Brussels, 9.2.2005

SEC(2005) 194 final

Recommendation for a

COUNCIL DECISION

giving notice to Greece, in accordance with Article 104(9) of the EC Treaty, to take measures for the deficit reduction judged necessary in order to remedy the situation of excessive deficit

(presented by the Commission)

EXPLANATORY MEMORANDUM

THE EXCESSIVE DEFICIT FOR GREECE

The excessive deficit procedure (EDP) is governed by Article 104 of the Treaty and by Regulation (EC) N°1467/97 of 7 July 1997 on speeding up and clarifying the implementation of the excessive deficit procedure, which is part of the Stability and Growth Pact. It is completed by the political commitments enshrined in the Resolution of the Amsterdam European Council on the Stability and Growth Pact of 17 June 1997.

The Greek authorities submitted on 4 May 2004 a revised EDP notification with a deficit of 3.2% of GDP for 2003. Although it was aware that this figure was provisional because it had not been certified by Eurostat, the Commission, taking into account its spring 2004 forecasts considered that this notification provided prima facie evidence for the existence of an excessive deficit in Greece in the sense of Article 104 of the Treaty. The Commission initiated the Excessive Deficit Procedure for Greece on 19 May 2004, with the adoption of the report foreseen in Article 104(3) of the Treaty. After examining the relevant factors taken into account in its report and regarding to the opinion formulated by Economic and Financial Committee (EFC) on 2 June 2004 in conformity with Article 104(4), the Commission adopted on 24 June 2004 an Opinion in conformity with Article 104(5) stating that an excessive deficit exists in Greece. The Council decided accordingly, in conformity with Article 104(6), on 5 July 2004. At the same time, the Council adopted a recommendation, according to Article 104(7) of the Treaty, addressed to Greece with a view to bringing the excessive deficit situation to an end by 2005. The Council established the deadline of 5 November 2004 for the Greek government to take appropriate measures to this end.

On 22 December 2004, in accordance with the provisions of Article 104(8) of the Treaty and of Article 4(1) of Regulation (EC) No 1467/97, the Commission recommended the Council to decide that no effective action has been taken in response to the recommendations addressed under Article 104(7) within the period laid down in this Recommendation. The Council decided accordingly on 18 January 2005. The Council acknowledged that the Greek government implemented measures in 2004 aimed at curbing the rising deficit and the 2005 budget projects measures leading to a significant budgetary adjustment.

According to Article 5 of Regulation (EC) No 1467/97, any Council decision to give notice to the participating Member State concerned to take measures for the deficit reduction in accordance with Article 104(9) shall be taken within one month of the Council decision establishing that no effective action has been taken in accordance with Article 104(8).

THE DEADLINE TO CORRECT THE EXCESSIVE DEFICIT

According to the Commission services autumn 2004 forecasts, the 2005 deficit is projected at 3.6% of GDP. While the Council recommendation under Article 104(7) set the deadline of 2005 for correcting the excessive deficit, the Council when issuing the “notice” under Article 104(9) can decide to confirm such a deadline or set a new one. Several elements have to be considered when defining the correction deadline in the specific case of Greece:

The currently estimated deficit outturn for 2004 will be substantially higher than expected when the Council adopted the recommendation according to Article 104(7). The Greek government data validated by Eurostat on 4 May 2004 was significantly revised in the September 2004 notification. According to the Commission services autumn 2004 forecasts, the general government deficit would attain 5.5% of GDP in 2004, compared with the 3.2% of GDP projected in spring and the 1.2% of GDP targeted in the original 2004 budget. This slippage is explained not only by the statistical revisions, carried out in cooperation with Eurostat to correctly apply the ESA 95 statistical system, and by expenditure overruns associated with the organisation of the Olympic Games, but also by slippages in some revenue and spending items, which had not been correctly estimated in the 2004 budget. Such slippages more than offset the restraining measures announced for 2004.

The deficit of 3.6% of GDP projected by the Commission services for 2005 contrasts with the deficit of 2.8% of GDP targeted in the 2005 budget approved by the Greek Parliament. The difference between the target in the official budget and the Commission services forecasts is mainly explained by three factors: (i) a difference of 0.2 percentage point of GDP in interest payments in the projected deficit outturn for 2004; (ii) differences in growth projections in 2005 (3.3% according to the Commission services, 3.9% according to the official budget), and (iii) a different assessment by the Commission services of the budgetary impact of some of the measures included in the 2005 budget, especially social security contributions, the wage bill and social transfers.

Over and above these two elements, recent confidence and leading indicators, as well as by quarterly data, indicates that the GDP growth rate of 3.3% for 2005 projected by Commission services autumn 2004 forecast could be revised downwards in the spring 2005 forecasts[1]. Moreover, the deficit outturn for 2004 may be higher than the 5.5% of GDP estimated in the Commission services autumn 2004 forecast, which might have carryover effects in 2005[2].

Given these factors, the adjustment necessary to bring the 2005 nominal deficit below the 3% of GDP threshold should be of at least 2.6% of GDP. This would be no less than 0.7 percentage point of GDP higher than the adjustment projected by the Commission services on the basis of the measures outlined in the official 2005 budget. While budgetary consolidation is important for growth in the medium term, especially if it is of the right composition, too large an effort in a single year may prove economically costly.

Nevertheless, the almost permanent excessive deficit situation of the Greek public finances, as revealed by the September EDP notification, coupled with the high level of debt and its unsatisfactory reduction path, are matters of serious concern. If Greece’s budgetary imbalances are not corrected, they will weigh on economic agents’ expectations and be damaging for both growth and long-term sustainability.

FISCAL POLICY REQUIREMENTS IN 2005 AND 2006

In view of the above, the Commission considers that extending to 2006 the deadline that the Council set in July 2004 for the elimination of the excessive deficit in Greece would set up the conditions for a balanced and lasting correction. Specifically, where 2005 is concerned, it is appropriate that the Greek government implements with rigour the measures approved by its Parliament in the 2005 budget, which, in the light of the Commission services growth projection of 3.3% for 2005 and the expected deficit outturn of 5.5% of GDP for 2004, are estimated to lead to a nominal deficit of 3.6% of GDP. This would make it possible to catch up in 2005 on the insufficient adjustment in 2004 and to establish a credible basis on which to bring the deficit clearly below 3% of GDP in 2006.

If the growth rate in 2005 and/or the 2004 deficit outturn are better than projected in the Commission services autumn 2004 forecasts, the Greek authorities are expected to use the additional room for manoeuvre to accelerate the deficit reduction. In the opposite case, the Greek government should keep the 2005 slippage to the minimum justified by the lower growth rate and/or by the higher 2004 deficit outturn, while taking advantage of any possible budgetary savings to compensate the slippage to the largest feasible extent.

Given the expected deficit outturn of 3.6% of GDP for 2005, bringing the deficit below the 3% threshold in the current year will require a nominal adjustment of at least 0.7 percentage point of GDP in the current year. Although there is much uncertainty surrounding growth prospects in Greece in 2006, the Commission services autumn 2004 forecast projects a central scenario in which real growth is expected to remain at a similar rate as in 2005, namely 3.3%. Furthermore, the excess of actual output over potential (almost 2% of potential output) is projected not only to remain high but also to slightly widen. Under a no policy change scenario, such widening should have an automatic positive effect on government accounts, improving the nominal deficit by around 0.1% of GDP. Consequently, given the projected growth rate of 3.3% in 2006 and the 2005 deficit outturn of 3.6% of GDP, the correction of the excessive deficit in 2006 would require measures of a permanent nature leading to a correction of the deficit of at least 0.6% of GDP.

In addition, beyond 2006, achieving an underlying budgetary position of close to balance or in surplus in the medium term is important in order to ensure a rapid reduction in the debt-to-GDP ratio, while avoiding excessive deficits. Consequently, as requested by the 2003-2005 Broad Economic Policy Guidelines, the Greek authorities should commit to continue reducing the cyclically-adjusted deficit by at least 0.5 percentage points of GDP per year.

OTHER POLICY REQUIREMENTS

After the upwards statistical revisions carried out in 2004, the Greek debt-to-GDP ratio rose to almost 110% in 2003, the highest level in the EU, well above the 60% reference value of the Treaty. The Commission services autumn 2004 forecasts project the debt ratio to stabilise at around 112% of GDP in 2004 and 2005 and then to fall only marginally about 110% in 2006. Albeit decreasing, the contribution of factors (below-the-line operations) other than net borrowing and nominal GDP growth, which have partially driven up debt in the past years, is projected to amount to 3 percentage points of GDP in 2005 and to 2 points in 2006. Although these developments of the so-called stock-flow adjustment represent an improvement respect to the past, it still remains high and is preventing the debt ratio from declining at a satisfactory pace. Consequently, it is necessary that the Greek government takes further action in order to identify and control factors other than net borrowing which contribute to the change in debt levels.

Where the statistical system is concerned, Greece has tackled a number of issues raised by Eurostat. However, as explained by the Commission in the letter giving formal notice of the infringement procedure No 2004/2234, open to Greece on 1 December, there are a number of elements which, in the view of the Commission, are questioning the adequacy of the mechanisms to ensure the prompt and correct supply of the information required by the existing legal framework. Therefore, further efforts are needed to improve the collection and processing of general government data, notably by enhancing such mechanisms.

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In view of the above findings, the Commission recommends the Council to give notice to Greece in accordance with Article 104(9) to take measures for the deficit reduction the Council judges necessary in order to remedy the situation of excessive government deficit by 2006 at the latest. The Commission also recommends that a report be submitted before 21 March 2005, outlining measures to be implemented in compliance with this Council decision. In particular, the report should include a description of the measures to be implemented in 2005 to reduce the budget deficit, assessing the implications of the 2004 deficit outturn disclosed in the March EDP notification of 2005, and the risks associated to the macroeconomic scenario. Greece should also include in this report a description as precise as feasible of the measures to be implemented in 2006 to reduce the deficit. The Commission and the Council will examine the report with a view to assessing compliance with this Council decision. The Commission also recommends, in accordance with Article 104(9), to request Greece to submit reports in accordance with a specific calendar. The Commission and the Council will examine such reports with a view to regularly assessing compliance with this decision.

Recommendation for a

COUNCIL DECISION

giving notice to Greece, in accordance with Article 104(9) of the EC Treaty, to take measures for the deficit reduction judged necessary in order to remedy the situation of excessive deficit

THE COUNCIL OF THE EUROPEAN UNION

Having regard to the Treaty establishing the European Community, and in particular Article 104(9) thereof,

Having regard to the recommendation from the Commission under Article 104(9),

Whereas:

According to Article 104(1) of the Treaty, Member States shall avoid excessive government deficits.

The Stability and Growth Pact is based on the objective of sound government finances as a means of strengthening the conditions for price stability and for strong sustainable growth conducive to employment creation. The Stability and Growth Pact includes Council Regulation (EC) No 1467/97 of 7 July 1997 on speeding up and clarifying the implementation of the excessive deficit procedure[3].

The Amsterdam Resolution of the European Council of 17 June 1997 on the Stability and Growth Pact[4] solemnly invites all parties, namely the Member States, the Council and the Commission to implement the Treaty and the Stability and Growth Pact in a strict and timely manner.

By Council Decision 2004/917/EC[5], of 5 July 2004, it was decided, in accordance with Article 104(6) of the Treaty, that an excessive deficit existed in Greece.

In accordance with Article 104(7) of the Treaty and Article 3(4) of Regulation (EC) No 1467/97, the Council addressed a Recommendation to Greece on 5 July 2004 establishing the deadline of 5 November 2004 for Greece to take measures to bring the existence of an excessive deficit to an end in 2005 at the latest.

When Decision 2004/917/EC was adopted, the Greek government data notified on 4 May 2004 was significantly revised in the September 2004. The deficit figure for 2003 rose to 4.6% of GDP (from the 3.2% notified on 4 May), while, according to the Commission autumn 2004 forecasts, the general government deficit was likely to reach 5.5% of GDP in 2004, compared with the 3.2% projected in spring. Furthermore, the measures approved by the Greek Parliament in the 2005 budget would not ensure that the general government deficit is brought below 3% of GDP in 2005. According to the Commission autumn 2004 forecasts, which projected a growth rate of 3.3% in 2005, the measures included in the Greek budget for 2005 are projected to lead to a nominal deficit of 3.6% of GDP, which is above the 3% threshold.

By Council Decision 2005/XXX/EC, it was established, in accordance with Article 104(8) of the Treaty, that no effective action had been taken in response to the Council Recommendation according to article 104(7) of 5 July 2004.

According to Article 104(9), if a Member State persists in failing to put into practice the recommendations of the Council, the Council may decide to give notice to the Member State to take, within a specified tiem limit, measures for the deficit reduction. Article 5 of Regulation (EC) No 1467/97, provides that any Council decision to give such notice shall be taken within one month of the Council decision establishing that no effective action has been taken in accordance with Article 104(8).

The following factors should be taken into account in determining the recommendations to be included in the notice. First the estimated deficit outturn for 2004 will be substantially higher than expected when the recommendation under Article 104(7) was adopted and the slippages more than offset the restraining measures implemented for 2004. As a result, the entire fiscal effort to be made in order to correct the excessive deficit by 2005 at the latest, as called for in the Council recommendation under Article 104(7) of the Treaty, should take place in the current year. Secondly, according to the Commission’s autumn 2004 forecasts, if fully implemented, the measures in the budget adopted by the Greek Parliament for 2005 would lead to a deficit reduction of 1.9 percentage points of GDP. This represents a considerable improvement of the fiscal position, but would be insufficient to bring the nominal deficit below the 3% threshold. Finally, this additional adjustment might become even higher if a number of risks on the macroeconomic scenario for 2005 and the fiscal outturn for 2004 materialise. Taking these elements into account, the total adjustment necessary to correct the excessive deficit in 2005 could be higher than 2.6 percentage points of GDP, which would require additional measures of a permanent nature leading to a correction in the deficit of at least 0.7 percentage point of GDP. Such an effort in a single year may prove economically costly.

In the light of these factors, it appears that the deadline which was set in July 2004 for the elimination of the excessive deficit in Greece should be extended by one year.

On the basis of a growth rate of 3.3% in the Commission services autumn 2004 forecasts for 2005 and 2006, and given the risks on the macroeconomic and budgetary outlooks, a rigorous implementation of the 2005 budget, together with measures of a permanent nature leading to a correction in the deficit of at least 0.6% of GDP in 2006 would result in a deficit of 3.6% of GDP in 2005 and bring it below 3% of GDP in 2006.

The Commission services autumn 2004 forecast project the debt ratio to stabilise at around 112% of GDP in 2004 and 2005, and to fall only marginally about 110% in 2006. This is the highest debt level in the EU, and is well above the 60% reference value of the Treaty. Moreover, the contribution to the changes in debt levels of factors other than net borrowing is also high. It is necessary that the Greek authorities should continue to pay due attention to such factors in order to reduce the debt ratio at a satisfactory pace, consistent with the projections for the general government balance and nominal GDP growth.

In view of significant statistical revisions, and in order to allow for an adequate monitoring of the situation of public finances in Greece, further efforts are needed to improve the collection and processing of general government data required by the existing legal framework, notably by enhancing the mechanisms that ensure the prompt and correct supply of these data.

Greece should submit a report to the Commission before 21 March 2005, outlining measures to be implemented in order to comply with this Decision. In particular, the report should include a description of the measures to be implemented in 2005 to reduce the budget deficit, assessing the implications of the 2004 deficit outturn to be disclosed in the excessive deficit procedure notification in March 2005, and the risks associated with the macroeconomic scenario. Greece should also include in that report as precise a description as possible of the measures to be implemented in 2006 to reduce the deficit. The Commission and the Council should examine that report with a view to assessing compliance with this decision.

According to the second subparagraph of Article 104(9) of the Treaty, the Council may request Greece to submit reports in accordance with a specific timetable in order to examine the adjustment efforts made in order to comply with this Decision. It is appropriate for Greece to submit reports just after the deadlines for reporting government deficits and debt provided for by Article 4 of Regulation (EC) No 3605/93, in order to enable the Commission to assess compliance with this decision.

In the view of the Council, adjustment measures should secure a lasting improvement in the general government balance. In order to ensure a sustained budgetary consolidation towards the medium term position of government finances close to balance or in surplus, as prescribed by the Stability and Growth Pact, a reduction in the cyclically-adjusted deficit by at least 0.5% of GDP per year is necessary after the correction of the excessive deficit.

HAS ADOPTED THIS DECISION:

Article 1

1. Greece shall put an end to the present excessive deficit situation as rapidly as possible and at the latest by 2006 through:

(i) a rigorous implementation of the 2005 budget as approved by its Parliament. This, on the basis of the macroeconomic scenario in the Commission’s autumn 2004 forecast, and given the projected deficit outturn of 5.5% of GDP in 2004, should result in a nominal deficit of around 3.6% of GDP in 2005;

(ii) implementing in 2006 adjustment measures of a permanent nature leading to a correction in the deficit of at least 0.6 percentage point of GDP. This, on the basis of the macroeconomic scenario in the Commission’s autumn 2004 forecast, and if the 2005 budget is fully implemented, as set out in point (i), should bring the general government deficit below 3% of GDP;

2. Greece shall further pursue the efforts to identify and control factors other than net borrowing, which contribute to the change in debt levels, with a view to ensuring that the government gross debt ratio diminishes sufficiently and approaches the reference value at a satisfactory pace in line with the correction of the excessive deficit;

3. Greece shall further pursue the efforts to improve the collection and processing of general government data, notably by enhancing the mechanisms that ensure the prompt and correct supply of the general government data required by the existing legal framework.

Article 2

1. Greece shall submit, by 21 March 2005 at the latest, a report outlining the decisions to respect the recommendations of this Decision. The Commission and the Council will analyse the report with a view to assessing compliance by Greece with this Decision;

2. Greece shall submit reports by 31 October 2005, 30 April 2006 and 31 October 2006, examining progress made in respecting the recommendations of this decision.These reports will be examined by the Commission and the Council with a view to assessing compliance by Greece with this Decision.

Article 3

Greece shall take the necessary measures to ensure that budgetary consolidation towards the medium term position of government finances close to balance or in surplus is sustained through a reduction in the cyclically-adjusted deficit by at least 0.5% of GDP per year after the excessive deficit has been corrected.

Article 4

Greece shall take effective action to comply with this Decision by 21 March 2005.

Article 5

This Decision is addressed to the Hellenic Republic.

Done at Brussels,

For the Council

[1] Confidence indicators published by Commission services point to a worsening of the economic situation. The Consensus forecasts of January 2005 project a growth rate of 2.7% in Greece in 2005, while the growth rate projected by the IMF in its World Economic Outlook of September 2004 was 3.0%. In the same line, developments in the OECD leading indicators might be anticipating a deceleration of growth in 2005.

[2] Data published by the Bank of Greece (Bulletin of Cojunctural Indicators) and the Accounting Office (Kratikos Proypologismos, November 2004) on the deficit in cash basis provide some indication of a non-negligible risk of overshooting in the State sector in 2004. However, a correct interpretation of these data needs to take into account that the Social Security sector might partially compensate the slippage, while the government usually collects significant VAT receipts at the end of the year and over the first two months of the year after.

[3] OJ L 209, 2.8.1997, p .6.

[4] OJ C 236, 2.8.1997, p .1.

[5] OJ L 389, 31.12.2004, p. 25.