Economic recession in Greece is expected to deepen in the second half of the year, reaching 3.5 pct for 2010, the Institute for Economic and Industrial Research (IOBE) announced on Wednesday.

In its quarterly report on the Greek economy, IOBE said this estimate was based on a prevailing adverse economic climate and the fact that government-sponsored reforms needed time to offer results.

IOBE stressed that rising unemployment reflected mainly an accelerating decline in employment (-2.3 pct in the second quarter compared with last year) and a continuing expansion of the workforce (it surpassed five million this year) leading to additional “new” unemployed people. These trends are likely to continue with the unemployment rate climbing above 13.5 pct in 2011.

Greece’s economic sentiment index in the June-August period remained at very low levels, 66 points, while the consumer confidence index fell to new record lows at -65 points in the same quarter, from -62 in the previous quarter. Moreover, Greek consumers remained steadily the most pessimistic in Europe.

IOBE said Greece has made a significant step towards avoiding the risk of default, something that would have grave consequences to the prosperity of its citizens. The support mechanism, despite continued disbelief by international markets, offered a “window of opportunity” to fully restore fiscal balance, liquidity in the banking system and smooth credit conditions in the private sector, setting the economy back on a growth track and in a real convergence process with the rest of Europe.

However, problems still existed, namely, divergence in fiscal goals and less liquidity in the private sector. A lower budget revenue growth rate (3.3 pct in the first eight months) compared with a 13.7 pct annual growth target was largely attributed to chronic problems of the tax collection and inspection mechanism. The report said that a government plan to offer tax amnesty to tax payers with pending tax cases was an ultimate solution but included several risks. The risk of lower liquidity could be partly resolved with commercial banks raising capital from the market.

IOBE noted that the most significant problem was that Greece continued employing an outdated growth model and stressed that a new model was necessary, friendlier to markets, boosting export activity and competitiveness, based on private investments.

The IOBE offered three scenarios over economic developments in Greece.

The first, a so-called “scenario of hope”, envisages that Greece will strictly adhere to the memorandum, implementing reforms and adopting a new modern growth model. In this case, the fiscal deficit could fall to around 7.0 pct of GDP in 2011 and to 5.0 pct in 2012, with the economy shrinking in 2011 but returning to a 1.5-2.5 pct growth rate in 2012.

Under this scenario, Greece could return to international capital markets gradually, although this was not secured since the country’s public debt as a percentage of GDP would continue growing to 144 pct in 2012 and 2013. Under these circumstances, markets could be unwilling to lend us money, keeping yield spreads at high levels. In such a case, the troika could extend its support mechanism. We will depend on economic and political developments, particularly in Germany.

The second scenario, a “scenario of disaster”, envisages that the government will abandon fiscal adjustment because of strong opposition, or fiscal adjustment could be continued without structural changes. In the first case, the country will face “instant death” as the "troika" will stop lending the country and Greece will default on its loans. In the second case, a "slow death" is expected. A default, based on international experience, will be catastrophic for the prosperity of Greece, while it could also undermine the stability of the euro currency.

The third scenario, the “salvation scenario”, envisages that the government will adopt all policies included in the first scenario, along with an aggressive policy to make a more efficient management of state assets, estimated at around 300 billion euros.

This could lead to a reduction of the public debt, one closer to Eurozone average rates. This effort should focus on sectors with comparative advantages, such as holiday homes for European "baby boomers" wishing to live in the European south, "green energy", etc.