# **3.2 The Period of Massive and Captive Debt Accumulation (1970-85)**

The period of rapid economic development with financial stability was followed by what can be described as a period of massive but captive debt accumulation. The collapse of the military government in 1974 left a legacy of financial instability, large public sector deficits and high inflation that persisted for almost a decade. These problems caused a postponement of policies of financial liberalization. The authorities were concerned that liberalization might lead to a substantial and perhaps unaffordable increase in the cost of public borrowing. In addition, there was also concern about the risk of financial instability. Despite the large public sector deficits of the 1970s, the level of public sector debt did not rise appreciably in relation to GDP, mainly because the rate of interest on the public debt was highly negative in real terms.

Following accession to the EEC in 1981, economic convergence to European standards became a major objective of policy. In a paradoxical way, one of the first indicators where convergence materialized was the level of government spending in relation to GDP. In the six years to 1985 general government outlays increased by as much as 17 percentage points of GNP, by far the steepest rise recorded in the OECD area at that time (OECD 1987:39). Whereas in 1979, the share of government expenditure to national income was one third below the level of OECD Europe, by 1985 it had increased to almost 49 percent and was close to that of OECD Europe.

The largest source of this rise came from increased spending on public sector wages and social pensions. The latter grew from 7.3 percent of GNP in 1979 to 13.3 percent in 1985 (OECD 1987:44). Low pensions were raised considerably, especially pensions to farmers, while coverage of pension rights was also extended to returning immigrants with no record of contributions to social security programs. Another source of increased government spending was support to loss-making public corporations. The combined deficit of these entities rose from 2 to 5.5 percent of GNP between 1979 and 1985. In addition, many private sector firms were unable to meet the competitive challenge of European firms that followed the dismantling of tariffs (Giannitsis 1993). Many of these firms were declared “problematic” and relied on financial support from state-controlled banks for their continuing survival.

The effect of these policies was a massive increase in the public sector borrowing requirement that reached 17.7 percent of GNP by 1985. The level of general government debt rose from 39 percent of GDP in 1980 to 73 percent in 1985.<sup>14</sup> External debt grew from 16 percent of total debt in 1980 to 31 percent in 1985. Most of the external debt was of a long-term nature, mostly syndicated loans from international banks, with little exposure to interest rate and refinancing risk. However, being denominated in foreign currency, it was exposed to foreign currency risk and suffered from the periodic devaluations of

> 14 Data from the 1987 OECD survey show that on a net basis the general government debt rose from 27 percent of GNP in 1979 to 63 percent in 1985. Adding the debt of public corporations brought the total to  85 percent of GNP, which was one of the highest ratios in the OECD area. Particularly disquieting was the speed at which the total public debt had grown, having soared in relation to GNP by nearly 55 percentage points between 1979 and 1985.

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