IMF Support for Greece Moves Ahead with €3.24 Billion Disbursement
IMF Survey online
January 18, 2013
- The Greek program ran considerably off track during 2012, but is now back on course
- Overall, Greece is making considerable progress with its adjustment program
- Sustained and strong implementation is now needed to lay the foundation for a turnaround
The implementation of policies agreed under Greece’s IMF-supported program ran considerably off track during 2012.
An extended election period effectively put on hold macro-structural reforms, privatization, and fiscal reforms. The delays had important repercussions on the economy, which was already expected to be weak. As a result, program projections undershot due to weaker confidence and tight liquidity conditions.
In recent months, however, Greece has made impressive progress under the new coalition government in terms of restoring fiscal sustainability and agreeing labor market reforms that are providing a much needed boost to competitiveness. Overall, the government’s program has been delivering some important results.
Moreover, the agreement reached by Greece and its European partners in December last year on how to address concerns about debt sustainability has created room for the government to move ahead decisively with reforms needed to revive economic growth and start reversing the process of job loss and declining incomes.
Completion of the review paves the way for the disbursement of €3.24 billion under the IMF-supported program that was agreed in March last year as part of a joint financing package with euro area member states amounting to €172 billion over four years.
In this interview, the IMF’s Poul Thomsen discusses the outlook for Greece, what it will take for the program to succeed, and what the key risks are.
IMF Survey: With Greece in its sixth year of recession, what are the prospects for recovery?
Thomsen: The prospects for recovery really depend on how well the government implements the program going forward. This is not an easy situation.
The socio-political setting in Greece remains fragile, and any doubts about the government’s commitment to the program could translate very quickly into renewed downward movements in output, as investors and consumers hold back and as deposit withdrawals tighten liquidity.
Moreover, the country has a very large debt overhang, which itself affects the willingness of consumers and firms to spend and invest. Finally, the economy is also faced with continuing fiscal adjustment, a continuing gap in its competitiveness, and weakness in its main export markets in the eurozone.
For consumers and investors to regain confidence, they will need to believe that the program can gain the necessary political support to be successful. Moreover, for Greece to fully exploit its access to eurozone markets and thus offset the demand drag of fiscal adjustment, it needs to address its competitiveness gap by fully implementing the program.
That’s why it is crucial to have a period of successful program implementation before Greece can find its way out of recession.
IMF Survey: Is the IMF now satisfied that Greece has embarked on a path of sustainable debt reduction?
Thomsen: Debt is too high in Greece, and our projections show that it will remain too high without debt relief or long-term transfers from Greece’s European partners.
Greece’s European partners have already taken a number of upfront steps to help bring debt down. They financed the buyback operation of Greek government bonds that was completed in December, and also restructured some of their own loan facilities. Both these measures will start delivering immediate benefits in terms of debt reduction.
Moreover, a framework is now in place to achieve a lasting solution to Greece’s debt problem. Greece’s European partners have agreed to take further steps within the program period to bring Greece’s debt significantly below 110 percent of GDP by 2022, provided Greece achieves its fiscal targets. These assurances in fact reflect an explicit acknowledgement—for the first time since the onset of the crisis—that Greece’s debt burden is unsustainable without debt relief or long-term transfers.
IMF Survey: How much fiscal consolidation does Greece have left?
Thomsen: Greece still has some distance to go. Unfortunately, the country started the crisis with a fiscal deficit of close to 16 percent of GDP, which is an almost unprecedented deficit to have in peacetime and without a banking crisis. A country cannot cure a problem of this magnitude overnight.
Greece has done a very impressive job of adjusting to date, having improved the primary balance by about 9 percent of against fierce macroeconomic headwinds. But given the scale of the initial imbalance, there is still further to go. Our estimates suggest further consolidation amounting to about 6 percent of GDP will be needed in terms of the headline primary balance. In structural terms, Greece is more than halfway there.
IMF Survey: With the IMF’s own research suggesting that too much austerity is self-defeating, does it really make sense for Greece to continue down the path of endless budget cuts?
Thomsen: There has been a lot of discussion about how fast Greece should adjust. The Fund has from the beginning argued for a longer fiscal adjustment period. But we also need to recognize that this requires financing, and Greece has already received commitments for unprecedented financial support.
The adjustment has thus been phased so that there is a balance between the need to reach a sustainable fiscal position in line with available financing and the need to stabilize the economy. The fiscal adjustment path will now reach the primary balance target—a surplus of 4½ percent of GDP—two years later in 2016.
Can Greece achieve this? Historical perspective is helpful. A couple of countries within the eurozone—Belgium and Italy, for instance—have in the past run high primary surpluses averaging 4½ percent of GDP or more for a decade, allowing them to bring down debt levels. In fact, Greece itself ran a primary surplus of 4½ percent of GDP in the late 1990s.
IMF Survey: But isn’t it possible that fiscal austerity leads to an even deeper recession than projected? Didn’t research find that the IMF underestimated the fiscal multiplier?
Thomsen: We need to recognize that there are many influences on economic activity that have an impact on how we measure fiscal multipliers ex-post. For instance, the multiplier used when the program was approved in May 2010 reflected assumptions about confidence, credit mechanisms, and external demand. However, an escalating political crisis severely eroded confidence and contributed to a far deeper than expected credit crunch, while structural reforms fell short of targets, slowing external gains.
The present program framework embeds a much higher multiplier than the original program because it became apparent that a different set of underlying assumptions would be needed. With this higher multiplier, we hope that projections will be borne out, but we always need to keep in mind that underlying assumptions can shift.
IMF Survey: Why is the program still largely based on pension cuts?
Thomsen: The adjustment has been extremely painful, but the focus on pensions was necessary because the surge in public pensions was the main reason behind the rise in Greece’s fiscal deficit. Moreover, other avenues of adjustment—raising taxes on wage earners and cutting discretionary spending—have largely been exhausted by now.
However, I want to emphasize that the program has been designed with a particular emphasis on protecting the most vulnerable social segments, both in terms of spending and tax measures.
Looking ahead, for the government to avoid further wage and pension cuts—which we agree are not desirable—it is critical that it seriously tackles tax evasion and reduces the size of the bloated public sector as planned. This would improve fairness and burden sharing.
IMF Survey: The reform agenda was delayed last year because of political uncertainty. Can you give us some examples of areas where Greece needs to take decisive action?
Thomsen: I’ll give you two examples. The first has to do with competitiveness. The Greek authorities have made a lot of progress in terms of reforming the labor market, and the results are showing up in greatly improved cost competitiveness. But these gains have not yet been translated into changes in prices. The reason for this is that many markets for goods and services in Greece remain protected, making it difficult for new firms to enter the market and instill greater competition.
Take baby formula. Until recently, it could not be sold in supermarkets—only pharmacies had the right to carry it. Last year, the government removed this restriction and prices promptly dropped 40 percent. But then the measure was reversed after it was opposed by those who had benefitted from the restriction. Baby formula is now back on the shelves of Greek supermarkets, but this illustrates what an uphill battle it is to inject more competition into the Greek economy.
The other area I want to highlight is tax administration. If Greece wants to succeed in its adjustment it will have to improve its tax collection. Greece has in fact received a large amount of technical assistance both from the IMF and from the European Union via the Task Force for Greece. The program started off with a planning and preparation stage and continued with reforms to the legal framework that governs tax administration.
But then the process stalled in the implementation phase. Over the last year in particular there have been problems, and the political uncertainty that led up to the elections last May meant that the appointment of a new tax administration director was delayed. With no leadership, reforms stalled. So this is an area where results have been very disappointing, and where strong leadership and deeper political commitment will be needed to get reforms on track.
IMF Survey: Why is it so difficult to get a grasp on the tax issue?
Thomsen: There is a lot of bureaucratic resistance to reform of the tax administration, and widespread perceptions in Greece that inaction in the administration is due to corruption. Corruption does indeed flourish in a situation where there is a lack of transparency—where it’s difficult for the average person, let alone outside observers, to understand the rules. And the rules are complex in Greece. However, the program is making important strides in streamlining Greece’s tax code, and simplifying procedures for accounting and tax collection. The government is also taking steps to make tax administration staff more accountable and giving the tax administration itself greater autonomy to protect it from political influence.
Ultimately, though, while international institutions can offer advice in terms of best practice, the people on the ground are the ones responsible for effecting change. The bottom line is that institutional change will take time and strong commitment. In Greece, we’re still closer to the start of the process than to the end.
IMF Survey: How much progress has been made in terms of improving competitiveness?
Thomsen: In terms of cost competitiveness, Greece has probably eliminated a little more than half of the competitiveness gap that we estimated the country had at the beginning of the program—a gap that amounted to more than 30 percent compared to its closest competitors. That in itself is a major achievement.
However, it is unfortunate that almost all the gain has happened through declines in nominal wages as opposed to productivity gains because of the delay in the structural reform agenda. The renewed push for reforms to improve the growth potential of the economy will hopefully result in stronger productivity growth and alleviate the downward pressure on wages.
IMF Survey: Given the continued squeeze on the financial sector, will Greek banks be able to provide enough credit to get the economy going again?
Thomsen: When you look at international experience with recovery from deep crises, they tend to occur without the availability of credit. Typically, there will be a period of deleveraging when companies and consumers pay down debt.
Greece could grow without a lot of credit in the near term. How? Overall, the private sector is in a net creditor position vis-à-vis the rest of the world, which suggests that many companies could probably finance new investment on their own.
That said, we need to watch that we do not end up with such tight liquidity that it slows the recovery further. We will look at funding plans by the banks to make sure they are consistent, and there will be an effort to prevent a collective attempt by banks to deleverage at a pace beyond program assumptions.
IMF Survey: What are the current expectations for privatization?
Thomsen: This is a critical structural reform that also has important implications for reducing debt. But progress has been held up by weak market conditions, technical constraints, and, importantly, political obstacles.
The government has made a lot of progress in eliminating technical barriers—for instance, identifying the salable pieces of land that are not encumbered by title problems and that already have zoning permissions. But it is going to take a while to sell all these assets, and we have to recognize that market conditions are not very favorable right now.
Regarding political obstacles, an independent agency was set up in 2011 to help manage the work, but if problems continue, the authorities may need to revisit its governance.
IMF Survey online: With the completion of the first and second reviews under the new IMF-supported program, how confident are you that Greece can now begin to rebuild its shattered economy while staying in the eurozone?
Thomsen: The program has given Greece the resources and time it needs to address its deep challenges. With the resources provided by euro area member states and the IMF, Greece will be able to recapitalize its banking system. The program also gives Greece time to adjust its fiscal position and complete the structural reforms it needs to improve its competitiveness.
All told, Greece has received €50 billion for bank recapitalization and another €120 billion in budget support. These very substantial resources are saving Greece from having to go through even more wrenching adjustment than is currently the case.
If it implements the program as agreed, Greece will survive and prosper in the eurozone. We are not there yet. But with steady implementation, I think the balance of opinion on Greece could begin to shift.
Greece: Snapshot of Reform Results
• A reinforced financial system. Deposits have been returning to the banking system since mid-2012.Core banks have been recapitalized, and their balance sheets significantly strengthened. Greek banks now have little exposure to the Greek state.
• A more competitive labor market. Unit labor costs have dropped by 15 percent since their pre-crisis peak. The minimum wage has been reduced by over 20 percent, the system for setting the minimum wage has been reformed (with the influence of insiders reduced dramatically), severance costs have been cut back, and onerous pre-approval requirements for work schedules and overtime have been eliminated.
• A more affordable pension system. Reforms will reduce pension spending from 17 percent in 2012 to about 14 percent of GDP in 2013, closer to the euro area average of 12 percent of GDP. Pensions below €1000 per month have been left untouched, to ensure that the most vulnerable are protected.
• More affordable prices and more consumer choice. Prices in Greece have now begun to fall. While progress has been too limited when it comes to instilling competition into important sectors of the economy, there have been some recent successes which point to further gains ahead. The retail sector in Greece was liberalized in late 2012. The sector has been characterized by high prices—especially for food—with productivity lagging the EU-15 average by 30-40 percent.