Public Information Notice No. 05/19

Public Information Notice: IMF Executive Board Concludes 2004 Article IV Consultation with Greece

February 9, 2005

On February 2, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Greece.¹

Background

The several years of strong economic growth continued in 2004, buoyed by supportive monetary conditions, an expansionary fiscal stance, and the Olympics. Rising incomes and a falling, though still high, unemployment rate underpinned strong household consumption, while increased profitability spurred investment spending, especially construction. However, imbalances have emerged and many longstanding structural impediments persist. Inflation has been above the euro-area average, eroding international competitiveness and export market shares. This, and the cyclical divergence with the rest of Europe, has resulted in large current account deficits and a negative contribution of the external sector to aggregate demand. On the supply side, a number of impediments have led to poor labor-market performance, while regulation and weak competitive forces weigh on product markets.

The fiscal position has deteriorated sharply. Following very large data revisions which significantly raised recorded fiscal deficits for 1997-2003, the general government deficit is expected to be some 5½ percent of GDP in 2004 and the primary surplus to fall to about zero; there is a risk of a still worse outcome. The public debt, at about 112 percent of GDP in 2004, has fallen little in recent years. The 2005 budget aims for significant fiscal consolidation, with the deficit falling by 2½ percent of GDP to (under the budget's growth assumptions) 2.8 percent of GDP. The end of Olympics spending is an important, and permanent, factor accounting for 1¼ percentage points of the improvement. The budget also contains temporary (tax amnesties and the collection of arrears) and ad hoc (containment of pension and public-sector wage increases) measures.

In 2005 and beyond, fundamentals point to slower growth and a gradual easing of inflationary pressures. Although household consumption is expected to remain strong, the fiscal adjustment planned for 2005 will dampen domestic demand, including investment, and the erosion of competitiveness may limit the benefit from any pickup in growth in Europe. The key risks to the outlook are external: sustained high oil prices and further rises in the value of the euro will undercut growth, both in Greece and in its major trading partners.

In the long-term, population aging threatens fiscal sustainability. On current estimates, pension and health-care costs will rise by more than in any other EU country between now and 2040, while high public debt and the weak budget position leave little room for fiscal maneuver. Regarding structural policy, the authorities, recognizing that Greece still lags significantly behind the EU in real per capita income despite the economic boom, have announced substantial reforms focused on improving product market performance.

Executive Board Assessment

Directors noted that past reforms, notably financial market deregulation, interest rate declines associated with euro adoption, and, more recently, stimulus from Olympics spending had all contributed to strong growth of the Greek economy in the past several years. This economic boom has been reflected in labor-market gains, with rising employment and a decline in the unemployment rate.

However, Directors also noted that widening economic imbalances threaten future growth prospects. The public finances have deteriorated sharply-only in part because of the Olympics-and the high debt-GDP ratio has fallen very little, with recent data revisions revealing that the fiscal position is much worse than earlier thought. Deteriorating competitiveness, due to sustained inflation differentials with the rest of the euro area, and strong domestic demand are reflected in poor export performance and a large current account deficit. Against this backdrop, Directors agreed that the key priorities for the Greek authorities are a strong and sustained fiscal consolidation effort along with further improvements in fiscal transparency, and structural reforms to put in place the conditions for sustained increases in output and living standards.

Regarding the revisions to the fiscal data, Directors welcomed the initiative by the new government to launch a fiscal audit immediately upon taking office. They regretted the significant past understatements of the deficit and public debt. Directors noted that the lack of accurate data has hindered surveillance and emphasized that complete, timely, and accurate fiscal data are essential for sound policy making. They supported the ongoing efforts of the authorities, working with Eurostat, to improve reporting, and the decision to compile financing-side fiscal data beginning in 2005. They urged the authorities to implement further reforms to bolster credibility and ensure the integrity of the data. This should include improving the independence and effectiveness of auditing, ensuring the independence of the statistical agency, developing a more comprehensive budget, closing special treasury accounts, and implementing a mid-year budget report. Directors welcomed the authorities' decision to undertake a full assessment of fiscal policy transparency in 2005. All these actions are essential to preserve the government's credibility and the confidence of investors, which in turn are essential for long-term growth.

Directors stressed that the first priority of economic policy is to restore the health of the public finances. They welcomed the appreciable adjustment aimed for in the 2005 budget, given the large fiscal deficit, high debt level, and the requirements of the Maastricht treaty. Directors felt, however, that greater reliance on permanent measures would have been preferable, and many expressed concern that the deficit targeted in the budget might be difficult to achieve, given the optimistic growth assumptions. Looking forward, Directors stressed that further durable adjustment measures will be needed to cut the deficit and reduce the public debt, especially in view of the large anticipated costs of population aging. They supported the authorities' intentions to introduce further tax reforms, but stressed that the fiscal costs of such initiatives would have to be offset by savings elsewhere in the budget. Directors urged the authorities to make strong and sustained efforts to contain current primary spending growth with a view to achieving budget balance over the medium term.

Directors agreed that fiscal adjustment will require restraint, prioritization, and strengthened expenditure management. They pointed in particular to the potential for containing the public sector wage bill, cutting government loan guarantees, stronger controls on health care, and a review of defense outlays. Directors urged the authorities to move expeditiously on implementing proposals to reform the health care sector and public procurement. To reinforce the process of fiscal adjustment, Directors recommended that the authorities develop an explicit medium-term budget framework laying out a consistent and realistic set of economic assumptions, deficit objectives, expenditure ceilings, and specific policy measures. They supported the authorities' request for Fund technical assistance on tax administration and public expenditure management.

Directors noted that population aging poses a key long-term threat to the public finances. Since pressures are expected to begin to be felt during the next decade, they expressed disappointment that pension reform is not part of the government's immediate priorities. Directors stressed the importance of early pension reforms and urged the authorities, as a minimum, to begin as soon as possible the public debate needed to develop a social consensus for change, including by laying out the cost of unduly delaying the reforms.

Directors welcomed the authorities' actions to ensure a robust banking system, including the strengthening of the Bank of Greece's supervisory capacity. Noting the risks from the rapid increase in private sector credit growth should the economic climate take a turn for the worse, Directors encouraged the authorities to monitor the situation closely and take prompt corrective action as needed. In light of weaknesses in the insurance sector, Directors welcomed the decision to establish an independent insurance supervisor. They looked forward to Greece's participation in the Financial Sector Assessment Program (FSAP) planned for this year.

Directors stressed the need to address structural weaknesses to promote sustained increases in output and living standards in the years ahead. They welcomed the authorities' plans to improve the business climate, including through tax simplification, improved tax administration, further privatization, and bolstering product market competition, and urged that the relevant measures be put in place as soon as possible. It will also be important to simplify judicial procedures, including those related to bankruptcy. Directors supported the authorities' intention to continue infrastructure spending, but stressed that public-private partnership arrangements should be accompanied by a full accounting of explicit and implicit government liabilities, transparent project selection and evaluation, and appropriate risk transfer to the private-sector partners.

Directors emphasized that faster progress is needed on labor market reform, and they urged the authorities to make strong efforts to build the necessary consensus for moving forward in this area. Enhanced labor market performance should be achieved through easing strict employment protection measures, extending part-time and temporary employment opportunities, improving education and training, and ensuring that wage settlements are in line with productivity and euro area inflation objectives.