George A Provopoulos: The adjustment process of the Greek economy
at a decisive juncture - critical challenges for economic policy
Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the 78th Annual
Meeting of Shareholders, Athens, 18 April 2011.
* * *
The Bank of Greece stressed from the start that the financial support agreement would play
an important role in addressing the crisis, by securing the necessary funding at a time when
Greece was virtually excluded from the markets, imposing disciplined adherence to
timetables, offering economic policy expertise and facilitating fiscal consolidation.
The financial support agreement averted bankruptcy and imposed a reorientation of
economic policy
Indeed, the financial support agreement has not only secured the necessary funding, but
also acted as a catalyst for a fundamental reorientation of economic policy in two main
directions: rapid fiscal consolidation and the implementation of structural reforms. This
reorientation should of course have taken place years ago, when conditions were more
favourable. By April 2010, all room for procrastination had been exhausted and the change in
direction was imperative. The policy package that began to be implemented was the only
way to halt the country's marginalisation, the only hope of creating the conditions to proceed
down a new path in an orderly manner and as soon as possible.
The interventions of the ECB and the liquidity support measures averted a credit
crunch
During that same period, when the downgrades of the credit ratings of the Greek sovereign
led to the downgrading of Greek banks, normal liquidity conditions were secured thanks to
the policy and interventions of the Eurosystem. With interest rates kept at low levels, the
stance of monetary policy remained accommodative. Meanwhile, the Eurosystem continued
to use non-standard monetary policy measures, which improved the liquidity position of
banks and the economy at a time when Greece was facing extremely adverse conditions.
Most importantly, the Eurosystem took the very important decision to provide funding to
Greek banks against collateral of debt securities issued or guaranteed by the Greek
government, irrespective of their credit ratings.
Businesses have, of course, been facing difficulties in their access to credit. One need only
consider, however, the insurmountable obstacles that would have arisen, in the absence of
these rescue measures, which indeed averted a credit crunch.
Adjustment began in 2010 with tangible results on the fiscal front
The effort to turn developments around began with interventions in several areas and
produced tangible results, mainly on the fiscal front. The general government deficit as a
percentage of GDP was reduced by approximately 5 percentage points. The European
Commission and the IMF, in three successive reviews, acknowledged the progress made,
rendering possible the smooth inflow of funding under the financial support agreement. This
averted the disastrous developments that seemed inevitable one year ago and a time margin
was given to carry out the changes in the economy that, in any case, would have to be
implemented, with or without the Memorandum of Understanding.
*****
Delays, but also objective difficulties, continue to feed market uncertainty
Within the past year, a lot has been achieved. However, in spite of the positive results and
the great effort, the factors that generate uncertainty and feed the markets' wait-and-see
attitude remain strong.

First, the debt dynamics remain unfavourable, because of the size of the
accumulated imbalances and because progress in adjustment has so far not been
fast enough in order to reverse these dynamics quickly and decisively.
 Second, has improved slightly, mainly as a result of decreases in
competitiveness
production costs. However, structural competitiveness, which is linked to the
creation of a business-friendly environment, has not. Furthermore, cost
competitiveness gains in 2010 were small compared to the cumulative losses of the
past decade.
 Third, in spite of reforms to the functioning of the public sector, substantial
improvement has yet to be made in the areas where deficits are initially generated
i.e. public administration, numerous agencies, local government - or in the efficiency
of tax collection. Thus, fiscal adjustment, after getting off to a strong start, by early
2011 is already showing signs of fatigue and deviating from targets. In 2010,
although there was a large reduction of the deficit, the initial target was missed.
Deviation from targets has also been recorded in the first quarter of 2011.

Fourth, in the area of structural changes, important legislation has been passed on
the pension system, healthcare, closed-shop professions and the labour market,
and in several cases there has been progress. In certain cases, however, the
reforms do not go deep enough and their implementation is often delayed, either
because of administrative inefficiencies or because of a reluctance to push ahead, in
the face of opposition.

Fifth, the real economy performed worse than expected. GDP in 2010 contracted
by 4.5%, due to a decline in private consumption by 4.5%, in public consumption by
6.5% and in gross fixed capital formation by 16.5%. However, the recession would
have been milder, if the reforms to improve the business environment, the utilisation
of Community funds under the National Strategic Reference Framework (NSRF) and
improving the efficiency of public spending had all progressed faster.

Sixth, the recession has led to job losses across all sectors of the economy and to
a rise in unemployment. In the last quarter of 2010, employment fell 4%
year-on-year, which translates into 180,000 jobs lost, while the rate of
unemployment reached 14.2% of the workforce. The average annual decrease in
employment (-2.7%) was smaller than the decline in GDP, causing productivity to
fall (by 1.8%).

Finally, information and public debate on the causes of the crisis, the actual state
of the economy and, especially, the objective circumstances that make this policy
package imperative have been fragmented and incomplete. The Memorandum of
Understanding is often seen as responsible for the symptoms of the crisis and not
as an inevitable response to the crisis. Furthermore, it has not been sufficiently
explained that the Memorandum has actually mitigated the symptoms of the crisis,
which would have been far more acute without it. The backing of reforms in several
cases has proved timid, while in the public debate the symptoms of the crisis are
blown out of proportion, without any mention of the reasons that make the changes
imperative.
As a result of this information deficit, a section of public opinion remains perplexed and
reserved in the face of the unfolding changes, as the new policy package calls into question
certainties long considered unchallengeable, while a convincing case has not been made for
the proposed way-out. The resulting uncertainty has kept social forces from actively joining
together in support of the effort. Of course, there have also been reactions which seek to
avert change and return to practices of the past.
The projections for 2011 leave no room for complacency
The projections for 2011, in spite of some positive signs, leave no room for complacency.
 The will continue. GDP is projected to decline by 3%, and a slightly larger
recession
decline cannot be ruled out.
 will continue to rise and will exceed 15%.
Unemployment

Average annual inflation will slow down significantly compared with 2010, but will
be close to 31⁄4%.

The annual rate of credit expansion to the private sector, already negative in the
first two months of the year, is expected to remain negative throughout 2011.

Competitiveness will continue to improve in 2011, as unit labour costs continue to
decline and inflation recedes.

The current account deficit will narrow to below 9% of GDP, as a result of the
recovery of exports and receipts from tourism and the continuing fall of consumer
good imports.
The old is on its way out, but the new is not yet here
Today we find ourselves at a critical crossroads. On the one hand, the old growth model,
dominant for so long, is collapsing. On the other hand, the new practices, new institutions
and new mentalities that will revitalise the economy have not begun to emerge. The key
desideratum would be a rapid transition from an unsustainable growth model to a new one
capable of instilling confidence in a positive outlook for the economy, mobilising productive
forces, restoring market trust and improving the overall climate.
This is a crisis of the growth model, not of the Memorandum of Understanding
The growth model that has exhausted its limits relied on domestic consumption, both public
and private, and was fuelled by borrowing. The business sector did not manage to sufficiently
tap into the opportunities opened up by Greece's participation in the euro area, while the
boost in households' expectations generated by this participation and the swelling of the
public sector encouraged consumerism. This led to negative net national saving from 2002 to
the present and to a continuous transfer of resources from the business sector to the
oversized, low-productivity public sector. This model favoured present consumption at the
expense of the future and was underpinned by the illusion that growth could be driven by the
public sector ad infinitum. The rise in consumption, characterised by a high propensity to
consume imported goods, encouraged and supported a "shallow" domestic
entrepreneurship, focused on the distribution sector and the final consumer. However, as the
factors that previously underpinned consumption have now been eliminated, this type of
business activity has inevitably suffered a serious blow. At the same time, the necessary
conditions to foster a new type of entrepreneurship have not yet been created. The current
crisis of the economy is the crisis of a growth model that could no longer be sustained. The
cost that society is summoned to pay today is also due to the delay in moving to the new
model.
*****
Focusing on the future: A new growth model
The new growth model that Greece needs implies a shift of focus from consumption to
saving, investment and exports, from statism and the perpetuation of privileges to
competition and business initiative. In other words, it means a new model of consumption,
entrepreneurship and public administration; it means increasing the share of investment and
exports in GDP; reducing the share of private and public consumption; giving a substantial
boost to saving; shifting entrepreneurial initiative to the competitive sector of production and
orienting it towards the international markets; ensuring that public administration functions in
a way that does not discourage investment and does not tolerate tax evasion.
A dynamic re-launch of our efforts is needed in order to give new impetus to reform
policies
Today, the Greek economy is at a watershed. Progress with adjustment has been made but
is still slow if debt dynamics are taken into account. What is now needed is a strong
re-launch of our efforts, to make up for the delays and give fresh impetus to reform policies.
The key prerequisites for this to happen are:

To demonstrate in practice that the government is firmly committed to moving
forward, without ambivalence and without hesitation, on the difficult path that it has
mapped out.

To inform the public regularly about where the economy stands, which policy goals
are being pursued, what difficulties and risks are present, how much ground still
needs to be covered, what the ultimate goal is and what the consequences of failure
would be.

To highlight clearly the benefits of the reforms, which are not only necessary, but
also morally right, abolishing privileges and aiming at equal and better opportunities
for all.

Τo reach a minimum of consensus among the political and social forces so as to
ensure continued adjustment, the duration of which will extend well beyond any one
government's term.
Priorities of economic policy
a) Stabilisation through measures for structural adjustment
There is absolutely no doubt that speeding up the recovery and economic growth will be key
to success in the years ahead. However, there will not be any recovery, if we do not address
the fundamental causes that led us into the crisis: the huge swelling of public deficits and
debts and the serious erosion of the country's competitive position. Therefore the first step
towards economic growth is to stabilise the economy. As international experience has also
shown, large public deficits and debts cannot foster growth; on the contrary, they undermine
it.
Speeding-up reforms in the public sector
The stabilisation process has entered its second and most difficult phase. Following
acrossthe-board wage cuts and tax increases, it must now focus with determination on structural
reforms in the public sector, so as to permanently reduce spending which stems from its
inefficient operation.
There is actually ample room for such changes. At the same time, we must seize two crucial
opportunities, present today, which could act as a catalyst for re-launching the reform effort.

First, the Medium-Term Fiscal Strategy Framework provides the chance to follow
a fiscal policy with clear objectives, well-specified measures and a definite timetable,
rather than piecemeal interventions and stop-gap measures. If the objectives of this
Framework are to be achieved, the factors generating the deficit must be eliminated
- most importantly, spending must be cut.

Second, the Privatisation and Public Property Development Programme, if
boldly and rapidly implemented, could contribute to a substantial reduction of the
debt and encourage the inflow of foreign direct investment.
b) Mitigating the impact of the recession and speeding up recovery
Economic policy, without concessions in terms of fiscal adjustment, must aim simultaneously
to mitigate the effects of the recession and to bring GDP growth back to positive territory as
soon as possible.
 To start with, any further increase in the tax burden of those businesses, workers
and pensioners who pay their taxes regularly must be avoided; instead, tangible
progress must be made in the fight against tax and social-security contribution
evasion. This is also crucial for bolstering a sense of equity and increasing
consensus for the adjustment programme.
 At the same time, all possibilities must be exhausted to:
- cut spending by eliminating the squandering of public funds and merging or
eliminating public-sector entities that are unproductive;
- re-allocate total expenditure towards growth-enhancing and socially beneficial
uses and increase the efficiency of public spending.
These actions will make it possible to support the more vulnerable groups of society,
to facilitate labour mobility across sectors and jobs and to increase the share of
public funds allocated to investment.

The EU funds that are at the country's disposal need to be absorbed at a quicker
pace, by using the instruments introduced by the new development law and by fully
activating the National Hellenic Fund for Entrepreneurship and Development
(ETEAN).

Finally, the implementation of structural reforms that entail zero or low budgetary
costs but which can yield quick results must begin immediately; such reforms
include those that reduce red-tape, tackle corruption and remove product and labour
market rigidities.
c) Attracting foreign investment
Given that domestic resources available for financing growth are currently very limited,
imported saving, in the form of foreign direct investment, must be encouraged. It is true that
conditions are unfavourable, as the climate is negative and large uncertainties prevail.
However, some positive side effects can be expected from the Privatisation Programme and,
of course, from all the urgently-needed measures to upgrade the business environment.
d) Improving competitiveness by speeding-up reforms
Growth hinges upon a rapid improvement in competitiveness. This means fostering new
competitive enterprises that are oriented towards the international markets. Growth also
hinges upon a radical change in the business climate, to be brought about by creating an
environment friendly to initiatives in the areas of production and investment. A much faster
pace is now needed for structural change in markets and especially in the public sector - i.e.
for reforms that, apart from recouping the losses in international cost competitiveness, will
improve structural competitiveness as well.
The main lines of reform - several of which are already in progress - should include:

Bolstering competition in markets for goods and services.
 Enhancing flexibility and mobility in the labour market.

Improving the absorption of Community funds, encouraging and facilitating
investment and enhancing the export orientation of the economy.

Increasing the effectiveness of education at all levels and encouraging innovation
and R&D.

Changing the present patterns of energy production and consumption.
e) Tapping into the growth potential
The main sources of growth are:

Large investments in the energy sector;

Upgrading tourism, by attracting higher-income visitors, encouraging well-off
pensioners and active professionals from other countries to take up permanent or
seasonal residence in Greece, promoting convention tourism, facilitating cruises and
attracting foreign visitors to Greece's mainland and mountain areas.

The further development of the merchant shipping industry.

The expansion of those manufacturing industries that have shown noteworthy
export dynamism, as well the performance of many dynamic businesses in all
sectors.
 with the processing of farming
Taking full advantage of agricultural production,
and livestock products.
 Turning Greece into a major for example,
hub for the transit of goods through,
the country's ports, as well as the provision of high quality healthcare and
education services to consumers from the wider Balkan and Eastern Mediterranean
region. The development of these service activities could avert an exodus of trained
scientists and at the same time encourage Greek scientists working abroad to return
home.
*****
The banking system up against serious challenges
Liquidity support through the government guarantee scheme remains necessary
It is a well-known fact that Greek banks did not cause the crisis, contrary to what happened
in other countries, but suffered the consequences of the fiscal derailment. The downgrading
of banks' credit ratings, consequent on the downgrading of the country, meant that banks
were shut out from the markets, while they also lost a significant proportion of deposits.
Against this background and in order to meet their liquidity needs, banks had recourse to the
liquidity support measures adopted by the Greek government including a State guarantee
scheme. Such measures had been adopted by all EU countries in 2008 at the height of the
global financial crisis.
It should be recalled that under this scheme the State, for a fee, guarantees debt securities
issued by banks; it does not provide banks with cash. These guarantees enable banks to
obtain liquidity from the Eurosystem by providing them with eligible collateral. It should also
be noted that, because of the haircuts applied, the liquidity that credit institutions can obtain
using government-guaranteed securities as collateral falls significantly short of the nominal
value of such collateral.
The ability of banks to raise liquidity from the Eurosystem by making use of government
guarantees has averted a credit crunch. Although nominal GDP fell by 2.1% in 2010, the
outstanding amount of bank credit to the private sector in December 2010 remained
unchanged year-on-year. Given the financial environment, without the extraordinary
provision of liquidity by the Eurosystem the banks would have been forced to expedite the
collection of their claims, cut back on loan rescheduling and reject applications for new loans
even from creditworthy customers.
However, the extraordinary liquidity support measures taken by the ECB and the government
are temporary in nature. They aim to give banks time to adjust their business model to the
new circumstances. This adjustment must be performed in an orderly manner, so as not to
further aggravate the current economic downturn nor dampen the recovery, once it begins. In
other words, banks must, as soon as possible, be in a position to intermediate between
savers and investors relying on their own resources, rather than on the extraordinary support
provided by the ECB or the State.
The new conditions make it imperative for the banking sector to change its business
model
The banking sector, just like the economy as a whole, has found itself up against
unprecedented challenges and has had to deal with a number of factors that have affected
its performance and generated conditions of uncertainty.
Today's reality is a given and, with regard to the future, the message is clear as to the basic
parameters of the economic environment and the regulatory framework. Banks will therefore
have to adjust their business models accordingly, by mustering all their forces.
Reorganisation and alliances are most successful when they are carried out with foresight
and are the outcome of informed decisions and friendly negotiation.
The reorganisation of the banking sector will considerably enhance its contribution to the
growth process, once the economy begins to recover. It will also support financial stability, on
condition of course that the primary factor for stability is in place, i.e. that the confidence of
economic agents, markets and the international community is restored and consolidated. No
reorganisation of the financial system can substitute for the need to pursue fiscal
consolidation and speed up structural reforms in the public sector and the economy at large.
*****
Creative adjustment to the European and international environment
As Greeks, we often interpret prevailing international conditions subjectively, with a
perspective that places Greece at the centre of things.
However, if we accept the fact that the international environment shapes an objective reality
that cannot be overturned just because that is our wish, we will realise that our prospects
ultimately depend on the consistency with which we adjust to this reality. This is especially
true of our relations with the European Union and the euro area, which are governed by
explicit rules that have been formulated with our participation. In fact, these rules are
currently being modified as the EU and the euro area work towards new terms of economic
governance that would avert a recurrence of crises and develop new mechanisms for
intervention. The European Stability Mechanism and the "Euro Plus Pact", the main
principles of which were recently decided, will create a new framework requiring all Member
States to make long-term commitments, in particular in the areas of fiscal discipline and the
focus of their economic policies on improving competitiveness - i.e. precisely the two major
challenges that Greece has to face one way or another.
Therefore, the developments under way in the EU and the euro area support and reinforce
the conclusion that we need to intensify our efforts for fiscal consolidation and a substantial
improvement in competitiveness.
Adhering to these guidelines would also be the best answer to the often-repeated scenaria
surrounding debt restructuring. Since last October the Bank of Greece has clearly explained
that such an option is neither necessary nor desirable. It is not necessary, because we can
achieve our goals if we properly implement the policies outlined above. Nor is it desirable,
because it would have disastrous consequences for the access of the government and of
Greek enterprises to international financial markets, as well as very negative effects on the
assets of pension funds, banks and individuals holding Greek government securities.
*****
Today, we are at the start of a long course of reconstruction of the economy, a path with
many obstacles and risks, but also opportunities that we need to exploit. The mobilisation of
all of the country's political and social forces is imperative for this effort to succeed. The final
outcome will depend on:

our collective will and determination;

our foresight and long-term perspective;

the ability to work out a well-coordinated and coherent plan of the necessary actions
and to implement it quickly and efficiently.
All of the above presuppose strict adherence to the final goal: to transform Greece
into a modern European country with economic prosperity and social cohesion.