George A Provopoulos: The strategy for the Greek economy’s exit from the crisis – what is at stake?

24 April 2012

In his speech, Mr Provopoulos, Governor of the Bank of Greece, said the choice was between orderly effort to reconstruct the economy within the euro area, and disorderly economic and social regression, which would eventually drive Greece out of the euro area and the European Union.

Past failures to act in a resolute and timely manner have magnified the actual costs of adjustment. The second adjustment programme, along with private sector involvement in the restructuring of Greece’s public debt, leading to its substantial reduction, mark the end of one phase of the crisis.

The recession and unemployment turned out worse than initially expected. The general government deficit was reduced in 2011, but meeting the fiscal targets for 2012 will require persistent efforts. The general government deficit as a percentage of GDP was reduced by 1.2 percentage point in 2011, according to figures released yesterday, while the primary deficit was reduced by 2.5 per cent of GDP. Furthermore, in the first quarter of 2012, the central government deficit, on a cash basis, decreased markedly year-on-year, while a primary surplus in the order of 0.5 per cent of GDP was recorded, compared with a primary deficit of 0.5 per cent of GDP over the corresponding period in 2011. Primary expenditure fell, albeit less than targeted, due to increased subsidies to social security funds. Attaining the full-year targets will obviously require persistent efforts.

A national strategy for the orderly reconstruction of the economy

It has now become clear that the changes undertaken thus far are insufficient.

• Both the fiscal and the external deficits remain high, implying that the country continues to live beyond its means, by relying on the financial support of its partners.
• Major structural weaknesses in the public sector still remain, even in cases where measures to eliminate them have been legislated.
• Market distortions undercut competition and hamper growth.
• Whilst cost competitiveness has improved, structural competitiveness still lags.

It is therefore clear that the difficult task which we have before us calls for a persistent effort over many years.

Measures with immediate returns

• Reforms to improve the business environment, including measures to deal with red tape and reduce the administrative burden on businesses, to simplify the regulatory framework, and to restore market competition.
• A speeding-up of the privatisation programme. Apart from generating proceeds that reduce the debt, privatisation may also entail further investment in order to exploit fully the assets to-be-acquired. Privatisations open up opportunities for foreign direct investment, which leads to technology transfer, efficiency increases and productivity gains.
• A faster absorption of the funds for the National Strategic Reference Framework (NSRF) and the securing of funds from international institutions, such as the European Investment Bank; such funds will ensure that important infrastructural projects that have been put on hold can be resumed.

Structural changes for a transition to a new growth model

Apart from measures with immediate returns, a long-term growth policy is needed. Such a policy must as of today strive for reforms to foster the transition to a new, export-orientated, growth model. These reforms must focus on changing the structure of production and on removing distortions. Greece’s euro area entry did not bring about any significant differentiation in the structure of production; as a result, the level of structural competitiveness has remained low. Structural reforms aimed at a business-friendly environment and at attracting foreign direct investment make a decisive contribution to progress in this direction.

Such reforms involve:

• bolstering competition in the markets for products and for factors of production;
• modernising public administration;
• ensuring a stable and growth-friendly tax system;
• speeding up judicial procedures;
• rationalising and simplifying the regulatory environment;
• encouraging innovation, research and export-oriented activities; and
• increasing the effectiveness of education at all levels.

The restructuring of the banking system

The key factor to improving financial conditions is the strengthening and restructuring of the banking system, currently in progress.

2012 will be a critical year in shaping the future structure of the banking system in Greece. Banks now face losses originating from the fiscal crisis. First, they are dealing with the implications of having invested in Greek government bonds, an instrument considered safe until recently. Banks’ published annual statements show that the related impact is quite substantial. Second, banks also face the consequences of the increased difficulty that households and businesses have in servicing their debt obligations on account of the protracted recession. These developments imply that it is imperative for banks to strengthen their capital base – a process which is already underway.

Anticipating these challenges, early in 2011 the Bank of Greece, in cooperation with the International Monetary Fund, the European Commission and the European Central Bank, began planning a number of measures to safeguard financial stability. These measures include:

• meeting short-term liquidity needs through the Eurosystem;
• formulating, in cooperation with the government, a resolution regime for credit institutions,  and applying it where necessary;
• securing €50 billion from the financial support programme for the banking system’s recapitalisation and restructuring.

Full speech

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