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Wednesday, May 15, 2002


The Greek Economy: Growing and Quickly Moving to a Stall?

The Greek economy has managed to outperform those of most of its European Union (EU) partners in the last five years, and many analysts expect it to continue doing so during the next three years. An increasing number of economists and businesspersons question the sustainability of this growth beyond 2005, however, pointing to insufficient progress in pushing for structural reforms. After registering a strong growth rate of 4.3 percent in 2000, the Greek economy grew by 4.1 percent in 2001, a tough year for most other EU countries – which faced the prospect of recession – as well for the global economy, which expanded at its slowest rate in almost two decades.

Estimates for Greece’s Gross Domestic Product (GDP) growth rate range from 2.5 to 4.5 percent this year although most analysts agree that the economy will expand by at least 3 percent. The Greek central bank has revised its GDP growth estimate downward to 3.5 percent as against a forecast 1.4-percent average growth rate in the eurozone. The Greek government projects a growth rate of 3.8 percent or better, while the European Commission forecasts 3.7 percent growth in 2002. Greece’s economic performance has helped it to narrow the income gap with its EU partners. According to the latest figures, Greece’s per capita GDP accounted for 68.6 percent of the EU average in 2001 as opposed to 64.1 percent in 1993 when measured in so-called equivalent purchasing power units. The gap in living standards is set to close further if Greek economic growth continues to outstrip the EU average in the next two to three years.

The case for faster economic growth relies heavily on investment spending, however. Indeed, figures show that gross fixed capital formation, which was the main contributor to GDP growth, with a 7.4 percent advance last year, will continue to be the main engine of growth this year and next. Private spending is also expected to contribute, but public spending is projected decrease, while the external balance – that is, imports minus exports – will continue to be a drag on GDP growth. “I expect Greek economic growth to continue to outpace average GDP growth in the EU through 2005, mainly thanks to huge capital inflows from the [EU’s] Third Community Support Framework (CSF),” says Christos Avramides, chief economist at Proton Investment Bank. “Beyond 2005, I believe the Greek economy will face big problems if it continues to lag behind others in structural reforms.”

Officially admitted to the EMU (Economic and Monetary Union) on January 1, 2001, Greece has been a main recipient of EU funds so far. Estimated net EU transfers averaged about 4 percent of Greek GDP in the last decade. Moreover, Greece is expected to collect a total of 26 billion euros from the Third Community Support Framework alone from 2000 to 2006. This sum increases when EU cohesion funds and subsidies from the EU’s Common Agricultural Policy are included. All in all, the country is expected to collect a net amount of 5 billion euros a year on average through 2006 even after allowing for Greece’s contribution to the EU budget in the same period.

It is uncertain, however, how much money the country will receive post-2006 given the EU’s likely enlargement with 10 new members, bringing the total to 25 countries initially and 27 later. All analysts expect net EU transfers to be reduced drastically as most new EU members will have a lower per capita GDP than that of Greece and the EU’s financing needs will grow, probably forcing it to overhaul the Common Agricultural Policy and present funding arrangements.

Investment spending linked to the 2004 Olympics is also expected to boost the economy in the next few years, but its effect will diminish post-2005, with long-term consequences difficult to ascertain. Many analysts point out that Greece may end up with a huge bill and few permanent gains to show for it as far as greater market share in tourism is concerned, for example. “It is a real possibility that the 2004 Olympics may produce a loss, and Greece will have to foot a bill as big as 10 billion euros thereafter,” Avramides says.

The combination of much smaller EU transfers after 2006 coupled with a large bill stemming from the 2004 Olympics may prove unbearable for a Greek economy struggling to reduce its public-debt level below 100 percent of GDP, even as it grows faster than its EU partners. “Greece will face big problems with public debt being the number-one problem,” Avramides adds, pointing out that public debt is rising in nominal terms. “Public debt continues to expand but GDP grows faster and therefore the public debt-to-GDP ratio declines.”

General government debt is projected to fall to 97.3 percent of GDP in 2002, 94.4 percent in 2003, and 90 percent in 2004, as against 99.6 percent in 2001, according to Greece’s revised stability and growth program. The fiscal balance is forecast to produce a surplus equivalent to 0.8 percent of GDP in 2002, 1.0 percent in 2003, and 1.2 percent in 2004, as against a tiny surplus of 0.1 percent in 2001. “The improvement in the budget balance in the last few years has been the result of higher tax revenues,” according to Avramides. “It is mainly due to the introduction of the automated tax system and cyclical growth, and a sharp reduction in interest payments on the back of falling interest rates, as the Greek economy prepared to meet the EU convergence criteria and enter the EMU. It is not the result of lower budget expenditures.”

Things may get even tougher if the European Commission forces Greece to revise its public debt figures upwards following a ruling of Eurostat, the EU’s statistical service, expected in July. Like other EU countries, Greece has used securitization proceeds to retire part of its public debt. Economists such as Salomon Smith Barney’s Miranda Xafa have long claimed that Greek public debt is increasingly shifted to special purpose vehicles and public entities outside the definition of the general government, with some 5.4 billion euros raised last year through securitization – the so-called prometoha (privatization certificates) and convertible bonds. These funds are not included in the current Eurostat definition of public debt, therefore reducing it accordingly.

With GDP growth decelerating, as the direct and indirect effects of spending linked to the 2004 Olympics fade away and net transfers from the EU are reduced significantly after 2006, tax revenues are expected to slow as the stock of public debt stabilizes at higher levels or even continues to grow, undermining fiscal consolidation. A number of analysts have warned that the combination of increased public debt and a slowing economy poses a real threat to long-term growth, and they urge painful but necessary structural reforms now, while the economy is growing at a satisfactory clip.

“Greece will have to do more to limit primary budget expenditure, reform its social security system, and deal effectively with loss-making state-owned entities such as Olympic Airways and OSE (the national railways), to enhance the long-term potential of its economy and arrest the public-debt dynamics,” says Avramides. “If it continues to drag its feet, it will end up paying a higher price later.” Limiting primary expenditures (which exclude interest payments), however, has proven a thorny issue for Greek governments since wages and pensions to civil servants account for a large portion of total government spending.

Moreover, a set of recent government proposals to reform the country’s ailing social security system have been met with skepticism by many analysts, who point out that the proposals fail to attack the root of the problem, which is widely viewed to be rising pension expenditures due to adverse demographics. Under current plans, budget funds equivalent to one percent of GDP will be earmarked for IKA, the country’s largest pension fund, from 2003 to 2032. Moreover, the budget will assume IKA’s liabilities to other state agencies and pay it 8.8 billion euros to settle past obligations. In addition, the state will endow IKA with 15-year, 3-percent, government bonds, which will start issuing annually from 2008 through 2023 in a bid to supplement IKA’s direct funding.

“Everybody knows that the government’s funding scheme aims at keeping the current system going and minimizing political cost. It essentially passes the ball to the next government,” says an analyst at a local brokerage who requested anonymity. “What is worrisome is that neither the government nor New Democracy (the conservative opposition party) is willing to tackle the problem for fear they are going to lose votes in the next national elections.” Greece is scheduled to hold general elections in the spring of 2004, but many political analysts and commentators think that elections will be held earlier, perhaps in the fall of 2003.

The lack of progress in reforming the country’s social security system and in privatizing state-owned companies – with the failure to sell money-losing Olympic Airways standing out – and the limited success in liberalizing the energy and fixed-telephony markets have compounded worries about the state of the Greek economy in the years ahead. It is therefore correct to conclude that it is very likely that the Greek economy will continue to outperform its EU peers in the next few years, fueled by EU transfers and 2004 Olympics spending. Continued hostility to undertaking much-needed structural reforms, however, paves the way for future underperformance and marginalization in an enlarged EU.

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