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Tuesday, January 01, 2002


All Signs Are Positive for the Greek Economy in 2002

The Greek economy exhibited remarkable resilience in 2001, and was able to weather an external economic storm. In 2002, the eurozone’s last entrant will be called upon to prove right the forecast of the Organization for Economic Cooperation and Development (OECD) of 4-percent growth, thus becoming the fastest-growing economy among the group’s 30 member countries, bringing down inflation and further reducing its high public debt-to-GDP ratio in the process.

The Greek GDP (Gross Domestic Product) grew 4.4 percent year-on-year in the third quarter and is now officially projected to grow 4.1 percent in 2001, well below the initial government goal of 5 percent but much higher than the European Union (EU) average, widely expected to be 2 percent or less. Two factors primarily accounted for achieving this growth in 2001: strong consumer spending and a construction boom. The industrial sector also contributed to economic growth but to a lesser degree.

Faced with the lowest nominal interest rates in decades, an aggressive lending campaign by banks, and an increase in disposable income, Greeks responded with a sharp increase in the use of credit to finance their purchases. Indeed, consumer credit rose 47.2 percent in the third quarter of 2001 vis-à-vis the same period in 2000, although it slowed down from the second quarter’s 52 percent year-on-year advance. Not surprisingly, the latest data showed retail sales growing 7.4 percent year-on-year in September despite a deteriorating (local and international) consumer and business environment that month.

Lower interest rates have also fueled demand for mortgage credit, which rose by 35.3 percent year-on-year in the third quarter in 2001. As a result, construction spending surged 17.1 percent year-on-year in the first seven months of 2001 despite a drop in disbursements from the Public Investment Program in the same period.

Although the Greek economy grew pretty well in 2001, it failed to contain inflation. Headline inflation dropped to 2.4 percent year-on-year in November, mainly thanks to falling gasoline and heating oil prices but it is expected to pick up to 2.7 -2.8 percent in December, and average 3.3 percent for the whole year compared to 3.2 percent in 2000. However, the stubbornly high consumer-price inflation rate should have come as no surprise. Unit labor costs rose faster in 2001 than in 2000, demand for consumer credit was strong, and second-round effects from oil-price hikes in 2000, along with the drachma’s slide to its predetermined parity against the euro, all contributed to the increase.

Greece also made limited progress in reducing its large public debt in 2001. The latter is estimated to have dropped to 99.6 percent of GDP in 2001 from 102.9 percent in 2000, aided by lower interest payments as a percentage of GDP and a large primary-budget surplus estimated at 5.3 percent in 2001. Despite this improvement, the Greek debt-to-GDP ratio ranks among the three highest in the European Union, raising concerns about fiscal policy in the face of adverse global economic conditions, as well as a rapidly slowing domestic economy.

Although the government has stated that reducing the debt–to-GDP ratio is a “policy anchor,” some analysts refer to flow discrepancies found in Greek public finances that probably explain why the public debt rises in nominal terms but falls as a percentage of GDP. Nevertheless, they admit that there is nothing improper in this, and that Greece’s reporting protocols are in line with EU definitions and norms.

Indeed, Greece received receipts from the sale of exchangeable bonds, privatization securities (prometoha), and securitization funds amounting to some 1.84 trillion drachmas in 2001. These receipts are not included in general government public debt as defined by Eurostat, the EU’s statistical unit. Had they been included in the definition of public debt, the nominal amount of debt would have risen accordingly, causing the much-cited debt-to-GDP ratio to fall less. Nevertheless, these receipts have partly offset other kinds of public financing, such as capital injections to public enterprises in order to strengthen balance sheets and amortization of military debt. Also, a part of these receipts is earmarked for settling arrears in the country’s largest social security fund, IKA, in 2002.

The accounting of these receipts probably solves the puzzle of a simultaneously declining debt-to-GDP ratio and a rising nominal public debt despite large primary-budget surpluses and declining interest-rate payments as a percentage of GDP. In 2002, the country’s debt-to-GDP is projected to drop to 97.3 percent, while the primary-budget surplus is forecast at 4.9 percent, down from 5.3 percent of GDP in 2001; interest payments are projected to fall to 6.4 percent of GDP in 2002 from 7.4 percent in 2001. Nevertheless, shifting the debt burden to state-controlled entities outside the domain of the general government raises more questions than it answers.

The confusing signals sent by the public debt about the effectiveness of fiscal policy brings to the forefront the 2002 budget passed by parliament a few days ago. The budget is widely regarded as neutral on economic activity and rather feasible based on a GDP growth assumption of 3.8 percent in 2002, which is below the OECD’s growth forecast, but above the European Commission’s 3.5 percent forecast. The main characteristics of this budget are a package of tax relief aiming at fostering growth alongside a more equitable distribution of taxes. These measures include an increase to 20 percent in the personal income exempt from taxation, a tax bonus for families with children, a reduction of the corporate tax rate to 32.5 percent from 35 percent for companies creating new jobs, and a 7-percent tax on interest earned on bank-to-customer repurchase agreements (repos). It should be noted that Greece taxes bank-deposit interest at 15 percent and fixed-bond coupons at 10 percent.

Nevertheless, some economists, such as Salomon Smith Barney’s Miranda Xafa, have argued that these measures are inadequate because they fail to address the main problem of the Greek economy, which is on the supply side and not the demand side. They contend that these measures will not do much for an economy growing at 3.8- 4 percent a year with a large current account deficit amounting to about 6 percent of GDP. They even argue that the corporate tax cut is not large enough to positively affect competitiveness when other countries, such as Germany and Ireland, have proceeded with much larger cuts. Indeed, they dispute the efficacy of linking tax cuts to job creation when companies can cut costs by adopting new technologies or outsourcing, meaning creating jobs elsewhere without reaping the benefits of the tax cut. Finally, they think that enforcement of the new corporate tax cut “may be tedious.”

All these points about the 2002 budget may raise concerns but do not dispute the bottom line. That is, the budget has set realistic, feasible targets compatible with the general goals of policy defined as high growth rates combined with low inflation and an improvement in public finances, as demonstrated by the projected government budget surplus of 0.8 percent of GDP in 2002 versus 0.1 percent in 2001.

The attainment of these goals might be endangered, however, by demands by the country’s main labor confederation for wage increases of 5-6 percent. Greece’s entry into the eurozone and the adoption of the euro as the national currency make such demands unsettling, especially at a time of widespread economic weakness elsewhere when eurozone hourly wages seem to be growing only around 3 percent this year. If unions succeed in getting what they want (which is rather unlikely), the chances for a rise in unemployment, currently at 10.9 percent, and a pick-up in inflation, which is expected to decline after the first quarter, are rather high. Negotiations on the new collective-bargaining agreement are to start in January and conclude in the spring.

Putting aside the risks of a deteriorating global economic environment, a rich wage agreement, and a stalemate on privatization and deregulation, the chances are that Greece will easily attain its stated policy objectives in 2002. Domestic spending should continue to be robust, aided by a pick-up in investment spending because of projects linked to the 2004 Olympic Games and the EU’s Support Framework III. Consumer spending should also continue briskly, as interest rates remain low and disposable income rises further on the back of tax cuts and modest wage increases. Tourism and exports may turn out to be weak, but not enough to endanger the country’s growth rate. Inflation should subside despite a euro-induced jolt at first, as the second-round effects dissipate, but it is likely to remain high by EU standards. The debt-to-GDP ratio should decline further, but still has a long way to go before getting closer to the 60-percent mark. All in all, the Greek economy is set for a solid performance in 2002, but this will not come risk-free.

Dimitris Kontogiannis is a financial columnist for the Greek daily, Eleftherotypia.
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