Yannis Stournaras: Greece and the eurozone at a crossroads
Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at an event organized by the
Young Presidents' Organization, Athens, 23 September 2016.
* * *
It is a great pleasure to be here today and have the chance to share with you my thoughts on the
policy steps that Greece and the euro area should take in order to address crisis legacies and to
ensure the long-term prosperity of our people.
1. Brief overview of the Greek and euro area crisis
The euro area crisis can be regarded as a current account crisis. Before 2008, capital flows from
euro area core countries were invested in non-tradable sectors (public consumption and
residential sector) in the periphery. The increase in domestic spending, whether public or private,
caused upward pressures on wages and prices harming competitiveness and export
performance and further worsening the current account of peripheral countries. Over time, stock
imbalances accumulated with private and/or public sectors becoming over-leveraged. The fallout
from the international financial crisis of 2008 was a sudden stop in inflows to the periphery,
triggering a sovereign debt crisis in Greece and banking crises in Spain and Ireland as property
markets collapsed. In Greece, the sovereign crisis weakened banks, resulting in increased
financial fragility and a banking crisis. In Ireland, and to a lesser extent Spain, the banking crisis
weakened the sovereign.
As banks and sovereigns lost market access, private sector capital was replaced by official
sector financing, accompanied by strict adjustment programmes to correct the flow imbalances
- the current account and fiscal deficits. For Greece, at least, the consequences were severe -
a fall in GDP of over 25% and a sharp rise in unemployment. This deterioration in the
macroeconomic environment caused debt servicing problems in households and companies
with the consequence that non-performing loans (NPLs) rose, weakening the asset quality of
banks. Similar, if less severe, consequences were observed in the rest of the periphery.
Hence, the root causes of the euro area crisis and the delayed and interrupted recovery reflect
failures in the area of what we call today macroprudential supervision, government failures,
especially on the fiscal front, and several structural weaknesses at the level of individual Member
States, as well as in the design of the Economic and Monetary Union (EMU). Many analysts have
said that if in the pre-crisis period we had the instruments of macroprudential supervision that we
have today, then the crisis would, most likely, not have occurred. Structural weaknesses include,
among others, the excessive reliance on bank credit in the euro area which, due to a weakened
banking system because of the crisis, has delayed recovery. At the same time, labour and
product market rigidities in euro area countries, as well as institutional deficiencies in the
management and resolution of NPLs (e.g. lengthy judicial procedures, inadequate insolvency
laws) delayed the much needed adjustment.
There were also deficiencies in the initial design of the monetary union. First, the Stability and
Growth Path (SGP) failed to avert the burgeoning public debt in the pre-crisis period. Second,
there was no monitoring and control over macroeconomic imbalances and the evolution of
private debt. Finally, at the outbreak of the Greek crisis in 2010, euro area crisis management
and resolution tools were poor or non-existent on account of concerns over moral hazard, and
due to the lack of an appropriate institutional setting. There was no provision for risk-sharing in
the setup of the EMU.
2. Policy steps taken by the Greek and euro area authorities
In recent years, both Greece and the euro area have gone a long way towards addressing the
causes of the crisis, while the ECB has taken decisive action to maintain price and financial
stability and support economic recovery in the euro area.
2.1 Greece: economic adjustment over the past six years
The economic adjustment programmes implemented in Greece since 2010 have succeeded in
eliminating the major macroeconomic and fiscal imbalances, in spite of delays and missteps. In
more detail:
The high primary deficit, which in 2009 was above 10% of GDP, has turned into a surplus.
The external deficit, the loss of competitiveness and labour market rigidities and constraints
have been addressed through structural reforms in labour and product markets as well as in
public administration.
In addition, there has been a sectoral reallocation towards tradable goods and services.
Moreover, bank recapitalization and considerable consolidation have been implemented amid
difficult conditions, while various policy steps to address non-performing exposures (NPEs) have
been taken.
2.2 The euro area: steps taken to strengthen the governance of the EMU and to address
the crisis
After the ad hoc Greek Loan Facility that financed the first Greek bailout programme, the euro
area set up the European Financial Stability Facility (EFSF) to provide financial assistance to
distressed Member States. The EFSF was replaced by the more powerful European Stability
Mechanism (ESM) in October 2012.
In response to the strong negative feedback loops between banks and sovereigns as well as
contagion among national financial markets, European leaders, in 2012, initiated the Banking
Union. Its three pillars are: the Single Supervisory Mechanism, the Single Resolution Mechanism
and the still-to-be completed common Deposit Insurance Scheme.
Significant progress has also been made as regards fiscal and economic surveillance. The
Stability and Growth Pact (SGP) was substantially strengthened by the adoption of the so-called
"Six Pack", and surveillance and coordination were enhanced through the so-called "Two Pack".
The European Semester, the Macroeconomic Imbalance Procedure and the Country Specific
Recommendations contributed to stronger macroeconomic surveillance.
Last but not least, the ECB has been addressing the severe and persistent disinflationary forces
in the euro area economy with a broad set of non-standard measures. To a great extent, these
measures have helped to improve financial conditions and boost the recovery in the euro area.
Macroprudential policy tools are also now available to secure financial stability.
3. The way forward
Current forecasts point to gradual recovery in both Greece and the euro area. However, the
recovery faces several headwinds, relating both to political risks linked to the rise of populism
and anti-EU rhetoric, the refugee crisis, Brexit and the crisis legacy, namely high unemployment,
high public and private debt.
In view of these risks and challenges, the way forward should involve structural reforms in order
to improve the growth potential and to make Greece and the euro area more resilient to future
shocks, as well as greater economic policy coordination, convergence and risk-sharing inside
the EMU.
3.1 Improve the growth outlook and make Greece and the euro area more resilient to
future shocks
As noted in the Five Presidents' Report, euro area economies should be able to absorb shocks
internally. Building such a capacity implies removing rigidities in the labour, product and capital
markets, so that the relative price adjustment mechanism can work in a flexible and timely
manner (in the absence of exchange rate adjustment) and for resources to be re-distributed
rapidly to their most productive uses.
Structural reforms in the labour and product markets, as well as improvements in the business
environment and the functioning of the public sector will attract private investment, increase
employment, productivity, and long-term growth, and will ensure more resilience to future
adverse shocks.
Furthermore, some of these structural reforms (for example cutting red tape) will raise
expectations of future income, and thus boost confidence and demand in the short term,
supporting the recovery. In addition, policies that raise labour force participation and reduce
structural unemployment are essential in order to boost future growth and employment.
In Greece, the unwavering implementation of the structural reforms described in the new ESM
programme is a prerequisite for economic recovery. Structural reforms are expected to
encourage innovation and the introduction of new technologies by increasing competition in
various sectors and attracting new investment, both domestic and foreign.
These developments will improve the quality of Greek exports, expand the export base and
strengthen the non-price competitiveness of the economy. In this way, the elimination of the
current account deficit that has occurred over the last six years will prove sustainable and
potential output will rise in the medium to long term.
In addition, putting idle public property to good use and speeding up privatisation processes are
strong tools not only to boost investment activity and foster sustainable growth, but also to
support fiscal adjustment, insofar as they reduce public debt. The Greek State, for historical
reasons, owns real estate, the development of which could attract investment and reduce public
debt. This is an opportunity, which has not been exploited yet, but necessitates appropriate
legislation for land use.
Alongside structural reforms, and in order to facilitate the current euro area recovery through a
stronger pick-up in lending, it is urgently needed to address the private debt overhang problem.
On the one hand, the high stock of NPLs reduces bank profitability and thus constrains the
supply of credit, which primarily affects bank dependent SMEs. On the other hand, high NPLs
delay corporate restructuring and thus thwart the ability of viable firms to finance new investment
projects.
Tackling the high stock of non-performing loans is the greatest challenge facing the Greek
banking system and the Greek economy. Greece has the second highest NPE ratio in Europe
(after Cyprus), with non-performing exposures at the end of the first half of 2016 reaching 45% of
total exposures or €108.7 billion.
A number of initiatives are underway with the goal of setting up an accelerated and efficient
framework of private debt resolution. These initiatives, amongst others, include: (a) the recently
voted amendment of Law 4354/2015, which paves the way for the development of a secondary
market for non-performing loans; (b) the establishment of an enhanced framework for
out-ofcourt workouts and the pre-bankruptcy procedures; (c) the elimination of a series of tax
obstacles both for borrowers and lenders; (d) the recently revised Code of Conduct for Banks for
the transparent, effective and, where appropriate, flexible treatment of cooperating borrowers
facing difficulties in servicing their debt obligations; (e) amendments to legislation to ensure the
cooperation of old shareholders in the restructuring of the underlying businesses; (f) the launch
of a comprehensive monitoring framework in relation to banks' non-performing exposure
resolution activities, and, finally, (g) a series of targets and key performance indicators that aim at
reducing overall non-performing exposures by 40% by the end of 2019.
3.2 Reforms in the institutional setting of the EMU to improve economic policy
coordination, convergence and risk sharing
The adjustment mechanism within the EMU should be facilitated by ensuring that it works both
for countries with sustained external deficits and for those with sustained external surpluses. To
this end, the Macroeconomic Imbalance Procedure should be strengthened and foster reforms in
countries that have been accumulating large and sustained current account surpluses. Crisis
stricken countries have improved their external positions on account of both higher exports driven
by structural reforms and lower imports due to the economic recession. By contrast, countries
that had high pre-crisis current account surpluses have not contributed to the much needed
rebalancing due to insufficient domestic demand and low growth potential.
Risk-sharing in the EMU should be enhanced along the lines proposed in the Five Presidents'
Report. Private risk-sharing can take place through actions that lead to a true financial union with
fully integrated financial and capital markets. These involve completing the Banking Union, by
creating a common Deposit Insurance Scheme and by setting up a credible common fiscal
backstop to the Single Resolution Fund that underlies the Single Resolution Mechanism. Such
steps are necessary to improve confidence in the banking system and break the bank-sovereign
feedback loop.
A genuine Capital Markets Union can be promoted through legislative changes that impose
harmonization towards best practices on securitization, accounting, insolvency and corporate
law, property rights etc. Such changes will allow for deeper integration of bond and equity
markets and will ensure that companies (and in particular SMEs) can gain access to capital
markets on top of bank funding. The Capital Markets Union will enhance cross-border investment
and consequently strengthen private sector risk-sharing across countries, as returns on assets
and access to credit become less correlated with domestic economic conditions in each
Member State.
Besides enhancing the channels of private risk-sharing, a fiscal stabilization tool to cushion large
macroeconomic shocks i.e., public risk-sharing, is warranted in the euro area as a whole. Such
a tool would provide essential insurance to asymmetric shocks, while, in case of symmetric
shocks, it would complement the single monetary policy, in particular, when the policy rates are
at the zero lower bound.
Whilst there appears little appetite at present for full fiscal union, there are alternative ways to go
ahead as proposed both by policy makers and academics. For example, building on the
European Fund for Strategic Investments (Juncker's Plan) and as proposed in the Five
President's Report, a common pool of EU funds for financing EU wide investment projects could
provide the impetus for closer integration in the future. These EU funds could possibly come
from Eurobonds issued by the ESM. Alternative options involve a common unemployment
insurance scheme, financed through social insurance contributions, or an all-purpose "rainy day"
fund financed by annual contributions of Member States in good times.
To avoid moral hazard, public risk sharing has to go hand-in-hand with greater coordination of
economic policies and could be linked to the implementation of country specific
recommendations and structural reforms, as well as sound and responsible fiscal policies in
compliance with the existing EU rules.
4. Conclusions and final remarks
Concluding, I would like to emphasize that indeed both Greece and the euro area are at a
crossroads, as they face several challenges and risks ahead. Some of the challenges are of a
political nature, related to populistic and anti-EU views driven by the refugee surge, while others
are related to the euro-area crisis legacies. Significant progress has been achieved in recent
years both in Greece and the euro area, while the accommodative monetary policy is supporting
the recovery.
However, further action is imperative, aiming at stepping up structural reform efforts and
incentivizing investment, in order to sustain the recovery and boost medium to long-term growth
and employment.
As regards Greece, the gradual relaxation of capital controls, along with improvements in
confidence and liquidity, are expected to contribute to the normalisation of economic and financial
conditions. In addition, the commitment of our European partners to take action, in order to
ensure the sustainability of public debt in the short and medium-to-long term, is a positive step
forward. However, the envisaged public debt management measures need to be specified,
quantified and frontloaded. This would enhance the credibility and acceptance of the policies
pursued, thereby helping to further consolidate the climate of confidence and strengthen
economic recovery.
In this context, a lowering of the medium-term fiscal target from a primary surplus of 3.5% of
GDP from 2018 onwards, to 2% of GDP, without affecting public debt sustainability prospects is
feasible, if coupled by mild debt relief measures. Such fiscal relaxation would have beneficial
effects for the Greek economy, as it would allow taxation to be lowered, freeing up resources for
supporting economic activity, while making fiscal targets economically and socially feasible.
The actions described above will attract foreign direct investment and set in motion a virtuous
circle signaling the exit from recession and a gradual recovery of the economy.
The completion of the EMU along the lines of the Five Presidents' Report, by allowing more
economic policy coordination and greater private and public risk sharing, is a prerequisite for its
long-term viability and the long-term prosperity of its Member States.
Last but not least, the euro area along with other areas of the world should confront certain of the
undesirable consequences of globalization and technical progress. The failure to tackle
unemployment, reduction of wages, worsening income distribution and tax evasion - mostly
related to uncontrolled offshore activities - give rise to what we call failure of elites and worldwide
populism.
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