Yannis Stournaras: Greek economy - current developments, challenges
and prospects
Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Hellenic
Observatory of the London School of Economics, London, 25 March 2015.
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Ladies and Gentlemen,
It is a great pleasure to be with you tonight. I will share with you my thoughts on the
prospects of the Greek economy and I will focus on four issues: First, the achievements so
far during the difficult years of the economic adjustment. Second, current developments in
the Greek economy and future challenges and prospects, in view of the 20 February 2015
Eurogroup agreement and the 20 March high level agreement between the Greek
government and the EU partners. Third, the reasons why Grexit is not an option. Fourth,
issues related to the sustainability of Greek public debt.
a) Economic adjustment during the past five years
Since the beginning of the crisis, five years ago, Greece has come a long way in adjusting its
fiscal and external imbalances and has implemented a bold programme of structural reforms.
First, there has been unprecedented fiscal consolidation. In 2013, Greece returned to a
primary surplus in the general government for the first time since 2002. Moreover, by
achieving a primary surplus (as defined in the programme) of 1.2% of GDP, it outperformed
the programme target of a balanced primary result in the general government. Fiscal
consolidation achieved a more than 11 percentage point improvement in the primary budget
as a percentage of GDP over the period 2009-2013, despite the deepening recession.
Adjusting for the effect of recession, the improvement in the "structural" primary budget
balance over the period 2009-2013 reached 18 percentage points of GDP, at least twice as
much as the adjustment in other programme member-states.
Second, competitiveness has been restored. Greece has now recovered all of the cost
competitiveness it had lost relative to its trading partners since joining the euro area. Cost
competitiveness has improved by more than 25 per cent since 2009. According to the ECB's
Harmonized Competitiveness Indicators, Greece has been one of the best performers in
improving labour cost competitiveness over the period 2000-2014.
This development reflects the effect of structural reforms in the labour market, which have
allowed more flexibility in the process of wage bargaining, as well as the impact of the sharp
rise in unemployment on labour costs. Structural competitiveness is also showing signs of
significant improvement, as suggested by indicators compiled by the OECD, the World Bank
and the World Economic Forum.
Third, external adjustment has been significant. The current account in 2014 was in
surplus for the second year in a row (0.9% of GDP) with exports of both goods and services
increasing at a faster rate than that of the previous year. This development marks a
significant turnaround of the current account balance of about 15 percentage points of GDP
since 2008. Adjustment came primarily through a decline in imports of goods, particularly in
2009, when world trade collapsed due to the global recession. However, after 2009,
adjustment was nearly equally shared between exports and imports.
It is worth highlighting that, during the last four years, exports of goods have rebounded, with
growth rates of real exports outpacing those of the euro area average. Moreover, the share
of goods exports in extra-EU trade has nearly doubled and the share in world trade has
increased by about 30% since 2010. These developments have occurred despite the
adverse liquidity and financial conditions faced by Greek exporters.
By contrast, exports of services underperformed until recently largely as a result of
uncertainty, which had a negative impact on tourism, and global factors, which affected the
performance of the shipping industry. Nevertheless, exports of services rebounded in 2013
and 2014 after years of underperformance, reflecting both a strong tourism season and,
more recently, a rebound of the global shipping sector.
Fourth, the policy agenda has included structural reforms. A series of structural reforms
have been implemented in labour and product markets as well as in public administration.
In the labour market significant changes were adopted aiming at:
- better aligning wage developments with firm performance; and
- enhancing labour mobility across sectors.
- More specifically, reforms involved measures to decentralise wage bargaining to
firm level, reduce minimum wages and increase flexibility.
Progress with structural reforms in product and services markets, by contrast, was markedly
slower than in the labour market. Nevertheless, according to the OECD, Greece ranks first in
the responsiveness to structural reform recommendations made by the Organisation.
Moreover, according to the Euro Plus Monitor 2014, Greece ranks first in the adjustment
progress among twenty-one European economies, based on indicators capturing fiscal and
external adjustment, labour costs and structural reforms.
This period also witnessed significant institutional changes geared towards streamlining the
public administration and downsizing the public sector. In the period 2010-2013, public
sector employment fell by more than 20% or 180,000 employees. New institutional reforms
were adopted that lay the foundations for ensuring the better control of public spending and
improving public financial management. Finally, the Greek authorities have greatly reshaped
the taxation system by adopting the Income Tax and Tax Procedures Codes and the new
unified Property Tax. Measures have also been adopted to bolster the autonomy of the
revenue administration in order to strengthen the collection of current and overdue revenue.
All these reforms will boost the growth potential of the Greek economy in the long term. Bank
of Greece staff estimates suggest that structural reforms in labour and product markets are
likely to increase potential growth by about 1.6% per annum over a period of ten years,
mainly coming from gains in total factor productivity.
Lastly, bank recapitalization and considerable consolidation have taken place.
Over the past few years, the landscape of the banking system has changed significantly with
the number of banks being reduced through mergers, takeovers and resolutions. Today the
system comprises four core banks and a number of smaller banks. The four core banks,
following recapitalization and the implementation of restructuring plans, are well-placed to
meet the new challenges that the banking system faces going forward. This was also
confirmed by the results of the Asset Quality Review and the EU-wide stress test exercise,
conducted by the European Central Bank (ECB) in cooperation with the European Banking
Authority (EBA), made public on 26 October 2014.
b) Current developments, challenges and prospects
Recent data suggest that, after six years of deep recession, the economy has started to
rebound since the second quarter of 2014. Real GDP grew by 0.8% in 2014, positive for the
first time since 2007. The increase in GDP is driven by buoyant exports of goods and
services, the recovery of private consumption and investment in machinery and transport
equipment. The pickup in economic activity also led to a strong rebound of dependent
employment and the decline in the unemployment rate, which, however, remains particularly
high.
Based on the latest available data, GDP growth in 2015 is projected to be higher than in
2014 and to pick up even further in 2016. The main elements of uncertainty weighing on the
prospects for economic activity in the medium term refer to our ability to fulfil successfully the
transitional agreement struck with our partners, a possible deterioration in public finances
and reform fatigue.
If these uncertainties can be contained, then the economy will show strong growth in 2015,
driven by exports of goods and services and by private consumption and supported also by
rising business investment.
Exports of goods and services are expected to remain one of the growth drivers in 2015, with
the global economic environment projected to improve as growth rates pick up both in the EU
and the other markets and world trade strengthens. A positive impact is also expected from
the further improvement in structural competitiveness and possibly in cost competitiveness,
combined with restored access to financing for Greek businesses and an improving business
climate.
Disposable income developments, the declining general level of prices and reduced
uncertainty are expected to affect consumer spending positively in the course of 2015.
Private consumption is therefore expected to increase in the year as a whole, supported by
the fall in oil prices and the ensuing strengthening of Greek households' real disposable
income.
However, although recent hard data show that the economy continues to show signs of
stabilizing, soft data paint a mixed picture, with PMI and some sentiment indicators softening
over the past two months.
Financial indicators (such as Greek sovereign and corporate bond yields and stock prices),
which had improved significantly from mid-2012 up until autumn 2014 in line with the
improved macroeconomic performance of the country and the consistent implementation of
the adjustment programme, have been deteriorating over the last months.
The 20 February Eurogroup agreement combined with the 20 March high level
agreement alleviated part of the uncertainty
The Eurogroup's decision on 20 February 2015 to grant Greece an extension of the current
programme and its approval on 24 February of the Greek government reform measures
alleviated part of the uncertainty and gave Greece's government time to complete the
reforms still pending and to set its own priorities. As a follow up, on 9 March, the Greek
authorities presented to the Eurogroup a more detailed list of reform measures which allowed
the commencement of the evaluation process. As reaffirmed by the joint statement by
Greece and the EU on 20 March, the Greek authorities are expected to present a full list of
specific reforms to be considered by the Eurogroup. These positive developments led to a
stabilization of bank deposits, after some outflows during the past three months. However, a
large risk premium has been built into Greek financial assets, which still remains at high
levels.
The Greek government is now proceeding fast towards agreeing a reform programme with
the EU partners and the involved institutions and making progress in the implementation of
the agreed policy actions. The 20 March high level agreement in Brussels confirmed the
willingness of all parts to respect the rules of the game and the procedures agreed in the
Eurogroup of 20 February.
Once the implementation of the current agreement is under way and Greece fulfils its
commitments, then financing and liquidity constraints for the Greek state and Greek financial
and non- financial corporations will ease and Greek assets should be expected to recover.
Moreover, the decision by the ECB's Governing Council to lift the waiver affecting marketable
debt instruments issued or fully guaranteed by the Hellenic Republic will soon be
re-examined and should be revoked, as in similar cases in the past, as long as Greece fulfils
its current agreement with its EU partners.
The full implementation of the agreed reforms and the conclusion of the evaluation process
are prerequisites for the restoration of confidence to the prospects of the Greek economy.
Moreover, upon the conclusion of the current evaluation procedure, the Greek government in
close cooperation with our EU partners should reach a mutually beneficial agreement on the
follow-up arrangement involving a credible reform and medium term fiscal policy programme
backed by a reliable credit line paving the way for Greece's return to international financial
markets.
These actions will enable Greece to benefit from July 2015 onwards from the recently
announced ECB decision on the implementation of Quantitative Easing (QE) at least up until
September 2016.
Provided that uncertainty is quickly resolved, the positive momentum of the economy will be
maintained and economic recovery will gain speed over the course of the year.
Policy actions that promote long term growth
In the long term, the growth outlook of the Greek economy is expected to improve following
the rebalancing of fundamentals such as the twin deficits and competitiveness, provided
reforms continue and emphasis is placed on the following priorities:
 Speeding up structural reforms in the product and services markets in order to
enhance competition and innovation, increase price flexibility and improve
competitiveness.
 Consolidating fiscal achievements. Efforts must focus on structural measures to
strengthen the independence and efficiency of tax administration, with the aim to
tackle tax and social contribution evasion. The application of modern, risk-based tax
audit methods and the activation of a nationwide asset registry are fundamental in
the fight against tax evasion.
 Reviewing tax exemptions and other favourable tax treatment. Tax exemptions
and favourable tax treatment, including reduced VAT rates, need to be reviewed and
streamlined.
 Lowering tax rates and reviewing the efficiency of public spending. To the
extent that fiscal achievements are safeguarded, a lowering of the direct and indirect
tax rates will become possible. On the expenditure side, efforts to better target
social benefits must continue, while the existing exemptions from the general
pension system provisions must be re-examined.
 Increasing public sector efficiency. Completing the national cadastre and
eliminating the chronic obstacles to the efficient and speedy delivery of justice are
fundamental prerequisites for a well-functioning state, as are the efficient
deployment of human resources and a transparent staff appraisal framework that
rewards productivity and work ethic.
 Strengthening active labour market policies with particular emphasis on
education and training, as a way to improve the job-finding chances of people on
the sidelines of the labour market, such as the long-term unemployed and young
people, who have borne the burden of unemployment.
 Managing in an effective way non-performing loans (NPLs). Greek banks must
now adopt an active management of distressed loans, in a manner that not only
eases the burden on cooperating borrowers facing temporary difficulties in servicing
their debt, but also enables banks to unlock funds tied up in troubled loans that are
unlikely to be repaid. The banking sector must be assisted in this effort through
improvements in the legal framework that would lift restrictions on, for instance,
(pre-) bankruptcy procedures, out-of-court settlements or, as already mentioned, a
speeding up of the judicial procedure.
c) Grexit is not an option
After six years of severe recession and five years of fiscal adjustment, the economy has
stabilized and is showing signs of improvement. If this momentum is maintained, the
economy is likely to return to a steady growth path in the next few years.
Grexit is not an option to Greece for the simple reason that the competitiveness of the Greek
economy has been restored over the past five years through internal devaluation and bold
reforms in the labour market. Hence, Grexit would deliver no benefit but a lot of pain.
In case of Grexit, the Greek economy would enter another deep recession characterized by
extremely tight financing and liquidity conditions, on account of massive deposit outflows and
a dramatic fall in confidence and living standards. These developments would lead to trade
disruption, push unemployment further up and reduce government revenues, generating
fiscal and financing gaps and concerns for the stability of the financial system. As a
consequence, another round of fiscal consolidation would be required, while capital controls
would be imposed and a deposit freeze could also be required. Moreover, the rapid
depreciation of the new currency would serve to improve Greece's international price
competitiveness, but this would also drive higher inflation as import prices rise. As a result,
the gains from depreciation would be only temporary. Finally, de-anchoring of inflation
expectations would imply substantially higher inflation, requiring a tightening of monetary
policy. Hence, leaving the euro would not allow the country to run an independent monetary
policy, as the primary goal of the central bank would be to stabilize the value of the currency.
Grexit would also risk the elimination of EU-budget related inflows to Greece (cohesion and
structural funds, agricultural subsidies). Overall, Grexit would imply huge costs for the Greek
people, firms and the Greek financial system. IMF and official debt would run in arrears,
while foreign law bonds would force Greece into a lengthy litigation process in international
courts. In the event of such actions, it is uncertain how long it would take until Greece would
regain access to financial markets and would depend on the eventual resolution of official
foreign law debt.
On top of all, a Grexit scenario could also have negative contagion effects on weak euro area
countries, by introducing a permanent convertibility risk premium into sovereign bond yields
and financial asset prices. Last but not least, Grexit might entail very substantial geopolitical
risks.
d) Actions to improve debt sustainability
Turning to public debt sustainability, some points are worth-highlighting:
 Nearly 80% of Greece's general government debt is held by the official sector, i.e.
bilateral loans by EU countries under the GLF, IMF and EFSF loans, as well as debt
securities held by the ECB and NCBs.
 Up until now, Greek debt has benefited from the lowering of the interest rate and the
extension of maturities on the GLF loans. The interest rate charged on bilateral
loans from euro-area partners is Euribor plus 50 basis points, which is currently
about 0.56% per year. GLF loans have an average maturity of about 16 years. In
addition, the lending rate from the European Financial Stability Facility (EFSF) is a
mere 1-10 basis points over the average borrowing cost of the EFSF. The average
maturity of EFSF loans is over 25 years with the last loan expiring in 2051, while
Greece benefits also from the deferral of principal payments on GLF and EFSF
loans by 10 years and a 10-year grace period for interest payments on most EFSF
loans.
Moreover, Greece has been receiving the profits made by the ECB and NCBs on
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their Greek government bond holdings (SMP and ANFA).
As a consequence of these actions, the average maturity of the Greek government debt has
increased from 6.3 years in 2011 to about 16.5 years by end 2014 and debt servicing costs
have decreased to levels comparable with other southern European countries (i.e. around
4.3% of GDP in 2014), while the actual debt servicing cost is much lower, i.e. about 2.6% of
GDP if one takes into account that the interest paid to the ECB and euro-area national
central banks (NCBs) is returned to Greece and interest payments on EFSF loans are
deferred. Taking into account the fall in interest rates over the past three months, the actual
interest expenditures of Greece will be likely about 2% of GDP in 2015.
In view of the existing favourable debt servicing arrangements, it can be argued that the
stock of debt, despite amounting to approximately 177% of GDP, need not pose such a big a
concern, conditional on there being a credible commitment to the agreed fiscal targets and
the implementation of structural reforms which can improve the growth potential of the Greek
economy in the long term.
However, in view of the progress achieved so far in terms of reaching primary surpluses and
meeting the various conditions incorporated in the adjustment programme, further debt relief
should be provided to Greece along the lines of the Eurogroup decision of 27 November
2012. This is necessary for achieving a further credible and sustainable reduction of the
Greek debt-to-GDP ratio and in order to smooth out a demanding government borrowing
profile post 2022/23, i.e. after the expiration of the 10-year grace period currently applied on
GLF interest payments and on EFSF loan principal and interest payments.
There are various ways to do that without losses for euro area creditors.
For example:
 By reducing the lending rate on the Greek Loan Facility by setting the spread over
the Euribor - currently at 50 basis points - to zero;
 by a further 10-year extension of the maturity profile of EFSF and GLF loans.
The combination of these actions would amount to a net present value benefit of about
17 percent of 2015 GDP for Greece over the next 35 years, thus improving debt
sustainability. This will also make possible a relaxation of fiscal targets, making some room
for additional investment spending and catering social needs.
In fact, extending maturities and reducing interest rates on the outstanding debt may improve
the growth outlook of the Greek economy and, hence, provide further support to public debt
sustainability.
Bank of Greece Staff estimates that a permanent reduction of the interest payments -to-
GDP ratio by 0.6 percentage points can lead to an increase in real GDP by a total of 4-7%
over the next ten years, depending on the fiscal policy mix. This corresponds to a boost in
real GDP growth of 1⁄2 percentage point per year on average for a ten-year period. The
economic rationale that debt relief of this form can provide a "growth dividend" is that
reducing the debt servicing costs can free up resources which can be used for investment,
job creation and economic growth. The growth dividend is more pronounced if such debt
relief is combined with a credible expenditure based fiscal consolidation programme.
However, broadening the tax base and fighting tax evasion should not be expected to weigh
negatively on growth performance.
Alternative options could also be considered to improve the sustainability of Greece's public
debt. However, they might be more contentious as they likely involve some costs for euro
area partners.
Concluding remarks
Concluding, the immediate challenges of the government are to:
consolidate fiscal achievements, further specify and agree with the institutions the

full list of specific reforms by the end of April 2015,
 implement the agreed reforms in order to allow for a speedy and successful
conclusion of the current evaluation procedure.
This would allow Greek banks to regain full access to the ECB's monetary operations,
alleviating liquidity pressures, reducing the funding costs for the Greek financial system and
the Greek economy as a whole, and exploiting the accomodating monetary policy applied by
the ECB in the Eurozone.
The conclusion of the current evaluation procedure by the end of June 2015 will pave the
way for a final agreement on the follow up arrangement between Greece and the EU
partners. This should involve a credible medium term fiscal and structural reform programme,
backed up by a reliable credit line, as well as further debt relief along the lines of the
November 2012 Eurogroup decision. These actions are prerequisites for strengthening both
economic growth and employment and for Greece's return to international financial markets,
thus, signaling the definitive exit from the crisis.
The new Greek government has a unique opportunity to implement bold structural
reforms, which would be backed by a large majority of political forces in the country.
This is in my view a historical opportunity which should not be missed.
Thank you very much for your attention.