The Bank of Greece Report on Monetary Policy 2009-2010
23. March 2010. | 10:12
Yesterday, in accordance with its Statute, the Bank of Greece submitted its Report on Monetary Policy 2009-2010 to the Greek Parliament and the Cabinet. The Bank’s Governor, Mr. George Provopoulos, delivered the report to the Speaker of Parliament, Mr. Filippos Petsalnikos.
The key message of the Report can be summarised as follows:
The report is submitted at a particularly difficult time.
The Greek economy is in the midst of a deep crisis, characterised mainly by a large fiscal deficit, huge debt and the continued erosion of its competitive position.These problems arose before the international crisis of 2008 and it was inevitable that, in the absence of bold and decisive actions, they would lead to an impasse. There were no such actions, the situation deteriorated markedly, culminating in the derailment of public finances in 2008 and 2009.
The international crisis amplified the cumulated negative effects of those chronic weaknesses and accelerated the downturn of the economy.
The Bank of Greece had issued timely warnings concerning the gravity of the situation:
• In October 2008, i.e. about a year and a half ago, the Bank of Greece stressed in its Monetary Policy Interim Report that the Greek economy was at a crucial juncture and that, as the global economic situation worsened, the macroeconomic imbalances and structural weaknesses of the domestic economy would become more severe and more difficult to address.
• In the Monetary Policy Report that followed in February 2009, the Bank of Greece warned about everything that is happening today – stressing, in particular, the possibility of a rise in the cost of borrowing. As that Report stated, “a widening of the yield spread would increase the future burden on taxpayers”.
• Lastly, in October 2009, the Monetary Policy Interim Report underlined the need to send a clear message to the markets that Greece is determined to implement a multi-year plan of fiscal consolidation and structural reforms.
Unfortunately, the developments during the past few months have confirmed the Bank’s warnings and undermined confidence in the future of the Greek economy: Since April 2009, Greece has been subject to the Excessive Deficit Procedure, as the deficits of both 2007 and 2008 exceeded the reference value set by the Treaty.
In 2009, as the Bank of Greece had warned, the general government deficit reached 12.9% of GDP and public debt stood at 115% of GDP. These developments triggered a series of downgradings of Greece’s credit ratings and led to a large widening in the yield spread between Greek and German government bonds – resulting in increased borrowing and debt-servicing costs for the Greek government.
The increase in debt-service expenditures, in turn, increased the country’s budget deficit, made fiscal consolidation more difficult to achieve, and had serious repercussions for the real economy and the banking system. The Greek economy is caught in a vicious circle, with only one way out: the drastic reduction of the fiscal deficit and debt so that there is an immediate reversal of the current trend.
Large fiscal deficits and debts can, of course, also be found in other countries. Unlike Greece, however, these countries are able to finance their deficit mainly from domestic savings. Because of the low level of private savings in Greece, the public debt cannot be financed from domestic sources, resulting in a widening current account deficit and a rising external debt.
Thus, the problem of the fiscal deficit becomes intertwined with the problem of the external deficit and debt and the twin deficits emerge as the main factor fuelling a dangerous vicious circle.
The main manifestation of this situation is growing budgetary imbalances, rising public debt and a loss of competitiveness, which is clearly reflected in the current account deficit. But the crisis is also taking its toll on the entire economy, hampering the functioning of the banking sector, undermining confidence, creating unprecedented uncertainties, and challenging social and economic attitudes and patterns of behaviour that have prevailed in the country for decades.
The ramifications of the economic crisis are spreading across all of society, which must now recognise the problem and change attitudes and practices in order to come to terms with it.
The data presented in the Report shed light on the multi-faceted crisis that the Greek economy is currently experiencing.
After a decade of positive performance, GDP contracted by 2% in 2009, mainly because of the sharp drop in investment, but also due to weakening private consumption and exports. GDP is projected to fall in 2010 as well, although the size of the fall will be decisively affected by the effectiveness and the pace of implementation of the economic policy measures recently announced by the government.
At the present time, the decline in GDP is projected this year to be around 2%. It is also important to note that the Greek economy remains in recession while the economies of many other industrialised countries are recovering, albeit at an uneven pace.
In the euro area, in particular, the recovery has been under way since the third quarter of 2009. The euro area recovery remains fragile, however, because it has been largely driven by expansionary fiscal policies. These policies will gradually have to be phased out, given that most advanced economies have accumulated large fiscal deficits and debts.
The recession in the Greek economy has spread to all sectors of production, negatively impacted on employment, and raised the rate of unemployment. According to provisional data, total employment declined by 1.1% in 2009, while the number of employees is estimated to have fallen by about 1.5%.
The adverse developments in the economy and, above all, in Greece’s fiscal balances, together with impaired confidence, have also taken their toll on the banking system.
Unlike what happened in many other countries, where the crisis first broke out in the banking system and spread from there to the real economy, Greece’s banking system, which is fundamentally sound, has faced liquidity constraints since the severe fiscal imbalances have led to a downgrading of the country’s credit ratings, thereby restricting bank access to finance, and raising funding costs. Meanwhile, the recession led to a slowing in the growth of deposits, affecting the supply of credit.
In spite of these problems, the year-on-year rate of credit expansion to the private sector remained positive throughout 2009, contrary to the situation in the euro area as a whole, where negative growth rates have at times been recorded. As the Bank of Greece has repeatedly stressed, the Greek banking system showed remarkable resilience during the international crisis. In order for it to retain this resilience, it will be necessary to remove the exogenous factors that affect its functioning and to restore confidence in the future of the Greek economy.
In response to the serious challenges brought about by the crisis, policy makers have recently shown a strong resolve to reverse the negative trends of previous years. Thus, the Budget for 2010 and the Stability and Growth Programme (that sets out the general medium-term policy orientation) were supplemented by measures that strengthen the probability of achieving the fiscal targets.
The overall policy formulated seeks to reverse a trend that led to accumulated problems and a dangerous impasse. Changing that course will not be easy. It will require an equally prolonged effort to break the vicious circle that was pushing the economy into a state of decline, threatening to undermine standards of living. The recently announced policy measures mark the beginning of a large-scale effort. If implemented effectively, these measures will lead to a durable virtuous circle that will restore the Greek economy to a path of sustainable growth, enabling Greece to achieve economic and social progress.
For this to happen, the policy measures announced must be implemented in their entirety and without delay. This would make a crucial contribution to the restoration of confidence, which would have a favourable impact on the cost of government borrowing, with positive repercussions on bank funding costs and, further down the line, borrowing costs for businesses and households. In the present circumstances, fiscal consolidation is a sine qua non for restarting the economy.
The next step will be to support the recovery process with structural reforms aimed at substantially bolstering competitiveness, steadily improving productive conditions and modernising the growth model. Such reforms must also aim at greater transparency and, most importantly, at improving the operation and increasing the efficiency of the wider public administration.
The crisis that the Greek economy is facing today is all-encompassing and multi-faceted. It therefore calls for a bold response of the same kind: immediate, sustainable, ongoing and convincing fiscal consolidation, coupled with structural reforms aimed at facilitating the operation of markets and improving competitiveness. Most important, Greece must eradicate the patterns of behaviour, attitudes and policies that have brought us to the present crisis situation.