growth model.

Fourth, to address urgently the issue of unemployment, by inter alia strengthening active labour market policies. This can be achieved by making more effective use of resources available from the Structural Funds to support social cohesion.

Fifth, to complete pension reform in practice, by developing the occupational and private life insurance pillars, which, under certain conditions, could help offset the declines in main, first-pillar pensions. This would require eliminating existing obstacles and rigidities.

Sixth, to enhance liquidity in the short term, by accelerating: (i) the payment of public sector arrears to the private sector; and (ii) the utilisation of available resources of the National Strategic Reference Framework (NSRF) and the European Investment Bank to support investment and relaunch infrastructure projects.

Key to restoring normal liquidity conditions will also be the strengthening of the banking sector, which – along with the completion of structural reforms – will help to rebuild confidence in the economy and increase both the supply and demand for bank financing.

In the long term, however, given that domestic savings are not sufficient to finance growth via bank lending, alternative sources of financing the economy need to be tapped, complementing bank credit and EU funds. In this respect, as the economic and business outlook improves, Greece must seek to attract foreign direct investment through privatisations and to take advantage of the opportunities offered by the corporate bond market.

Full press release

Full report (in Greek only)

© Bank of Greece