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Lecture delivered in honour of Professor Xenophon Zolotas, Honorary Governor of the Bank of Greece, by the President of the Deutsche Bundesbank, Prof. Hans Tietmeyer, in Athens on 17/10/97.

Mr. Tietmeyer considers European monetary integration and its implications for the international monetary system Lecture delivered in honour of Professor Xenophon Zolotas, Honorary Governor of the Bank of Greece, by the President of the Deutsche Bundesbank, Prof. Hans Tietmeyer, in Athens on 17/10/97. I. The twentieth century does not lack for experience or lessons derived from different international monetary arrangements. Now -- just before this century comes to a close -- Europe is about to embark on a new experiment with far-reaching implications: a monetary union of nation states with a supranational central bank. Some economists see this as things coming full circle. The century began with the gold standard. It will end with a monetary union. As at the beginning of this century, at its end there will be a “denationalised” currency. Countries cannot produce this money more as they see fit. Whereas earlier this century they tied themselves to the availability of gold, in the future European monetary union the guardian of the currency will be a European Central Bank which is independent of national decision-making and which is committed solely to the objective of internal monetary stability. Those economists who stress this historical connection generally take an optimistic view of it. They expect the single currency to bring about an economic and political commitment which is in itself strong enough permanently to compel the participating countries to abide by the rules of the game. Without the option of altering the exchange rate and without the option of an autonomous interest-rate policy, national monetary policy will not be available as an instrument for correcting a current account deficit within the Union. The only possibility will be an adjustment in the real economy. According to this view, monetary union will have a strong disciplining effect. It will exert sufficient pressure on countries to tackle their real problems and to solve them internally, too. To that extent, it will carry on those effects of the gold standard which are regarded as having been successful. This optimistic reference to experience of the gold standard is not entirely convincing, however. First of all, one might ask how far that view idealises the way in which the gold standard worked. That is something which historians may argue over. At all events, that era was by no means a golden age. Be that as it may -- above all, the conditions for the functioning of the gold standard were different then. Countries’ government ratios were in the order of scarcely more than ten per cent at that time. The adjustments that were necessary given a change in competitive conditions -- which, naturally enough, primarily concern the private sector -- were spread comparatively widely over the major part of the economy. By contrast, the government ratio in many European countries nowadays is around fifty per cent or more. Adjustment in line with market conditions is thus now concentrated -- more or less -- on half of the economy. Prices and wages were also more flexible a hundred years ago; at any rate, more flexible than they are now in the majority of countries on the European continent. And, above all, the government had a different perception of its own role. Its core tasks at that time were to frame and protect the domestic legal system and to pursue national interests abroad. Nowadays, in the eyes of citizens and the electorate, the nation state and the government have a much deeper and more general economic and social responsibility for growth, incomes and employment. It is, at any rate, very optimistic under present-day conditions to assume that monetary commitment by the monetary union and the supranational central bank would only have to be strong enough and that it would then be able to enforce any desired adjustment needs automatically. What should not be overlooked is that abiding by the rules of the game depends on countries having an adequate capacity to be correspondingly flexible, just as it presupposes the common political will to submit to those rules of monetary stability on a lasting basis. That far-reaching economic and political dimension of monetary union should not be underestimated -- precisely in the world of today and tomorrow. The abolition of the exchange rate is, at all events, an occurrence of far-reaching importance. II. The exchange rate is a price; one of the most important in an economy. Like all prices, its prime task is to manage allocation. Put in simple terms, this means that if the exchange rate is at a level which is appropriate to competitive conditions and if the fundamental determinants -- such as differences in the inflation rate and productivity or the conditions of demand -- remain largely constant, then the exchange rate can and should be as stable as possible, too. It is then that its information content is at its highest. And this also brings about a high degree of certainty in planning for economic arrangements. If, on the other hand, there is a change in the fundamental determinants, the exchange rate should realign as rapidly as possible -- unless an economy is in a position to correct disequilibria quickly and efficiently by virtue of its own adjustment measures. These two requirements which exchange rates are expected to meet appear at first glance to pose a dilemma for monetary policy. On the one hand, the exchange rate should be stable; on the other, it should react as quickly as possible to fundamental imbalances. But, given appropriate policies, this is a pseudo-problem. It is largely solved for a monetary policy which is guided by the internal objective of stability; a steady policy geared to monetary stability helps in both respects. It reduces volatility because it introduces calm into the markets. At the same time, it is the best contribution that monetary policy can make to keeping fundamentally forced exchange rate changes at a low level and to strengthening flexibility and market mechanisms domestically. This pseudo-dilemma is then essentially solved for exchange-rate policy, too. That is because a country cannot in any case freely decide between exchange-rate systems -- say, more fixed or more flexible rates -- in line with its preferences like a visitor to a restaurant between different dishes on the menu. Fixed exchange rates presuppose the ability to cope with that arrangement. It is therefore not a matter of whether one finds less flexible exchange rates, or even their final elimination in a monetary union, “appealing” or “attractive”. The crucial point is: fixed exchange rates must be feasible and, above all, sustainable under prevailing political and economic conditions. III. Post-war global and European monetary history was inseparably linked for a quarter of a century with the Bretton Woods system. In origin, it was a gold exchange standard with fixed but adjustable exchange rates against the US dollar, for which there was an obligation to exchange currency for gold. At its inception there was, above all, the desire to overcome the monetary conditions of the 1930s. Competitive devaluations, far-reaching import restrictions and exchange controls seriously hindered world trade and economic cooperation between countries at that time. Against that historical backdrop, many economists rightly celebrated the Bretton Woods system as a great success. Without doubt, it put in place important groundwork for today’s high degree of openness in the goods and financial markets. Admittedly, a comprehensive assessment must not overlook at least three problem areas. Firstly, even the Bretton Woods system displayed the “vulnerability” of almost all systems of fixed exchange rates. Current account imbalances were combated too hesitantly. Corrections of exchange rates were made too late and often brought about new misalignments. Secondly, the years in which the system flourished have to be seen against the backdrop of restricted convertibility. It was not until 1961 that most west European countries introduced full convertibility. And precisely in the United States, too, capital controls were a frequently deployed instrument into the 1960s. Incidentally, even the financial markets which -- from the present perspective -- were still not very developed at that time showed their strength in that situation. There was, on the one hand, the ability to bypass administrative regulations. The Euro-dollar market came into being as early as the late 1950s, for example. On the other, there was the ability to exert speculative pressure on a currency with an exchange rate that appeared no longer to deserve confidence. Thirdly, countries with a better domestic stability record than the anchor country at that time, the United States -- such as Germany in the 1096s and early 1970s -- imported inflation through the fixed rate system. The expression “dollar inflation machine” was in use for a time. A firm anchor and a timely realignment of parities -- those are the basic requirements of any stability-oriented system of fixed exchange rates. The European Monetary System established at the end of the 1970s has performed better than the Bretton Woods system in a number of respects. It has provided a better solution for the question of the nominal anchor -- without officially designating the D-Mark for that role. Rather, it is a role which the D-Mark has acquired on account of its long-standing stability and its early convertibility. The parity-grid system permits the currency which is most stable on a long-term basis to set the standard. The anchor in the ERM is a position which can be recalled, however. Admittedly, even in the ERM there have been times when exchange rates that had become doubtful have not been corrected in time -- as the events of 1992 and 1993, in particular, showed. At all events, it was possible to guide the ERM out of the crisis by a formal widening of the fluctuation margins and largely stabilise it in the ensuing period. IV. Despite a number of earlier reform efforts, the Bretton Woods system eventually collapsed in 1973. Since then, the exchange rates of most European countries and of Japan have floated against the US dollar. By abandoning the fixed rates against the US dollar, monetary policy gained new freedom. From that time onwards, it has, above all, been able to pursue a domestic goal. The initial phase in the era of flexible exchange rates was clearly marked by differences in the domestic stance of monetary policy in a large number of countries. That was apparent particularly in the 1970s when most countries were hit hard -- although to differing degrees -- by oil price movements. A number of countries -- including Germany -- were principally concerned with restoring domestic monetary stability or with ensuring that it was jeopardised as little as possible in the long term. Others attempted to use a relaxed monetary policy to cushion the adjustment needs of their economies caused by the oil price shocks. In line with that, there came to be wide differences between inflation rates. Those differences had the following results. Firstly, the countries which gave priority to safeguarding monetary stability adapted more quickly to the new conditions and also achieved better results in the medium term with regard to the goal of employment. Secondly, a disparity arose between individual countries in terms of the reputation and credibility of their anti-inflationary stance -- some of the effects of which are still felt today. Thirdly, the plan to realise a European monetary union which was initiated at the end of the 1960s at the Hague Summit foundered before a real political decision had been taken. The initial phase of world-wide flexible exchange rates thus up to now has two crucial messages. Firstly, the best contribution that monetary policy can make to lasting growth and employment is a clear anti-inflationary stance. In the long term, jobs cannot be “bought” by higher inflation. That was already true even in the 1970s when unemployment -- at least in many industrial countries -- was still predominantly cyclical in nature. That is all the more the case today when unemployment in Europe has largely structural causes. The permanent anti-inflationary stance of the monetary union is therefore an essential condition for Europe’s future success in creating and safeguarding jobs. Secondly, it would be disastrous for the monetary union if political differences concerning the role of monetary policy were to emerge as they did in the 1970s. That is because countries cannot pursue different monetary policies in the monetary union. That would lead to political conflicts -- with the European Central Bank, which operates supranationally, and probably also between the political opinions that prevail at the national level. V. That first phase with -- in some cases -- high rates of inflation initially brought the system of flexible exchange rates into disrepute. The 1980s taught new lessons, however -- at least following the change of course in domestic policy starting in France after 1983. Inflation rates gradually receded in many countries. This was a broad process. It took place in the European countries which belonged to the European Monetary System. It also took place in countries without fixed exchange rates, however. Obviously, many countries changed their orientation. External exchange rate pegging, such as to the D-Mark in the European Monetary System, certainly made that easier for some countries. But it also became apparent that what mattered crucially in the final analysis was the political will for monetary stability. This reorientation was undoubtedly in part a reaction to the negative experience of an inflation-accommodating monetary policy in the 1970s and early 1980s. At the same time, it was made easier by the fact that over the years, together with a clear-cut target, a number of central banks had also gained greater independence. For that reason, the system of flexible (or, at least, sufficiently, flexible) exchange rates is now regarded in a certain way as having been rehabilitated. It is precisely on the condition of free movement of capital and financial markets which nowadays largely operate internationally that it can indeed exert pressure for a monetary policy geared to stability. Another hope of the supporters of flexible exchange rates is likely to remain unfulfilled, however: the hope that speculation will always have only a stabilising impact and that, following a change in the fundamentals, the exchange rate will glide smoothly and gently to a new equilibrium level. In actual fact, the path taken by exchange rates is often quite bumpy and cannot always be explained convincingly even ex post. Overreactions are not infrequent. Obviously, expectations of future economic and political trends play a major role in the formation of exchange rates. Not only do they contribute to higher volatility because swings in mood often set in abruptly. They can apparently also superimpose themselves on current data so strongly that misalignments may occur, at least for a while. The sharp appreciation of the D-Mark against the US dollar in spring 1995 was a development of that kind. Admittedly, a fair critic has to concede two mitigating arguments to the system of flexible exchange rates. First of all, it is undoubtedly too simplistic to blame the system for every obviously excessive exchange rate movement of currencies whose rates are formed flexibly. There are some, for example, who regard the excessive trend of the US dollar in the 1980s as the nightmare of the present global monetary system. But one has to recognise, of course, what lay behind this. It was during that period that the resolute reversal in the Fed’s monetary policy under Paul Volcker coincided with the expansionary fiscal policy of the Reagan administration. In particular, US fiscal policy stood in marked contrast at that time with German fiscal policy, which was on a course of moderate consolidation. It is quite possible to ask the question: “What other exchange rate arrangement would have actually withstood those tensions?” If anything, fixed exchange rates would probably have increased those tensions or would at least have politicised them more strongly. The Plaza and Louvre cooperation initiatives were probably the most that could be achieved at that time, although it has to be said in passing that the results were by no means only positive ones -- as is shown by the example of the development of asset price inflation in Japan, which was encouraged at that time by an expansionary monetary policy, and its consequences -- from which that country is still suffering. As a second line of defence it can be pointed out that world trade is developing at a furious pace despite flexible exchange rates between the major international currencies. That may be due to the fact that incorrectly valuated exchange rates tend to correct themselves in the medium term. It may also be due to the fact that good possibilities are now available for guarding against sharp exchange rate fluctuations. This can take the form of hedging operations in the financial markets. It can also take the form of a diversification of production centres. To that extent, highly volatile exchange rates can influence not only trade but also direct investment. And that undoubtedly has longer-term effects which should not be underrated. For that reason, exchange rates which are as stable as possible are, of course, important -- but more in terms of real rather than nominal stability. However, the question remains of how the objective of real exchange rate stability can be achieved as comprehensively as possible. There is unlikely to be an answer which is valid for all countries and their relations with each other. VI. In the current debate in Europe the question is also asked repeatedly whether the future euro/dollar exchange rate will be more stable than, say, the present relationship between the D-Mark and the dollar. Ultimately, this is an empirical question, of course. It can really be answered only in the light of the monetary union. There are a number of considerations which point in differing directions. The euro will probably have a larger and deeper financial market than the D-Mark. That means, first of all, that the price effects will tend to be slighter when assets are switched by the individual investors and that the exchange rate will also be moved less as a result. The larger euro financial market might, however, also lead to investors generally regarding the euro -- more than the D-Mark now -- as a substitute for the US dollar. That might increase the desire to switch funds in certain situations. In that case, the exchange rate would tend to fluctuate more. At times, one also encounters the argument that the euro area -- as a large economic and currency area -- will be relatively less dependent on foreign trade, particularly as the structure of exports is heavily diversified. The outcome would be -- at least, according to the standard textbooks -- that the euro/dollar exchange rate is not as important for Europe. This argument is undoubtedly fundamentally correct and also of significance. The comparison with other major currency areas -- such as the dollar area -- has only limited validity, however. The high share of domestic transactions is not the only reason why the United States can, if anything, neglect the dollar’s exchange rate. It can also do that because its own currency area corresponds to its national boundaries. In the United States, not only is there a comparatively high degree of labour mobility and flexibility in labour costs, there are also compensatory and cooperative mechanisms in the area of public finance at the level of national government. These are able to cushion remaining regional and sectoral tensions which cause major exchange rate fluctuations. The supranational monetary union in Europe has neither comparable mobility and flexibility nor compensatory mechanisms in the area of public finance. This, too, reveals, the particular conditions of monetary union in Europe. In the European monetary union asymmetrical effects will probably tend to lead more quickly to a need for real adjustment in the countries or regions concerned. VII. The present world monetary system is, of course, not just characterised by the major international currencies floating against each other. At the same time, many countries have entered into arrangements to peg exchange rates of varying intensity. There are essentially two motives for this: Firstly -- particularly in the case of smaller economies -- the foreign trade motive. Countries want to strengthen their international economic integration with a fixed exchange rate. Secondly, the stability motive. By pegging the exchange rate, countries want to import credibility for an anti-inflationary stance -- particularly one which is to be newly established. The record of these arrangements is as varied as the forms of pegging themselves. A number of emerging countries and countries in transition have had mixed experiences of pegging their exchange rates to other currencies. However useful it was for them in an initial phase to gain confidence in the international markets by pegging their exchange rate, it has almost always been the case that tensions have arisen and, unfortunately, often erupted after a few years if the trend in domestic competitiveness was not able to keep up with the anchor country on a long-term basis. That has become apparent not only for some countries in Latin America and in eastern Europe but only just recently in South-East Asia, too -- especially if exchange rates have not been adjusted quickly enough to changed competitive conditions. The prospects of a pegging of exchange rates being successful have to be seen in the context of the present-day international financial markets. Their impact on the permanence of exchange rate pegging is an ambivalent one. On the one hand, the international financial markets can make arrangements of this kind obsolete more or less overnight if the conviction disappears that the pegging will hold. On the other hand, they encourage strategies of this kind since they offer the countries the option of financing quite sizeable current account deficits. Mainly two problems arise when pegging the exchange rate. Firstly, it may be that a country is currently achieving a comparatively high level of monetary stability but the markets still doubt the country’s determination to persist with that strategy. In that case, real interest rates -- at least in a transitional phase -- are relatively high. Doubts about sustainability threaten to become a kind of self-fulfilling prophecy. That was at certain periods the French problem with its franc fort policy. Secondly, it may be that a country achieves a significant fall in inflation by pegging the exchange rate. But a certain -- if only slight -- inflation differential vis-à-vis the reference currency often stubbornly remains nonetheless. That may be due to inflation expectations from the past which are not entirely eliminated. That may also be due in part to a political deficit; a fiscal policy that fails to give adequate support to the pegging of the exchange rate or an overgenerous domestic monetary policy in the light of capital inflows. Be that as it may, the outcome is that the currency gradually appreciates in real terms. The current account shows a chronic deficit. In a situation of that kind, a country must consider a strategy to find its way out. The fixed parity is not sustainable on a lasting basis, even if the financial markets go along with it for a time. This implies an important message for the envisaged monetary union in Europe since monetary union does not offer the possibility of a way out. The requisite ability to achieve lasting domestic and external stability must be established and proven before entry in all the member states. That is what the entry criteria aim for. It would be a risk to hope that a country’s necessary ability to achieve stability will gradually come about after entry into monetary union. Even if this were achieved over time, price competitiveness might already have been seriously impaired by then. And the catching-up process would be even more ambitious. There will, in fact, be certain regional differences in inflation rates within the monetary union. That is a normal process, to the extent that it will reflect differing trends in productivity or shifts in patterns of demand. Enormous economic tensions would occur, however, if it were also a reflection of varying ability to achieve stability and hence to accept the supranational monetary policy. Sufficient anti-inflationary convergence must therefore precede entry into monetary union, not the other way round. At all events, the reverse order would not be without considerable risks. VIII. It is desirable and beneficial to have as high a degree of exchange rate stability as possible against the currencies of other EU and non-EU countries, too. Stable exchange rates need convergence -- either in the sense that fundamental deviations do not occur or in the sense that existing imbalances are rapidly eliminated owing to a high level of flexibility in domestic prices and in the structure of the economy. In principle, that is a valid statement irrespective of the exchange rate system, in fact. It just happens to be the case that in the reverse situation -- if there is a lack of convergence -- the exchange rate system plays a major role. If exchange rates are flexible, divergence in anti-inflationary policy can increase volatility but it is less dramatic overall. In turn, the degree of convergence is also lower, of course. The degree of convergence tends to be higher with fixed but adjustable exchange rates. If there is, nevertheless, no adequate convergence, costs will depend on whether there is a timely realignment. If prompt action is taken, the consequences will be contained. By contrast, if the realignments take place only under pressure from the markets, high costs can easily arise -- not just for the country itself, by the way. A “case” like this can easily negate the credibility of a whole system or make the unilateral pegging of other countries -- even those in other continents -- more difficult. For that reason the fact that the alignment of the exchange rates in ERM II is to be made easier than in the present system is a positive development. It is to be hoped that this will prove its value in practice, too, in future. The choice of the exchange rate system must, at any rate, be consistent with the economic and political conditions which obtain in the participating countries. A mixed world monetary system -- with floating key currencies, on the one hand, and regional integration through monetary union and fixed exchange rates, on the other -- might not be the best of all hypothetical worlds. But that system is probably the one that corresponds most closely to conditions in the real world. It is not inherently a badly designed structure or a non-system. There can indeed be appropriate graduations of flexibility that are in line with the realities. IX. Understandably, the question is now frequently being asked: “What place will the euro take in the future world monetary system?” The answer which is often given is the notion of a future tripolar system consisting of the dollar, the yen and the euro. That vision is, at least, not very accurate. If one wants to speak of a tripolar system at all, the weights in it will differ quite considerably. Even now, it is becoming apparent that the yen’s potential relative to the other two currencies will, if anything, remain limited. At all events, in the foreseeable future it will probably lack the regional base in Asia itself which the euro is likely to have in Europe. But the euro will first have to earn its position. That is because an international currency essentially needs three properties: • • • a high level of lasting stability a strong base in the real economy and efficient financial markets. The euro has the potential to fulfil those three conditions. But that will not occur automatically. For that to happen, the preconditions have to be right. Replacing the dollar as the leading currency is, however, probably not on the agenda. Monetary history has shown that a key currency being superseded is ultimately due to an internal crisis in the country in question. The former leading country loses the confidence of the markets. The capacity for domestic stability diminishes. The economy becomes less competitive. That was also the history of the decline of the pound sterling as a global key currency following the Second World War. There are no indications whatsoever of a comparable development in the case of the US dollar. On the contrary, the dollar is a strong currency and -- despite a current account deficit and growing external debt -- the US fundamentals do not point to a change in that situation. X. The euro and the dollar can enter into fruitful competition, however. The world monetary system as a whole will be able to benefit from healthy competition between two currencies which are geared to stability. There are three particular factors which would promote productive competition of this kind: Firstly, that the current high degree of correspondence in the anti-inflationary stance of the United States and Europe continues; secondly that fiscal policy in both the Unites States and Europe remains on a similar course of consolidation and -- particularly in Europe -achieves further progress; and thirdly, that both the United States and Europe fulfil the expectations of meeting the economic challenges which they face. The United States must demonstrate that its high debtor position and hence its future financial obligations are covered by the dynamism, efficiency and innovative potential of its economy. The Europeans must show that they are making structural changes to tackle the problem of unemployment and that they are improving their competitiveness in global markets. Productive competition of this kind does not imply a rejection of greater world-wide cooperation in economic and monetary policies with the aim of contributing to higher exchange rate stability. On the contrary, it is precisely in the future, too, that cooperation of this kind will be meaningful and desirable. In saying this, what should not be overlooked is that exchange rates are not the actual operational parameters. Rather, they are the result of economic developments and economic policy in the participating countries. For that reason, there is one lesson which should conclude this lecture. It is perhaps as old as monetary history itself. A suitable monetary framework can help a country to carry out the structural reforms which are needed. Being a substitute for the adjustments which an economy has to make to changed conditions, however, is something which monetary policy -- however good it is -- cannot do.

bank of greece

Speech given by Mr Nicholas C Garganas, Deputy Governor of the Bank of Greece, at the 'Athens Summit 1999' on 18 September 1999.

Mr Garganas gives a speech on integrating Greece into the euro area and the challenges ahead Speech given by Mr Nicholas C Garganas, Deputy Governor of the Bank of Greece, at the “Athens Summit 1999” on 18 September 1999. * * * The adoption of the euro as a common currency by a first group of eleven European Union Member States on 1 January 1999 was rightly described as an historic event since the move to the final stage of Economic and Monetary Union indeed marks a decisive step towards full economic and political integration between the countries participating in this endeavour. The vigorous and credible implementation by Greece of policies aimed at achieving a high degree of sustainable economic convergence and meeting the terms of the Maastricht Treaty for EMU participation have yielded concrete results, thus placing Greece directly on the road to joining the euro area by the target date of 1 January 2001. Over the past few years, convergence towards price stability has been impressive. The annual rate of inflation in August was 2%. Great progress has also been achieved regarding the general government budgetary position. In 1998, the deficit stood at 2.5% of GDP, and is expected to fall further (to just over 1.5%) this year, continuing the downward path of the debt–to–GDP ratio, which currently stands at 105%. The gradual reduction in budget deficits, together with the entry of the drachma into the Exchange Rate Mechanism, has led to an appreciation of the drachma (first against the ECU and this year against the euro), and lower long-term interest rates. In the first half of this month, the ten-year government bond spread versus Germany was around 163 basis points, compared with 196 basis points in March 1999 and 425 basis points in September 1998. The remarkable nominal convergence achieved by Greece indicates that its objective of meeting the Maastricht criteria by early 2000 is now becoming a reality. Although it is widely anticipated that Greece will be admitted into the euro area by June next year so that it can adopt the single currency on 1 January 2001, we should not allow this achievement to dim our view of what remains to be done. As I see it, Greece faces two broad sets of challenges. First, in the remainder of 1999 and in 2000, macroeconomic policy has to remain firmly focused on keeping the EMU process on track and on securing the conditions that will make for a smooth transition and positive performance upon entry. From this point of view, the main challenge is that of sustaining price stability. Second, Greece is faced with the additional challenges of completing the necessary budgetary consolidation and stepping up the structural reforms required to prepare the economy for the demanding competitive environment of monetary union. Let me discuss each of them in turn. Maintaining price stability First, there is the issue of establishing conditions that will secure price stability between now and the end of 2000. On current projections, in the remainder of 1999 and early 2000, inflation (as measured by the Harmonised Consumer Price Index) is expected to average close to – or slightly below – 2% – a rate that is consistent with the Bank of Greece’s definition of price stability. The benign outlook for inflation reflects a number of important policy choices, most notably the tight monetary policy stance adopted to date, centred on high interest rates and a strong drachma. The reduction in inflation is also supported by a moderation of wage settlements. However, the current favourable inflation prospects reflect, in part, the impact of recent indirect tax cuts and other administrative measures. Given the need to maintain price stability throughout the year 2000 and beyond, the present tight monetary conditions will have to be maintained as long as is feasible to ensure against unforeseen inflationary pressures. Should there be renewed inflationary pressures, there are evident limits to what monetary policy could do to maintain price stability in the run-up to EMU. I do not have the time to discuss these constraints in detail. I can only mention the fact that the ability of interest rate policy to curb credit growth is being eroded by the public’s widespread perception that interest rates will necessarily decline by end-2000 and by firms’ recourse to foreign borrowing. Looking further to 2001, the alignment of Greek interest rates with those in the euro area and the slide of the drachma to its central ERM parity when Greece enters the euro area will, of course, entail a substantial easing of monetary conditions. This prospect for a substantial easing of monetary conditions in early 2001 could result in a reversal of the downward trend in inflation in the course of 2000 and beyond. Against this background, the macroeconomic policy mix will need to undergo a fundamental rebalancing, with other policy instruments – notably fiscal, wage and structural policies – being called upon to offset the effect of monetary easing on inflation and thereby help to maintain price stability. Let me now turn to the matter of the challenges facing Greece with respect to the completion of the adjustments required to prepare the economy for the exigencies of monetary union. Three interrelated issues are important in this respect. First, the need to sustain efforts to achieve and maintain a sound budgetary position consistent with the Stability and Growth Pact, and a speedy reduction in the still high debt-to-GDP ratio. Second, the need to strengthen Greece’s ability to respond to “asymmetric” shocks, i.e. negative shocks affecting the entire national economy and only that economy. Third, the challenge of stepping up the structural reforms required to secure Greece’s smooth participation in the euro area and to reap fully the opportunities offered by EMU. Sound public finances As I indicated at the outset, Greece has made enormous progress in reducing the large imbalances in its public finances over recent years. However, additional progress is required in order to ensure compliance with the Stability and Growth Pact’s medium-term objective of a budgetary position close to balance or in surplus. That will allow Greece to deal with cyclical fluctuations while keeping the government deficit within the reference value of 3% of GDP. It will also allow a speedy reduction in the still high public debt ratio and help prepare for the fiscal impact of population ageing. A sound budgetary position will impart a layer of flexibility into the economy. Since, following entry into the euro area, adjustment to adverse cyclical developments and country-specific disturbances will, to an important extent, rest with budgetary policy, it will be of paramount importance to ensure that the automatic stabilisers will be able to play their role. Greece needs to step up its budgetary adjustment to put its debt ratio firmly on a declining path and to bring it down swiftly below the reference value of 60% of GDP in the near future. A further steady decline in public debt and an appropriate debt management strategy would reduce the vulnerability of Greece’s public finances. Moreover, a speedy reduction in public debt is essential because Greece, like other EU Member States, will face increased pension liabilities in the second decade of the next century as a large number of people will retire because of a marked ageing of the population. As a result, public pension spending is likely to increase sharply in relation to GDP, particularly if there is no reform of the social security system. Reducing the debt-to-GDP ratio to 60% will not be easy. While Greece can count on comparatively large privatisation proceeds, it is burdened by a currently high government debt ratio, significant contingent liabilities and a large debt accumulated by its chronically loss-making public enterprises. An exercise on the dynamics of the debt ratio carried out under certain assumptions and starting from 2000 onwards suggests that it would take 10-12 years for the debt-to-GDP ratio to be brought down to 60%. 1 Maintaining Greece’s primary budget surplus at its present level (6.7%) for 10-12 years – which is what is assumed in this exercise – would virtually remove the scope for easing the high tax burden on Greek citizens over the next 10-12 years and would imply little room for public spending increases. It would be more realistic for the government to speed up and expand its privatisation plans, using the proceeds to reduce the debt stock. The government could also press ahead as fast as possible with the reform of the social security system (for example, along the lines implied by the Spraos Committee Report). The government could also intensify its efforts to reduce tax evasion, rationalise public expenditure and reform the wider public sector. Asymmetric shocks Let me now turn to the issue of country-specific disturbances. With the date of Greece’s entry into EMU approaching, attention should now shift from issues of transition to monetary union to the challenges posed by EMU for Greece. By definition, EMU implies the loss of national monetary autonomy. One of the criticisms often levied against the EMU project is that member countries will not be able to respond to adverse economic disturbances via changes in national monetary policy or the nominal exchange rate. It is then argued that country-specific disturbances will result in a recession and a surge in unemployment. In reality, the exchange rate is potentially appropriate for coping with adverse economic developments and country-specific shocks only in a narrow set of circumstances. Mutatis mutandis, the same can be said of monetary policy. Shocks that are truly national are already relatively infrequent. And they will become even more so once Greece joins the euro area: the stability-oriented macroeconomic framework will reduce the likelihood of policy-induced shocks (such as disturbances originating from reckless fiscal behaviour), which in the past have been an important source of country-specific shocks. Moreover, the increasing openness and trade integration of EMU members will further blur the economic importance of national boundaries, thereby reducing the national specificity of economic disturbances. In the case of Greece, there will be the added benefit to be derived from the process of catching up. A single currency will greatly enhance prospects for bringing in new industries, as the elimination of exchange rate risk will encourage firms to produce closer to their markets. Large infrastructure projects already underway – and financed through the Community Support Programmes – will improve competitiveness and provide a further inducement for firms to move to Greece. It is therefore likely that the conditions after EMU entry will be favourable to growth and employment creation in the Greek economy. To argue that the incidence of country specific disturbances will diminish is not, however, to say that such shocks will disappear altogether. In those circumstances, in which a change in the exchange rate or national monetary policy would have been helpful, alternative adjustment mechanisms will have to be provided for responding to macroeconomic disturbances once national authorities have lost monetary and exchange rate independence. To achieve this it is assumed that Greece would need growth of 3.5% a year, a cost of public borrowing of 5%, and a primary budget surplus of 6.7% of GDP. It is also assumed that the general government takes on contingent liabilities and debt of public enterprises (outside the general government). At the macroeconomic level, it was argued earlier that, in the case of Greece, public finances will have to regain the necessary room for manoeuvre to cope with adverse economic developments and country-specific disturbances. Where structural adjustment, rather than mere macroeconomic stabilisation, is called for, an improvement in price competitiveness will be needed. This brings me to the crucial role of structural reform. Structural reform On the structural front, there has been much progress in several areas over recent years and it is beginning to yield substantial benefits to the economy. But, given the breadth and the magnitude of the structural problems, much still remains to be done. I focus here only on a few selected issues where I feel that significant breakthroughs would make a major contribution to preparing the economy for the exigencies of monetary union. In particular, more stress needs to be placed on enhancing competition in product markets and improving labour market flexibility. Greater market flexibility will not only allow Greece to cope with country-specific disturbances more easily, but it will also, by reinforcing Greece’s competitiveness, ensure a tension-free macroeconomic growth process and increase the employment-content of growth. Although legislation was passed in 1998 aimed at addressing some key rigidities in the labour market (the inflexibility of working time, wages, the ineffectiveness of job matching mechanisms), the performance of the Greek labour market has not yet materially improved. This year’s National Action Plan for Employment is a well-articulated approach intended to provide an overview of the government’s initiatives and plans in this area. But more stress needs to be placed on improving the quality and job-relevance of vocational training. The government’s privatisation and flotation programme has been steadily implemented. This has contributed significantly to debt reduction and enhanced competition in the banking system. But privatisation needs to expand into other areas, including key economic sectors that remain dominated by public enterprises. Tax reform is also needed to alleviate the tax burden, particularly, although not exclusively, on wage earners and to bring the tax structure into line with that in the euro area, thereby preventing the movement of capital and labour to lower-taxed areas. In concluding, I would note that the achievements to date are impressive and have paved the way for Greece’s forthcoming participation in the euro area. By meeting the challenges of completing the necessary budgetary consolidation and stepping up action across the broad spectrum of structural reforms, Greece will not only be able to join the euro area in a strong competitive position, but will also reap the full benefits from participation in EMU.

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Address by Mr Nicholas C Garganas, Deputy Governor of the Bank of Greece, at the Euromoney International Bond Congress, held in London on 15 February 2000.

bank of greece

Speech by Mr Lucas Papademos, Governor of the Bank of Greece, at the Euro Information Conference, Athens, 17 October 2001.

Lucas Papademos: The completion of the changeover to the euro Speech by Mr Lucas Papademos, Governor of the Bank of Greece, at the Euro Information Conference, Athens, 17 October 2001. * * * I would like to welcome you to the third session of the Euro Information Conference. Your presence here attests to the importance you attach to the successful changeover to the euro, our new currency, our money. It is a particularly great pleasure for me to welcome the Minister of National Economy and Finance, Mr Yannos Papantoniou, and the President of the European Central Bank, Dr Willem Duisenberg, to whom I express my warmest thanks for their participation. I would also like to thank the other distinguished speakers and colleagues who participated in the first two sessions of the Conference. I We have now reached the last lap in what has been a long and arduous journey culminating in the introduction of the single European currency. About 75 days from today, the euro banknotes and coins will be put into circulation and the withdrawal of the national currencies of the 12 euro area countries will begin. The euro will thus become a visible and tangible reality for some 300 million European citizens and numerous other economic agents worldwide. In the current juncture of increased uncertainty about international developments and economic prospects, the interest of the public in the introduction of euro banknotes and coins may reasonably have been reduced. This does not mean, however, that the completion of the changeover to the euro does not constitute a high priority for us all. And it is of particular importance, especially in a period of uncertainty, to prepare ourselves in time and adequately, so that the changeover to the single currency is smooth and successful. Creating Monetary Union in Europe and introducing the euro has indeed been a long, complex and unprecedented process. This vision first took shape over 35 years ago. The official political decision and commitment of the EU Member States came nearly ten years ago, with the signing of the Maastricht Treaty on 7th February 1992. A long period of extensive preparations followed to ensure that the appropriate economic and monetary conditions were established and to complete the necessary institutional and technical adjustments for the establishment of Economic and Monetary Union in Europe. The euro came into being as a currency in scriptural form in eleven EU countries on 1st January 1999. After joining EMU, Greece also adopted the euro as its currency on 1st January 2001. The introduction of the euro in scriptural form was a particularly difficult venture, but it was also a significant step towards the creation of the European monetary union and the implementation of the single monetary policy. The venture was difficult as it required many and complex institutional, technical and operational adjustments of central banks, credit institutions and financial markets. It was, however, a significant step, as in this way the money market was integrated and the monetary regime in 11 EU countries was radically and irrevocably changed. Equally difficult from a technical point of view and important for the economy and the conduct of monetary policy was the adoption of the euro as Greece’s currency in January 2001. Consequently, the euro is already with us and is actually the single currency adopted by 12 EU countries. This reality, however, is not sufficiently visible to the general public, which uses national banknotes and coins in its day-to-day transactions. That is why many people consider the euro a “virtual” currency. Moreover, since the euro does not exist in physical form, many firms and organisations have not fully adjusted their accounting and IT systems to the single currency. With the circulation of euro banknotes and coins on 1 January 2002, the changeover to the single currency will be completed and it will become a visible, tangible and irreversible reality. The last stage of the transition will produce further specific benefits for consumers and firms. It will also favourably affect the international acceptance and external value of the euro. At the same time, I believe that it will enhance and speed up the overall process of European cooperation and unification. II Completion of the changeover to the euro with the entry into circulation of euro banknotes and coins and the withdrawal of national currencies is also a complex undertaking, possibly more difficult than the introduction of the euro in scriptural form. It requires a wide range of preparatory work by the monetary and economic authorities and credit institutions in general. This work involves not only the production and distribution of euro banknotes and coins but also institutional and operational adjustments in the public sector. At the same time, however, this venture calls for the preparation and adjustment of those who will actually use the single currency: citizens, firms, organisations and other economic agents. The successful completion of the changeover to the euro thus calls for concerted efforts, preparations and cooperation between all parties involved, at both the European and the national level. I would first like to briefly reflect on the role of the Bank of Greece in this process. I will then focus on some of the challenges that we will be facing, but also on the benefits that will arise from the completion of the changeover to the euro. The Bank of Greece is responsible for the production of the euro banknotes and coins to meet cash requirements on Greek territory. In cooperation with the commercial banks, the Bank of Greece will also be responsible for the withdrawal of the drachma banknotes and coins. This is an enormous task not only because of the large volume of drachma banknotes and coins that have to be exchanged, but also because in the case of Greece only one year will have elapsed between the adoption of the euro in scriptural form and the actual circulation of the new currency in physical form, compared with three years in all the other euro area countries. It is estimated that some 650 million drachma-denominated banknotes and 7,000 tonnes of drachma coins, of a total value of 3 trillion drachmas, will have to be withdrawn in Greece. Owing to the shorter time available for production, some of the needs inevitably had to be met by importing banknotes and coins from printing works abroad. Most of the production needs have nevertheless been met by the Bank of Greece Printing Works in compliance with the common standards for the production of high-quality currency incorporating a large number of security features. To ensure the sufficiency of stocks in the event of extraordinary needs, we have taken steps to have a total of 617 million euro banknotes and 1,600 million euro coins (or 8,300 tonnes of euro coins) ready for circulation. In the case of Greece, the volume of banknotes and coins in circulation is relatively large in comparison with the size of its economy and with many other euro area countries, because cash is widely used in transactions. This is reflected in the ratio of currency in circulation over GDP, which amounts to 6.4% compared with 5.4% in the euro area on average. This percentage may seem quite high, but is not very far from the respective percentages of some other euro area countries such as Germany (6.2%) or Italy (6%), and is well below that of Spain (9%). Moreover, Greece does not lack alternative savings instruments; indeed, the share of currency in circulation in the broader monetary aggregate M3 is small (6%) and smaller than the euro area average (6.9%). Against this background, it is fair to assume that established behavioural patterns, saving patterns in particular, should not pose any particular constraints on the substitution of the euro for the drachma - at least no more than elsewhere in the euro area. On the other hand, the geography of the Greek territory does make the frontloading of euro cash to banks and the public more difficult. The Bank of Greece now has the required stock of euro banknotes and coins and is presently frontloading to banks according to schedule. Sufficient amounts of euro cash have already been delivered to the 27 branches of the Bank of Greece across the country. Another part of the euro stocks will be supplied to commercial banks through 96 branches of the National Bank of Greece, with which the Bank of Greece holds cash surpluses from funds under its management. Frontloading is at present free of charge. The counterpart of frontloaded euro banknotes and coins will be debited to banks gradually in the course of January 2002, so as to help them deal with the costs of frontloading and supplying. Let me add that the Bank of Greece is in a position to meet part of the demand for euro banknotes in neighbouring Balkan countries and, in cooperation with the respective central banks, is planning the frontloading of euro banknotes in the region. It is estimated that the public in these countries are currently holding significant amounts of legacy currencies, predominantly German marks worth at least 6 billion marks, which will have to be exchanged for euro. Until the end of the year and while the central bank will be frontloading euro banknotes and coins to banks, the latter will assume the task of supplying the economy with the new currency: they will be sub-frontloading euro coins (as from 1 November 2001) and euro banknotes of lower denominations (5 and 10 euro) to retailers (as from 1 December). Starting from 17 December 2001, the public at large will be supplied with 13 million starter kits, containing euro coins of all denominations. Meanwhile, banks are completing the adjustment of their information systems and the technical preparations that will enable ATMs to dispense euro cash as from 1 January 2002. From mid-January 2002 onwards all ATMs of banks will operate in euro only. What we have heard so far during the first two sessions of this Conference confirms that the Greek banking system is in an advanced state of preparedness for the changeover. I believe that, with close cooperation between the Bank of Greece, commercial banks and the Hellenic Bank Association, the necessary preparations will have been accomplished by the end of the year and that the banking system, on its part, will have established the proper conditions for a seamless transition to the euro. III As already mentioned, however, a successful transition also hinges on the preparation of the public at large, retailers and other economic agents. These have therefore to be familiar with the euro banknotes and coins and with the overall changeover process. The 2002 Information Campaign, prepared and conducted by the European Central Bank and the national central banks of the euro area, is targeted at citizens and business firms of the euro area and beyond and its objective is to raise awareness of the euro banknotes and coins, by providing comprehensive practical information. The campaign involves various actions, as the President of the ECB Mr Duisenberg will later explain in greater detail. Still, I would like to make two points. First, that the campaign relies heavily on the participation of public and private organisations and enterprises which have become “europartners” and act as “information multipliers”. Today's Conference, which has been organised in the context of the 2002 Information Campaign, brings together more than 100 europartners. We are looking forward to having a closer cooperation with them over the next weeks. Second, as you may have already noticed, the first TV commercials and advertisements in the press are here, as part of the 2002 Information Campaign which will gradually gain momentum and will culminate around the turn of the year, with the distribution of information leaflets. Furthermore, the Bank of Greece has scheduled additional information briefings and events intended to complement the joint European campaign. Such briefings and events include: • additional TV spots concerning the introduction of the euro in physical form and the adjustment to the new monetary environment; • the production and distribution of a board game called “Euroraces” intended to familiarise children and their parents with the new currency, as well as of a comic book entitled “Eurocles” for older children; • public expositions of 100 works of art in the shape of enlarged euro coins, made of polyester and painted by children from all the euro area countries; • the production of 1 million “euro converter cards”, with information on the banknotes’ security features; • additional information conferences on the euro throughout Greece with the participation of Bank of Greece officials. I believe that the joint Eurosystem Information Campaign, the complementary information events scheduled by the Bank of Greece, as well as the programme jointly organised by the Ministry of National Economy and the European Commission will, by the end of the year, succeed in addressing the awareness gap which continues to exist with regard to the completion of the changeover to the euro. IV A general conclusion that can be drawn from the previous sessions of this Conference is that the necessary technical preparations and operational adjustments for the introduction of the euro are progressing satisfactorily in the banking and the business sector. This, combined with the anticipated improvement in public awareness, seems to indicate that the transition to the euro will be a smooth one. This encouraging conclusion does not leave room for complacency, nor does it mean that the changeover does not entail costs for the preparation and adjustment to the new monetary environment. Adjustment costs are to some extent inevitable owing to the nature and the scale of the task. However, we must strive to minimise these costs, through adequate and systematic preparation and information. At the same time, we must bear in mind that the costs and possible inconveniences associated with the completion of the changeover to the euro are only temporary, while the advantages to be reaped will be both considerable and permanent. The macroeconomic and microeconomic benefits for Europe and Greece from the introduction of the euro are numerous, and have been enumerated in detail in the past. I do not intend to go over them here, even though I have the impression that all of the parties involved may not be fully aware of them. I would, however, like to focus on two points which are directly related to the present conjuncture and to the conversion procedure to the euro in physical form, and which specifically concern Greece. Our economy has already drawn numerous benefits from Greece’s adoption of the euro, since this adoption presupposed stability and led to it. Greece has achieved a high level of monetary and exchange rate stability in the long run, which promotes economic growth. The shielding of the economies of Greece and of the other euro area countries from exogenous shocks proved adequate in the aftermath of the tragic events of 11th September. The sudden and significant rise in uncertainty caused by the terrorist attacks on the United States was not accompanied by the tensions on the foreign exchange markets that we had become accustomed to seeing in the past. Apart form the macroeconomic benefits, however, the upcoming introduction of the euro banknotes and coins will ensure full transparency of prices, enhance consumer awareness and increase competition. As a result, inflationary pressures will be contained in the medium run. And, of course, the conversion costs between various currencies, which are quite considerable for consumers, especially in sectors such as tourism, will be eliminated. In order to fully reap these benefits, consumers should try to become familiar not only with the physical appearance of the euro banknotes but also with the new scale of values. They should try to think of monetary values, not as amounts of drachmas but as amounts of euro. On the other hand, enterprises should introduce the new currency to their everyday transactions the soonest possible and refrain from any non-transparent pricing policies that could later weaken their competitive position. One type of cost that might arise from the introduction of the euro - and which should be avoided or minimised - refers to unwarranted price increases on the occasion of the redenomination of prices as from 1 January 2002. European Commission surveys reveal that euro area citizens are concerned about this possibility. These concerns are also related to the fact that familiarisation with the new scale of values - what is expensive and what is not, in euro - is a learning process that will take time and require effort, alertness and patience on the part of citizens. However, so far there is no evidence that some enterprises might try to take advantage of consumers' lack of experience and increase their prices even before the beginning of 2002. In any case, competition is expected to protect consumers from unjustified price increases, as anyone who would charge higher prices would be faced with a loss of customers. Furthermore, enterprises are obliged by law to indicate prices both in euro and in drachmas, as well as to display, in their place of business, a conversion table from the drachma to the euro and vice-versa. This should help consumers become familiar with the new scale of values. Rounding rules must be strictly observed. Consumers, however, should be vigilant, in order to avoid any speculative increase in prices. The physical introduction of the euro is an unprecedented event in European history. Its success does not hinge uniquely on concerted efforts of authorities at the European and the national level, but also on the preparation and cooperation of everyone of us. Citizens and enterprises should be prudent and calm during the physical introduction of the euro and the withdrawal of the drachma, and be understanding and patient in the face of any minor problem that may arise, since short-term adjustment costs will be more than offset by significant, long-lasting benefits.

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Address by Mr Nicholas C Garganas, Deputy Governor of the Bank of Greece, to the Hellenic American Bankers Association, New York, 23 April 2002.

Nicholas Garganas: The Greek economy within the euro area Address by Mr Nicholas C Garganas, Deputy Governor of the Bank of Greece, to the Hellenic American Bankers Association, New York, 23 April 2002. * * * It gives me great pleasure to be able to address you today about the transformation of the Greek economy over the last few years. Since the beginning of 2001, Greece has been participating in the euro area as its 12th member. Her entry to the euro area reflects the substantial progress which was made with macroeconomic stabilisation and convergence of the Greek economy to those of the other euro area member states. Disinflation, helped significantly by the monetary and exchange rate policies pursued by the Bank of Greece, alongside fiscal consolidation, ensured that the Maastricht Treaty criteria for euro area entry were all met by early 2000. Introduction of euro notes and coins From 1 January 2002, Greece, along with the other countries of the euro area, introduced euro notes and coins. The operation, conducted swiftly and smoothly, and warmly welcomed by the public, has gone remarkably well. The success is all the more remarkable as Greece effectively had two years less than the other euro area countries to prepare for the physical introduction of the euro, since it became a member of the euro area only from the beginning of 2001. While the cash changeover represented the concluding act of the move to the single currency, many of the benefits of the euro materialized even before joining EMU. The successful cash changeover, which marks a further move towards successful integration with EU partner countries, will reinforce these positive effects. Sound economic fundamentals Thanks to the successful nominal convergence process in the second half of the 1990s, which was a condition for joining EMU, Greece can now count on sound economic fundamentals and macroeconomic stability. Fiscal consolidation was rewarded last year by the general government position being in balance; public debt, although still high at just under 100 per cent of GDP at the end of 2001, has been declining continuously from its peak of just over 111 per cent in 1996. One of the most remarkable economic developments of recent years has been Greece’s success in restoring low inflation. Consumer inflation averaged 17.25 per cent in the twenty-year period to 1994. By mid-1999 it had fallen to about 2 per cent. Rising inflation after the autumn of 1999 can mainly be attributed to higher oil prices and depreciation of the drachma, which, in turn, reflected the weakness of the euro against non-European currencies as well as the drachma’s necessary convergence (from an appreciated level) to its central rate within ERM II by the end of 2000. After subsequently subsiding to below 3 per cent in the final three months of 2001, in January of this year inflation again accelerated, largely on account of an increase in domestic unprocessed food prices caused by severe winter weather. After falling by one percentage point to 3.4 per cent in February, it rose again, to 4.0 per cent this time, on account of rising oil prices, renewed pressures from unprocessed food prices, as well as upward rounding of prices (expressed exclusively in euro since March 1st). If we look at the last three years (1999-2001) as a whole, however, inflation averaged 3.1 per cent, a level not experienced since the 1960s. While inflation in Greece has been above the euro-average in recent years, this is to be expected in an economy, which is growing at a relatively fast rate compared with those of its trading partners. This result reflects the so-called productivity bias of fast growing economies. Macroeconomic stabilisation has been accompanied by healthy growth rates. Since 1996 output growth has exceeded the euro area average. Greek growth has averaged 3.5 per cent compared with 2.4 per cent in the euro area as a whole. The growth rate of real GDP was 4.1 per cent in both 2000 and 2001 (provisional data), significantly higher than the euro area average of 3.3 per cent and 1.5 per cent, respectively. The growth differential widened considerably in 2001 as economic activity in Greece, benefiting from macroeconomic stability and the euro- entry-related decline in interest rates, held up well in the face of the global slowdown which hit most other euro area countries. Trends in the labour market have also been relatively satisfactory in recent years. The unemployment rate declined to 10.4 per cent in the first three quarters of 2001, i.e. 2 percentage points than at its peak in late 1999. But unemployment still remains the second highest (after Spain) in the euro area. Growth prospects While the forecast for Greek economic growth in 2002 was revised downwards in the aftermath of the 11 September events, real growth is nevertheless projected to be within the range of 3.5 to 3.8 per cent. This strong output performance is expected to continue in the medium term. Output growth should be sustained over the medium term by relatively robust domestic demand, underpinned by improved economic fundamentals, strong private investment spending, expenditures in preparation for the Olympic Games of 2004 and economic infrastructure projects partly financed by EU Community support funds. The growing openness and export orientation of the economy, mainly towards the economies of Central and Eastern Europe and the Balkan countries should also foster growth. In particular the return to stability in the latter countries has benefited Greece significantly. The 2001 update of the Stability and Growth Programme of Greece projects an average annual real GDP growth rate close to 4 per cent in 2003 and 2004. Higher growth than the rest of the euro area is necessary over the long run if standards of living in Greece (measured by GDP per capita in PPS), which are at present around 71 per cent of the EU average, are to converge on the European average. However, further structural reforms may prove critical to enhance growth over the longer term and accelerate real convergence. Further economic benefits to be expected from EMU membership Aside from macroeconomic stabilisation and enhanced growth prospects, there are further economic benefits to be expected from the adoption of the euro. 1. As I mentioned earlier, the adoption of the single currency has further increased economic integration with the European partner countries, which will stimulate trade and investment. Transaction costs and uncertainty are reduced. The euro contributes to a stable environment that is less exposed to exchange-rate fluctuations. These factors will boost investment and trade. They will also encourage tourism, an important sector of the Greek economy . 2. The euro is contributing to greater efficiency of the European economy by acting as a catalyst for the integration of financial markets. Greek companies will have access to a wider and deeper financial market, which means a lower cost of funds. Indeed, short-term bank lending rates to enterprises fell by almost 7 percentage points in the period December 1999 to December 2001; long-term rates fell by 5.5 percentage points over the same period. 3. Membership of EMU makes low inflation prospects more credible, and thus contributes both to lower interest rates and to moderate wage demands based on lower inflationary expectations. 4. Adoption of the euro is also promoting greater efficiency of the Greek economy by stimulating reforms in product, services and labour markets. Deregulation and a reduction of state intervention, in part through privatization, are important in reforming markets for goods and services. Increased labour market flexibility is also being encouraged. 5. Against these benefits, it could be argued that with EMU membership Greece has lost its independent exchange rate and monetary policies, which could be useful instruments for improving competitiveness and employment. However, it cannot be said that this loss is very great. In small open economies, especially those with strong trade unions, nominal devaluations are quickly offset by wage increases that aim to avoid a cut in real wages. Hence, nominal devaluations do not lead to sustained real devaluations. Greece clearly comes in this category. A similar line of reasoning applies to a monetary expansion leading to temporarily low interest rates. Challenges for the future Membership of the euro area brings with it new challenges for economic policy in the years ahead. With independent monetary and exchange rate policies no longer available to target national policy goals, emphasis has shifted towards fiscal policy and to policies to promote labour [and product] market flexibility as a means of restoring strong non-inflationary growth in the face of a negative shock. Budgetary policy will continue to be geared to maintaining public finances close to balance or in surplus in the medium run, while supporting growth by acting in a counter-cyclical manner (and allowing automatic stabilizers to work fully) as envisaged in the Stability and Growth Pact. This is supplemented by the Greek authorities’ goal of reducing the General Government debt-to-GDP ratio to 60 per cent by 2010. The latter target is crucial given Greece’s presently high debt ratio and the need to make further progress on fiscal consolidation prior to the onset of expenditure pressures relating to the ageing population. Prudent fiscal policies will also be crucial to offset the progressively larger negative private savings – private investment gap which otherwise could induce unsustainable movements in the total savings – total investment gap and correspondingly in the current account deficit. In 2002, the general government surplus is expected to be 0.8 per cent of GDP. In 2003 and 2004 the projected budgetary surplus should average 1.1 per cent of GDP, according to the 2001 update of the Greek stability and growth programme. At the same time, the debt ratio is expected to decline from 99.6 per cent in 2001 to 90 per cent of GDP in 2004. EMU membership is acting as a catalyst for further progress on the structural front and for the reinforcement of macroeconomic stabilization as Greece deepens its economic and financial integration with the euro area. Continued structural reforms will tend to increase total factor productivity, which has been a significant driving force behind growth in recent years. In this respect, considerable progress has been made with the liberalisation of markets, the safeguarding of competition and institutional changes aimed at ensuring the smooth operation of product and financial markets. Among these, the most important measures taken in 2001 were: the ending of the state monopoly in the electricity sector, the opening-up of the fixed telephony market and the awarding of UMTS licenses and supplementary CGM licenses. The liberalisation of sea transport, an area of major importance, is planned for this year. There has also been an extensive programme of privatisation. Some important companies (like Olympic Airways, the Piraeus Port Authority and the Postal Services) are scheduled to go through privatisation schemes this year. Some publicly-owned companies only recently scheduled for privatisation include the Postal Savings Bank and the General Bank, the Athens Water and Sewage Company (already partially privatized) and the public gas company (DEPA). The government agenda for structural reform also includes pension reform at the centre of the current policy debate in Greece (social dialogue on this issue was launched last month and is currently underway). Some steps are also being taken to reform the health care system, where there is vast room to improve service delivery and public expenditure control. The government is also proceeding to an overall tax reform; the proposals of an experts’ Commission were made public earlier this month; after public discussion, the government will make its decisions in the summer and new provisions will take effect as of January 2003. The tax reform is expected not only to improve the efficiency of the Greek economy, but also to reduce the administrative costs of collecting taxes and the compliance costs for the taxpayers. The challenge now is to broaden and deepen the efforts undertaken to date to strengthen competition and efficiency in factor and product markets, efforts which are essential to ensure real convergence. Further progress is required on labour market reform. There remains foremost a need to facilitate labour market entry and to improve training. In product markets, the privatisation progress should be combined with broader measures to ensure competitive market outcomes across the economy. Further efforts to reduce bureaucratic inefficiencies are also required to lift impediments to new businesses - including foreign direct investment. In conclusion, despite the slowdown in the world economy, the Greek economy continues to perform very well. Real convergence is the clear priority for the coming years and the authorities still face some major challenges to facilitate the process. Nonetheless, the commitment of the authorities to both fiscal reform and policies to improve the operation of product and labour markets augurs well for their likely success in meeting these challenges over the coming years.

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Speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at The Economist Conference: Private Banking and Asset Management, Athens, 22 October 2002.

Nicholas C Garganas: The European financial marketplace Speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at The Economist Conference: Private Banking and Asset Management, Athens, 22 October 2002. * * * Ladies and gentlemen, Let me start and by thanking The Economist for inviting me to speak at this conference. In recent years, there has been a visible acceleration in the development and integration of EU financial markets. In what follows, I will discuss, first, why financial integration is desirable, second, why it has occurred, third, trends toward financial integration in the EU, and fourth, the role of public policy in supporting integration. Why is financial integration desirable? I think it fair to say that the main function of the financial system is to serve the needs of the real economy, encouraging productive investments, allowing risks to be diversified, mobilising savings, monitoring firms’ use of funds, etc. To this end, the development of both markets and sound financial institutions plays a key role. To the extent that increased financial integration allows the tasks of markets and institutions to be completed more efficiently, it will bring about greater benefits through two main channels: increased capital accumulation and higher productivity of capital. Through these two channels, the greater efficiency of an integrated EU financial system will lead to increased economic growth and a higher standard of living for EU citizens. Three main interrelated factors have underpinned the acceleration of integration of EU financial markets. The first factor is globalisation. The integration of financial markets in Europe is part of a wider global development. Globalisation has many dimensions, all of which have been stimulated by the decline in costs of communication, transportation, data processing, and transactions. The second factor is the advances in creating a common regulatory framework across the EU as part of the effort to complete the Internal Market in financial services. The adoption of a common EU policy has been accompanied by liberalisation of financial markets in the Member States. As I will discuss shortly, however, there is still some distance to travel in this respect. The third factor is the adoption of the euro. Before January 1999, the need to operate in many national currencies was a major obstacle to financial integration in the Union. The presence of a sizeable exchange risk limited the attractiveness of cross-border investment, reduced the incentive to proceed with regulatory harmonisation at the EU level, and dampened competitive pressures in Member States' home markets. The introduction of a common currency for twelve Member States has altered this situation dramatically. The euro has eliminated exchange risk as a source of fragmentation in the EU financial system. It has also increased price transparency, stimulating competition. As a result, deeper integration has led to more homogeneous markets, a wave of consolidation among intermediaries and exchanges, and the emergence of new and innovative products and techniques. The introduction of a common currency –the euro-- has perhaps had its biggest impact on the unsecured money market, that is the interbank deposit market. There is now virtually full convergence in interest rates across the euro area with little or no differences in the rates wherever the funds are exchanged. This outcome is, to a significant extent, a consequence of monetary union as all the regional money markets existing before EMU formed a large euro area money market. The ability to move funds across the euro area enabled the emergence of a deep, liquid and homogeneous money market. Despite recent progress, however, the EU financial system remains fragmented. Member-State financial structures have evolved over time under the influence of specific national preferences with regard to legal and regulatory frameworks. For example, progress in integrating the secured money market, that is, the market in which money is exchanged for collateral and repos, or repurchase transactions, and which includes the markets for T-bills and CDs, has been hampered by differences in national rules about collateral, settlement and matters concerning the handling of insolvency. Nonetheless, a large increase in gross issues in euros by monetary financing institutions, non-monetary financial corporations and nonfinancial corporations has occurred (see Figures 1-3). Whilst the levels of monthly issues differ across groups (reflecting the fairly recent recourse by nonfinancial corporations in Europe to short-term securities markets in contrast to banks’ use of the CD market to raise funds), there is no doubt that the advent of the euro has contributed to a marked change. Bond markets, both government and corporate, remain even less integrated. In the former case, yields have converged significantly, with remaining differences reflecting either credit risk or liquidity risk. In particular, smaller countries often have difficulties in generating deep markets across the whole maturity spectrum. One solution that has been proposed is greater coordination of debt issues. This proposal, however, has met with some resistance, not least because national debt issuance is affected strongly by national-specific fiscal characteristics. With regard to markets for corporate debt, the lack of integration reflects the fact that euro-area companies have traditionally relied much less on debt raised in financial markets than have their Anglo-Saxon counterparts. Financial intermediaries play a much more important role in the euro-area than in Anglo-Saxon financial systems. Finally, equity markets remain fragmented despite several mergers between exchanges, the increased use of electronic trading and higher positive correlations between share price movements across exchanges. The current, bearish climate in equity markets appears to be delaying further integration through the creation of integrated networks which can facilitate cross-border trading. The introduction of the euro is also providing new impetus to competition between financial institutions. Wholesale banking markets have been integrated for some time now, but retail markets remain fragmented. Banks have tended to concentrate on domestic consolidation and have expanded crossborder by signing agreements with banks in other countries so as to facilitate the supply of services to their largely domestic customers. Since some EU financial markets remain fragmented despite the benefits of financial integration, let me now turn to actions that can be taken to create an integrated EU financial market. In this regard, what is the role of public policy? In my view, there are two major areas where public policy action can contribute to more-effective financial integration. The first relates to the need to remove remaining legal or regulatory barriers. The second involves responding appropriately to the new challenges raised by a more financially-integrated environment. Regarding the need to remove existing barriers, the need of action in this area has been recognised at the highest political level. Successive European Councils have declared the integration of EU financial markets as a high priority of economic reform in the EU. This priority is reflected in a coherent policy strategy at the EU level and in the urgency which has been attributed to its implementation. The issue is being addressed mainly within the context of the Commission’s Risk Capital Action Plan (RCAP) and the Financial Services Action Plan (FSAP). The RCAP focuses on improving the provision of finance to new enterprises, often working in high technology, high risk areas. These firms often cite a lack of external finance as a major impediment to their expansion. Given the dynamism they provide to an economy, measures to alleviate the shortage of finance are crucial in meeting the wider goals of the EU member states, namely increasing employment, productivity and growth. At the Cardiff European Council in June 1998, financial services were given a high profile and the European Commission was asked to prepare a framework for action. The result was the Financial Services Action Plan, a package of 42 policy initiatives aimed at improving the functioning of the EU financial system by 2005. Among the objectives underlying the plan are the creation of a single wholesale financial market in the EU and open and secure retail markets. In general, the emphasis is on promoting financial markets, which are considered to be underdeveloped in Europe. Although more than half of the FSAP initiatives have been adopted or finalised, much work remains as agreement is proving difficult in some areas. One such area is that of methods of corporate governance. A wide variety of systems exists at present, varying, in part, according to the role of banks versus markets in corporate governance and the extent to which corporate governance mechanisms associated with growth of financial markets can co-exist with other methods based on institutions. The EU is sensitive to such differences. However, the greater development of markets necessitates the implementation of rules to regulate market behaviour, for example, in the areas of takeovers and takeover bids. Such differences need to be overcome quickly if the aim of implementing the FSAP by end-2005 (and the RCAP by end-2003) is to be realized. In this connection, the recent adoption by the Commission of a Directive on Prospectuses will introduce a truly single passport for issuers. Also, a Commission Regulation has recently been adopted on the application of International Accounting Standards (IAS) in the EU. It requires that all EU listed companies prepare their consolidated accounts in accordance with IAS from 2005 onwards. Aside from the stumbling blocks in specific areas, there is also the more general question of the extent to which the infrastructure required for the smooth operation of a cross-border financial system will tend to emerge naturally through the operation of market forces and the extent to which it needs to be actively promoted by the authorities. I am inclined to think that a more proactive role for the authorities is needed to encourage the development of pan-European settlement and clearing systems, securities depositories, etc. Market forces may be impeded by the existence of strong national interests (existing national organisations often have strong monopoly powers which operate to prevent change) and/or the presence of diverse regulatory and legal environments (if a pan-European institution has to observe many different national regulations, depending on the nature of the transaction, then little will be gained by such an institution’s existence). Further financial integration brings not just benefits, but also challenges in terms of the measures needed to secure financial stability and to protect consumer and investor interests. A number of the measures in the FSAP address issues such as liquidation of financial institutions, the capital adequacy of banks and the question of how to deal with financial conglomerates. The EU has long been involved in strengthening cross-border cooperation among the member states in the area of supervision. The first two Brouwer reports, published in 2000 and 2001, examined supervisory procedures in some detail. In the second report, emphasis was placed on the need to coordinate supervision across sectors (banking, insurance, securities) in the face of the creation of large financial conglomerates. A third Brouwer report was published in September of this year which, inter alia, suggested recommendations for the procedures by which Community regulation is agreed, drawn up and adopted in an attempt to speed the presently rather cumbersome process. Financial markets cannot function properly cross-border without a co-ordinated regulation and supervision for banking, insurance and securities markets as well as across these markets. The current set of committees is structured by sector and includes committees for discussion, advisory committees and committees with regulatory powers. Following the introduction of the Lamfalussy decision-making process in the securities markets, the current structure of committees came under scrutiny. In this connection, the Lamfalussy process, which was originally designed to establish a unified regulatory and supervisory framework for the securities’ sector, is to be extended to cover banks, insurance companies, and financial conglomerates. This framework will lead to closer coordination of supervisory practices. In conclusion, I think it fair to say that European financial integration has come a long way. Yet, the process is far from complete. EU financial integration is one of the cornerstones of the effort to boost the dynamism of the European economy. A more efficient and integrated EU financial system will increase the availability of capital and increase the productivity of capital, with positive knock-on effects on output growth and employment creation.

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Address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Conference of the European Commission ¿Europe, The Mediterranean and the euro¿, Athens, 4 February 2003.

Nicholas C Garganas: International role of the euro Address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Conference of the European Commission “Europe, The Mediterranean and the euro”, Athens, 4 February 2003. * * * Introduction Ladies and gentlemen it is a pleasure to participate in an event organised by the European Commission. I would like to thank the Commission for inviting me to address some of the basic considerations that confront the euro in its emergence as an international currency. Let me begin by asking the question: “How does a currency acquire the status of an international currency?” This question is being asked more and more often as the euro takes on increasing importance in the global financial system. The interwar period was dominated by two currencies - the US dollar and the pound sterling - while the postwar world has been dominated by the US dollar. Unlike the situation in national economies or monetary unions, where the currency used is determined by government decree, currencies are used internationally because of neither an Act of Parliament nor an Act of God. Rather the choice of currencies used for international transactions is mainly the result of invisible hand processes. Currencies attain international status because they meet the various needs of foreign official institutions and foreign private parties more effectively than do other financial assets. What factors contribute to the use of a specific money as an international currency? Why was the Dutch guilder the dominant international currency in the 17th and 18th centuries, the British pound in the 19th and early 20th centuries, and the dollar since the end of the second world war? Several factors are essential if a currency is to be used internationally. First and foremost, an international currency must be perceived as sound. To be acceptable, market participants must be willing to hold it as a store of value. This circumstance means that inflation in the country or monetary union issuing the currency must be low and stable relative to those of other currencies. Inflation reduces the purchasing power of a currency, discouraging its use internationally. It also leads to exchange-rate depreciation and uncertainty. A necessary condition for the international use of a currency, therefore, is that a currency’s future value in terms of goods and services has to be perceived as predictable and stable. Clearly, many currencies meet this test; yet few emerge as international currencies. Therefore, there must be - and there are - additional factors that help determine the internationalisation of a currency. One such factor has to do with size. The size factor relates to the relative economic and demographic area for which the currency serves as legal tender - in other words the “habitat” of the currency. A strong, competitive economy, open to, and active in, international trade and finance will naturally generate a large quantity of foreign exchange transactions with at least one leg in the home economy to support its wide-ranging business activity. Another factor underlying the international use of a currency is the presence of an open, welldeveloped financial system. This factor is a necessary part of a strong, competitive, and open economy. Just as relatively low levels of inflation and inflation variability contribute to the international demand for a currency, well-developed financial markets supply assets appropriate for international use, and strengthen the demand for additional assets as well. Well-developed financial markets in the currency’s issuing jurisdiction contribute to the international use of that currency. Central banks and other investors have preferences for safe, liquid financial instruments; deep and liquid financial markets that offer a full array of instruments and services will attract business from abroad that might otherwise have stayed at home. Money as a conveyer of information History has shown that the forgoing three factors - a stable currency, a strong, competitive economy, and deep, broad and liquid financial markets - are necessary for the international use of a currency. History has also shown, however, that only a single currency, or at most a few currencies, emerge as major international currencies at any one time. To understand why this is so, we need to consider a key function of money. Money conveys information about prices. When you are in Greece, for example, and you want to compare the prices of two hotel rooms, you compare them in euros. The euro, in other words, conveys essential information which allows you to make price comparisons so that you can reach a decision. Money, in its capacity as a transmitter of information, performs a function similar to that of an international language. The greater the number of people who speak a language, the more it can facilitate communication. The same is true with money. A currency would hardly do you any good if you are the only person who uses it. The utility of money depends, in part, on how many others use it. When a Saudi Arabian exporter, who does not speak Italian, sells crude oil to an Italian importer who does not speak Arabic, the transaction may well be conducted using the English language and it may will be denominated and settled in US dollars. The US dollar, in this case, is used as a “vehicle” currency, that is, it is used to denominate and execute foreign trade transactions that do not involve direct transactions with the issuing economy. This use leads, as does the use of English, to easier communication in transmitting information. As is the case with a language, the more popular is a currency the more useful it is to those who use it. Because the attractiveness of any international currency grows as its use increases, an international currency has a tendency to become a natural monopoly. This circumstance explains why only a single money, or a few moneys, are used as international currencies at a particular time. Benefits and costs An international currency provides several major benefits to the issuing economy. First, the economy derives seigniorage, because the non interest-bearing claims on it are denominated in its own currency. When Argentina, for example, imports autos from Japan, it must pay for them with foreign exchange it earned through its exports; it is highly unlikely that the Japanese importer would be willing to accept the Argentina currency, the peso. When the US, however, imports Japanese autos, it can pay for them with Federal Reserve notes, which are just a paper claim on the US government. The Board of Governors of the US Federal Reserve System estimates that seigniorage revenue for the United States amounts to between $11 billion and $15 billion per year. Second, as the international use of a currency expands, loans, investments, and purchases of goods and services - both foreign and domestic - will increasingly be executed through the financial institutions of the issuing economy. Thus, the earnings of its financial sector are likely to increase. Third, the tendency of world trade to be denominated in the international currency means that the issuing economy will be less vulnerable to changes in the value of its currency than are other economies. If the US dollar, for example, depreciates sharply against other currencies, this will have a smaller effect on US inflation than is the case in other economies. This is because most US imports are denominated in dollars. Therefore, when the dollar declines on the foreign exchange market, the price of US imports - in dollars - need not change. The main cost of having an international currency is that it can complicate the conduct of monetary policy. Because foreigners hold a substantial share of the currency, a portfolio shift away from the currency, for example, can lead to large capital outflows and/or large declines in the exchange rate. Concerns about the effects of changes in portfolio preferences caused both the German and the Japanese governments to take measures to restrict the international uses of the deutsche mark and yen, respectively, during the 1970s and early 1980s. Concerns that the imbalances in the US economy, including the large current account deficit, could lead to a massive sell-off by foreigners of their holdings of US dollar balances have underpinned concerns of a possible hard landing for the US currency. The international role of the euro Let me now turn to the specific focus of this session - the international role of the euro. It is important to note that the ECB has adopted a neutral stance concerning the internationalization of its currency, implying that it neither fosters nor hinders the process. It accepts the view that the international role of the euro is primarily determined by the decisions of market participants. How, then, does the euro stack up in terms of the conditions that determine an international currency? The first factor I mentioned that determines international currency use is a stable currency. The mandate of the ECB is to maintain the purchasing power of its currency. Since its inception, therefore, the ECB has sought, and it has attained, stability of its currency. This stability is proof that the institution is performing well. Yet, in the quest for stability, monetary policy cannot go it alone. It needs to be complimented by a consistent fiscal-policy stance. Indeed, the academic literature has coined a name for the connection between monetary and fiscal policies, calling it “fiscal dominance”. The implication of this connection for the international role of the euro is that, to ensure the future stability of the euro, member states will need to adhere to the Stability and Growth Pact. The second factor determining international currency-status is size. Measured in terms of population, the euro area is one of the largest economies in the world, with more than 300 million inhabitants. By comparison, the populations of the United States and Japan are about 270 million and 125 million, respectively. The euro area is the largest trading partner of the world economy, accounting for almost 20% of world exports, compared with about 15% for the United States and 9% for Japan. The GDP of the euro area is equivalent to some 16% of world GDP, about 6 percentage points less than the share of the United States but more than twice the share of Japan. However, even more important than the current figures is the potential for the future development of the euro area, in terms of population and GDP, if and when the so-called “pre-ins” (Denmark, Sweden and the United Kingdom) join the Eurosystem. The entry of these countries would result in a monetary union of some 376 million inhabitants, about 40% larger than the United States and almost triple the size of Japan, with a GDP only slightly less than that of the United States and 2¼ times that of Japan. All these facts and figures, which demonstrate the demographic and economic importance of the European Union, will be further strengthened by EU enlargement. Let me now turn to financial markets in the euro area. The introduction of the euro and the successful implementation of the TARGET payment system have contributed to the potential for highly integrated financial markets within the euro area. With regard to capital markets, the euro has seen a strong development in the bond market. The launch of the euro seems to have acted as a catalyst for the development of a bond market in which corporations can issue debt securities of unprecedented size. As a result, the introduction of the euro has created the second largest bond market in the world. This circumstance has led to declining transactions costs, as bid-ask spreads have narrowed, and increased diversity, as new types of issuers participated in the market. The integration of the euro area bond market, and the associated reduction of borrowing costs in euro, have meant that the euro has been playing an increasingly significant role as a financing currency. in the international debt securities market, recent data indicate that the share in outstanding amounts of euro-denominated instruments issued by non-residents totals 29%, compared with 44% for the US dollar and 13% for the Japanese yen. In contrast to borrowers, investors are interested in income prospects and they demand high efficiency and liquidity of the financial markets in which they invest. These market characteristics exist only if the financial markets are deep and wide. Such is not yet the case in euro-area equity markets. These markets tend to be smaller, on average, than their counterparts in many other industrialised countries and they account for a commensurately smaller share of trading activity. This situation is very much a result of the segmentation of national markets, which have been built around national securities depositories and settlement systems intimately connected to the national payment infrastructures The challenge is to remove institutional and economic factors that raise the cost of cross-border operations. In particular, further integration will require harmonization of accounting rules, tax regimes, and legal frameworks, and the acquisition of the necessary technical infrastructure for handling crossborder holdings and settling securities. The costs of these regulatory obstacles are identified in the Financial Services Action Plan, issued by the European Commission. The Action Plan lists priorities and time-scales for legislative and other measure to tackle three strategic objectives: (1) completing a single wholesale market; (2) developing open and secure markets for retail services; and (3) ensuring the continued stability of EU financial markets. It also addresses the importance of eliminating tax obstacles and distortions for the creation of an optimal single financial market. To date, 30 of 42 measures contained in the Action Plan have been completed. I hope the remaining obstacles identified in the Action Plan will be removed within the scheduled deadlines. As I mentioned, the relatively narrow euro-area financial markets have meant that the euro area has not approached its full potential as an international asset. As of the end of 2001, 13% of the identified official holdings foreign reserves were in euro, compared with about 68% for the US dollar and about 5% for the Japanese yen. As a medium-of-exchange and asset vehicle in the foreign exchange markets, the US dollar remains the dominant global vehicle; the euro’s share in global spot trading amounts to about 20%. Concluding remarks The other speakers on this panel will provide specific information about the current state of play of the euro as an international currency. The evidence they will present will confirm that the euro has emerged as the world’s second most important international currency. Yet, the evidence will also confirm that the dollar is still far ahead of the euro. Before I turn the lectern over, let me make a few remarks about future prospects. Two essential, inter-related elements will help the euro attain equal status with the U.S dollar. First, improved productivity and competitiveness of the euro area will raise the rate of return on euro area assets, boosting the role of the euro as in investment currency. This prediction is predicated on profound changes in areas such as product and labour market regulations, public debt and fiscal deficits, and social security systems. Second, continued financial market integration, a necessary condition for further investments in euro assets, will require changes in, and harmonisation of, legislations, regulations, market practices, and infrastructures. The euro has made an impressive debut on the global stage. To a significant extent, this situation reflects the credibility credentials earned by the ECB in its first several years of existence. It also reflects the perceptions of market participants of the euro area as an economy with strong growth potential. Determined efforts in the remaining areas I have discussed would fulfil these perce3ptions and add to the attractiveness of the euro in the international arena, allowing it to seriously challenge the hegemonic role now played by the US dollar. Ladies and gentlemen, thank you for your attention.

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Luncheon address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Seminar on ¿Monetary Strategies for Accession Countries¿, Hungarian Academy of Sciences, Budapest, 28 February 2003.

Nicholas C Garganas: Exchange-rate regimes on the road to EMU: lessons from Greece’s experience Luncheon address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Seminar on “Monetary Strategies for Accession Countries”, Hungarian Academy of Sciences, Budapest, 28 February 2003. The references for the speech can be found on the Bank of Greece’s website. * * * Ladies and Gentlemen, I would like to thank Magyar National Bank, the Institute of World Economics of the Hungarian Academy of Sciences, and the Center of European Integration Studies of the University of Bonn for inviting me to speak to you today. In contemplating the subject of this seminar, one is struck by how dramatically things have changed in the course of a decade. In 1992 and 1993, when the Exchange Rate Mechanism - or ERM underwent a series of speculative attacks, the prospects of a European monetary union were viewed, by many observers, with considerable skepticism. This skepticism was not without foundation. After all, hadn’t there been previous false starts on the road to EMU? Hadn’t the Werner Report prescribed a European monetary union by the end of 1970s? Yet, here we are today, having fulfilled the dreams of Pierre Werner and his colleagues and having celebrated the fourth birthday of EMU. Today, I would like to address some lessons from the experience of Greece, the newest member of the euro area, in its quest for EMU membership. I will confront what appears to be a dilemma. As we have heard this morning, much of the economics profession appears to have been converted to the “hypothesis of the vanishing middle”; for economies well integrated into world capital markets, there is little, if any, middle ground between floating exchange rates and monetary unification. Effectively, this hypothesis rules out intermediate regimes. Yet, a requirement for entering the euro area is participation in ERM II, which is, after all, an intermediate regime. How can this dilemma be resolved? The Retreat from Intermediate Regimes Before I discuss Greece’s experience, let me address the reasons underlying the retreat from intermediate regimes. What has caused this retreat? First, an explosive increase in capital flows during the 1990s has made the operation of intermediate regimes problematic. As has already been discussed at this seminar by Jorge Braga de Macedo and Helmut Reisen, according to the thesis of the Impossible Trinity, developed in the 1980s, under a system of pegged exchange rates and free capital mobility, it is not possible to pursue an independent monetary policy on a sustained basis. Eventually, current-account disequilibria and changes in reserves will provoke an attack on the exchange rate. The enormous increase in capital flows has been accompanied by abrupt reversals of these flows. Whereas the logic of the thesis of the Impossible Trinity suggests that exchange-rate attacks typically originate in response to current-account disequilibria and build up gradually, in fact, recent speculative attacks have often originated in the capital account, have been sudden and difficult to predict, and have included the currencies of countries without substantial current-account imbalances. Capital-flow reversals have involved a progression of speculative attacks, mostly against pegged-exchange-rate arrangements. These reversals of capital inflows and resulting exchange-rate devaluations or depreciations have often been accompanied by sharp contractions in economic activity and have, at times, entailed “twin crises” - crises in both the foreign-exchange market and the banking system. Finally, there has been a tendency of instability in foreign-exchange markets to be transmitted from one pegged-exchange-rate regime to others in a process that has come to be known as “contagion”. The victims of contagion have seemingly included innocent bystanders - economies with sound fundamentals whose currencies might not have been attacked had they adopted one of the corner solutions. This triad of factors - (1) the difficulty of conducting an independent monetary policy when the exchange rate is pegged and the capital account open, (2) sudden capital-flow reversals, and contagion - have profoundly affected the way we think about exchange-rate regimes. The Experience of Greece: Pre-ERM The foregoing factors significantly affected the Greek economy in the 1990s. Through 1994, the performance of the Greek economy was pretty dismal. Growth was almost flat, and inflation and the fiscal deficit as a percentage of GDP, were in the double-digit levels throughout the period. Other EU countries were moving forward in their quests to become members of EMU while Greece was falling farther and farther behind. Clearly, a regime change was called for. It came in 1995. The signing of the Maastricht Treaty in 1992 and the government’s publicly-stated objective of joining the euro area provided powerful incentives for mobilising broad public support for policy adjustment. Among the policy measures undertaken were the following: • Fiscal policy was progressively tightened. The fiscal deficit, as a percentage of GDP, fell from over 10 per cent in 1995 to around to 4 per cent in 1997. • Financial deregulation, which had begun in the late 1980s, was completed and in 1994 the capital account was opened. The deregulated financial system facilitated the use of indirect instruments of monetary policy so that small, frequent changes in the instruments became feasible, enabling rapid policy responses. • The Greek Parliament approved independence of the Bank of Greece and provided the Bank with a mandate to achieve price stability. For its part, beginning in 1995, the Bank of Greece adopted what became known as a “hard drachma policy”, under which the exchange rate was used as a nominal anchor. For the first time, the Bank announced a specific exchange-rate target. Underlying this policy, both in Greece and elsewhere during the 1990s, was the belief that the adoption of a visible exchange-rate anchor could enhance the credibility of the dissinflationary effort because (1) the traded-goods component of the price level could be stabilised and (2) wage-settling and price-setting behaviour were restrained. I will not go into details of the operation of the hard-drachma policy. Suffice it to say that, during the years 1995-97, real interest rates at the short-end were kept in the vicinity of 5 per cent. Fairly specific targets for the exchange rate were announced in each of the three years and were achieved. Importantly, inflation fell from about 11 per cent in 1994 to under 5 per cent at the end of 1997 while, in the first three years of the policy, real growth almost tripled compared with the rate of 1991-94. Yet, as is typically the case with all nominal-anchor exchange-rate pegs, this regime produced difficulties. As predicted under the thesis of the Impossible Trinity, the ability to conduct an independent monetary policy under an exchange-rate peg and open capital account became increasingly demanding. The wide interest-rate differentials in favour of drachma-denominated financial instruments led to a capital-inflows problem. The Bank of Greece responded by sterilising these inflows, limiting the appreciation of the nominal exchange rate, reducing the impact of the inflows on the monetary base, and buying time for other policies to adjust. Still, the sterilisation entailed quasi-fiscal costs and, by preventing domestic interest rates from falling, tended to maintain the yield differential that had given rise to the inflows. Additionally, the Greek economy experienced a fundamental problem associated with all exchange-rate nominal-anchor pegs during the move to lower inflation; the real exchange-rate appreciated significantly contributing, along with strong domestic demand, to a widening current-account deficit. This circumstance brings me to the second and third of the triad of factors - sudden capital-flow reversals and contagion. The widening current-account deficit, combined with rapid wage growth, fed market expectations that the drachma was overvalued and provided the basis for contagion from Asia, which commenced with the devaluation of the Thai baht in July 1997. The sharp rise in interest rates required to support the drachma increasingly undermined growth and fiscal targets. A further regime shift was needed. That regime shift was provided by the ERM. Effective March 16, 1998, the drachma joined the ERM at a central rate that implied a 12.3 per cent devaluation against the ECU. As I will explain, entry into the ERM allowed Greece to orient its policies to stability, fostering convergence. Because participation in the ERM, without severe tensions, plays a role in the convergence criteria for joining the euro area, it acts as testing phase for the central rate as well as for the sustainability of convergence in general. Lessons from the ERM Before I discuss the drachma’s experience in the ERM, let me posit a question: What kind of an intermediate exchange-rate regime do we have in mind when we refer to the ERM? In my view, the present ERM system is the result of an evolutionary process. Like all Darwinian evolutions, several distinct versions of the species can be distinguished. To provide analytic focus, I think it useful to distinguish among the following. ERM Mark 1. This species lasted from the inception of the EMS, in 1979, to 1987. Compared with the 2 per cent bands under the Bretton-Woods system, the ERM bands of fluctuation, at 4.5 per cent, were fairly wide and the system was supported by capital controls. For some currencies, the bands were even wider, at 12 per cent. Small realignments occurred frequently. Between March 1979, when the system started, and January 1987, realignments occurred on eleven occasions. The foregoing features of the system allowed France, for example, to devalue the franc by shifting the upper and lower limits of its band without affecting the market exchange rate, helping to forestall the possibility of the large profit opportunities that give rise to speculative attacks. ERM Mark 2. What has been dubbed the “new EMS” began to take shape in 1987. Increasingly, the deutsche mark was used as a nominal anchor, with the Bundesbank’s reputation as a stalwart inflation fighter supporting the monetary authorities of some participating countries in their efforts to attain anti-inflation credibility. Except for an implicit devaluation of the Italian lira in January 1990, when that currency moved from the wide band to the narrow band, realignments ceased to be a characteristic of the system. In 1990, the remaining capital controls were eliminated by participating countries. German reunification required a tight monetary policy to counterbalance the large fiscal deficits generated by reunification. With other ERM countries in recession and requiring a loosening of monetary policy, the ERM was confronted with a classic (n-1) problem. ERM Mark 3. Beginning in September 1992, many of the currencies participating in the ERM were subjected to attacks, eventuating in a series of devaluations and the suspension of the pound sterling and the Italian lira from the system. These attacks were sudden and massive. Thus, they were different from the currency realignments of the 1980s, which were mainly the result of pressures that had build up gradually in response to current-account disequilibria. With the lifting of capital controls, the attacks in 1992-93 arose on the capital account and sometimes infected the currencies of countries with seemingly-sound fundamentals, such as France. Several new terms made their way into the lexicon of economists: (1) capital-account-driven crises, (2) sudden-stops, and (3) contagion. ERM Mark 4. In a last-ditch effort to rescue the system, in August 1993 the ERM bands were widened to ± 15 per cent. As things turned out, this move helped salvage the system. It provided necessary breathing space for nominal convergence to occur. ERM Mark 5, or formally, ERM II. Under the present arrangement, exchange-rate stability is explicitly subordinated to the primary objective of price stability for all participating currencies and obligations under the system are deliberately more asymmetric than under the previous ERM. The notion of asymmetry is particularly important in underlining the principle that it is the country whose currency comes under pressure that has to undertake the necessary policy adjustments. Let me now return to the case of the drachma and the ERM. By the time that the drachma entered the ERM, in March 1998, the participating countries had demonstrated their determination to form a monetary union by attaining considerable nominal convergence, as specified in the Maastricht criteria. This convergence took place under a backdrop of market-based economies that could compete effectively in an open economic and financial system. In these conditions, the system built up a considerable amount of trust. As Otmar Issing has pointed out in several recent papers, the trust evoked by governments, including in their ability to deliver credible, non-inflationary policies, is a prerequisite for the existence of a stable currency, both internally and externally. When the drachma entered the ERM, it became a beneficiary of the credibility established in the system over the previous years. It also benefited from the market’s knowledge of the availability of the system’s mutual support facilities, such as the Very Short-Term Financing Facility. Yet, Greece’s participation was not a free ticket. The other participants in the system did not wish to endanger the credibility that had taken so long to achieve. They rightly asked for an entry fee. This fee included the following elements. • The new central rate - which as I have noted, involved a 12.3 per cent devaluation - had been agreed by all members. • The devaluation of the drachma was both backward looking and foreward looking. The magnitude of the devaluation took account of both past inflation differentials between Greece and other EU countries and prospective differentials in the period leading up to Greece’s expected entry into the euro area. Thus, the new central rate was meant to be sustainable. • A package of supportive fiscal and structural measure was announced. Efforts to restructure public enterprises were stepped up. The aim of the measures was to ensure the sustainability of the drachma’s new central rate. In other words, the ERM was meant to be a testing phase for EMU participation, not a free pass into the euro area. Unlike many other devaluations of the mid-1990s and late-1990s, the drachma’s devaluation was not followed by further rounds of speculative attacks, nor by a financial crisis. Unlike other devaluations, it was not followed by contraction in economic activity, but by an acceleration. Moreover, and again in contrast with the other devaluations of this period, the impact of the drachma’s devaluation on inflation was strictly contained. What accounts for the drachma’s successful exit from one central rate to another? In my view, the key ingredients of the successful devaluation were the following. • Unlike other currencies that were devalued during the mid-1990s and late 1990s, the drachma exited a unilateral peg and entered a systems’ arrangement, benefiting from the credibility of the ERM. • Fiscal tightening continued following the devaluation. The fiscal deficit, as a per cent of GDP, fell to about 1 per cent in 1999, from 4 per cent in 1997. Labour-market policy gradually adjusted to the needs for fiscal discipline and for enhancing international competitiveness. • Prudential regulation and supervision of the banking system had been strictly enforced and there was no net foreign exposure of the banking system. Thus, there was no currency-mismatching problem - i.e., large, uncovered foreign-currency positions, which, under conditions of currency devaluations, raise the debt burden of domestic foreign-currency borrowers, resulting in bankruptcies and financial crises. In addition to placing the Bank of Greece’s disinflation strategy within a new institutional framework that gave it added credibility, the ERM provided another important advantage. Entry at the standard fluctuation bands of ± 15 per cent gave the Bank ample room for manoeuvre. Thus, when capital inflows resumed following ERM entry, the Bank allowed the exchange rate to appreciate relative to its central rate, helping to maintain the tight monetary-policy stance and to contain the inflationary impact of the devaluation. The exchange rate remained appreciated relative to its central rate throughout the rest of 1998 and for all of 1999. In 1999, for example, the drachma traded (on average) 7.7 per cent above its central rate while, for most of that year, the three-month interbank rate stood about 700 basis points above the corresponding German rate. As a result of the tightened and consistent policy mix, inflation reached a low of 2 per cent during the second half of 1999. Then, in order to limit the degree of depreciation that would be required for the market rate to reach its central rate and the resulting inflationary pressures, the central rate was revalued by 3.5 per cent in January 2000. The rest, as they say, is history; having fulfilled all the Maastricht criteria, on January 1, 2001 Greece became the 12th member of the euro area. Concluding Remarks What are the key lessons that emerge from Greece’s experience? Let me highlight the following. First, an intermediate exchange rate regime can be viable in today’s world of high capital mobility provided that (1) the participants adhere to sound and sustainable policies, including those that ensure the existence of a well-functioning market economy, and, (2) the intermediate regime is used as a transitional arrangement on the road to the corner solution of a monetary union. There is no contradiction between the existence of ERM II and the hypothesis of the vanishing middle regime. Second, ERM II provides the credibility of a systems’ arrangement, built up in a Darwinian evolution, and flexibility through the wide fluctuation bands that may be necessary to achieve nominal convergence. The credibility derived by participating in the ERM II should not, however, be endangered by use of frequent adjustments of the central parity. As the ERM experiences of the 1980s and 1990s vividly demonstrated, frequent adjustments of central parities within a pegged regime are feasible only in the presence of capital controls. In today’s world of high capital mobility, exchange-rate changes are not instruments that policy-makers can use flexibly and costlessly. The more often they are used, the less can be the credibility of a pegged exchange-rate system. Third, the need of a consistent policy mix is crucial and has important implications in terms of how we need to view policy analysis. An implication of both the Mundell-Fleming model and Mundell’s famous assignment problem is that monetary policy and fiscal policy constitute two, separate policy instruments. Yet, the simple accounting fact that government expenditure has to be financed by either taxation, borrowing, and/or money creation, implies that any analysis of monetary policy must make consistent assumptions about fiscal policy. Monetary policy and fiscal policy, in other words, are not independent policy instruments. They must work in tandem on the road to EMU, and in EMU. Fourth, ultimately, a credible exchange-rate regime depends upon the trust evoked by governments. A governance structure that enforces the rule of law and sanctity of contracts and a political system that delivers credible, non-inflationary policies are prerequisites for the existence of a stable exchange-rate regime. Ladies and Gentlemen, thank you for your attention.

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Address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the celebrations marking the 75th anniversary of the ...

Nicholas C Garganas: Why is the role of the central bank important? Address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the celebrations marking the 75th anniversary of the Bank of Greece, Athens, 3 November 2003. * * * Your Excellency the President of the Hellenic Republic Mr. Prime Minister, Your Beatitude, Ladies and Gentlemen, Allow me to thank you for having accepted our invitation to join us in today’s event. Let me also extend a warm welcome to Jean-Claude Trichet, who became President of the European Central Bank on November 1. This occasion marks Jean-Claude’s first official function outside of Frankfurt in his new position. Thank you for being with us today, Jean-Claude. We wish you every success in your new position. I also would like to extend a very warm welcome and a special thanks to my central bank colleagues from the European System of Central Banks as well as those from other parts of the world who have honored us with their presence for this celebration. This year we celebrate an important anniversary - the 75th year since the establishment of the Bank of Greece. During this period, the conventional wisdom about a central bank’s institutional role and about what a central bank can and should do has undergone enormous change. There has, however, been one constant underlying the responsibilities of a central bank - the importance of discharging these responsibilities to the health of the national economy. Why is the role of the central bank important? Because, an economy’s central bank is entrusted with safeguarding the value of the economy’s currency and with ensuring the soundness of its financial system. Safeguarding the value of the currency is not always an easy task. The correct answer to this challenge forms the basis of an efficiently running economy and of social cohesion. As John Maynard Keynes observed, “there is no subtler, no surer means of overturning the existing basis of society than to debauch the currency”. It would be comforting to find in the history of central banking a record of steady progress and orderly development from earliest antecedents to present knowledge. The facts, however, are different. The past 75 years have included remarkable achievements and some setbacks both globally and in the Greek economy. The role of the central bank in an economy’s fortunes - and misfortunes -is aptly demonstrated by the history of the Bank of Greece. During this sometimes turbulent period, the Bank of Greece demonstrated an ability to adapt to changing circumstances, often playing a leading role in providing solutions to the main economic problems of the day. Let me use the occasion of the Bank’s 75th anniversary to elaborate briefly. Following a period of monetary instability, in March 1927, the Greek government sought the assistance of the League of Nations to improve the health of the economy, to secure monetary stability and to help the Greek banking system function better. Negotiations with the League followed and a stabilisation plan was hammered out. Among the terms of the so-called Geneva Protocol, signed in September 1927, was the establishment of a central bank, exclusively responsible for issuing banknotes. Until that time, the National Bank of Greece, a private institution, had the privilege of issuing banknotes, which it waived in favour of the newly established central bank. The Bank of Greece commenced its operations in May 1928. The two main tasks assigned to the Bank, as specified in its Statute, were to ensure a stable currency and to regulate currency circulation. To this end, the Statute provided for the Bank to have reserve assets; it also set a strict limit on the financing of budgetary deficits by the central bank. The Bank of Greece could not have begun operating at a more difficult time. This was a time when the international monetary system was operating primarily under the gold-exchange standard. Effectively, the gold standard aimed at securing the stability of a currency by tying money supply to the gold reserves of the central bank, thus leaving little room for conducting an independent monetary policy. The gold standard has been described as nailing the domestic economy to a “cross of gold”. Today, many historians blame the gold standard for helping precipitate the Great Depression that began in 1929. Regardless, the global stock market crash of 1929 and the ensuing global financial crisis of September 1931 saw many countries driven off the gold standard. The new international environment was hardly a favorable one for a fledging central bank. Concerned about the instability that might follow in the absence of the gold standard -and with the recent period of monetary instability entrenched in their memories - the Greek authorities attempted to maintain the link to gold. The drachma, however, came under heavy selling pressures, and, in April 1932, Greece had to leave the gold standard. Leaving the gold standard made monetary policy a matter of the discretionary judgement of the authorities at the Bank of Greece. The new monetary regime opened up the possibility of the Bank playing a more active role in domestic economic affairs. The Bank was no longer bound by the discipline imposed by the gold standard. However, in common with most other central banks at the time, it pursued monetary and credit policies geared toward safeguarding price stability and ensuring a sustainable balance of payments; after all, this was in accordance with its Statute. In addition, the Bank sought to remedy the inefficiencies of under-developed money and capital markets by instituting measures to attract savings to the banking system and to improve credit allocation. In April 1941, the Axis Powers occupied Greece. For several years, London became the seat of both the exiled Greek government and the Bank of Greece, with the Bank’s gold secretly transferred to South Africa. Within occupied Greece, the economic situation became increasingly grim and hundreds of thousands of Greeks died of hunger. The Axis powers forced the country to pay not only for the upkeep of the occupying troops, but also for their military operations in Southeastern Europe. The puppet regime established by the occupiers forced the Bank of Greece to resort to the printing press. As a result, the country was beset with hyperinflation; between April 1941 and October 1944, the cost of living rose 2.3 billion times. In these difficult circumstances, the country’s economic system collapsed. To give another example of the magnitude of inflation during the occupation, let me mention that in November 1944, immediately after liberation, a so-called “new” drachma was introduced; it was set equal to 50 billion “old” drachmas! In March 1946, a stabilisation plan, which was part of the London Agreements, set up the Currency Committee, which was to become responsible for monetary, credit and exchange rate policies for several decades. This Committee consisted of five members, including the Minister of Coordination, the Minister of Finance, and the Governor of the Bank of Greece. The Committee was given control over the issuance of money, and the authority to allocate credit among sectors and activities as well as to determine lending terms. After suffering through World War II and the civil war, the economy was in ruins. The hyperinflation produced long-lasting effects on attitudes, and savers were unwilling to deposit their funds in the banking system. To help attract funds back to the banking system, the central bank sought to reestablish price stability. At the same time, the Bank of Greece was also called upon to support economic reconstruction and to help lay the foundations for growth. However, circumstances were difficult, since certain factors, including substantial expenditures on defense, social policy, and support of the agricultural sector, caused strong growth of the money supply. The Bank’s task was made even more difficult in view of the country’s underdeveloped financial markets. Yet, the Bank was successful in conducting a tight monetary policy. This, together with the decline in fiscal deficits, resulted in inflation falling dramatically, from over 40 per cent in 1948 to 5 per cent in 1952. This created suitable conditions for a reform in exchange rate policy. In April 1953 the drachma was devalued by 50 per cent against the US dollar and then joined the Bretton Woods system of pegged exchange rates. In the following year, another “new” drachma was introduced and set equal to 1,000 “old” drachmas. Coupled with the nominal anchor provided by the Bretton-Woods system and tightened fiscal policy, the “new drachma” played a key role in reducing inflation expectations. During the next fifteen years real GDP growth averaged 7 per cent, one of the highest in the world. At the same time, average inflation in Greece was less than 2.5 per cent, confirming that strong long-term growth is not feasible without price stability. The Bank of Greece not only helped restore and maintain monetary stability, but its interest-rate policy was decisive in channeling private saving to the banking system. The nominal anchor of the Bretton Woods system proved unsustainable in the long term. Pressures to finance the Vietnam war led to an expansionary monetary policy in the United States and inflationary pressures spilled over to the rest of the world. This, along with the inherent weaknesses of the arrangement, proved the undoing of the Bretton Woods system, which broke down in March 1973. Once again, the lesson that there is a need to separate monetary policy from political influences had to be re-learned. The drachma’s link to the US dollar was maintained up to the spring of 1975. The decades of the 1970s and the 1980s were difficult ones for policy makers worldwide. Among other things, they had to deal with two oil price shocks in 1973-74 and in 1978-79, an international debt crisis in the early 1980s in Latin America and a global stock market crash in 1987. Particularly during the 1970s, Keynesian ideas, which, to some extent, downplayed the connection between monetary policy and inflation, were at their peak. In Greece, during the second half of the 1970s and the 1980s, the central bank conducted monetary policy under difficult circumstances, as the policy mix was often inappropriate. Compounding the difficulty of the Bank’s task was the fact that the financial system operated under a complex framework of rules and provisions, which proved not only ineffective, but also distorted credit allocation and limited the scope for conducting an effective monetary policy. The abolition of the Currency Committee in 1982 and the transfer to the Bank of Greece of its functions in the fields of monetary, credit and exchange-rate policies as well as banking supervision marked the beginning of a new era in the Bank’s history. With broader responsibilities, beginning in the mid-1980s and until the mid-1990s, the Bank of Greece undertook the leading role in the deregulation of the financial system. Financial liberalisation was a gradual process, however, so that the lifting of controls could take place in tandem with the restructuring of the economy and thus avoid the potentially destabilising effects of abrupt and sharp reversals of international capital flows. This strategy proved wise; in the 1990s many Asian economies, which had not given sufficient consideration to sequencing, were exposed to severe financial crises. After financial liberalisation in Greece had been completed in the mid-1990s and up to entry into EMU and the adoption of the single monetary policy in January 2001, the Bank of Greece had at its disposal more effective and flexible market-oriented means of monetary control and was able to react quickly and effectively to changes in economic conditions. The supervisory functions of the Bank have also changed considerably, shifting from the task of ensuring commercial banks’ compliance with credit and exchange controls and regulations, to the monitoring and the evaluation of bank asset quality, and the solvency and capital adequacy of these financial institutions. During the late 1980s and the 1990s, a substantial shift occurred in thinking about the role of the central bank in the economy. Experience of past episodes of hyperinflation in various countries, as well as of moderate inflation, exemplified in the breakdown of the Bretton Woods system, led to the finding that monetary policy is not necessarily independent of the government of the day. Sometimes central banks have to finance government spending and this results in higher inflation and, ultimately, lower growth. Thus, the views that the goal of monetary policy should be to provide price stability and that the central bank should be made an independent institution in the pursuit of this goal gained ground. These ideas underpinned the monetary policy of the Bank of Greece in the 1990s as it sought to support the effort to satisfy the Maastricht Treaty criteria and to join the euro area on 1st January 2001. The Bank’s ability to attain its goals was considerably improved by the abolition of the monetary financing of the fiscal deficit, mandated under the Maastricht Treaty, in 1994, and the law, enacted in 1997, granting independence to the Bank of Greece with a mandate to achieve price stability. In an effort to bring down inflation, in the mid-1990s the Bank adopted a “hard-drachma policy”, under which the exchange rate was used as a nominal anchor. Real interest rates were kept at high levels to help ensure the success of this policy. The hard-drachma policy operated, at times, under difficult conditions, yet it proved highly credible and immensely successful. Ironically, the source of the difficulty was related partly to the success of the policy. The policy’s credibility led to enormous inflows of foreign capital, complicating the conduct of monetary policy. The Bank was able to neutralise these inflows, absorbing excess liquidity and thus buying time for other policies to adjust. Within three years of the policy, inflation was more than halved, falling to under 5 per cent, while economic growth accelerated sharply. The fiscal consolidation that took place beginning in the mid-1990s, and moderation in wage increases, contributed importantly to an increasingly-sustainable policy mix, enhancing the credibility of monetary policy. With the outbreak of the Asian financial crisis in late 1997, and its spread to other parts of the world, there were pressures on the drachma. The Bank of Greece initially raised interest rates to stem these pressures. Then, in March 1998, the drachma entered the Exchange Rate Mechanism of the European Monetary System, so that it could satisfy a Maastricht criterion, and was devalued to help maintain international competitiveness. Unlike the currency devaluations in many other countries around this time, the drachma’s devaluation was not followed by the aftershock of a banking and financial crisis. A well-supervised Greek banking sector, with adequate prudential regulations in place, limited the exposure of commercial banks to foreign currency risk and, therefore, safeguarded the financial system. In the years following the drachma’s entry into the ERM, the Bank of Greece maintained a tight monetary policy so that the inflation criterion of the Maastricht Treaty could be satisfied. Fiscal policy continued to be tightened and wage restraint was maintained. With an ever-more-balanced policy mix, real economic growth accelerated. The rest, is history. On 1 January 2001, Greece became the 12th member of the euro area, where price stability is entrusted to the independent European Central Bank and the Eurosystem. The Bank of Greece is now part of a larger family, the Eurosystem, and continues to exercise extremely important functions. It is an integral part of the Eurosystem, which comprises the European Central Bank and the national central banks of the euro area. The Governor of the Bank participates in the ECB’s Governing Council, which, among other things, sets monetary policy for the euro area. The Bank is responsible for implementing monetary policy in Greece and ensuring the smooth operation of the payments system, which it runs and which is part of the EU’s Target System. The Bank also is in charge of supervising the banking system and maintaining financial stability With the opening of financial borders in the euro area, these functions will take on added importance in the coming years. In carrying out its responsibilities successfully the Bank has benefited enormously, in the present and in the past, from an extremely well-trained and highly dedicated staff. In my view, this has been the key to its success. Such has been the journey of the Bank of Greece during the past 75 years. As you can see, in common with the experiences of other central banks, the journey has not been without bumps and turns along the way. Yet, the history of the Bank demonstrates that the Bank has always fulfilled its obligations and, in so doing, it has earned the trust of the Greek citizens. In the early part of the last century, the famous Swedish economist, Knut Wicksell, said that “Monetary history reveals the fact that folly has frequently been paramount; for it describes many fateful mistakes. On the other hand, it would be too much to say that mankind has learned nothing from these mistakes”. I might add that in recent years we have learned a great deal from the mistakes of the past. As confirmed by the history of the Bank of Greece, the role of central banks, both institutionally and in actual practice, has been upgraded in such a way that it contributes to the improvement of living standards. Ladies and Gentlemen, thank you for your attention.

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Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Second International Banking Forum for the Southeast European Markets Economist Conference, Athens, 4 December 2003.

Panayotis Thomopoulos: The financial environment in Southeast Europe Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Second International Banking Forum for the Southeast European Markets Economist Conference, Athens, 4 December 2003. * * * It is a great pleasure to address this Banking Forum at this juncture as I believe that the economies are turning the corner and can now start enjoying the benefits of stability and growth within the framework of closer ties with the European Union. After a difficult and hesitant start in the 1990s, there is now clear evidence that the transition economies of Southeastern Europe have improved their macroeconomic management and enhanced their financial systems so that they can look forward to sustained and high-quality growth. Greece, as the only member of the European Union in the region, has a clear interest in promoting the stability and growth of all our neighbors, and I can be proud that both the public and the private sectors of Greece have played a role in the emerging success story of Southeastern Europe. We see our neighbors' economies mainly as complementary to our own, not as competitors, and the many Greek businesses that are active in the region, especially in the financial sector, are proof of the increasing collaboration between my country and its neighbors. I believe that Greece will continue to make a positive contribution to the economies of the region, but, I must admit, that I draw comfort from the fact that Greece is now surrounded by open, dynamic economies, and I would add friendly countries. It would be an understatement to say that we have turned a page of our history. In effect, the collapse of communism ended not the thirty, or hundred years wars, but more than one thousand years of intrabalkan conflicts and Greece is fully supporting Balkan countries' E.U. membership, which would further strengthen the political and economic ties between all Balkan countries. Let me start with a short look at the international environment that the countries in Southeastern Europe are facing. The overall economic situation has improved significantly during the last few months. After months when expectations of a recovery were based mostly on so-called "soft data," like surveys of consumer and business confidence, we are now seeing real "hard data" that point to the resumption of growth in all the main regions of the world economy. All members of the EU have now emerged from recession, although the growth rate is not what we would have wished it to be. Growth in the eurozone should accelerate slowly, and within the next year the growth rate should gradually approach its potential, estimated at around 2 ? % per annum. The US, on the other hand, is growing fast, maybe too fast. Certainly, I do not wish to belittle the achievements of the American economy, especially its high productivity growth, but the continuation of the twin deficits are certainly a cause for concern, in that a sudden correction could have far-reaching implications for the international financial system. The US sees with benign neglect its twin deficits. On the one hand, it expects that continuing fast rate of growth would generate sufficient tax revenues over the medium term, which, in combination with the gradual phasing out of some tax relief measures, will reduce the deficit and, on the other hand, they expect the current balanced of payments correction to be realized via a devaluation of the US dollar, which would help the sustainability of the US recovery and generate higher profits in dollar terms from the US investments abroad. In summary, they don't expect an abrupt and substantial rise in interest rates, which would have had adverse effects both on the fiscal deficit and on consumer demand, thus precipitating a cyclical downturn. However, the European point of view, if I am allowed to summarize, is that an unsustainably fast growth rate, based on private and public borrowing is not good for anyone and the US cannot be an exception. The EU, and especially the eurozone, has played a constructive role in promoting a stable financial environment. The recent appreciation of the euro is an indication of the markets' confidence in our economies. I believe that a strong euro is good for Europe and the world, as it helps fight inflationary pressures and supports the confidence of consumers and producers. It is also clear that the eurozone cannot solve all the imbalances that threaten the stability of the international economy. I do not wish to enter the debate on whether the fiscal stimulus in the US was necessary two years ago, at the onset of the economic slowdown, but certainly it has to be reversed now as the US is growing at an unsustainable rate. At the same time, third countries, especially those in Asia, should contribute themselves by allowing market forces to play a greater role in the determination of their exchange rate, and by abandoning their mercantilistic attitudes. However I should mention that, there is an open debate whether a revaluation of the chinese renminbi is at present appropriate, given, on the one hand, the fact that it will make relatively small difference, as far as it concerns China's trade surplus, if the chinese wage expressed in US dollars from about 10% of the US or EU average wage rises to 15% or 20% as a result of the revaluation, and on the other hand, a revaluation could lead to a deterioration of the already Chinese banks' fragile conditions and would also make more expensive the acquisitions of Chinese factories, commercial sites, etc by foreign investors. One positive development that I cannot stress enough is the absence of any challenges to the financial stability in Europe and the US. Unlike the situation in the early 1990s, we have recently gone through a period of a prolonged and synchronized slowdown, made worse by geopolitical risks, with no major financial institution being impaired. There have been of course problems, especially in the European insurance sector, exacerbated by natural catastrophes, but all financial institutions have managed through. Undoubtedly, those who make mistakes, or are simply unfortunate, suffer in a market economy. Nonetheless, such problems, whenever they surfaced, were contained and did not have systemic repercussions that could threaten the macroeconomic stability of our economies. Indeed, in our E.U. economies we have long recognized the key role of the banking sector and its health has been a constant preoccupation of the authorities, especially of Central banks which, even those not directly involved in supervision, have a wider responsibility for the good functioning of the financial system as a whole and the payment systems. We have been building sound banks, which not only can withstand successfully cyclical pressures and other kinds of shocks, but also they bring crucial support to the economy when failures appear in other, less important, parts of the financial system. The bursting of the stock exchange bubbles and the subsequent substantial decline in their capitalization, in certain countries amounting to as much as 30 to 50% of GDP, produced relatively little damage and which was, moreover, contained thanks to the banking sector. Likewise, as a result also of what I would say, the least, "not very prudent policies" the significant losses of insurance and re-insurance companies in the last few years have been partly absorbed by the banking sector, which responded promptly to their needs for liquidity and capital injections. The banking sector in some countries has unwillingly assumed the responsibility for the well being of the financial sector as a whole, because it understands the danger of systemic risks, that can wreak havoc. I cannot pretend that there were not tensions here and there, or losses due to the write-offs of nonperforming loans, to plummeting share values and to laying off costs, but only a few banks posted operating losses and, moreover, those, as a rule, were relatively small. Even today, after three years of a downturn, the capital adequacy ratio, has remained well above the minimum 8% in almost all cases, and for the E.U. as a whole the average is above 10%, which underlines the good health of the banking system. Moreover, it is expected that it will continue to improve as the recovery gets underway. Here, I wish to repeat the very positive role of Central banks, which, almost all were over more than 50 years, and many of them still are the supervisory authorities. Indeed, central banks succeeded in creating a competitive and sound banking system in Europe during the last fifteen years or so, during a period characterized by liberalization in financial markets and intense competition both within Europe and from the US banks. The lesson I draw is that with the help of their natural interlocutor, the central banks, the private sector has become more adept in dealing with risks and the supervisors have learned from the mistakes of the past and improved their vigilance. Looking ahead, the new prudential practices to be introduced under Basel II will further improve our ability to deal with financial risks and better tailor our prudential requirements to each market's special needs. Another positive development is the diminishing danger of contagion, as we have seen after Argentina's default, which did not lead to widespread withdrawal of funds from emerging markets. This is particularly significant for the emerging market economies in Southeastern Europe, which look to a greater integration in the world economy without the fear of being hit by a crisis that originates elsewhere. All this of course, provided they maintain healthy fundamentals. Turning now to the developments in the Southeastern Balkans themselves, the present situation is a far cry from the bleak picture at the early stages of transition, more than a decade ago. Apart from often-bloody conflicts, hyperinflation and financial stability seemed endemic in the region only a few years ago. Regarding the financial sector, starting from an initial position with practically no commercial banks, the countries in the region faced problems that were often beyond their administrative and regulatory capabilities. Financial institutions were reformed with insufficient regulation and unclear focus and expansion was associated with improprieties, scandals and fraudulent schemes during the early stages of transition. Therefore, the financial sector was unable to attract deposits and develop extensive client networks. Finally, state banks were compelled to carry a high number of non-performing loans, which had been accumulated by the government subsidization programs to state run enterprises. The development of the financial sector was hampered at the beginning by inadequate macroeconomic management. Fiscal deficits were mostly excessive, and often monetized, and the inevitable outcome was high inflation. It is encouraging that in the last few years we can see clear evidence of maturity in economic management. The path to macroeconomic stabilization was different for every country. In the region we can now observe all types of monetary and exchange rate regimes, from formal euro-ization and currency boards linked to the euro, all the way to monetary targeting. This is proof, if proof was needed, that there is no single solution, to economic problems but that the policies of each country should be tailored to its specific needs. Going beyond the diversity of the region, at this point I would like to underline two characteristics of the financial system of practically all countries in the region, which are the result of their past, but will also shape their future developments. The first is extensive currency substitution. As a result of past inflation, but also because of the large numbers of people working abroad, foreign currencies, and especially the euro, play a large role and they have often become the main currency in use. One can gauge the degree of currency substitution by noting that in all countries in the region deposits in a foreign currency account for at least half of all bank deposits. One must add to this, money "kept under the mattress" and capital flight. Undoubtedly all these were a vote of no confidence in domestic policymakers. People showed their dissatisfaction with local financial institutions and monetary authorities by moving their savings abroad, or by using other, more stable currencies. This high degree of currency substitution can only be found in some Latin American countries and undermined the effectiveness of monetary policy. The ability of monetary authorities to extract seignorage was severely limited, and this is a partial justification of the high inflation rates. At the same time, monetary management became more difficult, as small shocks had a disproportionately big impact on inflation and the exchange rate. In some countries, namely Bulgaria, the extent of hyperinflation and currency substitution left little alternative to the authorities but to accept the reality and move to a hard peg in the form of a currency board linked initially to the Deutschemark and now to the euro. Similar regimes were also imposed on Bosnia, after the Dayton Accord, and Kosovo. The euro is an appropriate anchor for an exchangerate-based policy in these countries, as they are closely integrated with the countries of the eurozone. Most of their transactions, not only trade-related, but also workers' remittances, official transfers and financial transactions are with countries of the eurozone. A measure of macroeconomic success is the receding level of currency substitution. In 2002, the last year for which we have full data, bank deposits in foreign currencies fell as a proportion of total deposits in all countries in the region, sometimes quite fast in countries with strong performance in the context of monetary or inflation targeting, with only one exception. This is indicative of a growing trust in the domestic currency and the effectiveness of stabilization. It is all the more important that this achievement should not be squandered, and that prudent macroeconomic policies should continue. Nonetheless, I would like to warn of possible problems, especially in those countries that have tied their exchange rate to the euro, one way or another. The weakness of the euro until last year undoubtedly helped both their growth performance and their external competitiveness. From now, in a period of strong euro they will have to rely more on domestic productivity gains and structural adjustments to maintain their growth rates. In addition, and as growth takes hold in advanced economies, countries in the region will have to adjust to interest rates higher than their current historically low levels. An area where much remains to be done is the area of developing an efficient and stable financial system. In this respect, the economies in the region lag behind the other transition economies that are due to join the EU next year. The public sector still controls a substantial part of the banking system, and there is an obvious need to continue the efforts to privatize the remaining state-controlled banks. As in most transition economies, state interference has not been a stabilizing factor, quite the opposite. State controlled banks have often lost substantial sums in politically-motivated investments and have contributed to systemic crises in all those countries. As in other transition economies, we can foresee that an increasing number of banks will been taken over or become affiliated with foreign ones. Setting aside nationalistic prejudices, I think this should be seen as a welcome development as a whole, provided the foreign entrants are strong and wellsupervised financial institutions. In the acceding countries of Central Europe foreign banks already play a major role after the crises that hit those countries in the late 1990s, and the overall experience has been positive. (Foreign banks control more than 80% of the domestic market in a few central european acceding countries). Foreign banks bring with them many advantages, especially in the case of countries with a limited experience with sophisticated financial markets. At first, they have access to better know-how and technology. More importantly, they are mostly immune from political interference. While local participants are often intimidated or pressured to give loans to well-connected borrowers, foreign institutions generally feel stronger to resist such pressures. Also, foreign banks are considered "safer" by local depositors, who recognize that they are not manipulated by the political authorities, and who also understand that foreign banks are supervised by the more experienced supervisors at home. Finally, experience with other emerging markets shows that foreign banks are better able to withstand losses in cases something goes wrong. The international evidence shows that banks affiliated with ones from advanced economies have access to capital at lower cost than local ones and can be recapitalized faster and more easily than the others. Of course, foreign banks may have its disadvantages. Foreign-owned financial institutions may lack understanding of how the local market works. Indeed, it has been noted that such banks often tend to concentrate on financing affiliates of foreign firms, or only large local firms. There is thus a danger that local small and medium enterprises may find their access to credit curtailed. There is also the possibility that foreign-owned banks will alter their credit based not on the local conditions, but on the conditions in their home economies. Indeed, in Greece we have observed that foreign banks have entered the market and subsequently they expanded or left in a haphazard way, not on the basis of local conditions or profitability, but mostly on the basis of wider strategies whether to expand globally or not. Formally, we can say that this increases the correlation of emerging markets with the outside world. Research shows that the operations of financial multinationals are becoming a major channel for the transmission of business cycles. For that reason, economies in the Southeastern Europe will find that their economies are more and more affected by what is happening in the rest of Europe than with what is happening locally. Although at times of local euphoria you may regret being held back by the European business cycle, over time the benefits of becoming tied to the more stable economy of the eurozone will become overwhelming. This is especially so for countries that are applying for EU membership. Greater synchronization with the European cycle will smooth their path towards full membership. Foreign ownership of banks will also allow a greater risk diversification than what might be achievable by small local banks whose whole portfolio is locally invested. Foreign banks can thus behave in a less riskaverse way than local ones. The issue of financial stability and proper supervision is very important for us, at the Bank of Greece, as Greek firms have invested heavily in our neighboring countries. In most of them Greece is among the five biggest suppliers of foreign direct investment. Of course, this has to some extent caused delocation of greek companies, with a negative impact on investment and employment in Greece over the short to medium-term, but for an economy growing at almost 4% p.a. since 1997 and with an investment GDP ratio of 24% delocation does not pose a serious threat to its long term performance. Looking at the data in preparation for this speech, I was amazed by the number of branches of Greek banks in our neighboring countries. This shows that Greek banks have entered planning to offer a wide range of services and they see their future closely linked to the evolution of the host economies. They are not entering in order to concentrate in just a few lucrative activities and offer services to other Greek firms. The positive effects of the presence of foreign banks predicted by theory are supported by the experience of Greek banks in the countries of Southeastern Europe. Greek banks are already wellestablished in Bulgaria, Romania, Serbia-Montenegro, Albania and FYROM, representing at least 20 percent of the banking system according to assets and in some of them their share is between onethird and two thirds. Overall, they are better capitalized than their competitors, something that could be expected as they have access to a more diversified source of funds. Their better capitalization allows them to take somewhat higher risks, as shown by the fact their loans to the private sector are generally a higher share of their assets than for the average bank. Although they take somewhat more risk, they are profitable overall, more than their average competitors. This signifies that Greek banks in the region have some comparative advantage, either in the form of access to capital markets, or because of superior organization and know-how, and good understanding of local conditions. While Greek banks play a major role in the neighboring economies, their exposure to these economies is generally small. For no Greek banks does the exposure to Southeastern Europe exceed 3 percent. This is simply a reflection of the different levels of development in Greece and nearby countries. The result is that while Greek banks face little risks from their exposure to these economies, they themselves are important for the stability of the financial system in the Balkans. In the Bank of Greece we are well aware of this, and we take our responsibilities to our neighbors very seriously indeed. As home country supervisors we recognize that our ability to exert prudential supervision has effects beyond Greek borders. In recent years we have signed several agreements, in the form of memoranda of understanding, and we are discussing some further ones with other supervisors in the region in order to enhance our ability to ensure the stability of the banks under our jurisdiction. What is needed, beyond formal agreements, is the confidential and frank exchange of all information among supervisors in order to identify problems early on, before they become threatening. In this era, we should also be vigilant to avoid abuses of the financial system for illegal activities, such as money laundering and terrorism financing. Of course, we take comfort from the fact that the Greek banks that have expanded in the Balkans are quite strong, well above the necessary prudential ratios. Actually, the fact that Greek banks have been able to retain a very high share of their local market is also an indication that they have some comparative advantages that allow them to thrive in an internationally competitive environment. I must admit that our interest in the stability and growth of our neighbors is to some extent a reflection of selfish instincts. We realize that strong and growing economies in this region are not only useful for the Greek economy, but also a prerequisite for the political stability of the Balkans. I mentioned before that the presence of foreign financial firms in the Southeastern Europe would transform their business cycles. But it works the other way round. Greece's orientation toward the dynamic economies in our region has helped us somewhat weather better than most the recent economic slowdown. In a very specific way, one can see the growing interlinkages in the Balkans as evidence of how trade in goods and financial services can help growth and stability. Looking ahead, the challenges for our neighbors remain formidable. Now that the first steps towards stabilization and growth have been taken, what lies ahead is the more difficult issues of managing an emerging economy. Top of their priorities I would like to put the improvement of their governance structures, the further deregulation and privatization and the strengthening of the respect for property rights. I should end by saying that they can count on our continued support.

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Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Euro-Mediterranean Seminar, Eurosystem and Mediterranean country national central banks, organised by the Bank of Italy and the European Central Bank, Naples, 14-15 January 2004.

Panayotis Thomopoulos: Anti-inflationary exchange rate policy in Greece in the 1990s Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the EuroMediterranean Seminar, Eurosystem and Mediterranean country national central banks, organised by the Bank of Italy and the European Central Bank, Naples, 14-15 January 2004. * * * I would like to thank the ECB and the Bank of Italy for the successful organization of this meeting. Greece has been for more than three thousand years at the cross-roads between North, South and Eastern Mediterranean countries and, we Greeks have been able to enrich our culture and ideas from our relationship with all the nations around the table and I am sure that to-day’s exchange of experiences will be to the mutual benefit of all present. I look forward to an even closer cooperation in the future between the Eurosystem, with the ECB taking the appropriate initiative, and the rest of the Central banks from the other regions of the Mediterranean. When the Maastricht treaty was signed, Greece was meeting all the criteria of a country in crisis. Stagflation, with mounting macro-economic imbalances, were the main characteristics of the economy. In the 15 years up to 1993, average inflation was almost 17%, GDP growth was barely 1% per annum, while the fiscal deficit was creeping upwards reaching some 13,5% of GDP by 1993 and pulling up the debt - to - GDP ratio to over 110%. It was, therefore, not surprising that the government’s commitment to prepare Greece for the satisfaction of the Maastricht criteria in 1999 and membership of the Euroarea by 2001 (2 years after its creation) was received with disbelief by almost all foreign and domestic observers. From the beginning of 1994, when the new stability oriented policy was initiated, a managed exchange rate was a key policy plank in the stabilization process and contributed importantly to disciplining economic agents and setting in motion wage and price restraint, which brought the rate of inflation down to some 2% on average in the twelve months to early 2000 thus making possible our Euroarea membership. Between end 1994 and early 1998, i.e. in the period preceding our ERM I membership, the Bank of Greece and the government had decided to follow a policy of managing the exchange rate by not allowing the drachma to depreciate as fast as was needed to compensate for the inflation differential vis-a-vis our trading partners. This was done purposefully in order to put a break on inflation and inflationary expectations, which in the past were strongly fed by the recurrent devaluations of the drachma, which, sometimes, more than fully accommodated the excessive wage and price rises. While there was some real appreciation of the drachma, the resulting disequilibrium was not as large as some argued, especially participants in the financial markets. Studies conducted by the Bank of Greece indicated that the real overvaluation of the currency was of the order of 10 percent after taking into account the Balassa-Samuelson effect and a number of other factors. This anti-inflationary exchange rate policy started having its impact on inflation after less than one year and was accompanied by other policy measures, with the result that domestic disequilibria were narrowing and our policy was gradually gaining credibility. This permitted the government to persuade the labor unions to abandon the backward looking wage indexation scheme, which by its nature had perpetuated the inflationary spiral for years and instead to move to forward looking wage increases, based on the continuously declining annual inflation target set by the government. Lower inflation was, in turn, facilitating fiscal consolidation as a result, of (a) the progressive narrowing of the very high interest rate risk premia on government debt and, (b) the actual decline in interest rates in line with inflation. As a consequence, government expenditure on interest payments fell from 13% of GDP in 1993 to less than 7% in 2001, when Greece joined the European Union. Falling inflation was also making our managed exchange rate easier to operate. However, we were conscious that an exchange rate adjustment would have to take place at the time of joining the ERM I, so as to offset the loss of external competitiveness reflecting the previous few years of real appreciation of the drachma. We had fixed 10% as an upper limit for the real appreciation, because, first, a moderate appreciation would not frighten the markets and, second, the subsequent necessary correction of the exchange rate would be limited. We were aiming at a limited correction that would not impact unfavorably on other macroeconomic variables, in particular inflation and would not generate expectations for further depreciations. Indeed, central banks which follow a managed exchange rate policy have to be very careful not to allow a big appreciation of the real exchange rate, that would subsequently open the stage for big speculative attacks, which because of the usual overreaction of markets could trigger capital flight. Indeed, there are numerous examples, starting with Argentina and going backwards, that capital flight on the one hand, deprives the domestic economy of much needed investable funds and, on the other hand, drives the exchange rate to abnormally low levels, which immediately set the stage for a wave of price rises and drive the economy into recession. If this situation is allowed to develop the original anti-inflationary exchange rate policy would ultimately cause much more damage than if a pure free floating policy was followed. Anti-inflationary exchange rate policies, which aim to eliminate imbalances and disequilibria, so as to improve domestic economic performance, inevitably entail a cost. There is no free lunch in a global and competitive world, especially when market makers are, sometimes, enticed by speculators and wild rumors. Indeed, for almost 4 years the cost, borne by the Bank of Greece, of sterilizing the excessive short-term capital inflows attracted by the high interest rate policy, in combination with the exchange rate policy amounted to almost ½% of GDP per annum. Furthermore, the government proceeded with fiscal consolidation and structural reforms as well as other measures which were introduced (notably extensive privatization) as a necessary complement to the anti-inflationary exchange rate policy. These policies underpinned the improvement in the functioning of the economy and gave a significant boost to business confidence. The determination with which the three Cs were pursued - consistent policies, continuity in policies and confidence building, after two to three years of hesitation, swayed the labor unions, businessman and the public at large to back the stabilization policies with the aim of entering the Euroarea as soon as possible. In addition to targeting the exchange rate, the Bank of Greece always kept a close watch on the growth of M3 and domestic credit expansion and through open market operations absorbed any excess liquidity, which, if it had been allowed to reach the real economy, could have aggravated inflationary pressures. Moreover, when necessary, we also imposed stricter terms on banks’ obligatory reserve requirement deposited at the bank of Greece, which were already relatively tight (an amount equal to 12% of deposits with the banking system and it can be noted that they were remunerated at a negative real interest). However, at the Bank of Greece we knew that this was not sufficient to ensure a smooth run up before entering first the ERM I and subsequently the Euroarea. Speculators are always waiting round the corner and, sometimes, markets may wish to test the country’s resolve to maintain its exchange rate targets. Therefore, we followed throughout the six years before entering the Euroarea a high interest rate policy so as first to keep foreign investors happy and keep their confidence but also in order to build a high level of foreign exchange reserves so as to be able to have sufficient reserves to thwart speculative attacks. Indeed, when the 1997 south-east Asian crisis spill over effects reached Greece in September-October and american hedge funds started speculating heavily (up to $2 billion daily) against the drachma and the word was spread that the drachma would devalue by as much as 28% we were able to defend our parity by drawing on our foreign exchange reserves and by raising interest rates temporarily, for a couple of days at a time. We were, however, concerned not to scare the markets, which might have perceived our moves as resulting from panic, and, therefore, we were very careful about how the policy tightening was presented. Instead of raising our intervention rate (lombard rate) from 19% to 330% we temporarily put a surcharge of 0,4% daily at the end of October. This move looked innocuous and passed smoothly, while penalizing heavily banks’ cost of borrowing. Accordingly, we sent the right signal to the market and this permitted us to eliminate the surcharge within a few days, so a quasi-normal situation was soon restored. We were also very careful in the way our foreign exchange interventions were executed. In most cases, we wanted to show our determination to defend the parity and, therefore, the Bank of Greece’s foreign exchange department intervened directly in the market but, sometimes, we judged that an intervention through a friendly foreign bank could be more persuasive and influence market sentiment better. Both the government and the Bank of Greece knew that our fundamentals were rapidly improving and our economy had entered a virtuous cycle of rapid growth, falling inflation and fiscal deficits and with relatively small current account deficits by past standards, so we did not hesitate even for a second, regarding our policies and goals. We became even more determined than before to continue our stabilization policies and defend the exchange rate so as not to delay our entry in to the Euroarea. Our determination paid off and foreign exchange markets after a few months of turbulence calmed down in early 1998. Conditions were then considered propitious to achieve our intermediate goal, to enter ERM I in calm waters accompanied by a small devaluation to correct the previous real appreciation. We succeeded in catching the markets by surprise and not being forced to make a devaluation under duress, with all its destabilizing effects. Moreover, the new ERM parity agreed with our EU partners was broadly consistent with Greece’s fundamentals and costs and productivity levels and satisfied the markets. And judging from Greece’s record of the last 6-7 years: an annual growth of GDP 3.9%, inflation at the end of 2003 at 3.1% only 1 percentage point above the Euroarea average, and a fiscal deficit at 1.5% of GDP in 2003, the exchange rate with which the drachma entered the ERM in 1998, and the subsequent conversion rate into the euro in 2001, were appropriate and reflected Greece’s overall competitive conditions. I would like to tell you how markets behave or rather misbehave: in the heat of speculation, many investment banks were spreading the word (even via the monthly bulletins they circulated and one of them through a teleconference in London) that there would be a devaluation of the drachma of up to 28%. We disproved the pessimistic views and the actual devaluation upon entering ERM I was 12,3%. Immediately afterwards market sentiment changed and the drachma traded at well above its central parity. As a result, the central parity was revalued later in January 2000 and the total devaluation by the time the drachma entered the Euro area was only 7,9%. The lesson that can be drawn from the greek experience is that a managed exchange rate policy needs to be consistent with the other policy planks, notably fiscal and structural policies which, in turn boost markets’ confidence and, therefore, facilitate the exchange rate policy. Confidence is crucial for the successful realization of the policy goals. As I mentioned above, the cost of sterilizing the excessive short term capital inflows (almost ½% of GDP) may appear at first sight too high, but the benefit of stabilization, notably the resulting sustainable investment-led high rate of GDP growth of almost 4% since 1997, which is expected to continue well into this decade, far outweigh any temporary sacrifice the economy incurred in order to fulfill our stabilization goals. The road to the Euro was not strewn with roses, it was not smooth and I don’t want to underestimate the difficulties. With regard to the sequence of policies and priorities, we took a calculated risk starting our stabilization policies by adopting a policy that allowed for a moderately appreciating real exchange rate. We walked on a tightrope, sometimes for months in a row, as there were occasional bouts of jitters based on market expectations, even until the last moment, that our Euroarea entry would be deferred or that we would join at a significantly depreciated rate. Accordingly, whereas our goals were ambitious, our policies erred on the side of caution. We made gradual adjustments and, as an insurance, always had at hand a sufficient large cushion of foreign exchange reserves and a relatively high interest rate differential vis-a-vis Euro rates, even until the last few weeks before entry into the Euroarea.

bank of greece

Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Economist Conference, Athens, 7 May 2004.

Panayotis Thomopoulos: Great expectations for 2004 - a year of optimism? Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Economist Conference, Athens, 7 May 2004. * * * I am glad that I can answer the question posed for this session in the affirmative. Yes, 2004 is a year of optimism, and, provided that appropriate policies are introduced, optimism should continue in 2005 as well. However, since we are living in a rapidly changing world, single global periodic shocks of various origins are, unfortunately, becoming a routine and since macroeconomic equilibria and “harmonious” growth are mirages, the answer cannot be a simple Yes. It is more propitious to say yes, but. Ôhe but refers to two factors. First, there are growing divergences in economic performance across the globe, with the result that the dividends of the recovery are not being evenly spread among the major regions of the world. Although the differences in economic performance can be attributed mainly to domestic factors, the policies of certain economic powers are also contributing to the sub-optimal performance of other regions. Second, looking further ahead, it is appropriate to sound a warning that in an uncertain international environment governments, central banks and financial supervisors as well as the private sector should not take for granted the recent good performance. Rather they should take decisive action to prolong this recovery and avoid the realization of downside risks. After three miserable years of below par growth, it is now clear that the world economy has entered a period of improving economic performance. World output is expected to increase by 4.6 percent this year, 50% faster than in the previous two years, while world trade, which practically stagnated in 2001 and 2002, will increase by nearly 8 percent this year. Although this performance falls short of the heady days of the late 1990s, it is a significant improvement over the recent past. This rebound now covers practically the whole world, albeit to varying degrees, with most major countries benefiting from accelerating growth. However again the rate of growth in certain regions will continue to be considerably below their potential rate. Even Japan is now looking forward to a durable recovery in part as a result of the decrease in banks’ contingent liabilities and of strong export demand, especially from China. Many Latin American countries have turned the page of distress and have been recording fast, though still fragile, growth. Argentina’s growth is impressive, some 10%, but unless it clears its foreign debt hurdle there is no guarantee that the recent performance will continue over the medium term. Russia and a few transition economies also show strong growth, although, as in the case of many Latin America countries, the boom in raw materials and energy prices has significantly contributed to this outcome. To a large extent, this world recovery is due to the strength of the Asian economies, which have overcome the trauma of the crisis in 1997-98 and are now growing again at rates around 6-7 percent. It is not only the Asian dragons and China (the latter leading with a rate of growth of slightly above 10% annually), but particular mention should also go to India, which is now reaping the benefits of the liberalization it introduced after the mid-1990s and is now growing at 7%, a rate more than double its customary 3 percent. It should be recalled that the US is also growing rapidly and its import demand has continued to be a source of growth for the world economy. Whereas some 10 years ago the E.U. was the main beneficiary of dynamic US demand, nowadays the center of gravity has moved to the Pacific rim. This is reflected in a rate of growth of world trade in the Pacific rim estimated at about 11% on average in 2003/2004, which is more than three times the corresponding rate of growth of the overseas trade of the EU. In 2003 more than one quarter of the increase in world trade was due to China, whose international trade grew at almost 40% last year. The east Asian tigers (Korea, Taiwan, Thailand, Malaysia) have been dwarfed by a Colossus which, however, has the vitality of a tiger. In order to better gauge the growing role of China in the world economy, assuming that its high growth rate continues, we can calculate that the annual increment of its GDP in the years to come is as if a country of almost the size of Spain (the 9th biggest market economy worldwide) was being integrated into the world economy every year. Accelerating growth is taking place in a non-inflationary climate, with price increases remaining at or below 2 percent in the developed world and in many emerging economies. We can now take comfort that we have, at least temporarily, tamed the beast of inflation that bedeviled our economies in the 1970s and 1980s, while the fears of deflationary pressures that were widespread last summer have certainly not materialized. These improvements are partly due to improved macroeconomic policies, but they also reflect fundamental changes as a result of new technologies, as well as a more competitive and pro-business climate all over the world. The rapidly growing share of world exports originating from the low labor cost countries (China, India and others) is also exerting a downward pressure on prices globally. The much-maligned dotcom bubble did reflect an improvement in technological possibilities, which we are now observing as increasing productivity in many countries. It is not for nothing that much of the global investment revival now comes from the technology sector. Within this overall booming environment, it is slightly distressing that the core economies of the eurozone remain the laggards. Although all European economies have now emerged from recession, the three main economies, Germany, France and Italy, will see very modest growth of less than 1 ½ percent in total this year. Certainly, this slow growth cannot be blamed on macroeconomic factors, which remain conducive to growth. The external environment is improving fast, monetary policy, as conducted by the ECB, remains supportive of growth, and fiscal policy, as reflected in an overall fiscal deficit in the eurozone of close to 3 percent, is expansionary. Even the euro’s appreciation has been halted and wage growth remains moderate at 2¾% annually. While it is easy to eliminate macroeconomic policy as the cause of slow growth in the eurozone, it is much more difficult to pinpoint the culprits of this sluggish recovery. Maybe there is no single cause, and the situation differs from country to country. Some eurozone members, like Italy, have difficulty adapting to a situation where the nominal exchange rate is appreciating and the country faces growing competition from low-cost producers in many of its traditional industrial sectors (textiles, shoe making, garments etc.). Prior to Eurozone membership, many, especially in the business sector, had taken it for granted that the exchange rate only depreciates. In other countries, the uncertainties induced by the stubbornly high unemployment rate and the slow progress in structural changes are depressing economic sentiment and are holding back consumption and investment, despite the marked improvements in corporate profitability across sectors in 2003 & 2004. I do not think that the Eurozone is facing the fundamental problems that Japan faced over the last ten years. It is more the confluence of many factors that exert a negative influence on our economies. Pessimism is one of them and has permeated many economic circles and is in itself a worrying phenomenon. This is reflected in the fact that the recent recovery, instead of being compared to stronger previous cyclical recoveries, is compared to the worst phases of the cycle - the declining output towards the end of 2002 and the first half of 2003. In the same vein, a very low potential rate of growth of barely above 2% per year for the Euroarea is considered by many as a normal benchmark against which outcomes are measured. Therefore, a 0,5% shortfall, i.e. a rate of growth in the Euroarea of about 1.5% as is projected for 2004, is implicitly considered broadly satisfactory, despite the fact that there is still a negative output gap. Given the interaction between actual GDP growth and potential growth, a sharper rebound of the Euroarea, as was the case in cyclical upturns in the past, would by itself have raised the rate of growth of potential GDP. Indeed, if assisted by bold structural reforms the rate of growth of potential in the Euroarea could be raised to over 2.5%, the same rate as in the 1980s and a rate more normal for mature economies. The potential rate of growth of the US has averaged just over 3% over the last twenty five years. If too much pessimism regarding the potential rate of growth dampens actual growth and, therefore, may to some extent be self-fulfilling, equally dangerous is over-optimism, or better (to use the famous words) irrational exuberance, that is quickly disproven. What is needed is a sober assessment of the situation and the introduction urgently of appropriate structural reforms, so that not only macro - but also micro economic policies are geared to supporting a stronger non-inflationary growth than today. Though the cause of to-day’s ills in the Euroarea are essentially of domestic origin, I hinted earlier that exchange rate policies followed by certain heavy weights in international trade have resulted in a real effective appreciation of the euro more than is warranted and, moreover, it seems that from a dynamic point of view the appreciation is much greater than the published figures show, which are necessarily based on past data. As a result, whereas the Euroarea, one of the richest regions of the globe should have had a sizeable current account surplus so as to fulfill its natural world role as a sizeable capital exporter (a surplus would also be expected because of its weak cyclical phase), the current account surplus of the Euroarea has averaged only $17 billion annually since 2000, compared to $26 billion for China and $ 80 billion for the dragons, whose per capita income is still relatively low. Of course, if Euroarea growth was faster, this aspect would not be so important since more market determined exchange rates in these countries would probably only add not more than one quarter of a percentage point to Euroarea growth. However, with average growth in the Euroarea of less than 0.7% in 2002/2003, even a small stimulus matters. In this context I would like to say something about the Greek economy itself. Unlike our partners in the EU, we are now enjoying strong growth that will stay close to 4 percent this year as in the last five years. Admittedly, the stimulus from the forthcoming Olympic Games and the inflow of EU structural funds has contributed to the good economic performance; but I think it is true to say that endogenous factors have been significantly more important. Public expenditure on the Olympic Games, amounting to just over 1% of GDP in the last few years, has also had the negative effect of raising the fiscal deficit to about its upper limit of 3%, set by the European Treaty, and has also intensified inflationary expectations. As a result external competitiveness will again probably be eroded somewhat in 2004, in turn restraining GDP growth. As for financial support from the E.U., it is worth mentioning that net inflows from the E.U. have fallen from over 5% of GDP at the end of 1990s to 2.8% in 2003. The Greek economy has succeeded in absorbing this negative shock without strains and the probable further decline in net E.U. funds, after 2007, which is related to E.U. enlargement, does not pose a serious threat to growth. Against these negative influences there is an array of positive factors, starting from the fundamental changes in the economy that have occurred in the last fifteen years and are easily visible to the naked eye. Not only is the economy functioning more efficiently, and reflecting a high investment-to-GDP ratio of 26%, the capital base both in the private and public sector has broadened and deepened, but also business initiative is on the rise, and the factors in combination with the removal of exchange rate risk and low interest rates creates a more stable environment and helps promote both consumption and private investment. Greece, being close to the fast-growing economies of Eastern Europe and the Balkan area, benefits from its ever-improving economic links with them and is becoming a hub for many of them. We are also seeing the first fruits of the heavy infrastructure investment and structural reforms we undertook in recent years, which underpin a relatively fast rate of underlying productivity growth, at almost 3%, or nearly three times that of the Euroarea. While some deceleration of growth immediately and for a short period after the Olympics may occur, I remain confident that Greece will stay on a dynamic growth path for years to come provided that fiscal consolidation accelerates and bureaucratic blockages are eliminated. While one can be fairly confident about the world economy’s prospects for 2004, I have already hinted that challenges may emerge in 2005 and beyond. Real GDP growth is not expected to accelerate in 2005, while the downside risks loom larger. These challenges are a bit further down the road, but in a fast-moving world prevarication is not a good strategy and I shall mention the most important: Certainly, the largest threat looming over the world economy in the medium-to-longer term is the “twin deficits” in the US. The fiscal deficit is the most worrying and despite plans for a drastic cut over the next few years, it may be difficult to achieve it in the light of the U.S. involvements worldwide, the likely increase in the interest rate on Treasury Bills, and a projected slowdown of economic growth from the high rate of 4.7% estimated for 2004. Only ambitious measures could make a significant dent in the fiscal deficit and this is needed both for the US and for the stability of the world economy. A decline of the fiscal deficit will by itself reduce somewhat the current account deficit. But, given the asymmetry between the high income elasticity of demand for imports in the US of over 2 and the low foreign income elasticity for US exports only of 1, only a partial correction is possible. Elimination of the current account deficit cannot, therefore, be envisaged under present conditions and, moreover, it is not needed. Given the safe heaven status and high profitability in the US, financing the balance of payments deficit is less of a problem. Indeed the fears that the deficit would trigger further rapid depreciation of the US dollar, equal to that seen in the last two years, have not materialized and most likely will not materialize. The world is finally getting accustomed to the idea that a structural deficit of around 3% of GDP over the medium term can be sustained, and this should be the goal. The rise in the price of oil close to $40 per barrel is a serious threat to the world economic recovery and needs to be urgently addressed. If maintained, such a high price could impact negatively to the tune of 0.5% of GDP over the next eighteen months and will exacerbate inflationary pressures. Fast rising world demand, especially in China with its low energy and raw-material efficiency (as in the case for energy in the US), is an important factor behind the steep rise of oil and particularly of raw and intermediate material prices. On the supply side, the policy of some big oil producing countries, which have subordinated the goal of a stable international environment conducive to sustainable growth world-wide to their short-run need for revenues to cover fiscal deficits, is also contributing to the maintenance of high oil prices. Political factors may have also played role in the changing attitude of some producers. The rise in oil and raw material prices is accentuating inflationary pressures and may lead to a premature monetary policy tightening in many countries, especially if these pressures are allowed to spill over to wages. Such a move would definitely lead to even slower growth than the mechanical impact of the rise in the oil price would suggest. Especially in the US, which has followed an expansionary monetary policy in the last few years, a rise in interest rates may have a strong cumulative impact on growth. Though such a development would help reduce the current account deficit it will certainly make fiscal consolidation in the US even more difficult. Last, but not least, Chinese growth may slow, but this is a welcome development since recent very strong growth was exacerbating disequilibria in China and world-wide. The authorities seem to have realized that growth close to 10-12%, as recorded in the last few quarters, intensifies inflationary pressures and encourages investments in uneconomical projects, which have no chance to service their debt. The official inflation rate of 3% is being questioned in financial circles, which estimate that actual inflation is closer to 6% and if we include real estate and asset prices, inflation probably is even higher. Recently, the central bank tightened monetary conditions and introduced credit restrictions and the authorities ordered the postponement and even cancellation of many projects not only in order to prevent overheating but also in order to encourage banks to clear their non-performing portfolio and increase their capital base. The authorities seem also to be considering an appreciation of the renminbi, though not immediately, which would ease inflation and contribute to a better management of their financial resources. We have to see whether these measures will contribute to a soft-landing, thus allowing China to avoid the bitter experience of some of its neighbors in 1997-1998, when their credit and asset inflation bubble burst. The rate of growth of potential output in China is estimated at around 7% per annum, which is still high, and thus China will continue to be a dynamic player in the world economy, while at the same time help to stem the rising disequilibria world wide.

bank of greece

Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Euromoney Conferences, Athens, 24 November 2004.

Panayotis Thomopoulos: Post-Olympic Greece 2004 - infrastructural development and financial innovation Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Euromoney Conferences, Athens, 24 November 2004. * * * Ladies and Gentlemen, It is a rare opportunity to be able to address a distinguished audience as this one on such a topical issue as the future of Greece in the post-Olympics era. In everyone’s mind there is the question whether Greece can sustain the relatively high level of growth achieved in recent years now that the demand stimulus coming from the preparations for the Olympics has come to an end. This is an important change for Greece indeed, coming on top of all the difficulties faced by the world economy such as the oil shock, the geopolitical uncertainties and the threat of a disorderly resolution of global imbalances. Trying to forecast the future is always a perilous activity and under today’s circumstances one might be inclined to take a pessimistic view. I would like to diverge from the pessimists and I will use my time to explain why Greece can continue on a path of strong growth if we can address the forthcoming challenges by adopting sound and market-friendly policies. To use a sporting metaphor, in the 1960s and 1970s Greece won the European gold medal with the fastest GDP growth, afterwards our successive coaches failed, but again since 1994 we came under the discipline of an excellent coach, the German inspired Maastricht Treaty and finally in 2004 we won the European Champion Football Cup (EURO). Indeed, Greece’s annual rate of GDP growth of 3.7% between 1997 and 2004 was the second highest in the EU, after that of Ireland, and one-half bigger than that of the euro area. I believe that we can retain again a position near the top if we put our best effort to it. Year 2005 will be a difficult one, as the necessary fiscal adjustment and high oil prices will constrain growth. However, over the medium-term, I do not see a danger of a severe slowdown or recession. Of course, we cannot continue to grow for extended periods at rates above 4%, so some deceleration is to be expected and may do us some good by helping contain inflationary pressures. Our growth rate may regress back to our long-term potential, which I estimate to be around 3½%. I want to note that the OECD in its medium-term scenario has recently reached the same broad conclusion - estimating an average growth rate of about 3½% per annum up to the end of this decade, which is some 1?% percentage point higher than the scenario presented for the euro area as a whole. Of course, if the international economic environment improves, especially EU growth turns out to be much higher than 2% Greece will also reach a higher growth path. On the demand side, both private consumption and investment should continue to be strong. The continuation of the Community support programmes, though on a declining trend, will help support public and private investment for quite a few more years. The on going investment in infrastructure, especially in the peripheral regions, will continue to underpin a fast rate of productivity growth, as the Olympics 2004-related investment has done for the Athens area. Businessmen and ordinary citizens can at last appreciate the fruits of all this endeavour and forget the discomfort caused as the various works were heading to completion, and I am sure many of our visitors today benefit from the renovated Athens area. The list of projects underway or planned, eg Egnatia highway, highway links with our northern neighbours and beyond, are essential and will provide the necessary complement to private investment, while business investment should also respond to the announced tax relief. Despite fears to the contrary, I do not see a danger for private consumption. Private indebtedness has indeed increased fast but its level is still quite low by European standards. Compared to the increase in the private wealth of Greek households, reflecting both the rise in asset prices and in the housing stock, the net private indebtedness has not increased much. Recently, we have started seeing a gentle deceleration of credit growth, which, I believe, is a sign of responsible behavior both by borrowers and banks. Despite horror stories in the newspapers, we are far from the position where indebtedness would threaten growth. As long as growth remains robust, households will see no reason to cut back their consumption habits drastically, although temporary minor adjustments cannot be ruled out. Indeed, in a phase of disinflation, as the one expected over the next couple of years with the aim to narrow the inflation differential vis-a-vis the euro area, a small adjustment in consumption trends may take place. The external sector should be able to assume a more prominent role. After a couple of disappointing years, there are already some indications that tourism is picking up, helped by the positive image of Greece projected by the Olympics and assisted by the improvement in transport infrastructure and the upgrading of hotel and tourist resorts in general. Moreover, the price fever associated with the Olympics seems to have subsided and hoteliers appear to be scaling down prices to more competitive levels, while bookings for 2005 are on the rise. In general, tourism will remain a buoyant source of growth for the Greek economy, especially if the government decides to allow shops to stay open all week-afternoons and to extend the opening hours of the archaeological sites and museums up to late afternoon so as to make again our city centres attractive. The authorities should have made a cost/benefit analysis in order to assess the significant overall economic gains that could be derived if, as in the rest of the civilised world, our museums and archaeological sites were open also in the afternoons. Shipping goes through an upswing, and the related balance of payments receipts will probably reach a record €12 billion in 2004, exceeding by a wide margin travel receipts, while the immediate prospects for shipping remain favourable. However, we have to note that although shipping may this year become the largest net export earner, its multiplier effect on the rest of the economy is smaller than that of tourism. And this because it employs about 80% fewer people than tourism and, owing to the high revenue per capita in shipping, the saving rate is much higher and correspondingly less is spent on home products. The emerging upturn in Europe will also help our exports of goods and services. On the supply side, the huge investments in recent years are now starting to bear fruit, while we should not forget the contribution of immigrants to both supply and demand. Immigrants have become an essential part of our production system, and - I would also add - of our society, while, at the same time, they are becoming a unique economic and political link with our neighbouring countries, from which they originate. They undoubtedly help the integration of the Balkan countries and contribute to the economic development of the wider region. Much has been said about the fact that Greece is a laggard in implementing the Lisbon strategy. This is partially true, but look at it from the other side, there is much more we can still achieve by embarking on the implementation of the Lisbon agenda. This should be a priority for policy makers. Liberalising the labor and product markets can bring benefits even in the short-run. Allowing greater labor flexibility can induce entrepreneurs and, especially, foreign investors to enter the market. Removing oligopolistic practices can be a spur to growth and help contain prices. Flexibility in labour market does not mean less protection but more protection to all workers. The strict labour laws, which are, sometimes, unfortunately, interpreted even stricter by judges, is an important factor behind the big underground economy. Unregistered labour has no job protection but is also less well paid than registered workers. The insider/outsider issue, which has reached big proportions in Greece, is also an important factor behind the recorded high unemployment rate, especially affecting young people. The relatively small proportion of registered workers also undermines the capacity of the pension system to pay in the future the full pension entitlements to to-days working population. Accordingly, the insiders may not even themselves be so well off at the end of the day as they think. More flexible labour laws which will bring to the surface the unregistered labour and the concomitant increase in social security contributions will also help to establish a sound pension system delivering all its commitments. Accordingly, it is up to the authorities to move in the right direction and also benefit from the reform dividend. One thing that should be clear to all is that the future will be different from the past. Growth in recent years has been based on domestic demand, fuelled by construction, overall easy monetary conditions and large deficits, as are now recorded. These favourable factors will play a smaller role in future, as the fiscal position moves gradually to balance or surplus and real interest rates increase, reflecting a decline of inflation and a rise in the nominal interest rate, if the ECB changes its monetary policy stance. So we have to give more prominence to external sources of growth and structural measures. We must adopt an “extrovert” policy that gives priority to improving our role in the world economy. Sometimes I hear arguments for import substitution as a source of growth. Let us be frank; for a small, country-based economy, as the Greek one, only firms which can also export can have the critical mass of production to remain viable in a highly competitive global economy. It is better to delete import-substitution from the Greek vocabulary. In reshaping our economy, we should focus on areas where we already enjoy a comparative advantage, and by this I have mainly services in mind. This does not mean that we should neglect agriculture and industry. I simply want to say that these two sectors have ceased to be pillars of growth. The Greek agricultural sector has followed the international trend and has now shrunk to less than 7% of GDP, and will probably further decline close to the European average. Manufacturing’s share in GDP has stagnated and may from now on follow a slow downward trend. We should not be fooled that these trends can be reversed, nor should we try to engage in interventions that distort markets and incentives. In particular, the ongoing reforms of the Common Agricultural Policy and the final liberalisation of textiles trade next year will put further pressure on these sectors. Greek farmers and entrepreneurs can certainly improve the quality of their products and move to higher value-added product lines. They should use the window of opportunity offered now by the unusually low interest rates to embark on the necessary investments. But it should be clear that Greece is now an advanced economy, with a high per capita income by international standards, and cannot expect to remain competitive in labour-intensive and low value-added industries. The high productivity growth of the recent past has transformed the Greek economy but has also brought along new challenges. In a recent study by the OECD in the 10-year period up to 2003, out of the 30 OECD countries, Greece ranked fifth, after Ireland, Korea, Luxembourg and the Czech Republic, in the productivity growth table, with a 2.8% annual rate of increase in labour productivity, some 40% faster than the OECD average. We should invest in quality and develop a distinctive image of Greek products. We should also exploit our geographic location and the traditional orientation of our trade toward countries in South-Eastern Europe and the Middle East. We have long complained that we were in a difficult geopolitical position, reflecting the condition of our neighbors, but now we can enjoy that our neighbors in South-East Europe and the Middle East are becoming market economies and are growing fast. Our industry has been quick to seize on this opportunity and has re-oriented Greek exports toward this region, whose share of Greek exports has risen from less than 15% in early 1990s to about 25% last year. I was amazed to see that Bulgaria is now our fourth biggest customer, while Turkey has moved up to the sixth place. Greece occupies a very advantageous geographical position; especially northern Greece with its port Thessaloniki is bound to become again the indispensable transit link for trade and travel for all the Balkan countries. FYROM has no other sea outlet, but Thessaloniki also is closer to Sofia than the Bulgarian ports in the Black Sea, and the same applies for large regions in South-East Romania, South Serbia etc. Companies established in these regions will find it more convenient to use Thessaloniki as a trading port than other sea outlets. Especially, if one takes into account the queuing time needed to cross the Bosphorus, the economic advantage of the Greek ports is more than evident. This will be even more so when the EU co-financed trans-European transport networks, opening up the Aegean ports to our northern neighbours and beyond, will reach a maturity phase towards the end of this decade. Can Thessaloniki become the Rotterdam of the Balkans? Keeping all proportions I would reply YES, and its expansion in recent years and especially after 2007 when the road linking Turkey to the West (the Egnatia highway) will have been finished is a guarantee that Thessaloniki along with Northern Greece will be restored to its past trading and economic glory, to say nothing about the fact that it is a very pleasant, in many respects more than Athens, city to live in. Greece is in a special position in that its exports of services far exceed its exports of goods. In fact, our non-oil good exports are now somewhat less than tourism receipts and even less than those from shipping, while our total receipts from services cover more than four-fifths of our total non-energy good imports. Many foreign observers indicate, as a source of concern, Greece’s trade imbalance but they forget that -in the world we live in- services are growing faster. We should build on our success in these areas. It is well known that Greece is a major world power in shipping and by far the most important shipping nation in the European Union and, on the basis of new orders, it may increase even more its world market share over the medium term. For both economic and geopolitical reasons, Europe needs a strong merchant fleet, and here lies Greece’s important contribution to the Union. Greece, with a shipping tradition of more than three thousand years, should maintain its comparative strength in this area both for its own benefits and the European Union’s as a whole. Shipping is a sector subject to practically unhindered international competition; it is, therefore, necessary not to impose on it measures and regulations that could impair its competitiveness, apart from those required for environmental reasons. We should also look at ways to enhance the role of Piraeus as an international shipping center. From my previous remarks, it becomes clear that Greece can and should play a significant role as a bridge between the industrial countries of Europe on the one hand and South East-Europe and the Middle East on the other. We should aim to attract direct investment from foreigners, who will use Greece as their regional headquarters and for their high-end activities, while the more labor-intensive phases of production will be located in neighbouring countries with more abundant labor supply. Greece is well placed for this role. Our labor force is well educated, with a significant part of it having a working knowledge of a foreign language. Both the quality of life and infrastructure have improved enormously in the last few years, especially in the Athens region as a result of the major works undertaken for the Olympics, and now, as the government has announced, the attention will be directed to Thessaloniki. Undoubtedly, many other countries in the region, notably Turkey, may aspire to do the same but I think we have the edge. Greece has an open society, accustomed to working within an international environment. Indeed, many Greeks have spent years abroad working or studying, and this is an asset for them and for the country. Many have also ties to the countries of South East Europe and the former Soviet Union, as well as to Middle East countries where they had lived and whose languages and business environment they know. Don’t forget that not so long ago more than 300,000 Greeks were living in Egypt. The other very important advantages often cited are related to Greece’s membership of the EU for nearly a quarter of a century. Greece offers: 1. legal certainty, as the rules and laws it applies are the same or very similar to those in the other more industrialised EU countries; 2. macroeconomic stability and the strong currency of a euro area member; 3. a friendly business environment; 4. a resilient economy and society that have proved their worth under normal conditions but also in turbulent economic periods (e.g. oil shocks, speculative attacks against the drachma, abrupt rises and declines of the stock exchange that would have forced many other economies to bend on their knees). 5. a sound banking system, with an extended network in all the Balkan countries. Banking is the oiling mechanism of the capitalist systems and if the oil is not of a good quality sooner or later the engine will come to a stop. Turkey’s banking crisis and the related foreign exchange crisis a few years ago is a reminder. From the early 1990s the Bank of Greece, as the supervisory authority, laid down the rules and brought pressure to bear for the modernization and strengthening of the banking sector. To-day we coordinate our efforts with the commercial banks to promote the necessary adjustments in line with Basel II. The new International Reporting Financial Standards and Accounting Standards, should make the banking system even more flexible, strengthen its capital base and improve its internal control and risk management systems. Given also the significant presence of Greek banks in the Balkan countries the Bank of Greece has signed Memoranda of Understanding for cooperation with the supervisory authorities of these countries. Greek firms have also risen to the task of responding to globalisation not by adopting a defensive strategy, but by embracing globalisation themselves. There have been very significant direct investments by Greek firms abroad, especially in the Balkans. This is particularly evident in the financial sector, where Greek banks now occupy top positions in all our neighboring countries. About 5,000 Greek firms, mostly small to medium-size enterprises but also a few large ones, are now operating in the Balkan countries and Greece is between the three biggest investors in the region. This inevitably entails some delocalisation of part of Greece’s manufacturing and trading units. However, so long as they retain in Greece their high value added activities (their headquarters, their commercial and their research activities etc), this delocalisation in the long run helps both the host and the home country economy. I always try to give an example: The UK lost some 3.5 million industrial jobs (50% decrease) between 1978 and 2003 and gained over this period some 3 million jobs in the financial sector (100% increase); as the value added in the latter may be 4 times higher than in industry, the total gain for the economy has been enormous and is the main explanation of the success growth story of the UK in the last couple of decades. I have repeatedly stressed the example of London as a financial center, and all factors favours Athens for becoming a regional financial center, not only for the Balkans but even for countries further away. Likewise, Athens and Thessaloniki can become trading centers for companies operating in the wider area. Attracting foreign firms should form a central part of our future strategy. In the foreign direct investment league, especially in manufacturing, Greece unfortunately comes close to the bottom in Europe. But this hides the fact that many foreign firms, either completely on their own or in alliances with Greek firms, operate in Greece, but usually under the trademark of the original Greek owner, even if he has died long ago. This special partnership has to develop further, because each side complements the other and cross border alliances are an essential support for growth, especially in the case of smaller countries. Though, as I said, even if up to now Greece’s performance in the area of foreign direct investments has been quite disappointing, I believe things are about to change. After many years of sustained effort there is now a new, pro-business mentality, as evidenced by the wide political consensus on the need to further promote market-friendly reforms and the recent lowering of corporate taxation is in the right direction. Above all, we need to reduce bureaucracy and combat decisively all cases of improper practices. On the latter issue, we should adopt a policy of “zero tolerance.” We should establish clear and simple rules for the conduct of business, which should not be amenable to interference from politicians and public servants. The “rules of the game” should be transparent and the same for all. In a recent OECD study on the business sector, Greece, though not the worst performer, unfortunately ranks among the countries with most bureaucratic impediments: large number of licenses and certificates required from different authorities both in order to open a new business but also even when operating for years, big delays in issuing them, lengthy judicial procedures, retroactive tax controls, sometimes going back to more than 10 years etc. I believe that, if the authorities tackle in an efficient and pro-business manner these problems and simplify the system, a big obstacle to success will have been overcome. To this end, the authorities should not weigh the supposed political cost, since over the medium-term the political cost of inertia is much greater. Even if some mistakes are inevitably made when trying to change long established practices, reform always pays in the medium to long run. I don’t underestimate the cost, since reforms meet resistance from the few but well-organised bodies that have every interest in perpetuating the anomalies. Against this resistance, those who are expected to benefit from the reforms are not so militant and organized, since they represent a broad spectrum of people but lower benefits per person. Besides, benefits from reforms are not always immediately visible and thus those expected to benefit do not appear to be as combative as the opponents of reforms. Greece’s post Olympic advantage lies in services. Especially I see Greece as the main provider of modern and high value-added services in the Balkans and even beyond. I identified tourism, which moreover, can now draw significant benefits by using the Olympic infrastructure for the organisation of big international conferences and other events. The expansion of shipping and related activities, the development of a regional financial sector in Greece, the establishment of foreign trading companies should henceforth also be the pillars of a fast rate of growth. Last but not least the proposed opening of higher education to private funded institutions should lead to an improvement of the overall educational standards, while bringing to Greece foreign students from the wider region. In addition to the export earnings, a big proportion of foreign students will stay in the country and will instill dynamism to the economy, as well as they will strengthen the links between Greece and the countries of their origin and raise Greece’s position in the world. To sum up, I see the forces that have sustained Greek growth until recently (namely fiscal stimuli, unprecedented low real interest rates and significant EU co-financed infrastructure projects) will weaken slowly and should be replaced by new sources of growth: a more extrovert business sector, which is already starting to reap the benefit of its recent investments abroad, an administrative machinery friendly to entrepreneurship and lower taxation, as well as greater flexibility in the labour and product markets. All these factors can underpin a continuing high rate of productivity growth in the years to come.

bank of greece

Introductory speech by Mr Panagiotis Thomopoulos, Deputy Governor of the Bank of Greece, to the Alumni Association of the London School of Economics, Eugenides Foundation, London, 20 April 2005.

Panagiotis Thomopoulos: Impact of the Basel II requirements on banks and their business customers Introductory speech by Mr Panagiotis Thomopoulos, Deputy Governor of the Bank of Greece, to the Alumni Association of the London School of Economics, Eugenides Foundation, London, 20 April 2005. * * * It is an honour for me to address such a distinguished audience and to introduce an expert on the subject , Mr Edward L. Harris, who has participated in the preparation of Basel II and who, I am sure, will make very interesting comments on the effects of Basel II on shipping. The new, more risk sensitive framework for the calculation of banks’ capital requirements, introduced by the Basel Accord and known as “Basel II”, was initially intended for the internationally active banks. In Europe it will take the form of the Capital Requirements Directive and it will be implemented by all banks irrespective of size and focus as well as by investment firms. The approaching implementation of the new framework has intensified the discussion on its effects on the stability of the financial systems as a whole, on the health and the behaviour of individual banks and, last but not least, on the access of businesses to banks’ financing. Since the first draft, in 1999, arguments have appeared both against and in favor of the Accord. The former highlighted its complexity, its costly implementation as well as its technical integrity, such as the problem of procyclicality. The arguments in favor emphasized the incentives it gives for better risk management, the reduction of regulatory arbitrage opportunities and the attainment of capital requirements that better reflect the risks of the banks. After a long and heated discussion, three impact studies and revisions of the Accord, we can say that now the balance seems to have tipped towards the advocates of the Accord. Its cited shortcomings have either been addressed or by far outweighed by the favourable effects it will bring to the banks, their customers and the economy as a whole. Effects on banks In order to better understand Basel II effects on banks, it is worth reiterating the objectives of the Basel Committee regarding the overall level of minimum capital requirements. According to the introduction of the new Accord, issued in June 2004: “The objectives are to broadly maintain the aggregate level of minimum capital requirements, while also providing incentives to adopt the more advanced risk sensitive approaches of the revised Framework” The new framework intends to achieve this objective through three Pillars: The first pillar aligns the minimum capital requirements more closely to banks’ actual underlying risks and allows banks, under certain preconditions, to rely on their own measures of those risks. It changes significantly the calculation of capital requirements against credit risk and introduces capital requirements against operational risk. The second pillar, supervisory review, requires that banks enter into a dialogue with their supervisors on the methods and internal estimates, that they develop in order to determine how best to manage all their risks, including how much capital beyond the minimum requirement a firm should hold. The third pillar, market discipline, by enhancing transparency, strengthens the ability of marketplace participants to reward well-managed and capitalised banks As intended by the Committee, the overall capital requirements of banks are not expected to fall significantly. The capital requirements for credit risk should in most cases decrease, more so if the most advanced approaches are used, but this should be largely counterbalanced by additional capital set aside against operational risk. According to the Quantitative Impact Study of the Basel Committee in 2003, the average decrease of capital requirements for European Union institutions should be around 5.3%, ranging from an increase of 1.9% for banks using the standardized approach for credit risk to a decrease of 8.7% for the ones using the most advanced A-IRB (internal rating based) approach. For banks using the standardized approach the increase of capital requirements stems solely from the operational risk charges, amounting to 10.3%, which were not counterbalanced by the reduction in credit risk charges. For banks using the more advanced approaches the reduction of credit risk charges far outweighs the additional charges for operational risk. In total, for the EU banks using the standardised approach, mainly small banks, even after allowing for the 10.3% reduction, their capital adequacy ratio will remain well above 10% and only a few, with a share in total banking sector assets of 0.2% may experience some difficulties. However, these banks may be able to raise some additional capital or merge with more capitalised banks, and in any way as their market share is insignificant they do not pose a systemic risk. Regarding Greek banks, this QIS showed an increase of capital charges by 7.5% stemming by a decrease of credit risk charges by 2.5% and an increase of operational risk charges of 10%. It should, however, be noted that the Greek banks which participated in the QIS used the most simple (standardized) approach. However, since then Greek big banks (with a market share of 70%) are gradually introducing IRB methods, so that when the new framework will be introduced, they will be able to reduce their credit risk charges. All the more so, that mortgage credit and consumer credit, as well lending to small business, which have under the new accord a preferential treatment in relation to capital requirements, are growing much faster than the rate of growth of total credit. This, in combination with the starting high level indicates that the capital adequacy ratio in Greece should remain on average above 12%. Of course the individual banks’ capital requirements reductions depend not only on the type of approach used but also on the composition of the portfolio and its quality. Banks with a larger proportion of retail credit, including credits to Small & Medium sized Enterprises (SMEs) will experience a larger reduction of their capital requirements. Also banks with collateralized exposures or with customers having a better, external or internal, rating, which, of course, reflects better quality, will have a larger reduction. The largest reduction will of course be for banks with good quality portfolios that use the most advanced approaches for the calculation of capital requirements. It is only natural and fair that banks using the more advanced approaches will benefit most. After all, the new framework is intended to provide incentives for the upgrading of the banks’ risk management systems. However, the reduction of capital charges for credit risk should not be expected by itself to motivate banks to adopt the more advanced methods. The high costs for the implementation of the more advanced systems will discourage a number of banks. In a study conducted by PriceWaterhouseCoopers for the European Commission, the implementation cost in Europe was estimated at about € 20-30bn, with individual banks spending € 30 - 150 m, depending on their size, sophistication and approach used. Although one cannot deny that a significant amount of these costs result from the need for regulatory compliance to the new framework, an equally large part are the result of improvements in credit risk and operational risk management systems that would have been introduced even in the absence of Basel II. Basel II has accelerated the process and should, with time, both increase shareholder value and strengthen the financial systems worldwide. In a globalised world, without many financial frontiers, the competition driven need for improved risk management systems are motivating banks to move more and more to the more advanced approaches. And this because the better measurement of credit risk would allow banks to better evaluate the return of their main product i.e. credit and the profitability of their business lines. Accordingly, banks are introducing the advanced approaches for the calculation of capital requirements so as to be better placed to identify opportunities in the credit market and be able to exploit them through more focused marketing initiatives and better pricing. Traditionally, banks use some discrimination in their pricing decisions but mostly, because of their inability to adequately differentiate the credit risk of their individual obligors there is a crosssubsidisation of products and customers. Therefore, the system irrespective of the credit worthiness of the borrower was contributing to rather level pricing, especially as regards capital requirements. For example, consider two unsecured corporate loans, one to a rather good customer, with external rating A and an internally estimated probability of default of 0.12% and another worse one with an external credit rating of BB and an internally estimated probability of default of 1,5% . According to the current framework the required capital to be set aside against both customers would be 8% of the amount lent. According to the new framework: • If the standardized approach is used the capital to be set aside the first customer would be 4% while the capital set aside for the second customer would be 8%. • If the Foundation IRB Approach is used the capital required against the first customer would be 2.7% for the first and 8.9% for the second. The new framework allows, therefore, greater differentiation of the amount of capital to be set aside against loans to each of these customers. In addition, the current framework required the same amount set against lending irrespective of the type of obligor (corporate, small business, retail customer). Only mortgage were allowed, under certain conditions lower capital requirements. The new framework makes a distinction between corporates, small businesses (those with exposures of less that € 1m to the banking group) and individual (retail) customers. For the advanced approaches a further differentiation exists for corporates with sales of less than € 50 mil. To summarize, the new IRB framework is a customer-tailored system, whereas the existing one is essentially “one size fits all” irrespective of the weight and height of the customer. Effects on businesses There is a lot of discussion regarding the effects of the new Accord on lending, especially to SMEs (small and medium sized enterprises), which in Greece are the great majority of firms. After some adjustments, to take into account these concerns, the reduction in capital charges for small and medium enterprises (exposures below € 1 million) and well-provisioned past-due loans as well as the recognition of credit risk mitigants, such as collateral and guarantees, render the new framework much more favourable than the existing one. Generally the capital requirements for loans to corporate are likely to fall significantly (up to 80% in some cases) for excellent credit quality with credit risk mitigants, such as eligible collaterals. In the QIS it was found that corporate, non-SME lending would benefit in a pan - European level from a reduction of capital requirements of 2.5%. The reductions would be more for corporate SMEs i.e. corporates with annual sales lower than €50m, and would amount to 4%. Enterprises with exposure of less than € 1 m can be treated as retail customers, resulting to a further decrease by a significant amount of capital requirements, eventually passing the benefit onto companies themselves. Under the advanced approaches, the capital requirements for a loan to a corporate with PD =1.5% and LGD = 45% would be as much as 8.9%, whereas if the customer was an SME treated as retail would be only 4.52% Of course the requirement for reliable data on the basis of which the banks would be able to judge the creditworthiness of their customers, may create an additional burden to SMEs to produce timely and accurate accounting and other financial information. However the availability of such information might also lead to more efficient management of such companies based on more informed and less intuitive decisions. What is more important is the fact that the meaningful differentiation of risk will lead to a more efficient allocation of capital. Banks will be able to identify companies of high creditworthiness and offer them credit, at preferential terms, supporting thus their growth. This would benefit, not only healthy companies, including SMEs, which will find it easier and less costly to borrow from banks, but also the economy as a whole. However, starts-up may find some difficulties in raising loans and, therefore, other means of finance have to be further developed. Especially for new technologies, where Europe is lagging, venture capital is not readily available: the sums raised in 2003 were 1/3 below of those raised in the US and the average technology investment almost 1/10 of the US, thus further underlining the need in Europe to lift the financing obstacles for the dynamic technology sectors.

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Speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Conference on Financial Stability and Implications of Basel II, Central Bank of the Republic of Turkey, Istanbul, 16 May 2005.

Nicholas C Garganas: On the practice of financial stability in Greece - the implications of Basel II Speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Conference on Financial Stability and Implications of Basel II, Central Bank of the Republic of Turkey, Istanbul, 16 May 2005. * * * Ladies and Gentlemen, I thank the organizers of this conference for inviting me to be here today. I am especially pleased to be speaking on such an important issue. The concept of financial stability, considered from different perspectives, which is the main focus of the Conference, is appropriately receiving considerable attention in the light of the variety of risks confronting financial systems. My presentation will deal with the practice of financial stability assessment in Greece, key aspects of the Basel II implementation process in Greece, and some implications of Basel II for financial stability. It is generally agreed that the objective of financial stability assessment is to review the main sources of risks and vulnerabilities likely to affect the stability of the financial sector and to evaluate its capacity to absorb the impact of adverse disturbances. The Bank of Greece’s assessment of the stability of the Greek financial sector is contained in a section devoted to that issue of its semi-annual report to the Greek Parliament. Moreover, the Bank’s Annual Report to the General Meeting of its shareholders also contains a section on the stability and the supervision of the Greek banking sector. Before presenting the Bank’s approach to financial stability assessment, let me provide some key aspects of the Greek supervisory framework and of the Greek financial sector. Effectively there are three bodies responsible for supervision of the financial system as a whole. • The Bank of Greece regulates and supervises credit institutions and some special institutions such as credit companies, financial leasing and factoring companies, etc. It also has a mandate to contribute to the overall stability of the financial sector. • The Hellenic Capital Market Commission regulates the capital markets and supervises investment firms and collective investment funds. • Finally, the recently-established Commission for the Supervision of Private Insurance is responsible for insurance companies. Cooperation between the three domestic supervisory authorities is crucial to the pursuit of financial stability. To this end, a Memorandum of Understanding has been signed between the Bank and the Capital Markets Commission which lays down the practical arrangements for cooperation; in addition a representative of the Bank sits on the Commission’s Board. Cooperation with the new supervisory body for the insurance industry is expected to be organized along similar lines once the authority is fully operational. Banks dominate the Greek financial sector, accounting in terms of assets for approximately 85% of the entire financial sector. The banking sector itself is characterized by relatively high concentration with the 5 largest banks controlling 65% of the total assets of the banking sector. The Bank of Greece’s regulatory framework is essentially based on the relevant EU Directives which are closely aligned to the Basel I framework. In the Greek context, credit risk is the main component of banking risks. Overall the profitability and capital adequacy of Greek banking groups is satisfactory. On a consolidated basis, the rate of return on equity and the rate of return on assets before taxes were respectively 16,1% and 1% for 2004 and the capital adequacy ratio reached 12,8% at the end of 2004. In view of the dominance of the banking sector in the Greek financial system, I will focus on this sector. First, let me outline the approach followed by the Bank to assess the stability of the Greek banking sector. On the one hand, this approach involves an evaluation of the information provided by a number of indicators relating to the risk profile of banks and the economic condition of households and firms, and an assessment from a stability perspective, of developments in key macroeconomic variables and markets. On the other hand, the Bank seeks to determine the banking sector’s capacity to absorb negative shocks. For this purpose, it utilizes data on bank profitability and capital adequacy and also takes account of the results obtained from stress tests. To derive the main indicators, the Bank makes use of information submitted by banks in their supervisory reports on exposures in default, provisions, concentration ratios and credit migrations of individual exposures. Alongside ratios calculated from this source, data from household and firm surveys on both debt and income/profit levels provide information on the debt-bearing capacity of the household and business sectors. Data from supervisory returns also provide information on market and liquidity risks. In its evaluation of the information provided by all these indicators, the Bank takes into account the corresponding EU and Eurozone average values of these indicators where available. As regards macroeconomic variables and markets that may affect the stability of the banking sector, the Bank focuses on developments in the GDP growth rate, interest rates and exchange rates, and in the stock and real-estate markets. The direct impact on the financial condition of the banking sector of adverse developments in interest rates and exchange rates and in share and real-estate prices can be quantified using data on bank exposures to each of these risk factors. The indirect impact on banks of adverse developments in GDP growth and the aforementioned risk factors on banks mainly consists of an increase in credit risk arising from the effect of such developments on the financial condition of households and enterprises and thus on their debt-servicing ability. At present, the Bank makes only a broad qualitative assessment of this indirect impact in its published stability analysis. In order to assess the banking sector’s capacity to absorb the impact of adverse disturbances, the Bank focuses on a number of developments in banks’ financial condition and makes use of stress testing. The latter involves the Bank asking banks to quantify the impact on their own funds and capital adequacy ratios of pre-specified adverse changes in the values of certain basic risk factors. The risk factors considered are the probability of default and the loss given default, interest rates, share prices and exchange rates. In addition, the Bank is working towards developing a macro stress-testing framework, especially for credit risk. Let me now move on to discuss issues related to Basel II, which represents a major change in the supervisory framework and a challenge to both supervisors and banks. Before considering some implications of Basel II for the stability of the banking sector, I would like to refer to the preparations for Basel II implementation in Greece and to the choices Greek banks are expected to make between the alternative approaches for calculating capital requirements. A large majority of Greek banks are expected to adopt the standardized approach in determining capital requirements for credit risk. However, a number of banks, comprising a share of around 50% of the total assets of the banking sector, are reasonably expected to adopt the foundation IRB approach for a significant part of their total portfolio. The Bank of Greece is encouraging banks to move to the IRB approach because this approach will require an improvement in their risk measurement and management systems. Thus, it will strengthen their competitive position and their capacity to successfully adapt to changes in the economic environment. For operational risk, although the majority of Greek banks are expected to adopt the basic indicator approach to determine capital requirements, most of the large banks plan to adopt the more refined standardized approach. The Bank of Greece is working closely with the banks to help them prepare for the implementation of the new rules. In this connection, it has already put out 5 consultation documents dealing with issues where there is national discretion. These documents discuss measures which the Bank intends to adopt as well as other matters requiring clarification and supervisory guidance. Detailed consultations with each bank planning to use the IRB approach have begun so that problems can be identified and resolved, while the preparations of banks intending to use the standardized approach will be reviewed at a later stage - sometime before the end of 2006. An important issue for the Bank of Greece is to evaluate not only the technical aspects of the banks’ internal systems and the methodologies used to validate their output, but also to ascertain whether the output of these systems is utilized in managerial decision-making in such areas as loan approval and pricing, provisioning, and capital allocation. At this stage it is difficult to determine the overall impact of Basel II on the total capital requirements of the Greek banking sector. The impact will depend not only on the alternative approaches adopted by the banks, but also on the composition and quality of their assets, both of which are affected by economic conditions. However, one limited preliminary indication was provided by the result of the 2003 quantitative impact study. For the 6 Greek banks that participated using only the standardized approach at that time, there was a 7.5% net increase in the combined capital requirement for credit and operating risk compared to the corresponding requirement under the existing framework (a 2.5% decrease of the requirement for credit risk and a 10% increase for operating risk). Pillar II on supervisory review requires the conduct of risk-based supervision and the existence of detailed systems and policies at each bank to determine, maintain and allocate economic capital in accordance with its risk profile. This increases the pressure on supervisory resources as well as banks. In Greece, supervision has traditionally focused more on examining the accuracy of supervisory returns submitted by the banks, on a point-in-time evaluation of the quality of loan portfolios, and on the technical calculation of capital requirements to cover credit and market risk. In recent years, however, increasing emphasis has been placed on the assessment of internal control and risk-management systems, taking into account the risk profile of each bank. In this respect, the Bank of Greece found it necessary to impose a minimum capital adequacy ratio above the statutory minimum of 8% on some banks. To enhance its ability to conduct risk-based supervision, the Bank has taken steps to improve the skills of existing supervisory staff through specialized training and has also recruited personnel with skills in quantitative risk analysis. The banks have also strengthened their risk management units, but, in order to successfully implement Pillar II further efforts will be required. Pillar III enhances market discipline by requiring credit institutions to disclose appropriate risk information, allowing the market to reward well-managed and well-capitalized credit institutions. Let me now turn to some implications of Basel II for the stability of the banking sector. To successfully implement Basel II, Greek banks will need to further improve their risk measurement and management systems and to develop their contingency planning. This will enable them to react more promptly and effectively to disturbances affecting their risk profile. In addition, the Bank of Greece, in its stability assessment, will utilize the output of the banks’ improved internal systems to undertake more timely and accurate estimates of the total impact of alternative stress scenarios on the risk exposures and capital adequacy of the banking sector. Therefore, it will be in a better position to evaluate the sector’s overall resilience. It has been argued that Basel II is likely to produce a procyclical effect. According to this line of reasoning, for banks using the IRB approach, capital requirements for credit risk will increase during cyclical downturns because of a deterioration in the quality of loan portfolios and, conversely, decrease during cyclical upturns. As a result, bank capital adequacy will deteriorate during downturns, given the difficulty of raising new capital in such conditions. Consequently, Banks will be under pressure to restrict their lending during downturns, while during upturns they will tend to unduly expand it. It should be kept in mind, however, that bank lending is likely to be pro-cyclical to some degree, irrespective of the supervisory framework. Yet, the possible additional pro-cyclical effect arising from the IRB approach can be mitigated. In the context of Pillar II, supervisors should insist that banks hold capital comfortably above minimum requirements under normal conditions and also require banks to conduct rigorous stress tests in order to assess the adequacy of capital buffers. In addition, it would be advisable to encourage banks to adopt a more forward-looking through-the-cycle approach in their credit quality assessments and in their provisioning policy. At present, even the more sophisticated Greek banks tend to employ only a point-in-time approach to determine the values of the main credit risk parameters. In its consultation document regarding the minimum requirements for the Internal Rating Systems, the Bank of Greece has announced that, although it will accept Point in Time systems, it encourages banks to incorporate the effects of the economic cycle in their assessments. During the various consultation phases preceding the finalization of Basel II, concerns were also expressed with respect to the impact of Basel II on small and medium enterprises (SMEs). It was argued that capital requirements applicable to loans to these firms, especially under the IRB approach, would increase compared to the existing framework, leading to an increase in their financing costs or, possibly, to a decrease in the amount of credit supplied to them. Both these factors would adversely affect their financial condition. This, in turn, would have negative consequences for economic growth and employment and would impact on financial stability, particularly in countries such as Greece, where SMEs account for a large share of total output and employment. I believe, however, that the final version of Basel II substantially alleviates these concerns. In Greece, the majority of banks will adopt the standardized approach. For the significant part of their total exposures to SMEs, which will qualify as retail exposures, the applicable risk weight will actually decrease compared to the existing framework. For most of the remainder, the risk weight will remain unchanged. Even in the case of banks adopting the IRB approach, most of their SME customers are expected to derive some benefit either from the firm-size adjustment for corporate exposures or from the generally lower risk-weight function for retail exposures. Increased disclosure under Pillar III is expected to strengthen market discipline by increasing transparency. This will have a positive effect on stability to the extent that anticipated market reaction dampens banks’ incentives to assume excessive risks. However, the influence on bank behavior of the direct market discipline exercised by depositors, other creditors, and shareholders, is often limited either because these stakeholders lack sufficiently strong incentives or because, in some cases, the interests of the different stakeholders do not coincide. In particular, the actual or presumed existence of public safety nets may dampen the incentives of depositors to exercise discipline. Wider and more pertinent public disclosure is expected to enhance the information content of listed banks’ share prices and of interest spreads on subordinated bank debt. This will increase the accuracy and predictive power of fragility indicators based on market data, such as the distance to default, an indicator derived from market prices of bank shares. At this point, I may mention that the 10 banks whose shares are listed in the Athens Stock Exchange account for over 75% of the total assets of all credit institutions operating in Greece. Based on empirical evidence, changes in the distance to default represent a useful forward-looking indicator for stability assessment purposes, especially if based on weighted average values for the entire banking sector rather than for each individual bank. In general, marketbased fragility indicators are a useful supplement to supervisory data, which are derived as a rule from accounting records. In concluding, I would like to stress the increasing importance of maintaining financial stability in the increasingly competitive environment of recent years, following the deregulation of the Greek financial system and the liberalization of capital movements. These changes have made the Greek banking system more sensitive to international capital flows, which can sometimes be volatile and unpredictable. The internationalization of the activities of Greek banking groups, Greece’s entry into the eurozone, and the integration of European financial markets, although generating significant benefits, have also increased the exposure of the Greek financial system to contagion risks. In the light of these developments, the Bank of Greece has instituted - and continues to institute - changes that improve the quality of its financial stability analysis, so that timely and accurate assessment of risks be made and, where necessary, appropriate policy responses can be formulated. I believe that the implementation of Basel II in Greece will yield significant benefits because of its effects on the risk profile and the risk management systems of banks in the evaluation of their capital adequacy. This, after all, is a key determinant of their capacity to absorb adverse shocks. Therefore, both from a supervisory and a financial stability perspective, the difficult task of implementing Basel II in Greece will be well worth the effort. Thank you for your attention.

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Luncheon address by Mr Nicholas C Garganas, Governor of the Bank of Greece, before the Euro 50 Group, Athens, 24 June 2005.

Nicholas C Garganas: Adjusting to the single monetary policy of the ECB Luncheon address by Mr Nicholas C Garganas, Governor of the Bank of Greece, before the Euro 50 Group, Athens, 24 June 2005. * * * Ladies and Gentlemen, I would like to thank Prof. Richard Portes for his kind introduction. It is indeed an honour and a pleasure to address such a distinguished audience of academics and practitioners specialized in the field of European economic policies and broader issues linked to the Euro. This meeting is an important event. It takes place at a time of tensions about the impact of the single monetary policy on the euro area and when several commentators have raised doubts about the sustainability of monetary union. Europe's single-currency undertaking is perhaps the boldest attempt ever in which a large and diverse group of sovereign states has attempted to reap the efficiency gains of using a common currency. The euro has created a new monetary reality for 307 million Europeans that few would have thought possible a generation ago. Like most bold undertakings, however, the euro has had its share of ups and downs. When the euro was launched in 1999, skeptics were doubtful whether it would be possible to make the euro a stable currency. Yet, the euro, which is probably the most visible and tangible symbol of this integration process, is now in its seventh year and has been firmly and credibly established as a stable currency. Today, I want to address a widely-debated issue - namely, whether a single monetary policy can fit all parties in a supposedly heterogeneous currency area. This issue has been debated extensively since the start of EMU. The debate has recently intensified, reflecting concerns about the increased divergence of growth rates over the past few quarters and uncertainties deriving from French and Dutch rejections of the Constitutional Treaty. Before I discuss this issue, allow me to offer the following qualification. My perspective is that of someone from Greece, a small, open economy with a history of very high inflation and enormous fiscal deficits in the 1980s and the first half of the 1990s. Other countries' perspectives might well highlight features other than those that I will discuss. EMU: An optimum currency area perspective EMU brought unique challenges for monetary policy. Critical observers took the view that a single monetary policy was doomed to failure. This skepticism was supported by the arguments of the traditional theory of optimum currency areas, which recommended monetary unification only among economies with flexible markets, free mobility of labour, a centralised fiscal policy, and a limited incidence of asymmetric shocks. Clearly, these conditions did not - and do not - hold for the euro area. After all, the euro zone is characterised by significant rigidities in labour and product markets, the absence of a significant centralised fiscal transfer mechanism, and national economies with unique institutional and economic features - a set of circumstances that results in a high incidence and impact of asymmetric shocks. In these circumstances, so the argument goes, such shocks are likely to lead to widening price differentials so that a common nominal interest rate in the monetary union results in different real interest rates among countries. For member countries with relatively-strong domestic demand and a higher-than-average inflation rate, the lower real interest rate fuels domestic demand and national inflation. Conversely, for countries with relatively-weak domestic demand and a lower-than-average inflation rate, the high real interest rates put further downward pressures on domestic demand and inflation. A one-size monetary policy, in other words, does not match the needs of all members. The foregoing, traditional view of optimum currency areas neglects several important factors. It seeks to identify the characteristics that a country should satisfy prior to joining a monetary union - that is, ex ante. We now know, however, that participation in a monetary union may itself induce changes in economic structure and performance ex post through at least two channels. These channels operate through enhanced credibility and trade and financial integration. How does the credibility channel work? A major benefit of participating in EMU, especially for countries such as Greece, Italy, Portugal, and Spain that have had recent histories of relatively-high inflation rates, has been the credibility gain derived from eliminating the inflation bias of discretionary monetary policy. With low and stable inflation and inflation expectations, nominal interest-rate differentials between these countries and countries with histories of relatively-low inflation rates, such as Germany, have almost been eliminated. With lower nominal interest rates in traditionally high-inflation countries, the cost of servicing public-sector debt is reduced, facilitating fiscal adjustment, and freeing resources for other uses. Moreover, with low and stable inflation, economic horizons lengthen, encouraging a transformation of the financial sector. The lengthening of horizons and the reduction of interest rates stimulate private investment and risk taking, fostering faster growth. For Greece, entering the euro zone has meant not only the loss of an independent monetary policy the fruits of which were amply demonstrated in the 1980s and the early 1990s - but also the credibility gains associated with a stable, low-inflation monetary regime. In the 15 years until 1994 - the year in which Greece's efforts to qualify for euro-area entry began in earnest - inflation averaged almost 20 per cent while real growth averaged less than 1 per cent. In contrast, during the past 6 years real growth has averaged more than 4 per cent while inflation has been slightly above 3 per cent. Another way to infer the credibility gains is by looking at interest-rate spreads. In 1997, the year in which a 10year government bond was first issued in the Greek financial market, the yield differential between that bond and the comparable German bond was 412 basis points. Today, it stands at only 24 basis points. I suggest, therefore, that giving up a nationally-tailored monetary policy has not, in fact, been a cost, but a benefit. Now let me turn to the trade channel. Recent empirical work has shown that a common currency can promote trade and growth over and above any effect produced by separate currencies tied together with fixed exchange rates. For the euro area, the evidence suggests that the adoption of the euro has already increased trade among EMU members by between 4 and 16 per cent compared with trade among European countries that have not adopted the euro. Increased trade integration leads to morehighly-correlated business cycles because of common demand shocks and greater intra-industry trade, reducing the need for country-specific monetary policies. There are additional reasons that a monetary union reduces the incidence of country-specific shocks. One of the principal causes of asymmetric shocks - the effects of divergent monetary policies - no longer exists. Furthermore, it is to be expected that the deepening of financial-market integration will also entail a convergence in the transmission mechanism of monetary impulses. Finally, the common currency helps to increase price transparency and, therefore, competition in goods, services and factor markets, leading to a further alignment of economic cycles. Inflation differentials The fact remains, however, that there are inflation differentials among the members of the euro zone. How significant are these differentials and how concerned should we be? Recent evidence provided by the ECB shows that, over the period 1990-99, the 12 countries now comprising the euro area experienced a downward trend in the degree of inflation dispersion - measured as the standard deviation of that dispersion - from about 6 percentage points in the early 1990s to a low of less than one percentage point in the second half of 1999. Since that time, inflation dispersion has changed very little - that is, it remains less than a percentage point. To provide a basis of comparison, since 1999 inflation dispersion across the euro area has fluctuated close to the level observed across the 14 metropolitan statistical areas of the United States. Remarkably, the process of nominal convergence in the euro area was not accompanied by greater dispersion of real GDP growth rates, which has remained close to its historical average of around 2 percentage points following the adoption of the euro. There is one notable difference, however, between inflation differentials in the euro area and those in the United States. Although inflation differentials in the euro area have not widened, they have exhibited a relatively-high degree of persistence, higher than that experienced across the 14 metropolitan statistical areas of the United States. Seven of the 12 euro-area economies have recorded annual inflation rates that have remained either persistently above or persistently below the euro-area average since 1999. One of those countries is Greece, where inflation has persistently exceeded the euro-area average by about one-and-a-half percentage points since Greece became a member of the euro area in 2001. Several factors have contributed to the persistence of inflation differentials across euro-area economies. One factor in relatively-low income countries, such as Greece, is the so called BalassaSamuelson effect, according to which long-term differentials in regional inflation are attributable to differences in the rate at which productivity increases in the various regions' tradable and non-tradable goods sectors. Although it is difficult to quantify this effect with precision, it provides only a partial explanation for the persistent inflation differentials that exist in the euro area. In any case, this effect is a transitory one. It is part of what I have called the adjustment mechanism - in this case, the adjustment to a higher standard of living. Other factors contributing to the inflation differentials within the euro area, including misaligned fiscal policies, wage dynamics not linked to productivity developments and structural inefficiencies such as rigidities in product and factors markets, are not so benign. Redressing these problems, as you know, is not within the domain of monetary policy. National economic policies are the relevant instruments to enhance the ability of individual countries to respond to economic shocks and to national divergences. I believe that EMU has helped stimulate reforms in the euro area. Major reforms are undoing the rigidities accumulated over decades, preparing social institutions for the looming demographic changes and making the euro area increasingly competitive internationally. It is crucial to continue strengthening competition in labour and product markets, for example, through liberalisation and deregulation, to improve the efficiency of price signals. National fiscal policies also provide important instruments. They can react to shocks in such a way as to counteract the emergence of differentials. However, sound public finances are an essential element of price stability and are necessary if automatic stabilizers are to work fully without the risk of excessively high deficits. In this respect it is important that Governments strive to achieve balanced budgets or surpluses in periods of favourable economic activity. What difference would such changes make? I previously referred to the relatively-low dispersion of real growth rates in the euro area, which is, in fact, of an order of magnitude near that existing among regions of the United States. The dispersion among US regions, however, is centered around a higher average growth rate. Since 1999, the US economy, which is more flexible than that of the euro zone, has grown at an average rate of about 3.1 per cent, compared with about 1.9 per cent average in the euro area. It is important that national labour market policies enhance flexibility at the national and regional levels. Structural policies should also aim at improving the efficiency of the wage and price setting mechanism to reduce the persistence of inflation divergence. In this connection, I should note that in some countries, such as Greece, wage behaviour has not fully adapted to the new regime. Conclusions Let me conclude with the following thoughts. Recent events have given rise to some populist rhetoric about the wisdom of a single currency within Europe. A few commentators have posed the question: Why have a monetary union in Europe? My perspective is very different. I share the sentiment of my colleagues on the Governing Council who have dismissed as "absurd" speculation that the euro area's future has been thrown into doubt. A single-size monetary policy has worked extremely well, delivering price stability so that changes in prices convey more effective information about demand and supply conditions. The credibility of the ECB's monetary policy has delivered interest rates that are at historically low levels to all member countries of the euro-area. Yet, price stability and low interest rates are not enough to raise growth and improve living standards. They provide the fabric upon which a more dynamic Europe can be woven. Recent events, in my view, only confirm that a currency union requires greater competition than do independent monetary areas. Market reform and strict fiscal rules are not luxuries for members of a monetary union, but necessities. In response to those who are asking, "Why have a single currency? let me cite some wise words penned by the late Irish playwright, George Bernard Shaw. "Some people," he wrote, "look at things as they are and ask, 'Why?' I look at things as they might be, and ask 'Why not?'" This, Ladies and Gentlemen, is the way I look at the future of Europe. Why not, indeed? Ladies and Gentlemen, thank you for your attention.

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Speech by Mr Panagiotis Thomopoulos, Deputy Governor of the Bank of Greece, at an event organised by the European Bank Training Network and the Hellenic Bank Association, Athens, 4 May 2006.

Panagiotis Thomopoulos: Banking regulation in Europe - a brief overview of current developments Speech by Mr Panagiotis Thomopoulos, Deputy Governor of the Bank of Greece, at an event organised by the European Bank Training Network and the Hellenic Bank Association, Athens, 4 May 2006. * * * Good evening, Ladies and Gentlemen. Allow me to begin by welcoming you to Athens and wishing you a pleasant stay. It is a great pleasure and honour for me to address such a distinguished audience. I would also like to seize this opportunity to thank the European Bank Training Network and the Hellenic Bank Association for organising this event and all of you for your participation. My objective here today is to provide you with a brief overview of the current developments in banking regulation that are taking shape in the European “arena”, and to outline the main challenges that European regulators and supervisors face, as the degree of integration in the European financial market increases. Before presenting you with some of my thoughts on this subject - a subject which, I am sure, all of you know well - I should like to say a few words about Greece, where I have a comparative advantage. Disciplined by the requirements of euro area candidacy and membership, Greece succeeded in lowering its inflation rate from over 16% in the fifteen years until almost the mid-1990s to just above 3% from 2000 onwards. At the same time, GDP growth rose from less than 1% in the first period to almost 4% over the last ten years. The Greek economic scene has also been transformed thanks to the advantages derived from euro area membership, including the stable macroeconomic environment and low interest rates. The Olympic Games hosted in Athens in 2004 contributed, in turn, to creating a favourable environment for growth. However, liberalisation and privatisations, as well as a reinvigorated private entrepreneurial spirit, have been the principal growth-driving forces. This spirit has manifested itself in Greece's re-orientation from an inward- to an outward-looking economy. We now see ourselves as a dynamic part of South-East Europe, where large Greek communities, numbering hundreds of thousands, after taking root in the distant past, continued over the centuries to play an important role in the economic and social life of their respective countries. The story of these communities goes back a long way, beginning in ancient Greece, followed by 5 centuries under the Roman Empire, then continuing for 1,000 years during Byzantium. Then came nearly 600 years of Ottoman rule and, more recently, the communist take-over of these countries, which resulted in an expulsion of all non-communist Greeks. After an interlude of some 50 years, the historic forces are back at work. More than 5,000 Greek companies now operate in the neighbouring Balkan countries and are among the main foreign investors in Bulgaria, Fyrom, Romania, Albania and, more recently, Serbia. This development has resulted in a delocalisation of Greek industry to our neighbouring countries and a steady inflow of migrant workers to Greece. The Greek banking sector has also undergone a radical transformation, evolving from the highly regulated sector it was 15 years ago, when the Bank of Greece set over 150 different levels of interest rates to become a free, competitive and dynamic sector and a key pillar in Greece’s successful economic performance. Despite their relatively small size by European standards, the Greek banks ' high profitability has enabled them to build sound foundations. Just like other sectors, the Greek banking sector has also expanded to South-East Europe. This offers Greek banks the opportunity to benefit from the growth potential of a rapidly developing region with low levels of financial intermediation, to increase their size and efficiency, and to continue to flourish in the very competitive international financial environment. The market penetration of Greek banks, based on their total assets in the neighbouring countries, ranges from 11% to over 30%. Moreover, the foreign claims of Greek commercial banks on the Balkan region countries have reached almost €11 billion, which represents 25% of Greek banks’ total foreign claims and 58% of their own funds. Unfortunately, the state of the Greek economy is far from rosy and many challenges still lie ahead. After euro area entry, fiscal discipline was relaxed and during the last five years the fiscal deficit has, in fact, worsened. Only this year has it been budgeted to fall below 3% of GDP, while continuous efforts will have to be maintained to reach a balanced position, as required by the EU. Moreover, the euphoria after euro area entry prompted a '' money illusion '' with labour unions demanding and obtaining high nominal wage increases, regardless of the impact on real incomes and unemployment, as a result of the the loss of external competitiveness. This makes it even more urgent and imperative to raise productivity growth further and develop high value- added activities. We, therefore, need to intensify our structural adjustment efforts in the labour and product markets, promote innovation and technology, and ease bureaucratic restrictions, as recommended in the Lisbon agenda. My personal opinion is that the morass of bureaucracy is the main impediment to a faster rate of growth. The Greek banking sector thus faces a double challenge: it has to apply all of the new regulations, control mechanisms and risk-based methods (Basel II), while expanding rapidly both in Greece and abroad, and, at the same time, from a risk management and internal control point of view, it has to rapidly integrate its subsidiaries and branches in South-East Europe, where the environment still differs from that of the average euro area country. Expansion toward potentially much larger markets - Turkey, Poland and Egypt today and Ukraine tomorrow - calls for even better internal risk exposure-monitoring systems. This is a parameter which the new capital adequacy framework, in combination with the recently established regulatory framework on internal control, deals with. The Bank of Greece, as the supervisory authority, has indeed been adapting its regulatory and supervision apparatus to deal with the new challenges, and has encouraged the banking sector to maintain a high Capital Adequacy Ratio (13% at the end of last year). This provides a more than adequate buffer against the fact that uncovered non-performing loans are still slightly higher in Greece than on average in the euro area and the fact that Greek banks are still benefiting from a favourable cyclical phase and, therefore, have not yet experienced the adverse effects of a slowdown. In parallel, given the specificities of Greece ' s banking system and economy, the Bank of Greece has imposed stricter measures on some banks (e.g. a CAR much higher than 8%). Likewise, given the rapid growth of lending to households (30% on average since 2001), the Bank of Greece has instructed banks that debt-servicing burdens on households should not exceed 30-40% of disposable household income. While adhering to the risk-based approach, which gives individual banks more freedom to estimate their possible losses and manage their own risks, the Bank of Greece considers that the supervisory authorities should always be alert (not to say, vigilant) and, when necessary, not only adjust the capital requirements of individual banks, but also periodically test the internal control mechanisms and risk management systems, in the context of Pillar III. Only as a last resort should other more direct measures be applied. Current developments Now, getting back to the subject of today ' s conference: During most of the 1990s, efforts in the financial services sector were focused on achieving a smooth changeover to the single European currency. However, once the euro was successfully introduced, attention shifted to improving the functioning of the single European financial market. The late 1990s saw the launching of an ambitious plan - the Financial Services Action Plan - , which contained a series of legislative and other measures that would allow the European financial services sector to gradually realise its full potential. Since then, major changes have taken and are still taking place in the financial regulation landscape. The most outstanding of them, in the banking sector, is the forthcoming new capital requirements framework, which is one of the final measures of the EU Financial Services Action Plan. The new capital requirements framework The new Directive - or CRD as it is called - will make the existing banking supervision framework more risk-sensitive and will promote enhanced risk management among financial institutions. This should improve the effectiveness of the framework in ensuring financial stability, maintaining confidence in financial institutions and supporting the macroeconomic environment in general. Improved risksensitivity in capital requirements should facilitate a more effective allocation of capital, thus contributing to boosting the competitiveness of the EU economy. There has, however, been some discordance of opinion about certain aspects of the CRD, which has fortunately been largely resolved. The new Directive is, in fact, a new supervisory framework of a rather revolutionary nature, adapted to the globalised world we live in. Apart from introducing new approaches for the calculation of capital requirements, the CRD provides for the establishment of intensive cooperation and information exchange mechanisms among supervisors, the option of delegating tasks among supervisors, information exchange requirements among banking supervisors, central banks and finance ministries in emergency situations, and - a completely new element - disclosure requirements both for banks and for supervisors. Of the above-mentioned elements, one issue that has sparked much debate and, to some extent, controversy, is the allocation of supervisory tasks or responsibilities between the home and the host supervisor, i.e.: (i) the authority that supervises the parent bank (i.e. the consolidating supervisor) and the authority that supervises a ''significant'' subsidiary bank or (ii) the supervisor of the bank located in the country of origin and the supervisor located in the country where a ''systemically relevant'' branch is established. The main concern in this debate is finding the right balance, so as to enhance the efficiency of the supervisory arrangements, while ensuring their effectiveness and respecting the existing accountability arrangements at the national level. The Bank of Greece has a strong interest in the outcome of this debate, in which it actively participates, in the hope that an optimum balance will be reached. Needless to say, this interest also reflects the fact that the Bank of Greece is both the host supervisor for incoming EU banks and the home supervisor for outgoing Greek banks, which are expanding mostly to the neighbouring Balkan countries, some of which are preparing to implement the EU framework. In performing its roles, as mentioned above, the Bank of Greece consistently follows policies that encourage the European integration process and refrains from creating unnecessary administrative burdens or erecting other obstacles, without, of course, putting the effectiveness of its supervisory tasks at risk. Other regulatory initiatives • In parallel with the preparation for the new supervisory framework ' s implementation, discussions are under way regarding the revision of the Directive on Deposit Guarantee Schemes and the Electronic Money Directive. • Another major issue that has sparked considerable controversy concerns the so-called supervisory approval process. The debate was initially triggered by certain market participants, who fear it to be an obstacle to cross-border mergers and acquisitions. The Bank of Greece and the central banks of many other countries have repeatedly stated that isolated cases, in which a misuse of supervisory powers may have occurred, should not be generalised. In Greece, as it is the case in the EU as a whole, the supervisory authorities base their decisions regarding the merger or acquisition by a foreign institution of a domestic bank strictly on supervisory criteria. The new decision-making structure for financial services Apart from the introduction of the new capital adequacy framework, another radical change that has been introduced involves the decision-making process at the EU level for the financial sector, also known as the Lamfalussy process. A new financial services committee architecture has been established. The Lamfalussy approach, which was originally elaborated for the securities sector, now extends to the banking and insurance sector, as well. Given the time constraint, an extensive presentation of the Lamfalussy framework would probably be inappropriate. However, there is reason to underline some of its main objectives, which are: • to develop regulation that can adapt quickly to new market developments and practices, support integration and enhance EU competitiveness, and • to strengthen cross-border and cross-sector cooperation among supervisory authorities and the convergence of day-to-day supervisory practices and implementation. It is worth mentioning that the new decision-making structure has not yet reached its full potential. On the one hand, there is a some concern about the potential proliferation of work among the various committees and working groups and the consequent risk of confusion and wasted resources. On the other hand, the process has started to yield significant benefits, especially in the field of supervisory convergence, which should overcompensate for few negative aspects. The Committee of European Banking Supervisors (CEBS) The CEBS, as part of the Lamfalussy framework, is the institutional committee that brings together all the banking supervisors of the EU countries and the central banks, including the ECB, as observers. The CEBS has three main tasks: • to provide advice to the Commission; • to ensure the consistent implementation of Community legislation in the banking sector and the convergence of supervisory practices; and • to promote supervisory cooperation and exchanges of information. The CEBS has an advisory role within the EU legislative procedure. The CEBS’s other focus is to promote a consistent approach to banking supervision through increased convergence of standards and practices and enhanced cooperation and information sharing. The ultimate goal is to build a common supervisory culture and a practical operational network of banking supervisors within the established EU legal framework. This is of particular importance for the efficient supervision of crossborder banking groups, as the appropriate dissemination of information relating to risks and the elimination (if possible) of work duplication are expected to reduce the administrative burden and costs for the supervised institutions, while reducing the strain on supervisory resources. This does not mean that there are no benefits for smaller institutions, with a predominantly domestic or even local focus, as convergence will imply the establishment of a level playing field across the EU. Next steps Changes in the regulatory framework and the organisational structure of the decision-making process are necessary but not sufficient conditions for the realisation of the EU financial market ' s strong growth potential. This can be more easily achieved if financial integration is accelerated. This belief is the driving force behind the new EU financial services strategy for the next 5 years, which is currently under discussion among the EU institutions, while, at the same time, market participants are being consulted. Up to now, the elements that seem to be part of this strategy and are closely related to the banking sector are the completion of certain ongoing projects (i.e. mortgage credit, consumer credit, the New Legal Framework for Payments, etc.) and the undertaking of new legislative initiatives (i.e. investment funds, bank accounts, credit intermediaries). One of the legislative initiatives that requires special attention is the proposal for a Directive on payment services. The proposed Directive, which is part of the wider Single European Payments Area Project, aims to establish a modern and harmonised legal and operational framework necessary for the creation of an integrated retail payments market, which would enable payments to be made more quickly and easily throughout the EU. The proposal also aims to introduce more competition in payment systems and facilitate the realisation of economies of scale. This will improve efficiency and reduce the cost of payment systems for the economy as a whole, an issue of high importance to the Bank of Greece, as electronic payments systems are not very much in demand in Greece. Future challenges Supervisory architecture within the EU Lately, several discussions have revolved around the issue of the EU supervisory architecture, one of the arguments being that the complexity of supervisory arrangements increases in parallel with the growth of a banking group ' s cross-border activity. Without dismissing these concerns, we do not share the view that the conduct of cross-border activities is connected with a significant supervisory burden. On the contrary, the most important obstacles to the expansion of cross-border activity in the banking sector are the differences in the tax treatment of banking products among different states, cultural differences and the lack of proximity (except in the case of branches). Different views on the supervisory architecture advocate alternative models of supervision, ranging from complete centralisation to total decentralisation. Each approach has its own merits, but also raises a number of complicated strategic and operational issues that need to be addressed. I believe that in no way should extreme solutions be adopted and instead implement the Lamfalussy approach, which though is not a panacea, has the definite advantage of allowing for a lot of flexibility. First of all, it provides for a range of different degrees of centralisation in the regulatory process, which would entail a more or less harmonised set of rules depending on the issues that need to be addressed. In this way, it facilitates the swift adaptation of community legislation to new developments in the financial markets, which in many cases have cross-sectoral dimensions. Moreover, it boosts regulatory and supervisory convergence while at the same time allowing for the efficient handling of differences arising from the fact that the vast majority of the 8,000 credit institutions in the EU operate domestically and sometimes even locally, in markets with diverse characteristics and which can better be assessed by local supervisors, as the history of the last 50 years has taught us. In this context, I think that we can go a long way with the Lamfalussy framework. And I do not think we are anywhere near the stage where we can say that we have fully exploited all the possibilities it has to offer, at least in the banking sector. In addition, the Lamfalussy framework and the way it is applied will evolve over time in response to the evolution of markets. The Eurosystem’s perspective I would like to conclude my speech with a specific reference to the Eurosystem's perspective of the above-mentioned regulatory developments. It is worth noting that the Eurosystem's primary relevant concern stems from the fact that it is responsible for monitoring financial stability in the euro area, and at the same time recognises that a smooth-functioning financial system is a vital transmission mechanism for ECB monetary policy. Within this context, the forthcoming implementation of the new capital requirements framework, as well as the strengthening of supervisory cooperation within the EU, are seen as particularly encouraging developments, as they considerably enhance the existing financial stability framework. Of course, as the financial market landscape changes and the degree of European financial integration increases, new concerns are likely to arise, regarding, for instance, the ability of the system as a whole to respond to a possible emergency situation in a timely and effective manner. The Bank of Greece, as a member of the Eurosystem, keeps a close eye on developments, while participating actively in the respective discussions within the EU institutions for the establishment of common arrangements.

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Presentation by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the conference on Regional Financial Stability Around the Eurozone, organised by the Euro 50 Group, Istanbul, 1 June 2006.

Nicholas C Garganas: Regional financial stability around the Eurozone Presentation by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the conference on Regional Financial Stability Around the Eurozone, organised by the Euro 50 Group, Istanbul, 1 June 2006. * * * I am delighted to have been asked to participate in this conference on “Regional Financial Stability Around the Eurozone”. This topic has gained importance as the economies - and particularly the financial systems - of South-Eastern European (SEE) countries have increasingly developed linkages both within their region and with the Eurozone. In recent years, SEE countries have generally experienced high rates of economic growth, improvements in macroeconomic fundamentals, and a significant transformation and growth of their financial systems. For sustainable future growth and development in the region, the maintenance of financial stability is an essential precondition. In turn, the existence of an effective legal and regulatory framework for the financial sector and the conduct of financial supervision in accordance with international best practices plays an important role in promoting financial stability. To this end, considerable efforts have already been made to strengthen the legal and regulatory frameworks of the financial sector in SEE countries and to improve supervisory practice. In what follows, I will briefly discuss the various channels through which external assistance towards regulatory and supervisory reform in South-Eastern Europe has been provided, identify some areas where further reform and expertise appears necessary, and suggest some cooperative arrangements that could contribute to this objective. Over the past fifteen years or so, technical assistance to improve the legal and regulatory framework of the financial sectors of SEE countries and the implementation and enforcement capabilities of the competent national authorities has been provided in various forms by international organisations such as the IMF, the World Bank, and the BIS. Although a comprehensive discussion of all these projects is not realistic in my short presentation, it may be worthwhile to at least mention a few of them. Supervisory personnel from SEE countries have participated in training seminars offered by the Financial Stability Institute of the BIS and by the Joint Vienna Institute. Under the joint IMF-World Bank Financial Sector Assessment Program, international teams of experts have assessed the financial sectors of SEE countries and the degree of compliance with Basel Core Principles and have identified weaknesses and proposed corrective measures, many of which have since been implemented by the countries concerned. In coordination with international institutions, the United States Agency for International Development (USAID) has supported projects in many SEE countries to improve the regulatory framework for the financial sector and the conduct of supervision. As SEE countries aspire to eventual EU membership, the European Commission has been particularly active in the region both in providing technical assistance and in monitoring progress in financial sector reform. As regards technical assistance, the European Commission’s main instrument is the Twinning Programs financed by the PHARE and CARDS facilities. Twinning Programs are particularly useful since each beneficiary country determines its specific needs and is subsequently able to choose the one that best meets its requirements among the proposals submitted. Twinning Programs also help to establish close working relationships between the authorities of recipient countries and those of the EU countries which provide technical assistance. The ECB has also provided technical assistance to SEE countries through various channels such as short-term missions, conferences and internships. ECB assistance was given in the fields of money and banking statistics, payment and settlement systems and financial stability as well as in other fields which fall outside the scope of my presentation. Moreover, the ECB, acting as co-ordinator of Eurosystem projects, is currently working on a number of projects in the region, including the finalisation of plans for a 6-month CARDS funded project to Bosnia and Herzegovina. Apart from these Commission and ECB initiatives, technical assistance has been provided to SEE countries on a bilateral basis by the financial sector authorities of individual EU countries, usually through less formal ad hoc arrangements focusing on specific areas where particular SEE countries require expertise. Finally, the Memoranda of Understanding concluded between the banking supervisory authorities of EU countries and those of the SEE countries provide for regular meetings to discuss supervisory principles and practices and, in some cases, include specific provisions for co-operation in staff training. In most SEE countries, the basic legal and regulatory framework for the financial sector is now in place and largely conforms with international standards. Nevertheless, there are differences between SEE countries as regards the state of development of financial sector regulation and supervision. Generally, there is a positive relationship between progress in these areas and how far each country has moved along the path leading to EU membership. As Bulgaria and Romania are acceding countries and Turkey, Croatia and FYROM are EU-candidate countries, they have generally made greater progress in adopting the acquis Communautaire in the financial sector compared to the remaining SEE countries, which are in various stages of the Stabilisation and Association Process. As a rule, in SEE countries the legal and regulatory framework and the implementation and enforcement capabilities of the supervisory authorities are more developed in the banking sector compared to other segments of the financial system. This is due to the fact that the capital markets are still underdeveloped in SEE countries, with the banking sector dominating the financial system in these countries. Accordingly, both the national authorities and the foreign providers of technical assistance place more emphasis on regulatory and supervisory reform in the banking sector. [Bulgaria and Romania have nevertheless made progress toward harmonization with EU regulations on capital markets.] Meanwhile, in all SEE countries except Turkey, foreign banks, mainly from EU countries, have acquired, through their subsidiaries and branch networks, a dominant position in local banking systems. This development has increased competition, facilitated the transfer of expertise especially in credit assessment and risk management and enhanced the ability of local banking systems to operate under more demanding supervisory standards. In contrast with the banking sector, the insurance sector in SEE countries is still underdeveloped and tends to be characterized by weak governance and regulation, despite improvements in recent years, mainly in Bulgaria and Romania in connection with these countries’ preparation for EU accession. Furthermore, reflecting the persisting problems in governance and regulation, the insurance sector in SEE countries tends to be undercapitalized. In the banking sectors of SEE counties, it appears that the degree of progress towards achieving international best standards has not been the same in all areas of regulatory and supervisory interest, particularly as regards the implementation and enforcement capabilities of the competent authorities. In a number of countries, assessments on behalf of the European Commission and the IMF have revealed remaining weaknesses in such fields as anti-money laundering, consolidated supervision of financial conglomerates, implementation of International Financial Reporting Standards (IFRS), integrated assessment of risk management systems and the extent of co-operation with foreign supervisors. [As regards the IFRS, it is worth noting that Bulgaria, Romania, Croatia, and Serbia have already implemented these standards for companies and banks, while Turkey and Albania envisage their implementation by 2008.] Moreover, SEE countries face important medium-term challenges relating to the effective application of the principles of good corporate governance across the financial sector, the implementation of the Basel II capital adequacy framework and the development of a comprehensive methodology for financial stability assessment, including the design of a macro stresstesting framework, especially for credit risk. Although central banks in some SEE countries have already made progress in financial stability assessment, more work needs to be done and such assessments need to increasingly take into account potential repercussions from regional and wider European developments. The above considerations indicate areas where further assistance may be required by particular countries. Apart from programs supported by international organisations, continuing recourse to bilateral co-operation arrangements between authorities of EU countries and those of SEE countries would be particularly useful. In this respect, the experience of the authorities of EU countries that have relatively recently completed the reform of their financial sector in accordance with international standards would be a valuable input to the authorities of SEE countries that currently face similar challenges. Also, peer group reviews by financial sector supervisors from other countries could play a useful role in periodically assessing the effectiveness of financial sector regulation and supervision in each SEE country and in offering advice on needed improvements. Finally, national Banking Federations of SEE countries can help to bring the operation of local banks up to EU standards through multilateral co-operation in the areas of staff training and convergence in the implementation of sound operating and risk management systems. To this end, the national Banking Federations participating in the Interbalkan Banking Forum have recently signed a Memorandum of Understanding. It is important to recognize that, as the financial systems of SEE countries are liberalized and their economies become more open, the task of maintaining financial stability becomes more challenging. In meeting this challenge, I believe that arrangements for supervisory co-operation and the provision of technical assistance can continue to play a useful role in supporting national efforts for further regulatory and supervisory reform aimed at strengthening the resilience of the financial sector of SEE countries and achieving conformity with EU standards. Let me conclude by stressing the importance of the financial system for economic growth. Why is the financial system so crucial? The answer is that the financial system can be thought of as a coordinating mechanism that allocates capital to building factories, houses and roads. If capital is misallocated, the economy will operate inefficiently and economic growth will be low (Mishkin, 2005) 1 . Effectively, just as a high level of human capital increases the productivity of labour, so an efficient financial system increases the productivity of all factor inputs. For this reason, a financial system can be thought of as the central nervous system of an economy. If it is stable and efficient, it coordinates the economy’s activities, helping to improve the living standards of its citizens Thank you for your attention. Mishkin, S. Frederick (2005), “Is Financial Globalization Beneficial?” NBER Working Paper No. 11891 (December).

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Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Covered Bonds Conference, organised by Barclays International, Athens, 1 September 2006.

Panayotis Thomopoulos: The Greek economy and its outlook Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Covered Bonds Conference, organised by Barclays International, Athens, 1 September 2006. * * * Ladies and Gentlemen, I am delighted to address this meeting devoted to an issue of growing importance to the financial community. Experts will speak on the subject of this conference as for me I shall try to introduce the subject of Greece. It is two years since the successful conclusion of the Athens Olympics and I am glad to observe that the Greek economic performance since then has vindicated those of us who have remained optimists all through the last decade. While two years ago many feared that the Greek economy would slide into a protracted period of slow growth or even recession when the spending for the Olympics ended, and cited Spain as a precedent, we now see that the Greek economy remains one of the strongest in the EU. This performance, achieved in the context of a very significant domestic fiscal adjustment and the Eurozone’ s slow growth until recently, indicates that Greece has a dynamism that reflects important changes on the supply side. In the rest of my speech I will highlight the main strengths of the Greek economy, the risks facing us and the necessary policy measures needed to avoid those risks and maximize the benefits from our strengths. As I alluded to before, many feared that the demand-led expansion in the run-up to the Olympics would be followed by a significant slowdown and some even predicted that Greece risked falling back into a vicious circle of stagflation. Indeed, between 1980 and 1994, economic performance was abysmal: GDP grew only at 0.7% annually and inflation averaged 16% combined with a rising fiscal deficit, culminating at 13% of GDP in 1993. Considering the significant initial disequilibria it is not surprising that in the 1990s few believed that Greece would satisfy the strict criteria for Euro area membership, and even after joining the Euro area in 2001 many doubted that it would be able to sustain for long the high rate of GDP growth of 4% p.a. experienced in the 9 years to 2004, compared with only 1.9% for the Euro area as a whole. Indeed, the fears increased as the deterioration of the fiscal situation, associated with the Olympic Games’ overruns partly due to sizeable additional expenditure for security as well as the budgetary relaxation called for a substantial fiscal adjustment, with inevitable dampening effects on growth. Similarly, it was pointed out that the turn-around from a rising trend in net EU transfers in relation to GDP to a falling trend would also impact negatively on growth. Indeed, net transfers fell, from 4.7% of GDP in 1995-1997, to 2.1% of GDP in 2005, but growth continued unabated. In addition, since 2004 Greece, which is heavily dependent on oil imports, suffered from the rapid rise in energy prices as well as from the appreciation of the Euro, which affected especially Greece’s main manufactured export products – textiles, garments, shoes – which after the lifting of the quotas had to confront strong competition from the emerging markets in Asia and the countries in transition in South-East Europe. The fact that Greece avoided the problems faced by other countries, such as Portugal, after a period of excessive demand growth is a sign of underlying improvements on the supply side. However, equally important is the restoration of the historical links between Greece and the countries in SouthEast Europe, around the Black Sea as well as with Egypt. For more than 2000 years large Greek communities, in some cases numbering hundreds of thousands, had settled and prospered in these countries. The communist regimes, revolutions and nationalism caused the amicable relations with our wider neighbours to be suspended, and many of these communities disappeared towards the end of the 1940s and in the 1950s: for example, in the 1950s more than 250000 Greeks had to leave Egypt. After 1990, the historical forces of gravity have been re-established; nationalism, as is the case in all EU countries, is now taught only in history books. As a result, friendly relations with our neighbouring countries have been restored. Greece has been a key supporter of Bulgaria’s and Romania’s EU membership, and eventually Turkey’s, as well as of the other South-Eastern European countries. A little story of the weight of history is the immigration to Greece in the last ten years of thousands of Greeks, whose ancestors had settled in Russia between the 1st and 3rd century B.C. and who, in spite of the fact that they were cut off from Greece for almost 800 years, spoke some Greek and preserved many Greek traditions. Until almost the end of the 1990s, Greece had a big handicap: it was located at the periphery of Europe without direct land connections to the main EU members and was surrounded by countries whose economic development had stalled for about 50 years. Nowadays, its geographical location has become an advantage, almost all of its neighbours are growing fast, much faster than the EU as a whole, and very soon two of them will become EU members. Greece is offering these countries entrepreneurship, expertise and capital as well as a market for their products and surplus labour. Indeed, the Greek private sector has responded quickly and positively to the opening of the region. Greek firms and individuals who spoke the language and knew the culture are establishing themselves in large numbers. Some 5000 Greek firms have set up businesses in these countries in diverse activities, ranging from small bakeries, restaurants, hotel chains, to supermarkets, food processing plants, mines, cement factories, metallurgical and aluminium factories, I.T. companies, including telecommunications, trading, shipping and other service companies. Likewise, attracted by the low labour costs and tax rates, many Greek firms relocated their plants, mainly textile, garment, shoe making plants as well as other light industries, from Northern Greece to Bulgaria, FYROM, Albania, i.e. they moved some 30 to 80 kilometres over the other side of the border. This opening and the establishment of a network of Greek firms in all our neighbouring countries, which are moreover growing rapidly, has given a new impetus to the Greek economy - the size of the market is no longer the 11 million Greeks but about 60 to 80 million consumers and many more if we include parts of Turkey which are close to Greece. The economic interdependence between Greece and its neighbours is now reflected in the sizeable Greek direct investment to South-Eastern European countries. Greeks are among the first two or three foreign investors in these countries. The enlarged market gave the opportunity to Greek firms to increase their size and to establish different processing plants in different countries, according to their cost advantage, with the result that their international competitiveness has been greatly enhanced. This development has been particularly noticeable in the banking sector, as I shall refer below. Contrary to the direction that capital was taking, labour migrated to Greece: the number of immigrants who have settled in the last 13 years is estimated at about 1 million (mainly from the wider neighbourhood) raising the population to 11 million and causing the labour force to increase by up to 20%. For developed countries, this probably represents the largest foreign worker inflow in such a short space of time. In total, the whole region of South-East Europe is becoming a unified economic space as it used to be for centuries, first in antiquity, then under the Byzantine and, later, the Ottoman Empire. It is true that Greece is located in, and oriented towards a region of relatively high growth, including the rapidly growing Middle-Eastern countries, whose governments and their nationals have a long tradition of friendship with Greece. The outlook for all these countries remains favourable and indeed, since the start of this decade import demand from our trading partners has systematically exceeded the growth of world trade. While this is significant, it is more significant to note that in 2005 Greece increased its market share in its export markets for the first time after more than a decade of retrenchment, associated with the decline of textile production, and we are on track to repeat this good export performance this year, as exports of goods increased by 13½ percent in the first half of this year, excluding idiosyncratic items such as refined petroleum and ships. A number of indicators suggest that this development is not a statistical artefact but may indicate a more permanent improvement in economic performance. The good export performance is not restricted to a few countries of destination or sectors, but is quite widespread. The opening of the economic space of South-East Europe coincided with a sustained effort to improve domestic economic performance and this has been underpinned by three factors. • First fixed investment has grown robustly: 7.3% annually since 1995, and 10% for private non-residential investment; this compares with 3.3% for the Euro area as a whole. Moreover, the investment boom affected all sectors: in the second half of the 1990s industry benefited mostly, with fixed investment rising at over 15% annually, whereas in the first half of this decade investment in the service sector, including tourism as well as the construction sector, recorded very high rates of growth. • Second, extensive privatisations and liberalisations unleashed entrepreneurial spirits and led to the creation of competent new managerial class, which is progressively taking up the reins of the business sector, which, until recently, was almost exclusively run by family members of the owners. This development owes much to the growing interest of foreign companies to buy or take a strategic position in Greek companies following Greece’s decision to join the Euro area. Foreign firms recruit Greek senior staff to run their businesses. Out of the 200 biggest Greek companies a very large proportion is fully or partly owned by foreign companies who prefer to buy existing Greek firms, so as to avoid the heavy and lengthy bureaucratic procedures in setting new companies in Greece. The new managerial class has promoted the restructuring of firms and focused on efficiency, with the result that labour productivity grew by 3% annually in the ten years to 2005 compared with 0.8% for the Euro area and 2.2% for the US, the country which mostly benefited from the I.T. boom. • Third, although the Government sector is still a drag on the economy, the progress towards fiscal consolidation and the tentative efforts to reduce state intervention and to simplify bureaucracy have started bearing some fruits. The fact that industrial production has started growing again after a protracted period of retrenchment is another signal in the same direction and indicative of a newfound dynamism. Greece has traditionally been a service economy, with a relatively small manufacturing sector. Although Greek manufacturing firms, with the exception of the declining sectors such as textiles, show healthy profitability – with profit rates above most other European counterparts– and we see new firms being set up in dynamic sectors, the contribution of manufacturing to GDP will continue to be much smaller than in the rest of the EU. The service sector is the engine of growth in Greece and here we see an encouraging performance not only with respect to our main export product, that is tourism, but also with many other export-oriented services in higher value-added sectors which are showing buoyancy. Again, over the last two years the number of tourists arriving in Greece has grown faster than world tourism, indicating that the positive image generated by the Olympics is now producing tangible results. Shipping, a sector of traditionally strong Greek presence has been doing well recently and contributing significantly to Greece’s export earnings (about $15 billion). In effect, over 15% of world shipping and more than 20% of world tankers are owned and run by Greeks all over the world. More importantly, Greek ship-owners are using the current propitious circumstances to renew their fleet, thus ensuring a significant future presence in a sector, where Greeks have thrived for over 3000 years. The success of the Olympic Games is one reason behind the favourable turn of events. It has helped not only tourism, where benefits were expected all along, but even more merchandise exports, as well as other service sectors as it has reinforced the image of Greece as a stable and reliable partner. That was a positive side-effect that was not much foreseen, as the focus was on promoting tourism. Nowadays, many foreign firms use Greece as a gateway to South-Eastern European countries or in partnership with Greek firms penetrate these markets. Thessaloniki, the second biggest Greek port is expected to play a pivotal role in the economic integration of the Southern-Eastern European countries. The border of Bulgaria, and of landlocked Fyrom are about 80 kms from Thessaloniki and for their respective capitals, Sofia and Skopje, Thessaloniki is the natural outlet to the Mediterranean Sea. Likewise, the southern provinces of Serbia and parts of Romania can equally be served efficiently by the port of Thessaloniki, which, in addition has an interesting cultural life and a pleasant life style. The advantageous location of Thessaloniki will become even more evident after the completion of the planned and partly financed by the EU of the North-South EU road and railway axes. The renewed optimism about the Greek economy is now reflected in many areas. I wish to refer to the example of construction and housing. There was a widespread belief that construction would be the main victim of a slowdown in the post-Olympics period. There was talk of a housing bubble and of a supply glut. Indeed there was a construction slowdown in the immediate aftermath of the Olympics and a levelling off of housing prices, but since last year we are seeing a renewed dynamism in this sector, unexpected in its degree. In addition to Greeks, many more foreigners than in the past are building secondary residences in the Greek islands and in the mainland. Total credit growth at around 20% annually and 30% for credit to households since 2001 has been one factor underpinning strong private demand in recent years and has been fuelled by the low Euro area interest rates. I fully accept that we should monitor developments in this area but we are far from becoming alarmed. Greece is a country with a still relatively low household debt-to-GDP ratio – 38% compared with 56% for the Euro area. The rapid credit expansion in this area reflects fundamental changes in the Greek economy and has underpinned the transformation of a fragmented stagnant inward-looking banking sector into a dynamic modern banking sector with strong international competitive presence. The lifting of foreign exchange controls in the mid-1990s and of household credit restrictions in 2001 as well as privatisations and the mergers between a large number of smaller banks since 1997 has created Greek champions (up to the second half of the 1990s almost 2/3 of Greek banks were controlled by the State and were moreover, badly run, compared with about 15% presently, which are managed by professionals). The biggest 5 banks with a 78% market share have been very active is modernising their business not only in Greece but also in acquiring or setting up new banks in all the South-Eastern European countries, where the market share of Greek banks is more than 20% on average, with a high of over 33% in FYROM and a low of somewhat less than 20% in Romania. In this region Greek banks employ around 16.000 employees in their subsidiaries or branches, and few thousand more in EU countries, US, Australia, Canada etc. The recent acquisition of Finansbank, the fifth largest private bank in Turkey by the NBG and of a smaller Turkish bank by Eurobank, as well the purchase of an Egyptian bank by the Bank of Piraeus, is transforming the scenery of the Greek banking sector, which is becoming more international. The size of Greek banks is increasing so that the disadvantage of their small size is gradually being removed and banks are now in a position to extend their activities into more profitable lines of banking, e.g. private banking, consultancy for M&A, investment banking, asset management etc. Greek banks can now start enjoying economies of scale and scope. These factors are all reflected in their high profitability: This year the return on equity is expected to exceed 20%. At the same time, Greek banks are reinforcing their role as a vehicle facilitating trade in goods and services, investment and capital flows as well as migration between the countries in the wider region. This has led to intensive competition between the Greek banks both in the home market and abroad, with the result that the high Greek interest rate spreads over most Euro area countries’ bank loans has considerably diminished to the benefit of the consumer. Indeed, competition and financial liberalization allows households to better manage their portfolios of assets and liabilities and in a fast growing economy most households would find it preferable to bring forward the benefits of their expected higher incomes in the future. There is also a stock adjustment issue; starting from a very low level of indebtedness and realizing that Greece has entered a period where interest rates are much lower and risks have diminished, as well as because of their rising wealth, households find it acceptable to carry a larger stock of debt. The flow of borrowing as households adjust to their higher level of desired debt may be very high for a protracted period. Undoubtedly, as regulators of the banking system we are concerned and we know that many things have to be improved. There is a need for better consumer protection and better education of borrowers about the risks of bad financial choices. We should not forget that the experience of Greeks over the last 15-20 years has been one of falling interest rates first as they converged to the Euro area’s average and then as the ECB relaxed its monetary policy. Now that the ECB is undergoing a phase of monetary policy tightening, the experience of rising interest rates may come as a shock to many households in Greece. In spite of this, between 2002 and 2005, we saw a reduction in the ratio of non-performing loans, a reduction that was particularly steep in the case of mortgage loans where the ratio dropped from 6.9 percent to 3.6 percent over the period. As far as the Bank of Greece is concerned, our supervisory role obliges us to ask banks to increase provisions, to tighten credit standards and in general to introduce efficient credit control mechanisms, including state-of-the-art risk management units so that even if non-performing-loans increase their CAR will still remain well above 10%: today it is almost 14%. At the same time in collaboration with the host supervisors in the South Eastern European countries, the Bank of Greece monitors closely developments at home and abroad. An area that we should look into is whether immigrants to Greece can become a valuable bridge and help trade between Greece and their home countries. There is some anecdotal evidence that this is already happening. I should like to note that Greece has always been a country of immigration and has successfully absorbed all the successive waves of immigration throughout the centuries. Greek society has always been open to foreigners: in antiquity, the orator Isocrates (in 380 BC) defined as Hellenes all those who shared our culture, and by definition spoke Greek, and not those who shared a common blood, i.e. of Greek ancestors. Even in the Oath of Alexander the Great (324 BC), it is stated that: ”Unlike the narrow minded, I make no distinction between Greeks and Barbarians. The origin of citizens, or the race into which they were born, is of no concern to me. I have only one criterion by which to distinguish them. Virtue. For me, any good foreigner is a Greek and any bad Greek is worse than a Barbarian”. The word Barbarian had a different meaning that to-day and was then referred to people speaking a language that Greeks could not understand, as it sounded “bar-bar”. I believe that Greece is now seeing also the fruits of the significant infrastructure investments that took place over the last decade, partly financed by the EU, and of the more tentative structural reforms enacted over this period. There is also a deepening understanding among the population at large, and the business community in particular, that Greece should embrace globalization at last if it is to further improve the living standards. Indeed, it is striking to note that globalization until recently passed Greece by. We were a much more closed economy than most other economies of similar size and level of development. Apart from our location at the periphery of Western Europe, this was the result of an undue reliance on the state to provide the stimulus to growth and job creation and the corresponding over-regulation of the economy, as well as the lack of intra-industry trade as our production was basically oriented to cater for home needs. I believe this was an aberration in Greek history. Greeks embraced globalization long before it became a fad. Notice our strong shipping and merchant traditions, the prospering Greek communities established all over the world, the Greek scientists and researchers that thrive in foreign universities and research centres. Continuing the adjustment to the new international economic order is a one-way road for Greece. We must start by admitting that Greece cannot compete in labour-intensive, low-wage sectors. Rather than trying to sustain such industries, we should look to what activities we should develop for the future. We should also realize that the public sector, already burdened by debt and facing the pressures of an ageing society cannot continue acting as the engine of employment creation. But let’s note the positive facts: Greece possesses an enormous stock of highly qualified scientists and researchers, both here and abroad. Greek students studying in foreign universities represent a very high percentage of these universities’ foreign student body but unfortunately many remain abroad enticed by higher earnings and the better research facilities than Greece. But in recent years reflecting the rapidly growing living standards and the significant improvements in urban amenities there is a growing number of Greeks returning to Greece. Greece has also moved further than most countries to becoming a service economy. We are thus at a good starting point to thrive in a knowledge-based world economy. Membership of the eurozone provides a stable macroeconomic framework with low interest rates and inflation as well as legal certainty that should allow private business to plan for their long-term growth. A change that is now bearing fruits was the gradual emergence of Greece as a source, instead of as destination, of foreign direct investment, particularly toward neighbouring countries. While at the time there were fears of an exodus of jobs, we now see that those investments abroad conferred multiple advantages to Greek firms. First of all, they entered new markets, learning a lot about what is demanded there. While much of the demand is filled locally, high-value added exports from Greece play a significant role. Also, the move of the labour-intensive parts of the production process abroad allows the parent firm to survive and prosper, safeguarding the high-end, mainly managerial and research, jobs located in Greece. It is noteworthy that most of the outward investment, which on average has amounted to about half the inward flows, is concentrated in sectors where Greece has enjoyed a comparative advantage, such as food and beverages, finance, trading companies construction, cement, even textiles. They form thus part of Greek firms’ strategies to maintain and enhance their competitive position. Contrary to popular beliefs, outward Greek investment flows are not directed exclusively to low-cost countries. The UK and the US figure prominently among the recipients of Greek FDI, where the four largest foreign subsidiaries of Greek firms in 2005 were located. This indicates that such flows are used mainly to enter foreign markets or acquire necessary know-how and technological expertise. I find it extremely encouraging that this year we are seeing significant gross flows of foreign direct investment, even if the final net amount may turn out to be small. Indeed, outward FDI flows have been about half the level of inward flows in recent years; as a result, Greece now has a stock of investments abroad exceeding 16 billion dollars, and this may well underestimate the true amount if we take into account the complex statistical problems that surround the collection of this data and the fact that many Greek firms retain (without declaring) in the South-Eastern European countries their exports earnings in order to finance their investment there instead of borrowing at a higher interest rate from the local bank. It is becoming clear that Greece should now actively support efforts to enhance the stability of the international financial system and provide guarantees to cross-border investments. The inward investment flows not only show that Greece is becoming an advantageous place in which to invest, they also bring with them important benefits, such as know-how. Outward flows should be seen as our entry ticket to foreign markets and as a way for Greek firms to regain their cost advantage. While much in Greece bodes well for future development, we must not shy away from confronting and solving existing problems. There is a need for government activism, if only to redress the mistakes of the past. In addition, the new environment brings with it new challenges and the need for action. Bureaucracy, despite some progress in the last 10 years, is still stifling entrepreneurial initiative; simplified procedures, personnel which are better acquainted with international practises, especially at higher echelons, and less duplication of work are necessary both in order to boost private activities but also in order to reduce the operational cost of the state. Much has been said about the fiscal imbalances and I would be the last to downplay the need for fiscal consolidation. The accumulated public debt is a burden we should get rid off as soon as possible. Not only does it consume a large part of tax revenues, it is also a source of uncertainty. Small changes in interest rates impose a heavy toll on public finances, as is the case with changes in investors’ sentiment and risk preferences. A similar argument can be made about addressing the lingering problem of our social security systems. Both the explicit public debt and the contingent pension obligations form a source of uncertainty for the private sector, which may reasonably fear revenue-enhancing tax measures in the future. Putting the public finances in order, as planned by the government, by achieving at least a balanced budget should reassure investors and help promote investment in the country. While the aim should be the elimination of the fiscal deficit, this macroeconomic objective should be reconciled with the microeconomic objective of reducing the tax burden on the economy, and, especially, continuing to alleviate the taxes on entrepreneurship. This aim has become even more pressing as we are facing increased tax competition, especially from neighboring countries and new members of the EU. You may have noticed regular advertisements trumpeting some country’s low tax rates. Combating tax evasion can provide significant revenues, even in the short-run, while at the same time improving efficiency by leveling the playing field. The long-run solution is to have a more efficient and focused public sector that will absorb fewer resources to deliver its necessary services. I now turn to two particular areas of concern, perhaps interrelated ones, the high level of unemployment, and inflation persistence. A black spot in the otherwise bright picture of the Greek economy is the stubborn persistence of unemployment. After almost ten years of continuous robust growth, unemployment remains unacceptably high. Unprecedentedly low and falling interest rates, both real and nominal, have played a role by encouraging capital deepening and substitution away from labor. There was also significant labor hoarding at the start of the period for various reasons. Likewise, agricultural employment still represents 8% of the labour force, 4 times as high as the EU average and, to the extent that it diminishes, the outflow of rural labour will continue to inflate total unemployment. Still, no one can deny that there has been insufficient employment creation and so it is worth taking some time to analyze the reasons for that. First, let’s dispose of some erroneous arguments. Trade and globalization cannot be blamed for this situation. Greece was an unusually closed economy and still has one of the highest unemployment rates in Europe. Indeed, unemployment has fallen, albeit slowly, in the last couple of years just as Greece started opening up to international competition. By the same token we should not look to immigrants as the scapegoats. They are performing jobs that the locals would not undertake. In some cases, by providing low-cost input they help keep production in Greece, thus helping betterremunerated Greek workers. This is much more evident in the case of agriculture where production of several crops would have become uneconomic save for the abundant labor supplied by immigrants. Instead of looking to put the blame on outsiders for our unemployment problem, it is better to admit that domestic policies are the main reasons for this unacceptable situation. First, there is obviously a mismatch between demand for specialized labour and supply, which calls for a better professional orientation of the tertiary educational level. Likewise the regulatory regime, supposedly created to safeguard jobs, is now discouraging job creation and leads firms to try and minimize the labor input. We should adapt to an economic system that is changing fast and where overly-rigid labour relations together with laws encouraging oligopolistic practices in the business sector, have a detrimental effect on employment itself. There is also a need to reduce the wedge between wage costs to firms and the wages received by employees. This wedge is one of the highest in Europe and is due to the very high social security contributions. It is necessary to reduce this difference in a non-distortionary way. Another issue for concern is the lack of competition and the rigidities that pervade many product markets in Greece. As I travel quite often abroad I am very often struck by how much dearer some goods and, especially, services are in Greece than in other European countries with higher wage levels. Opening up to foreign entrants and international trade as well as lifting entry barriers to various professional jobs should help induce greater competition and reduce the power of local oligopolies. A strengthened Competition Authority is also a useful tool, and its increased activity is certainly welcome. To sum up Greece, as the other EU countries, is facing its domestic problems but also the challenges arising from the unprecedented rapid globalization. Developments so far shows that Greece is responding successfully by recording the second highest growth rate, over 4% on average since 1996, in the Euroarea and more than twice as high as the Euroarea average. However, the continuation of this successful record requires sustained efforts towards budget consolidation and simplifying bureaucracy. Indeed, provided policies remain focused on promoting the necessary structural reforms and that there are no disorderly upheavals on the international front, the Greek economy should continue to perform well.

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Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Euromoney Conference "Greece's rapidly changing banking sector", Athens, 1-2 November 2006.

Panayotis Thomopoulos: Supervision of credit and financial institutions – structure of the Greek banking system Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Euromoney Conference “Greece’s rapidly changing banking sector”, Athens, 1-2 November 2006. * * * First, I would like to thank you for inviting me to this interesting conference. Before proceeding with issues concerning the structure of the banking system, I would like to say a few words about the Greek economy. Disciplined by the requirements of EMU membership, Greece succeeded in bringing inflation down from around 16%, where it was for most of the first half of the 1990s, to an average just above 3% since 2000. GDP growth, by contrast, rose from an annual rate of less than 1% for about 15 years up to the 1990s to almost 4% over the last ten years. This represents a rate which is twice the euro-zone average. Finally, the fiscal deficit also fell significantly from the double digit figures experienced in the early 1990s. In short, the Greek economy was transformed by euro area entry. Subsequently it was aided by the advantages flowing from the stable macroeconomic environment and low interest rates of the euro area, as well as from the Olympic Games in 2004. On the supply side, liberalization and privatizations as well as a reinvigorated private entrepreneurial spirit have been the principal driving forces. This spirit has manifested itself in the re-orientation from an inward to an outward looking economy, especially after joining the euro area in 2001. Greece is now fully espousing globalisation, and its overall beneficial effects more than outweigh the severe damage inflicted on a few traditional Greek industries, such as textiles. The financial sector has been the avant-garde of the globalisation process in Greece and has followed, albeit with some delay, the path laid by euro area financial institutions in speeding up consolidation, integration and internationalisation. Indeed, the Greek banking sector has transformed itself in 15 years from a highly regulated and inward looking one into a competitive and dynamic sector that is now a basic pillar for the successful economic performance. Since its gradual deregulation in the 90s reaching full liberalization in 2003, when the last regulations concerning consumer credit were abolished, it has been transformed to one of the most competitive, outward looking sectors in the Greek economy, with its assets increasing more than fourfold in the last ten years. The release, after the euro area entry, of the high obligatory reserves (12%) held at the Bank of Greece, easier access to the main international financial markets and to the ECB refinancing facilities as well as the sizeable growth in Greek national income increased considerably the lending capacity of the Greek banking sector, underpinning its expansion. The average rate of growth of bank lending to the private sector (corporates and households) has exceeded 20% since 2000, almost three times the annual growth of nominal GDP, with lending to households growing at over 30% on average. Such a high rate of growth, also stimulated by low euro area interest rates, has contributed importantly to the significant rise in the standard of living of the Greek population and to the fast rate of growth of GDP. Indeed, a significant proportion of bank lending has been financing private investment, and has thus contributed to the growth of potential capacity. Today there are 62 banks operating in Greece, of which 22 are commercial banks, 16 cooperative banks, 23 foreign branches and one special credit institution (the Loans and Consignments Fund which is exempt from the provisions of Banking Law 2075/92). The banking sector plays a dominant role in the financial sector, since it accounts for approximately 85% of total financial sector assets; if we include the financial subsidiaries of the banks as well, that is, insurance companies, mutual funds, brokerage houses etc, the figure is close to 95%. Its importance is also underlined by the fact that banks with their subsidiaries represent about 1/3 of the capitalisation of the Athens Stock Exchange, and the evolution of share prices in the banking sector has a proportionately greater impact on the general index of the stock exchange. Within the banking sector, commercial banks have a market share of around 85%. Foreign branches account for around 10%, the Loans and Consignment Fund 3.5%, while cooperative banks represent less than 1%. The degree of concentration of the Greek banking sector is somewhat above the euro area average, even if we exclude Germany with its more than 2000 mainly small local banks; it is, however, around the average of countries of a broadly similar size. The five largest banks control 66% of the banking system assets, which is lower than the 85% of the Netherlands and Belgium, close to the 69% of Portugal, but above the 45% of Austria. Financial liberalization, the facility with which capital was raised in the Athens Stock Exchange until 2000, and favourable prospects for continuing high profit rates encouraged the creation of numerous private banks especially in the period up to 2001 and was followed by a scramble for market shares both by new and old private banks. This resulted in a major card reshuffling of the financial system. Whereas until the mid-1990s one state controlled bank – the NBG – (including its subsidiary the National Mortgage Bank) had a market share of almost 50% and, as such, was effectively the market maker, to-day its domestic market share is 23%, closely followed by two private banks with a market share of 18% each and two others with 10% each. If we include subsidiaries and branches abroad the largest bank’s share – the NBG – is higher but it is still far below that of 10-12 years ago. The more even distribution of market shares does not leave much room for anti-competitive practices. I would like to note that not only there is a better distribution of market shares today but also, reflecting strong competition, the ranking has significantly changed: banks with a market share of 18% today had less than 10% in 1995 and a couple with double-digit markets shares in 1995 have now a single-digit market share. Foreign financial institutions are also present, especially in the wholesale banking sector, and they constitute a challenge for the better. As in most European countries, the Greek banking landscape can now be characterized as highly competitive. This is also underlined by the sometimes aggressive advertisements by individual banks trying to take away other banks’ customers, by offering very advantageous loan terms, especially to those who regroup their dispersed accounts among different banks in one bank. In the very competitive international environment, and especially after joining the euro area with its unified money market, the small size of Greek banks was an important handicap that banks themselves perceived as being a serious threat to their longer-run existence. Effectively they thought that either they would be an easy prey for larger foreign banks or they would be unable to compete with the larger European banks, which had much lower operating costs. In 1998, among the first 100 EU banks, there was only one Greek bank and it occupied the 78th place. A wave of Mergers and Acquisitions (M&As) started towards the end of the 1990s and is still continuing, and which was also aided by the privatization process. Today, the Greek banking system occupies a place in Europe that corresponds to the size of the country with three Greek banks being among the 100 largest EU banks; furthermore the first Greek bank moved from its 78th place before 2000 up to the 63rd place. The Bank of Greece, for its part, has been continuously encouraging both the creation of larger and more efficient financial institutions through M&As as well as greater foreign presence in the Greek financial market. Its aim is to strengthen competitive forces, encouraging banks to adopt best practices and modern management techniques, introduce new bank products and lower the cost of borrowing. This, together with the rapid expansion of the Greek banking sector abroad, should help to gradually establish Athens as a regional financial hub. This is, I think, a realistic goal but it does have some prerequisites: Greek banks for their part need to accelerate their process of modernization, especially by rapidly expanding the use of low cost electronic means of payments, and increasing the offer of sophisticated bank products, while improving their risk management techniques in line with Basel II. In the course of 2006 the key driver of structural developments has been the full or partial privatization of state-controlled institutions. Emporiki Bank was acquired by Credit Agricole, while the Postal Savings Bank was granted a banking license in conjunction with an Initial Public Offering (IPO) on the Athens Stock Exchange. In the last 10 years, the National Bank of Greece has been gradually cutting loose from state control. To this end, the appointment of professional managers and the last capital increase, which led to a dilution of the state’s shareholding, have been decisive factors. As a result, the share of directly state-controlled institutions declined further to about 13% of total banking system assets from about 80% some 10-12 years ago. These developments are expected to further enhance competition to the benefit of the Greek consumer. Concurrently, the consolidation among private medium-sized banks continued. Marfin Popular Bank is emerging as an important player, after the participation of Dubai Financial in its share capital and the planned triple merger between Marfin Bank, Egnatia Bank and Laiki Bank (Cyprus). Proton, which is focused on investment banking, is also acquiring a retail bank to expand into retail banking activities. Greece, at present, is primarily a retail banking market; but, gradually, as Greek banks’ networks abroad increase, Greek banks will also serve the growing number of Greek multinational firms both in their domestic activities and abroad. Thus the shift towards wholesale and investment banking is expected to gather strength. Competition is rather intense and a variety of new products are entering the market across the whole gambit of the banking portfolio. However, financial innovation is more pronounced in mortgage loans, where demand for credit has been particularly strong: mortgage loans continued to grow at over 30% per annum in the first half of 2006. Many banks, many more than in most EU countries, offer mortgage loans “à la carte” according to the possibility of repayment by the borrower. Initially, interest-only mortgage loans were introduced where the borrower pays, typically for a period up to 1/3 of the total duration of the loan, only interest. Then, mortgages with an initial grace period, during which no capital payments are made, appeared. Later, came mortgage loans with embedded flexibility in repayment, where monthly installments can be increased, reduced or skipped and the duration of the loan can be adjusted. Finally, foreign currency mortgage loans are being offered (initially in Yen, recently in Swiss franc), while many banks have securitized a significant part of their mortgage loans. The increasing wealth of the upper income categories has also led to the establishment of private banking departments which offer very sophisticated structured products to their wealthy clients. The Greek banking system is in good health, and this was verified by the detailed examination it underwent during the Financial Sector Assessment Program which we undertook last year under the auspices of the International Monetary Fund. In the context of this exercise, a stress test was conducted which showed that in general the Greek banking system can withstand various adverse economic situations contemplated by the scenarios. Even in the worst case scenario, where it was assumed that the probability of default increased by 60%, the resulting fall in the Capital Adequacy Ratio (CAR) was just over 1 percentage point. As the overall CAR is around 13%, even a 1 percentage point reduction, or slightly more, leaves it at quite satisfactory levels. Profitability in the Greek banking sector is above EU averages, something which is partly explained by cyclical factors (in 2005 the return on equity in Greece was 17% compared to 12% for medium sized banks in the EU). The non-Performing Loans ratio (NPLs), although still higher than European averages, has declined to 6.3% in 2005 from 7.1% in 2004 due to increased write-offs. We have to note that this relatively high ratio is partly accounted for by a couple of medium sized banks, which are, however, in the process of cleaning up their bad loan portfolio. The Bank of Greece also encourages the banks to write-off doubtful loans timely and we are, therefore, confident that the NPL ratio would converge to the EU average sometime in the next few years. In addition, it should be noted that the provision coverage ratio, which stood at 61.5% in 2005, is quite satisfactory, and given the long tradition of collateralized lending, as banks ask for real estate security, the loss-given-default rate is relatively low. However, even if the relatively high ratio of NPL does not represent a short-term risk, the Bank of Greece closely monitors the fast rate of growth of credit of individual banks and their progress in reducing their NPLs. Even if there is no immediate risk and though the household debt to GDP ratio at 38% is much below the euro area average of close to 60%, a Central bank has to err on the side of caution and address all longer term issues that might undermine the soundness of the banking system. To this end, the Bank of Greece has lately introduced a series of measures: some of them have resulted in higher capital adequacy ratios by imposing on certain banks a minimum CAR above the 8%, in higher provisioning coefficients, especially for consumer loans, in speeding up write offs of NPLs, and we have explicitly limited annual debt repayment to 30-40% of household income. At the same time and in line with the new philosophy of Basel II, in April 2006 the Bank addressed more fundamental problems by imposing new and more efficient rules pertaining to internal control systems, and all associated functions: internal audit, risk management, flow of information to the top echelons, compliance functions, governance as well as measures aimed at improving decision making and procedures in credit disbursements. The growth outlook of the Greek banking sector remains favourable, first as profits continue to increase, and second the Greek economy is underbanked by any measure used. This underlines the still great potential for further growth. Population per branch, at 3.100, is 20% more than the euro area average; population per employee is 181, 25% above the euro area average; and assets per employee amount to €4.600, 65% below the euro area average. Moreover, Greek banks are still far from reaping all the economies of scale and scope that modern banking systems provide. Banks are largely dependent on cash and make very little use of electronic means of payments – the use of electronic fund transfers and direct debits is about 90% below the euro area average. In addition, because of the reluctance to use electronic fund transfer services, Greeks are obliged to keep a great number of accounts with different banks, e.g. an average Greek has 2.6 overnight deposits, by far the highest number of bank accounts per inhabitant in the euro area, and twice the euro area average. This results in a high cost both to the individual and to the bank. However, as from 2008 this situation will have to change with the introduction of the Single European Payments Area (SEPA). Indeed, Greek banks and DIAS –the electronic retail payment system– are working together to be ready to exploit the advantages of SEPA by 2008 and thus reduce considerably the high cost of a cash based banking system while providing more upgraded electronic fund transfer and direct debit services to their clients. The Greek banking sector also faces a number of additional challenges; it has to apply all new regulations, mechanisms and the risk based methods required by the new capital adequacy framework known as Basel II, while expanding rapidly both in Greece and abroad. At the same time, it has to integrate as quickly as possible its subsidiaries and branches in South Eastern European countries, where the environment still differs considerably from that of the average euro area country. The implementation of the new framework requires substantial effort from both credit institutions and supervisory authorities. This is especially true for internationally-active banking groups, irrespective of the approach they are planning to implement. However, one should keep in mind that the Basel II framework is effectively accelerating a process that had or should have started earlier and would be necessary even if the new framework had not been introduced. The new framework was designed by the Basel Committee of Banking Supervisors for “internationally-active” banks. It provides a number of options in terms of the methods used for the estimation of capital requirements under Pillar I. It is worth noting that even the simpler ones, especially the standardized approach for the estimation of capital requirements for credit risk, requires a degree of sophistication in terms of systems and data that very small banks may find it difficult to fully fulfill at short notice. Basel II rather than being a new framework for the estimation of capital requirements is a new framework for the organization and corporate governance of risk management as well as, and this is even more important for the Bank of Greece, for the streamlining of banking supervision. It is essential that supervision, without overlooking the legal responsibilities of supervisors and their particular concerns, follows or rather adjusts its methods to some extent to the management methods of banking groups. Past are the days that a supervisory authority monitored a few simplistic types of credit. Nowadays, banks provide different forms of credit with many more risks than before and invest in complex products which required very strong internal control mechanisms that previously did not exist. In addition, Basel II highlighted the need for the enhancement of cooperation between home and host supervisors. The Bank of Greece, as a supervisor involved in the supervision of consolidated banking groups, has already organized a “college of supervisors” among the supervisors of the neighboring countries in order to accommodate their particular interests in the Basel II implementation process and we exchange views regularly on the situation of banks with cross-border business. Gradually a common supervisory culture will have to be established. I have already mentioned the expansion of Greek banks in the neighboring countries since the early 90s with the result that that Greek banks’ share in the banking sector of our neighbors is now around 20%. Although the presence of Greek banks is not limited to the wider region, it is in this area that it is most important in terms of both size and local market share. They have some 1200 branches with a total number of employees over 16000 in South East Europe and, if we include some other countries, primarily Cyprus and Turkey, the number is close to 27000; these are significant numbers for a region which is underbanked. In around 8 years time, may be up to one-half of the profits of certain large Greek banks will be derived from their operations abroad and the rank of the Greek banks in the list of the European banks will continue to improve. All four major private Greek banking groups have been engaged in recent acquisitions abroad. EFG Eurobank Ergasias SA acquired Turkey’s Tekfenbank AS in May and bought a Ukrainian lender in July. It is also opening branches in Poland. Alpha Bank SA is also looking at countries of the wider region where it has not yet a presence. Piraeus Bank SA bought the Egyptian Commercial Bank last year, the first Greek banking purchase in the Arab world’s most-populous nation. But the most significant acquisition is that of the National Bank of Greece which bought a controlling stake in Turkey’s Finansbank AS. That is the biggest takeover ever by a Greek company outside its home market. Furthermore, the NBG also expanded its presence in Serbia acquiring a medium-sized local bank. As I have already said, the contribution of South East Europe, including Turkey and Romania, to the profitability of Greek banks is expected to increase in the future. However, in order to achieve this they have to integrate their new acquisitions smoothly into their systems and culture; this is by no means an easy task. We at the Bank of Greece make sure that banks that expand their activities abroad not only have enough capital but also have the organizational structure to support such an expansion. As many of you probably know any acquisition of a credit or financial institution abroad and any expansion of branch network has to be approved by the Bank of Greece after a thorough assessment of its capital base and its internal control and risk management system. This is not only a regulatory requirement but also a business necessity in order to accurately monitor risks and thus maintain their competitive position in what is a very sought after market.

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Background paper to speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the SEANZA Symposium, Bank Negara Malaysia, Kuala Lumpur, 25 November 2006.

Nicholas C Garganas: Macroeconomic management in an environment of aggregate supply shocks – lessons from recent experience Background paper to speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the SEANZA Symposium, Bank Negara Malaysia, Kuala Lumpur, 25 November 2006. * * * The issue that this background paper addresses concerns macroeconomic management in the face of supply side shocks. While the main focus is on monetary policy reactions the paper will also touch briefly on the possible roles of other policy responses, as well as issues related to the policy mix. Supply-side shocks have played an important role in shaping the economic history of the global economy over the last 40 years or so. The most common supply-side shock, familiar to both economists and non-economists alike, has been that associated with variations in the price of oil. However, other examples include shocks to total factor productivity, arising from innovation and/or technical progress. A recent example of this type of shock is the technology boom of the late 1990s in the US, leading to the creation of the so-called ‘new economy’. Some theoretical considerations Supply-side shocks affect production and, therefore, both potential and actual outputs. Consider, first, the effect on potential output. A negative supply shock (eg an increase in the price of oil or a slowdown in productivity) reduces the potential output of an economy for given levels of inputs and the price level. Alternatively, it increases prices for a given level of output. As production costs rise, profit margins are squeezed and, in an attempt to maintain mark-ups, firms raise their prices. For a given level of demand, therefore, the negative supply shock leads to a fall in output and there will be upward pressure on the price level. If the upward pressure on the price level is not accommodated by the monetary authority, it will lead to negative demand effects, causing actual output to fall. Moreover, supply-side shocks may induce additional demand effects if, as is likely, consumers and investors are forward looking. These demand effects will be larger the more permanent the shock is deemed to be. A permanent fall in potential output is likely to generate pessimistic expectations of future income and wealth, causing consumers to cut back on expenditures. The decline in the real rate of return on investment will lead firms to invest less. This effect might be particularly strong in the case of a negative supply shock that arises from a slowdown in the rate of technological progress. Additionally, firms may feel the effect of increased financial constraints as falling profits reduce the amount of funds that can be generated internally. Thus, negative supply-side shocks can cause declines in both potential output and actual output. That growth will slow or, perhaps, turn negative, other things being equal, is not in doubt. What is less clear is what the ultimate effect will be on the price level (or, more generally, inflation). Initially the difference between actual output and potential output, the output gap, is likely to be positive, generating inflationary pressures. However, once the demand effects begin to bite, the output gap will narrow and inflationary pressures subside. At this point, it is perhaps worth noting that the impact on prices or inflation may differ depending on the source of the negative supply shock. In the case of an oil price shock, the impact on inflation is likely to be greater than other shocks. Aside from being an important input to the production process, oil is also a consumption good and hence its price feeds directly into consumer prices. Prices may also increase to the extent that workers resist the erosion of their real wages by seeking higher nominal wages that must be reflected in the prices of goods and services they produce. This behaviour generates a second round of price increases, resulting possibly in a wage-price spiral. Wage-price spirals are a special concern to policy makers since they are likely to amplify the initial impact of an oil (or any other) price increase. The timing of such second round effects depends crucially on such factors as the average duration of the wage contract and the inclusion of “escalator clauses” in contracts. Evidence from the US and Europe suggests that this time lag is around one year1 in those currency areas. The above analysis leads to the conclusion that policy makers face a particularly difficult challenge when dealing with supply-side shocks, unlike demand shocks, which influence both growth and inflation in the same direction, thereby simplifying somewhat the policy response. A negative supply shock tends to reduce growth (perhaps even causing it to become negative), while increasing inflation. Thus monetary policy faces a trade-off; if the authorities seek to maintain real economic activity, they will risk setting off an inflationary spiral. An important consideration when deciding on the policy response is whether the shock is expected to be permanent or temporary. A temporary shock is unlikely to warrant a policy response provided consumers, investors and policy makers recognise that the shock will be short-lived. In the case of a temporary shock, an imminent recovery will be expected so that the additional demand effects are unlikely to materialise; at the same time any fall in potential output will be temporary. In these circumstances, a response from monetary policy would be inappropriate. The impact of the shock may well have dissipated by the time that the impact of the monetary policy actions is felt. In other words, the long lags associated with monetary policy make it unsuited for fine-tuning the economy to smooth the effect of temporary shocks. By contrast, a permanent supply-side shock will lead, at least in the short run under conditions of inflexible wages and prices, to the challenge identified above – that is, dealing with lower growth and, most likely, higher inflation. The response of the monetary authorities will depend on their goals. One possible policy framework, although not the one followed by the ECB, is a Taylor rule under which specific weights are assigned to both inflation and growth in formulating monetary policy. One could imagine a situation whereby the interest rate remains essentially unchanged in the short run – the rise in the rate necessitated by the increase in inflation being exactly offset by the reduction necessitated by the fall in growth. In practice, however, it is more likely that the interest rate will rise, given the emphasis most central banks place on price stability in the medium term. A rise in the policy rate also has the advantage that it might keep the lid on possible second round effects if the source of the shock is an oil price rise. What is crucial here is the focus on price stability in the face of shocks. By maintaining price stability, central banks can help ensure that actual output returns to its potential level without the distorting price signals provided by rising inflation. In the long run, though, a permanent negative supply shock will lead to a reduction in the equilibrium interest rate. In such a situation, monetary policy will concentrate on the need to bring the market rate back into line with the equilibrium rate. Implicit in the preceding argument is that the policy maker can clearly identify both the nature of shocks and their impact. In practice, however, things are not nearly so clear-cut. The problems associated with measuring potential output, and hence the output gap, are well known and so there is no need to repeat them here. An additional problem is that, even if we have what we consider to be a satisfactory way of measuring potential output, estimates of potential output in real time usually differ from those calculated with historical hindsight (Figure 1)2. If it is difficult to measure potential output in general, it is even more of a challenge to measure it accurately at the time when the monetary authorities need to make a decision. Moreover, aside from the problems of measuring potential output, there is also the question of whether it is possible to determine whether shocks are temporary or permanent. Clearly, the more quickly a permanent shock can be distinguished from a temporary one, the more quickly it can be determined what, if any, the policy response should be. In practice, this implies a continuous assessment by the monetary authorities of developments on the supply side and, given that an assessment at any particular point in time is likely to be surrounded by considerable uncertainty, the monetary policy response is likely to be gradual. Taylor (1999) provides direct evidence for the US; evidence for Europe is indirect, but suggests that the duration of wage contracts is around one year as, in the US (see Smets and Wouters, 2002). The literature suggests that policy recommendations using real time data may differ substantially from those based on ex post revised data (see, for example, Orphanides and van Norden, 2002 and Gerdesmeier and Roffia, 2004). For instance, the inflation pressures in the US that accompanied the 1970s oil price shocks can partly be attributed to the monetary authorities’ misperception of the output gap (on the basis of real time data, potential output was overestimated) and this led to an easier monetary policy than might otherwise have been followed (see Hunt, 2005). Experience in the euro area and the US with supply-side shocks The discussion until this point has largely been in an analytical context. One of the basic messages to emerge from the analysis is the fact that theory does not give us a clear lead – there are too many ‘ifs’ and ‘buts’. For this reason, it is useful to examine the recent experience with supply-side shocks and to draw some lessons from this experience. As Figure 2 shows, the oil price has climbed sharply in the last few years, from under $30 a barrel in 2003 to its high of over $70 a barrel in early August of this year. The factors contributing to this sharp increase stem from both the demand-side and the supply-side. On the demand side, there has been the rapid increase in the energy needs of emerging market economies, especially China and India; on the supply side, there has been low spare capacity throughout the production chain in an environment of geopolitical tensions. Even allowing that the price of oil has recently fallen back to below $60 a barrel, the rise in the price of oil from under $30 a barrel represents a very significant oil price shock. It has come at a time when both the US economy and that of the euro area have been experiencing diverging productivity developments. Since the mid-1990s, the US has experienced a positive productivity shock with the long-term trend in productivity having picked up significantly following twoand-a-half decades of downwardly trending productivity. By contrast, in the euro area, the downward trend that began in the 1970s has continued (Figure 3)3. The responses of both the US and the euro area, in terms of inflation and output, to the oil price shock have, until now, been subdued. The US economy has continued to expand at a robust pace. While growth in the third quarter of this year was considerably below expectations, this outcome was primarily a reflection of the slowdown in housing; whilst inflation rose to around 4% this summer, it has subsequently subsided with the Fed’s recent cycle of monetary tightening inter alia having contributed to this outcome. In the euro area, the recovery, while slow in getting under way, is now broadening and deepening. Output this year is growing at close to, if not above, potential. Moreover, inflation, while higher than the “close to but below 2%” definition of price stability set by the ECB, is much below the levels experienced after the first two oil price shocks. These outcomes appear to be more modest than the predictions of econometric models, estimated on the basis of past relationships when oil-price shocks exerted a relatively large impact on inflation and growth. For example, euro area econometric models predict that a 50% increase in oil prices, ceteris paribus, would add almost 0.7 percentage point on average to CPI inflation in the first year, while reducing GDP growth by around 0.4 percentage point (Table 1)4. We have not, however, seen such large effects this time around. Consequently, other factors appear to have worked to explain the actual outcomes following this particular shock. This argument can be elaborated on. In the US, the negative supply shock of the rise in oil prices has occurred at a time that the trend growth rate in productivity has been rising, a positive supply shock. Increased labour productivity during the 1990s came from capital deepening; after the burst of the technology bubble at the turn of the millennium, total factor productivity took over as the main engine of labour productivity growth5. In addition, it has been argued that Alan Greenspan, having recognised the productivity shock early on (and certainly earlier than many others, including wage earners so that wage pressures remained low), was able to exploit the benefits of the shock in terms of lower inflation and higher output growth by not raising policy rates to the new, higher equilibrium rate implied by the shock in the long run6. It has also been pointed out that deregulation of energy markets in the US has made the economy more resilient to oil price shocks since price increases no longer have the same negative effect on productivity that they did in the past7. On developments in both labour productivity and total factor productivity since 1960, see also Skozlas and Tissot (2005). On the impact of oil price rises on the US economy, see Bernanke et al (1997), and the exchange with Hamilton and Herrera (Hamilton and Herrera, 2004; Bernanke et al, 2004), Carlstrom and Fuentes (2005) and Jones et al (2004). The Federal Reserve Bank of San Francisco (2005) refers to evidence that suggests that, following a 50% rise in oil prices, output in the US two years hence will have fallen some 0.4 percentage point below steady state and inflation will have risen by 0.2 percentage point. ECB (2006b), p.76. See Blinder and Reis, 2005. Dwahan and Jeske, 2006. The mechanism through which this works is as follows. In the early 1970s, energy prices in the US were still controlled. Hence, following the first oil price shock energy was rationed and it was not necessarily the case that the most productive units were those that got access to the energy available. Thus oil price shocks led to negative effects on productivity. However, the US experience does not get us very far in understanding that of the euro area. The continued decline in trend labour productivity growth, induced by both a reduction in capital deepening and total factor productivity8, implies that the euro area was already experiencing a negative supplyside shock when the oil price rise occurred. This situation suggests that there are factors at work, perhaps in both the US and euro-area economies, which have helped dampen the impact of this latest negative supply side shock. These factors include the following. First, there is a group of factors that might come under the general heading of structural changes in industrial economies. Some analysts point out that industrial economies are less dependent on oil today than they were during the 1970s (see Figures 4-6). Output is now much less energy-intensive compared to previous decades and other sources of energy have reduced industrial countries’ dependence on oil9. However, this cannot be all of the story since if the effect of an oil price rise is proportional to the amount of energy used in production, then, other things being equal, we would still have expected to see a sharp slowdown in economic growth as a consequence of the recent sharp rise in prices10. Yet, there has been no such slowing in growth. A second structural change is the increase in globalisation, which has significantly raised competitive pressures in industrialised countries11. Aside from generating a dampening effect on prices in industrialised countries through reduced import prices (a positive supply shock), globalisation has also weakened the power of trade unions. This situation appears to have contributed to subdued second round effects, helping industrial countries avoid wage-price spirals. Employers now resist wage increases in the face of high energy prices in order that their mark-ups are not squeezed. Moreover, international competition has reduced the pricing power of firms substantially, making companies more reluctant to increase their prices than was the case after previous oil prices increases. In addition to these changes to economic structures, a major factor in containing the effects of negative supply shocks is the enhanced credibility of the monetary authorities – what we might call changing institutional structure. Enhanced credibility can be seen as a consequence of the granting of independence to central banks and the fact that many more central banks are now charged explicitly with, and aim to achieve, the goal of price stability. The two major negative supply shocks of the 1970s and the differing monetary policy reactions to them can be considered to have been decisive in changing attitudes towards monetary policy. This experience, in turn, led to the institutional changes just mentioned. The oil price rises of 1973-74 and 1979-80 were both accompanied by increases in inflation and declines in output in most industrial countries. However, the monetary policy reaction to the shocks differed. By and large, the first oil shock was accommodated, as monetary policy was loosened, in order to offset the negative impact on growth; in contrast, monetary policy was significantly tightened after the second oil-price shock with the main focus of central banks on the containment of inflation12. The non-accommodation of the second oil price rise led to a contraction of output in the short run, but contained the inflationary impact of the shock. It can be argued that the contraction in output was larger than it otherwise might have been since monetary policy during the second oil shock had to be tightened sufficiently not only to deal with the second oil shock, but also to counter the inflationary pressures that remained from the first shock. Additionally, the fact that the monetary authorities did not aim to contain inflation during the first oil price shock implied that it was more difficult during the second shock to alter expectations. Central banks thus faced a high cost, in terms of recessions, in their attempt to restore price stability in the 1980s. A basic conclusion for policy making that emerges from these two episodes is the following: inappropriate policies in the face of negative supply shocks that exacerbate the inflationary consequences of shocks ultimately lead to an economy paying a higher price over the medium run ECB (2006b), p.76. Andersen and Bernard, 1991. Dhawan and Jeske, 2006. This factor has been noted by Weber (2006), King (2006) and Liikanen (2006). The OECD (2006) calculates that, in the absence of the effects of globalisation, inflation in the advanced countries taken together would have been around 0.3 percentage point higher over the period 2000-2005. See also ECB (2006a). Even if monetary policy was tightened eventually in the aftermath of the first oil shock in Germany and the US, it was relaxed at the time of the shock. than would be the case if the authorities pursued policies directed toward price stability. Inappropriate policies in the short run make it more difficult for the authorities to stabilise the economy during subsequent shocks13. Such a conclusion is confirmed by movements in headline and core inflation after the first and second oil price shocks. Figure 7 shows the reaction after the first oil price shock; figure 8 after the second oil price shock. Core inflation responded much quicker after the second shock; this provides support for the argument that inflationary expectations had become entrenched after the first shock, necessitating a strong dose of monetary tightening. Another conclusion that emerges from the above discussion concerns the difficulty of conducting policy in a world of uncertainty. Consider some of the changing relationships mentioned above. These include the decline in the energy intensity of production, the increase in global competition, including its effects on wage behaviour and profit margins, and the ascendancy of central-bank credibility. The upshot of these, and other, changes is that the economic world in which we function is the best described by a structure whose parameters are constantly changing, helping to explain why the predictions of the models about the effects of the most-recent oil price shock have been off the mark. The challenge for the monetary official is to operate in a way that does not depend on a fixed economic structure based on historically average coefficients. These lessons have been enshrined in the new institutional environment of monetary policy-making that spread throughout industrial countries during the 1990s. By recognising the limits of using an activist monetary policy in a world characterised by uncertainty and changing parameter values, monetary authorities focused their attention on what they could deliver — price stability over the medium term. Crucially, that environment gave monetary policy a new credibility and created a regime of low inflation expectations. In such a regime, inflation is less sensitive to oil price increases. In the context of a New-Keynesian Phillips Curve, for example, inflation depends, inter alia, on current expectations of future inflation. If expectations are solidly anchored, then inflation will not increase in response to a negative supply shock because economic agents will not expect a rise in inflation. Therefore, the policy actions of the monetary authorities that aim at price stabilization, as well as the ability of the monetary authorities to communicate their policy commitments effectively to the public, have kept inflation expectations contained and contributed significantly to the muted response of inflation to this oil shock. In addition to not leading to a surge in inflation, the recent oil price shock has not led to the kind of recession experienced during the previous oil shocks. In part, this outcome may have something to do with the fact that the recent oil shock reflects, in part, buoyant demand for oil in the US, China and India. Consequently, the deterioration of the terms-of-trade in oil importing countries, appears to have been counterbalanced by higher demand for their goods from the countries that demand more energy. However, again, the monetary policy framework and increased credibility of monetary policy help explain the more muted output response. Central banks may face less of a trade off between output and inflation14. Because the dynamics of inflation are strongly affected by inflation expectations, a credible central bank has the ability to contain inflation without substantially reducing output, since the knowledge that action will be taken if necessary may itself be sufficient. Indeed, evidence indicates that monetary policy effectiveness is the driving force behind improved macroeconomic performance, as measured by the reduction of inflation and output volatility15 (Figure 9). Underlying this increased effectiveness lies central bank independence and greater transparency which gives monetary authorities the chance to communicate their monetary policy objectives more effectively. The ECB’s two-pillar monetary policy framework, which takes account of real, monetary and financial factors, provides conditions under which credibility is attained, allowing the euro area to reap the benefits just discussed. The explicit goal of maintaining price stability, along with an actual quantitative See Yellen, 2006. Woodford (2003). Cecchetti and Krause (2004) provide evidence supporting this view. Their results are based on the estimation of monetary policy efficiency frontiers, which are defined in terms of inflation and output volatility. One may, of course, argue that it is not the effectiveness of monetary policy that explains the better macroeconomic performance but rather the fact that there has been a reduction in the variability of supply shocks. The authors divide the change in performance into the proportion accounted for by the improvement in policy effectiveness and the proportion that is due to changes in the variability of shocks. They find that for the majority of the 24 countries analyzed over the 1980s and 1990s, more effective policies underlie the improvement in overall macroeconomic performance. definition of stability as an inflation rate below but close to 2%, helps anchor inflationary expectations. Figure 10 shows how inflationary expectations have been anchored since the creation of the euro area and the ECB. In spite of the slight rise in expected inflation since the early years of economic and monetary union, expectations remain anchored around 2%. At the same time, new information relevant for monetary policy formulation is assessed in Governing Council meetings using the two pillars – the economic and monetary analysis. The economic analysis focuses on real activity and financial conditions, factors that influence price developments in the medium term. The monetary analysis provides a longer-term perspective based on the fact that inflation is ultimately in the long run a monetary phenomenon. Overall, the strategy does not justify short-term activism and efforts to “finetune” the economy. The existence of an explicit goal, in combination with the current framework for monetary policymaking, has been successful in enabling the ECB to establish credibility during its short history. The ECB’s institutional structure also facilitates transparent policy-making and the communication of policy decisions to the general public and financial markets. That this communication has been successful is supported by some evidence suggesting that the ECB’s focus on a quantitative definition of price stability has influenced price and wage setters in the euro area. Although prices tend to move very sluggishly in the euro area compared to, say, the US, inflationary shocks dissipate at a similar rate to the US – the extra rigidity in the euro area is offset by the benefits of the effectiveness of monetary policy in anchoring euro area inflationary expectations16. So what does the foregoing analysis imply for policy prescriptions now? As inflation expectations appear to be appropriately anchored, it may be tempting for policy-makers to follow an accommodative monetary policy, riding the back of increased credibility. However, an accommodative monetary policy would not be a prudent prescription since the inflation expectations of economic agents may rise, ending the period of low inflation expectations. Indeed, if inflation expectations depend not only on current inflation, but also on average inflation in an earlier, higher inflation, regime, a large and persistent shock, such as a negative energy supply shock may well lead economic agents to raise their expectations that the monetary authority will shift to a higher inflation regime17. The credibility that monetary authorities have gained so far must not be jeopardized by loosening the tolerable inflation range. A credible central bank can help stabilize the economy during this oil shock without moving to a higher inflation target. Indeed, the credible central bank can take advantage of its credibility during an oil price shock because it faces less of a trade off between inflation and output than a less credible central bank. This situation enables the credible central bank to counter the shock through a smaller tightening of monetary policy than would otherwise be the case because the dynamics of inflation due to expectations are self-contained18. In the specific case of the ECB, credibility and well-anchored inflationary expectations have allowed monetary policy to be quite accommodating despite actual inflation at or above 2% for more than two years. More recently, however, there have been potential upside risks to inflation stemming from both real economic and monetary developments. As a consequence, the ECB has acted to preempt any unfolding of these upside risks by withdrawing monetary accommodation. This circumstance underlies the rising rates in the euro area during the past year. A potential role for other economic policies? So far attention has concentrated on monetary policy responses to supply shocks. Before concluding, it is useful to make a few remarks on the potential role for other economic policies. First, an economy’s tolerance of negative supply shocks will be enhanced if labour market flexibility is increased. This fact is something that is widely recognised and, in the EU, it has resulted in the adoption of various policies designed to reduce rigidities within the framework of the Lisbon ECB (2006b), p.79. See Gagnon, 1997. The idea underlying this argument is provided by Woodford (2003). Current inflation is a function of marginal cost (including changes in oil prices) and inflation expectations. If inflation expectations are well anchored they need not impact on current inflation during an oil price shock because market participants know that the central bank will take action to stabilize inflation. Hence, the amount of actual monetary tightening will be less than that required by a less credible central bank because inflation will not have its own internal dynamic resulting from less-than-well anchored expectations. Agreement. In the absence of central bank credibility, a monetary policy response to a negative supply shock is especially necessary because of the sluggish response of real wages to the shock. Negative supply side shocks increase marginal costs (either directly in the case of an oil price shock or through the need to employ more labour to produce the same output in the case of the negative productivity shock). Inflation in these contexts is the result of a lack of adjustment of real wages. Thus the more quickly real wages adjust, the more quickly actual output will converge to the new potential output. If economies were more flexible, then the challenge for monetary policy posed by a negative supply shock would be much reduced19. Second, if monetary policy is focused on price stability and anchoring inflationary expectations, the potential recessionary effects of a negative supply-side shock could be countered through fiscal policy. If fiscal conditions give governments the flexibility to let automatic stabilisers work following a negative supply shock, tax revenues will fall and transfers increase, stimulating the economy. Moreover, a tight monetary policy that aims at countering the inflationary consequences of an adverse supply shock could be accompanied by a discretionary fiscal expansion, i.e. a reduction in tax rates or an increase in government spending. The latter policies might further contain the recessionary impact of the shock by offsetting the negative effect of the oil price rise on private demand. Therefore, if government has the necessary flexibility, fiscal policy could lessen the stabilization burden of monetary policy. In the euro area, however, the scope for fiscal policy is, at present, limited because of the failure to tighten fiscal policy, during previous years when output was above trend. As a result, many countries have been left with significant fiscal deficits and high debt levels. Even the room for automatic stabilizers to work, while staying within the rules of the Stability and Growth Pact, is extremely limited. This situation highlights the need for governments to undertake the fiscal reforms necessary to generate a fiscal balance or surplus over the economic cycle. Only in this way can fiscal policy be available as a tool to counter the impact of any future negative supply shocks. Conclusions To conclude, the message of this paper is that central banks should not respond to negative supply shocks by loosening monetary policy. To do so would simply undermine the credibility that many central banks have worked to acquire and increase the costs of restraining inflation in the future. 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An Estimated Stochastic Dynamic General Equilibrium Model of the Euro Area. ECB Working Paper No. 171. Taylor, J.B. 1999. Staggered Price and Wage Setting in Macroeconomics. In Taylor J. B. And M. Woodford (eds), Handbook of Macroeconomics, Volume 1, 1009-1050. Trehan, B., 2005. Oil Price Shocks and Inflation. Federal Reserve Bank of San Francisco Economic Letter, 2005-28. Weber, A. A., 2006. Oil Price Shocks and Monetary Policy in the Euro Area. Whitaker Lecture before the Central Bank and Financial Services Authority of Ireland. Woodford, M, 2003. Interest and Prices. Foundation of a Theory of Monetary Economics. Princeton University Press. Yellen, J. L., 2005. Productivity and Inflation. Federal Reserve Bank of San Francisco Economic Letter, 2005-04. Yellen, J. L., 2006. Enhancing Fed Credibility. Federal Reserve Bank of San Francisco Economic Letter, 2006-05. Table 1: Impact of a 50% increase in oil prices on euro area inflation and GDP growth Source: ECB (2004). Figure 1: Potential Output: real time and latest estimates compared Source: ECB, 2005. Monthly Bulletin, February, Box 5 Figure 2: World Oil Prices (November 1960-November 2006) 01/01/1960 31/12/1964 31/12/1969 31/12/1974 31/12/1979 30/12/1984 30/12/1989 30/12/1994 Source: Thompson Financial, Datastream 30/12/1999 29/12/2004 29/12/2009 Figure 3: Labour productivity in the US and the Euro Area Source: Source: R Gomez-Salvador, A Musso, M Stocker and J Turunen, 2006. Labour Productivity Developments in the Euro Area, ECB Occasional Paper, no. 53. Figure 4: Oil dependency in the Euro Area (1971 and 2000 compared) Figure 5: Oil Dependency in the US: 1971 and 2000 compared Others 2% Hydro 4% Coal 17% Nuclear 1% Natural gas 32% Oil 44% Hydro 3% Nuclear 8% Others 3% Coal 23% Natural gas 24% Oil 39% Source: Energy Information Administration Figure 6: Oil Input to Production Figure 7: German Headline and Core Inflation during First Oil Price Shock 7.5 6.5 Nov 1974 5.5 Feb 1973 March 1974 4.5 Jan-75 Nov-74 Sep-74 Jul-74 May-74 Mar-74 Jan-74 Nov-73 Sep-73 Jul-73 May-73 Mar-73 Jan-73 Nov-72 Sep-72 Inflation including Energy and Food Core Inflation Figure 8: German Headline and Core Inflation during Second Oil Price shock Oct-81 Mar-82 Sep-78 Jun-79 Feb-79 Feb-82 Dec-81 Oct-81 Aug-81 Jun-81 Apr-81 Feb-81 Dec-80 Oct-80 Aug-80 Jun-80 Apr-80 Feb-80 Dec-79 Oct-79 Aug-79 Jun-79 Apr-79 Feb-79 Dec-78 Oct-78 Aug-78 Jun-78 Apr-78 Feb-78 Inflation including Energy and Food Core Inflation Figure 9: Changes in Performance due to Policy Source: Cecchetti et al (2004), Figure 4. Figure 10: Indicators of long-term inflation expectations in the euro area 3.0 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 France (2013 maturity) (1, 2) 1.0 Euro area (2012 maturity) (1, 3) Euro area (2015 maturity) (1, 3) 0.5 0.5 SPF Consensus Economics 0.0 1999M01 0.0 2000M01 2001M01 2002M01 2003M01 2004M01 2005M01 2006M01 The ten-year break-even inflation rate reflects the average value of inflation expectations over the maturity of the index-linked bond. It is calculated as the difference between the nominal yield on a standard bond and the real yield on an inflation index-linked bond, issued by the same issuer and with similar maturity. Issued by the French Government linked to the French CPI excluding tobacco. Issued by the French Government linked to the euro area HICP excluding tobacco. Survey of Professional Forecasters conducted by the ECB on different variables at different horizons. Participants are experts affiliated with institutions based with the European Union. This measure of long-term inflation expectations refers to an annual rate of HICP expected to prevail five years ahead. Survey of prominent financial and economic forecasters as published by Consensus Economics Inc. This measure of long-term inflation expectations refers to an annual rate of inflation expected to prevail between six and ten years ahead.

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Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the European Finance Convention, Athens, 31 January 2007.

Panayotis Thomopoulos: Recent developments in housing finance Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the European Finance Convention, Athens, 31 January 2007. * * * Ladies and Gentlemen, It is a great pleasure and an honor to address such a distinguished audience of practitioners in the area of finance on such a topical issue. Before speaking succinctly on the housing market and its interlinkages with the rest of economy, I would like to say a few words about long term issues and challenges. In particular in the field of mortgage lending the effects of today’s decisions will be felt during the next 25 or even 35 years, when the last installment of a 25 or 35-year loan is repaid. Today most analysts and market actors seem optimistic about future developments and this because markets are mainly preoccupied with the short term, and tend to project current trends into the future. And if you want to lengthen the time horizon, many analysts, traders etc. will cite the famous words of J. M. Keynes, “over the long run we are all dead”, thus bringing the discussion back to current developments and a focus on the short-term. Indeed reading the figures and short-term forecasts about the world economy presented by the OECD, IMF and others one cannot but be optimistic. The global economy has been growing at an average rate of almost 5% since 2001, and the short-term prospects point to a continuing high rate of growth. The world has not seen such a high long-term rate of growth since the 1950s and 1960s. Moreover, whereas in the past only a small proportion of the world population (1/4) were reaping the dividends of growth, nowadays nations accounting for almost ¾ of the word population are benefiting from rising standards of living, though to varying degrees. Are these revolutionary developments and do they signal a new area of the world history? I believe the answer is yes and yes. The developed world, that is essentially EU, US & CND, Australia, N. Zealand, Japan & Korea, are no longer the only global actors, and the consequences of the economic upheavals are being felt in the world political arena, cultural attitudes, social behaviour and unfortunately the climate across the globe. Every year more than 50-60 million people from emerging market countries, essentially in China and India, are entering the market economy, both as consumers and as producers of tradeable goods and services. The previous great leaps were the absorption into the market economy of only 70 million people from Korea, Taiwan, H.K. and Singapore in the 1970s and 1980s, that is, over a 20-year period, and the absorption of an additional 30 or a little more million from the European transition economics over the last 10 years. But those leaps implied a very slow rate of absorption, considerably smaller than that of the last few years which has witnessed the absorption into the market economy of large population categories from China and India. The economic growth of the emerging and transition market economies, though a positive world development as it is associated with diminishing income inequalities among countries leading to more balanced world development, has, nonetheless, produced some major shocks as reflected not only in the rising trend in energy and raw material prices but, more importantly, in the increasing pollution of sea and land, global warming due to carbon dioxide emissions, etc. Indeed, if we want to prevent a major climatic catastrophe on a global scale, the waste of energy, water and other resources, not only by emerging economies but also by developed economies, will have to be reversed at a great cost in the future. Just as under international accounting standards future liabilities, such as companies’ pension liabilities, are deducted from company incomes, so the future cost of today’s actions should be taken into account. Accordingly today’s global and individual countries’ GDP growth rates, which supposedly measure the improvement in the standard of living, should be adjusted downwards. Such an adjustment is necessary as there is too much complacency and the hidden economic costs of today’s actions are not properly taken into account. Any new era brings along new problems, requires new solutions and increases the range of potential crises and risks, which are not properly gauged, as they are not yet calibrated. Moreover, by projecting today’s favourable trends, financial markets often generate a benign perception of future developments, which do not, however, reflect all the underlying forces at work. Indeed, the significant transformation of the financial environment has led to heightened and new risks associated with the introduction of innovative products (e.g. derivatives), the existence of highly leveraged non-regulated financial institutions and markets, combined with world liquidity increasing considerably faster than the value of the underlying real assets. Regarding world politics most probably China and later India will become great world powers but during the transitional period before a new world order is established the risk of political tensions cannot be ruled out, and their impact on the world economy and markets cannot be fully understood today. Another area of concern is that the benign inflation trends of the last few years, which are almost exclusively due to moderate wage claims in the developed countries and which have more than offset the impact of the rise in energy and raw material prices, may not continue for ever. Indeed, over the last 5 years average real wages have been stagnant, and probably more than one-half of wage earners have experienced real income losses, while profit margins have been rising strongly. Lately we have been seeing the first signs of a change in labour behaviour and, although, over the next couple of years wage growth will probably continue to be about 2% in most developed economies, this cannot be taken for granted over the medium to longer run. To sum up there are risks in the horizon: a) steep rising costs from global warming, pollution and the quick rate of depletion of non-renewable resources; b) apart from the proximate concerns regarding the Middle East imbroglio there are political risks further down the road, which are associated with the emergence of new global powers during the transition to a multi-polar world; c) crisis in segments of the financial markets which may necessitate drastic measures at a high cost to prevent a spill over; and d) increasing income inequality in the developed world may trigger, especially in Europe, a backlash with sudden wage increases putting pressure on inflation. Seeing today’s 10, 20 and 30-year interest rates on mortgage loans, and low bond rates in general, I have the feeling that these risks are not fully reflected in interest rate spreads. Focusing more on the specific subject of interest today, I am afraid that, in addition to financial assets, some countries’ real assets, including housing are overvalued today, and a disorderly adjustment of asset values could have important effects. This is what has been called the $400 trillion question. Financing of the housing sector is an area of economic analysis that has come to prominence only in the last couple of decades. Two, perhaps inter-related, developments have contributed to this new prominence, financial innovation and the wide gyrations in housing prices that have been observed in the last two decades, starting with the real estate collapses in Japan and other Asian countries. No one can claim that house prices never fall or that real estate is an area of boring stability. In recent years, the housing sector has thus emerged as a major channel for the transmission of monetary policy but also as a reason for concern regarding financial stability. Financial innovation has allowed financial intermediaries to structure their products more in line with consumers’ demands and to take on more risky products as the possibilities of securitizing their exposure has increased. Since housing finance is normally very long-term – typically mortgages are for twenty to thirty years – the mismatch of maturities is correspondingly more acute. Securitization allows financial intermediaries to overcome this problem to some extent and thus facilitate the extension of more credit in this market. However, transferring risks does not mean that nobody will pay the bill if conditions deteriorate and those who will pay the bill are usually also bank clients (or the banks may pay compensation to holders of securitized bonds in order to minimize reputational risks); thus “securitization does not completely insulate banks” and this simple maxim tends to be ignored today. Consumers for their part have a wider array of options to choose from and this has led to an increase demand for mortgages. At the same time, the removal of many regulatory restrictions and the increased integration of markets, especially in Europe, have led to increased competition and an overall reduction in interest rate spreads to the benefit of consumers. Many borrowers who were previously excluded from the market now have access to affordable credit and can enter the housing market. A particular phenomenon that is widespread across the Atlantic but is starting to spread over here is equity withdrawals, whereby homeowners use the accumulated equity in their houses to finance current expenditures. Whilst this may depress savings in an economy, it may also improve its resilience to shocks, as the interest rate on mortgage-backed loans is normally lower than for other forms of consumer credit. Another issue that may be acting toward increasing the risks in the economy is the propensity of market participants to take on risks which they do not fully understand. A specific example is the proliferation of mortgages in foreign currencies, which make borrowers vulnerable to little understood exchange rate risk and lenders to credit risk, which may remain hidden for a long period as long as everything goes well. Of course, extension of credit to new borrowers at a time of diminishing spreads coupled with little understanding of risks may be a source of concern regarding financial stability, especially if house prices become stretched. This brings me to a second issue, of housing finance as a channel of monetary transmission. Obviously, as households take on more housing debt, they react faster and more strongly to interest rate movements, thus allowing the Central Bank through their interest rate policy to have a greater influence on macroeconomic activity. A faster and fuller pass-through of interest rates facilitates the conduct of monetary policy and enhances its effectiveness. In this context much depends on whether mortgages are with fixed or floating interest rates. Countries, of course, differ widely on this, for historical, legal or other reasons. Whether the expansion of the mortgage market is responsible for the often-observed significant increases in housing prices is a moot point. There are many good reasons that support higher prices, such as demographic changes, as smaller families require more overall living space, expectations that real and nominal interest rates will remain low, and regulatory restrictions that curtail land supply. Surely, the ample liquidity that has been pumped into the markets in recent years has created conditions conducive to speculative excesses. Most countries in the euro area have not yet had any experience of significant correction in nominal housing prices. It is possible that both borrowers and creditors have underestimated this possibility and in some cases both credit expansion and housing prices increases look questionable. Developments in Greece are a good illustration of the forces that operate throughout Europe. After the full liberalization of the financial sector we have seen a real revolution of housing finance. Since 1996, mortgages have more than doubled as a share of banks’ portfolios, while there was a fivefold increase of mortgage debt as a proportion of GDP. The first trend was the result of falling interest rates and increased competition that led banks to search for new areas of profitable expansion. Households, on the other hand, facing improved conditions, as exemplified by that fast growth of GDP and lower costs of borrowing, reacted quite rationally by increasing their indebtedness. The ratio of homeownership in Greece has been among the highest in Europe, fluctuating around 80 percent in recent years. Mortgage demand has probably been used to improve housing conditions rather than enter the market for the first time. Demand from economic immigrants has supported this trend by allowing existing homeowners to sell their entry-level properties in order to move to more expensive ones. As I see it, we are still in the process of stock level adjustment, as the level of mortgage indebtedness at 27% of GDP is still below the European average (of about 38%), though the gap is narrowing rapidly. House prices increased fast at the start of this period relative to disposable income, although we are seeing some leveling-off lately. Research conducted at the Bank of Greece by Sophocles Brissimis and Thomas Vlassopoulos shows a two-way causal relationship. Increasing house prices have allowed or forced households to borrow more, while at the same time the availability of housing credit has fuelled house prices. The steep increase in mortgage lending, starting from a very low level, did initially create problems for the quality of Greek banks’ portfolios. Initially, the ratio of non-performing mortgage loans appeared quite high, but over the last six years it has almost halved. With pressure from the Bank of Greece and following the development of more comprehensive credit control systems, the ratio of non-performing mortgage loans now stands at about 3½ percent down by 1 percentage point in two years, indicating a much better ability of Greek banks to manage their risks. This is reinforced by the fact that mortgages in Greece are normally lower as a percentage of market values than elsewhere. Moreover, Greeks are more sentimentally attached to their homes than are Americans and other Europeans, and therefore perceive house-eviction as a terrible social blow. It was useful that the rapid expansion of mortgage credit took place at a time of high growth and macroeconomic stability since this allowed banks to absorb the “growing pains” emanating from their entry in this market without impairing their stability. Developments in South-Eastern Europe in many ways resemble Greece’s experience in the preceding decade. One significant difference is the relatively low stock of existing housing units, which are often of a rather low quality for today’s needs. There is thus a much more urgent need to upgrade and expand the housing stock. Given the relatively benign climate in those countries recently, households may be inclined to overextend themselves. These emerging market economies are starting from a very low level of financial development, which translates also into a very low level of housing credit. This low level of housing credit is more a result of financial under-development rather than of skewed credit policies on the part of financial institutions. It is to be expected therefore that housing credit will expand quite fast for the foreseeable future as the financial sector expands toward advanced economies’ levels. This is quite a rational reaction of creditors and borrowers to the economic situation and may accelerate for those countries that join or are expected to join ERM II and later EMU. In those countries, the reduction of the risk premium and perceived policy stability will also encourage credit expansion. While from a macroeconomic point of view all these developments may seem quite predictable, there is a fear that both borrowers and lenders in these countries may not have an adequate understanding of the risk they are taking. Financial institutions may lack the necessary expertise to manage a fast expansion of their housing loans portfolio, and in the rush to gain market share they may extend credit to ever-riskier borrowers. While the ratio of non-performing loans in South Eastern European countries does not look threatening now compared with other emerging markets, one should note that overall household credit in these countries is much lower and thus more manageable than elsewhere and the macroeconomic situation has been quite propitious. Two further differences are worth noting: a strong penetration of foreign-owned banks and a large percentage of loans are in foreign currency. The first special characteristic is the significant penetration of foreign banks in these countries, which typically control more than half of the local market. I should add here that Greek banks are quite active in this area and are expanding fast. Foreign banks may be a source of stability. They bring with them a much longer experience, direct access to the capital markets of mature economies and, last but not least, they are supervised by their home country’s supervisors who also have a longer experience. In the particular circumstances of these countries, it is also worth noting that foreign banks and their supervisors are less prone to succumb to pressure from local politicians. The challenge for them is to adapt their experience to the realities in their host countries. The second interesting characteristic is that the highest rate of growth of loans in foreign currency is not in countries with a fixed exchange rate regime, like Bulgaria, but in countries that have a policy of inflation targeting coupled with a benign neglect of the exchange rate. It is true that in recent years the ample supply of liquidity internationally has combined with increased risk tolerance on the part of investors to support a rather stable external environment for emerging and transition economies and in particular predictable exchange rates. While we all hope it is going to continue, we should be well aware that recent years have been a departure from longer-term trends. In addition, in some countries in the region one suspects that a process of real appreciation is taking place, a process that will have to be corrected sooner or later. The current account deficits observed in many countries in the region raise concerns regarding their sustainability. Any loss of confidence on the external side may easily cause some upheaval in the domestic financial market. Countries in South-Eastern Europe have the advantage of being able to learn from best practices developed in more advanced countries and avoid the mistakes of others. They should take the opportunity offered now by a relatively stable international environment and their domestic fast growth to put mortgage lending on a stable footing. The credit information infrastructure should be strengthened, the legal procedures for dealing with defaults should be simple, clear and transparent, and both banks and borrowers should realize the risks they take, especially as they move to more sophisticated instruments.

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Remarks by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the panel discussion: "The Future of Europe", at the Cultural Days of the ECB, Frankfurt am Main, 24 October 2007.

Nicholas C Garganas: EU enlargement Remarks by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the panel discussion: “The Future of Europe”, at the Cultural Days of the ECB, Frankfurt am Main, 24 October 2007. * * * 1. I am delighted to be taking part in this discussion on the future of Europe. My remarks will deal with the issue of enlargement. EU enlargement has been a long and involved process. The EU has expanded on five occasions, growing from six members to 27 members. Beginning with the First Enlargement in 1973, enlargement has been at the core of the EU’s development. It has provided both political and economic benefits. The first four enlargements involved only two or three countries on average and took place every 10 years or so. The fifth enlargement was much larger; it comprised 12 countries and took place in two stages – in May 2004 and January of this year. Although it was larger, it went smoothly and was a success. The 12 countries were integrated into the EU without any problems for the EU or for the countries themselves. It brought over 100 million new citizens, with rising incomes, into the EU. Politically, enlargement has helped to overcome the division of Europe and succeeded in establishing a regional system based on democracy, and a respect for human rights and the rule of law. It has helped the EU respond to major changes, including the fall of dictatorships and the collapse of communism, bringing stability and solidarity among its members. Economically, enlargement has helped to increase prosperity and competitiveness, enabling the enlarged Union to respond better to the challenges of globalization. In sum, enlargement has increased prosperity in the Union and has strengthened the security of all EU citizens. In a continent the history of which had been marked by turbulence and conflicts, these political and economic benefits are not small achievements. 2. Now let me say something about the present enlargement agenda. As you know it covers Turkey, Croatia, and the Former Yugoslav Republic of Macedonia, which are at different stages on the road towards EU membership. These countries have been given by the Council the clear perspective of becoming EU members once they fulfill the necessary conditions. However, these countries each face some difficulties, especially since some enlargement fatigue appears to have set in. After growing from six members to 27 members, we should expect some slowdown in the pace and extent of adjustment. Indeed, it is worth noting that the latest enlargement took place after many years of careful preparation. With regard to Turkey, politically, there has been some opposition to that country’s entrance. However, the EU has to honour its existing commitments towards countries already in the process of negotiations, provided that countries can fulfill all the necessary conditions. Turkey has continued to make progress in reforms. However, the pace has slowed during the past year. Significant further efforts are needed to fulfill fully the Copenhagen political criteria. In particular, concrete steps are needed for the normalization of bilateral relations with all EU member states. All three countries should ultimately be admitted into the EU but sufficient time should be allowed for the necessary reforms to be implemented. Their dates of entry into the Union depend on the results of their reforms. Each country will be judged on its own merits. 3a. What should be the next round of enlargement? Potential candidates are the remaining countries of the Western Balkans, that is Albania, Bosnia and Herzegovina, Montenegro, and Serbia, including Kosovo. That the future for these countries holds the prospect of eventual EU accession is widely acknowledged and has been mentioned on several occasions, for example by the European Council in Feira in 2000 and the EU-Western Balkans Summit in Thessaloniki in 2003. Each of these countries will be invited to join the EU once the accession criteria have been met. Nevertheless, this group of potential candidate countries still has some way to go before reaching that point. The speed of accession is determined by how quickly countries meet the political and economic criteria. The political criteria require that countries ensure the stability of institutions guaranteeing democracy, the rule of law, the protection of human rights and respect for, and protection of, minorities. The two basic economic criteria are, first, the establishment of a functioning market economy, and, second, the ability to withstand competitive pressure in the Union. Meeting these basic criteria requires determination and time. Economic reforms have been initiated – and are progressing – in many of these countries. Nevertheless, these countries continue to face challenges. They are, however, making genuine transition efforts and, given sufficient time, I expect they will be able to prepare their economies for membership. The recently acceded Member States have proved that this is possible. 3b. Although the speed of further enlargement of the EU depends on the pace of reforms in candidate, or potential candidate, countries, this process is only one part of the EU’s enlargement policy. The other part concerns the capacity of the EU to integrate new members. In this connection, I believe that the EU should look at its own governance and adjust it where necessary in order to ensure that its institutions and decision-making processes remain effective and accountable, and that it can maintain its capacity to function, for the sake of current Member States as well as in view of further enlargement. The institutional reform treaty approved by the EU summit in Lisbon on October 19, reshapes the main institutions of the Union – the European Council, the Commission and the Parliament – and takes us a good way toward enhancing the EU’s capacity to function. The new reform treaty should be ratified as soon as possible and at least by the time that the next new member is likely to be ready to join the Union. The prospect of EU accession offered to the countries of the Western Balkans and to Turkey is an important catalyst for reform in these countries. There are clear benefits on the whole for the EU in terms of growth, stability and security. However, these need to be better communicated to the public. It is essential to listen to citizens and address their concerns. Although enlargement has been a success story, in my view we have not done as well as we might have in communicating the benefits that this policy of enlargement has brought to citizens of the enlarged EU. For example, earlier concerns about the effects of enlargement on Labor migration and on wages have proved to be unfounded 4. What about enlargement beyond the Western Balkans and Turkey? Should there be a further enlargement of the EU after the integration of the Western Balkans and Turkey? A key issue we will need to address is the ultimate borders of the European Union. This issue is not an easy one to address because European borders are not clearly defined. The European identity combines geographical, historical and cultural elements. Ultimately, the shared experience of ideas, values and historical interactions that contribute to the European identity are qualities that change over time. Therefore, the EU will need to continue to evolve. The legal basis of the enlargement is Article 49 of the Treaty on European Union, which states that “Any European State, which respects the principles set out in Article 6(1) may apply to become a member of the Union”. However, this treaty provision does not mean that all European countries must apply, or that the EU must accept all applications. A great strength of the EU has always been its ability to adapt to changing circumstances, and I am confident that it will continue to do so in the future. In this way, the EU will continue to ensure a prosperous and secure environment for its citizens. Ladies and Gentlemen, thank you for your attention.

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Address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at a visit to the Central Bank of Chile, Santiago, 12 October 2007.

Nicholas C Garganas: Does one size fit all? Monetary policy and integration in the euro area Address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at a visit to the Central Bank of Chile, Santiago, 12 October 2007. * * * The euro has created a new reality for 318 million Europeans and has probably become the most visible symbol of European integration. Its introduction was in itself a remarkable achievement, representing the culmination of a process of convergence and integration that began many years ago. However, the introduction of the euro did not mark the end of European economic integration. Instead, the euro created new challenges for monetary policy. I want to focus on two of those challenges in my presentation: • First, how would the newly-created European Central bank build credibility? Here, I will argue that the adoption of a credible monetary policy strategy and its systematic implementation would be crucial. • Second, does the single monetary policy fit the particular circumstances in each of the countries of the euro area? In addressing this question, I will argue that the traditional way of thinking about what constitutes an optimum currency area overlooks the fact that the criteria used to judge optimality are, to some extent, endogenous. In particular, I will argue that the creation of a monetary union can itself create conditions that are favourable to the well-functioning of the union. I. The ECB’s monetary policy strategy and its implementation The monetary policy strategy – which was initially adopted in 1998 and confirmed with a few clarifications in 2003 – drew on decades of central bank policy experience and the strategies of the most successful (in terms of inflation performance) central banks in the euro area. The strategy includes three key elements. First, there is the objective of price stability. The view that monetary policy can contribute most to economic welfare by maintaining price stability is supported by a large body of empirical evidence. Ultimately, monetary policy can influence only the price level and can have no lasting influence on real variables. Price stability is defined as a year-on-year increase in consumer prices for the euro area of “below, but close to, 2 per cent”. The “close to” was added in 2003 to establish a safety margin above zero inflation to guard against deflationary risks. In the light of the long lags involved in the transmission of monetary policy, price stability is to be maintained in the medium term. Second, there are the “two pillars” of economic and monetary analyses. • The economic analysis focuses mainly on the assessment of current economic and financial developments from the perspective of the interplay between supply and demand in the product and factor markets, and provides short- to medium-term indications of inflation. • The monetary analysis, which acts as a cross-check to the economic analysis, focuses on money and credit developments in recognition of empirical evidence suggesting that monetary growth and inflation tend to be closely related in the medium to long run. The third element in the strategy is central bank independence, counterbalanced by accountability and transparency. The Maastricht Treaty granted full political independence to the ECB in its pursuit of price stability. When exercising their duties, neither the ECB nor the National Central Banks, nor any member of their decision-making bodies, is allowed to seek or receive instructions from EU or member-state institutions. Long terms of office for members of the Governing Council, who serve on the Council in a personal capacity, and a rule that members of the Executive Board cannot be reappointed, also contribute to minimizing potential political influences on members of the ECB’s decision-making bodies. In a democratic society, however, central bank independence needs to be counterbalanced by accountability, that is, an obligation on the part of the central bank to explain its decisions to the public and its elected representatives. In turn, accountability requires transparency with respect both to objectives and decision-making. To this end, monetary policy decisions taken by the ECB are explained “in real time” at a press conference immediately after each rate-setting Governing Council meeting. The ECB’s record over the past nine years has been a positive one. It has delivered low levels of inflation, inflation expectations and long-term interest rates. Average inflation in the euro area since its inception has been 2.03 percent, a shade higher than the ECB’s definition of price stability, notwithstanding significant price shocks stemming mainly from oil price increases. Inflation expectations have also been remarkably close to the ECB’s definition of price stability and long-term interest rates have been at historically low levels for a significant period since the formation of the monetary union. The anchoring of expectations clearly attests to the ECB’s credibility. Figure 1: Annual inflation (HICP) and Main Refinancing Operations (MRO) rate (January 1998 - August 2007) (in percent) 5.0 5.0 HICP 4.5 HICP excluding unprocessed food and energy 4.5 4.0 MRO rate 4.0 3.5 3.0 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 Ja n Ju 98 l1 Ja 98 n Ju 99 l1 Ja 99 n Ju 00 l2 Ja 0 0 n Ju 01 l2 Ja 01 n Ju 02 l2 Ja 02 n Ju 03 l2 Ja 03 n Ju 04 l2 Ja 04 n Ju 05 l2 Ja 05 n Ju 06 l2 Ja 06 n Ju 07 l2 3.5 Source: ECB By maintaining low inflation and securing long-term inflation expectations at levels consistent with price stability, the ECB makes its best possible contribution to supporting sustained economic growth and employment creation. The stability-oriented policies have supported both households, by maintaining the purchasing power of their income and savings, and the business sector, by creating an environment of low and stable interest rates, conducive to investment. Figure 2: Indicators of long-term inflation expectations in the euro area (January 1999 - September 2007) (monthly averages) 3.0 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 France (2013 maturity) (1, 2) Euro area (2012 maturity) (1, 3) Euro area (2015 maturity) (1, 3) 0.5 SPF Consensus Economics 0.5 0.0 0.0 Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul 1999 1999 2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 2007 Notes to Figure 2: (1) The ten-year break-even inflation rate reflects the average value of inflation expectations over the maturity of the index-linked bond. It is calculated as the difference between the nominal yield on a standard bond and the real yield on an inflation index-linked bond, issued by the same issuer and with similar maturity. (2) Issued by the French Government linked to the French CPI excluding tobacco. (3) Issued by the French Government linked to the euro area HICP excluding tobacco. (4) Survey of Professional Forecasters conducted by the ECB on different variables at different horizons. Participants are experts affiliated with institutions based with the European Union. This measure of long-term inflation expectations refers to an annual rate of HICP expected to prevail five years ahead. (5) Survey of prominent financial and economic forecasters as published by Consensus Economics Inc. This measure of long-term inflation expectations refers to an annual rate of inflation expected to prevail between six and ten years ahead. Source: ECB II. Does one size fit all? While the success of the monetary union in delivering low inflation and a credible currency is beyond dispute, the issue of whether a single monetary policy can “fit” all member states of the euro area, continues to be hotly debated. i) EMU: an optimum – currency – area perspective EMU brought unique challenges for monetary policy. Critical observers took the view that a single monetary policy was doomed to failure because the euro area does not fulfill the prerequisites of an Optimum Currency Area (OCA). This implies that if national economies are affected by asymmetric exogenous shocks or if shocks are transmitted to different degrees in different economies, because of unique economic and institutional characteristics in national economies, the mechanisms which could temper their impact either do not exist or are not strong. It is certainly true that the euro area is characterized by a lack of labour mobility, because of linguistic and cultural differences. There is also an absence of a significant centralized fiscal transfer mechanism. In these circumstances, so the argument goes, shocks are likely to lead to widening inflation differentials so that a common nominal interest rate in the monetary union results in diverging real interest rates among countries. For member countries with relatively-strong domestic demand and a higher-than-average inflation rate, the lower real interest rate fuels domestic demand and national inflation. Conversely, for countries with relatively-weak domestic demand and a lower-than-average inflation rate, the high real interest rates put further downward pressures on domestic demand and inflation. A one-size monetary policy, in other words, does not fit all. The foregoing, traditional view of optimum currency area is static in nature. It assumes that a country’s characteristics, such as its degree of trade integration, are immutable. The experience of the euro area, however, suggests that participation in a monetary union may itself induce changes in economic structure and performance. Indeed, a good deal of academic research, much of it reflecting the experience of the European monetary union, also indicates that the creation of a monetary union can itself create conditions that are favorable to the well-functioning of the union. 1 The experience of the euro area has demonstrated that a common currency can affect an economy’s characteristics through at least two channels. These channels operate through enhanced credibility, and trade and financial integration. In what follows, I will discuss each of these channels in turn. How does the credibility channel work? A major benefit of participating in EMU, especially for countries such as Greece, Italy, Portugal, and Spain that have had recent histories of relatively-high inflation rates, has been the credibility gain derived from eliminating the inflationary bias of discretionary monetary policy. Since there is no devaluation risk, and no need of an interest rate premium to cover the risk of devaluation, nominal and real interest rates are lower than otherwise. Low and stable inflation and inflationary expectations lengthen economic horizons, encouraging a transformation of both the financial and real sectors. Let me now turn to the trade-creation effects of a common currency. Recent empirical evidence has shown that a common currency (as opposed to separate currencies tied together with fixed exchange rates) can also promote trade 2 . The basic intuition underlying this view is that a set of national currencies is a significant barrier to trade. In addition to removing the costs of currency conversion, a single currency and a common monetary policy preclude future competitive devaluations, and facilitate foreign direct investment and the building of long-term relationships. These outcomes, in turn, can promote (over-and-above what may have been attained on the basis of the elimination of exchange-rate uncertainty among separate currencies) reciprocal trade, economic and financial integration, and the accumulation of knowledge. Greater trade integration can increase growth by increasing allocative efficiency and accelerating the transfer of knowledge. The euro-area’s experience indicates that the euro has indeed acted as a catalyst for trade integration. Intra-euro area trade in goods increased from 26% of euro area GDP in 1998 to 33% in 2006. Intra-area trade in services has also risen. Recent empirical work has shown that similar increases in trade have not taken place among European countries which did not adopt the euro 3 . For a survey of this literature, see DeGrauwe and Mongelli (2005). See Rose and Stanley (2005) for a survey of the literature on the trade-creation effects of a common currency. See Baldwin (2006). The euro has also had a positive effect on intra-euro area FDI. Between 1999 and 2005 (the latest data available) the stock of intra-euro area FDI more than doubled, from around 14 per cent of euro area GDP to over 30 per cent. Increased trade integration, along with growing intra-euro area FDI flows, lead to more highly-correlated business cycles because they increase the incidence of common demand shocks and result in more intra-industry trade. As a consequence, the need for countryspecific monetary policies is reduced. 0.9 Figure 3: Euro Area Rolling Business Cycle Correlations and Logarithmic Trend Line (1997-2008) 0.8 0.7 0.6 0.5 0.4 0.3 business cycle correlations 0.2 Log. (business cycle correlations) 0.1 1997- 1998- 1999- 2000- 2001- 2002- 2003- 2004- 20052000 2001 2002 2003 2004 2005 2006 2007 2008 Notes to Figure 3: • The rolling business cycle correlations are constructed by calculating the pairwise correlation coefficients between all euro area countries for the various 4-year periods (1997-2000, 1998-2001, etc). The average of these coefficients is calculated for each time period. • Data source: EU AMECO database There are additional reasons that a monetary union reduces the incidence of country-specific shocks. One of the principal causes of asymmetric shocks − divergent monetary policies − no longer exists. Furthermore, it is to be expected that deeper financial market integration will also entail a convergence in the transmission mechanism of monetary impulses. The introduction of the euro has helped make the euro area financial markets more integrated. The money market has been almost perfectly integrated since the formation of monetary union. The significant growth of the euro corporate bond market, while still smaller than its US counterpart, also provides evidence of integration and widens the range of potential investors to which firms have access. National bonds and equity market returns exhibit closer co-movements than they did prior to the introduction of the euro, offering investors the opportunity to diversify their holdings and reduce the risks for a given level of return. The main area where financial integration has lagged is that of retail banking where, in spite of an increase in cross-border M&As in recent year, cross-border activity remains relatively limited. Figure 4: International Corporate Bonds by Country of Nationality: Amounts outstanding (millions USD) Euro Area Germany Spain France Greece 03-07 03-06 03-05 03-04 03-03 03-02 03-01 03-00 03-99 03-98 03-97 03-96 03-95 03-94 03-93 03-92 Italy Source: BIS database Figure 5: Spreads between 10-year benchmark european sovereign bond yields and the German benchmark (per cent) 01-90 07-90 01-91 07-91 01-92 07-92 01-93 07-93 01-94 07-94 01-95 07-95 01-96 07-96 01-97 07-97 01-98 07-98 01-99 07-99 01-00 07-00 01-01 07-01 01-02 07-02 01-03 07-03 01-04 07-04 01-05 07-05 01-06 07-06 01-07 07-07 -2 France Italy Spain Greece Source: BIS database Figure 6: Correlations between German and other European returns -on composite stock indices - Rolling 24-month window 0.75 0.5 0.25 02-92 08-92 02-93 08-93 02-94 08-94 02-95 08-95 02-96 08-96 02-97 08-97 02-98 08-98 02-99 08-99 02-00 08-00 02-01 08-01 02-02 08-02 02-03 08-03 02-04 08-04 02-05 08-05 02-06 08-06 France Italy Spain Greece Source: BIS database Forces for further integration will continue, as market participants increasingly exploit the new environment of monetary union. In addition, a number of initiatives, supported by the Eurosystem and/or the Commission, will help increase integration. An example is TARGET2, the new payment platform for the financial system, which is expected to begin operating in November 2007. As integration proceeds, we can expect that the monetary transmission mechanisms across the euro area will continue to converge, helping the implementation of the single monetary policy. To the extent that countries nevertheless continue to experience asymmetric shocks or asymmetric responses to common shocks, financial integration can help members of a union insure against the effects of such shocks by providing opportunities for diversification of income sources and adjustments of wealth portfolios. In effect, the members can mitigate the effects of shocks by insuring one another through their holdings of financial claims on each other’s output in financial markets. ii) Inflation and growth differentials Despite the increased trade and financial integration in the euro area, the fact remains that divergences in economic performance continue to exist. How significant are these, and how concerned should we be? Recent evidence, provided by the ECB, shows that, over the period 1990-99, the euro area experienced a downward trend in the degree of inflation dispersion − measured as the standard deviation of that dispersion − from about 6 percentage points in the early 1990s to a low of less than one percentage point in the second half of 1999. Since that time, inflation dispersion has changed very little − and for some time now it has been less than a percentage point. Figure 7: Dispersion of annual inflation rates within Euro Area (13 countries), US (14 Metropolitan Statistical Areas) and US (4 regions) (unweighted standard deviation in percentages) US4 US14 2006M01 EA13 6.00 2005M01 7.00 5.00 4.00 3.00 2.00 1.00 2007M01 2004M01 2003M01 2002M01 2001M01 2000M01 1999M01 1998M01 1997M01 1996M01 1995M01 1994M01 0.00 Source: US Bureau of Labor Statistics and ECB Another fact worth emphasizing is that inflation dispersion in the euro area does not differ that much from dispersion across a similarly-sized monetary union, that of the US. Where the euro area does differ from the US, however, is that the observed differentials seem to be more persistent in the euro area. In part, persistence can be explained by the so-called Balassa-Samuelson effect, according to which long-term differentials in regional inflation are attributable to differences in the rate at which productivity increases in the various regions’ tradable and non-tradable goods sectors. This situation represents an equilibrium adjustment process that does not, in principle, require economic policy correction. Indeed, differentials arising from this source importantly do not lead to a permanent worsening of the competitive position of the country experiencing the higher inflation. However, given the degree of convergence in living standards experienced by euro area countries over the last decade or so, it is difficult not to conclude that the contribution of the Balassa-Samuelson effect to inflation differentials now is likely to be relatively small. This may well give cause for concern since it suggests that the differentials originate from the fact that adjustment mechanisms in the euro area are not functioning as smoothly as they might and that policies other than monetary policy are not consistent with inflation rates close to the euro area average. Thus, other factors are contributing to the inflation differentials within the euro area, including misaligned fiscal policies, wage dynamics not linked to productivity developments (something reflected in the significantly different rates of growth in unit labour costs across the union), and structural inefficiencies such as rigidities in product and factor markets. Persistent differentials that result from these factors lead to a loss in competitiveness and cannot be considered benign. Figure 8 indicates a strong positive relationship between average inflation rates in different euro area economies and the average growth of unit labour costs over the period since monetary union began. Figure 8: Cumulative Deviation of Inflation and ULCs Relative to Euro Area Average (1999-2006, in percentage points) -5 -10 -15 BE DE IE GR ES FR IT inflation LU NL AT PT FI ULCs Source: BIS database Figure 9: Dispersion of real GDP growth rates within Euro area (13 countries), US (50 states and D. Columbia) and US (8 regions) (unweighted standard deviation in percentages) 5.00 EA13 4.50 US50 US8 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 Source: US Bureau of Economic Analysis and EU AMECO database It is important to note that the process of nominal convergence from the early 1990s onwards, which culminated in the adoption of the euro, was not accompanied by a greater dispersion of real GDP growth rates. Nor has dispersion increased following the adoption of the single currency. If any trend is discernable, it is a slight downward one, with dispersion remaining close to its historical average of around 2 percentage points, which is no greater than that found in the US. Moreover, inflation and growth across the euro area appear to move together. Those countries with higher than average inflation rates (Ireland, Greece, Spain, for example) appear to have higher growth rates. This suggests that, to the extent that inflation differentials do not reflect differences in growth rates of productivity, the dampening effect of loss in competitiveness has been offset by other factors, such as interest rate decreases in the period up to the adoption of the euro, inflows of EU structural funds, immigration and financial liberalization. These favourable factors are unlikely to persist indefinitely and, once they diminish, the consequences of falling competitiveness are more likely to become a dominant determinant of actual growth outcomes. Figure 10: Scatter Plot of Inflation and Growth in Euro Area Countires (1999-2006) Growth 0.12 0.1 0.08 0.06 0.04 0.02 -0.02 Inflation Source: ECB and EU AMECO database III. Conclusions A single-size monetary policy has worked extremely well in the euro area. I have argued that this is partly the result of endogenous changes brought about by the very existence of the monetary union. Increased trade and financial integration, spurred on by the common currency, have contributed to making the euro area closer to an optimum currency area. In addition, the credibility of the ECB’s monetary policy has delivered low interest rates and price stability. Yet these are not sufficient alone to increase economic growth and raise living standards. Low interest rates and a stable price level provide the fabric upon which a more dynamic Europe can be woven. Whilst endogenous responses by the private sector to the creation of monetary union can contribute to the necessary increases in flexibility in product and labour markets, there is also a need for countries themselves to adopt measures in this direction. Between 2001 and 2005, euro area growth was relatively weak. Moreover, in spite of declines in the dispersion of inflation rates and growth rates, their persistence raised some concerns in terms of the competitiveness of certain countries within the euro area. In these circumstances, some countries (the most prominent example being Germany) undertook structural reforms, the fruits of which began to be seen in the second half of 2004. Thus euro area unemployment has fallen sharply, reaching its lowest level since the start of monetary union. Although this outcome reflects, in part, a cyclical rebound, part of the decline in the unemployment rate may well be due to the impact of structural reforms. However, structural impediments continue to exist in the euro area; they help explain still high levels of unemployment and low participation rates. Further reforms can only foster economic growth and create additional employment opportunities. Fiscal developments in the euro area have also been favorable in recent years. However, budgetary improvement has largely been the result of strong output growth and revenue windfalls. Only a small part has been due to policy measures. Against the background of the current economic expansion, it is essential to sustain the momentum toward improving public finances and to accelerate the pace of fiscal consolidation. This would strengthen the capacity of the euro area to adjust to external shocks, increase consumer and investor confidence, and hence support growth and employment. To conclude, the euro area has indeed come a long way. The success of the single currency has demonstrated that one size can fit all. Such has been the success of the euro area that it has given rise to considerations, still at an early stage, of regional currency arrangements in Africa, Asia and Latin America. Nevertheless, much more needs to be done to ensure that the euro area becomes a more dynamic force for growth in the global economy on a sustainable basis. It is my view that the experience of the euro area to date only serves to highlight the fact that a currency union requires more flexibility in factor and product markets, and greater competition than do independent monetary areas. Flexible markets and strict fiscal rules are not just superfluous conditions for members of a monetary union. They are necessities that make monetary union work by providing the adjustment mechanisms that the one size fits all monetary policy cannot. References: Baldwin R E (2006) “The Euro’s Trade Effect” ECB Working Paper, no. 594. De Grauwe P and Mongelli F P (2005) “Endogeneities of Optimum Currency Areas: what brings countries sharing a single currency closer together?” ECB Working Paper, no. 468. Rose A and Stanley T D (2005) “A meta-analysis of the effect of a common currency on international trade”, Journal of Economic Surveys, vol. 19.

bank of greece

Address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the conference ¿The ageing of Europe¿s population ¿ consequences and reforms¿, organized by the Bank of Greece, Athens, 17 January 2008.

Nicholas C Garganas: The ageing of Europe’s population: consequences and reforms – with particular reference to Greece Address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the conference “The ageing of Europe’s population – consequences and reforms”, organized by the Bank of Greece, Athens, 17 January 2008. * * * I am very pleased to welcome to the Bank of Greece two distinguished colleagues from the Governing Council of the European Central Bank and good friends – Yves Mersch, Governor of the Central Bank of Luxembourg, and Erkki Liikanen, Governor of the Bank of Finland – to participate in a Public Discussion on the subject “The Ageing of Europe’s Population: Consequences and Reforms”. We chose this subject in part because it is widely recognised that the ageing of Europe’s population in the coming decades will have serious economic, budgetary and social implications for all European countries. Nevertheless, there is often strong opposition to policy changes aimed at addressing those implications. In part, this situation reflects the fact that the costs of inaction are not borne immediately, making it easy to postpone the necessary adjustment. At the same time, the longer that adjustment is postponed, the greater the costs of failing to act today will be. An open discussion, especially a discussion that compares the reform experiences of various countries, can therefore help improve understanding of these matters. As such, it is a prerequisite to reaching a broad social consensus on the needed reforms. I would now like to introduce our distinguished guests: Yves Mersch became the first Governor of the Central Bank of Luxembourg, upon its creation in 1998. He began his professional career as a lawyer, following postgraduate studies in law and political science at the University of Paris. After joining the civil service in 1975, he was seconded to the International Monetary Fund and the United Nations. In 1989, he became “Director of the Treasury” in Luxembourg. In that capacity, he was the personal representative of the Finance Minister in the negotiations that led to the Maastricht Treaty. He has also served on the boards of major private and public companies. Erkki Liikanen’s distinguished record of public service predates his becoming Governor of the Bank of Finland in 2004. He was a member of the Finnish parliament for almost 20 years (1972-90), Finland’s Minister of Finance between 1987 and 90, and a Member of the European Commission for almost 10 years (1995-2004). During his service at the Commission, he was initially responsible for “budget and personnel administration” and, in his second term, for “enterprise and information society”. I will open the discussion by outlining, in broad terms, the key projected demographic developments in the coming decades in the EU, with particular reference to Greece; the economic and budgetary implications of these developments; the related policy challenges; and the extent to which progress has been made in addressing these challenges. Governor Mersch, drawing on the experience of other European countries, will discuss the ways demographic, social and political factors have influenced the implementation of pension reforms in various countries as well as the key features of these reforms. Governor Liikanen will share with us Finland’s experience in dealing with the challenges posed by population ageing. Issues related to population ageing have been studied in recent years both at the national and the EU levels by the Economic Policy Committee at the request of the Council of Economics and Finance Ministers, or ECOFIN Council. An effort has been made to produce results that are comparable across countries by relying, to the extent possible, on common assumptions, data definitions and methodologies. Building on demographic, labour market and GDP projections for each country in the EU25, in 2006 the EPC published long-term projections of age-related spending – covering pensions, health care, long-term care, education and unemployment transfers – as a basis for assessing the risks to the sustainability of public finances. The projections are based on the assumption of “no-policy change” – i.e., they reflect only enacted legislation. They also take into account the current behaviour of economic agents – for example, participation rates in the labour market are based on the most recently observed trends by age and sex. It is important to note that the projections do not constitute forecasts. Rather, they indicate the potential timing and scale of economic and budgetary challenges that would result from ageing populations if present trends continue. Demographic projections As I noted earlier, the age structure of the population in the EU25 is expected to change dramatically between now and 2050. Increasing life expectancy will tend to raise the elderly population (ages 65+) by about 77% in the EU25; and by 80% in Greece. 1 At the same time, the low fertility rates – i.e., fertility rates below natural replacement levels – will contribute to a decline in the working age population (ages 15-64) by 16% in the EU25, and by 21%, in Greece. 2 As a result, the old-age dependency ratio – defined as the ratio of the elderly population to the working age population – is projected to double to 51% in 2050 in the EU25 and to more-than-double, to 61%, in Greece. The population of the EU25 in 2050, projected at roughly 454 million, will be only slightly (less than 1 percent) below that of 2004 as the negative influence of the low fertility rates in all countries will be largely offset by the positive influences of the continuous increase in life expectancy and net inward migration. By comparison, the Greek population is projected to decline by 3% notwithstanding continued net inward migration. 3 Employment projections With the working-age population projected to decline significantly between now and 2050, it is clear that the level of employment can be sustained only if the employment rate – i.e., the proportion of population of working age that is employed – were to rise sufficiently to offset the fall in the working-age population. The following two factors are expected to contribute to a rise in the employment rate. First, the female employment rate will rise as older women with low employment rates retire and are gradually replaced by younger women, who have higher employment rates – the so called “cohort effect”. Second, the employment rate of older people is likely to increase, in part because of already adopted pension reforms. However, the projected increase in the employment rate in the EU25 will not be sufficient to prevent a 5% decline in the level of employment between 2004 and 2050. In Greece, the projected decline in employment is even larger, 13% over the same period, reflecting both demographic developments and a more modest increase in the employment rate. The projections of life expectancy are based on extrapolations observed over the previous 17 years. The fertility rate is assumed to rise gradually during the projection period from 1.5% to 1.6% in the EU25 and from 1.3% to 1.5% in Greece Non-nationals reached 7.3% of the population of Greece according to the 2001 Census and more than 8% of the population in 2004 (Eurostat estimates); on average during 2006, 15% of workers who paid contributions to the main employee social security fund (IKA) were foreigners and accounted for more than 10% of IKA's contribution revenues. GDP projections As a result of these employment trends, and on the basis of consistent-across-countries assumptions on productivity growth, potential GDP growth is projected to decline in the decades to come. For the EU15, the annual average potential GDP growth rate will fall from 2.2% in the period 2004-2010 to 1.3% between 2031 and 2050. An even steeper decline is foreseen in the new member states (EU10), because of both demographic developments and the underlying assumption that productivity growth rates in these countries will converge to those of the EU15. In Greece, that convergence is also expected to lead to a fall in productivity growth, contributing to a decline in potential GDP growth from an annual average rate at 2.2% in the period 2004-2010 to below 1% per year in the 2030s and 2040s. Public spending projections Population ageing is projected to lead to increases in public spending in most EU member states by 2050 on the basis of current policies although there is wide disparity in those increases across countries. In more than one third of the Member States, the long-term budgetary impact of the projected increases will be at least 5% of GDP. These countries have so far made only limited progress in reforming their pension systems or are experiencing maturing pension systems. For the new member states (EU10) as a whole, the increase is projected to be much smaller, but this situation reflects mainly institutional changes. A switch to private pensions scheme in Poland is expected to make a substantial contribution to a decline in public pension spending in the new member states. 4 Excluding Poland, age-related spending is subject to increase by more than 5% of GDP. Most of the projected increase in public spending will be on pensions, health care and long-term care. Offsetting savings in areas as education and unemployment benefits are likely to be limited. With respect to Greece, data on public spending projections are not available as such projections have not yet been submitted. However, according to projections prepared in 2002, pension expenditures will rise from 12.4% of GDP in 2005 to 22.6% of GDP in 2050. 5 The net increase in total old age-related expenditure (excluding spending on long-term care, for which no official figures are available) is projected to be 11.5 percentage points of GDP, reaching 32.7% of GDP in 2050. This compares with rises in pension expenditures by slightly more than 2 percentage points of GDP in both the EU-25 and the EU15 over the same period, reflecting the implementation of important pension reforms in many of these countries According to ESA95, defined-contribution funded pension schemes are not considered as part of the general government sector. These projections were first published in the Greek Report on Pension Strategy (Ministry of Economy and Finance-Ministry of Labour and Social Security, September 2002) and reproduced in the 2004 Update of the Hellenic Stability and Growth Programme 2004-2007 – Revised (March 2005). Initially, pension expenditure had been projected to reach 24.8% of GDP in 2050 (see: Ministry of Labour and Social Security, Actuarial Report on the Greek social security system – Report of the Government Actuary Department UK, 19 April 2001; also: European Commission, Economic Policy Committee, Budgetary Challenges Posed by Ageing Populations, EPC/ECFIN/655/01, Brussels, 24 October 2001). The downward revision in 2002 reflected the more favourable demographic data obtained from the 2001 census, estimates and assumptions of a faster decrease in rural population, assumptions of a faster reduction in unemployment, more conservative assumptions with regard to annual increases in pensions, and the parametric changes introduced by Law 3029/2002. The new data affected the projection in more than one way. For instance, the presence of immigrant workers and the migration of rural populations to urban centers imply higher current IKA revenues, but also higher future expenditure. since the 1990s. Total old age-related expenditures are projected to rise by about 3½ percentage points of GDP in both the EU-25 and the EU15. 6 Long-term fiscal sustainability Population ageing will have a significant impact on economic growth and lead to pressures to increase public spending. In order to gauge the magnitude of this challenge, the assessment of long-term sustainability of public finances has become part of the regular EU budgetary surveillance. According to the Commission, in the absence of reform measures and budgetary consolidation, a considerable “sustainability gap” of about 3.5% of GDP, i.e., a gap between the structural budgetary position in 2005 and a sustainable fiscal position, emerges in both the EU and the euro area. 7 Unless measures are taken to fill this gap, the government debt/GDP ratio is projected to remain above 60% over the coming decades for the EU as a whole and, from around 2020, to start rising considerably, reaching almost 200% of GDP in 2050. The debt/GDP ratio would exceed 60% – the Maastricht debt criterion – in more than two thirds of the Member States. In about one half of the member states, the initial budgetary position illustrates that the public finances are on an unsustainable path even without considering the long-term budgetary impact of ageing populations. With respect to the effects of ageing on the sustainability of public finances in Greece, European Commission projections of the general government debt-to-GDP ratio indicate that this ratio would more than triple between 2005 and 2050, reaching 346.0%, though the ratio would be somewhat lower if the recent GDP revision were taken into account. Policy challenges for Greece The projections presented so far highlight the fact that demographic, economic and fiscal prospects are more unfavourable for Greece than for the EU as a whole. As projections – rather than forecasts – they can be useful in identifying specific areas where Greece compares unfavourably with other EU countries and, therefore, improvement is presumably feasible with the adoption of appropriate policies. Demographic changes will have major implications for the pension and healthcare systems and, hence, for the sustainability of public finances. The implications are particularly unfavourable for Greece, in light of its initial fiscal position, the second highest debt/GDP ratio in the EU. This circumstance underscores the need of a comprehensive set of policies to change demographic prospects, enhance employment and its productivity through reform of the product and labour markets, reform the pension and healthcare systems, and pursue sustained fiscal consolidation. A number of measures can help boost employment rates. These include improving child-care and introducing flexible working time and leave arrangements, implementing reforms that would attract more youth, women and older persons to the labour market (thereby also helping to raise the effective age of retirement), and facilitating the integration of immigrant workers. Economic Policy Committee and European Commission, "The impact of ageing on public expenditure: projections for the EU25 Member States on pensions, health care, long-term care, education and unemployment transfers (2004-2050)", European Economy, special report no. 1/2006 (February). To understand the challenge that policy-makes face, the Commission has estimated the size of the budgetary imbalance on the basis of the so-called “sustainability gap indicators”. These indicators measure the size of a required permanent budgetary adjustment that permits one of the following conditions to be met: i) reaching a target of 60% of GDP for the Maastricht debt in 2050 or ii) fulfilling the intertemporal budget constraint over an infinite horizon. In addition, greater labour productivity growth in the long run should be achievable through accelerated structural reforms in the product and labour markets, increased productive investment in physical capital, and the upgrading of human capital. The projected very large increase in Greek pension expenditures over the long term – much larger than in most other EU countries – clearly suggests that, in the absence of an early and major pension reform, fiscal consolidation measures by themselves (e.g., tax increases or reductions in non-pension public spending) would not be able to eliminate the projected budgetary imbalances without jeopardising the provision of essential public services. The pension reforms should aim to ensure the long-term viability of the public pension system, which should nevertheless continue to function as an important social safety net. Finally, the sooner the fiscal consolidation is undertaken and the reforms are implemented, the better, for both fiscal sustainability and for long-term growth. The primary fiscal balance required to stabilise public debt on a sustainable basis is significantly higher in the long run than in an early adjustment scenario. Moreover, delayed adjustment entails lower economic growth because of increasing crowding out effects and the economic disincentives stemming from rising taxes. These results are confirmed by work done at the Commission and the IMF. In sum, population ageing will have important demographic, economic, and fiscal consequences for Europe. Moreover, these consequences will be especially pronounced in the case of Greece. Many countries in the EU have already undertaken reforms that should cushion them from population ageing and its consequences. In the case of Greece, it is essential that appropriate policies be adopted. These policies should aim at improving the fiscal position, safeguarding the viability of the pension and healthcare systems, alleviating the demographic prospects, and enhancing productivity through reform of the product and labour markets. Table comparing the projections of the main variables for the EU25 and Greece Greece EU 25 Elderly population (ages 65+) Now-2050: +80% Now-2050: +77% Working age population (ages 15-64) Now-2050: -21% Now-2050: -16% Old-age dependency ratio 2050: 61% 2050: 51% Total population 2004-2050 -3% -1% Employment 2004-2050 -13% -5% -- Spending on pensions +10.2% +2.2% -- Total ageing-related spending +11.5% +3.4% Government debt/GDP: projection 346% almost 200% Rise in public spending as % of GDP 2005-2050 Source: Economic Policy Committee and European Commission projections.

bank of greece

Speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Economist Conference on "Social security reform in Greece", Athens, 14 February 2008.

Nicholas C Garganas: The Greek experience Speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Economist Conference on "Social security reform in Greece", Athens, 14 February 2008. * * * I would like to thank the organisers of the Economist Conference on "Social security reform in Greece" for their invitation and for this opportunity to speak on the subject of the implications of ageing populations – a subject of great importance for many countries, especially for Greece. A main accomplishment of social policies in the second half of the last century – at least in the case of advanced countries – is that being old is no longer considered synonymous with a low quality of life. That accomplishment has been made possible through the provision of public pensions. In Greece, of course, a significant proportion of pensions are still very low, but this can be considered a consequence of inefficiencies and weaknesses in the social security system as it stands at present. Yet, as Europe’s population ages, a demographic shift will take place in the next forty to fifty years that will pose significant challenges to the pension systems of our countries. The ageing of society will make it increasingly difficult to maintain an adequate level of public pensions for our older citizens. To provide an idea of the demographic changes that are expected to take place in the next forty to fifty years, consider the following projections with respect to Greece, issued by the European Union’s Economic Policy Committee. These projections cover the period from 2005 to 2050. • Projection number 1: here is some good news – people will live longer, so that the population comprised of ages 65 or above will increase by some 60 per cent. • Projection number 2: low fertility rates will contribute to a decline of some 20 per cent in the working-age population, defined as ages 15 to 64. • Putting these two projections together means that the ratio of the elderly population to the working age population – what is known as the old-age dependency ratio – is expected to more than double between 2005 and 2050, reaching more than 60 per cent. This would mean that while there are currently more than three workers for each pensioner, in 2050 there would be only 1.6 workers per pensioner. Thus, Greece, like many other European countries, will be confronted with a sharp rise in the old age dependency ratio. This situation, in and of itself, however, need not put pressure on the financing of the country’s pension system. In particular, if the proportion of the population of working age that is employed were to rise, this rise could help offset some of the fall in the working-age population. Unfortunately, even here the news is not favourable. The employment rate is projected to rise modestly, but not enough to raise the level of employment. In fact, the level of employment is projected to decline by some 13 per cent between 2005 and 2050. To sum up what I have said so far, thanks to advances in health care, people will be living longer, so that there will be a large increase in the proportion of the population aged 65 or more in the years ahead. At the same time, there will be fewer people of working age and fewer people actually working. What, then, are the implications of these demographic projections? For one thing, they imply a sharp fall in Greece’s potential GDP growth, perhaps more than halving potential growth between now and the 2030s and 2040s. With more people, and fewer producing goods and services, there will be less output for each of our citizens. For another thing, the projections, if realised, would put enormous strains on our public finances. To give you an indication of the magnitude of these strains, according to projections prepared in 2002, pension expenditures in Greece will rise from 12.4% of GDP in 2005 to 22.6% of GDP in 2050, i.e. by 10.2 percentage points of GDP. The net increase in total old age-related expenditure (excluding spending on long-term care, for which no official figures are available) is projected to be 11.5 percentage points of GDP, reaching 32.7% of GDP in 2050. This situation compares with rises in pension expenditures of slightly more than two percentage points of GDP in both the EU25 and the EU15 over the same period, reflecting the implementation of important pension reforms in many of these countries since the 1990s. Consideration of this set of facts yields the conclusion that pension reforms, public expenditure, employment, and growth are interdependent. Pensions constitute a major share of public expenditure and that share is projected to rise sharply in the years ahead. Moreover, pension systems and labour-market performance have close ties, and these ties have important implications for economic growth. Pension systems embed incentives that affect the labour supply of, and demand for, mature workers, while a high level of employment also ensures high levels of contributions into the system and contributes to the productive capacity of the economy. My discussion has so far focused on the implications of an ageing population for Greece’s projected public expenditures. There is, however, another dimension with respect to the public finances that warrants attention – the implications of population ageing for the sustainability of the public finances. These implications are especially unfavourable for Greece in the light of the country’s high debt-to-GDP ratio, which is the second highest in the EU. In this connection, European Commission projections of the general government debt-toGDP ratio for Greece indicate that this ratio will more than triple between 2005 and 2050, reaching 346%, though the ratio would be somewhat lower if the recent GDP revision were taken into account. Clearly, there is need of a comprehensive set of policies to change demographic prospects, enhance employment and its productivity through reform of the product and labour markets, reform the pension and healthcare systems, and pursue sustained fiscal consolidation. A number of measures can help boost employment rates. Female participation rates could be increased by increasing child-support and making working-time arrangements more flexible. The latter measure would also attract more younger workers into the labour force. Another type of measure that directly confronts the problem posed by an ageing population concerns the retirement age, which might be postponed on a voluntary basis. In other words, workers could be given a choice of continuing to work, even on reaching minimum retirement age. They may want to do so if the pension gain from staying longer in the workforce exceeded the cumulative pension lost from retiring later. In addition, greater labour productivity growth in the long run should be achievable through accelerated structural reforms in the product and labour markets, increased productive investment in physical capital, and the upgrading of human capital. The projected very large increase in Greek pension expenditures over the long term – much larger than in most other EU countries – clearly suggests that, in the absence of an early and major pension reform, fiscal consolidation measures by themselves – for example, tax increases or reductions in non-pension public spending – would not be sufficient to eliminate the projected budgetary imbalances without jeopardising the provision of essential public services. Pension reforms should aim to ensure the long-term viability of the public pension system, which should nevertheless continue to function as an important social safety net. Finally, the sooner the fiscal consolidation is undertaken and the reforms are implemented, the better, for both fiscal sustainability and for long-term growth. The primary fiscal surplus required to stabilise public debt on a sustainable basis is significantly higher in the long run than in an early adjustment scenario. Moreover, delayed adjustment entails lower economic growth because of increasing crowding out effects and the economic disincentives stemming from rising taxes. I began my speech by referring to the remarkable achievement of the second half of the last century whereby public pensions have greatly improved the quality of life of our older citizens. A return to a situation – or, in the case of Greece, the persistence of a situation – in which older people are poor or dependent on others is unacceptable. As people come to live longer they should expect that the quality of their lives during retirement years will be gratifying. Unless pension reform is implemented – and soon – population ageing will have severe economic consequences, including fiscal consequences. There is, however, light at the end of the tunnel. Some countries, as we have seen, have already implemented reforms, and their examples can help show the way for others. The aim of reforms is to provide a better standard of living for all of our citizens, not just for today, but for tomorrow as well. Ladies and gentlemen, thank you for your attention.

bank of greece

Keynote speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Meeting of the International Chamber of Commerce (ICC) Commission on Banking Technique and Practice, Athens, 16 April 2008.

Nicholas C Garganas: Recent financial market developments and implications for the euro area and the world economy Keynote speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Meeting of the International Chamber of Commerce (ICC) Commission on Banking Technique and Practice, Athens, 16 April 2008. * * * It is a pleasure indeed to welcome you to Athens for this meeting of the International Chamber of Commerce Commission. This meeting is taking place at a time of turmoil in global financial markets and a significant downturn in global economic growth. I am delighted to have this opportunity to offer some remarks about the present situation and the challenges ahead. We are living in the era of the great globalization and the ICC has been an invaluable voice championing the benefits – including enhanced economic growth, prosperity, and job creation – of increased economic and financial integration. While globalization brings important benefits it also, sometimes, brings heightened risks and uncertainties, as recent financial market developments vividly illustrate. The last nine months have been a very challenging period for both policy makers and market participants. During this period, we have witnessed a major reappraisal of risk and a considerable, and still ongoing, turmoil in key financial markets. We have also seen – especially in the US and, to a lesser extent, in the euro area and the rest of the world – downward revisions of growth prospects amid increased risks and uncertainties. In order to be able to ensure that the full benefits of globalization are shared by our citizens, it is necessary to be able to manage the risks and uncertainties associated with globalization. My remarks today, will deal with the origins of the ongoing financial markets turmoil, the policy responses to this turmoil, mainly by the major central banks, and prospects and policy challenges for the euro area and the global economy in the light of this turmoil. Greece will, therefore, not be the focus of my remarks this morning. Let me just note that Greek banks generally have a relatively comfortable capital base and strong profitability, their exposure to U.S. sub-prime mortgage loans has been negligible, while the impact of the international financial market turmoil on the Greek banks has so far been indirect and rather contained. However, the financial market turmoil is far from over and there are still risks ahead of us. For this reason, the Bank of Greece has urged financial institutions to be especially prudent in their portfolio management. Origins of the current financial market turmoil Although the financial market turmoil was triggered by problems in the sub-prime loans of the U.S. mortgage market, the origins of this turmoil can be traced to earlier developments. In the four-year period to mid-2007, the world economy had been characterized by exceptionally benign macroeconomic and financial conditions, as indicated by strong growth and low levels of inflation and (long-term) interest rates. Such conditions of “low volatility” fostered a “search for yield”, a rise in leverage to increase returns further, and an underpricing of risk in some key asset markets. These developments were supported by – and, in turn, they encouraged – further financial innovation, as evidenced by the rapid growth in securitization of bank loans, in credit risk transfer instruments and in other complex structured finance products. Rapid financial innovation over the last 30 years has undoubtedly benefited the world economy by allowing a deepening of capital markets, easier access to credit by households and enterprises, and a more effective utilization of resources. However, especially in recent years, financial innovation has also been associated with structural weaknesses and complacency in risk management. For instance, the low transparency of these complex products may have made it easier for investors to underestimate the risks they take on. In addition, with prudential regulation sometimes lagging behind financial innovation, some institutions may not have been sufficiently transparent about their exposures to complex structured finance products, on and off their balance sheets. Moreover, as such products were often difficult to value owing to inadequate information about the underlying assets, investors often relied too heavily on credit rating agencies. However, the methodology used by the credit rating agencies was not transparent, failing to identify the risk characteristics of the complex structured finance products, including their illiquidity. It is also well known that it was the distorted incentives in the “originate-and-distribute” business model of financial institutions that led to a decline in credit standards, the root cause of the “sub-prime” problem. More generally, the extent of leverage taken on by banks, bond insurers, hedge funds, and other financial institutions was probably not adequately appreciated, nor were the risks of a disorderly unwinding. Eventually something was bound to happen that would trigger a widespread reappraisal of risk, resulting in re-intermediation and de-leveraging. This turned out to be the escalating losses on US sub-prime loans, which showed up in certain hedge funds and structured investment vehicles (SIVs) in the US and in Europe in mid-2007. Subsequently, the market tensions spread through the market for structured finance products and asset-backed commercial paper to the key interbank money markets in Europe and the US, the core of the international financial system. Central bank policy reaction Since last August, the major central banks – including the ECB, the Bank of England and the U.S. Fed – have responded to the liquidity squeeze in the interbank money markets by expanding the scale and scope of their routine operations. They have injected extra liquidity, lengthened the maturity of their lending facilities, and (in the case of the Fed) expanded the list of counterparties and widened the range of acceptable collateral in their operations. These actions have contributed to a significant improvement in money market conditions since late December in the euro area, the UK and the US. Nevertheless, there remains much uncertainty in the market about the liquidity and capital adequacy positions of financial institutions, which has implied the need for continued central bank operations. Some large financial institutions – notably in the U.S. and in non-euro-area Europe – have already acknowledged large losses in their balance sheets over the past few months, necessitating capital injections (e.g., by Citibank and UBS) or acquisitions by other, financially strong institutions (e.g., that of Bear Stearns by JPMorgan Chase). Financial institutions have generally attempted to acknowledge their losses and appropriately value their balance sheets but there are difficulties in properly valuing some complex financial assets, not least because markets have often ceased to operate properly for such assets. There is thus a risk of potential future losses, which has maintained a climate of uncertainty and contributed to the weak performance of financial institutions in the equity markets. The IMF has recently estimated that total potential losses of the financial sector could amount to almost US$1 trillion, of which only about one quarter has so far been acknowledged and written down. As regards the ECB, I should stress – in my capacity as a member of ECB’s Governing Council of the ECB – that the market operations since last August have not been intended to change, nor have they changed, the overall monetary policy stance in the euro area, which is set by the decisions on interest rates. (As you may recall, the ECB policy rates have remained unchanged since June 2007.) Rather, the money market operations are intended to safeguard financial stability and ensure, through the orderly functioning of the interbank money market, that the Governing Council’s interest rate decisions are transmitted to the financial markets and the real economy. The economic outlook and policy challenges The economic outlook for the euro area is surrounded by an unusual degree of uncertainty. The financial market turmoil is likely to last for some time and its impact on the real economy is difficult to assess at this time. Much depends on how far banks might tighten their lending terms in response to losses and the unwelcome transfer onto the balance sheet of offbalance sheet items. For the time being, there is little evidence that the financial market turmoil has influenced the dynamics of credit aggregates in the euro area. 1 Meanwhile, the cost of funding for firms and households appears to have edged upwards, albeit only slightly, in the euro area in recent months. The latest available information, therefore, suggests that the impact of the financial market turmoil on euro area economic activity is not likely to be sizable. The sound fundamentals of the euro area economy and the absence of major macroeconomic imbalances should help cushion the effects of the financial market tensions. Nevertheless, caution is warranted. The impact on some banks’ balance sheets has been considerable and a number of financial institutions may have to strengthen their capital positions and be more cautious in their lending policies. According to the March 2008 projections of the ECB staff, real GDP in the euro area will rise in a range of 1.3% to 2.1% in 2008, representing a deceleration from 2.6% in 2007. Meanwhile, the short-term outlook for inflation is not satisfactory. Inflation reached 3.5% in March, reflecting mainly the rapid rise in oil and other commodity prices, and is likely to remain at elevated levels above 2% in the coming months and moderate toward 2% very gradually. Globally, the economic expansion is loosing speed in the face of the financial crisis. Outside of the euro area, growth in the advanced economies of Western Europe is decelerating. The U.S. economy is likely to experience a more serious slowdown, with minimal – if not negative – growth in the first two quarters of 2008, followed by a gradual recovery thereafter. The emerging and developing economies, led by China and India, have so far been less affected by financial market developments, although activity is beginning to slow in some countries. In the light of the financial market turmoil, the balance of risks to the short term global outlook remains tilted to the downside. At the same time, inflation has increased around the world, boosted by the continuing buoyancy of food and energy prices. In this environment, the greatest contribution that central banks can make is the firm anchoring of medium to longer term inflation expectations. Looking ahead, a key challenge – especially in the U.S. where most of the financial sector losses are concentrated – will be to ensure that systemically-important financial institutions expeditiously repair their balance sheets, by raising equity and medium-term funds, in order to boost confidence and avoid a contraction of credit. This will help avert a spiral of declining asset values, balance sheet losses, reduced lending and damage to the real economy. Policy makers will need to address systemic vulnerabilities in ways that minimize moral hazard and fiscal costs. Meanwhile work is being done, in international institutions and fora – such the IMF and the Financial Stability Forum – to analyze the causes of the financial market turmoil and propose policy directions to strengthen financial resilience. The growth of bank loans to the domestic private sector has remained robust in recent months and, importantly, this has not been driven by an involuntary increase in banks’ balance sheets, according to the ECB staff’s preliminary analysis. In sum, the present financial market turmoil contains lessons for both market participants and policy makers. Risks and uncertainties are an inherent part of economic progress. Indeed, as the great economist Joseph Schumpeter, wrote in the first half of the twentieth century, risks and uncertainties are basic to the process of what he called “creative destruction” through which innovations and economic progress are made. By learning to better manage these risks and uncertainties we can ensure that we will be able to realize the full benefits of globalization, that is, enhance prosperity for all our citizens. Let me conclude by saying that the ICC has provided a valuable forum for the exchange of ideas on the benefits and challenges of globalization. This meeting is taking place at a particularly challenging time for global financial markets. I very much hope that the surroundings in Athens will provide inspiration for an especially successful meeting. Ladies and gentlemen, thank you for your attention.

bank of greece

Speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the presentation of the Bank of Greece Annual Report to the Annual General Meeting of Shareholders, Athens, 22 April 2008.

Nicholas C Garganas: The Greek economy – developments, prospects and economic policy challenges Speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the presentation of the Bank of Greece Annual Report to the Annual General Meeting of Shareholders, Athens, 22 April 2008. * * * The main features of economic developments and prospects The main features of economic developments during 2007 were the international financial turmoil and the rise in food and oil prices. These phenomena marked the second half of 2007 and have continued into 2008, leading to an intensification of inflationary pressures and a slowdown of economic activity. These events in the international economy have, not surprisingly, adversely affected inflation and the rate of growth of the Greek economy. The annual growth rate of GDP showed a significant deceleration during the second half of 2007. Lower growth is also expected to be a feature of 2008. High uncertainty internationally increases the downside risks to growth. At the same time, inflation has accelerated in recent months, reflecting mainly increased imported inflation and, to a smaller degree, higher production costs. The consequences of the international financial turmoil for the Greek banking system during 2007 were limited and, largely, indirect. Greek banks continued to have healthy profits and satisfactory capital adequacy ratios in 2007. Nonetheless, there is little room for complacency. Continued turmoil in international financial markets, the fast pace of domestic credit growth and the increasing penetration of Greek banks into new markets in Southeastern Europe all contribute to raising banks’ risks. Hence, managing these risks effectively is of the essence. Macroeconomic imbalances continue to pose a problem for the Greek economy. The current account deficit widened further in 2007 and reached a very high level as a percentage of GDP, as domestic savings (which are relatively low) fell well short of domestic investment (which is relatively high). Whilst the general government deficit remained for the second year in a row below 3% of GDP, imbalances remain high, as reflected in the debt-to-GDP ratio. If the negative consequences of the continuing crisis in international financial markets are to be minimised, efforts to make the Greek economy more resilient to external shocks have to be stepped up. This highlights the importance of continuing fiscal consolidation and efforts to raise national savings, increase productivity growth and contain production costs, in order to improve the international competitiveness of the economy. The international and European economic environment The international financial turmoil had its origins in the sub-prime mortgage market in the United States. Rising delinquencies in that market disrupted various segments of the money markets, in particular the asset-backed commercial paper market. The drying up of liquidity in that market caused large losses and asset write-downs by a number of financial institutions which had significant exposures to complex structured finance products whose valuation was now very uncertain. More generally, international financial institutions are still reducing their leverage and the outlook for the international financial system continues to be uncertain. The process of significant market correction is still ongoing and has triggered a deep and candid review of practices, rules and procedures that influence the functioning of international financial markets and the behaviour of market participants. Whilst the world economy continued to grow at a high rate in 2007, the fallout from this turmoil is expected to cause growth to slow to 3.7% in 2008, according to IMF forecasts, from 4.9% in 2007. This slowdown is also expected to affect the euro area, where growth – according to the ECB staff projections made at the beginning of March – is expected to be between 1.3% and 2.1% in 2008, compared with 2.6% in 2007. The risks to growth are clearly on the downside internationally. Aside from the fact that financial turbulence has been spreading to other markets, uncertainty remains high. Rapid economic growth in recent years has been accompanied by a build-up of global imbalances, as low US interest rates encouraged high consumer spending and lax lending standards. The problems in the subprime market could be interpreted as merely a manifestation of the deeper problems of the world economy, which might jeopardise growth prospects over the medium term. At the same time, inflation has been accelerating, as oil and food prices rose sharply again in the first quarter of this year. Inflation in the euro area hit 3.6% in March and is expected to remain high in the coming months, falling back gradually later in the year. Macroeconomic developments in Greece in 2007 and the outlook for 2008 Economic activity These international developments had a limited impact on the Greek economy in 2007. The rate of growth was 4.0% in 2007, down slightly from 4.2% in 2006. Thus, the Greek economy continued to grow significantly faster than the euro area as a whole in 2007, with growth driven mainly, as in previous years, by the increase in domestic demand (both private consumption and investment); however, growth decelerated in the second half of 2007. According to Bank of Greece projections compiled at the beginning of the year and published in February, GDP growth was expected to be around 3.7% this year. However, the growth rate of the Greek economy will probably be lower, to the extent that the slowdown in world growth and external demand is sharper than initially assumed, rises in oil and food prices steeper and financing costs higher. That having been said, it is still expected that growth will be higher than in the euro area as a whole. Employment and unemployment The increase in economic activity in 2007 was accompanied by employment growth of 1.3% and a reduction in the rate of unemployment by around half a percentage point to 8.3%. Nonetheless, it seems that the Greek economy is still characterised by a smaller capacity to create jobs compared with other countries in the euro area. This can be attributed to the continuing restructuring of the Greek economy (most notably, the decline in agriculture and the ensuing heavy job losses), labour market rigidities (e.g. lower use of part-time employment), as well as some mismatches between supply and demand in the labour market. Because of these factors, employment rates, especially for women, remain much lower than the EU-15 average. Inflation and international price competitiveness Average inflation in 2007 fell to 3.0%, mainly as a result of oil price developments, which were later reversed, as well as a slowing of the annual increase in processed food prices (until September). However, inflation picked up significantly in the last quarter of 2007 and the first quarter of 2008, reaching 4.4% in March of this year. It is expected that inflation will remain at high levels in the coming months, mainly because of the sharp increase in imported inflation, but will gradually decline thereafter. According to Bank of Greece projections compiled at the beginning of the year and published in February, average annual inflation in 2008 was expected to be 3.4%. However, certain risks then highlighted now seem to have materialised, mainly as regards developments in oil prices internationally and unit labour costs domestically; hence, average inflation will be higher than initially projected and is expected to be around 4%. There are significant elements of uncertainty surrounding these projections as regards international developments; the outcome of wage negotiations will also be of particular importance. It is worth noting that the new National Collective Labour Agreement provides for average annual increases in minimum wages of 6.2% in 2008 and 5.7% in 2009, higher than under the previous two-year agreement (6.2% for 2006 and 5.4% for 2007). Therefore, the rise envisaged for this year is higher than the one in 2007. Inflation in Greece remains significantly higher than in the euro area as a whole; as a result, the price competitiveness of the Greek economy continues to deteriorate. The persistent positive inflation differential can be attributed to both macroeconomic factors, related to developments in aggregate demand and production costs, and the fact that certain markets do not operate efficiently due to unsatisfactory conditions of competition. External balance Deteriorating price competitiveness and low structural competitiveness are two factors explaining the continuing increase in the current account deficit (from 11.1% of GDP in 2006 to 14.1% in 2007). In addition, high rates of growth of private consumption, which is the counterpart to low savings, have also contributed to the high and widening current account deficit. The impact of high trade deficits on the net foreign debt of the Greek economy is reflected in increased net interest payments, which act to further increase the current account deficit. Prospects for reducing the deficit are not particularly favourable and it is expected that in 2008 it will remain almost unchanged as a percentage of GDP, if not increase. Fiscal developments and prospects As regards fiscal aggregates, the general government deficit reached 2.8% of GDP in 2007, compared with 2.6% in 2006, mainly as a result of one-off factors. The consolidated general government debt fell only slightly from 95.3% to 94.5% of GDP and remains the second highest among the EU-27 countries. The Updated Stability and Growth Programme for the period 2007-2010 envisages a fiscal tightening in 2008, with the general government deficit projected to fall to 1.6% of GDP and debt to 91%. Nonetheless, the pace of debt reduction remains slow, especially in the context of the expected increases in expenditure in the coming years as a consequence of population ageing. Monetary policy, interest rates and credit expansion In the euro area, the risks to the short-term inflation outlook are on the upside; the latest data on macroeconomic aggregates point to ongoing but moderating real GDP growth; uncertainty due to the financial turmoil remains high. In the light of these developments, the European Central Bank has kept its key interest rates unchanged since June 2007. In its last meeting on 10 April 2008, the Governing Council of the ECB confirmed, on the basis of an analysis of the latest data, its assessment of prevailing upside risks to price stability over the medium term. As price stability is the ECB’s primary objective according to its mandate, the Governing Council judged that stabilising medium- and long-term inflation expectations is its highest priority; hence, it kept the interest rates unchanged. Thus, the minimum bid rate on the main refinancing operations remains at 4%. The Governing Council also underlined that the current monetary policy stance will help achieve this objective and reiterated its strong commitment to preventing the materialisation of upside risks to price stability over the medium term. The hikes in the minimum bid rate on the main refinancing operations of the ECB, along with higher money market rates, had an upward effect on interest rates on both deposits and loans in Greece (although their rise was, in general, smaller than in the euro area as a whole). However, whilst the rate of growth of the overall financing of the economy slowed during 2007, it remained at the relatively high level of 13.1% in the fourth quarter. This reflects the high rate of financing of the private sector (both firms and households), while the rate of financing of the government sector was negative throughout 2007. These figures suggest that the international financial turmoil had no impact on the supply of bank financing to the domestic private sector until the end of 2007. Stability of the banking system In spite of the continuing international financial turmoil, the stability of the Greek banking system has remained high, supported by – inter alia – satisfactory levels of profitability and capital adequacy. Greek banking groups’ capital adequacy ratio, which stood at 11.2% at end-2007, continues to provide satisfactory leeway for ensuring the stability of the banking system. Greek banks had very little exposure to instruments associated with the US subprime mortgage market and this largely explains the fact that the impact from the international turbulence was limited and indirect. Nonetheless, one should not lose sight of the fact that the current turmoil in the international financial system has acquired a dynamic driven by self-feeding and interdependent risks. Therefore, its impact does not regard only the degree of individual banks' direct exposure, but also the risk that the turmoil may take on a more systemic character. At the same time, competition in the domestic Greek banking market is becoming more intense and the cost of financing is increasing, leading to a small decline in net interest rate margins in 2007 over 2006 (at bank level). It is important that banks do not try to make up for this decline by further credit expansion, especially to borrowers of low credit quality. While the ratio of nonperforming loans to total loans fell further to 4.5% at end-2007, from 5.4% at end-2006, it is still considerably higher than the EU average. In the light of these developments, the points that the Bank of Greece has been stressing for some time have become even more relevant. In particular, banks need to further improve the quality of their loan portfolios by implementing stricter criteria when selecting borrowers. The implementation of the new supervisory framework (“Basel II”) should help in this respect. Also, households must weigh carefully their ability to service a loan before resorting to lending. Growth prospects, structural weaknesses and macroeconomic imbalances The high levels of growth witnessed over the last 12 years have led to considerable progress in the real convergence of the Greek economy on the more advanced economies of the EU. However, Greece still lags behind in terms of levels of development and social welfare, as per capita GDP (in purchasing power parities) falls short of the EU-15 average by 11.6%, as a result of lower productivity (measured per hour of work) and lower employment rates. In addition, there are serious macroeconomic imbalances and structural weaknesses, which are reflected in relatively high inflation, a large current account deficit, which has pushed up Greece’s external debt considerably, and high public debt. Finally, challenges such as population ageing, globalisation and, more immediately, a slowdown in world growth will make it difficult for such growth rates to be maintained in the future without more intense efforts to tackle the structural weaknesses of the economy. The average growth rate of almost 4% achieved over the last 12 years was primarily driven by boosting domestic demand. Private sector consumption and investment were bolstered by the fall in interest rates following Greece’s euro area entry, as well as by rapid credit growth. Relatively high fiscal deficits, although declining in recent years, also helped to boost aggregate demand, but at the same time contributed to a further accumulation of public sector debt. Productive capacity, which has increased, has responded to the growth of demand, but not to a sufficient extent, thus resulting in an excess demand situation. Demand-led growth has its own natural limits. Based as it is on the build-up of debt (both private and public) to finance consumption, ultimately an increasing proportion of GDP will have to be devoted to its repayment. As a consequence, only through a transformation of the economy into a more productive and outward-looking one will it be possible to maintain such high growth rates. Such a transformation should focus on three areas: first, continuing fiscal consolidation; second, adopting wage and pricing policies consistent with price stability; and third, promoting structural reforms to improve productivity and the supply conditions of the economy and to strengthen competition. Correcting fiscal imbalances The demands that population ageing will place on government expenditure make the need for continued fiscal consolidation even more pressing. In particular, a reduction in public debt by 2015 (when the effects of population ageing on government spending will be first felt) to 60% of GDP is of the essence. Hence, more intense efforts are needed, focused on both the revenue and the expenditure sides of the budget. It is not in the interests of the low competitiveness of the Greek economy to raise tax rates; there is, however, still room to reduce tax evasion as a means of raising revenue. However, crucial to achieving surpluses is the control of expenditure, in particular of certain categories such as personnel outlays, subsidies or guarantees for public sector companies, which account for a large part of government expenditure and have been growing very fast. Wage increases, pricing policy and competition Wage bargaining should take into account productivity developments, the implications of wage increases for price competitiveness, as well as the level of unemployment. The rise in oil prices inevitably represents a transfer of income from oil-importing to oil-exporting countries, which cannot be effectively offset by nominal wage increases, since these lead to higher inflation which erodes the purchasing power of domestic incomes. At the same time, competition should be strengthened in markets operating inefficiently, so that firms can contribute, through their pricing policies, to an evolution of prices which is compatible with production cost developments and with keeping profit margins at levels that do not undermine price stability and competitiveness. Structural policies for increasing employment and improving productivity Structural reforms must continue in order to improve productivity and the structural competitiveness of the Greek economy. Increasing employment Greece has lower employment rates and higher unemployment rates in comparison with the EU-15 averages. Demographic projections suggest that Greece will experience over the coming years a decline in the working-age population. Growth will therefore depend, in part, on raising employment rates by increasing the flexibility of labour markets, bringing into the labour market sections of the population with relatively low participation rates (especially women and older people) and continuously upgrading the skills of the labour force. Improving productivity Growth should also be based on bolstering labour productivity. Improving productivity requires first and foremost a modernisation of the business environment. Policies in a number of areas could help here. The strengthening of competition in product markets can encourage innovation and the implementation of measures to reduce production costs. Competition can be encouraged by removing barriers to business start-ups and reducing the complexity of the regulatory environment surrounding firms. Productivity levels in business also depend on the efficiency of public administration. It is commonly agreed that inefficient staff allocation and the operational framework of public administration do not meet the requirements of the Greek society and economy in an efficient manner, while reform proceeds at a relatively slow pace. In order to reap the full benefits of the introduction of information and communication technologies in public administration, training of personnel and upgrading administrative procedures are essential. Creating the conditions in which economies of scale can be exploited is also important for improving productivity levels. In the past, the small scale of Greek enterprises severely hindered their ability to exploit economies of scale. However, globalisation and the opening up of markets in the region have weakened this constraint. Additionally, the creation of clusters of firms with similar activities can also help smaller companies benefit from economies of scale by cooperating in cost sharing, know-how transfer and specialisation of services and products. A second area which can contribute considerably to raising productivity is that of infrastructure. Despite the progress made, there is ample room for improvements in the areas of both transport (land, sea and air) and network industries (energy, water and communications). Finally, investment in both human and physical capital has an important role to play. With the opening up of new markets in the region, investment in physical capital has now become more attractive. Of equal importance is investment in human capital through education and vocational training. Whilst in Greece the percentage of 20-24 year olds who have finished at least high school education is higher than in the EU-15 countries (84.1%, compared with 76.4%), the results of the PISA exams designed by the OECD to test knowledge and skills showed Greek students performing much worse than students from the other EU-15 countries. At the same time, although technology is evolving rapidly, the percentage of companies in Greece offering on-the-job training for their employees is lower than in the EU15, while the participation of the population in life-long training programmes is low. These observations suggest a need for closer cooperation between the education system, firms and research centres. Since many of the interventions proposed can be financed by the Community Support Frameworks, they will not place an undue burden on public finances. Conclusions The best way to minimise the negative consequences for the Greek economy from the continued crisis in the international financial system, external inflationary pressures and the expected slowdown in the growth of world economic activity is to continue the efforts to improve the fundamentals of the economy. The aforementioned policies will bear fruit in terms of further raising living standards. In the last 12 years, real per capita GDP has risen by a cumulative 51%. However, despite strong growth, 13% of employed persons, 25% of pensioners and 33% of unemployed persons are still below the poverty line. Moreover, in between households that have already benefited from growth and enjoy increasingly high incomes, on the one hand, and poor households, on the other hand, there is also a considerable number of households living on the verge of economic and social insecurity. While the establishment of the National Fund for Social Cohesion is a positive step towards tackling poverty and inequality, in itself it is not enough. It is also necessary to implement policies for reducing unemployment, raising the percentage of skilled workers and facilitating labour market entry. To conclude, therefore, if living standards are to continue rising and the problems of poverty and inequality are to be tackled, it is necessary to place much greater emphasis on productivity-driven growth. Demand-driven growth which is not accompanied by rising productivity has its own natural limits and cannot be expected to shelter the Greek economy from the impact of a possible slowdown in world growth and a rise in world inflation. By contrast, policies to improve productivity can better insulate the economy from external shocks and lay more solid foundations for higher living standards in the future.

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Speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at a public lecture, Athens, 30 April 2008.

Nicholas C Garganas: The single monetary policy and the analytics of OCAs – what has the euro area experience taught us? Speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at a public lecture, Athens, 30 April 2008. * * * It gives me great pleasure to be here today to give this public lecture on the European experience with monetary union. The fact that the lecture is taking place at my Αlma Μater makes this occasion a particularly special one for me, and I am grateful to Howard Davis and Kevin Featherstone for extending me the invitation. I hope that what I have to say will provide some food for thought. Indeed, I am hopeful that I may be able to convince some sceptics in the audience – and I know that they are out there – that monetary union among European countries can and does work! The adoption of the euro by 11 EU countries in 1999 was a remarkable achievement. It represented the culmination of a process of integration and convergence that had begun some 50 years earlier. The creation of the euro could be viewed as the end of a process, with Europe having finally reached full economic and monetary integration. Such a view, however, would, at best, be incomplete. Although the introduction of the euro marked the culmination of a long process, it also marked the beginning of another one. In particular, it created new challenges for economic policy. I will focus on these challenges in what follows. A natural starting point for analysis of the benefits and costs of a monetary union is the theory of optimum currency areas, originated by Robert Mundell in the early 1960s, and an important reason for his Nobel Prize in Economics. This literature on optimum currency areas identifies two main costs of a country’s participation in a monetary union. These costs are the loss of an independent monetary policy and the ability to alter the nominal exchange rate in order to mitigate the effects of asymmetric shocks. The theory also identifies the desirable characteristics that potential members of a single currency area should have in order to minimise these costs. The characteristics are sometimes viewed as preconditions for judging whether a nation should join a currency union. I will argue that this traditional way of thinking about judging optimality is incomplete. Underlying my argument are the following two factors. • First, the traditional approach has to be modified to take modern developments in monetary theory and policy into account. In a world in which monetary policy is best suited to achieve price stability, the loss of monetary policy independence may not be very costly. In fact, for a small open economy, such as Greece, it may actually provide net benefits. • Second, it can be misleading to view the optimum-currency-area characteristics as preconditions for ensuring the success of a country’s participation in a monetary union. In particular, to view the characteristics as preconditions overlooks the fact that the characteristics, or criteria, can themselves be endogenous. I will argue that the creation of a monetary union can itself create conditions that are favourable to the well-functioning of the union. I. The loss of monetary policy independence to the ECB Let me first turn to the matter of the loss of monetary independence. Modern monetary theory emphasises the role of monetary policy in providing price stability. By so doing, monetary policy can best provide a stable environment, which is a prerequisite for growth. This view contrasts strongly with the view that monetary policy can be used for fine-tuning the economy. The intellectual underpinnings of the emphasis on price stability can be traced to Milton Friedman’s and Ed Phelps’ critique of the Phillips curve in the late 1960s. On a brief personal note, I was privileged to have been taught macroeconomics at LSE by A W Phillips. Professor Phillips was an excellent teacher who made contributions in many areas of macroeconomics. In fact, it is well known that Milton Friedman tried to recruit him to the University of Chicago, but, fortunately for LSE, he declined. The Phillips curve expressed the idea of a trade-off between inflation and unemployment. The Friedman-Phelps insight, which helped earn those economists their respective Nobel prizes, was that the trade-off was, at best, temporary. Repeated attempts to reduce unemployment by allowing inflation to rise would result in ever-increasing inflation with unemployment returning to its natural rate. Although the Friedman-Phelps hypothesis swept through academia in the 1970s, policy makers were slower to catch on. As a result, the 1970s, and in some cases the 1980s, provided a real-world laboratory for testing the Friedman-Phelps hypothesis. As we now know, central banks that kept trying to pin down the rate of unemployment wound up with both high inflation rates and high unemployment rates. This was a lesson that would not be lost on subsequent generations of central bankers. Building on the Friedman-Phelps insight, Finn Kydland and Ed Prescott showed that a central bank engaged in discretionary policies has an incentive to promise low inflation, but then to run an expansionary monetary policy that produces higher inflation without lowering unemployment. In a contribution that helped earn these authors the Nobel Prize in 2004, Kydland and Prescott showed that, to be credible, central bankers must demonstrate that they are fully committed to a low-inflation objective. Full commitment in the Kydland-Prescott framework, necessitates independence from political pressures to follow inflationary monetary policies. Otherwise, once inflation expectations become entrenched, it can be very difficult to reduce them. The costs of doing so, in terms of higher unemployment, can be substantial. Again, the experiences of country after country which pursued expansionary monetary policies in the 1970s and 1980s provided the laboratory. These insights, and the subsequent literature built around them, contributed to the now widely-held view that central banks should have independence from the political process with a mandate to achieve price stability. In this way the monetary authorities can make the best possible contribution to supporting sustained economic growth and employment creation. The monetary policy strategy of the ECB can be seen in this light. It involves three key elements. First, there is the objective of price stability which the ECB defines as a year-onyear increase in consumer prices for the euro area of “below, but close to, 2 per cent”. The “close to” was added in 2003 to establish a safety margin above zero inflation to guard against deflationary risks. Price stability is a medium-term goal reflecting the long lags involved in the transmission of monetary policy. Second, the “two pillars” of economic and monetary analyses have been formulated so as to enable the ECB to attain its objective. • In the economic analysis, an assessment of current economic and financial developments from the perspective of the interplay between supply and demand in the product and factor markets is made. This provides short- to medium-term indications of inflation. • As a cross-check to the economic analysis, the monetary analysis focuses on money and credit developments in recognition of empirical evidence suggesting that monetary growth and inflation tend to be related in the medium to long run. The final element is central bank independence. The Maastricht Treaty grants full political independence to the ECB in its pursuit of price stability. In a democratic society, however, central bank independence needs to be counterbalanced by accountability, that is, an obligation on the part of the central bank to explain its decisions to the public and its elected representatives, including, in the case of the ECB, those in the European Parliament. In turn, accountability requires transparency with respect both to objectives and decision-making. To this end, monetary policy decisions taken by the ECB are explained “in real time” at a press conference immediately after each rate-setting Governing Council meeting. The success of the ECB’s monetary strategy is borne out by its record. Since the inception of the euro area, average inflation in the euro area has been 2.08%, a shade higher than the ECB’s definition of price stability. Inflation expectations have also remained firmly anchored around the ECB’s definition of price stability, attesting to the ECB’s credibility. Long-term interest rates have been at historically low levels. For countries such as Greece, with histories of high inflation, the gains from joining the euro area have been very substantial. For years, Greece suffered from double-digit inflation. Growth was anaemic and unemployment rose in spite of periods of fairly loose monetary policy. Nominal interest rates were high, reaching close to 30 per cent at times during the 1980s. In contrast, the low levels of nominal interest rates experienced in the euro area, reflecting the low levels of inflation expectations, have created conditions for an improved business climate, higher investment and, ultimately, higher growth. In sum, the loss of monetary policy independence, identified in the earlier optimum-currencyarea literature as one of the two main costs of joining a monetary union, is not necessarily a cost after all. That earlier literature was formulated in the context of Keynesian demandmanagement policies that were popular in the 1960s. Since that time, however, both economic theory and the experience of high unemployment coupled with high inflation have taught us the importance of a credible monetary policy aimed at providing price stability. Moreover, I have argued that for countries with histories of high inflation and political interference in policy formation, a credible monetary policy can be attained by joining a monetary union with an independent central bank. I also mentioned, however, that the earlier literature on optimum currency areas identified a second cost of joining a monetary union – the loss of the exchange-rate instrument. After all, monetary policy can be focused on price stability, but, in the face of an asymmetric shock, the nominal exchange rate may change so that adjustment is facilitated. How important, then, is the exchange-rate instrument in dealing with asymmetries among the countries participating in the euro area? II. Asymmetric shocks and the loss of the exchange rate as a policy instrument: the preconditions for monetary union reassessed The early literature on optimum currency areas included a search for mechanisms that could replace the exchange rate or compensate for its absence. This search led to the identification of a number of criteria on which the optimality of a potential currency area could be assessed. These criteria effectively became preconditions for forming a single currency area. I will argue that this traditional view is static in nature. It assumes that a country’s characteristics are immutable. In fact, the experience of the euro area suggests that participation in a monetary union can, in itself, induce changes in economic structure and performance that make the currency area optimum. Much academic research, based on the experience of European monetary union, indicates that the creation of a monetary union can itself create conditions favourable to the well-functioning of the union, either through endogenous changes in the way the economies of the union operate or through policy changes induced by the existence of the union. Let me illustrate by discussing some of the so-called preconditions enumerated in the early literature and looking at their evolution within the euro area. Mundell, in 1961, identified high mobility of the factors of production (both capital and labour) as a precondition for giving up the use of the national exchange-rate. While labour mobility is still low within the euro area, reflecting, in part, linguistic and cultural differences, the mobility of capital has been increasing as evidenced by the positive effect that the euro has had on intra-euro area FDI. Between 1999 and 2006 (the latest data available), the stock of euro area FDI more than doubled, from around 14 per cent of euro area GDP to over 30 percent. The importance of the mobility of financial capital was highlighted not only by Mundell (1961), but also by James Ingram who, in 1962, emphasised the role that financial market integration could play in reducing the costs of monetary union. Deeper financial market integration can help in a number of ways. First, it can cause the transmission mechanism of monetary impulses to become more similar throughout the countries of the union. Second, it can help reduce the impact of asymmetric shocks by causing equilibrating movements in capital flows. Finally, it can allow members of the union to insure against the impact of asymmetric shocks since it provides opportunities for diversification of income sources. If members of the monetary union hold claims on other countries within the union, then the income effect of any asymmetric shocks would be mitigated. The introduction of the euro has helped make euro area financial markets more integrated. The money market has been almost perfectly integrated since the formation of monetary union. The significant growth of the euro corporate bond market also provides evidence of integration and widens the range of potential investors to which firms have access. National bonds and equity market returns exhibit closer co-movements than they did prior to the introduction of the euro. The main area where financial integration has lagged is that of retail banking where, in spite of an increase in cross-border mergers and acquisitions in recent years, cross-border activity remains relatively limited. Forces for further integration will continue, as market participants increasingly exploit the new environment of monetary union. In addition, a number of initiatives, supported by the Eurosystem and/or the Commission, are further encouraging integration. An example is TARGET2, the new payment platform for the financial system, which began operating in November 2007. As integration proceeds, we can expect that monetary transmission mechanisms across the euro area will continue to converge, helping the implementation of the single monetary policy and bringing the euro area closer to an optimum currency area. Ronald McKinnon, in 1963, added the criterion of openness. The more open the economies of a monetary union, the less effective nominal exchange rate changes will be in facilitating adjustment because the changes are more likely to feed onto domestic prices and wages, offsetting the competitiveness gains. Recent empirical evidence, however, has shown that a common currency (as opposed to separate currencies tied together with fixed exchange rates) can promote openness, or trade integration. The basic intuition underlying this view is that a set of national currencies is a significant barrier to trade. In addition to removing the costs of currency conversion, a single currency and a common monetary policy preclude future competitive devaluations, and facilitate foreign direct investment and the building of long-term relationships. These outcomes, in turn, can promote (over-and-above what may have been attained on the basis of the elimination of exchange-rate uncertainty among separate currencies) reciprocal trade, economic and financial integration, and the accumulation of knowledge. Greater trade integration can increase growth by increasing allocative efficiency and accelerating the transfer of knowledge. The euro area’s experience indicates that the euro has indeed acted as a catalyst for trade integration. Intra-euro area trade in goods increased from 26% of euro area GDP in 1998 to 33% in 2006. Intra-area trade in services has also risen. Recent empirical work has shown that similar increases in trade have not taken place among European countries which did not adopt the euro. Kenen (1969) emphasised product diversification, the idea being that countries which were more diversified or less specialised in production would be less likely to face asymmetric shocks. Indeed, before the formation of European monetary union, there was considerable worry that monetary union would cause national economies to become more specialised as production became concentrated to reap the benefits of scale and agglomeration economies. Whilst there is perhaps little evidence that the advent of monetary union has caused economies to become even more diversified, there is no evidence that they have become more specialised, thus allaying these early fears. Another contribution to optimum-currency area literature, again made by Peter Kenen in 1969, brought out the importance of establishing a fiscal transfer mechanism at the supranational level in order to help stabilise economies hit by asymmetric shocks. While such a centralised fiscal mechanism is extremely limited in Europe, the Stability and Growth Pact with its emphasis on budgets being either in balance or surplus over the economic cycle is designed to ensure that national budget have the flexibility to react to adverse asymmetric shocks. In sum, the creation of the euro may itself be contributing to the very conditions that make the use of nominal exchange-rate adjustments among the members of the euro area less necessary than was the case before they joined the euro area. Nevertheless, it can be argued that a country surely must give up something if it no longer has the exchange-rate tool. My reaction to this argument is that adjustment of the nominal exchange-rate is not a magic bullet. One should not expect an economy with competitiveness problems, running, say, current account deficits equal to 6 per cent of GDP, to depreciate the nominal exchange rate and become competitive for-ever-after. We tried this policy in Greece in the 1980s; and wound up with higher inflation, undiminished current-account deficits, and a currency that became prone to speculative attacks. By its very nature, the current account is the result of intertemporal decisions with respect to savings and investment by the private sector and government. It should not be surprising, then, that the nominal exchange rate cannot be relied upon to bring about lasting adjustment. Such adjustment requires changes in an economy’s structure, and, as I have argued, membership in a monetary union can encourage those changes. III. Conclusions I have argued that ways of thinking about monetary union have evolved considerably from the early days of the literature on optimum currency areas. Developments in modern macroeconomics recast the goals of monetary policy. The focus nowadays on price stability and the creation of the conditions necessary to support growth and employment changes the balance of the arguments about the cost of giving up an independent monetary policy. Provided that the monetary policy framework at the union level delivers price stability, there is little to be lost from transferring monetary policy to the union level. The success of the euro area has demonstrated that one size can fit all. Let me briefly mention three pieces of evidence which support this. First, inflation dispersion has declined and has been around 1 percentage point since the second half of 1999. This compares favourable with inflation dispersion across a monetary union of similar size, the US. Second, the decline in inflation dispersion has not been at the expense of higher growth dispersion. Growth dispersion has remained close to its historical average of around 2 percentage points and, if any trend is discernable, it is a downward one. Finally, business cycles appear to have become more correlated. The evidence from almost 10 years of monetary union in Europe points to a euro area which is endogenously adapting itself to become an optimum currency area. The euro area provides clear evidence that the criteria identified in the earlier literature do not need to be exogenously in place prior to monetary union. I do not want to leave you with the impression, however, that euro area policy-makers can sit back and relax because all the necessary work has been done. After all, I began this lecture by remarking that the adoption of the euro created new challenges for economic policy. The adoption of the euro was neither the beginning nor the end of an optimum currency area among European countries. The process is ongoing, and much more needs to be done, especially in regard to structural policies, to ensure that the euro area becomes a more dynamic force for growth in the global economy. It is my view that the experience of the euro area to date only serves to highlight the fact that a currency union requires flexibility and competition in factor and product markets. These are the characteristics that will make monetary union work more effectively. Thank you for your attention. Bibliography Baldwin, R. (2006) “The euro’s trade effects”, ECB Working Paper no. 594. Ingram, J. C. (1962) Regional Payments Mechanisms: The case of Puerto Rico, Ralleigh: University of North Carolina Press. Kenen, P. (1969) “The Optimum Currency Area: an eclectic view” in Mundell, R. and Swoboda, K. (eds) Monetary Problems of the International Economy, Chicago: Chicago University Press. Krugman, P. and Venables, A. (1996) “Integration, Specialization and Adjustment”, European Economic Review, 40, 3-5, 959-67. Kydland, F. and Prescott, E. (1977) “Rules rather than Discretion: the inconsistency of optimal plans”, Journal of Political Economy, 85, 473-91. McKinnon, R. (1963) “Optimum Currency Areas”, American Economic Review, 52, 717-25. Mundell, R. (1961) “A Theory of Optimum Currency Areas”, American Economic Review, 51, 657-65. Rose, A. K. and Stanley, T. D. (2005) “A Meta-Analysis of the Effect of Common Currencies on International Trade”, Journal of Economic Surveys, 19, 3, 347-65.

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Dinner speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, on the occasion of the ECB Governing Council meeting hosted by the Bank of Greece, Athens, 8 May 2008.

Nicholas C Garganas: The euro and Greece Dinner speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, on the occasion of the ECB Governing Council meeting hosted by the Bank of Greece, Athens, 8 May 2008. * * * Your Excellency Mr Prime Minister, President of the European Central Bank, Speaker of the Parliament, Minister of Economy & Finance, Commissioner, Dear Colleagues and friends, It is a great pleasure to welcome you to Greece on the occasion of today’s meeting of the ECB’s Governing Council. Let me say a few words about the location of tonight’s dinner, the Zappeion Hall. It was built in the second half of the 19th century as a center to host cultural exhibitions modeled after the Crystal Palace exhibition hall that was part of first World’s Fair, held in London in 1851. The architecture is neoclassical, with a Corinthian portico, and an organization of spaces that is fully in harmony with the purpose for which it was built. The building, inaugurated in 1888, was used as the Olympic Village for the first of the modern Olympic Games in 1896. The building also has a rich political history. In 1979, the signing of the Treaty of Accession of Greece into the European Economic Community took place here. The meetings of the Governing Council that take place outside of Frankfurt twice a year serve an important function. These meetings allow the Governing Council to conduct its normal work activities while strengthening the cooperation and relations among our respective institutions. The meetings underline the cohesiveness of the Eurosystem and serve as a reminder that the system belongs to all euro-area citizens. Intimate cooperation among the members of the Eurosystem team, the national central banks of the system and the ECB, is the key to the success of the single monetary policy of the euro area. In this regard, let me mention that, as a member of the Eurosystem family, the Bank of Greece has enjoyed excellent working relations with all the members of the Eurosystem over the years. The euro has been a major success in so many respects. Despite the skepticism that surrounded its birth, on June 1st the ECB will celebrate its 10th anniversary, with its standing high. At all levels, the euro has delivered the goods. At the level of economic performance, its creation was intended to promote a macroeconomic environment in which countries could thrive in an increasingly competitive market place. The euro area’s track record in terms of inflation performance, low interest rates, employment creation, financial-market integration, and trade expansion demonstrate conclusively that the original objectives of the singlecurrency area are being fulfilled. Furthermore, the euro has eliminated the potential risk of exchange-rate crises involving national currencies, to which many of our economies were previously exposed on a daily basis in a world characterized by free capital flows. Moreover, the euro is now established as the world’s second most important currency, the significance of which is not lost upon a central banker. In effect, small countries, such as Greece, have traded in the vulnerability associated with the free movement of capital for the greater security and credibility provided by a major international currency and its central bank. At another, no-less-important, level, the euro is a symbol of shared values and a common objective – the objective of bringing our citizens closer together in an environment in which they can prosper. I need to add, however, that the benefits of a single currency and a credible central bank do not come automatically. They depend to an important extent on the economic policies pursued by the euro area countries themselves. From a national perspective, therefore, the challenge is to maximize the benefits of participation in a monetary union by making further progress on the path of reform. For Greece, it is particularly important to bring down the relatively high inflation rate in order to improve its competitive position. To achieve this objective, it is particularly important to continue on a sustainable and credible path to fiscal consolidation and to improve fiscal performance by reducing the country’s high government debt ratio. In particular, public finances should have sufficient room for manoeuvre in order to better cope with expected substantial increase in age-related expenditures. It will also be important, in both the public and private sectors, to attain moderate labor cost developments that take into account productivity growth, labor market conditions, and developments in competitor countries. Attention must also focus on overcoming the structural constraints on economic growth and job creation, notably by fostering labor force participation. In this regard, the strengthening of competition in product markets, which will help keep profit margins at levels consistent with price stability, and improvements in the functioning of labor markets, are key elements in raising potential growth. For fifty years, the EU and its predecessor organizations have brought peace and stability to the member states. The single market and EMU have built on that achievement by creating an edifice on which European economies can grow. By continuing to work together as a team, we will be able to ensure ever-more prosperous lives for our citizens. Let me not take up any more of your time, but let me wish you an enjoyable time during the remainder of your stay here. Ladies and Gentlemen, thank you for your attention.

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Key remarks by Mr George Provopoulos, Governor of the Bank of Greece, at the meeting with the Presidency and Members of the Hellenic Federation of Enterprises, Athens, 14 July 2008.

George Provopoulos: International financial turmoil and its impact on the Greek economy Key remarks by Mr George Provopoulos, Governor of the Bank of Greece, at the meeting with the Presidency and Members of the Hellenic Federation of Enterprises, Athens, 14 July 2008. * * * The international financial system It will take some time until normality is fully restored... 1. The international financial turmoil, which began almost a year ago, is still ongoing and continues to affect financial markets and macroeconomic aggregates. Extreme situations have been avoided, thanks to the action taken by major central banks (in the form of finetuning operations to restore normal liquidity conditions) and by governments, in particular those of the United States and the United Kingdom, aimed at averting the risk of a broader systemic crisis. 2. However, it remains uncertain how long it will take before credit markets return to normal conditions. Τhis continued uncertainty is reflected in, at times, strong tensions in money and credit markets (which are more sensitive to risk factors– whenever these appear) and in equity markets (where there are occasional swings of investors' risk aversion and, thus, liquidity preference, as well as of their uncertainty regarding the macroeconomic outlook of the United States or other countries). 3. Due to globalisation, uncertainty in the global economy also affected the Greek economy and the economies of the wider SE European region, although these economies have proved quite resilient. Impact on the real economy: Despite the slowdown, the economic fundamentals of the euro area are sound. Greece needs to intensify, rather than simply not relax, efforts to address structural weaknesses and macroeconomic imbalances… 1. The uncertainty surrounding the global economic outlook remains higher than usual. It seems that the adverse effects of the financial turmoil on world economic activity will be stronger and more protracted than initially thought. This is the case in particular with the US economy (where the housing crisis is serious and is spilling over to other sectors). Any prolongation or deepening of the economic slowdown in the United States could have repercussions on the euro area and thereby on the Greek economy. 2. I should clarify that by "uncertainty" I mean the possibility that downside risks to the growth projections made until recently could materialise. According to these projections made by international organisations, the growth rates of the global economy and of the European economy are slowing down, but growth is continuing, despite the fact that a small number of euro area countries recorded zero or negative GDP growth in the first or the second quarter of 2008. 3. According to available projections, while some downward revision during the next two months cannot be excluded, growth rates should remain positive in 2008, of the order of 1.5-2.1% in the euro area and 3.4-3.5% in Greece. In both cases, exports and domestic demand will remain the main drivers of growth, although their contribution to growth will be smaller than in 2007. However, in spite of the shocks experienced during the last twelve months, the economic fundamentals of the euro area as a whole remain sound. 4. As far as Greece is concerned, the adverse international environment makes it imperative to intensify, rather than simply not relax, efforts to address the macroeconomic imbalances and structural weaknesses which are reflected in: - the large current account deficit; - the still high public debt-to-GDP ratio; - the persistent inflation differential vis-à-vis the euro area as a whole; and - the unemployment rate, which despite its decline remains relatively high. The increase in the world prices of oil and food commodities This increase presents a major, but not unprecedented, challenge. This time we have to deal with the challenge in a correct and, above all, timely manner, ensuring that it does not trigger a second round of endogenous, broadly-based inflationary pressures. Targeted relief of economically weaker groups must be prioritised. This will require a brave effort from all parties involved, enterprises and households alike, to adapt to the new conditions. We must not repeat the painful mistakes of the past. 1. Adding to the credit-related macroeconomic uncertainties are those that arise from the possibility of further increases in the world prices of oil and other raw materials as well as food. 2. All of us, i.e. policy makers and social partners, have a duty to make sure that the fundamentals of the Greek economy improve and that heightened macroeconomic risks do not materialise. As our economy now faces the effects of exogenous and to some extent temporary shocks, it is of the utmost importance to ensure that the adverse effects of domestic factors – i.e. the macroeconomic imbalances and structural weaknesses that I mentioned earlier – on our medium-term prospects of output, employment and incomes are contained. Should we fail, hard times for all of us will last longer, while most of the burden will be shouldered by the most vulnerable, economically weaker social groups. 3. Increases in the world prices of oil and other commodities (in particular food) are, for the countries importing these commodities, a type of compulsory levy or tax in favour of commodity-exporting countries. In other words, it is an unavoidable transfer of income from the households and enterprises of commodity-importing countries to commodity-exporting countries. This transfer reflects a shift in relative prices at the global level. Neither households nor enterprises can ever make up for this loss of income, therefore efforts to pass the cost on to each other only serve to ultimately aggravate the adverse consequences for all parties involved. This is the lesson we have learnt from the oil shocks of the 1970s and from the ensuing adventures of countries that failed to recognise this hard reality in time. 4. The mistakes made when we were facing the first two oil shocks (i.e. the relaxation, of fiscal, monetary and incomes policies in the 1970s and the 1980s) must not be repeated. Let me recall, for those who have not experienced or have forgotten those episodes, that inflation (in Greece) had exceeded 33% by early 1974 and remained at double-digit levels throughout the next twenty years (until 1994). During that period, the fiscal deficit also reached double-digit levels as a percentage of GDP, and debt, which has been accumulating ever since, will take a long time before it can be repaid. Lending rates, which at the time of the first oil shock were administratively set, soared during the gradual interest rate liberalisation (1984-1993) to almost 30% (specifically, interest rates on short-term lending to businesses ranged between 27.5% and 29.5% in 1990-1994). These facts should be kept in mind when we decide on our actions and responses today. 5. Priority should initially be given to alleviating the impact of the oil shock on the more vulnerable social strata. In Greece, this can and must be achieved through targeted interventions and in a manner that would not jeopardise fiscal prospects. At the same time, business firms and households should realise that the irrecoverable losses of purchasing power entailed by higher oil and other commodity prices can be effectively offset in the long run only through policy interventions and initiatives, mainly by the government and by businesses, aimed at strengthening productivity and the forces of competition in all markets. 6. Of course, apart from the structural factors that determine the growth prospects of productivity and of real incomes, the establishment of conditions of price stability in the medium term can also make a crucial contribution. Actually, achieving and securing price stability over the medium term is the primary objective of the monetary policy conducted by the ECB, according to its Statute. Monetary policy in the euro area Monetary policy in the euro area will remain fully committed to the mandate, the institutional responsibilities and the primary objective entrusted to the ECB by the 320 million of European citizens. Following the recent increase in the ECB interest rates, the rise in medium-term inflation expectations among credit market participants came to a halt. Business firms and consumers can be assured that the ECB will not allow secondround inflationary pressures to threaten price stability in the medium term. The ECB does not make a pre-commitment on the future level of its interest rates. It takes into account a comprehensive set of information available at any given time and decides on the basis of its current assessment of prevailing risks to price stability over the medium term. 1. In an economic environment like the present one, the only effective contribution that monetary policy can make to the cause of economic growth is through its firm commitment to the objective of price stability in the medium term. I emphasise the words "in the medium term", given that monetary policy cannot offset the short-term fluctuations of inflation around its medium-term trend level which are due to exogenous factors such as developments in world prices of oil and other commodities. 2. What monetary policy can and must do is ensure that inflation in the medium term remains consistent with promoting economic growth and job creation. To ensure achievement of this goal, monetary policy must above all ensure that exogenous inflationary pressures do not trigger second-round effects, through firms' price-setting behaviour, wage agreements or other developments that anticipate a rise in inflation over the medium term. Such phenomena turn what is a temporary problem into a permanent one, aggravate shortterm rises in inflation and strengthen medium-term inflation dynamics. 3. The Governing Council of the ECB decided the recent increase in interest rates for a dual purpose: first, to prevent broadly based second-round effects on inflation as those I just described; and second, to counteract the increasing upside risks to price stability over the medium term, evidenced by the facts summarised below: - Between the autumn of last year and June 2008, inflation rates have risen significantly. June data showed clearly that inflation in the euro area as a whole would be above the medium-term target of 2% for a more protracted period than previously thought. - Moreover, the continuation of vigorous money and credit growth and the absence thus far of significant constraints on bank loan supply in a context of ongoing financial market tensions confirm the assessment of upside risks to price stability over the medium term. - At the same time, while the assessment is made that real GDP growth weakened over the first half of this year (despite satisfactory figures for the first quarter which reflected temporary factors), the economic fundamentals of the euro area remain sound. 4. In the first few days after the recent increase in the ECB interest rates, the signals coming from credit markets indicated that the upward trend of inflation expectations has come to a halt. Last week's indications were that expectations have started to decline. These are encouraging signs, which, however, should not lead to complacency. Indeed, headline inflation rates of around 4% in the euro area and 4.9% in Greece are disconcerting. According to recent surveys, both in Greece and in the euro area, citizens cite inflation as their number one problem and source of concern. 5. Let me assure you that the ECB, as it has always done, will stand ready to achieve its primary objective and fulfill the mandate entrusted to it by 320 million European citizens. That is, it will continue to take any action necessary to ensure the firm anchoring of inflation expectations at sufficiently low levels and to safeguard price stability over the medium term.

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Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at The Economist Conferences 8th Banking Forum: Banking and the Economy in turbulent times, Athens, 26 January 2009.

Panayotis Thomopoulos: The role of central banks as financial supervisors Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at The Economist Conferences 8th Banking Forum: Banking and the Economy in turbulent times, Athens, 26 January 2009. * * * Ladies and Gentlemen, I would like to thank the Economist Conferences and their representatives for Greece and Cyprus for inviting me to address this conference and its distinguished participants. Representing the authority responsible for the supervision of Greek credit institutions, I am confident to state that the term “crisis” is not the suitable one to describe the current condition of the Greek banking system. There are problems more of a liquidity nature after the drying up of the London interbank market for small to medium sized banks. As well as there is need to guarantee the fluidity of the reduced liquidity to the real economy, which are both addressed thanks to the ECB funding and the state’s €28 billion banking support package. On the other hand, due to the fact that Greece was not lured by the ephemeral fashion of detaching the supervisory functions from the Central Bank contributed to making more efficient both planks of the Bank of Greece’s functions and especially the supervisory role, for which the Bank has complete responsibility. Recently, the new Governor Mr George Provopoulos, in order to further strengthen the Bank of Greece’s role in this very sensitive but key area, established a new department dedicated to the monitoring of financial stability. Accordingly, under one roof there are now six different departments and, hence, there is a cross fertilisation of ideas, exchange of information and a decision making process encapsulating the knowledge, the analysis and points of view of these departments: the Economic Research Department, the Supervision of Credit and Related Financial Institutions Department, the Government Financial Operations and Accounts Department, the Payment Systems Department, the Financial Operations Department, and the Financial Stability Department. The end result is a synthesis reached by the Banking and Credit Committee, chaired by the Governor, with members the two deputy Governors and six directors. After the presentation of the possible effects of the international financial turmoil on the Greek banking system and the challenges in implementing the aforementioned Greek state plan, I will make a short reference to what the international trends are with regard to possible supervisory reforms. The first question is: How the current financial turmoil may affect the Greek banking system and the real economy. I would like to remind you that fifteen years ago the Greek banking system was characterised by an oligopolistic nature, with one bank acting as a piper calling the tune, controlling almost 60% of the system, while there were many administrative shackles and high obligatory reserves to the tune of 12% restricting banks’ activities and limiting credit availability. In two words, it was an underdeveloped bureaucratic financial system and supervision was moulded accordingly. The liberalisation of the financial system completed after Greece’s entry into the euro area, and the merging of many small banks into bigger units made the banking system very competitive. I am dismayed when I hear about “banks’ cartel” as if the proponents of this thesis don’t see individual bank’s aggressiveness to gain market shares and the significant reallocation of the pie. During the last 10 years, supervision by the Bank of Greece was transformed and played a leading role in promoting a sound and competitive banking system, which was thus capable of extending its activities in S.E. Europe. Three years ago, the Bank of Greece asked individual banks to assess their future developments in view of the likely end of the expansionary phase of the economic cycle and their need to be prepared to endure lean years. Today the soundness of the Greek banking system is not questioned; yet, the contagion from the global crisis has led to the drying-up of the interbank market and an increased dependence of banks on funding from the European Central Bank. It should, however, be noted that since the last week there are positive signs of a gradual normalization of the inter bank market concerning Greek banks. Rising risk premia have been increasingly reflected in widening interest rate spreads, leading to tighter credit conditions and, superimposed on the cyclical slowdown, should ultimately result in a marked slowdown in economic growth for 2009, as broadly forecast by international organisations. Indeed, the external shock has greatly reinforced the inherent weaknesses of the Greek economy. A possible deterioration in the economic environment in the South East Europe should also have negative implications on the subsidiaries of Greek banks. However, as banks’ exposure to the S.E. European countries is less than 9% of total assets, the total impact on Greek banks will be relatively limited. Moreover, this impact was incorporated into a worst case stress scenario conducted by the Bank of Greece for the banks, which – under this unlikely event – assumed that NPLs would almost double (compared with the base scenario for 2008) and S.E. European countries’ currencies would devalue. The total effects from this very bad scenario were limited, and the Capital Adequacy Ratio (CAR) continued to be above the limits allowed. Nonetheless, because the aim is for Greek banks to have sufficient capital and liquidity buffers as well as to minimise any negative spill-over effects on the Greek economy from the global financial crisis, the € 28 billion state banking support package has been arranged, thus ensuring that, even under the very bad scenario, Tier 1 capital will remain between 8-10% in 2009-2010. The enhanced preparedness of the Greek banking system. The current financial turmoil found the Greek banking system in a state of revision of its strategic priorities in line with Basel II. I will not cite the numerous and detailed Acts of the Bank of Greece (and individual consultations), which called the banks to strengthen internal control systems and risk management, built high capital ratios exceeding 11% and maintain high liquidity ratios. For this reason, the Bank of Greece, joining a small number of EU countries, imposed liquidity ratios in 2005, which, moreover, lean towards the severe side. Indeed, thanks to these buffers in October 2008, when, due to the increasing global uncertainty after Lehman’s debacle there were some withdrawals of deposits, the Greek banks surmounted the situation without great difficulties. The Bank of Greece, since 2006, has asked banks to reduce their credit risk, control better their credit expansion, decrease the ratio of non performing loans and provide incentives for write-offs. By mid-2008, banks were already well engaged to meet the target of the 3½%ratio for non performing loans for the end of 2008, but the global crisis has interrupted this downward trend of NPLs. It should be noted that, the outburst of the ongoing financial turmoil found Greek credit institutions without exposures to toxic assets, quite solvent and in the midst of a tidying-up process. This also explains the continuing high rate of return on equity during the first nine months of 2009 (14%) and the CAR around 10½%. Since the beginning of the global crisis in 2007, large banks were required to submit a strategic plan concerning the funding of their future activities. On the basis of Pillar 2 of Basel 2 framework, Greek banks have been advised to adjust their risk appetite and to increase their capital base in accordance with the results of a series of stress tests, and in such a way that, despite an adverse global financial landscape and macroeconomic environment, their Tier 1 CAR would be maintained at 8-10% in 2009 and 2010, as already stated. Within the Euro area co-ordinated framework, the €28 billion banking support package arranged by the Ministry of Economy and Finance in close co-operation with the Bank of Greece addresses both the issues of the capital base and liquidity of the banks, so as to minimize the risks from the global crisis on the real economy. The banks, in turn, will channel the available liquidity to the real economy, because this is also in their own interest, since their own profitability depends on giving loans. To restore medium-term liquidity, the guarantee of the Greek State, will be provided to credit institutions for the issuance of new medium-term loans, as well as for notes that will be issued or refinanced up to the end of 2009 and for a maturity of up to 3 years. The total amount of this guarantee will not exceed €15 billion and it will be provided either against a commission and the provision of adequate collateral or without collateral, but against a higher commission. Measures for strengthening the capital base: Credit institutions may benefit, on a voluntary basis, from the purchase by the Greek State of preference redeemable shares, up to an aggregate amount of €5 billion. These shares will pay a fixed annual return of 10% and they will be eligible as Tier I capital, allowing credit institutions to enhance their capital base. The state plan has now entered its implementation phase and most of the banks are preparing their participation, but the impact of the measures will be felt more in the 2nd quarter of 2009. Despite popular belief, Greek credit institutions are ready to make use of the measures. Although specific criteria have been already set, a fair distribution of the total available amount of €28 billion remains an extremely delicate task. It is also difficult to estimate how much each bank will ultimately draw and which part of the whole amount must be retained to be used in a later stage. It should be noted that, in exchange of the Government bonds and guarantees, the Bank of Greece will have to assess, process and monitor on a continuous base the volume and the variety of the collaterals given by the banks. This means that we will have to be constantly alert and the relevant mechanisms at the Bank of Greece must operate efficiently at full capacity for as long as it will be deemed necessary. Basically, the aim of the measures is to restore as far as possible normal market conditions and, along with the interest rate cuts announced by the ECB, to bring interest rates back to levels that do not hinder growth. The government guarantee should also contribute to the reestablishment of banks’ mutual trust and to the normalisation of interbank lending. There are positive signs in this area as Greek banks have started lending each other bigger sums for longer duration than overnight or one week. However, the process may encounter unexpected hurdles and, therefore, may be lengthier than it is desirable. Necessary regulatory changes: What changes might be envisaged to financial regulation and the structure of the financial sector as a result of the current crisis? I will try to answer taking into consideration what is under discussion in the various international fora, bearing in mind the global nature of the current turmoil. As you are aware, a number of reforms have been put forward at the European and international level, notably by the ECOFIN Council and the Financial Stability Forum (FSF), and have recently been reflected in the declaration of the G20 summit. However, we will have to bear in mind that any changes will be implemented gradually and, in some cases, only after the crisis is over, especially those aiming to the control of risk taking, as the system is currently in reverse mode. There is a need for fair evaluation and strengthening of regulatory regimes, prudential oversight and risk management, and ensure that all financial markets, products and participants are regulated or subject to oversight, as appropriate to their circumstances. In the same vain and to the extent that they represent a substantial factor for the smooth functioning of markets, credit rating agencies will be required to meet specific standards. The philosophy of auto-regulation and “markets know best” as they care for the interests of the economy and of themselves has been wiped out by the ongoing traumatic experience. But we don’t want to go to the other extreme of over-regulation and nationalisation of the banks. The banking system will probably have to operate with higher capital buffers than prior to the crisis, in order to address specific loopholes revealed by the crisis, to meet increased capital requirements calculated under Pillar 2, especially after the data concerning the crisis period will be fed into the internal capital calculations. The merits of introducing a limit on the leverage ratio of financial institutions are also under examination, which also might call for more capital. Liquidity risk now urges for more attention by both banks and regulators. In this respect, liquidity buffers have to be higher than before although several challenges involved have to be addressed, such as how to design relatively simple measures for funding liquidity risk and whether to impose minimum liquidity buffers. Markets have excessively rewarded short-term profits at the expense of lower long-term performance or plain losses. The excessive focus on the short-term has resulted in a significant underestimation of low probability but high impact risks, as well as in an increase of risk-taking behaviour. In this context, there is a need to create an incentive framework that adequately assesses and rewards performance over the medium to longer term. There are no doubts that the financial system has a natural tendency to amplify business cycles and there is a need to mitigate pro-cyclical effects stemming from the current regulatory framework. A number of potential areas need to be investigated, including capital requirements, valuation and leverage, banks’ compensation schemes and provisioning regimes. A key issue for regulators is how to make use of the build-up of risks and leverage during boom times – for example, through countercyclical capital and liquidity buffers that would be accumulated during booms and allowed to run down during periods of downturns and stress in the financial system. Weaknesses in bank transparency and valuation practices for complex products have contributed to the build-up of concentrations in illiquid structured credit products and the undermining of confidence in the banking sector. In this respect, concrete and solid industry practices must be promoted. The availability of aggregate information regarding the main risks to the financial system needs to be significantly enhanced. Information should be available concerning institutions, instruments and markets that are currently unregulated but whose risks raise financial stability concerns given their potential systemic impact. The effectiveness of the financial safety net composed of deposit insurance and access to emergency lending facilities at the central bank was also tested. The role of lightly regulated investment banks, and other financial institutions is dwindling under the international trend for more regulation and supervision. The need for more cross border co-operation between central banks, especially with regard to liquidity, and the spread of toxic structured products around the world became evident during the crisis 1 . New arrangements to facilitate the future cross-border liquidity management of banks are necessary, like the establishment of swap lines and auctions of foreign liquidity, and the acceptance of foreign collateral, as some major central banks do already. Issues related to the potential evolution of the financial sector: These are discussed in international fora and also within the Bank of Greece, in order to be ready to apply the new regulations on time. Higher capital and liquidity buffers and higher risk premia will entail a higher cost of capital and credit than before the crisis. That is not necessarily bad, as in hindsight it seems that risk has been underpriced. Financial firms basing their business models on cheap access to funding in wholesale markets will either have to adapt or disappear. Competition for deposit financing will also be intense for a while. On the product side, simpler products will be considered more attractive because regulators and investors will remain sceptical of complex structured products. The originate-to-distribute model remains to be fixed, and the interests of all the various players in the securitisation chain have to be better aligned. However, that does not mean that the model will disappear. At the fundamental level, the idea of distributing risk away from the institutions at the core of the financial system to investors that are willing and able to share in the risks is basically sound. But banks have to see that the leverage of the institutional investors is not excessive, because, in the end, banks may discover to their surprise that they are the ultimate investors. Finally, the financial sector will become smaller and less leveraged, but the weight of traditional banks should increase, in the interests of soundness and profitability over the long term. The supervisory role of central banks Some years ago, when the separation of supervisory and central bank functions was considered as a politically correct action, there were voices arguing against this mode, and in many countries central banks succeeded to retain the supervisory function despite strong national and international pressures. The experience on the financial market turmoil confirms and reinforces the arguments in favour of a strong interaction between the prudential supervisory and central banking functions. We at the Bank of Greece resisted proposals for the establishment of a single national supervisory authority in the form of UK’s FSA. I am sure that, if this division of responsibilities had taken place, we would be now collecting the pieces of some of the Greek banks. Many argue that cases like Northern Rock failure could be avoided if supervisory and central bank functions were not separated. Cross-border strains in dollar funding markets have been dealt with through swap lines between central banks and the auction of dollar term liquidity by the ECB and the Swiss National Bank, the Bank of England, the Bank of Japan and the Bank of Canada. There are three main arguments, also confirmed during the present crisis, in favour of combining prudential supervision with central banking, namely (i) information-related synergies between supervision and core central banking functions; (ii) the macroprudential approach argument; and (iii) independence and technical expertise. First, the experience of the central banks of the Eurosystem highlighted the existence, in practice, of relevant information-related synergies between the central banking and the prudential supervisory function. In general, the sharing of supervisory information was facilitated when the central bank had the possibility of direct access to information on individual financial institutions that was properly assessed and fully understood given its operational supervisory involvement. In terms of content of information exchange, the central banks normally sought information on individual institutions’ liquidity positions and forecasts, intra-group and inter-bank exposures, bank’s liquidity and funding policies, and data related to potential channels of contagion. Central banks are the lender of last resort and the activation of the Emergency Liquidity Assistance (ELA) in the euro area requires speed and detailed information regarding conditions of vulnerable banking groups seeking assistance. NCBs cannot give blank cheques and, therefore, this necessitates NCBs to have full knowledge and advance preparation that only NCBs with the supervisory responsibility can do. On their part, supervisory authorities sought information on money and financial markets, banks’ liquidity positions and collateral provided by banks in open market operations, patterns of banks’ recourse to payment systems (e.g., timing of flows during the intraday session; ratio between available and used intraday credit), and volumes in post-trading systems. The monitoring of the Target and other payment systems by the Eurosystem (including the NCBs) is a decisive advantage in this area. This information is necessary to central banks (CBs) as a basic input for conducting their monetary policy. CBs are required to estimate the liquidity deficit of the banking system and in accordance to their policy objectives to determine the size of their intervention through open market operations, with the view to steer market rates to desired level (which of course should be consistent with the official rates).This is why CBs are required to know among others and on a daily basis the amount and the quality of the available collateral. Moreover, according to E.U Treaty, Central Banks (and the Eurosystem) are responsible for overseeing payment systems (domestically and cross border operating). In this respect the Eurosystem runs the Target 2 system for both cross border and within the country transfers of funds in Euro. Thus, ensuring the real time execution of the orders, as the transfers are in central bank money. Privately run payment system do not provide to the same extend this guarantee. In addition, it was decided that the Eurosystem will develop the Target 2 security settlements system (the TS2) operating on a centralized platform, thus providing additional guarantee that the movement of cash and titles will automatically match. This removes the counterparty risk of not fulfilling contractual obligations. The smooth functioning of cross border payments and settlement systems are essential for preserving the stability of the financial system and for the timely execution of individual banks’ commitments. These services provided by central banks give an important advantage to them over FSAs, especially in times of crisis. Second, the experience of the turmoil confirmed the need for strengthening in general the interplay between the financial stability assessment of central banks and the prudential oversight of individual financial institutions. This stems from the fact that the turmoil has been characterised by a combination of disruptions in the functioning of some markets, including money markets, and concerns over the state of health of individual financial institutions. In practice, the supervision of individual institutions should benefit from the outcome of the financial stability assessment of central banks, which in turn should rely also on input coming from supervisors. The close linkage between the two functions is also recognised in the reform projects in the UK and the US where the envisaged reinforcement of the financial stability role of the central bank is always accompanied by the possibility for the latter to have direct access to supervisory information. Third, the independence and expertise argument highlights the quality of the contributions central banks can make to financial stability, also benefiting from their independence. Allow me at this point to say a few words about the role of the ECB. First, without the liquidity injection of almost €1 trillion by the ECB the euro area banking system could not have overcome the financial crisis. Second, I would like to underline the important role that the Vice-President of the ECB, Mr Lucas Papademos – as responsible for Financial Stability in the ECB – has played for the preparation of the EU banking support package framework. The recognition also by the EU governments of the crucial role of the ECB during the present financial crisis, in addition to the growing calls for a EU banking co-ordinator in the regulation and supervision field, augurs well that if a decision is taken on this issue the role of the ECB in this area should be further enhanced. Conclusions In conclusion and given that the severe stress in global financial markets and its impact on the Greek economy will probably last for some time yet, we can argue that the measures taken by the Greek state represent a necessary and proportionate package to enhance, first, financial stability and hence ensure the deposits and the savings of the population (which is one of the key obligations of supervisory authorities) and, second, confidence in the Greek economy, provided that during the initial implementation phase, all parties involved will perform their tasks in the best possible manner. Moreover, there are a number of positive factors: no Greek bank has faced any crisis; in 2008 their high profit rates will be sufficient to help banks to further increase their capital base. Of course, many questions remain on the adequacy of the measures at the euro area level and on the volume and pattern both of the state financial support and fiscal stimulus. Examples of repetitive packages introduced in some countries and calls by non-euro area countries to be assisted may lead – in the end – to bigger packages than presently envisaged. As far as it concerns the exit strategy, this is still lacking, but first things first.

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Speech by Mr George Provopoulos, Governor of the Bank of Greece, at the 17th Meeting of the Economic and Environmental Forum of the OSCE, Athens, 18 May 2009.

George Provopoulos: Reflections on the economic and financial crisis Speech by Mr George Provopoulos, Governor of the Bank of Greece, at the 17th Meeting of the Economic and Environmental Forum of the OSCE, Athens, 18 May 2009. * * * I am delighted for the opportunity to address this meeting of the Economic and Environmental Forum of the OSCE. As the history of this Organization clearly demonstrates, the management and resolution of security crises call for forceful and well-articulated policy responses. My presentation – reflecting my comparative advantage as a central banker – will deal with a crisis of a different kind – the economic and financial crisis that has engulfed the global economy for almost two years. My remarks will deal with four broad issues – the origins of the crisis, the policy responses taken so far, the prospects for an economic recovery during the next year, and the policy challenges that remain to be addressed. Although I will touch upon global developments in the course of my presentation, my main focus will be the euro-area economy and, to a lesser extent, the Greek economy. The origins For four years, through the summer of 2007, the global economy boomed. Global economic growth rose at an average rate of 5 per cent a year, its highest sustained growth rate since the early 1960s, while inflation remained generally contained. To some analysts, it began to look as if the global economy had entered a new phase – which some characterized as "The Great Moderation" – robust growth without the ups and downs of the normal business cycle. That picture changed dramatically with the eruption of the financial crisis in August 2007, following the collapse of the U.S. subprime mortgage market. What were the factors that led to that crisis? The seeds of this crisis were planted over a number of years and relate mainly to changes that took place in the financial industry. During the past ten years or so, a dramatic shift took place in the financial sectors of many economies. The management of economic risk, aimed at facilitating trade and investment, became less of a core activity of international finance. In its place, the financial industry came to be dominated by the risk inherent in arbitrage and deliberate exposure to asset price changes. In other words, the financial system increasingly moved away from activities geared to hedging existing economic risks – activities that promote trade within and among nations – and toward activities aimed at creating and promoting new risks. Clearly, the liberalization of financial markets and innovations in those markets have made important contributions to economic welfare, providing substantial improvements in the productivity of our economies. However, as the demand for finance increased, financial institutions began to increasingly rely on innovative funding techniques. For example, the securitization of assets – that is, the transformation of, say, mortgages into tradable financial instruments – has the potential to facilitate the diversification of risk. Yet, securitization also meant that banks were able to sell their credit – for example, their mortgage loans – immediately after they had been extended. Such innovative financial techniques had several consequences. First, they enabled lenders to expand the volume of their operations and conserve on capital. Second, they weakened lenders' incentives for prudent screening. The resulting decline in lending oversight contributed to rapid credit growth, helping to underpin asset price bubbles in some markets, including the housing market in the United States. Third, the complex structure of many structured products made it difficult for the ultimate holders to assess the quality and price of the underlying instrument. Another contributing factor to the crisis is important to mention. For most of the past ten years, a chronic shortage of savings in some of the world's most advanced economies – especially the United States – was funded by savings from emerging market economies, particularly those in Asia. For example, during the period 1999 to 2006, the U.S. current account deficit – a measure of that economy's shortage of savings – doubled as a share of gross domestic product, rising from 3 per cent to 6 per cent. In turn, Asian emerging market economies, especially China, recorded huge current account surpluses and accumulated enormous foreign-exchange reserves, mainly denominated in U.S. dollars. Effectively, the United Stated paid for its deficits – or shortage of savings – by supplying dollars to the rest of the world, contributing to the creation of excess global liquidity and asset-price bubbles. Feedback loops All of this came to a head in August 2007 with the outbreak of the U.S. subprime crisis. Although that crisis produced a substantial slowdown in U.S. economic growth, initially much of the remainder of the global economy, including the euro area, was largely unaffected. The global economy bent, but it did not break. Financial wounds continued to ferment, however, despite the efforts by policy-makers to sustain market liquidity and capitalization. Concerns about losses from bad assets raised questions about the solvency and funding of some key financial institutions. The situation deteriorated rapidly in September 2008, following the default of Lehman Brothers, the large U.S. investment bank, and the rescue of A.I.G., the largest U.S. insurance company. These events prompted a huge increase in perceived counterparty risk as banks faced large writedowns. Moreover, the solvency of some of the most established financial firms came into question, market volatility surged, and liquidity dried up. In effect, the entire U.S. financial system was put under severe strain. The impact of these events was felt across the global economic and financial systems, and the world economy entered its sharpest downturn since the Great Depression of the 1930s. A striking feature of this crisis has been the successive revisions – all in a downward direction – of global growth forecasts. To give an example, one year ago the IMF forecasted that global growth in 2009 would be 3.8 per cent. In October of last year – that is, shortly after the events of Lehman Brothers and A.I.G. – the IMF reduced its global growth projection for 2009 to 3.0 per cent, lower, to be sure, than the earlier forecast, but still a fairly robust rate. In January of this year, the IMF again reduced its growth forecast for 2009, this time to 0.5 per cent. Several weeks ago, the IMF released a new forecast. The IMF now projects that global growth will turn negative – on the order of 1.3 per cent – this year. What happened to produce such a dramatic turnaround? Because the banking system was at the epicenter of the crisis, the ramifications were quickly transmitted to all sectors in all countries of the global economy, and were magnified by a collapse in business and consumer confidence. Historical evidence confirms that financial crises are more likely to be followed by severe economic downturns when they are centered in the banking system and occur in the context of rapid build-ups of credit and house prices – characteristics that were features of the present crisis. Adding to the strains, the turbulence exposed long-simmering internal vulnerabilities within some emerging economies, focusing investors' attention on currency mismatches on borrower's balance sheets and excessive credit growth in those economies. Moreover, the severity of the crisis has been exacerbated by a corrosive feedback loop between the financial and the real sectors of the economy, which has, to some extent, undermined policy-makers' efforts to address the situation. Specifically, a disfunctioning of financial markets has reduced economic activity while the weakening of activity has, in turn, impacted on the capital position of the financial sector and, thus, its ability to provide credit to enterprises and households. Policy responses The policy responses, in both advanced and emerging-market economies, to the crisis have been rapid, bold, and unprecedented. Central bankers around the world have been on the front lines to sustain demand in the face of the financial-market disruptions. In what follows, I will focus my remarks on monetary-policy and fiscal actions in the euro area and the responses of the international community. What did the Governing Council of the ECB do in response to the crisis and why did it do it? Broadly speaking, the Governing Council's responses took place in two stages – the first stage corresponds to the outbreak of the crisis and the second stage to its intensification. Upon the first signs of financial-market turbulence, in August 2007, the Governing Council moved to ensure the functioning of the money market. The so-called "wholesale" money market plays a key role in the economy because it is the market in which banks borrow and lend to each other. In times of distress, however, banks and other financial institutions seek to reduce their exposure to risk. To do so, they move to reduce their illiquid investments, including some loans, and increase their liquidity. This process is what is known as "deleveraging". If a large number of banks do this at the same time, it can lead to large reduction of loans to corporations and consumers, inflicting damage on the economy. Because banks were concerned about both the amount of liquidity they could obtain and the length of time for which they could hold on to the liquidity, in August 2007 the ECB provided liquidity at long time horizons as a way to insure banks against future liquidity shortfalls. This action helped increase public confidence that banks would be able to meet their obligations. Since the intensification of the crisis this past fall, the Governing Council's actions entered a second stage. The Council has reduced its key policy interest rate from 4.25 per cent to 1.00 per cent. Such a large reduction in such a short period of time has been unprecedented in the euro area. As a result of this reduction, we are providing unlimited funding to banks at a rate of 1.00 per cent. In addition, sound and creditworthy banks can secure overnight funds in the interbank market at a rate that is between the 1.00 per cent main policy rate and the deposit rate, the latter of which is only 0.25 per cent. Moreover, we have taken several measures that are not standard in order to encourage banks to extend new credit or to continue to roll over maturing loans to firms. These measures include fixed-rate, fullallotment tenders which grant eligible banks access to unlimited funding for up to six months at our main policy rate, and the expansion of the list of eligible assets that can be used as collateral. I should also mention that ECB President Jean-Claude Trichet recently announced that additional non-standard measures will be implemented in the next few months. As concerns about the extent of the downturn have mounted, euro-area governments have also turned to fiscal policy to support demand. Fiscal policy is providing support through automatic stabilizers and the use of government balance sheets to shore up the financial system, including capital injections to banks. In addition, many euro-area governments have taken discretionary measures to stimulate their economies. While discretionary fiscal measures can help bolster aggregate demand and limit the impact of the financial crisis on the real economy, the room for such measures is subject to a number of important limitations. • First, the use of fiscal policies will need to take account of the sustainability of public finances. While global developments have played a role in the widening of euro-area sovereign-interest-rate differentials since last fall, country-specific factors, including projected debt levels, have also played an important role. • Second, a clear and credible commitment to long-run fiscal consolidation is more essential than ever in present circumstances. Any loss of market confidence could raise long-term real interest rates and debt-service costs, offsetting the expansionary effects of measures already taken and adding to financing costs. Therefore, fiscal support measures should be accompanied by a plan to withdraw the stimulus as the crisis abates. • Third, to attain such a credible commitment, it is crucial that euro-area countries respect fully the provisions of the Stability and Growth Pact. This will provide the necessary medium-term framework with which to preserve the public's trust in the sustainability of the public finances. • Fourth, as growth is a key factor in restoring debt sustainability, directing expenditures toward productive areas – such as government investment in transportation, infrastructure, and education – would be beneficial. A similar argument applies for tax reforms that reduce distortions. • Fifth, as indicated by the foregoing remarks, for some countries there is no room for discretionary fiscal expansion. I might add that, reflecting past choices, Greece is one of those countries. It would be possible, however, to boost public investment in Greece without any significant budgetary effects if the advance payments of Community funds are used for the financing of infrastructure projects. Let me say a few words about the policy response to the crisis at the international level. The IMF has been the main vehicle for coordinated action by the international community. The Fund's resources have been greatly expanded and actions have been initiated to further increase the Fund's resources through, among other vehicles, a quota increase and an SDR allocation. In turn, the Fund has responded with a record lending commitment totaling some $157 billion. A number of European countries – including Belarus, Hungary, Iceland, Latvia, Romania, Serbia, and the Ukraine – have undertaken adjustment programs supported, in part, by financial assistance by the Fund. These programs have helped increase confidence and have reduced pressure on capital outflows. Prospects for recovery The picture that I have described thus far is of a global economic downturn that is by far the deepest since the Great Depression of the 1930s and of a policy response, including monetary and fiscal actions, and support measures for banking systems, that are unprecedented in both breadth and magnitude. It is important to point out that this policy response is very different from that which took place during the Great Depression. During the 1930s, many large economies did not pursue expansionary monetary or fiscal policies. In the early years of the Great Depression, some countries, including the United States, operating under the rules of the gold standard, implemented tight monetary policies in order to stem gold outflows. With regard to fiscal policies, the conventional wisdom of that earlier period was that budgets should not be expansionary, even during depressions. That wisdom did not begin to change until 1936, the year in which Keynes published a book that ushered in the Keynesian Revolution. Moreover, during the 1930s there was no IMF to provide support for countries facing balance-of-payments' difficulties. Instead, many countries implemented extensive trade protectionism to deal with balance-of-payments problems. In terms of policy responses, therefore, we are in a better position at the present juncture than was the case in the 1930s. Nevertheless, there are also some differences between the 1930s and the present situation that are not so favorable to the latter situation. • First, in 1929, when global stock markets crashed, the U.S. banking system was in a relatively-healthy condition. It took three years of deep depression to wreck havoc on U.S. banks. The response of the U.S. policy-makers – including their introduction of deposit insurance – quickly got the U.S. banking system up and running again. In the present situation, the U.S. banking system has been the epicenter of the problem from the start, and the issue of pricing toxic assets has yet to be resolved. • Second, there is some concern that the fiscal response to the present crisis may, in some countries, be overly aggressive. The largest fiscal deficit of the United States, for example, during the Great Depression was less than 6 per cent of GDP. In contrast, the deficit in the U.S. is expected to exceed 13 per cent of GDP this year and be close to 10 per cent of GDP next year. Other countries will also be running up huge deficits. The IMF projects that the aggregate fiscal deficit of the euro area will rise from 1.8 per cent of GDP in 2008, to over 6 per cent of GDP in 2010. These deficits could put upward pressures on long-term interest rates, helping to abort a recovery. This situation underscores the concern that I expressed earlier about the need to formulate clear exit strategies at an early stage. Based on what I have said so far, the key factor determining the course and speed of a recovery will be the rate of progress toward returning the financial sector to health. History shows, however, that recoveries from financial crises, especially when they are global in nature, are significantly slower than recoveries from other types of shocks, such as shocks to oil prices. Moreover, recovery from the present situation is made especially difficult in light of the complexities involved in dealing with bad assets and restoring confidence among banks. These factors underlie the IMF's projection – to which I referred earlier – of a 1.3 per cent contraction in global output this year. The euro area is projected to experience an even steeper decline in economic activity than the rest of the global economy. Both the IMF and the European Commission project that the euro area economy will contract by about 4 per cent this year. This contraction reflects an expected sharp contraction in euro-area export markets along with the effects of financial stress and housing corrections on domestic demand. The IMF also projects that global growth will re-emerge in 2010, but at 1.9 per cent it would be sluggish compared with past recoveries. With regard to the euro area, the ECB Governing Council expects that economic activity will be very weak for the remainder of this year before gradually recovering in the course of 2010. Recently, there have been some positive signs in the euro area economy, mainly reflecting financial-market developments and confidence indicators. Those so-called "green shoots" suggest that the economy may be stabilizing. It is important to keep in mind, however, that, if stabilization is indeed taking place, it is at a very low level of activity. It will take some time before our economies fully recover and grow at a robust pace. Allow me to say a few words about the Greek economy. As a result of the crisis, I expect that growth will slow from almost 3 per cent last year, to zero per cent this year, perhaps even moving into negative territory. Moreover, several fundamental problems beset the Greek economy, including low international competitiveness, reflected in very-large current-account imbalances, a large fiscal deficit, and a very-high debt level. To restore competitiveness and correct the fiscal imbalances, bold and wide-ranging reforms in the public sector, and structural reforms to enhance productivity and raise the employment rate, are required. The Bank of Greece's Annual Report, published last month, provides a roadmap for the implementation of a credible medium-term strategy aimed at addressing the economy's problems. Clearly, we have reached decision-time in Greece. It is now time to move forward and there is no room for delay. The international financial crisis has had a more limited impact on the Greek banking system than on many others and the fundamentals of the Greek banking system remain sound. To a significant extent, this is a consequence of the very limited exposure of Greek banks to toxic assets and their relatively-strong liquidity positions, which reflects the fact that Greek banks are largely deposit-based. Nevertheless, the weakening of economic activity will affect the ability of individuals and companies to service debts, and reduce profits. In its supervisory role, the Bank of Greece has been closely monitoring the banking system, tightening credit standards and supervisory controls, to ensure continued soundness. As you may know, Greek banks have been large investors in other economies of Southeastern Europe. With the sharp weakening of economic activity in the region, the Bank of Greece has called on banks to be prudent in their assessments of economic conditions in those economies so as to limit risk exposure. Finally, in line with all EU governments, the Greek government has been implementing a plan for enhancing liquidity and strengthening banks' capital base. The Bank of Greece has been encouraging banks to make use of the plan. The challenges ahead The recovery from this crisis may be slow, but there will be a recovery. What, then, are the policy challenges that lie ahead? I believe that there are two main types of challenges that need to be addressed. The first challenge concerns macroeconomic policies. Clearly, the short-term effectiveness of these policies will depend on their medium-term credibility. As I have emphasized, to retain their credibility, exit strategies will be needed to convert fiscal and monetary policies from extraordinary short-term support to sustainable medium-term frameworks. With regard to the euro area, monetary policy is formulated in a medium-term context, with the aim of ensuring price stability. Measures of price expectations show that our policy is highly credible. The second challenge concerns financial sector reform. The pace of the recovery will crucially depend on how quickly confidence can be restored in the soundness of the financial system. To this end, it is essential that the revealed weaknesses in the functioning of the financial system and the inadequacies of the regulatory and supervisory frameworks are effectively and promptly addressed. In particular, there is a growing consensus among policy-makers about the need to strengthen and broaden the regulatory framework and to develop macroprudential supervision globally and in the European Union. There are different views about how to best achieve that goal. At the initiative of the European Commission, a group chaired by Jacques de Larosière undertook a comprehensive review of the EU framework for financial regulation and supervision. The group proposes to establish a European System of Financial Supervisors, bringing together the national supervisors with three independent supranational "Authorities" (for banking, insurance, and securities markets), accountable to the EU institutions. These Authorities would oversee the work of, and resolve disputes among, national supervisors, who would retain responsibility for the conduct of supervision. Cross-border institutions would be supervised by colleges of home and host supervisors. To bridge the gap between macroand micro-prudential oversights, the group proposes creating a European Systemic Risk Council linked to the European Central Bank. This council would comprise the Governors of the European System of Central Banks, the heads of the Authorities, and the European Commission. The group advocates the establishment of "a truly harmonized set of core rules" harmonized and prefunded deposit insurance schemes, and more detailed criteria for burden sharing. If implemented, the approach would constitute a historic step forward, putting in place important building blocks of an EU financial stability framework that is consistent with the objective of creating a single financial market. Conclusion The key priority among policy makers is to bring back economic growth and help bring about prosperity for everyone. The crisis that we presently face is a dual one – a financial crisis and an economic crisis. As I have stressed, our policy response should also be of a dual nature, one part of which involves a short-run response and the second part of which involves a medium-term response. In the short run, we should do whatever is feasible to support economic recovery. In the medium term, we should be prepared to pursue a credible exit strategy from the extraordinary policy interventions while developing an effective framework for financial supervision at the EU level. The former, short-term, response will help pave the way to recovery. The second, medium-term, response will help ensure that we do not experience a similar crisis in the future. Ladies and gentlemen, thank you for your attention.

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Speech by Mr George Provopoulos, Governor of the Bank of Greece, at the Annual Meeting of the International Monetary Fund, Istanbul, 6 October 2009.

George Provopoulos: The state of the Greek economy in light of the financial crisis Speech by Mr George Provopoulos, Governor of the Bank of Greece, at the Annual Meeting of the International Monetary Fund, Istanbul, 6 October 2009. * * * The global economy is now emerging from its most severe crisis since the Great Depression of the 1930s. Why was this crisis so severe? Because the financial system was at its epicenter, the ramifications of the crisis were quickly transmitted to all sectors and countries. The effects of the crisis were magnified by a collapse in business and consumer confidence. History shows that financial crises are more likely to be followed by severe economic downturns when they are centered in the banking system and occur in the context of rapid build-ups of credit and fast-rising asset prices. This has also been the case with the present crisis. The policy responses to the crisis have been rapid, bold, and unprecedented. These responses reduced uncertainty and improved economic sentiment. With the global recovery in its initial stages, and economic activity still far below pre-crisis levels, it is too soon to begin withdrawing the stimulus measures. However, the formulation of a medium-term macroeconomic framework for the post-crisis period will be crucial. It will facilitate the achievement and maintenance of a sound fiscal position and enhance the ability of the monetary authorities to deliver price stability. It will also help foster financial stability. The challenge will be to choose the correct timing for the withdrawal so as to avoid: first, a premature unwinding of public interventions; second, jeopardizing what has been achieved in stabilizing economic and financial conditions; third, letting these measures continue for too long, at the risk of distorting incentives and damaging public balance sheets. Safeguarding the sustainability of public finances will be a key objective in many advanced economies, the deficit and debt ratios of which have reached levels unseen in peacetime. The IMF has played a key role in helping the global economy weather the storm. The tripling of IMF resources has significantly increased the Fund’s lending capacity, and the new SDR allocation has provided additional liquidity to the global economy. At the same time, the launch of the Flexible Credit Line will add flexibility to the Fund’s lending framework. The best way to manage a crisis is to prevent it. The present crisis has revealed that macroprudential factors play an important role in determining the size, nature, and propagation of systemic risk. Therefore, it is essential to establish an effective framework for macroprudential supervision that will ensure both the systematic analysis of risks and the formulation of policies to address such risks. The state of the Greek economy The economic slowdown has been less severe in Greece than in many other European countries. However, this outcome reflects factors that, if left untreated, will reduce growth potential in the medium term. Specifically, the performance of the Greek economy during the crisis reflects the relatively-low level of openness and the deterioration of public-sector balance sheets from a position that was already worrisome prior to the onset of the crisis. A factor that has, however, supported the Greek economy has been the soundness of its banking system. Greek banks have been free of toxic assets and their exposure to the emerging economies of South-Eastern Europe has remained within manageable limits. A recent stress test conducted in close cooperation with the IMF has reaffirmed the soundness of the Greek banking system. The relatively-high growth rates experienced by the Greek economy since its entry into the euro area reflect a catching-up process. To sustain a robust growth rate in the future, Greece will need to address several key challenges, reflected in persistently very large currentaccount imbalances, high fiscal deficits, and worrisome debt levels. These imbalances are the result of structural rigidities, which have undermined competitiveness over time. To restore competitiveness and remove the imbalances, a dual agenda needs to be concurrently implemented: first, a multi-year program of fiscal consolidation, which can reduce risk premia and crowd-in private investment, raising the growth potential of the economy; second, bold and wide-ranging institutional reforms in the public sector and structural reforms in product and labor markets, which can enhance productivity and raise the employment rate. Only by undertaking these reforms will the Greek economy be able to become more competitive and increase its growth potential and the prosperity of its citizens. The broad support received by the newly-elected government will greatly facilitate the implementation of the reform agenda.

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Opening address by Mr George Provopoulos, Governor of the Bank of Greece, at the Conference of Bank of Greece & Oxford University: "Challenges and Prospects of South East European Economies in the Wake of the Financial Crisis", Athens, 16 October 2009.

George Provopoulos: Key challenges for South East Europe inlight of the crisis Opening address by Mr George Provopoulos, Governor of the Bank of Greece, at the Conference of Bank of Greece & Oxford University: “Challenges and Prospects of South East European Economies in the Wake of the Financial Crisis”, Athens, 16 October 2009. * * * I am very pleased to welcome you to the Bank of Greece for this conference, co-sponsored by the Bank of Greece and the University of Oxford through the latter’s program on South East European Studies. The focus of this conference is the policy responses to the most severe economic and financial crisis that the world has faced since the Great Depression and the key challenges that lie ahead for South East Europe in light of the crisis. This morning, I would like to share with you some thoughts about policy responses to the crisis. I will also provide some observations on the challenges that lie ahead. I will have more to say about the major challenges facing the economies of South East Europe during this afternoon’s panel discussion. My remarks about policy will deal with three broad issues: first, the response of the Governing Council of the European Central Bank to the crisis; second, the pace at which the extraordinary monetary and fiscal stimuli now being provided should be withdrawn; and, third, the need to develop a macro-prudential approach to financial regulation. Monetary policy Exceptional times call for exceptional measures. The policy response of the ECB to the crisis has been rapid, bold and frequently unconventional. With the intensification and broadening of the crisis, beginning in October 2008 the ECB Governing Council reduced its key policy rate from 4.25 per cent to 1.00 per cent in a period of only seven months. This was an extraordinary response for a central bank that had, until that time, moved at a measured pace in changing rates, abiding by the principle that a certain degree of persistence in policy-rate changes increases the effectiveness of rate adjustments. 1 Interest-rate reductions may not be very effective, however, during times of extreme stress when conventional channels of monetary-policy transmission are blocked or impaired. In the aftermath of the collapse of Lehman Brothers, financial markets froze and credit intermediation collapsed. Uncertainty pervaded the markets, counterparties were viewed with suspicion, and the flow of credit all-but halted. In these circumstances, the ECB undertook a number of non-standard measures to enhance the flow of credit and support the functioning of the money market. Our approach consists of five broad elements. • First, the full accommodation of banks’ liquidity needs at a fixed rate. • Second, the expansion of the list of assets used as collateral. • Third, the lengthening of the maturities of long-term refinancing operations. • Fourth, the provision of liquidity in foreign currencies. See Jean-Claude Trichet, “Credit Alertness Revisited”, paper presented at the symposium on “Financial stability and macroeconomic policy”, sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, 22 August 2009. • Fifth, purchases of covered bonds in order to stimulate a market that has been traditionally an important source of funding for banks. In addition to this exceptional support to domestic financial markets, the ECB has also provided assistance to non-euro-area financial markets. For, example, we have entered into either swap or repo arrangements with Denmark, Sweden, Hungary, and Poland. Moreover, E.U. countries have strongly supported recent measures to increase IMF resources through, among other vehicles, bilateral loans to the Fund, an SDR allocation, IMF gold sales, and a quota increase. In turn, the Fund has responded to the crisis with a record lending commitment, which includes programs to Belarus, Bosnia-Herzegovina, Hungary, Iceland, Latvia, Poland, Romania, Serbia, and the Ukraine. In addition to the foregoing actions by the ECB, euro-area governments launched major fiscal-stimulus programs while supporting banks with guarantees and capital injections. Together, these measures reduced uncertainty and increased confidence, contributing to an improvement in economic and financial conditions. Exit strategy With the recovery in the euro area in its initial stages, and with economic activity still far below pre-crisis levels, it is too soon to begin a withdrawal of the stimulus measures. Nevertheless, the development of a medium-term macroeconomic framework for the postcrisis period will be crucial. It will help facilitate the achievement and maintenance of a sound fiscal position and the ability of the monetary authorities to deliver price stability. It will also help foster financial stability. The challenge will be to choose the correct timing of the withdrawal so as to avoid: first, a premature unwinding of public interventions; second, jeopardizing the achievements in stabilizing economic and financial conditions; third, letting these measures continue for too long, with risks of distorting incentives and damaging public balance sheets. Among the factors that will shape the ECB’s approach to exiting the nonstandard measures are the following: • First, we will act with the aim of securing price stability in the medium-term. By implication, any non-standard measure that may pose a threat to price stability will be promptly withdrawn. If no such risk exists, a measure can be maintained in case of significant financial-market tensions. • Second, we have built a degree of phasing out into the exit process through the design of our measures. In the absence of new policy decisions, several of these measures will unwind naturally, for example, through pre-determined termination dates. • Third, the ECB’s operational framework comprises a broad set of instruments so that the exit strategy can be formulated in a flexible way. For example, the interestrate corridor allows short-term interest rates to be changed while keeping some nonstandard measures in place should the need arise. Therefore, the Governing Council can choose the way in which interest-rate action is combined with the unwinding of the non-standard measures. Let me turn to the issue of the exit from expansionary fiscal policies. In my view, an important medium-term risk to sustained recovery revolves around deteriorating fiscal positions. The large increases in fiscal deficits and public debt incurred to provide stimulus to the economy have already raised concerns in financial markets, as suggested by the widening sovereign spreads relative to pre-crisis levels, for economies with large fiscal burdens. If the recovery were to stall, followed by a prolonged period of very-low growth, deficits and debt could swell to difficult-to-sustain levels. Governments will, therefore, need to start addressing mounting long-run fiscal challenges by committing to large reductions in deficits once the recovery is on a solid footing and advancing reforms that will put public finances on a more sustainable path. I need to add that Greece is among the euro-area countries for which the challenge of medium-term fiscal viability is especially urgent. Financial sector regulation The best way to manage a crisis is to prevent it happening. At the root of the market failure that led to the crisis was optimism bred by a long period of high growth, low real interest rates, and policy failures. One such failure was that financial regulation was not equipped to address the risk concentrations and distorted incentives underlying the financial innovations. This circumstance raises another medium-run challenge. The present crisis has revealed that macro-prudential factors play an important role in determining the size, nature, and propagation of systemic risk. Therefore, it is essential to establish an effective framework for macro-prudential supervision that will ensure a systematic analysis of risks, as well as the formulation of policies to address such risks. Let me say a few words about the framework for macro-prudential supervision envisaged for the E.U. Following the publication of the Report of the de Larosiére Group in February 2009, the Commission issued a package of draft legislation in late September with the aim of creating a European Systemic Risk Board – or ESRB. The main task of the ESRB will be to identify and assess risks to the stability of the EU financial system and issue risk warnings when the identified risks appear significant. Several features of the proposed framework are important. • First, the European System of Central Banks will play a key role in the functioning of the ESRB. The voting members of the ESRB’s General Board will include the 27 governors of the EU’s national central banks and the President and Vice President of the ECB. • Second, the ECB will be assigned the task of ensuring sufficient human and financial resources for the ESRB’s Secretariat. • Third, the ESRB will not be responsible for the implementation of macro-prudential policies. That responsibility will remain with national authorities and national supervisors. • Fourth, since the ESRB will not implement macro-prudential policies, the effective monitoring of the follow-up to its warnings and recommendations and the consistent and timely implementation of the recommendations will be crucial for the performance and the credibility of the new macro-prudential supervisory framework. The creation of the ESRB will, in my view, constitute a historic step forward, putting in place an important building bloc of an EU financial-stability framework that is consistent with the objectives of creating a single market. Challenges for Southeastern Europe Some of the policy challenges facing the euro area also need to be addressed by the countries in Southeastern Europe. Moreover, many of the countries in Southeastern Europe are confronted by additional challenges. Let me mention some of these challenges, as well as some questions that we may wish to consider during the course of this conference. • First, prior to the crisis many countries in the region ran large current-account deficits underpinned by capital inflows. As the crisis demonstrated, however, capital flows can be subject to abrupt and sharp reversals. What policy measures can be used to deal with surges of capital inflows and their sudden reversals? • Second, much of lending in the economies concerned has been denominated in foreign currencies. This situation can lead to corrosive feedback loops between banking crises and foreign-exchange crises, compounding the effects of each. What policies can be taken to safeguard domestic banking systems from exposure to foreign-currency borrowing? • Third, some banking systems of euro-area countries have relatively-high exposures in the countries of South East Europe. In addition to the measures, including bilateral MOUs among some national central banks, that have already been taken, what other actions would help minimize the risks that may arise from strong financial linkages? • Fourth, many of the economies in Southeastern Europe tend to be relatively closed. Moreover, the trade linkages among the countries of Southeastern Europe themselves are quite limited. In other words, the shares of the exports of each country in Southeastern Europe to the rest of the region tend to be relatively small, given the geographical proximity of our countries. These shares are typically in the range of 15 per cent to 30 per cent. What accounts for this circumstance and how can we boost both the level of trade in goods and services, and intra-regional trade among our economies, thus helping to generate a virtuous cycle of growth? These are some of the issues that perhaps can be addressed. I look forward to a lively discussion. Thank you for your attention.

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Speech by Ms Eleni D Dendrinou-Louri, Deputy Governor of the Bank of Greece, at the conference: "The future of banking in Greece: redefining the business of financial services to drive growth and expansion in 2009 and beyond", Athens, 21 January 2010.

Eleni D Dendrinou-Louri: Assessing the performance and regulation of the Greek banking system Speech by Ms Eleni D Dendrinou-Louri, Deputy Governor of the Bank of Greece, at the conference: “The future of banking in Greece: redefining the business of financial services to drive growth and expansion in 2009 and beyond”, Athens, 21 January 2010. * * * Ladies and Gentlemen, I would like to thank “The Banker” and “Financial Times Global Events” for inviting me to participate in this conference and giving me the opportunity to address such a distinguished audience. In this intervention, I will present an overview of the Greek banking sector and outline the major challenges and opportunities that Greek banks face. I will finish by providing a perspective about the new regulatory framework changes proposed by the Basel Committee. During the current decade, the Greek banking system has enjoyed a favourable macroeconomic environment, in both Greece and in South Eastern Europe (SEE). This situation has contributed to healthy profitability, underpinned by rapid loan-portfolio growth, relatively wide net interest margins, high-yield lending to SEE borrowers and broadly resilient fee-income generation. These factors, in conjunction with the negligible exposure of Greek banks to US subprime assets and other complex structured products, considerably mitigated the financial fallout from the first wave of the recent global financial crisis, the worst since the Great Depression in the 1930s. However, the Greek economy and other markets where Greek banks operate, notably SEE, have not been spared by the second round effects of the crisis. The liquidity squeeze and the asset-quality deterioration tested the Greek banking system, which fared rather well in the course of the previous year (9months to be exact). More precisely:  Greek banks’ capital adequacy remained at satisfactory levels and was gradually strengthened;  Profitability declined but remained at overall satisfactory levels;  Credit risk increased and so did loan loss charges, with signs of moderation in the 3rd quarter of the year;  Enhanced by ECB funding, the Greek Government’s liquidity support package, and the increase in deposit base, the liquidity position of Greek banks remained satisfactory. In more detail: Capital In the first 9 months of 2009, the capital adequacy of Greek commercial banks and their groups was substantially enhanced. This development was attributed mainly to a considerable increase in prudential own funds, while a marginal rise was recorded in riskweighted assets. In addition to the quantitative increase of equity capital, its qualitative enhancement via the increased share of Tier 1 capital in prudential own funds played a dominant role in the banking system’s overall stability. The main factors behind the increase in prudential own funds of banks and their groups were the:  Issuance of preference stocks acquired by the Greek government as part of the liquidity enhancement plan (Law 3723/2008)  Completion of capital increases funded by the market  Internal financing stemming from non-distributed profits  Appreciation in the prices of stocks held by banks. As a result, Greek banks’ capital levels are at a par with the EU average (11.7 percent), with a Tier 1 ratio of 10.6 percent (Q3 2009) from 7.9 percent at end 2008. The leverage ratio stands at 13.4 and is significantly lower than the European average. Profitability Greek banks have remained profitable. Net interest margin stood at 2.6 percent during the first 9 months of 2009, twice the EU average. However, profitability declined y-o-y by around 42%. This outcome was the unavoidable result of the crisis that hit Greece with a time lag and was aggravated by the structural and fiscal imbalances that characterise the Greek economy. Impairment charges have been the key drag on profits. ROE and ROA after taxes (7.5 percent and 0.5 percent, respectively, during the first 9 months of 2009) also declined but remain above the EU average. The cost-to-income ratio, at 51.9 percent, has decreased thanks to cost containment and is lower than the Large and Complex Banking Groups’ euroarea weighted average (60.7% for the first half of 2009). However, it is of some concern that trading income, notable for its high volatility, represented a considerably large chunk of profits before taxes. The increase of trading income during the first 9 months of 2009 compared with the same period a year earlier, was attributable mainly to the increase in the price of Greek government bonds and stock prices in the second and third quarters of 2009. These trends have currently been reversed, rendering any gains from trading and financial transactions during the last quarter of 2009 and the first part of 2010 highly unlikely. Asset quality In the course of 2009, the quality of the loan portfolio declined, resulting in an increase of the NPL ratio (on a solo basis) to 7.2 percent in September 2009 (from 5.0 percent in December 2008), albeit at a decelerating rate. The NPL ratio increased for all types of loans, but the increase was more pronounced for consumer loans (September 2009: 11.7%, December 2008: 8.2%). The NPL ratio for mortgages reached 6.9% (from 5.3% at the end of 2008) and for corporate loans reached 6.4% (from 4.3% at the end of 2008). With Greece experiencing the first domestic recession since the early 1990s and with a rather subdued private sector credit expansion and a public sector trying to address chronic fiscal imbalances, the medium-term outlook regarding asset quality is challenging. A further decline in loan quality and increases in impairment charges are likely both domestically and abroad; economic conditions in SEE have improved but significant challenges still remain, observed and expected increases in unemployment being a key concern. Additionally, a high percentage of loans in SEE is FX-denominated and unhedged from the borrowers, which should further strain the balance sheets of households and corporates. So Greek banks should be particularly vigilant and pro-active in the management of their loan portfolio and overall balance-sheet. Liquidity The global financial crisis and the freezing of liquidity in international markets have affected funding operations, a situation that, has in turn affected the liquidity buffers. As in other European economies, given the difficulties in wholesale financial markets, ECB lending facilities have become a major source of funding, alongside the increase of the banks’ deposit base and the Greek Government liquidity support package. All of these sources of funds helped the Greek banking system to increase its liquidity position during 2009. At the end of September 2009, the loan-to-deposit ratio stood at 113%, one of the lowest in EU, and the financing gap (i.e., the difference between deposits and loans) shrank. The total borrowing of Greek credit institutions from the Eurosystem/Bank of Greece, at the end of November 2009 amounted to 8.5% of total assets. At the same time, the liquidity allotted to Greek banks in the ECB’s open-market operations represented 6.3% of the total liquidity provided at the Eurozone level. In the December one-year Eurosystem financing operation this percentage dropped to 6.0% and is expected to fall again this month. During the course of 2009 Greek banks issued €4.3 bn of unsecured debt with a 2–3 years maturity in the capital markets. They also issued €1.5 bn of covered bonds. Banks’ funding plans for 2010 take into account that the liquidity to be provided by the ECB will eventually return to its pre-crisis level. Thus, banks are now re-oriented to the capital markets. The extent to which their funding plans will be realised depends on the degree of normalization of international financial markets. Exposure to SEE – challenges and opportunities During the last 15 years, Greek Banks expanded in SEE, while in the last few years they also expanded in Turkey, Poland and Ukraine. The assets of their braches and subsidiaries in those countries represent 10 percent of the total of the Greek banking system’s assets. Before the crisis, Greek banks benefited greatly from the high lending growth (especially in housing and consumer loans) in these countries, the strong economic performance of these countries, and their accessibility to money markets because of Greece’s participation in the Eurosystem. With the recent crisis and in response to deteriorating macroeconomic conditions, most banks in the region revised their business plans and curtailed their short-term activities. In recent months the scale of external support to the region has become clear. In a repetition of the banking crises of the ‘90s, the financial-rescue packages funded by the International Monetary Fund, the European Union and other IFIs, were very important for the viability of the domestic banking systems. Greek banks have been strong supporters of the so-called “Vienna Initiative” and have maintained their overall exposure to the area despite falling demand for loans. At the current juncture, the main challenge for the banks in the region is to sustain capital adequacy in the face of falling loan quality, coupled with a still adverse macroeconomic environment eroding banks’ profitability. Another major challenge is to preserve adequate liquidity. The key factors that will determine the extent of the successful operation of Greek banks in SEE will be efficient risk-management practices and internal control systems, adequate deposit and liquidity provisions and efficient administration strategy and operation. At the same time, Greek banks, as already agreed under the IMF support schemes, will at least maintain their current exposure levels and continue to provide financing to the real economy. Ladies and Gentlemen, Despite the perceived easing in international money and capital market conditions, serious challenges persist for the banking sector and Greek banks in particular. They mostly have to do with the domestic macroeconomic environment, the country’s fiscal imbalances and recent downgrades of sovereign ratings and the markets’ rating of Greek state debt. It is hence of critical importance that Greek banks take great caution in planning their medium-term strategy with respect to their capital base and fund utilization. They need to maintain considerable capital margins over and above the required minimum levels, as well as ample liquidity buffers. One way to achieve this objective is by promoting internal financing. Furthermore, in the context of the present situation, banks should give priority to the strengthening of their ability to absorb any unforeseen losses. The prudent management of their payout and remuneration strategies is, hence, strongly advised. Banks must also persevere in their efforts to further strengthen the risk management culture, methodologies, processes and controls and improve governance. As managing risk is not always straightforward, qualitative analyses are needed to complement quantitative analyses. We can see good steps taken in this direction. In a challenging economic environment, Greek banks need to find the appropriate balance between improving asset quality, harnessing the cost of risk and providing the necessary liquidity to the economy. Financial institutions need to have a clear view of the risk they undertake relative to available capital and liquidity buffers. When planning their future strategy, banks should also take into consideration proposed changes in the supervisory and regulatory framework, aiming at strengthening the resilience and enhancing the stability of the banking system. One should bear in mind that the cornerstone of sustainable economic growth is the ability of banks to facilitate credit intermediation between savers and investors and to provide the critical services consumers and enterprises obtain from banks to run their daily lives and business. One cannot forget that some of the reasons behind the recent financial crisis were the build up of excessive leverage, insufficient capital and liquidity buffers and the pro-cyclical amplification of risks. International regulatory bodies promptly reacted to address the identified deficiencies of the current framework. The Basel Committee recently published proposals on ways to redesign the existing regulatory capital and liquidity framework. The target date for the implementation of these proposals is end-2012, with “appropriate phase-in measures and grandfathering arrangements for a sufficiently long period to ensure a smooth transition to the new standards”. Increased capital requirements for trading books and securitizations, proposed at the beginning of 2009, are expected to be effective as of December 2010. These “Basel III” draft proposals: 1. Re-define eligible capital. All regulatory adjustments are to be applied to the morestrictly defined and more internationally harmonized common equity component of Tier 1. Tier 2 capital instruments will be standardized, and Tier 3 capital will be phased-out. Explicit minima for common equity, Tier 1 and Total Capital as percentages of Risk Weighted Assets will be determined after the comprehensive impact assessment, that will take place in the first half of 2010, is concluded. 2. Tighten risk coverage by better addressing the counterparty credit risk (CCR) arising primarily from derivatives, repos and securities-financing activities. This change is motivated by the fact that “two-thirds of the Counterparty Credit Risk losses were due to credit valuation adjustments and only about one-third were due to actual defaults”. 3. Limit the inherent procyclicality of the existing framework with the introduction of (a) capital buffers beyond the regulatory minimum, which will be built-up in good times so that they can be drawn upon during stress periods and (b) “forwardlooking” provisioning based on expected losses to substitute for the current “incurred loss” provisioning model. 4. Introduce a non-risk metric, the leverage ratio, to supplement existing Pillar 1 risk metrics. 5. Propose a short-term Liquidity Coverage Ratio in order to ensure that financial institutions have sufficient high quality liquid resources to survive an acute stress scenario calculated for 30 calendar days into the future and a longer-term NetStable-Funding Ratio which promotes an institution’s resiliency by creating incentives for more-stable funding choices. Ladies and gentlemen, Before closing, I would like to say a few words about an important lesson of the recent crisis which can be summarized in the following sentence: “Regulatory reform is a necessary, but not a sufficient condition for a safer financial system”. Broadening the focus from the supervision of individual institutions by taking into account system-wide risks is an urgent priority. We need to understand the ways the components of the financial system interact; we need to realize that because of these interactions, systemwide risk can be much larger than the sum of the risks posed by individual institutions. Developing a system-wide view of financial risks, of the way they are distributed within the financial system and of the systemic importance and contribution to systemic risk of each individual institution are some of the key tasks of the macro-prudential dimension of regulation. This is the mandate of the Financial Stability Department of the BoG, created as a separate entity during the fourth quarter of 2008. At the level of the EU, this analysis of risk is in the hands of the newly-established European Systemic Risk Board (ESRB). The credibility and effectiveness of both critically depend on not only the quality of the risk assessments but also on the timely and efficient translation of those assessments into concrete policy recommendations. I would like to leave you with these last thoughts: Despite the significant progress of this past year, the reform program is far from complete. Sustaining the reform impetus is crucial, especially now that the recovery of the banking sector from this unprecedented credit crisis, across the world and in Greece, appears under way. For the financial industry and us regulators, this situation simply means that good plans have to be carried to fruition, changes need to be institutionalized, and adjustments to the business models need to continue and not be forgotten. Reform is a continuous process, not merely a reaction to a shock. Thank you for your attention.

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Welcome remarks by Mr Ioannis Papadakis, Deputy Governor of the Bank of Greece, at the European Bank Coordination Meeting, Athens, 19 March 2010.

Ioannis Papadakis: Combatting the impact of the financial crisis Welcome remarks by Mr Ioannis Papadakis, Deputy Governor of the Bank of Greece, at the European Bank Coordination Meeting, Athens, 19 March 2010. * * * It is an honor and a pleasure to welcome you to Athens for the European Bank Coordination Meeting, hosted by the Bank of Greece and co-organized with the European Commission, the IMF and the EBRD. Moreover, I am very pleased to be given the opportunity to share with you some preliminary thoughts on the achievements of our efforts to support IMF programs in the region through concerted private sector involvement. The financial crisis that erupted in 2007 is now in its third incarnation. Having started as a crisis affecting certain marginal financial markets in the US, it subsequently spread fast with its impact being felt on the financial and the real sectors of most economies in the world. In its current incarnation, it is turning into a fiscal crisis, as markets realize the true cost of the measures implemented to minimize the damages and the impact on the macroeconomy. In addition, the crisis has brought to the fore a number of weaknesses and deficiencies in the functioning of the international financial system, putting the effectiveness of the supervisory and regulatory framework under the microscope. The discussion regarding the origins of the crisis and the work that needs to be done has created a long list of “do’s and don’ts”. It has also led to an even more lively and lengthy discussion about the appropriate means to achieve the ultimate goal and the timing of the required measures. Let me briefly mention five areas of action, which I believe deserve priority:  First, there is need to deal effectively with short-termism in the quest for high profits, by protecting the system from the incentives created by excessive bonuses and the irrational pricing of risks.  Second, the transparency of financial markets and structures needs to be enhanced by putting greater emphasis on risk disclosure by systemically important institutions, instruments and markets.  Third, the pro-cyclicality of the financial system needs to be mitigated by improving both the quality and quantity of bank capital and by ensuring that banks create enough prudential liquidity buffers in good times to have reliable shock-absorbers on which to depend, if and when bad times come.  Fourth, there is a need for a macro-prudential approach to financial supervision that takes into account not only the links between financial behaviour, economic activity and macroeconomic policies (e.g. the crisis triggered a freefall in economic activity that called for policy relaxation, the exit from which could postpone economic recovery), but also the interconnectedness between financial institutions, markets and cross-border activity.  Last but not least, the whole system of checks and balances must not breed complacency in any of the actors involved, as the crisis has shown that tail events may be rare but are still possible. With the benefit of hindsight, it would not perhaps be too unfair to say that the initial policy response to the crisis was timid and to some extent reluctant. Soon however, in the face of such unprecedented challenges, governments, national central banks, international financial institutions and supervisory and regulatory authorities around the globe all demonstrated a remarkable unity of purpose. The extraordinary magnitude of the crisis led to the acceptance that extraordinary measures were needed, if a repeat of the 1930s was to be averted. In order to forestall the impact of the crisis, policy makers deployed both conventional instruments (such as cutting key policy interest rates and increasing public spending) as well as a battery of non-conventional ones. I would add, if I may, that intellectually this has been an exciting period, as we were often driven to think outside of our usual toolbox. Indeed, sometimes we were forced to think the unthinkable, as we realized that in crisis situations the accepted wisdom is not always wise. Even more importantly for our purpose, we all came to realize that in our globalized world “no country is an island.” International interrelationships are today so strong that no country can go it alone in the open seas. This has led to enhanced international efforts to coordinate through both existing and new arrangements. The international financial institutions have played a catalytic role here. We must acknowledge this and thank them for it. The institutions themselves accepted that the magnitude of the crisis was such that it could not be addressed by any of the actors acting alone. The European Bank Coordination initiative started just a little over a year ago as an ad hoc effort to stabilize the flow of funds to a few economies in Central and Eastern Europe. It has now attained the stature of a successful coordinating mechanism, which is worth keeping and, when appropriate, replicating in other parts of the world. This initiative of ours has achieved an admirable coordination between the official and the private sector. The mere fact that so many diverse actors were brought together to act in a consensual way for the common, as well as their own, good is an encouraging indication that the international community has matured. After years of endless theoretical discussions on the potential merits of private sector involvement in crisis management and resolution, the EBCI emerged almost spontaneously as the appropriate response to actual and acute problems. Coordinated international assistance to countries that both needed and deserved it has been crucial for mitigating the impact of the crisis. For example, the balance of payments support packages by the IMF and the EU to six European countries have helped to deflate the mostly exaggerated market concerns about the fundamental viability of the region’s economies and banking sectors. The size and firmness of such a wide commitment is what acted as a catalyst to mitigate and reverse the negative mood toward particular countries in the region. The precision and timeliness of our mutual commitments is what marked the turning point that brought us back from the brink of a fully fledged regional crisis in late winter 2008/early spring 2009. Given the importance of foreign-owned banks for the region’s financial sectors, our coordination was pivotal in addressing the reversal of capital flows and in dampening the economic cycle. The precise and firm commitment by each and every one of the parties involved allowed us to promptly address potential co-ordination failures, shape a macroprudential approach for dealing with the impact of the crisis on the region and, by doing so, enhance the efficiency of the policy measures taken by each individual country. We at the Bank of Greece are proud to have been supportive of this initiative, right from its inception. Needless to say, we shall continue to support it whatever the circumstances. As the initiative now stands, we are even in position to successfully tackle the details where the devil often lurks. For example, how should the need for adequate external financing and reserves buildup be balanced with the need to strengthen financial stability and avoid excessive lending expansion. The European Bank Coordination initiative owes much of its success to the efforts made by each and every one of us. What we have achieved so far provides us all with the impetus to continue our efforts towards more and better cooperation in concert. Here in Europe, the Memorandum of Understanding of 2008 among the supervisory authorities is already fostering better and deeper cooperation, while the creation later this year of a new institutional framework for financial supervision and regulation will also provide a firm basis for effective coordination. What we all wish and strive for is the enhanced and long-lasting stability of the European and, ultimately, the international financial system. I congratulate you all for your good efforts over the last year to bring about and safeguard stability in the countries involved. I thank you for participating in today’s meeting. The Bank of Greece as host owes a special thanks to the European Commission, the IMF and the EBRD for the help they have provided us in organizing today’s event. I wish you all a fruitful meeting and a pleasant stay in Athens.

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Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the Annual Meeting of Shareholders of the Bank of Greece, Athens, 27 April 2010.

George A Provopoulos: The state and prospects of the Greek economy and economic policy challenges Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the Annual Meeting of Shareholders of the Bank of Greece, Athens, 27 April 2010. * * * The Greek economy is in the midst of a deep, structural and multi-faceted crisis. The exit from this crisis will therefore require a multi-annual, persistent and systematic effort. It will require a break with the past. The main features of the crisis are the large fiscal deficit, the huge debt and the continuous erosion of the country’s competitive position. These problems were already present prior to the global crisis of 2008 and it was inevitable that, in the absence of bold and decisive action, they would sooner or later lead to an impasse. As no such action was taken, the situation deteriorated. Meanwhile, the global crisis amplified the cumulated effects of the chronic weaknesses and accelerated the downturn of the economy. The outcome is the present situation, which is reflected in the twin deficits and twin debts, and in the close intertwining of the public deficit and debt with the external deficit and debt. Today’s crisis does not simply reflect a temporary cyclical downturn. Nor, of course, is it solely reflected in the public sector and in the worrisome competitiveness deficit. It concerns the entire economy, its structures, the mentality and patterns of behaviour that prevailed for years, the distorted growth model that we followed. This means that it is not possible to overcome the crisis by resorting to short-term remedies. On the contrary, what is needed is a persistent and systematic effort: an effort that is sustained, concerted and groundbreaking. Sustained, because changing the structures that have led us to where we are today will be an arduous task that cannot be easily achieved in the short term. Concerted, so that we can ensure a smooth aftermath, by minimising the shocks. Groundbreaking, because today’s problems cannot be addressed if we keep on thinking the same way as we did when we created them. Overcoming the crisis will, in other words, require a break with the past. *** The Bank of Greece had issued timely warnings about the gravity of the situation, stressing in its reports that the macroeconomic imbalances would only become more severe as the global economic situation worsened. Clear warning was also given that the cost of borrowing was likely to rise. Moreover, the Bank stressed the need to send a clear message to the markets that Greece is determined to implement a multi-year plan of far-reaching fiscal consolidation and bold structural reforms. *** The developments that followed confirmed these dire warnings. The economy has entered a vicious circle and there is unprecedented uncertainty, which led to a series of downgradings in Greece’s creditworthiness. These downgradings led to a large widening in spreads, resulting in an increase in the cost of government borrowing and debt servicing. This situation, to the extent that it persists, worsens Greece’s fiscal position, makes fiscal consolidation even more difficult to achieve, seriously hurts the real economy and the banking system, and refuels the climate of uncertainty, thus exerting a general debilitating effect. The only way out is to restore confidence, by drastically reducing the deficit and the debt and by recovering the competitiveness that has been lost. *** The crisis of the Greek economy is unfolding in a global environment characterised by high uncertainty, in spite of the existing signs of recovery. The recovery of the world economy, proceeding so far at an unsteady step, on the one hand has been supported by accommodating monetary policies and on the other by expansionary fiscal policies; the latter, however, now increase the risks concerning the sustainability of public finances. These risks in the advanced economies are compounded by: (a) the large increases in the fiscal deficits and the public debt; (b) the adverse demographic prospects due to population ageing; and (c) the assessment that a return of potential growth and employment to their pre-crisis levels should not be expected soon. Additional risks stem from the fact that public finances are exposed to shocks originating in the markets. The uncertainty about the timing and the intensity of “exit policies” from the fiscal stimulus measures leads to a widening in spreads of government bond yields. Therefore, the cost of financing the public debt is expected to rise, while growth rates will be lower than prior to the crisis. The wider the gap between the interest rate on the public debt and the growth rate, the larger the fiscal adjustment needed to halt the upward trend in the public debt-to-GDP ratio. This is why structural reforms are needed in order to boost potential growth. It goes without saying that these remarks apply a fortiori to Greece. *** The crisis that the Greek economy is currently experiencing is reflected in the sharp weakening of economic fundamentals and in the deterioration of the economic outlook. 1. What triggered the particularly adverse developments was the derailing of fiscal aggregates: in 2008 and 2009 the situation deteriorated and in 2009 the deficit, as the Bank of Greece had warned in time, widened to a double-digit percentage of GDP. According to the latest revised data, the deficit in 2009 reached 13.6% of GDP. 2. The public debt increased to 115.1% of GDP, the highest ratio in the euro area, following that of Italy. According to projections based on plausible assumptions, the debt-to-GDP ratio will continue to rise and will tend to stabilise only in 2014, and then again at very high levels (130%). Indeed, if the 2009 debt is eventually revised to 120% or 122% (as is considered possible by Eurostat), these projections will have to be revised unfavourably. Large fiscal deficits and debts can, of course, be found in other countries as well. Unlike Greece, however, these countries are able to finance their deficits mainly from domestic saving. Greece’s gross national saving, public and private combined, was just above 5% of GDP in 2009. This shortfall in national saving is primarily due to Greece’s large fiscal deficits, but also to the fast increase in private consumption over the past few years. Due to the low level of saving, the public debt cannot be financed from domestic sources, resulting in a widening current account deficit and a growing external debt. Thus, the fiscal problem becomes intertwined with the external deficit and debt problem, and the twin deficits feed each other in a dangerous vicious circle. 3. The current account deficit reached 14.6% of GDP in 2008 and, after a temporary decrease to 11.2% of GDP in 2009, began to widen again in the first two months of 2010. The large trade deficit is directly attributable to the loss in competitiveness, which has cumulatively exceeded 20% in the 2001–2009 period. Further, it is estimated that, in terms of relative consumer prices but also in terms of relative unit labour costs, the decline in competitiveness is likely to continue through 2010. 4. The real economy has entered a recession since 2009, as GDP contracted by 2% last year, mainly on account of a sharp drop in investment, but also because of falls in private consumption and exports. In its latest Report on Monetary Policy released in March, the Bank of Greece estimated that GDP would decline by around 2% in the current year. Given the present circumstances, this projection is surrounded by high uncertainty and is subject to high upside risks. 5. The recession spread across all sectors of activity in 2009, negatively impacted employment, and caused an increase in the rate of unemployment. Total employment declined by 1.1%, the number of employees fell by 1.6% and the unemployment rate climbed to 9.5%. A further drop in employment is projected for 2010, while the rate of unemployment will come close to 11%. 6. The adverse developments, mainly in Greece’s fiscal aggregates, together with the blows to market confidence, ultimately took their toll on the banking system. Whereas in many other countries the crisis first broke out in the financial system and from there spread to the real economy, in Greece things worked the other way round. The Greek banking system only began facing liquidity constraints when the severe fiscal imbalances led to successive downgradings of the country’s credit rating – and consequently the credit ratings of Greek banks, thereby restricting their access to international capital markets. Meanwhile, the slowdown in deposit growth, due inter alia to the recession, affected the domestic supply of credit. It is worth noting that, in spite of these problems, the annual rate of credit expansion to the private sector remained positive throughout 2009, contrary to the situation in the euro area as a whole, where there have also been periods of negative credit growth rates. The Greek banking system showed remarkable resilience during the global crisis; the provision of ample liquidity from the Eurosystem at low cost was one of the reasons for this. For the banking sector, retaining this resilience in the future, especially in view of the gradual phasing-out of the extraordinary measures for the provision of liquidity, will be conditional upon dealing with the fiscal crisis, which affects its functioning, and restoring market confidence in the future of the economy. Even after this happens, however, the new conditions that will emerge will be quite different from the ones in which the banks used to operate. The lessons drawn so far from the crisis will lead to a revision of the supervisory framework, now under examination by the Basel Committee. Greek banks must therefore adapt to the new situation with insight, bearing these impending changes in mind. At the current stage it is imperative that they: • maintain sizeable requirements; • set aside adequate provisions for credit risk; • rationalise their operating costs; • manage available sources of funding flexibly and prudently; • and, more importantly, adopt realistic and prudent medium-term strategies that will allow for consolidation. capital buffers, above the regulatory minimum capital A sound financial condition, effective risk management and the establishment of bigger and more robust formations will be key conditions for enhancing banks’ shock absorbing capacity and for unfettered access to sources of funding. In my opinion, in the medium term changes in the banking sector are inevitable. The Bank of Greece, on its part, will continue to keep a close eye on developments and intervene as necessary to ensure that the next difficult steps can be made in the most effective manner. Economic policy In order to address the major challenges, economic policy has been steered toward decisions which, if effectively implemented and enriched with bold structural reforms, will lay sound foundations for the serious and far-reaching effort required. So far, the decisions have mainly aimed to reduce the fiscal deficit and restore market confidence in the future of the economy. As far as the first objective is concerned, the supplementary measures announced in early March are in the right direction and were favourably received by the EU institutions. Even after the announcement of these additional measures, uncertainty remained strong. The markets continued to maintain a wait-and-see attitude, as suggested by the subsequent ongoing widening of bond yield spreads. This attitude of the markets is basically due to the serious confidence and credibility deficit that the Greek economy still faces. To this, however, one must add the concerns about the competitiveness and the growth outlook of the Greek economy, i.e. the parameters which will determine the smooth servicing of the public debt in the future. In other words, the markets still have their attention focused on public debt dynamics. Against this background, it is particularly positive that the Greek government requested the activation of the support mechanism. It is assessed that the use of this mechanism will play an important positive role in overcoming the crisis, for the following reasons: 1. In the short term, it secures borrowing funds at relatively low cost, alleviates market pressures and contributes to the normalisation of liquidity conditions for the banking system as well. 2. In the medium term, the operation of the mechanism, with the involvement of the European Commission, the ECB and the IMF, imposes a tighter discipline in respecting time schedules, provides a valuable source of know-how in elaborating and implementing economic policy, and bolsters market confidence. 3. In the long term, the relatively lower cost of borrowing reduces the interest burden on public debt, thereby providing further support to fiscal consolidation. The aim of the support mechanism is to facilitate and ensure the implementation of structural reforms which, apart from being absolutely essential, should have been carried out long ago. Under no circumstances, however, should the existence of the mechanism lead to complacency or a relaxation of efforts. The brunt of the task falls to the Greek State, which holds full responsibility for convincing that the economy is irrevocably engaged on a new trajectory. The concerted and consistent implementation of the measures announced will help to gradually improve the climate. In order to bring about a definitive reversal of the negative trends, we must surpass ourselves and favourably surprise the markets, by achieving even greater improvements than the ones projected. In particular, it will be of crucial importance for the overall economic climate, if fiscal consolidation on the expenditure side progresses even further than currently planned and achieves a deficit reduction this year of more than 5% of GDP, especially considering that the deficit figures for 2009 were revised upward to 13.6% and may undergo further revision. Such consolidation can be achieved by aiming, with greater decisiveness and at a quicker pace, to curtail the squandering of public funds and to merge or eliminate public sector entities that are not really productive. Cutting expenses is in any case the suitable option for achieving the ambitious fiscal targets over the next two years, given that any further increase in tax rates would have very adverse repercussions on economic activity and would prove counter-productive – in the sense that it would lead to a contraction, instead of an increase in revenue. The recommended acceleration – as of this year – of fiscal consolidation, through reducing expenditure and rationalising the operation of the public sector, will indeed favourably surprise the markets and contribute to restoring confidence faster. This will help reduce further the cost of government borrowing, with favourable chain reactions on bank borrowing costs and, consequently, on borrowing costs for businesses and households. Greece can and must enter a lasting virtuous circle as soon as possible. Today, fiscal consolidation is the first and foremost tool for promoting growth. But it does not suffice by itself. Our response to the crisis must have twin targets, in response to the twin causes that have led us to where we stand today. Thus, fiscal consolidation must be undertaken together with a systematic effort to recover the losses in competitiveness, by setting specific quantitative targets each year. Further, under the present circumstances, Greece’s growth model cannot be based on consumption, public and/or private, as unfortunately was the case in the past. Instead, it must rely on investment and exports. Greece, one of the most closed economies in Europe, must now become more open. This, however, will be impossible, unless competitiveness is effectively restored, through bold structural changes. These changes must aim at: (a) reorienting the production model, with an emphasis on two interconnected elements: first, investment that raises productivity and, second, an orientation towards exports; (b) increasing competition in the product and labour markets, so that, on the one hand, unit labour costs can support an improvement in competitiveness as well as job creation and, on the other, these costs are not unduly passed on to the final prices of goods and services; (c) improving the business environment by reducing red-tape, stamping out corruption and modernising the functioning of public administration; (d) prompt and efficient utilisation of EU funds available under the National Strategic Reference Framework (NSRF); (e) promotion of clean or “green” growth and change of the current pattern of energy production and consumption, and (f) upgrading the education system and encouraging innovation, research and entrepreneurship. *** The required reforms are of the utmost urgency. The big problems, which we were reluctant to address for years, stand before us now. This is why the responsibilities that we must all assume in the face of this huge challenge are of historical importance. The road to the exit from the crisis will be long and hard. This is why a greater effort will be required from all of us over a longer time. Our course in the forthcoming years will largely be determined by the target we set ourselves and our commitment to achieving it. Do we want a country that is trapped in a low-level equilibrium or do we want to make Greece modern and dynamic? And since we obviously want the latter, what is certain is that we can no longer rely on recipes of the past, characterised by: • a myopic focus on the present, at the detriment of the future, • a consumption behaviour, verging on overindulgence, that has been exceeding the productive capacity of the economy by far, • selective and at will compliance with laws and regulations, • shifting of responsibility onto others, • a refusal to make the slightest effort towards consensus-building, • dogmatic interpretations of reality, • claims to maintain acquired privileges which go against the interest of society as a whole, • a short-termist and an easy-profit culture. All these will have to change if we want to overcome the present deep crisis. We must now shift our focus to the future and carry out the necessary reforms at a rapid pace. Today’s crisis is unlike anything we have seen before, at least in our post-war history, and it cannot be tackled with the logic of the past. The recognition, by all of us, of the severity of the problems at hand will help build the social consensus that is needed on the difficult course that lies ahead – a course that can support the growth prospects of the economy, thus securing social cohesion. This highlights the complex role that the government is assuming today, being called upon, with perseverance and resolve, to overcome obstacles, break up the rigidities of the past, open up new pathways and demonstrate in a convincing manner that the gains to be reaped at the end of the long effort outweigh the costs that we will have to bear along the way. The decisions taken so far are promising, as economic policy is gradually shifting in this direction and is attempting to define a new course. On this course, it must have support from all of us. The course will be long and arduous. However, there is no other option: we have the historical duty of pursuing it to the end, mobilising the forces, capabilities and talents of this nation, which have come to the surface in previous periods of crisis bringing about amazing results.

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Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the Scholars Association of the Alexander S Onassis Public Benefit Foundation International Conference, Athens, 21 June 2010.

George A Provopoulos: The Greek economic crisis and the euro Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the Scholars Association of the Alexander S Onassis Public Benefit Foundation International Conference, Athens, 21 June 2010. * * * It is a great pleasure to take part in this conference on the “Financial and Economic Crisis” organised by the Scholars Association of the Onassis Foundation. Aristotle Onassis, the originator of this foundation, was, among other things, a creative thinker and a philanthropist. He arrived in Greece in the early 1920s as a refugee and, through wise decision-making and hard work, became an internationally-prominent entrepreneur. However, he never forgot his origins and, as exemplified by this foundation, passed on to future generations the ability to advance scientific and artistic knowledge. My presentation will deal with the origins of the present crisis in Europe and the lessons of the crisis for Europe’s single currency, the euro. Greece is at the epicentre of the crisis; my presentation will, therefore, highlight the Greek roots of the crisis. The origins To provide some perspective to the present situation, let us look back just a year. At that time, conferences were being held throughout Europe celebrating the tenth anniversary of the euro. Academic economists were writing articles speculating that the euro was poised to challenge the U.S. dollar as the leading international currency. What a difference a year makes! Today, analysts are writing about a possible break-up of the euro zone, a notion that, as I will explain, is absurd. Meanwhile, the euro has fallen sharply against the dollar since the beginning of this year, and the speculation that the euro will soon replace the dollar as the leading international currency has subsided. How did we come so far so fast? How could Greece, a country with only about 2 ½ per cent of euro-area GDP, cause tremors of such magnitude that they have shaken the foundations of Europe’s single currency? To answer these questions, we need to consider the basis upon which monetary union in Europe has been built. The inception of the euro zone on January 1, 1999 marked a world premiere. For the first time in history, sovereign states – eleven at that time – abandoned their own national currencies in favor of a common currency, the euro, and surrendered their monetary-policy sovereignty to a newly-created, supranational institution, the European Central Bank. All previous monetary unions among sovereign states involved at least an element of coercion. For example, the fifteen countries that comprised the former Soviet Union had no choice but to use the rouble as their currency. In the case of the euro zone, in contrast, the members willingly gave up their national currencies for the euro. The euro was adopted because a monetary union confers a number of important advantages on participating countries.  For countries with histories of high inflation, such as Greece, it lowers inflation expectations and, therefore, nominal interest rates. With lower nominal interest rates, the cost of servicing public-sector debt is reduced, facilitating fiscal adjustment and freeing resources for other uses.  With low inflation, economic horizons lengthen, encouraging borrowing and lending at longer maturities. The lengthening of horizons and the reduction in interest rates stimulate private investment and risk-taking, fostering economic growth.  For all participating countries, it does away with the possibility of competitive devaluations, thus boosting intra-area trade.  It introduces a common measure of value across countries, increasing price transparency and, therefore, competition.  It eliminates the costs of converting currencies, thereby facilitating trade and investment.  It eliminates exchange-rate fluctuations among participating countries, thereby reducing risk premia.  It eliminates the need of foreign-exchange reserves for intra-area transactions, thereby reducing the cost of conducting business. These advantages of a common currency exist so long as the central bank of the monetary union delivers price stability and is credible. In the case of the euro zone, the ECB quickly established its anti-inflation credentials and became credible. So much for the benefits of the euro. What about the costs? In joining the euro area, a country gives up two potential tools to adjust the domestic economy in the event of a countryspecific shock. First, it loses the ability to set its own domestic monetary policy. Second, it loses the ability to change the nominal exchange rate of its currency. To compensate for the loss of these two potential tools, a country should possess the following:  relatively-low fiscal imbalances, so that fiscal policy can be used counter-cyclically in case a country-specific shock occurs, and  flexible labour and product markets, so that the country can be competitive without having to rely on changes in the exchange rate of a domestic currency to achieve and/or maintain competitiveness. The need of low fiscal imbalances and flexible labour and product markets is especially important in the euro area. Unlike the United States, for example, the euro area does not have a central fiscal authority that can redistribute fiscal resources from a low-unemployment region to a high-unemployment region to reduce the effects of asymmetric shocks. Moreover, because of language and cultural differences among European countries, labour is less mobile among euro-area countries than it is among regions of the United States. For these reasons, it is all-the-more important to have adjustment mechanisms in place at the national level in the euro zone. Low fiscal imbalances and flexible product and labour markets provide mechanisms to smooth the adjustment to shocks. Against the backdrop of these advantages and constraints of a common currency, let me describe some salient features of the Greek economy since it became the twelfth member of the euro area on January 1, 2001. The Greek economy: 2001–2009 Entry into the euro area provided Greece with an improved, stability-oriented environment. The ECB was – and is – the guardian of monetary stability. The Stability and Growth Pact was supposed to help ensure fiscal discipline. These changes in the economic environment were crucial benefits for a country that had experienced persistent budget deficits, and inflation rates that were at double-digit levels from the early-1980s until the mid-1990s. Not surprisingly, the new environment, especially the low interest rates, contributed to robust real growth rates. From 2001 through 2008, real GDP rose by an average of 3.9 per cent per year – the second-highest growth rate (after Ireland) in the euro zone – underpinned by household spending for consumption, housing investment, and business investment. Inflation, which averaged almost ten per cent in the decade prior to euro area entry, averaged only 3.4 per cent over the period 2001 through 2008. On the surface, therefore, the Greek economy appeared to have entered a new era marked by robust growth and low inflation. Beneath the surface, however, long-standing problems were continuing.  Fiscal policy was pro-cyclical throughout the period 2001 through 2009, with deficits consistently exceeding the Stability Pact’s limit of 3 per cent by wide margins and no durable progress in lowering the public debt-to-GDP ratio.  Expansionary fiscal policy was mainly expenditure-driven, leading to a rise in the share of government spending; in the three years, 2006 to 2009, the share of government spending increased from 43 per cent of GDP to 50 per cent.  Although inflation in Greece during 2001 through 2009 was low by the country’s historical standards, inflation was relatively-high by euro-area standards. Inflation was, on average, more than one percentage point higher per year than in the rest of the euro area. Wage increases, adjusted for productivity changes, also exceeded the average increases in the rest of the euro area.  With both prices and wages growing at relatively high rates, competitiveness declined. In the period 2001 through 2009, competitiveness, as measured by consumer prices, declined by almost twenty per cent; as measured by unit labour costs, competitiveness declined by over 25 per cent.  With relatively high real growth rates and declining competitiveness, the currentaccount deficit, which already had topped 7 per cent of GDP in 2001, rose to about 14 ½ per cent of GDP in both 2007 and 2008. The large and growing fiscal and external imbalances were not sustainable. On various occasions, including the publication of our Annual Reports and our bi-annual Monetary Policy Reports, during the past several years the Bank of Greece has stressed the unsustainability of these imbalances and the need of urgent policy adjustments. Unfortunately, our calls for actions were not heeded. The present financial crisis is the outcome of the lack of policy responses to the imbalances. The crisis in the Greek economy The present financial crisis marks a third stage of the crisis that erupted in August 2007, following the collapse of the US subprime mortgage market, and escalated with the demise of Lehman’s Brothers thirteen months later. Yet, during the first two years of the global financial crisis, the Greek economy escaped relatively unscathed. There were few, if any, forewarnings that the Greek economy would become the object of the speculators’ attention. The spread between Greek and German sovereign ten-year bonds, a key indicator of relative risk as perceived by credit markets, hovered around 130 basis points during the period August through October 2009. Earlier in the year, at the height of the Lehman’s phase of the crisis, spreads had climbed to over 300 basis points. That earlier widening of spreads occurred despite the fact that markets were expecting a fiscal deficit of less than 4 per cent of GDP and a debt-to-GDP level of only about 96 per cent of GDP, figures that would be repeatedly revised upward during the remainder of the year. In the fall of 2009, two developments combined to disrupt the relative tranquility of Greek financial markets. First, in October the newly-elected Greek government announced that the 2009 fiscal deficit would be 12.7 per cent of GDP, more than double the previous government’s projection. In turn, the 12.7 per cent figure would undergo further upward revisions, bringing it up to 13.6 per cent of GDP. Second, in November 2009 Dubai World, the conglomerate owned by the government of the Gulf emirate, asked creditors for a six-month debt standstill. That news rattled financial markets around the world and led to a sharp increase in risk aversion. In light of the rapid and sharp worsening of the fiscal situation in Greece, financial markets and rating agencies turned their attention to the sustainability of Greece’s fiscal and external imbalances. The previously-held notion that membership in the euro area would provide an impenetrable barrier against risk was shaken. It became clear that, while such membership provides protection against exchange-rate risk, it cannot provide protection against credit risk. The subsequent course of events has made global headlines, so I do not need to dwell on details. Allow me, however, to highlight the following.  First, in contrast to the origins of initial stage of the global crisis in August 2007, which involved a crisis in the U.S. banking sector that spilled over to the real economy, in Greece the problems posed by both the fiscal and external imbalances spilled over to the real economy. The Greek banking sector has had sound fundamentals as reflected, for example, in high capital-adequacy and Tier 1 ratios.  Second, the crisis in Greece contributed to widening spreads in other euro-area countries judged to have large fiscal and/or external imbalances. The spread of the crisis to other parts of a geographical area represents a continuation of a process observed in other recent crises, including those in Latin America in 1994/95 and in Asia in 1997/98.  Third, the commitment by the Greek government to reduce the fiscal deficit from last year’s 13.6 per cent of GDP to 8 per cent this year and below 3 per cent in 2013, and the 110-billion euro support package agreed between the Greek government and the European Commission, the ECB, and the IMF, are unprecedented in terms of magnitudes. I have no doubt that the government will take whatever measures are needed to attain its fiscal objectives to ensure fiscal sustainability. It will, however, take some time to convince the markets of the government’s determination to achieve those goals. Decades of fiscal mismanagement and faulty fiscal reporting have caused the markets to adopt Saint Thomas’s dictum: to see is to believe.  Fourth, I am also confident that the government will implement the structural reforms and privatisations that are part of the support package. These are needed to reduce excessive bureaucracy and rigidities in the labour, product and service markets that discourage investments in high-value added sectors. Allow me to say a few words about Greece’s debt situation. Some market analysts are of the opinion that Greece’s debt dynamics are unsustainable. They are wrong. They overlook the fact that a crucial element underlying the evolution of the debt-to-GDP ratio is the denominator of that ratio, which includes the growth of real output. In this connection, the combination of factors comprising the support program – that is, fiscal discipline, the liberalisation of markets, privatisations, and measures to increase the efficiency of the bureaucracy – will contribute to confidence, decrease the size of the public sector, reduce interest-rate spreads, and boost competitiveness and economic growth. In turn, higher growth, along with declining fiscal deficits, will cause a reversal of the rise in the debt-to-GDP ratio observed in recent years. Moreover, fiscal discipline will add to saving, thereby supporting private investment and growth potential. These effects may not be visible immediately, but they will materialize and will revitalise the Greek economy. Some lessons What, then, are the lessons that can be drawn from the crisis? In my view, some of the key lessons concern the limits to the use of fiscal policy and are as follows.  First, the view that fiscal policy can be used in a flexible way to smooth the effects of shocks in a monetary union has been shown to be overly simplistic. As the case of Greece illustrates, the systematic use of fiscal policy in the past can lead to problems of debt-sustainability, constraining the current use of fiscal policy. I need to mention that fiscal expansions in many countries with relatively-low debt levels in the immediate aftermath of the Lehman crisis were successful in lessening the impact of the dislocation in their real economies. Even in those countries, however, there is now a need for decisive actions to achieve a lasting and credible consolidation of public finances.  Second, rather than smoothing the adjustment to shocks, in Greece pro-cyclical fiscal policy has been the major source of shocks. It has led to an increase in the size of the government sector in the economy, increasing bureaucratic inefficiency and crowding-out the traded-goods sector of the economy.  Third, fiscal transfers in the face of permanent shocks can have the perverse effect of locking resources in place, and, thereby, preventing necessary adjustment. The remedy for non-competitive areas of the economy is not to channel even-larger amounts of government spending into those areas but rather to introduce structural reforms that improve overall competitiveness by allowing the transfer of resources to the more-dynamic sectors of the economy.  Fourth, as we have seen, a country with large fiscal imbalances that is in a monetary union can create negative spillover effects, raising interest rates and increasing the cost of debt servicing for other members of the union. The credibility of the ECB provides the potential of a low interest-rate environment, which can foster higher growth and employment throughout the euro area. However, as recent events have underlined, monetary policy needs to be complemented by responsible fiscal policy to maintain such a low-interest-rate environment. Conclusions As I mentioned at the outset, the euro area has the capacity to deliver enormous advantages to its members. To benefit fully from those advantages requires fiscal responsibility and open and flexible markets. It also requires a governance structure that will ensure that the Stability and Growth Pact fulfills its role as a key pillar of the euro area. The support package agreed between the Greek government and the European Commission, the ECB and the IMF provides the government with a unique opportunity to adjust the economy. The package provides a blueprint for sharply reducing fiscal imbalances and for the undertaking of structural reforms. It will set-off positive growth dynamics that will, among other things, lower the debt-to-GDP ratio. The growth potential of the Greek economy is enormous. It is my firm belief that the present crisis will prove to be the catalyst that will reshape the economy, making Greece a competitive and prosperous member of the euro zone. It is also my firm belief that it will not be long before articles again start talking about the euro’s strong position as an international currency. Ladies and gentlemen, thank you for your attention.

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Welcome address by Mr George A Provopoulos, Governor of the Bank of Greece, at the Bank of Greece - University of Oxford (South East European Studies at Oxford, SEESOX) conference, Athens, 11 February 2011.

George A Provopoulos: Economic policies, institutions, and the politicalsocial environment that can increase and sustain potential growth Welcome address by Mr George A Provopoulos, Governor of the Bank of Greece, at the Bank of Greece - University of Oxford (South East European Studies at Oxford, SEESOX) conference, Athens, 11 February 2011. * * * I am pleased to welcome you to the Bank of Greece. This occasion marks the second conference on South East Europe jointly organised by the Bank of Greece and Oxford University. The first conference, held in October 2009, dealt with the effects of the global financial crisis on this region and the policy challenges in the light of the crisis. The focus of this conference is different. It is on the longer-term growth potential of the region. Specifically, the conference will deal with the economic policies, institutions, and the politicalsocial environment that can both increase and sustain potential growth. We are fortunate to have with us a number of experts from the central-banking, academic and commercialbanking communities. They will share with us their views about the growth potential of the region and the policies that can help achieve that potential. The global crisis, which halted more than a decade of sustained growth in most countries of the region, has demonstrated that economic convergence in Europe is neither an inevitable nor an automatic process. Prior to the crisis, most of South East Europe was characterized by relatively high growth, based mainly on consumption spending, private and public. The increased consumption expenditure typically reflected rapid growth in domestic credit, to a significant extent financed through foreign-capital inflows. Rising public spending often contributed to a widening of fiscal imbalances. These imbalances had adverse consequences. Among other things, they added to domestic price pressures, reduced competitiveness, and, along with rising private consumption, contributed to higher external deficits. In some countries, inflation surged to double-digit levels, wage increases far exceeded gains in labour productivity, and there were excessive increases in asset prices, especially the price of housing. These external imbalances left the economies concerned extremely vulnerable to an external shock. That shock came in the form of an eruption of a crisis in the US subprime mortgage market in August 2007. In its early stages, the crisis was confined to advanced economies. Local and foreign banks in Central and Eastern Europe held only negligible amounts of so-called toxic assets. However, as access to international capital markets was impaired, countries in this region most in need of external financing experienced large declines in output. A number of economies in Central and Eastern Europe were only moderately affected. Output contraction, however, was especially severe in the Baltics and, to a somewhat lesser extent, in South Eastern Europe. This circumstance suggests that countries with the more serious imbalances and vulnerabilities were most at risk from external financial shocks. The lesson from this recent experience is that convergence efforts should be accompanied by stabilityoriented policies that contain the build-up of imbalances, both domestic and external. Policy efforts at the national and international levels helped contain the impact of the crisis on economic activity. The prevailing exchange-rate regimes were successfully defended and the domestic banking sectors showed considerable resilience. In many instances, fiscal and monetary policies were tightened. In some cases the tightening occurred within the context of programs supported by the IMF and the EU. As a result, financial conditions have stabilized and there are now clear signs of a recovery in economic activity in most countries in Central and Eastern Europe. Nevertheless, the global crisis has entailed large costs for the region. There has been a sharp decline in economic activity and unemployment has risen sharply in many countries. BIS central bankers’ speeches Moreover, the ongoing de-leveraging process, that is the need to repair household and corporate balance sheets, tighter bank-credit standards, as well as rising long-term unemployment, could slow the pace of economic recovery in many SEE countries. The South East Europe economies, like most other economies in Central and Eastern Europe, will likely experience reduced capital inflows, because investors have become more riskaverse. Consequently, foreign investment may decline compared with pre-crisis levels, leading to lower economic growth compared with the growth rates experienced in the years leading up to the crisis. In light of the above, there will be a need to formulate and implement economic policies geared toward developing alternative sources of growth – policies that will render the economies less vulnerable to external shocks and that will allow them to better navigate their way through shocks should they occur. One such source of growth concerns the tradedgoods sector. Growth based increasingly on exports will help avoid the boom-bust cycle and asset-price bubbles that have in the past been associated with non-FDI capital inflows. Such a growth will prove more sustainable. A more-diversified export base will also help protect the economies concerned from sector-specific shocks, while providing an important mechanism for limiting the build-up of external debt. Fiscal consolidation will be an essential element for securing high growth, by crowding-in private investment and making room for much needed infrastructure investment. Such consolidation will need to be accompanied by improvements in the effectiveness and efficiency of public spending as well as of the tax system and its administration. We look forward to a discussion of issues related to fiscal consolidation and macroeconomic adjustment in Session I of the Conference, which will be chaired by Mr. Yannis Costopoulos, Chairman of Alpha Bank. The desirability of establishing a more-diversified export-based growth in the region highlights the importance of improving competitiveness. In this regard, policies that encourage greater flexibility in the labour market, competitive product markets, and an improved business environment will be critical. Issues addressing the necessary policies will be discussed in Session II of the Conference, which will be chaired by Mr. George Tavlas, Director General at the Bank of Greece. Policies of stabilization and reform cannot be effectively implemented without public support. In a period of falling incomes and rising unemployment, achieving that support may prove challenging. It is especially important to try to ensure that the reforms are perceived by the public to be fair and effective, so that the short-term sacrifices are considered worthwhile. Issues related to the building of social and political support for reforms in South East Europe will be addressed in Session III of the Conference, which will be chaired by Mr. Thanos Veremis, Professor at the University of Athens. With reference to the financial sector in South East Europe, the presence of foreign banks in the region has increased both the efficiency of financial intermediation and the availability of credit to the real economy. Yet, it has been argued that, in some cases, financial stress originating in EU parent banks may have been transmitted to the Central and Eastern Europe region in the early stages of the crisis. It has also been argued that euro area-based parent banks helped fuel credit booms in the region and encouraged the use of unhedged foreigncurrency borrowing. After the crisis erupted, the “Vienna Initiative” responded to those criticisms. The Initiative promoted a dialogue among parent banks, home and host supervisors, and governments under the umbrella of the IMF, the EBRD and the EU. It made the countries in the region less vulnerable to shocks caused by sudden stops in capital inflows by committing parent banks to maintain their exposure to these countries. However, a number of challenges lie ahead, including the financial stability risks stemming form lending in foreign currencies and the substantial build-up of currency mismatches in private sector balance sheets. BIS central bankers’ speeches Moreover, the Basel III framework, which has recently been released, sets stricter capital and liquidity rules than those that presently exist. The new rules will encourage banks to rely more on deposit-taking, thereby rendering the banking industry of the region more stable. However, the new rules may also lead to slower credit growth, since commercial banks may have to tighten their lending practices. The Basel III framework may, therefore, affect the dynamics of the macroeconomy as well as the channels of credit that support economic activity. Issues related to the role of the banking system in the region will be addressed by fellow Central Bank Governors in Session IV of the Conference, which I will be honored to chair. Before concluding, I would like to touch briefly on the role of the ECB and the Eurosystem in the crisis. The Governing Council of the ECB has moved quickly and forcibly to adapt the ECB’s tools of monetary policy to the challenges of the crisis, most importantly by protecting euro area banks against liquidity shortfalls. We provided liquidity in unlimited volumes and with longer maturities to banks at an early stage. In parallel, we reduced the interest rate at which the banks can borrow from the Eurosystem to a historical low of 1%. We also launched a programme to purchase euro-denominated “covered” bonds issued in the euro area. As a result, concerns that a credit crunch might emerge have not been realised. Moreover, confronted with a serious malfunctioning of the market for sovereign debt last spring, the Governing Council of the ECB intervened in that market. This intervention was meant to ensure a smoother transmission of monetary policy in all euro-area economies. It is now a great pleasure for me to welcome our keynote speaker, Mr. Erik Berglöf, Chief Economist of the EBRD. BIS central bankers’ speeches

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Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the 78th Annual Meeting of Shareholders, Athens, 18 April 2011.

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. ***** BIS central bankers’ speeches 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, competitiveness has improved slightly, mainly as a result of decreases in 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 BIS central bankers’ speeches 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 recession will continue. GDP is projected to decline by 3%, and a slightly larger decline cannot be ruled out.  Unemployment will continue to rise and will exceed 15%.  Average annual inflation will slow down significantly compared with 2010, but will be close to 3¼%.  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. ***** BIS central bankers’ speeches 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. BIS central bankers’ speeches  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. BIS central bankers’ speeches 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.  Taking full advantage of agricultural production, with the processing of farming and livestock products.  Turning Greece into a major hub for the transit of goods through, for example, 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 BIS central bankers’ speeches 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 BIS central bankers’ speeches 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. 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Opening address by Mr George A Provopoulos, Governor of the Bank of Greece, at the presentation of the Report of the Climate Change Impacts Study Committee, Athens, 1 June 2011.

George A Provopoulos: The impact of climate change in Greece Opening address by Mr George A Provopoulos, Governor of the Bank of Greece, at the presentation of the Report of the Climate Change Impacts Study Committee, Athens, 1 June 2011. * * * First, I wish to welcome you and thank you for attending today’s event, which will present the results of an ambitious initiative undertaken by the Bank of Greece, namely a study of the economic, social and environmental impact of climate change in the case of Greece. As you all know, environmental issues are not usually a matter of concern to central banks, whose principal mission is to safeguard monetary stability. It has been my view, however, that environmental themes deserve more attention, especially in a country not accustomed to studying issues of a long-term nature. When the Bank of Greece, nearly two years ago, announced its initiative to set up a Study Committee, the need for action to deal with the impact of climate change was urgent, though not as much as it is today. In the course of these two years, we have all witnessed the ongoing change in the climate and its significant impact at the global level, but also an economic crisis that prevents us from understanding the long-term benefits of investment aimed at adaptation to climate change. With the release of this Report, the Bank of Greece, in line with its broader role and its tradition of studying the structural problems of the Greek economy, helps fill a gap as regards scientific analysis and information on climate change, on its impact and on ways of dealing with it. This Report represents a first attempt at a comprehensive study of the impact of climate change for Greece – in particular of the cost of climate change that would be borne by the economy, the cost of implementing adaptation measures, as well as the cost of moving to a low-emissions economy, in the context of the global effort to mitigate climate change. For the first time and for close to two years, this project brought together teams from different scientific disciplines; the teams included physicists of the atmosphere, climatologists and geophysicists, experts in agriculture, forestry and fisheries, as well as experts on water resources, tourism, the built environment and energy, not to mention economists and sociologists. The findings of the study document the need for Greece to shield itself from the risks of climate change and to adopt an appropriate long-term strategy. The climate changes, as they unfold, affect and will continue to affect our economy and society. However, the cost of addressing these changes is but a fraction of the cost that we would have to pay, if we allow climate change to continue unabated, without taking any preventive action. At the same time, considering that the occurrence of extreme climate events in the future cannot be excluded, policies for mitigation and adaptation should be viewed as contingency measures against such an eventuality and, as such, are advisable irrespective of the results of the cost-benefit analysis. At first glance, the current adverse economic conjuncture appears to constrain the financing of mitigation and adaptation policies. To the extent, however, that these policies can be exploited as an opportunity for new lines of economic activity and for growth, they can be part of the strategy for an exit from the crisis. In other words, the adoption of mitigation and adaptation policies, although appearing to be hampered by the grave economic problem faced by Greece today, can in fact contribute to its solution. The study not only demonstrated the need for action to deal with climate change, it also underscored the need to pursue research further. In this light, we, at the Bank of Greece, BIS central bankers’ speeches intend to continue with the effort of both disseminating information and contributing to research. The extremely useful study presented here today therefore marks only the starting point, the first step of an ongoing effort, which will be enriched and expanded as it proceeds. The time horizon set in this study extends well beyond the current adverse conjuncture and illustrates how firmly we believe in the future of our economy, as well as in the need to address its problems seriously. I consider that a happy outcome of our initiative is that it has offered an opportunity for cooperation to experts from different scientific disciplines, who for the first time joined forces in the study of such a complex problem. This constitutes a very positive example for the Greek scientific community. In closing, allow me one final word. Despite my opening remarks, some may still wonder why the Bank of Greece, at a time like this, should concern itself with climate change anyway. My answer to them is that the publication of a report analysing the impact of climate change on the Greek economy and outlining policy measures to deal with it over the next ninety years is also a clear-cut response to the outrageous and ridiculous scenarios recently going around. Let me point out that all of the estimates in the study’s cost-benefit analysis are made in euro terms. Before giving the floor to the other speakers, I would like to express my deepest gratitude to all of the distinguished scientists who took part actively in such an ambitious joint effort, without remuneration but out of sheer dedication to this important project which they were called upon to carry out. BIS central bankers’ speeches

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Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the 79th Annual Meeting of Shareholders, Athens, 24 April 2012.

George A Provopoulos: The strategy for the Greek economy’s exit from the crisis – what is at stake? Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the 79th Annual Meeting of Shareholders, Athens, 24 April 2012. * * * THE NEW ADJUSTMENT PROGRAMME PROVIDES MORE FAVOURABLE CONDITIONS THAN PREVIOUSLY, BUT EXIT FROM THE CRISIS WILL DEPEND EXCLUSIVELY ON THE COUNTRY’S WILLINGNESS AND ABILITY TO RISE TO THE HISTORIC CHALLENGE The historical stakes are still high Two years after the first Memorandum, we are now faced with a new challenge, one that is especially crucial for the country’s future. Despite the progress made, the failure to act in a resolute and timely manner, along with the recession, resulted in a worsening of the dynamics of public debt, making a new agreement for financial support necessary. The new loan agreement and the economic adjustment programme provide more favourable conditions than before for a return to growth. The new agreement offers conclusive evidence of our partners’ willingness to support us. However, uncertainty continues to surround the global economy, reflecting, in part, the sovereign debt crisis in European economies. The economic situation, both at home and abroad, leaves no room for complacency. To take advantage of the new opportunity, we must promptly implement what we have agreed to and make up for previous delays. There is no easy way out of the crisis. The adjustment must be pursued with determination. The current pre-electoral period has temporarily sidelined planned reforms. If, after the elections, there is any question about the will of the new government and society to implement the programme, today’s favourable prospects will be reversed; the country will then be at risk of finding itself very soon in a particularly adverse situation, which will impact negatively on citizens’ morale. What is at stake is the choice between: An orderly, albeit painstaking, effort to reconstruct the economy within the euro area, with the support of our partners; or a disorderly economic and social regression, taking the country several decades back, and eventually driving it out of the euro area and the European Union. Past failures to act in a resolute and timely manner have magnified the actual costs of adjustment The second adjustment programme, along with private sector involvement in the restructuring of Greece’s public debt, leading to its substantial reduction, mark the end of one phase of the crisis. With the help of our partners, and with a hard effort and at considerable cost, under the first programme changes were made that were important, but still insufficient in relation to the size of the economic problem at hand. This explains the repeated underperformance with respect to the targets of the adjustment programme after the first Memorandum. The related revisions would have been avoided had we accepted from the outset our full responsibility for the necessary change in course, once it had become clear that the growth model followed was no longer sustainable. BIS central bankers’ speeches The needed adjustment did not take place to the extent required. The Memorandum, which, in any case, contained reforms that should have been implemented long ago, was handled defensively and treated as an external imposition. This defensive stance, however, proved to be totally counter-productive – it magnified the costs of adjustment and deepened and prolonged the recession. A promising new start: a battle has been won, but the war is not over The lack of sufficient policy adjustment brought us to the restructuring of debt and the new loan agreement – choices which, given the circumstances, had become unavoidable. The restructuring improves the dynamics of public debt and creates a more favourable framework for the economy. Thus, a very difficult phase of the crisis comes to an end, at great social cost, but without any devastating effects. We now find ourselves at a promising new starting point. In this sense, a battle has been won, but not the war. This is why there can be no slackening off or complacency. On the contrary, continued vigilance, an intensification of efforts and a faster pace are required. In order to succeed now, we need to promptly make fundamental qualitative changes [mainly] to the functioning of the state, the operation of the public administration and, more broadly, institutions, the political system, the judicial system, the social partners, as well as the values and attitudes that shape our behaviour. The agreement of society and of political forces is needed on the main issue: the country’s European prospects and growth For these changes to proceed, what is needed is the broadest possible consensus across society and the spectrum of political views. Citizens must be convinced of the necessity of the changes stemming from the country’s choice of euro area membership; further, they must understand that an eventual failure to implement the changes would entail losses many times greater, as well as an irreparable break-up of social cohesion. It is to be hoped that political forces will agree on the issues that unite them, namely the country’s European prospects and its growth potential; in this way the continuity of the state will be ensured. The necessary changes can be realised today Today we are better positioned than just a few months ago to take effective action. The objective conditions that make this possible are in place:  The restructuring of the public debt substantially reduces the country’s obligations and the cost of servicing them, thereby facilitating fiscal adjustment.  The loan agreement and the accompanying economic adjustment programme were passed by Parliament with a large majority.  Whilst the fiscal deficit remains high, it has been substantially reduced. The objective of achieving primary surpluses from 2013 onwards is clearly attainable.  There is now broader public awareness of the gravity of the situation and of the need for radical change if Greece is to remain within the European Union.  The banking system proved resilient during a difficult period and today looks forward to its restructuring, which will enable it to operate more effectively to the benefit of the overall economy. These factors will help the economy, first, to recover from the crisis and, then, to settle onto a sustainable growth path. Nevertheless, the risks remain high and uncertainty is still considerable. BIS central bankers’ speeches The recession and unemployment turned out worse than initially expected  The recession that began in 2008 continues. In 2011, real GDP contracted by 6.9%. The situation worsened in the fourth quarter, reflecting, among other things, the fact that uncertainty remained high. The decline in GDP was driven by the fall in both consumption and investment, the latter dropping by more than 20%.  A further reason for the deterioration in GDP in the fourth quarter of 2011 was the halt in the upward trend in real exports of goods, after four successive quarters of growth. Exports of goods increased on average in 2011, but more slowly than in 2010 (3.6% against 5.4%). The decline in exports in the fourth quarter can be attributed not only to the slowdown in economic activity in our trading partners, but also to financial constraints faced by exporting firms (in particular, limited access to bank and trade credit).  On the supply side, output of the secondary sector fell sharply (almost twice as much as in 2010: –12%, compared with –6.1%). The decline in output of the tertiary sector intensified as well (–5.9%, against –3.1%). By contrast, agricultural output increased by 2.5%, but, because of the sector’s small size, this positive development had little effect on GDP as a whole.  The decline in production was the main cause of the net loss of some 300,000 jobs and the surge in the number of the unemployed by approximately 250,000 people in 2011.  Conditions in the financial sector deteriorated. The rate of credit expansion to the private sector, which has been steadily decelerating since 2008, turned negative in 2011. While this development can be partly attributed to reduced demand for credit on account of the recession, an important factor was also the liquidity squeeze experienced by banks, resulting from the loss of confidence brought about by the fiscal crisis. Today many sound businesses are suffering the consequences of that squeeze. The general government deficit was reduced in 2011, but meeting the fiscal targets for 2012 will require persistent efforts The general government deficit as a percentage of GDP was reduced by 1.2 percentage point in 2011, according to figures released yesterday, while the primary deficit was reduced by 2.5% of GDP. Furthermore, in the first quarter of 2012, the central government deficit, on a cash basis, decreased markedly year-on-year, while a primary surplus in the order of 0.5% of GDP was recorded, compared with a primary deficit of 0.5% of GDP over the corresponding period in 2011. Primary expenditure fell, albeit less than targeted, due to increased subsidies to social security funds. Attaining the full-year targets will obviously require persistent efforts. Meanwhile, there is considerable uncertainty in the international environment as well Global economic activity slowed in 2011 on account of the sovereign debt crisis in advanced economies, the general decline in confidence, and the high prices of commodities. The global economy’s recovery suffered a blow in late 2011 from the rise in uncertainty caused by the intensifying sovereign debt crisis in the euro area. As a consequence, the risks surrounding projections for 2012 remain elevated. GDP growth is expected to slow both in emerging and developing economies. In 2012, the euro area is expected to experience a mild recession. This projection is subject to considerable downside risks, relating in particular to an intensification of the debt crisis as well as further increases in commodity prices. BIS central bankers’ speeches In response to these challenges, the Eurosystem resorted to standard and non-standard monetary policy measures. At the same time, and in a move to restore market confidence, the firepower of support mechanisms was increased. The Greek economy: projections of key macroeconomic aggregates for 2012 The available short-term indicators for the first months of 2012 suggest that the recession will continue this year.  The Bank of Greece forecasts an average annual rate of decline in GDP of close to 5%; implying that the recession will be less pronounced than in 2011; this forecast assumes that the necessary structural reforms will be implemented without delay.  The average unemployment rate is projected to increase this year and exceed 19%, up from 17.7% last year.  Forecast reductions in unit labour costs for 2012–13, together with projected price developments, should lead to a marked improvement in competitiveness, thereby contributing to export growth and import substitution. In particular, it is estimated that by the end of 2012, two-thirds to three-quarters of the total cost competitiveness lost over the period 2001–2009 will have been recovered and that, by end-2013, all of the loss will likely have been recovered.  The current account deficit is projected to decrease from 9.8% of GDP in 2011 to roughly 7.5% of GDP in 2012 and that this downward trend will continue in the years to come.  The downward trend in inflation will also continue in 2012, with average annual inflation expected to be around 1.2%. In 2013 inflation is projected to fall further, possibly to below 0.5%. The recession is negatively affecting expectations and fuelling the vicious circle Delays with fiscal adjustment and the implementation of structural reforms, negative developments in the real economy and adverse conditions surrounding the provision of bank finance to the economy, apart from their direct impact on incomes and unemployment, are also contributing to uncertainty about the economic outlook. As long as the vicious circle of fiscal contraction-recession-uncertainty continues, the prospects for meeting deficit and debt targets will tend to weaken, thus refuelling negative expectations. Some consider the vicious circle to be due to the tight fiscal policy pursued. Though not without foundation, this interpretation is incomplete. It fails to take into account that, while fiscal consolidation does bring about a decrease in aggregate demand, it also affects expectations. Positive expectations can be generated when:  a fiscal consolidation plan convincingly forms part of a credible medium-term programme, aimed at reducing the share of the public sector in the total economy,  there is strong evidence that the economic adjustment programme is likely to succeed and that its continuity is ensured, regardless of changes in the political landscape. When these two conditions are in place, positive expectations can take hold, indirectly boosting consumption and investment. These indirect effects can, to some extent, offset the decline in demand brought about by the fiscal deficit reduction and gradually lead to economic recovery. BIS central bankers’ speeches A STRATEGY FOR EXITING THE CRISIS AND FOR SUSTAINABLE GROWTH MUST BE IMPLEMENTED CONSISTENTLY AND WITHOUT DELAY A national strategy for the orderly reconstruction of the economy It has now become clear that the changes undertaken thus far are insufficient.  Both the fiscal and the external deficits remain high, implying that the country continues to live beyond its means, by relying on the financial support of its partners.  Major structural weaknesses in the public sector still remain, even in cases where measures to eliminate them have been legislated.  Market distortions undercut competition and hamper growth.  Whilst cost competitiveness has improved, structural competitiveness still lags. It is therefore clear that the difficult task which we have before us calls for a persistent effort over many years. Recovery and growth through the mobilisation of the private business sector A strategy for recovery and growth is of utmost priority. Failure to tackle the recession could compromise our ability to meet the targets of fiscal consolidation. In the current context, growth requires the mobilisation of the private business sector; this cannot be achieved as long as the state continues to dominate the economy. Nor can it happen so long as the fiscal deficit and public debt are persistently high. Moreover, there cannot be growth so long as there is a climate of uncertainty and distrust exists about the prospects of the economy. The prerequisites for growth are therefore:  The restoration of confidence and the elimination of uncertainty;  the creation of an environment favouring entrepreneurship;  the transfer of resources from the bloated public sector to the production of goods and services by the private sector and – more generally – from the sector of non-tradable goods and services to that of the tradable. Actions for growth As early as in 2010, the Bank of Greece pointed out the need for a comprehensive Action Plan for Growth, which would run in parallel with fiscal consolidation, specify needed structural policies, and provide a framework for coordinating the growth-enhancing activities of the public sector that do not put the fiscal targets at risk. Such a plan is all the more urgent today. It includes the following goals: Measures with immediate returns  Reforms to improve the business environment, including measures to deal with red tape and reduce the administrative burden on businesses, to simplify the regulatory framework, and to restore market competition.  A speeding-up of the privatisation programme. Apart from generating proceeds that reduce the debt, privatisation may also entail further investment in order to fully exploit the assets to-be-acquired. Privatisations open up opportunities for foreign direct investment, which leads to technology transfer, efficiency increases, and productivity gains. BIS central bankers’ speeches  A faster absorption of the funds for the National Strategic Reference Framework (NSRF) and the securing of funds from international institutions, such as the European Investment Bank; such funds will ensure that important infrastructural projects that have been put on hold can be resumed. Structural changes for a transition to a new growth model Apart from measures with immediate returns, a long-term growth policy is needed. Such a policy must as of today strive for reforms to foster the transition to a new, export-oriented, growth model. These reforms must focus on changing the structure of production and on removing distortions. Greece’s euro area entry did not bring about any significant differentiation in the structure of production; as a result, the level of structural competitiveness has remained low. The last two years have seen an improvement in Greece’s cost competitiveness, mainly as a result of lower relative unit labour costs. While this is definitely a positive development, it is not sufficient. An improvement in competitiveness is sustainable only when it is based on productivity increases. For this to be achieved, structural reforms are required in order to remove barriers and allow the transfer of resources to the production of internationally-traded goods and services. The ultimate objective is export growth and import substitution, i.e. a strengthening of the position of domestic products in both the external and the home markets. Structural reforms aimed at a business-friendly environment and at attracting foreign direct investment make a decisive contribution to progress in this direction. Such reforms involve:  bolstering competition in the markets for products and for factors of production;  modernising public administration;  ensuring a stable and growth-friendly tax system;  speeding up judicial procedures;  rationalising and simplifying the regulatory environment;  encouraging innovation, research and export-oriented activities; and  increasing the effectiveness of education at all levels. None of this is new. The need for such reforms is widely recognised, and in many of these areas measures have already been adopted. However, the pace of implementation remains slow, meaning that the benefits are not yet visible. At the present critical juncture, all of these reforms must be pushed forward simultaneously, with boldness and resolve and without being watered down. THE RESTRUCTURING OF THE BANKING SYSTEM WILL CONTRIBUTE TO ECONOMIC RECOVERY AND GROWTH The recession and the evolution of credit flows interact The fiscal crisis and the climate of uncertainty have significantly worsened financial conditions during the past two years. Doubts as to the Greek economy’s ability to break out of the vicious circle affected Greek banks, with the result that they were shut out from international markets and experienced a continuous decline in deposits: from end-October 2009 to end-February 2012, domestic bank deposits by the private sector decreased by over €70 billion, an equivalent to approximately one-third of Greek GDP. The deposit outflows markedly constrained banks’ ability to provide credit to the economy. BIS central bankers’ speeches The economic recovery hinges upon the setting in motion of a virtuous circle, whereby an improved economic outlook fosters the strengthening of the banking system, so that the latter can, in turn, supply credit to the real economy, with positive feedback effects on expectations, and so on. It is possible to improve the funding potential Improving the funding potential for the economy can be achieved in the following ways: First, by restoring confidence, which could initially lead to a return of bank deposits of some €10–15 billion of cash now being hoarded and then encourage capital repatriation. This would substantially improve banks’ liquidity positions. Second, by attracting funds from sources other than the banking system. Two sources can be mentioned in this regard. The privatisation programme, with expected proceeds of €19 billion by 2015, mainly in the form of capital inflows from abroad, will lead to much greater total inflows if the additional investments required to fully exploit the assets to-beacquired are taken into consideration. Credit flows to businesses could be supported by an additional €15 billion, provided that our absorption rate of NSRF funds is improved. To this, one should add the funds available from the European Investment Bank. The restructuring of the banking system The key factor to improving financial conditions is the strengthening and restructuring of the banking system, currently in progress. 2012 will be a critical year in shaping the future structure of the banking system in Greece. Banks now face losses originating from the fiscal crisis. First, they are dealing with the implications of having invested in Greek government bonds, an instrument considered safe until recently. Banks’ published annual statements show that the related impact is quite substantial. Second, banks also face the consequences of the increased difficulty that households and businesses have in servicing their debt obligations on account of the protracted recession. These developments imply that it is imperative for banks to strengthen their capital base – a process which is already under way. Anticipating these challenges, early in 2011 the Bank of Greece, in cooperation with the International Monetary Fund, the European Commission and the European Central Bank, began planning a number of measures to safeguard financial stability. These measures include:  meeting short-term liquidity needs through the Eurosystem,  formulating, in cooperation with the government, a resolution regime for credit institutions, and applying it where necessary;  securing €50 billion from the financial support programme for the banking system’s recapitalisation and restructuring. The objective: a sound, strong and competitive banking system The banking sector, following its restructuring, will be more sound, efficient and robust. The publication of banks’ capital needs will substantially increase transparency, which will in turn help banks to gradually regain the confidence of markets and depositors. This will enable them to better perform their fundamental role of financial intermediation and contribute to the return of the Greek economy to a path of sustainable growth. BIS central bankers’ speeches THE FUTURE OF THE COUNTRY IS IN OUR HANDS Projections for domestic economic developments in 2012 are fraught with uncertainties. The economic outlook for the euro area is also subject to uncertainties, linked to the possibility of an intensification of the sovereign debt crisis. It is against this challenging backdrop that the Greek economy needs to make steady progress. To this end, work to win the war on all fronts has to continue uninterrupted from the very first day of the post-election period, starting with the construction of an efficient and flexible state that will serve both the competitive functioning of markets and social cohesion. This will avert conditions leading not only to our sacrifices going to waste, but also to a drastic deterioration in the standard of living. Thus, the speedy implementation of the policies contained in the second adjustment programme will place the economy back on track to recovery by the end of 2013 and gradually into a virtuous circle of confidence-fiscal balance-growth. Therefore, we all must assume the historical responsibility of making the choice – as a society, as a political system, as responsible citizens. The future of the country is today in our hands. BIS central bankers’ speeches

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Interview with Mr George A Provopoulos, Governor of the Bank of Greece, in Süddeutsche Zeitung, conducted by Mr Αlexander Ηagelüken and Mr Markus Zydra, published on 31 January 2013.

George A Provopoulos: Interview in Süddeutsche Zeitung Interview with Mr George A Provopoulos, Governor of the Bank of Greece, in Süddeutsche Zeitung, conducted by Mr Αlexander Ηagelüken and Mr Markus Zydra, published on 31 January 2013. * * * Governor Provopoulos, there is still a lot of scepticism towards your country. Why should Europe’s taxpayers give ever more money to Greece? As a Greek citizen I thank the European taxpayers – 230 billion euros to Greece is a gigantic sum. Previously we implemented fiscal consolidation, but we did not adequately implement structural reforms. As it became evident that the program was off track, confidence declined. Therefore, I can understand the concerns of European taxpayers. But I can tell them: this time the Greek government is committed to deliver. The country is changing. European taxpayers will get their money back. That sounds very optimistic. Look, there has been a lot of progress. Here are just a few examples: Greece cut its fiscal deficit by nine percentage points compared to 2009. It cut the structural fiscal deficit – that is, excluding cyclical effects – by even more: 15 percentage points. These figures are unprecedented for any country at any time. Plus, by the end of this year, Greece will have fully regained the 32 percent loss in competitiveness (measured in terms of relative unit labor costs) that we suffered from 2001 to 2009. But that's not the whole story. Greece hasn't fulfilled other promises. That is true. In the past structural reforms were not properly or adequately implemented. That was a big mistake, because they were needed to generate growth. And we badly needed measures that could offset the contractionary effects of fiscal consolidation. Some economists say: It's not about lower labor costs, the Greeks simply don't have products that can compete internationally. That is not true! We have tourism, shipping, light industry, agriculture, sources of renewable energy and so on – plus our ports are uniquely placed to serve as transportation hubs for a much broader area. With our warm weather we could be a significant agricultural producer. Instead we import tomatoes from Northern Europe where the weather is like this (points out of the window). A major problem however was the steady erosion of competitiveness. Do you really believe the politicians? It was you who testified before a parliamentary comittee last year that you had warned the two previous governments that the crisis would come – but they didn't do anything. True. When the financial crisis started in the USA, I believed that it would come across the ocean and hit countries with large imbalances, like Greece, the hardest. In January 2009, for example, I warned the political leadership that it was necessary to act because growth could not be sustained in light of the large fiscal and external imbalances. But since Greece had been growing at a rapid pace for many years, my warnings were not taken seriously into consideration. ...shoot the messenger… Exactly, the messenger was not popular. Again, both before and immediately after the October 2009 election in Greece I warned that the deficit as a percent of GDP could explode to double-digit levels. But my warnings were ignored. Instead, government spending continued to increase. Shocking enough. So why are you optimistic that Premier Samaras will act? BIS central bankers’ speeches Greeks, including politicians, realize that this is the last chance for Greece. We are all wiser and determined to keep Greece in the euro. Prime Minister Samaras and the other leaders of the coalition government are delivering and will continue to deliver. How is it to be the Greek in the ECB meetings? For nearly three years you had to ask for help nearly every four weeks... In fact, we meet every two weeks. I will answer as to a psychiatrist (laughs). Because of the painful, but necessary adjustment measures that I advocate, some Greeks do not view me sympathetically. In Frankfurt, as the only person at the table from the country from which the euro crisis originated, the situation has, at times, been difficult, even though I forewarned my country on the dangers that we faced. I must add that my Governing Council colleagues have gone out of their way to support Greece throughout the crisis. Still you try to be optimistic. Is that really founded? The Greek economy is set to contract more. Although this will be a difficult year, I believe that the worst is over for Greece. I expect the economy to contract by about 4 percent this year, mainly as a result of additional fiscal measures. The crucial question is, will the mood brighten because of the progress and thus boost the economy? I believe that we have been taking – and will continue to take – the measures necessary to restore sustainable growth. Plus, the banking system is more efficient and more competitive… …what did you do exactly? The banks were recapitalized and restructured. About a year ago, the banking system was comprised of 17 banks. Within the next few months, there will only be three large banks and a few small ones. What had been a credit crunch, as banks deleveraged, is being reversed. Now confidence is returning. How do you know that? I’m proud that the Bank of Greece protected financial stability in difficult – even dramatic – times. No Greek has lost a single euro in his bank account. And now deposits are even coming back! Depositors emptied 87 billion euros from their accounts during the crisis, more than one third of the deposit base. They sent the funds abroad or hid them under their mattresses. Since June the funds are returning to the banking system. So far around 15 billion euros have returned. In December alone 6 billion euros returned in deposits. Why did Greece’s fiscal position became so difficult despite the programme? The main reason for the deterioration of the debt dynamics was that we lost 20 percent of GDP since 2009. So if we are able to change the mood and boost confidence and growth, the debt dynamics will improve fast. In 2010 you were also optimistic that, under the May 2010 adjustment program, Greece will get out of the crisis without help from outside. After Greece started implementing the program in May of 2010, bond spreads halved the following months. That is why I was optimistic Greece would continue with the progress. But after the fall of 2010 a kind of reform fatigue set in. And then there was the talk about private sector involvement that eroded investors’ confidence. Was the debt restructuring a mistake? What is a mistake in this situation? If investors fear to lose their money, confidence is lost. Had Greece followed through with reforms, fully implementing its program, and in the absence of talk about the restructuring of private sector debt, the debt restructuring for the private sector could have been avoided. There was a criticism of you because you received a large severance payment after leaving your post in the bank Piraeus after only two years. BIS central bankers’ speeches In early 2008 when I left that bank for the central bank, the situation in the banking sector was very different from the present situation. At that time, there was still extreme optimism. My payment was made in such a situation and was also stipulated under my contract. It was approved by all the relevant bodies, including the shareholders of my previous bank at their General Assembly. Let me also point out that the Greek banking sector at that time was strong and had not received any state aid. In most countries, including Ireland, Iceland, Spain and the US, the banking sector was the source of the crisis. In contrast to the situation in other countries, Greek banks did not hold toxic assets or excessive real estate loans. Moreover, their capital ratios were high and their loan to deposit ratios were low. In Greece, the banking system was hit by the sovereign crisis. Do the business world and the rich people really do enough for your ailing country? There are countless cases of tax evasion. Although tax evasion is a problem in many countries, in Greece we have had relatively more. That is why I repeatedly called upon past Greek governments to tackle the problem. Fortunately, the present coalition government is acting. As a central bank we are doing our part to contribute. In this regard, may I also point out that the Bank of Greece provided evidence that has been the basis of criminal proceedings in the judicial system involving money laundering. Concerning tax evasion, the French submitted a list of Greek tax evaders that wasn’t followed on in Greece. This was most unfortunate. However, the Greek tax authorities are now taking the necessary actions. In this connection, they have asked banks to provide data of people who have moved money out of the country in order to investigate whether there has been tax evasion. We already see positive results from these actions. BIS central bankers’ speeches

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Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the 80th Annual Meeting of Shareholders, Athens, 25 February 2013.

George A Provopoulos: Overview of recent developments in the Greek economy Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the 80th Annual Meeting of Shareholders, Athens, 25 February 2013. * * * The outlook is improving – efforts should continue in order to ensure that the sacrifices are not in vain The improvement in Greece’s economic prospects is visible The ten months since the last General Meeting of Shareholders have seen important developments, which are now shaping a new and clearly improved economic environment. A year ago many analysts anticipated that a Greek default and exit from the euro area was almost inevitable. Today, such an eventuality is significantly reduced and the economy can look forward to a gradual exit from the crisis. The turnaround in sentiment has been due to a number of factors, which helped the Greek economy to avoid the risk of collapse and get back onto the track of rebalancing and stabilisation. The first among these factors was the affirmative answer of the Greek people to the historic dilemma concerning Greece’s continued participation in the euro area. The coalition government explicitly stated its determination to safeguard the country’s European path. This key choice, along with progress in making up for the major delays associated with the two consecutive national elections, made it possible for the Eurogroup to decide to support Greece financially. These developments had a beneficial effect on economic sentiment. On the domestic front, pessimistic expectations have dissipated considerably and confidence is improving. The Economic Sentiment Indicator stood at a two-year high in December 2012–January 2013. An improvement in confidence is also evidenced by the fact that domestic banks are now less reliant on refinancing from the Eurosystem. This is attributable to a reversal of the downward trend of deposits (which have increased by EUR 15 billion since the elections of last June), while it also partly reflects the first successful attempts of Greek banks to regain access to international money markets. Abroad, the climate as far as Greece is concerned is also turning around. Negative references to Greece are less frequent, while EU officials express unequivocally their desire to support Greece. The changed climate is reflected in a sharp narrowing of the yield spread between Greek and German ten-year government bonds. The second factor which has contributed to this improvement is the progress made in the implementation of the adjustment programme, particularly in addressing the twin deficits – fiscal and external. This progress is a sign of incipient rebalancing and restructuring in the economy. • In the fiscal domain, deficit reduction has been remarkable. Between 2009 and 2012, both the general government deficit and the corresponding primary deficit were reduced by 9 percentage points of GDP, while the fall in the structural deficit, at 15 percentage points, was even larger. • Regarding the external sector, the current account deficit shrank to 2.9% in 2012, down from a peak of almost 15% of GDP in 2008. More importantly, between 2010 and 2012, Greece recovered more than 75% of the loss in cost competitiveness incurred over the 2001–2009 period. BIS central bankers’ speeches A third crucial factor was the success in safeguarding financial stability and confidence in the banking system. Today we would not be talking about the prospect of recovery, had the banking system collapsed making Greece’s exit from the euro area inevitable. This risk was averted. In a period marked by record levels of uncertainty, not one depositor suffered the slightest loss. Not only was systemic stability fully preserved, but the groundwork was also laid for a robust banking system. The fourth factor behind the improvement in confidence has been the continued financial support from official lenders, which gives Greece time for the structural transformation of its economy to proceed smoothly. This support, provided on favourable terms, is unprecedented by international standards. A fifth factor that also bolsters confidence are the steps being taken towards supplementing the institutional architecture of both the European Union and the euro area. The ongoing discussions and decisions taken in this direction have helped to turn the international climate around; in turn, this affected sentiment in Greece favourably. For instance, the adoption of the proposal to move to a banking union will lead to a deepening of economic and monetary union. The announcement of “Outright Monetary Transactions” by the Eurosystem in September 2012, which by itself helped to restore relatively normal conditions in euro area financial markets, was of particular importance. In conclusion, the risk of collapse has been averted, the possibility of a Greek exit from the euro area is now significantly reduced, and confidence is gradually being restored. Yet, these encouraging developments leave no room for complacency. 2013 will be another year of recession and unemployment will continue to rise The Greek economy is still going through a deep crisis, and the risk of a derailing has not been completely eliminated. In 2012, GDP contracted for the fifth year in a row, bringing the cumulative decline for the five-year period 2008–2012 to 20.1%. This percentage will be bigger for 2008–2013, as the recession is expected to continue, albeit at a slower pace. The recession led to a dramatic decline in employment and pushed the unemployment rate up to a historically high annual average of 24.5% in 2012; a further rise is expected in 2013. This crisis, unprecedented in magnitude and duration, has multiple adverse effects as it: • reduces per capita income and living standards; • leads physical and human capital to become obsolete; • causes savings and banks’ deposit base to shrink, thereby leading to liquidity constraints; • feeds uncertainty and discourages investment; • hampers fiscal consolidation, as lower incomes mean less revenue for government. This fuels a vicious circle of deficits and recession that leads to repeated revisions of deficit and debt targets, undermining the credibility of the consolidation programme. The deeper-than-expected recession makes a faster pace of structural reforms imperative Over the last few years, the recession has turned out to be deeper than initially forecast. The reasons behind this should be sought in the way the adjustment programme was implemented: in the wavering, the mistakes and omissions and, above all, the lag in implementing structural reforms. This lag prevented the contractionary effects of fiscal consolidation from being mitigated and hindered the return of confidence. The same reasons also explain the unfavourable financial conditions that prevail. By contrast, if the structural BIS central bankers’ speeches reforms envisaged in the programme had been implemented consistently and from the programme’s inception, their favourable effects would already have made themselves felt and would have reduced the duration and severity of the recession. On a positive note, the depth of the recession and its implications have, in fact, been taken into account as shown by the revisions to the programme: the implementation horizon, the cost of borrowing and the maturities of the loans provided to Greece, the size of financial support and the measures to reduce the level of sovereign debt. In any event, the recession cannot be used as an excuse for not honouring the commitments made and, particularly, for any relaxation in the effort to promote the necessary reforms. If this were to happen, it would seriously undermine the gains in confidence that have come at the cost of painful sacrifices. 2013 will be a difficult year, but recovery will be visible in the course of 2014 As long as the prospect of an exit from the crisis is not clearly in sight, the continuing recession creates an unfavourable climate and feeds social tensions. Nevertheless, we are now at a turning point. There is no doubt that 2013 will be a difficult year, mainly due to the continuing recession and high unemployment. But we can expect recessionary forces to weaken gradually and the Greek economy to return to positive growth rates in the course of 2014. Positive effects are expected from: • a boost to liquidity and confidence as a result of the recapitalisation of banks and the return of deposits to the banking system; • a further improvement in cost competitiveness – expected in 2013 to more than offset the competitiveness losses of 2001–2009 – and a resulting increase in exports; • a speeding-up of the privatisation process, leading eventually to investments several times larger than the initial ones; • progress in the deregulation of markets; • the restarting of major infrastructure projects such as highways; • the implementation of private investment projects, with the support of the National Strategic Reference Framework (NSRF) and European Investment Bank funds; • the planned repayment of public sector arrears. In order to ensure that the above factors will deliver the expected results, it is necessary to safeguard the recent improvement in confidence. Any extreme or untimely demands put forward by different social groups would be counterproductive. Society as a whole stands to make a lasting gain when the economy gets back on its feet again. It also goes without saying that unlawful incidents against business operations – no matter how isolated – are particularly harmful to the investment environment and undermine the prospect for a recovery in employment. Pressing ahead with the implementation of the programme is a prerequisite for recovery Where we stand today bodes well for the future. It can be reasonably expected that real economic recovery will come fairly soon, provided that certain conditions are fulfilled. The most important is the continued implementation of the adjustment programme, with strict adherence to the targets and timetables set. This will ensure continued funding and eliminate once and for all the risk of exit from the euro area, consolidate confidence in the economy’s future, attract new investment and convey a clear message that the worst is behind us and an exit from the crisis is in sight. BIS central bankers’ speeches Implementation of a new model of outward-looking growth The rebasing of the country’s productive capacity on new foundations must be driven by strengthening its export orientation. This, in turn, requires shifting resources towards the production of competitive, internationally tradable goods and services. But if we are to succeed in transforming the economy, we must realise that the adjustment programme highlights only the minimum changes that need to be made. Thus, in no way does the programme relieve us from our primary responsibility as a nation to implement a broader national action plan for growth, incorporating policies for the transition to a new model of sustainable growth. Now that public finances are stabilising, it is essential that we proceed faster with fundamental reforms that will ensure: • an efficient public sector, both citizen- and business-friendly; • modern infrastructure; and • open, competitive markets. Effective use of EU funds Following the recent European Council decision, the Structural Funds available to Greece for 2014–2020 will total EUR 18.3 billion. These resources can play a decisive role in bringing the recovery forward and in implementing a long-term strategy for the transformation of the economy’s productive base. Under current circumstances, EU resources could help to address serious gaps in the financing of new investment projects. So far, EU funds, despite their positive contribution, have not been used to maximum advantage. This is precisely why such resources will function at this time as powerful tools for growth, provided they are integrated into a broader national plan for growth. Creating the conditions for lightening the tax burden of those who already pay taxes The central goals of the tax reform agenda should be to broaden the tax base and curb tax evasion. Indeed, fiscal adjustment should focus, first, on cutting down those expenditure items that are not conducive to growth and increasing the return on other items of expenditure and, second, on modernising tax administration in order to effectively tackle tax evasion. Action along these lines will create scope for reducing the heavy tax burden that has, increasingly in the last few years, been shouldered by those who already pay taxes. This will help foster a sense of equity in tax matters and will generate positive expectations that will partly offset the contractionary impact of spending cuts. The reform of the banking sector is key to restoring normal liquidity conditions Since the onset of the crisis, Greek banks have borne the brunt of the repeated downgrades of Greek sovereign debt. They were cut off from international markets, while the prevailing uncertainty led to large deposit outflows and a loss of more than one third of the banks’ deposit base in less than three years. The banking system’s funding constraints impaired its capacity to finance the real economy, causing problems for production, investment and export activity. Liquidity tensions were significantly eased by Greek banks’ recourse to the monetary policy operations of the Eurosystem and to emergency liquidity assistance (ELA) from the Bank of Greece. Thanks to the ample provision of liquidity from these sources, the decline in bank credit to households and businesses was much milder than the shrinking of the banks’ deposit base. Thus, the Bank of Greece contributed to mitigating the adverse impact of the sovereign debt crisis on economic activity. BIS central bankers’ speeches Heightened uncertainty in the first half of 2012 posed major risks to the banking system In the January–September 2012 period, the banking groups listed on the Athens Exchange recorded losses of EUR 5.1 billion. These losses reflected, on the one hand, additional writedowns on their Greek government bond holdings as a result of PSI and, on the other, impairment charges on loans to the private sector. Accumulated losses led to a sharp decline in banks’ capital adequacy; thus, their recapitalisation became necessary. The NPL ratio for the banking system as a whole rose to 22.5% by end-September 2012, from 16% at endDecember 2011. Despite the adverse conditions, the risk of instability was averted The uncertainties that prevailed during the prolonged election period led to successive surges in cash outflows from banks, requiring the latter to be supplied with an exceptionally large amount of banknotes to banks. The banks’ needs for banknotes were fully and efficiently met by the Bank of Greece. Even in the direst of circumstances, there was not the slightest doubt as to the banks’ ability to repay customer deposits. Otherwise, there would have been a collapse in confidence, with devastating consequences for financial stability and Greece’s membership of the euro area. Despite the extremely adverse conditions, action taken by the government and the Bank of Greece ensured that the banking system weathered the shock and that not one depositor lost a single euro of their savings. This response averted a collapse in confidence in the banking system and ultimately an exit from the euro area. The recapitalisation of banks is under way In May and December 2012, the four big banks identified as viable by the Viability Assessment Exercise of the Bank of Greece received an advance payment from the Hellenic Financial Stability Fund (HFSF) to replenish their capital above the regulatory minimum. The next steps of the recapitalisation process involve the issuance of contingent convertible bonds and the completion of capital increases by the end of April 2013. Private shareholders will retain control of HFSF-supported banks, provided that they subscribe no less than 10% of the new common shares to be issued. According to the Memorandum, the other banks will have to raise private capital by the end of April 2013. If they fail to do so, the Bank of Greece will activate the steps envisaged in the resolution framework, at the latest by June 2013, in a manner that will safeguard financial stability. Considerable progress to date in the consolidation of the banking system In 2012, despite the deep crisis, the groundwork was laid for the banking system to turn the page. Banks are already taking their first steps towards internal reorganisation, by adapting their business models. The entire banking sector is being reshaped through mergers. The size of the Greek economy and the excess capacity prevailing in the banking system call for fewer and stronger banks, which in the long run will be more resilient to exogenous shocks. This process of consolidation will be to the benefit of depositors and borrowers alike. Larger banks typically have easier access to international markets and, given their greater efficiency, have fewer incentives to undertake high-risk investments. At the onset of the crisis, there were 17 banks in operation. There were also 16 cooperative banks, with a combined market share of just 1%. The resolution and restructuring process is well under way, as evidenced by the following facts and data: • So far, the resolution framework has been used to resolve seven banks – four commercial banks and three cooperative banks. BIS central bankers’ speeches • At present, a merger between the two largest banks, the National Bank of Greece and Eurobank, is in the process of being completed. • Alpha Bank, the third largest bank, has absorbed Emporiki Bank, a subsidiary of Crédit Agricole. • Piraeus Bank has absorbed Geniki Bank, a subsidiary of Société Générale, as well as the sound assets and the deposits of the state-owned ATEBank; it is currently negotiating the acquisition of Millennium Bank. It is therefore expected that, in a few months from now, when the process is completed, the banking system will comprise three large, strong groups, as well as a few smaller banks. The market shares of these smaller banks, along with the presence of foreign banks, will ensure competition. The Greek banking system is clearly becoming more compact and efficient, as conditions are being put in place to enable it to exploit synergies and economies of scale. It is becoming stronger and better-capitalised. At the same time, it has retained its significant presence in south-eastern Europe. A robust banking system capable of financing economic recovery The restructuring and recapitalisation of the banking system are pivotal reforms that contribute to strengthening confidence in the prospects of the Greek economy. The gradual return of deposits is a first sign that developments in the banking sector are being positively assessed. The continued return of deposits and the successful completion of the recapitalisation process will help Greek banks to gradually regain access to international money and capital markets. We are already witnessing an incipient return of Greek banks to the international markets. On a more general note, the relaxation of banks’ capital and liquidity constraints is creating conditions for stronger credit flows to finance production, investment and exports. Having navigated through very troubled waters, the banking system is emerging stronger, more resilient, and able to finance growth. Challenges and opportunities The economic crisis has brought about not only acute problems, but also significant opportunities. The two most important opportunities, which pose a challenge for Greece, are: • First, to restructure the economy towards high-productivity and high-value-added sectors that would produce internationally tradable goods and services that can prove competitive both in the external and in the domestic market. • Second, to modernise public administration and rationalise the boundaries and the management of the public sector, while making it more citizen- and businessfriendly. The ability to rise to these major challenges hinges on building and strengthening social consensus as regards the implementation of the appropriate policies, so as to bring the recovery forward and create the conditions for sustainable growth. Comparing the current situation with the one prevailing just a few months ago, it is clear that much has changed for the better. Most importantly, the risk of default and exit from the euro area is now remote. Thus the main factor that had fuelled unprecedented market uncertainty with debilitating effects on the Greek economy is weakening. We can now expect, with reasonable certainty, that the steps made so far are indeed leading Greece out of the crisis and onto a path of growth. As this expectation is consolidated, sentiment in Greece will continue to improve, setting in motion a virtuous circle. For this to happen, though, the implementation of the adjustment programme must continue without deviations or delays. Commitment to achieving the targets, and where possible, overshooting the targets, will BIS central bankers’ speeches remove any remaining uncertainties and strengthen positive prospects, with very beneficial effects on social cohesion and the country's economic development. We have already come most of the way on a long and difficult road at tremendous cost to Greek citizens and businesses. The distance still to be covered, though shorter, will be equally difficult, as it will require additional effort on top of the earlier sacrifices. However, the groundwork for dealing with the long-standing problems of the Greek economy has been laid. Now that the end of this difficult road is finally in sight, we need to intensify our efforts and quicken our pace in order to cover whatever distance remains and ensure that the citizens’ sacrifices will not be in vain and that, better yet, a promising future lies ahead. BIS central bankers’ speeches

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Welcome remarks by Mr George A Provopoulos, Governor of the Bank of Greece, at the conference "The crisis in the euro area", Athens, 23 May 2013.

George A Provopoulos: The Greek economy and banking system – recent developments and the way forward Welcome remarks by Mr George A Provopoulos, Governor of the Bank of Greece, at the conference “The crisis in the euro area”, Athens, 23 May 2013. * * * I would like to warmly welcome you to this conference on “The Crisis in the Euro Area”. That such a conference is taking place here seems to be especially appropriate. After all, Greece is the country where the euro crisis started and which, for much of the past several years, has been at the epicenter of the crisis. What I would like to do is to briefly discuss some developments that led Greece into the crisis and then take stock of the progress that Greece has made in adjusting its economy. Before doing so, let me provide a preview of my main conclusion. Although Greece has been through some very rough waters, both in terms of its real economy and its banking system, the situation is turning around. Considerable progress has been made in addressing the weaknesses of the economy, making it much more competitive. Importantly, the country is well on the way to building a strong and competitive banking system. As the Governor of the institution responsible for banking supervision and financial stability, I gain special satisfaction from the fact that, after three years of deep crisis, the stability of the banking system has not only been preserved but it has strengthened. It has not, however, always been easy for the Bank of Greece. Let me now turn to the underlying causes, and the policy responses, to Greece’s sovereign debt crisis. How did this crisis come about? The entry of Greece into the euro zone in 2001 was widely seen as marking a transformation in the country’s economic performance. Entry into the euro area seemed to indeed mark a new regime. Between 2001 and 2008, real growth averaged almost 4 per cent a year, inflation fell to the low single digits, and interest-rate spreads between 10-year Greek and German sovereigns dropped to between 10 and 50 basis points, from over 600 basis points in the late 1990s. However, these were years when Greece was living dangerously. Unsustainable fiscal and external imbalances were building up. By 2009, the fiscal deficit had reached 15½ per cent of GDP and the share of government debt had increased to almost 130 per cent of GDP. Moreover, Greece’s cost competitiveness had deteriorated by 30 per cent, and the current account deficit had peaked at 15 per cent of GDP in 2008. These large and growing imbalances should have sounded warning alarms to the financial markets, but they did not do so for some time. Despite relatively low spreads on Greek sovereigns following the outbreak of the global financial crisis, as early as in 2008 the Bank of Greece began warning of the dangers inherent in the twin deficits. BIS central bankers’ speeches Outbreak of the crisis These dangers became evident – belatedly – to the financial markets in the fall of 2009 with the news that the fiscal deficit for that year would be much higher than had been earlier projected. Interest-rate spreads began a relentless upward climb and the sovereign became cut off from the global financial markets. In May 2010, the government agreed to an adjustment programme with the IMF and Greece’s euro-area partners in order to meet its financing needs. This adjustment programme was built around two key pillars. a. Fiscal consolidation b. Structural reforms (including privatizations and measures to combat tax evasion) The government placed more emphasis on the first and less emphasis on the second pillar. Moreover, the fiscal mix relied more on tax increases than on spending cuts. The Bank of Greece had advised that the mix should include 1/3 revenue increases (mainly through broadening the tax base) and 2/3 spending cuts. Fiscal consolidation led to a recession that was deeper than expected, partly because it relied heavily on increases in tax rates and was not combined with structural reforms to boost growth prospects. What had started out as a sovereign debt crisis spilled over to the banking system. Prior to the outbreak of the sovereign crisis, the banking sector had sound fundamentals – with high CARs, low loan-to-deposit ratios, and essentially no toxic assets of the kind that set-off the 2007 global financial crisis. The size of the banking sector at the outset of the crisis – at 200% of GDP – was much smaller than in other countries that experienced crises. In contrast to what happened in other countries, in Greece it was the sovereign crisis that led to a banking crisis, not the other way around. How did that happen? First, in terms of liquidity. A series of sovereign downgrades, and then bank downgrades, forced the banks out of the global financial markets. Uncertainty led to large deposit outflows. Banks had to resort to central bank funding, at first through Eurosystem monetary policy operations, but gradually, due to the lack of eligible collateral, to emergency liquidity assistance from the Bank of Greece, at a higher cost. Following the PSI last year, banks took huge one-off losses on their bond portfolios. At the same time, the recession led to a continuous increase in non-performing loans. What started out as a liquidity problem threatened to turn into a solvency problem. The twin crises generated negative feedback loops, creating a general crisis of confidence, compounding the problems faced by the banking system, and exacerbating the contraction in GDP. But a contracting GDP meant a shrinking denominator in the debt-to-GDP ratio. As a result, the debt dynamics worsened, and the crisis became self-reinforcing. Last year, Greece was said to be on the road to the unthinkable – an exit from the euro! The markets even had a name for it; GREXIT. So much for the bad news. Is there light at the end of the tunnel? BIS central bankers’ speeches Adjustment: fiscal The word “crisis” originates from the Greek word that means judgment. I believe that historians will judge this crisis to be a positive turning point for the Greek economy. Why do I believe this? Let me explain. Consider, first, fiscal adjustment. From 2009 to 2012, the fiscal deficit was reduced by some 9 percentage points of GDP. The primary fiscal deficit was 10½ per cent of GDP in 2009. It is projected to swing into a small surplus this year. What makes these achievements impressive is that they have taken place despite a contracting economy, which creates moving targets for fiscal consolidation. Greece’s fiscal consolidation is one of the largest ever achieved by any country at any time. Additional fiscal measures, amounting to 11½ per cent of GDP, are being implemented in 2013 and 2014. These measures will increase the primary fiscal surplus to 3 per cent of GDP in two years. After many delays, positive signs are also emerging with respect to tax evasion and privatizations. Further debt-reducing measures were announced by the EuroGroup last November, subject to Greece reaching a primary surplus, which the government expects to achieve this year. Adjustment: external Consider, next, external adjustment. As I mentioned, Greece had lost about 30 per cent in terms of cost competitiveness against its major trading partners in the period from 2001 to 2009. Since 2010, about 80 per cent of that loss has been recovered. By the end of this year, the entire loss will have been recovered. Competitiveness is also being promoted through structural reforms, which have increased the flexibility of labour and product markets. As a result of the improvements in competitiveness, a rebalancing of the economy is taking place. The share of exports in GDP rose from 18 per cent in 2009 to 25 per cent in 2012. It will continue to rise. The current account deficit, which reached 15 per cent of GDP in 2008, fell to 3 ½ per cent last year. It will continue to fall. The banking sector strategy I now turn to the banking sector. As I mentioned, what had started out as a liquidity problem threatened to turn into a solvency problem. We had to step-in to preserve financial system stability. The first step was to calculate the amount needed to recapitalize the banking system. The determination of the losses on the bond portfolios was straightforward. What was challenging was to calculate, in a conservative manner, all possible losses on the loan portfolios of banks in the coming years. BIS central bankers’ speeches For this purpose the Bank of Greece worked with BlackRock Solutions. Once this work was finished, most pieces were in place for the calculation of the capital needs of banks. The second part of our strategy was to assess which banks were good candidates for recapitalization with programme funds. The Bank of Greece, in association with Bain, conducted a “viability assessment”. The result of the “viability assessment” was that the four largest banks, now called “core banks”, were assessed as eligible for recapitalization with public sector funds. These banks were assessed as the most likely to repay such capital within a reasonable timeframe. The total amount set aside under the adjustment programme for the restructuring of the banking system is €50 billion. When our exercise started there were 17 commercial banks in operation: four core banks and thirteen non-core banks. So far, the resolution framework has been used to resolve 8 banks (5 commercial banks and 3 co-operative banks). All core banks have now concluded corporate decision-making processes to increase their capital by the amounts required by the Bank of Greece. Shortly, we will end up with four well-capitalized core banks and a few non-core banks. As a result, the banking system is becoming more compact and efficient, eliminating excess capacity and exploiting synergies and economies of scale. It is becoming stronger and is well-capitalized. Other developments The recent progress that Greece has made in restructuring its economy reflects, in large measure, the determination of the government to take ownership of the adjustment programme. The government has made it clear that Greece’s future lies within the euro zone. The benefits of the country’s adjustment extend beyond the credibility and competitiveness effects of the reduced macroeconomic imbalances. The adjustment means that Greece will continue to receive financial support from official lenders, so that it can complete the process of restructuring its economy and banking system. After its restructuring, the banking system will be in a position to resume its role as the main source of financial intermediation, supplying funds to support real economic activity. The euro area’s response to the crisis And what about the euro area as a whole? Here, there are two important factors at work that will make the euro area a stronger monetary union. First, just as the Greek economy is undergoing a major restructuring to make it a stronger, competitive economy, similar processes are occurring in other peripheral economies. Second, work is also under way to make the euro area a more complete monetary union, with:  strong economic governance;  procedures to prevent macroeconomic imbalances from emerging; BIS central bankers’ speeches  strong backstops and initiatives – including the ESM and Outright Monetary Transactions by the ECB; and  concrete steps towards the creation of a banking union. Vitor Constâncio will address banking-union issues in his presentation. Conclusions I have painted a picture of a Greek economy that is undergoing a major restructuring and I have argued that Greece has weathered its crisis. Consider the following developments. Since the peak of the crisis last June,  Equity prices have more than doubled.  Bond spreads have fallen by more than 2,500 basis points.  Deposits of the private sector have increased by about 12 per cent.  Hoarded banknotes – a key sign of uncertainty in the past – are returning to the banking system.  Reliance of domestic banks on Eurosystem financing is down by almost 35 per cent. As the overhaul of the Greek economy continues, I expect economic growth to resume starting in 2014. Let me conclude by saying that, despite predictions to the contrary, there has been no Grexit from the euro. Instead, I recently saw the word GREXIT had been replaced by the word GRECOVERY. As usual, the markets are right, but a little late! BIS central bankers’ speeches

bank of greece

Presentation by Mr George A Provopoulos, Governor of the Bank of Greece, at the 7th Hellenic Albanian Business Forum, Tirana, 13 November 2013.

George A Provopoulos: Where is the Greek economy heading? Presentation by Mr George A Provopoulos, Governor of the Bank of Greece, at the 7th Hellenic Albanian Business Forum, Tirana, 13 November 2013. * * * Introduction It’s a pleasure to speak to you here today. This forum is an excellent example of the close ties that exist between our two nations. Greek-Albanian trade relations, as we all know, are strong and expanding. Greek entrepreneurial presence in Albania continues to be important. Greece’s share in Albania’s FDI stock is more than 15%. Importantly, Greek banks have a considerable presence here and have contributed to Albania’s smooth transition to a market economy. Because of the important economic presence of Greece here, I will focus my remarks on developments in the Greek economy, especially with regard to the banking system. I will also provide a few remarks on the role of Greek banks in Albania. Let me first provide an overview of the impact of the Greek sovereign crisis on the banking system. Prior to the outbreak of the sovereign crisis, the banking sector had sound fundamentals – with high capital positions, low loan-to-deposit ratios, and essentially no toxic assets of the kind that set-off the 2007 global financial crisis. However, the sovereign crisis spilled over to the banking system, generating a general crisis of confidence, which intensified the contraction of GDP and worsened the debt dynamics. Yet, I believe that the future now looks brighter. Why do I believe this? Because, for one thing, during the past few years, throughout the contraction, Greece has made important progress in addressing its fiscal and external imbalances. In addition, the country’s banking system has been recapitalized and consolidated. Allow me to consider each of these areas – fiscal and external adjustment, and the restructuring of the banking system. Fiscal adjustment First, fiscal adjustment. Greece’s fiscal consolidation is one of the largest ever achieved by any country at any time under an IMF programme. From 2009 to 2012 the fiscal deficit was reduced by 10 percentage points of GDP. In 2013 we expect it to be reduced by a further 3 (2.9) percentage points of GDP. The structural fiscal deficit – that is, the deficit corrected for the business cycle – will have shrunk by almost 20 percentage points of GDP by end2013. A few years ago the primary fiscal deficit exceeded 10 per cent of GDP. This year the primary balance is in surplus. What makes these achievements especially impressive is that they have taken place despite a contracting economy, which creates moving targets for fiscal consolidation. External adjustment Let me now turn to external adjustment. In the 9 years, 2001 through 2009, Greece lost about 30 per cent in terms of cost competitiveness against its major trading partners. In just 4 years, 2010 through 2013, the entire loss has been recovered. Competitiveness is also being promoted through structural reforms. As a result of these improvements in competitiveness, a rebalancing of the Greek economy is taking place. The share of exports of goods and services in GDP rose from 19 per cent in 2009 to 27 per cent in 2012. The share of Greek exports of goods in world trade has risen by 30 per cent since 2010. The current account, which reached a deficit of 15 per cent of GDP in 2008, has moved into surplus in the first eight months of 2013, and we expect a surplus for the year as a whole. BIS central bankers’ speeches The banking sector strategy With the deepening of the crisis a few years ago, the Bank of Greece stepped-in to preserve banking system stability. Our efforts focused on two fronts: • Preserving banking system liquidity, and • Restoring capital adequacy. The Bank of Greece, as part of the Eurosystem, provided ample liquidity to banks at low interest rates using standard and non-standard monetary policy measures. Moreover, when banks came under intense liquidity pressures, the Bank of Greece provided them with emergency liquidity assistance. In terms of capital, a national backstop of €50 billion was established in the form of the Hellenic Financial Stability Fund. In addition, the Bank of Greece conducted a viability study of the banking system. Based on this study, viable banks have been fully recapitalized using a combination of state and private funds. Non-viable banks that were not able to raise private capital have been resolved, using state of the art resolution tools – tools that are now being introduced in many other countries. In total, 9 banks have been successfully resolved. As a result, today we have four well-capitalized viable pillar banks; one of them under state control – but soon to be privatized (Eurobank) – and three privately managed (NBG, Alpha and Piraeus). We also have a few smaller banks, that are also well-capitalized. This situation, with four large banks and a few smaller ones, should be seen in the context of a banking system comprising almost 20 banks a few years ago. I believe that the consolidation, and the elimination of excess capacity to be achieved over the next few years, are impressive. Moreover, there is a significant backstop facility (the “buffer”), in excess of €10 billion, to provide additional capital support to banks, should that be necessary. I am extremely satisfied that, having survived such an enormous economic and financial storm, the Greek banking system is becoming more competitive and well-capitalized. This result didn’t just happen – it was the result of enormous work, difficult decisions, and careful organization. However, this is not the end of the story for the transformation of the banking system. The second stage of our strategy is just beginning. This stage will be characterized by efforts to implement a new banking model. This model will allow banks to exploit synergies and economies of scale, and will, therefore, entail a further elimination of excess capacity. In this way, banks will become more efficient, gradually reducing their reliance on state aid and central-bank funding. Banks also need to refocus their business on their core activities. This step implies selling non-core assets and rationalizing their network and activities abroad. Rationalization does not mean outright sale. The banks will consider disposing operations that absorb disproportional amounts of capital and (scarce) liquidity. However they do not intend to proceed to fire sales of self-funded, efficient business units, a situation that characterizes most subsidiaries of Greek banks in Albania. But I will come back to this issue. As you may know, we have recently engaged BlackRock – for a second time – to update credit loss projections for banks’ loan portfolios up to 2016, and to study the efficiency of banks’ procedures in managing non-performing loans. As I mentioned, due to the efficient use of resources, a buffer of €10 billion is available [at the Hellenic Financial Stability Fund] as a public backstop, should additional capital needs arise. Moreover, we estimate that the sale of non-core assets and the exploitation of synergies arising from mergers will provide a further buffer of an estimated €5-€6 billion. Banks also need to manage their loan portfolios in a more efficient way. This involves primarily efficient resolution of non-performing loans. Improvements in the NPL management will lead to lower capital requirements. The reduced capital requirements are expected to free up resources that can be used to finance the new business model of the Greek economy. Thus, banks will play a key role in shifting funds from non-productive to productive businesses. Finally, low deposit rates are allowing banks to reduce funding costs and, thus, to ease the cost of BIS central bankers’ speeches financing for both retail and corporate clients. These developments should have a positive impact upon operating efficiency and, eventually, the ability of borrowers to service their obligations. Greek banks in Albania Now, let me say a few words about the Greek banks in Albania. Greek banks comprise an important part of the Albanian banking system as evidenced by the fact that they hold about 20% of total banking sector assets. They are well-capitalized, mainly self-funded, and play a vital role in the Albanian economy. However, individually their operations are rather small compared to those of other foreign banks in Albania. Therefore, some mergers may need to take place. In recent years, Greek banks have spread widely in South Eastern Europe. However, few banks managed to obtain, on an individual basis, a substantial market share and size, which are critical factors for efficiency and profitability. This shortcoming has to be addressed. A stronger presence of fewer banks would be better not only for individual banks, but also for the market and the domestic economy. The benefits of consolidation can be seen in the Greek banking market. A major challenge not only for subsidiaries of Greek banks, but for the Albanian banking system as a whole, is the rising level of non-performing loans. The rise in NPLs is a problem for most countries in the region, including Greece. Dealing with this situation is important for not only the robustness of the banks but, more importantly, for ensuring adequate credit supply to the real economy. It is for these reasons that the matter of effective management of NPLs is a top priority for the Bank of Greece. We have set up a plan to increase banks’ efficiency in dealing with troubled borrowers. The frameworks that the banks will develop will, of course, be disseminated throughout their groups and will contribute to the efforts by all supervisory authorities in Southeastern Europe to address the common concern of nonperforming loans. Finally, I would like to reassure you that Greek banking groups have not engaged in excessive deleveraging and they are not going to do so in the future. In fact, there has been no “home”-bias in the loan deleveraging process, rather the opposite. The need of strategic restructuring does not mean a weaker commitment by Greek banks. After all, their presence here and in other countries is a strategic choice as they see substantial long-term growth and earnings potential in both Albania and the region more generally. The future: the cost has been borne; we are now expecting to bear the fruits Dear friends We are now seeing the results of the changes that have been taking place in the Greek economy. Over the past year or so there has been positive news with respect to financial indicators and soft data; recently, there has been positive news in the hard data. The policy reforms – including fiscal adjustment and structural reforms – that Greece has been implementing during the past several years follow an established recipe. That recipe worked for the U.K. in the 1980s, Sweden and Finland in the early 1990s, Asia in the late 1990s, Germany in the early 2000s, and in many other countries. This recipe includes fixing social security, strengthening employment incentives, raising consumption taxes, and streamlining the public sector. Some of these measures – especially structural reforms – take some time to work. They require patience, perseverance, and the ability to ignore the siren calls of those who offer quick fixes. That recipe is now working in Greece. The benefits of the country’s adjustments extend beyond the credibility and competitiveness effects of decreasing macroeconomic imbalances. In light of these developments, I expect economic growth to return, starting in 2014. If Greece achieves a primary surplus in 2013, which seems very likely to happen, the euro area will be discussing further debt reducing measures in spring 2014. Indeed, financial markets apparently share my view about a positive future for the Greek economy. BIS central bankers’ speeches Recently, the FT ran an article that reported that both hedge and long funds are investing heavily in Greek banks. I can confirm that this is indeed the case. The markets have introduced a new term GRECOVERY – that is, a recovery of the Greek economy, to replace the earlier term, GREXIT. As my remarks today make clear, I believe that the markets’ reassessment is well-founded. Thank you for your attention. BIS central bankers’ speeches

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Speech by Mr George A Provopoulos, Governor of the Bank of Greece, for the Golden Series lecture at the Official Monetary and Financial Institutions Forum (OMFIF), London, 7 February 2014.

George A Provopoulos: The Greek financial crisis – from Grexit to Grecovery Speech by Mr George A Provopoulos, Governor of the Bank of Greece, for the Golden Series lecture at the Official Monetary and Financial Institutions Forum (OMFIF), London, 7 February 2014. * * * I want to thank David Marsh for inviting me to be here today. Since its establishment just 4 years ago, OMFIF has quickly become an important platform for the exchange of ideas on issues that concern the global economy, with an emphasis on Europe. In this connection, let me mention that I became Governor of the Bank of Greece in mid2008. During the following year – that is, in 2009 – the Greek sovereign- debt crisis erupted. Consequently, I have been at the battlefront of the euro crisis throughout the turmoil, and I would like to share with you my perspectives about what went wrong and what needs to be fixed to make the euro area a better-functioning economic and monetary union. My presentation will be structured as follows. I will begin by discussing the origins of the euro-area crisis. Next, I will describe the adjustment that has taken place within the stressed countries. With Greece at the epicenter of the crisis, my focus will be on what has happened in my own country. I will then turn to some related issues, notably, the reasons for the deep economic contraction in Greece and the problem of debt-sustainability. Finally, I will discuss changes that are being made to the euro-area’s institutional set-up and their implications for the single currency’s future. Origins of the crisis Five years ago the thought of a euro-area crisis seemed counter-intuitive. After all, as David Marsh points-out in his book on the euro, European monetary union was undertaken to make the kind of crisis that occurred impossible. However, when deciding on what architecture to give to the monetary union, policymakers settled on a “bare-bones” approach. The approach rested on a single independent, price-stability-oriented central bank – the ECB – and fiscal discipline by the member countries, fostered by the rules of the Stability and Growth Pact and enforced by the markets. The Maastricht Treaty called on countries to pursue sound economic policies that would support the ECB in maintaining its price-stability goal. The founding fathers of EMU thought that, since the euro would eliminate exchangerate risk from national interest rates, the single currency would make it easier to evaluate risk characteristics and, therefore, investment opportunities across countries. In other words, the elimination of exchange-rate risk would lead to greater transparency and increased market discipline on governments. The dominant view at the founding of the EMU was that current-account imbalances among countries in the monetary union would become as irrelevant as they are among regions of individual countries. Persistent current-account deficits were interpreted as capital flows from countries offering relatively-low returns on investments to countries offering relatively-high returns. In other words, they were part of an equilibrating process under which the fastgrowing periphery caught up to the core. This architecture proved inadequate for several reasons. First, the fiscal rules were poorly designed and under-enforced. Second, instead of increasing the pressure for structural reforms and policy adjustments needed to strengthen competitiveness in the periphery, market forces acted in the opposite direction. The markets mis-priced credit risk, underpinning large capital flows into the periphery and reducing interest rate spreads. The reduction in spreads led to a relaxation of the budget constraints that the peripheral countries BIS central bankers’ speeches faced and made it difficult to distinguish between those countries that were performing well in terms of policy adjustment and those that were performing poorly. To make matters worse, the current-account deficits in the periphery were financed through sources of volatile capital, such as debt securities and bank loans, rendering the periphery vulnerable to sudden reversals of capital flows. Third, the founders of EMU underestimated the importance of financial stability in a monetary union. Thus, whereas they focused on the prevention of fiscal imbalances and inflation, they made no provision to deal with private credit booms and busts or with the feedback loops between banking crises and fiscal crises. Under the original architecture, national authorities were solely responsible for banking supervision, resolution, deposit insurance, and financial stability. The combination of a lack of adequate fiscal rules, the absence of market-enforced discipline, the lack of attention to the interconnections between the banks and the sovereign, and increases in public and private indebtedness financed by volatile capital inflows was toxic. A tale of two crises Broadly speaking, the euro-area crisis has consisted of two separate crises – a sovereigninduced crisis and a banking-induced crisis, as I will explain. A sovereign debt-crisis mainly occurred in Greece. What the crisis countries – Cyprus, Greece, Ireland, Portugal and Spain – have had in common was large current-account deficits prior to the crisis. In the run-up to the outbreak of the crisis, Ireland had a current-account deficit of around 5 per cent of GDP. That was small relative to those of the other crisis countries. In Cyprus, Greece, Portugal and Spain, the deficits ranged between 12 and 15 per cent of GDP. The initial tremors of the euro-area crisis occurred in Greece in the fall of 2009 following news that the country’s fiscal deficit would be much higher than had been expected by the markets. The country suddenly found itself at the center of a sovereign-debt storm, and interest-rate spreads began a relentless upward climb. The outbreak of the Greek sovereigndebt crisis took the markets by surprise. It should not have done so. Greece joined the euro area in 2001. From that year until 2009, large and growing fiscal and external imbalances should have sounded loud warning alarms in the financial markets. During those years: • Fiscal deficits consistently topped 5 per cent of GDP, peaking at 15.6 per cent at the end of the period. • The widening of the fiscal deficits was mainly expenditure driven; the share of government spending in GDP rose by 9 percentage points – to 54 per cent. • The share of government debt in GDP rose from about 100 per cent at the beginning of the period to 130 per cent at the end of the period. • Greece’s competitiveness, measured in terms of unit labour costs against those of its major trading partners, deteriorated by 30 per cent. • The erosion of competitiveness, coupled with growth rates generated by consumption and an unsustainable fiscal expansion, led to a widening of the current-account deficit. Upon becoming Governor of the Bank of Greece in 2008, I began to publically warn the government – in not very subtle terms – that it needed to urgently take measures to address the fiscal and external imbalances. My warnings were overlooked. Once the crisis started in late 2009, it rapidly became self-reinforcing. The sovereign-debt crisis spilled over to the banking system, even though the banking sector had sound fundamentals – including high CARs, low loan-to-deposit ratios, and low ratios of total-bank- BIS central bankers’ speeches assets-to-GDP – prior to the outbreak of the sovereign crisis. As a result of the crisis, over the period from the end of 2008 until the end of 2013 real GDP contracted cumulatively by 25 per cent, intensifying the debt dynamics and contributing to the self-reinforcing nature of the crisis. In the remainder of the periphery – especially Ireland, Spain and Cyprus – it was the banking sector that generated a sovereign crisis, not the other way around as in Greece. Capital inflows were channeled mainly through national banking systems to help finance construction. Private indebtedness financed by the capital inflows surged, leaving the countries prone to the unwinding of the capital inflows. As with the case of Greece, the inflows fueled large competitiveness losses as rises in the prices of non-tradables spilled over to the tradables sector, setting the stage for a boom-bust cycle. In these countries, the bust came through the banking systems. What happened was that the large size of the banks relative to national GDPs undermined confidence in the sovereigns, creating doom-loops between banking systems and the sovereigns. To explain why this happened, consider the following difference between banks in the United States and those in the euro area. Although the largest banks in the euro area and the United States are of roughly the same size in terms of euro-area GDP and U.S. GDP, respectively, the largest euro area banks represent a much larger share of any individual national economy compared with the situation of U.S. banks. Consequently, banking crises in individual euro-area countries placed large fiscal burdens on governments, calling into question their solvency and making the use of counter-cyclical fiscal policy infeasible. In light of the exposure of the banks to the debt of their sovereigns, the deteriorating fiscal positions, in turn, affected the banks. The lesson from this experience was clear; an effective economic and monetary union needs to include a banking union. A crisis-induced economic adjustment The euro-area crisis served two vital purposes. First, it acted as a wake-up call to policymakers in economies that had become uncompetitive. Second, it brought to the surface fundamental weaknesses in the EU’s institutional structure. Consequently, since the onset of the crisis, policymakers in the stressed countries have made significant progress in addressing fiscal and external imbalances. At the same time, institutional flaws in economic and financial governance are being addressed. In what follows I will first focus on the adjustment that has taken place in Greece. Consider, first, fiscal adjustment. From 2009 to 2013, the fiscal deficit was reduced by some 13 percentage points of GDP. The structural fiscal deficit – that is, the deficit that corrects for the business cycle – has shrunk by 19 percentage points of GDP. The primary fiscal deficit – that is, the deficit that excludes interest payments – was 10½ per cent of GDP in 2009. Last year it swung into a small surplus. What makes these achievements especially impressive is that they have taken place despite a contracting economy, which creates moving targets for fiscal consolidation. Greece’s fiscal consolidation is one of the largest ever achieved by any country under an IMF program. In gross terms, fiscal-adjustment measures amounting to more than 30 per cent of GDP were implemented between 2010 and 2013. In net terms, the figure is, of course, smaller since the gross measures have the effect of making GDP contract. Additional fiscal measures are being implemented this year. These measures will increase the primary fiscal surplus to 1 ½ per cent of GDP this year. The new measures place emphasis on expenditure cuts to reduce the size of the government sector and allow the tradables sector to expand, so that exports can help generate growth. Consider, next, external adjustment. As I mentioned, Greece lost about 30 per cent in terms of cost competitiveness against its major trading partners in the period from 2001 to 2009. BIS central bankers’ speeches Since 2010, the situation has been reversed. As of the end of last year, the entire loss – and more – had been recovered. Competitiveness is also being promoted through structural reforms which have increased the flexibility of labour and product markets. As a result of these improvements in competitiveness, a rebalancing of the Greek economy is taking place. The share of exports of goods and services in GDP rose from 18 per cent in 2009 to 28 per cent last year. This share continues to rise. The current account, which was in deficit to the tune of 15 per cent of GDP in 2008, moved into surplus last year. Two factors about the improvement in competitiveness stand out. First, it has been achieved without the benefit of a nominal exchange-rate devaluation. Reflecting extensive labourmarket reforms, it has been based on reductions in unit labour costs – an internal devaluation. Second, it has been achieved against a backdrop of low inflation in the economies of Greece’s trading partners, a situation that makes it difficult to attain improvements in competitiveness. Consequently, in a matter of several years Greece has been able to transform its enormous external and primary fiscal deficits into surpluses – a remarkable achievement. The banking sector Let me now turn to the restructuring of the Greek banking system. It has been enormous. With the deepening of the crisis, the Bank of Greece stepped in to preserve banking system stability. Our efforts focused on two fronts: • Preserving banking system liquidity, and • Restoring capital adequacy. Ample liquidity was provided to banks, both through monetary policy operations and emergency liquidity assistance. Regarding capital adequacy, the first stage of our strategy included a viability assessment of the banking system. Based on this study, viable banks were fully recapitalized using a combination of state and private funds. State funds were provided by the Hellenic Financial Stability Fund, which had been established with a backstop of € 50 billion for that purpose. Non-viable banks, which were unable to raise private capital, were resolved, using state-of-the-art resolution tools – tools that are now being introduced in other EU countries. Before the crisis, the Greek banking system comprised almost 20 banks. Today we have four well-capitalized, viable pillar banks and a few smaller ones. We are now implementing the second stage of our strategy. This stage involves a new banking model that will allow banks to repay state aid and finance the recovery of the Greek economy. Having acquired the clean portfolios of resolved institutions or having merged, banks are now exploiting synergies and economies of scale, further eliminating excess capacity, and becoming more efficient. They are also refocusing on their core activities – selling non-core assets and rationalizing their networks and activities abroad. Late last year, we re-engaged BlackRock to update credit loss projections for banks’ loan portfolios up to 2016, and to study the efficiency of banks’ procedures in managing nonperforming loans. The efficient use of the backstop during recapitalization and resolution has left a buffer of around € 8–€ 9 billion, should additional capital needs arise. Moreover, the sale of non-core assets and the exploitation of synergies arising from mergers could add some €5 billion to the buffer. A “code of conduct” for banks’ dealings with distressed borrowers is being drawn up and will be implemented as of 2015. It has two objectives: first, to ensure the maximum repayment of non-performing loans; second, to alleviate pressures on borrowers whose ability to repay their debts is at present reduced. Improvements in NPL management will lower capital requirements, freeing up resources that can be used to finance a new growth model for the Greek economy. BIS central bankers’ speeches Some important outstanding issues I will now touch upon two important issues. • Why has the economic contraction been so deep in Greece? • Is the present level of Greek government debt sustainable? When Greece agreed to an adjustment programme with the troika – the IMF, the ECB, and the Commission – in May 2010, a recovery was projected for late-2012. Clearly, no one expected that the contraction, which began in late 2008, would last for 5 years and would cumulate to more than 25 per cent. Why did the projections go so severely off track? There are several reasons. The first reason concerns the magnitude of required fiscal adjustment. The magnitude of fiscal consolidation was bound to be substantial, because the size of the initial imbalances was very large. What increased the effects of the fiscal consolidation was the mix of policies adopted. Experience shows that fiscal consolidation programmes based on spending cuts lead to smaller economic contractions than those based on tax increases. For this reason, I have been calling for fiscal adjustment comprised of two-thirds expenditure cuts and one-third revenue increases – mainly generated by expanding the tax base – since the inception of the programme. During the initial stages of the programme, however, the adjustment measures comprised a mixture of 60 per cent revenue – largely tax – increases and 40 per cent expenditure cuts. The tax increases reduced after-tax income, restraining private consumption, and decreased the after-tax return on investment, reducing the incentive to invest. They thereby had a negative effect on consumer and investor psychology, contributing to a cycle of pessimism that engulfed the economy. The second reason for the deeper than expected economic contraction was that the Greek economy is relatively closed. In closed economies, any decline in demand hits domesticallyproduced goods more than imports. The decline in demand for domestic production, then, affects output more than if the economy were more open. I called attention to this matter in an article I wrote for the Financial Times in early 2012. The third reason that economic contraction reached unprecedented levels concerns the implementation of structural reforms, privatization, and measures to improve tax collection. For an adjustment programme to be effective, all the inter-connected parts must be in place. In the early stages of the programme, that did not happen. Implementation in each of these areas was slow and inefficient, exacerbating the contraction. The slow pace of implementation of structural changes contributed to a rise of uncertainty, including widespread speculation of a Greek exit from the euro. In turn, the uncertainty – and the fact that it inflicted a paralysis on the economy – magnified the size of the fiscal multiplier. Then, there is the issue of the sustainability of Greece’s public sector debt. Presently, the debt-to-GDP ratio stands at about 175 per cent and it is projected to decline to 110 per cent in 2023. Decisions agreed by the Eurogroup in November 2012 – including a reduction in interest rates and lengthening of maturities on official sector loans – have not yet been implemented. Those decisions were conditioned on the achievement of a primary fiscal surplus. That condition has now been achieved; the exact amount of the surplus will be announced in April. With that announcement, I expect that the Eurogroup will agree to measures to help improve Greece’s debt dynamics. That agreement, however, is not all that can be done to improve the debt dynamics. The major reason for the rise in the debt-to-GDP ratio during the past several years has been the sharp decline in GDP. What, then, can be done to boost growth, so that the denominator of the debt-to-GDP ratio acts in a stabilizing way? My earlier discussion points to several areas that need attention. BIS central bankers’ speeches • First, the pace of reform of the product and services markets, and the restructuring of the wider public sector need to be stepped-up. This would lower production costs and improve competitiveness. • Second, the size of the government sector should be reduced to facilitate a shift in production from non-tradables to tradables, allowing a competitive export sector to flourish. • Third, more emphasis should be placed on scaling-back government consumption instead of public-sector investment, since the latter can be a key contributor to the country’s future economic growth. • Fourth, a high priority needs to be given to privatisation and improving the ease of doing business, so as to attract more foreign direct investment. FDI has traditionally been low in Greece. Creating a more growth-friendly environment and speeding up privatization would clearly facilitate FDI. Addressing all of these areas would improve the business climate and reduce uncertainty, creating what I call a “new growth model”. That, in turn, would reduce the still-very-high borrowing costs faced by Greek firms while encouraging banks to begin lending to the real economy. Initiatives at the EU level What about the policy responses to the crisis? They have included actions in both the ECB’s monetary policy and in EMU’s architecture. The actions of the ECB have been decisive. The ECB has kept policy rates at historically-low levels; it has satisfied the liquidity needs of banks, and has expanded its collateral framework. The announcement of Outright Monetary Transactions – the OMT – has helped reduce tail risks of a euro break-up. Furthermore, under its forward guidance the ECB has made it clear that policy rates will be kept at present or lower levels for an extended period of time. Changes in the architecture include both improvements in macroeconomic surveillance and efforts to establish a banking union. Economic governance has been improved through three main pillars: the so-called “sixpack”, the fiscal compact, and the “two-pack”. These pillars involve stronger macroeconomic surveillance designed to identify imbalances earlier, monitor them effectively, and thus ensure their timely correction. These measures should go a long way to preventing the buildup of the large imbalances that were present before the crisis. Banking union is being designed to break the negative feedback loops between banks and the sovereign, as well as to create an integrated, stable and well-capitalised banking sector. The Single Supervisory Mechanism, which will become fully operational this November, will lead to the transfer of the supervision of almost 85 per cent of total euro-area bank assets to the ECB. A necessary complement to a supervisory mechanism is a resolution framework to deal with non-viable banks. Our experience with the successful resolution of 12 banks in Greece has shown that resolution mechanisms need efficient decision-making procedures, allowing resolutions to be done within a weekend, in order to safeguard financial stability. Resolution will also need a credible back-stop. The Fund envisaged will be built up by contributions over a maximum 10-year period. I favour a shorter period to ensure that a credible backstop will be available sooner. Finally, the harmonisation of Deposit Guarantee Schemes will help prevent the emigration of funds in search of higher coverage. The scheme will begin operation in January 2016. BIS central bankers’ speeches Concluding remarks I would like to offer some concluding remarks. For too long, the countries at the euro’s periphery sacrificed long-term gains for short-term gratification. We have seen the results. The policy reforms that the euro-area’s crisis countries are now implementing follow an established recipe. That recipe worked for the U.S. and the U.K. in the 1980s, Sweden and Finland in the early 1990s, Asia in the late 1990s, Germany in the early 2000s, and in many other countries. That recipe stresses the need to improve competitiveness, and includes fixing social security, strengthening employment incentives, privatisation, and streamlining the public sector. Some of these measures – especially those related to structural reforms – take time to work. The gains do not come overnight; they require patience and the ability to ignore the siren calls of those who offer quick fixes. Supported by the ECB’s policies and the strengthening of the EU’s architecture, that recipe is now working. • We have seen an end to the recession in the euro area. • Spreads have declined sharply in peripheral countries, despite recent disturbances in emerging markets. • Slowly – but surely – the monetary transmission mechanism has become less fragmented. • As progress toward banking union continues, fragmentation will further diminish. • Crisis countries have gone a very long way toward eliminating their imbalances. • Confidence is increasing. The case of Greece perfectly illustrates the progress that has been achieved. Since the peak of the crisis in mid-2012: • Spreads against 10-year German sovereigns have fallen by around 1,800 basis points, to around 700 basis points. • The Athens stock exchange has risen by about 85 per cent. • Bank deposits have increased by 9 per cent. • Reliance of banks on Eurosystem financing is down by about 50 per cent. • Economic sentiment has recently reached a 5-year high. • The twin deficits have been transformed into twin surpluses. • The recent release of the PMI for manufacturing for January 2014 points to expansion for the first time in 53 months. It is now generally expected that 2014 will be the year in which growth – although very modest at first – returns to the Greek economy. Underlying this expectation of growth are the following factors. • The substantial progress achieved in terms of competitiveness, including the effects of structural reforms in labour and product markets, will lead to an improved export performance. • The return of confidence will help support a rise in consumption and investment. • Fiscal drag will be considerably less than in previous years. Nevertheless, the euro’s financial storm clouds have not yet completely cleared. Here, again, the case of Greece illustrates the situation in the euro-area more broadly. The economic and financial environment in Greece remains fragile and sensitive to negative developments. The BIS central bankers’ speeches very high unemployment rate and the large sacrifices undergone by the Greek people led to social and political polarization. Political uncertainty, and the risks associated with that uncertainty, could escalate ahead of the European Parliamentary and local Greek elections that will take place in May, undermining the recovery. It is my hope that such an unfortunate scenario will not occur. Greek citizens, like the citizens in the other crisis countries, have had to undergo tremendous sacrifices during the past few years. These sacrifices are now bearing fruit and it would be tragic to see them washed away. Despite these risks, I am confident that Grecovery is on the way. The financial storm served an important purpose. It set in motion policy reforms at both the individual-country level and the euro-area level that will help foster a stronger and more secure Europe, improving the welfare of its citizens and enhancing its position as a major player on the world stage. BIS central bankers’ speeches

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Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the Bank of Poland Biannual EU Presidency Lecture "From Financial Crisis to Financial Stability: A European Odyssey", Warsaw, 12 February 2014.

George A Provopoulos: From financial crisis to financial stability – a European odyssey Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the Bank of Poland Biannual EU Presidency Lecture “From Financial Crisis to Financial Stability: A European Odyssey”, Warsaw, 12 February 2014. * * * I would like to thank President Belka for inviting me to be here. The occasion of these lectures provides an opportunity to take stock of the progress made toward European monetary and economic integration and the work that lies ahead. My discussion of these issues will be structured as follows. I will begin by describing some important shortcomings in the original euro area institutional set-up. This will lead me to a discussion of the origins of the euro area crisis. Next, I will describe the ECB’s reaction to the crisis, as well as the measures that have been, or are being taken, to address the euroarea’s shortcomings, focusing on economic governance and banking union. I will then take stock of where we stand today – both in the euro area as a whole and in peripheral countries. Finally, I will comment on what remains to be done to make Europe more dynamic and globally competitive. The euro area at its formation and the origins of the crisis When deciding on what architecture to give to the monetary union, policymakers settled on a “bare-bones” approach. The approach rested on an independent, price-stability-oriented central bank – the ECB – and fiscal discipline by the individual countries, fostered by the rules of the Stability and Growth Pact and enforced by the markets. The Maastricht Treaty called on countries to pursue sound economic policies that would support the ECB in maintaining its price-stability goal. The dominant view at the founding of the EMU was that current-account imbalances among countries in the monetary union would become as irrelevant as they are among regions of individual countries. Persistent current-account deficits were interpreted as capital flows from countries offering relatively-low returns on investments to countries offering relatively-high returns. In other words, they were welcomed as part of an equilibrating process under which the fast-growing periphery caught up to the core. This architecture proved inadequate for several reasons, setting the stage for the euro-area crisis. First, the fiscal rules were poorly designed and under-enforced. As a consequence, in the years leading up to the crisis, the ratio of sovereign debt to GDP in many countries remained at high levels. In some countries, the debt ratios increased. Second, instead of increasing the pressure for structural reforms and policy adjustments needed to strengthen competitiveness in the periphery, market forces acted in the opposite direction:  The markets focused on the elimination of exchange-rate risk, while at the same time they mis-priced credit risk, underpinning large capital flows into the periphery and reducing interest rate spreads.  The reduction in spreads and the abundance of capital led to a relaxation of the budget constraints that the peripheral countries faced and made it difficult to distinguish between those countries that were performing well in terms of policy adjustment and those that were performing poorly. BIS central bankers’ speeches  To make matters worse, the current-account deficits in the periphery were financed through sources of volatile capital, such as debt securities and interbank loans, rendering the periphery vulnerable to sudden reversals of capital flows. Third, the founders of EMU underestimated the importance of financial stability in a monetary union. Thus, whereas they focused on the prevention of fiscal imbalances and inflation, they made no provision to deal with private credit booms and busts or with the feedback loops between banking crises and fiscal crises. Under the original architecture, national authorities were solely responsible for banking supervision, resolution, deposit insurance, and financial stability. The combination of a lack of adequate fiscal rules, the absence of market-enforced discipline, the lack of attention to the interconnections between the banks and the sovereign, and increases in public and private indebtedness financed by volatile capital inflows was toxic. A tale of two crises Broadly speaking, the euro area crisis has consisted of two separate crises – a sovereigninduced crisis and a banking-induced crisis. The sovereign-induced crisis is mainly what happened in Greece. The initial tremors of the euro area crisis occurred in Greece in the fall of 2009 following news that the country’s fiscal deficit would be much higher than had been expected by the markets. The country suddenly found itself at the centre of a sovereign debt storm, and interest-rate spreads began a relentless upward climb. The outbreak of the Greek sovereign debt crisis took the markets by surprise. It should not have done so. Greece joined the euro area in 2001. From that year until 2009, large and growing fiscal and external imbalances should have sounded loud warning alarms in the financial markets. During those years:  Fiscal deficits consistently topped 5 per cent of GDP, peaking at 15.6 per cent at the end of the period.  The government debt to GDP ratio rose from about 100 per cent at the beginning of the period to 130 per cent at the end of the period.  Greece’s competitiveness, measured in terms of unit labour costs against those of its major trading partners, deteriorated by 30 per cent.  The erosion of competitiveness, coupled with high growth rates generated by consumption and an unsustainable fiscal expansion, led to a widening of the current-account deficit. Upon becoming Governor of the Bank of Greece in 2008, I began to publically warn the government – in not very subtle terms – that it needed to urgently take measures to address the fiscal and external imbalances. My warnings were overlooked. Once the crisis started in late 2009, it rapidly became self-reinforcing. The sovereign debt crisis spilled over to the banking system, even though the banking sector had sound fundamentals – including high CARs, low loan-to-deposit ratios, and low ratios of total bank assets to GDP – prior to the outbreak of the sovereign crisis. As a result of the crisis, over the period from the end of 2008 until the end of 2013 real GDP contracted cumulatively by 25 per cent, intensifying the debt dynamics and contributing to the self-reinforcing nature of the crisis. In the remainder of the periphery – especially Ireland, Spain and Cyprus – it was the banking sector that generated a sovereign crisis, not the other way around as in Greece. Capital inflows were mainly channeled through national banking systems to help finance construction. Private indebtedness financed by the capital inflows surged, leaving the BIS central bankers’ speeches countries prone to the unwinding of the capital inflows. As with the case of Greece, the inflows fueled large competitiveness losses as rises in the prices of non-tradables spilled over to the tradables sector, setting the stage for a boom-bust cycle. In these countries, the bust came through the banking systems. What happened was that the large size of the banks relative to national GDPs undermined confidence in the sovereigns, creating doom-loops between banking systems and the sovereigns. To explain why this happened, consider the following difference between banks in the United States and those in the euro area. The largest banks in the euro area and the US are of roughly the same size in terms of euro area GDP and US GDP, respectively. However, the largest euro area banks represent a much larger share of their individual national economies compared with the situation of US banks. Consequently, banking crises in individual euro area countries placed large fiscal burdens on governments, calling into question their solvency and making the use of counter-cyclical fiscal policy infeasible. In light of the exposure of the banks to the debt of their sovereigns, the deteriorating fiscal positions, in turn, affected the banks. The lesson from this experience was clear; an effective economic and monetary union needs to include a banking union. Finally, it is important to underline that a common feature of each of the crisis countries prior to the outbreak of the Greek crisis was their large current-account deficits. The counterparts of these deficits were deficits in the saving-investment behavior of either the public sector or the private sector. The contribution of the ECB to resolving the crisis Exceptional times call for exceptional measures. The ECB responded to the crisis in a bold, broad and, frequently, unconventional manner. In considering the ECB’s response, it is important to recognize that the euro area is largely a bank-based economy. The ECB’s response reflected this circumstance. Prior to the crisis, monetary policy mainly comprised adjustments to the policy rate. The crisis disrupted the transmission mechanism. Banks became reluctant to borrow from, and lend to, other banks; the interbank market broke down. Uncertainty and perceptions of high counterparty risk led to the fragmentation of financial markets. The ECB’s response to the crisis included the following: First, interest rates were reduced sharply. With the onset of the crisis, the policy rate, which stood at 4.25 per cent in July 2008 was lowered in successive stages; it presently stands at a historic low of 0.25 per cent. Second, to enhance the flow of credit both within and across borders, the ECB’s Governing Council took a number of unconventional measures. In particular:  To accommodate the liquidity needs of banks in the face of disruption in the interbank markets, the ECB introduced a policy of fixed-rate, full allotment. Under this procedure, banks were given access to as much funding as they desired, given adequate collateral, at a fixed rate. This measure has the advantage that it can react flexibly to liquidity shocks; it is set to continue until at least July 2015.  Longer-term refinancing operations were introduced (initially for a maturity of 6 months, then for one year, and, ultimately, for three years).  The list of assets acceptable as collateral was widened.  When, in the summer of 2012, the risk of contagion rose sharply and investors were pricing in the tail risk of a break-up of the euro area, President Draghi announced the OMT initiative – Outright Monetary Transactions. Under the OMT the European Central Bank pledged to make purchases in secondary, sovereign bond markets of securities issued by Eurozone member-states, under certain conditions. It is important to note that OMTs are not designed to finance government budget deficits but to remove the tail risk of a euro area break-up. Bonds would only be bought on secondary markets, would be of short maturity, and would not necessarily be held to BIS central bankers’ speeches maturity. More importantly, OMTs involve conditionality. Countries whose bonds are purchased need to be on an adjustment programme. To date, there has been no need to activate OMTs. The announcement of the availability of the OMT has sufficed.  Finally, in the summer of 2013, the ECB changed its monetary policy communication strategy to include forward guidance on the policy rate. Addressing the fundamental weaknesses in the EU’s architecture The ECB, of course, has not been alone in reacting to the crisis. The crisis brought to the surface the fundamental weaknesses in the EU’s institutional structure. As a result, important initiatives have either been taken or are in the process of being taken at the EU level. It is important to note that, although some of these changes are binding only for euro area countries, they have been largely endorsed also by non-euro area countries. It is true that the initiatives do stem from an analysis of the problems of the euro area in particular. However, they are equally valid for all countries in a union with such a high degree of monetary and economic integration. And this is especially true when one considers that, with the exception of the UK and Denmark, all countries joining the EU are committed to joining the euro area. Changes in the architecture include both improvements in macroeconomic surveillance and actions to establish a banking union. Economic governance has been improved through three main pillars: the so-called “six-pack”, the fiscal compact, and the “two-pack”. These pillars involve stronger macroeconomic surveillance designed to identify imbalances – both fiscal and external – on an early basis, and to monitor them effectively, thus ensuring their timely correction. The so-called “six-pack” reinforces the preventative arm of the Stability and Growth Pact and introduces a debt trigger for the excessive deficit procedure whereas in the past the trigger was confined to a fiscal deficit above 3 per cent of GDP. Additionally, it includes the Macroeconomic Imbalances Procedure under which a variety of indicators of such imbalances can be monitored. Under the Fiscal Compact, member states that have signed the Compact are required to limit structural deficits – that is, general government deficits over the cycle – to 0.5 per cent of GDP. Finally, the so-called “two-pack” gives strong powers to the Commission to intervene directly in budgetary plans before they are approved by the national parliaments. These new supranational tools will go a long way enguarding against the build-up of large imbalances of the kind that were present before the crisis. Other areas of intervention comprised the macroprudential oversight and the establishment of financial backstops:  The European Systemic Risk Board was established in 2011 to exercise macroprudential oversight of the EU-wide financial system.  The EFSF was established as a temporary financial backstop in 2011, while its successor, the ESM provides a permanent facility for responding to new requests for financial assistance by euro-area member states. However, the most ground-breaking reform of the EU’s architecture as a result of the crisis has undoubtedly been the banking union. As I mentioned, the crisis has exposed the weakness of a monetary union not accompanied by a banking union. In the early years of monetary union, considerable progress was made in integrating the various domestic – nationally-oriented – markets. In recent years, that progress has been reversed; there has been a marked retreat into nationally-based banking and financial systems. This retreat has led to a fragmentation of financial markets, contributing to the breakdown of the monetary transmission mechanism. To deal with that fragmentation, efforts BIS central bankers’ speeches are well underway to build a banking union. As the crisis was characterized by negative feedback loops between banks and the state, the banking union will help maintain financial stability. In Greece, where the crisis was sovereign-induced, the subsequent rise in sovereign spreads severely challenged banks’ capital adequacy. Greek banks’ capital was effectively wiped out after the haircut on Greek bonds. Recapitalization of banks was only possible through the introduction of the backstop of the Hellenic Financial Stability Fund, the resources of which were provided through official-sector loans to the Greek state. In other countries, where the crisis was bank-induced, the size of the banks often overwhelmed the fiscal capacity of the countries in which they were based. The case of Ireland is an example. Measures to ensure continued financial stability resulted in a sovereign deficit which reached 31 per cent of GDP in 2009. Sovereign debt in Ireland now stands at almost 120 per cent of GDP, up from around 25 per cent of GDP in the mid-2000s. For these reasons, the creation of a banking union is of paramount importance to promote financial integration and to ensure financial stability. Its further development is an important aim of the Greek Presidency. In this connection, I will now address three important issues. The banking union will include the following key components: a Single Supervisory Mechanism, a Single Resolution Framework and the accompanying Single Resolution Mechanism, a Single Resolution Fund, and the harmonization of Deposit Guarantee Schemes. The Single Supervisory Mechanism will become fully operational in November 2014. It will imply the transfer of supervision of around 130 banking groups (comprising some 2,000 individual banks) to the ECB. Almost 85% of total banking assets in the euro area will be covered. The Asset Quality Review, which will precede the full operation of the Single Supervisory Mechanism, provides a unique opportunity for the ECB to restore full confidence in the European banking sector. It will also give the ECB a vital snapshot of conditions in the banks for which it will be responsible. A necessary complement to a Single Supervisory Mechanism is a Single Resolution Framework to deal with non-viable banks and preserve financial stability. The Single Resolution Mechanism, and its associated funding through the Single Resolution Fund, outlines a framework establishing the procedure for dealing with banks that are considered non-viable. Our experience with the successful resolution of 12 banks in Greece in the last few years has taught us that resolution mechanisms need efficient decision-making procedures which allow resolutions to take place quickly, typically over a weekend. To this end, the decision about the viability of an institution should lie with the supervisor only. The Single Resolution Mechanism should not have the competence to decide on viability since this would imply multi-layered decision making, which for resolution would be, to say the least, inefficient. Resolution also needs to have a credible back-stop. Herein lies a significant challenge for the Greek Presidency. The European Council agreed a General Approach which will lead to an Intergovernmental Agreement, currently under negotiation. Under the General Approach, the Single Resolution Fund will be built up by contributions from banks over a maximum 10-year period. Should adequate funds not be available, the General Approach states that national authorities should be responsible. However, the continuation of national funding of resolution has a significant drawback. It implies that the negative-feedback loops which have been experienced between banks and sovereigns will remain. Thus, the issue of whether common backstop arrangements will be in place, both for the transition period and in the steady state, is in question. In addition, I believe that the 10-year period should be shorter in order to minimise the period during which, effectively, a credible backstop will not exist. Even at the end of the 10 years, the resources of the fund could be depleted. In such a situation, it would be useful if the Single Resolution Fund were able to BIS central bankers’ speeches borrow from the markets or have access to funds from the European Stability Mechanism. However, the challenges do not end there. The European Parliament is taking a somewhat different approach. It envisages that it will play a greater role in decision-making procedures. It also has reservations about the clear nature of the backstop. In short, there is still some way to go to forging an agreement on all aspects of bank resolution in the banking union. Finally, the harmonisation of Deposit Guarantee Schemes will help prevent the emigration of funds in search of better coverage. The scheme will begin operation in January 2016. Over time, however, it might be wise to revisit the issue of going beyond harmonisation to creating an EU-wide Fund, in order to further break links in the negative feedback loops that can develop between banks and the state. Where do we stand? Since the onset of the crisis, policymakers in the crisis countries have made significant progress in addressing fiscal and external imbalances. The euro area has achieved an improvement in its fiscal deficit from 6.4 per cent of GDP in 2009 to 3.2 per cent in 2013. Fiscal adjustment in programme countries has been extremely impressive. In Greece, the fiscal consolidation is one of the largest ever achieved by any country under an IMF programme: Between 2009 and 2013, the fiscal deficit was reduced by some 13 percentage points of GDP. The structural fiscal deficit – that is, the deficit that corrects for the business cycle – has shrunk by 19 percentage points of GDP. The primary fiscal deficit – that is, the deficit that excludes interest payments – was 10½ per cent of GDP in 2009. Last year it swung into a small surplus. What makes these achievements especially impressive is that they have taken place despite a contracting economy, which creates moving targets for fiscal consolidation. As I mentioned, the crisis countries have made significant progress in reducing their external imbalances. Between 2008 and 2013, the current account balances of Ireland, Portugal and Greece as a percentage of GDP improved by between 10 and 16 percentage points. Much of this improvement reflects price and cost adjustments. Unit labour costs have fallen significantly. As a result, labour cost competitiveness has improved by over 20 per cent in Greece, Ireland and Spain during the crisis. Structural reforms have also helped reduce external imbalances. That recipe worked for the U.S. and the U.K. in the 1980s, Sweden and Finland in the early-1990s, Asia in the late1990s, Germany in the early-2000s, and in many other countries. However, the effects of such reforms took time to impact on growth. The gains do not come overnight. The euro area is now emerging from recession, although the initial recovery is modest, fragile and uneven. The baseline scenario is for slow growth. Several factors are contributing to the initial weakness of the recovery. First, private and public sector balance sheets are still adjusting in many euro area countries. However, in light of the large fiscal adjustment that has already taken place, the fiscal drag is declining. Second, investment has been declining over the past year due to anaemic demand, weak confidence and bank deleveraging and, where loans are available, high lending rates, especially to SMEs in the stressed countries. Nevertheless, in light of (1) the very-large fiscal and competitive adjustments that have been taking place, especially in the stressed countries, (2) on-going improvements in the architecture, and (3) the ECB’s accommodative monetary stance, enhanced by forward guidance that will ensure low policy rates for an extended period of time, I expect that euro-area growth will gradually pick-up. The main risks to this scenario are as follows: The first risk relates to social and political factors. As a result of the crisis, euro-area unemployment, at 12 per cent, is very high. It is particularly high among young people. This situation is a fertile ground for the breeding of social tensions, undermining confidence in the European project and European institutions. The upcoming European elections could well BIS central bankers’ speeches produce results that reflect these tensions, as citizens look for extreme solutions. Political risks could make the implementation of necessary reforms more difficult. The second risk is that of the threat of deflation in the euro area. Since October of last year, inflation has been below 1 per cent. The January outcome was 0.7 per cent. It is important to recognize that deflation, defined as a general, self-propagating fall in prices, is not something that characterizes the euro area at present. To a certain extent, the deflation in some countries, including my own, is a result of the necessary rebalancing of economies that have lost competitiveness. Nevertheless, deflation makes it more difficult to achieve fiscal targets. Although I do not believe that we are headed for euro-wide deflation, a protracted period of low inflation has the potential to make deflation a reality. As ECB President Draghi has recently made clear, we are aware of the risks and are prepared to respond should the need arise. The ECB’s monetary policy stance remains accommodative. We have shown that we can draw on a wide and powerful toolkit to steer the economy in difficult times. The nonstandard measures that we have adopted have had powerful effects in ensuring, not only that we have stuck to our mandate with respect to inflation, but also that we have preserved financial stability. Concluding remarks: the future of Europe Let me conclude with the following remarks: Considerable adjustment in the euro area has already taken place in eliminating imbalances and restoring the conditions for sustainable growth. Financial market fragmentation is receding and the euro-area banking sector is undergoing unprecedented adjustment, as evidenced in the case of the Greek banking sector. Banks have taken measures to consolidate and to increase efficiency. They are strengthening their capital basis. Market tensions have been receding, as evidenced by the narrowing of spreads in sovereign markets and improved access to bank credit. Recourse to Eurosystem lending operations has fallen sharply – down some 45 per cent from its peak. More credible progress is, however, needed with respect to both balance sheet repair and the orderly de-leveraging of the non-financial sector. Such a process involves not only continued support to viable firms, but also the swift exit of non-viable ones. This process can deliver substantial benefits by helping to restore banks’ balance sheets to health, thus helping to restore credit flows. The Hellenic Presidency of the European Union is promoting policies that will help move the European project forward so that the conditions for a dynamic and globally competitive Europe are put into place. I have already mentioned the importance of furthering steps to a full banking union, a necessary condition for moving Europe forward. We have already seen the costs that a dysfunctional financial sector can impose on the real economy. In addition, the Hellenic Presidency will be giving emphasis to a number of other areas. These include: the financing of the real economy, focusing particularly on SMEs, since they account for about 99 per cent of firms and for around 60 per cent of jobs in the EU. To this end, progress needs to be made in relation to the Long-term Investment Funds Regulation, which focuses explicitly on the financing of large infrastructure projects and SMEs. Another policy area that will receive emphasis is that of tax policies and systems. Fighting tax fraud and tax evasion are crucial to exploiting the full benefits of the internal market. In this respect, the Presidency will promote the Directive of Administrative Cooperation for the extension of automatic exchange of information in early 2014 and the adoption of the revised savings taxation Directive by March 2014. Finally, work on the Directive on a Common Consolidated Corporate Tax Base will be taken forward. BIS central bankers’ speeches The crisis in Europe has come at a large cost to the people of Europe, particularly those in the crisis countries. Nevertheless, by serving as a wake-up call, the euro-area crisis has led to a strengthening of the monetary union, in particular, and the EU, in general. We are now emerging from that crisis. The lessons of the crisis will prove invaluable in the task of undertaking policies that will enhance growth, employment creation and financial stability. The crisis has taught that financial stability cannot be taken for granted. It has to be ensured through the steadfast implementation of financial institution supervision – both at the micro level and the macro-prudential level – and the appropriate conduct of monetary policy. I am confident that we are taking measures needed to ensure that we will not undergo a comparable crisis in the future. It is for that reason that I am optimistic about the future of Europe, and the ultimate goal of improving the living standards of all EU citizens. BIS central bankers’ speeches

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Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the 81st Annual Meeting of Shareholders, Athens, 27 February 2014.

George A Provopoulos: Indications are that 2013 was the last year of recession Speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the 81st Annual Meeting of Shareholders, Athens, 27 February 2014. * * * At the previous General Meeting of Shareholders of the Bank of Greece in February 2013, I had stated that, according to the Bank’s assessment, the Greek economy would soon stabilise. At the time, our forecasts indicated that the recession would gradually ease and that positive GDP growth rates would be observed in 2014. The developments in the past year have confirmed this assessment. More specifically, in the past twelve months: First, economic policy remained committed to the stabilisation programme. Consistent implementation of the programme boosted international markets’ confidence in Greece. As a result, the spread between Greek and German 10-year government bonds fell to 655 basis points at end-2013, from 1,000 basis points at end-2012. Second, the improvement in confidence is gradually feeding through into the real economy. The fall in GDP in 2013 turned out to be milder compared both with 2012 and with projections in early 2013, mainly on account of the robust performance of exports, especially tourism, and smaller declines in consumption and investment. Third, the risks to gradual stabilisation did not materialise. The most serious of these risks was the Cypriot crisis, which was dealt with promptly and effectively, without repercussions for confidence in the domestic banking system. Fourth, the recapitalisation of Greece’s four core banks was completed successfully, and major steps were taken towards restructuring and consolidating the banking system. These changes were carried out smoothly, without impact on the safety of deposits and financial stability. The year 2013 marks a turning point, with the elimination of the twin deficits and the restoration of the economy’s cost competitiveness The increasingly brighter outlook during the course of 2013 gradually led to stabilisation and permitted noticeable improvements in fiscal and macroeconomic aggregates: The first noteworthy development is the estimated achievement of a primary surplus for the first time since 2002. This is a remarkable achievement, considering the severity of the recession. Second, according to provisional data from the Bank of Greece, the current account posted a small surplus in 2013. The substantial improvement in the current account balance over the last four years was due to lower imports, as a result of the recession, and to increased exports. Between 2010 and 2013, while imports of goods and services in nominal terms contracted by 15%, exports rose by 21%. Third, after more than two decades of almost continuous losses in international competitiveness up to 2009, by 2013 Greece had recovered all of the cost competitiveness it had lost relative to its trading partners. This was due mainly to a decline in unit labour costs throughout the economy in the context of a deep recession with a surge in unemployment, and greater labour market flexibility. Price competitiveness, by contrast, has not yet fully recovered, as inflation only started to respond to weak demand and lower labour costs during 2013. Negative inflation of –0.9% in 2013 has contributed to improving the economy’s price competitiveness and supports real incomes. BIS central bankers’ speeches Structural reforms were implemented between 2010 and 2013 that had been overdue for decades The elimination of both domestic and external macroeconomic imbalances came as the result of a gradual adjustment of the economy from 2010 to 2013. During the same four-year period, a series of structural reforms were implemented in labour and product markets and in public administration. Structural changes in labour and product markets In the labour market, significant changes were adopted, aimed, first, at better aligning wage developments with firm performance and, second, at enhancing labour mobility across sectors. Progress with structural reforms in goods and services markets, by contrast, was markedly slower than in the labour market. Nevertheless, according to OECD estimates, Greece ranked first in responsiveness to structural reform recommendations made by the Organisation. Institutional changes to public administration The fiscal measures taken during the period 2010–2013 aimed at improving the budgetary balance as quickly as possible. They consisted mainly of increases in direct and indirect taxes, as 60% of the adjustment achieved came from increased tax receipts, while the remaining 40% came from expenditure cuts. Nonetheless, this period also witnessed significant institutional changes geared towards streamlining the public administration and downsizing the public sector. At the same time, new institutional reforms were adopted that lay the foundations for improving fiscal management and ensuring the better control of public spending. It should, however, be stressed that progress with several critical reforms, such as administrative reform and the restructuring of public entities through mergers or closure, was slow, thereby delaying an effective restructuring of public administration and an improvement in public services. Efforts have also been made to upgrade the tax collection mechanism. However, here as well, despite clear improvement, the necessary progress in curbing tax and contribution evasion has yet to be made. Financial stability was safeguarded by the bank of Greece with the support of the government During the crisis, Greek banks were cut off from international markets and, until June 2012, experienced an unprecedented outflow of deposits, equivalent to one third of the deposit base. In response, they resorted increasingly to short-term financing from the Eurosystem. At the height of the crisis in June 2012, total central bank financing to credit institutions came close to €140 billion. In addition, although Greek banks entered the crisis with satisfactory capital adequacy ratios, the heavy losses they suffered from 2010 onwards and especially the impact of Private Sector Involvement (PSI) resulted in nearly all banks being faced with a capital shortage at end-2011. The recapitalisation of Greek banks thus became imperative, in order to fully protect depositors. Under these adverse circumstances, the government and the Bank of Greece took a number of decisive actions aimed at safeguarding financial stability and protecting depositors. The most important of these actions involved: • the uninterrupted coverage of banks’ short-term liquidity needs and the public’s demand for cash; • the securing of adequate public funds for the recapitalisation and restructuring of the Greek banking sector; BIS central bankers’ speeches • the resolution of weak banks under a new legal framework; and • the recapitalisation of core banks. Steps towards the restructuring of the banking system The establishment of an appropriate resolution framework allowed for a smooth restructuring of the banking sector. By end-2013, twelve banks had been resolved, mainly via the transfer of their healthy assets to another bank. Also, following a bidding process, the assets and liabilities of Cypriot bank branches were transferred smoothly to a Greek bank. With the completion of the recapitalisation process by mid-2013, banks’ capital adequacy ratios had been restored. The Hellenic Financial Stability Fund (HFSF) is now the largest shareholder in each of Greece’s four core banks and has a buffer of over €8 billion to meet any further capital needs. The banking landscape today is different from that prevailing at the start of the crisis. Excess capacity has largely been eliminated, fewer but stronger banks are in operation, and the first benefits from the exploitation of synergies are already visible. Institutional reforms to reinforce EU economic governance The crisis served as a catalyst for strengthening economic governance in the EU, in general, and the euro area, in particular. Support mechanisms were created. Economic policy coordination and budgetary surveillance have been reinforced. The new fiscal framework, laid down in the “Fiscal Compact”, came into force in January 2013. Member States that have signed up to the Compact are required to adopt national fiscal rules to ensure that the annual structural government deficit does not exceed 0.5% of GDP, as well as a correction mechanism to be triggered automatically in the event of deviation from either the Medium-Term Objective (MTO) itself or the adjustment path towards it. At the same time, decisions were taken towards enhancing the institutional framework for financial supervision and safeguarding financial stability. Top priority was given to the establishment of a banking union. The approval of the Single Supervisory Mechanism, scheduled to become operational in November 2014, as well as the European Council’s agreement on a general approach to a Single Resolution Mechanism are important steps towards the completion of the banking union. In 2013, agreement was also reached on directives on deposit guarantee schemes and a framework for the recovery and resolution of credit institutions. As far as Greece is concerned, the institutional improvements to the EMU architecture will ensure that past mistakes in fiscal management are not repeated and will contribute in the long run to economic stability, while the banking union is expected to boost confidence in the banking system. Prerequisites for the materialisation of the forecasted recovery in 2014 Based on all the available data, it is reasonable to forecast that 2013 was the last year of recession. However, if this forecast is to become a reality, not only must the conditions contributing to the improved outlook remain unchanged, but they also have to be taken further. The prerequisites for this to happen are: • Resolve and consistency in implementing the stabilisation programme. The positive outcomes so far leave no room for complacency. On the contrary, they call for a continuation of fiscal adjustment for maintaining a sustainable and increasing primary surplus so as to ensure debt sustainability and consolidate the climate of confidence. BIS central bankers’ speeches • Elimination or at least minimisation of the risks and uncertainties that might be triggered by a deterioration in the social and political climate, as a result of growing confrontation in the run-up to the European and local government elections. Today, as we are near the end of a protracted recession, a comprehensive national policy that will lead us safely out of the crisis and onto a path of sustainable growth is required. To be effective, such a policy requires consensus building and compromise. Both, however, are difficult to achieve in a polarised climate, which acts only to amplify differences and thwarts the convergence of views. A prerequisite for growth is the continuation of fiscal adjustment. In this regard, top priority must be given to: • ensuring consistency in the execution of the 2014 Budget, thereby providing a strong signal that the fiscal adjustment is sustainable; • markedly upgrading the tax administration and the tax collection mechanism; • speeding up the resolution of tax cases pending before the courts; • cutting red-tape and the administrative burden on the private sector; • enhancing the quality of public services; • evaluating the performance of public services and civil servants according to transparent and objective criteria; and • further strengthening the institutional framework for budget preparation, execution and monitoring. Financing the economic recovery With the start of the fiscal crisis in 2009 and the deep recession that followed, both the supply and demand for credit contracted sharply. Against this backdrop, banks’ lending capacity was inevitably constrained, as the fiscal crisis strongly affected the credit ratings of both the country and domestic banks. Thus, bank credit to the private sector gradually declined, causing a large number of businesses to have difficulty financing their production activities. Subsequently, the banking landscape in Greece has changed. Recapitalisation and restructuring of the banking system are gradually restoring confidence and are creating the conditions necessary for the supply of bank credit to the economy to increase over the medium term. However, several factors continue to limit new lending in the short term. The most important are the following: First, net deposit inflows, a critical determinant of banks’ capacity to supply credit to the economy, remain low. Second, the loan-to-deposit ratio needs to be kept at a conservative level. This ratio has risen largely because of the loss of deposits during the crisis. Third, the reliance of domestic banks on short-term financing from the Eurosystem remains high, in contrast to other euro area countries, and must be gradually brought down to more reasonable levels. Fourth, despite the boost in confidence achieved after the recapitalisation, the accumulation of non-performing loans gives rise to concern. This accumulation makes banks reluctant to extend new credit, as it signals a high level of credit risk. Moreover, the non-servicing of loans deprives banks of income that could otherwise be recycled into new loans. Accumulating non-performing loans force banks to tie up more capital for future loan-loss provisions. BIS central bankers’ speeches The capacity for credit expansion will remain limited on account of these factors. This credit squeeze can, however, be offset in the short term by companies turning to alternative sources of funds, such as internal capital generation, corporate bond markets, equity markets, private placements and other modern financing tools, as well as resources available from EU Structural Funds and the European Investment Bank. In the medium term, though, the improvement in macroeconomic aggregates will pave the way to a gradual normalisation of credit expansion. Policy to speed up the restructuring of the economy and move quickly to sustainable growth The main objective of policy today is the strengthening of the productive capacity of the economy so that the emerging recovery can be the start of sustainable growth in the years ahead. The economy is in a process of transition from a growth model that has exhausted its limits to a new model, capable of ensuring robust, sustainable growth in the future. As the Bank of Greece has repeatedly stressed, this new growth model must be based on a shift: • from production of non-tradables to production of tradables; • from consumption to savings and investment. Admittedly, while the old growth model was discredited suddenly and violently, the new model has yet to emerge clearly into sight. Transformation is, by its very nature, slow and painful, as it entails a shift of capital and human resources across sectors and activities. It presupposes the emergence of new poles of attraction for capital, innovative investment and cutting-edge entrepreneurship. It can be facilitated by a reorientation of the banking system and policies to enhance labour mobility. The restructuring of the economy towards tradables production has already begun, but remains weak, against the backdrop of recession and heightened uncertainty. Restructuring can, however, be accelerated if economic policy assigns top priority to generating the necessary conditions conducive to the desired transformation. Such a policy objective requires: • Well-functioning markets for products, labour and capital. • A business environment in line with best international practices, with a low administrative burden for businesses, an efficient public sector and a stable and favourable tax framework. • A steady commitment to reducing the tax burden, especially on businesses. Declining taxation would both increase the incentive to invest and make more funds available for investment. • Accelerated implementation of the privatisation programme and strengthening of the legal framework for investor protection to attract foreign investment. • A shift on the part of companies to market-based financing. • The productive use of programmes for the co-financing of loans and guarantees with resources from EU Structural Funds and the European Investment Bank. • The active role of the banking system in the restructuring of businesses and sectors, with specific actions to support truly viable businesses and to encourage initiatives that promote bold sectoral restructuring. By adopting such a stance, banks could speed up the transition to the new growth model that Greece so urgently needs. BIS central bankers’ speeches The challenges and role of the banking system today As the only sector to have undergone such radical restructuring, the banking system today is well-positioned to play an active role and spearhead the restructuring of the business sector. What the banks have learned from experience can be equally valuable for businesses in other sectors. The banks should therefore see it as their duty to make an essential contribution to the transformation of production along the lines of the new sustainable growth model. To this end, bank strategy must be reoriented so as to avoid a recurrence of the trends of the previous decade, when credit was largely used for residential investment and consumption. New credit must now go to dynamic outward-looking enterprises with growth prospects. In other words, the limited liquidity available should be channelled into the real economy in a way that maximises its growth potential. It is pointless, and even dangerous, to let weak, non-viable businesses and saturated sectors to continue operating as usual. More reforms now in order to turn stabilisation into dynamic growth After a protracted period of deep recession, the Greek economy is showing signs of recovery. We now face the challenge of turning the incipient signs of stabilisation into dynamic growth built on solid foundations. This, today, is the main item on the national agenda, the only way to ensure that the sacrifices of the past years will not have been in vain. The front-runners in this effort will be dynamic firms that shift their activities to new products and markets, generating a virtuous circle of growth. Economic policy can and has to facilitate this effort. The banking system must also lead the way by effectively supporting the restructuring of the business sector. The Greek economy, after years of complacency, during which the twin deficits and debts rose to unsustainable levels, ultimately culminating in a crisis of unprecedented scale and depth, is now stabilising. The country has come a long way in terms of adjustment. However, the effort has not yet been completed. Now that we have succeeded in overturning the twin deficits into twin surpluses – a primary fiscal surplus and an external surplus – we must focus our attention on structural reforms and speed up their pace. It is in this area that our actions have not been broad and deep enough to ensure that structural changes can steadily feed through into sustainable growth. Regrettably, attempts at structural reform so far have been timid, characterised by wavering and delays. We all know of reforms that have been announced repeatedly over the past four years and yet have still not been implemented. If we want to move forward, we have to overcome these weaknesses. The anticipated recovery will prove hesitant and fragile, undermining the country’s growth prospects, if we fail to implement reforms, aimed to ensure: • a fundamental reorganisation of the state; • modernisation of the institutions of education, health care and justice; • the creation of competitive markets, including the opening-up of closed professions; and • the design of a stable tax system, friendly to entrepreneurship and labour, but strict with tax evaders. Only through such reforms can an environment conducive to sustained and healthy growth, as well as to economic and social progress, be created. BIS central bankers’ speeches

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Opening speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the EUROFI, Athens, 31 March 2014.

George A Provopoulos: The SRM, financing the real economy and related European initiatives Opening speech by Mr George A Provopoulos, Governor of the Bank of Greece, at the EUROFI, Athens, 31 March 2014. * * * It is a pleasure to welcome you to Athens for this high-level seminar, co-organized by EUROFI, the Greek Presidency, and the Bank of Greece. My remarks will focus on two issues. First, I will make a short comment on the agreement reached on the Single Resolution Mechanism (SRM). Second, I will provide reflections on another important issue – the financing of the real economy and European initiatives related to that financing. Resolution in the context of a banking union A prominent feature of the crisis was the existence of negative feedback loops between the fiscal and banking sectors. From that followed the major lesson, that an effective economic and monetary union must include a banking union. A key pillar of the euro-area’s banking union will be the Single Resolution Mechanism (SRM). I believe that the outcome of the recent negotiations on the SRM is satisfactory. First, it ensures the creation of a viable banking system for the euro area through the resolution of failing banks in an orderly fashion that protects financial stability. Second, the responsibility for deciding the time that resolution of a credit institution is warranted remains primarily a task for supervisors, while the Supervisory Board also retains the right to declare a credit institution “failing or likely-to-fail” in some cases. Third, resolution mechanisms need efficient decision-making procedures that allow resolutions to take place quickly and efficiently. In Greece, we resolved 12 banks in the last couple of years. All resolutions were carried out unannounced – typically over a single weekend – thus allowing a smooth, uninterrupted transition for depositors of the affected institutions. The resolution process under the agreement satisfies this condition. Finally, the mechanism needs a credible back-stop. In the Greek case, funds from the Economic Adjustment Programme were earmarked specifically for resolution and recapitalization. As a result, there was never any doubt about our ability to resolve and recapitalize banks. In this connection it has been agreed that the Single Resolution Fund is to be composed of contributions from banks over an eight-year period, while the pace of mutualisation envisaged is frontloaded. At the same time an enabling clause has been approved by the Council, so that the Fund can seek public bridge financing. Overall, I welcome the agreement as a step forward toward eliminating the negativefeedback loops between banks and sovereigns. Financing of the real economy Let me turn to the second issue. BIS central bankers’ speeches A key characteristic of the euro area economic recovery is the decline in loans to the private sector. This situation applies at both the euro-area and, in many cases, the individual-country levels. Because the euro-area economy is bank-based, bank lending is especially significant for SMEs, which produce the bulk of goods and services. Consequently, a credit contraction raises the question: Can the recovery be sustained in the presence of negative loan growth? A number of actions and initiatives are addressing this issue. I will confine my remarks to two areas. The first concerns monetary policy. Throughout the crisis, the ECB has put in place both conventional and unconventional policy measures with the objective of increasing confidence and restoring the smooth operation of the monetary transmission mechanism. The volume of credit would have contracted significantly more had it not been for the ample provision of liquidity to European banks by the Eurosystem. The declining path for real interest rates, suggested by the fact that inflation expectations are anchored close to 2% in combination with the ECB’s commitment to keep an accommodative monetary policy stance, will lead to a substantial increase of the demand for credit along the way. There is, however, still work to be done on the supply side of financial markets. This circumstance brings me to the second area that deserves attention, i.e. the need to restore confidence in the banking sector. Confidence has been undermined by the perception that some banks have been holding assets of questionable quality on their balance sheets. The resulting credit and counterparty risk has contributed to a rise in funding costs, preventing some banks from on-lending to the private sector. Supervisors, at both the European and individual country levels, are using tools – including stress tests, asset quality reviews and transparency exercises – to assess the resilience of banks and to request injections of capital, so that confidence in the quality of bank balance sheets can be restored. In this context, the establishment of the SSM and the comprehensive assessment taking place will provide a catalyst for the cleaning-up of balance sheets to take place more quickly and more comprehensively than would otherwise have been the case. The repair of banks’ balance sheets is unavoidable and will, of necessity, involve some deleveraging. However, deleveraging does not necessarily lead to credit contraction. The “positive” deleveraging policymakers seek is a procedure in which the growth of equity allows banks to recognize bad loans and refrain from rolling them over, in turn, freeing resources and allowing banks to provide loans to firms that can use them productively. Again Greece is a prime example of this scenario in action. Following the first recapitalization of our banks in 2012, we began to reform and consolidate the banking system. Banks sharply reduced reliance on central-bank funding while making provisions for bad loans. As a result, they have been able to attract private investors. Recently, we concluded follow-up stress tests that were exceptionally well received by the markets. Following the release of the results, two core banks have completed much larger than requested capital increases of approximately €3 billion, with significant oversubscription. One of them has issued an additional unsecured bank note for €500 million with a maturity of three years. BIS central bankers’ speeches These are the first signs of markets’ opening up to Greece again. I am therefore confident that the second stage of recapitalization will play an important role in restoring confidence in Greece and a healthy financing of the economy. As a longer-term strategy, it would be desirable at the European level to develop market standards to allow equity and bond markets to gain ground as a source of funding. Doing so would increase the volume of funds available for long-term investment, contribute to long-term sustainable growth, and increase the resilience of the corporate sector during periods of banking-sector stress. The development of a deep EU securitization market for corporate loans would provide capital relief to banks, improve risk sharing, and increase banks’ lending capacity. To sum up, it has to be accepted that the crisis exposed weaknesses in EMU’s original architecture. However, European institutions have responded to the crisis with decisive policies and significant reforms to the original architecture. Those responses will help create a more-effective, crisis-resilient, economic and monetary union in the future. The benefits of the efforts are already evident at the euro-area level, especially in the sovereign-bond markets, where conditions have normalized to a considerable extent. The benefits are also evident in individual countries such as Greece, where the crisis, deep though it was, gave us the impetus to consolidate and recapitalize the banking sector, while simultaneously undertaking reforms that will allow us to reap substantial benefits in the future. I thank you for your attention. BIS central bankers’ speeches

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Speech by Mr George A Provopoulos, Governor of the Bank of Greece, on the publication of "The Chronicle of the great crisis - The Bank of Greece 2008-2013", Athens, 11 June 2014.

George A Provopoulos: “The Chronicle of the great crisis – The Bank of Greece 2008–2013” Speech by Mr George A Provopoulos, Governor of the Bank of Greece, on the publication of “The Chronicle of the great crisis – The Bank of Greece 2008–2013”, Athens, 11 June 2014. * * * The Chronicle of the great crisis is the result of a joint effort by Bank of Greece staff. First of all, I would like to thank all those who contributed to the writing of this book. But far beyond the preparation of this text, a joint effort par excellence was required in order to successfully address the crisis itself. The purpose of the book is to record the intense and multifaceted activities of the Bank of Greece in the years from 2008 to 2013. This period will certainly mark a watershed in the history of modern Greece. In times which are critical and characterised by high risks, such as the ones in question, decision and policy making are also critical and characterised by high risk. The Bank of Greece was actively involved in such decision making, sometimes directly and other times indirectly, playing an important role both domestically and internationally, as a member of the Eurosystem. The Chronicle does not purport of course to compete with books of economic history that will be written in the future in order to recount and explain the great crisis of the Greek economy. Besides, the events discussed are too recent to allow an objective historical inquiry. For this reason, the account provided here is only limited to the Bank’s decisions, actions and other public interventions, which reflect our own, institutional, interpretation of what led to the crisis; which crucial decisions had to be made to address it; and what the Bank’s contribution was to the exit from it. The Bank’s role has mainly two aspects: first, its participation in the Eurosystem and in ECB decision-making, with a responsibility for monetary policy implementation in Greece; and second, the supervision of the banking system with a view to safeguarding financial stability. With specific regard to this second aspect – on which a large part of this book is focused – the Bank of Greece had faced enormous challenges during the crisis. In response, on many occasions it had to act rapidly and decisively, under extremely pressing conditions. During the crisis the Bank also sought to strengthen its role as an advisor to society, which at the time was inundated with conflicting information originating both in Greece and abroad, which resulted in confusion and higher uncertainty. Through our reports, speeches and interviews we tried to present the true facts in a simple, easily understood manner; to dispel misconceptions, and inform the public on the available options and their implications. The book presents an extensive discussion of the Bank’s public interventions and positions in the crisis period and describes the actions it took to safeguard financial stability. It provides detailed information on the enhanced banking supervision carried out in this very challenging period; on cash management and liquidity provision to the banking system; on the implementation of resolution and liquidation measures for credit institutions; and on the strategy for restructuring the banking system. In such a brief speech I could not cover the full spectrum of our actions during the crisis. Nevertheless, I would like to discuss three topics: first, the view of the Bank of Greece as to what caused the crisis; second, the Bank’s key positions regarding the policy orientations for exiting the crisis; third, the steps we took for safeguarding financial stability. 1. What caused the crisis In addressing the crisis, the Bank of Greece first assessed its root causes. Of course these causes were there before the crisis, but came to the forefront with particular intensity after BIS central bankers’ speeches 2008. Back in 2001 it was expected that Greece’s inclusion in the core of European economies would act as a catalyst to accelerate its real convergence with the advanced European countries. Unfortunately, these expectations did not materialise. In the years that followed, economic growth relied mainly on consumption rather than on saving and investment, while any attempts to change long-established structures met with strong reactions. Public spending kept increasing, while revenue could not possibly keep pace, leading to large deficits and historically high levels of public debt, despite the unprecedented low interest rates. The political system hesitated to take decisive reform initiatives. The country enjoyed the benefits of the single currency, but failed to show that it respected the obligations arising from participation in the monetary union. The distortions in the growth model the country was following had been repeatedly highlighted by the Bank of Greece. Its warnings however were not heeded. The country continued on its carefree path, borrowing and accumulating debts in order to consume increasingly more goods and services that it did not itself produce. With the onset of the global financial crisis the international environment drastically deteriorated, and countries with large structural imbalances were hit the most severely. As early as in late 2008, the Bank was warning that the crisis, which was about to hit Greece as well, would be deep and of a structural nature, adding that overcoming that crisis would require a long, methodical and painstaking effort, given that imbalances and structural rigidities accumulated over several years had to be urgently addressed. By late 2008, it had become evident that the implementation of a multiannual programme was needed in order to reduce the fiscal deficit, control debt dynamics and carry out extensive structural reforms which would boost the economy’s weak competitiveness. However, the policies adopted were timid, even though markets had started moving towards an overall reassessment of credit risk that did not preclude a Greek default, therefore imposing new, more onerous lending conditions. By early 2010 it was no longer possible to cover the deficits with financing from the markets. In Greece, the international financial crisis was evolving into a sovereign debt crisis. In April 2010 the Greek government submitted to the euro area countries and the IMF a request for financial support, and in May the first Memorandum of Economic and Financial Policies was signed. This triggered a process of sharp economic adjustment in order to avoid default and lay the groundwork for rebalancing the economy. This process, currently at an advanced stage, has not been linear or painless. For one, it had not been clear from the outset that the country could indeed achieve an orderly adjustment. This is why an exit from the euro area was often presented as looming or unavoidable. Moreover, the conduct of economic policy during that period was subject to critical swings between the consistent implementation of the adjustment programme and hesitation due to political cost considerations. In such a climate, significant modifications had to be made to the original agreements with our partners, in order to make up for implementation delays or errors in initial forecasts. Fortunately, collapse and exit from the euro area were prevented, thanks to the society’s choice in favour of the country’s future within the euro area, the assistance provided by our partners, and the efforts of successive governments. Thus, today we can look forward to the future with greater confidence, as we can expect that the economy will recover and, under certain conditions, will enter into a new, virtuous circle. The economic and social costs of the adjustment have been and remain heavy. The citizens’ sacrifices have been very painful. However, losses in terms of output, employment and incomes have been the price that had to be paid to prevent a collapse of the economy. Had this collapse not been averted, losses would have been much greater. An exit from the euro area, as I had put in an interview, would have opened the gates of hell. BIS central bankers’ speeches 2. Policy orientations to overcome the crisis Against today’s more favourable background for the country, recovery appears to be ante portas. The year 2014 marks a halt to a deep and protracted recession. Of course, the economy’s adjustment has not been completed. But as the first, difficult cycle seems to be coming to a positive end, it would be helpful to evaluate actions and omissions and, most importantly, draw lessons for the future. The Bank’s positions concerning the exit from the crisis have been expressed based on a number of policy orientations, reflected in its publications and described in detail in the Chronicle. These policy orientations can be summarised as follows:  First, Greece should make every effort to remain in the euro area and steer clear of default, which would have incalculable economic and social consequences.  Second, the adjustment programme and the agreements with our partners ensure the financing of the Greek economy. Without them, default would have been inevitable. This is why they must be implemented consistently. Moreover, to a very large extent the programme’s terms relate to changes that should have been implemented long ago.  Third, in order to return to growth, securing its European perspective, the country should eliminate its fiscal imbalances, improve its competitiveness and enhance the export orientation of its economy, modernise the state, restore competitive conditions in markets and reduce the burden of public debt. Greece also needs a new, outward-oriented growth model.  Fourth, fiscal adjustment should rely primarily on a rationalisation of expenditure. Revenue must be increased by reducing tax evasion and broadening the tax base to make possible the necessary lowering of tax rates and the tax burden in the future.  Fifth, the historical challenge that the country is facing necessitates the greatest possible alignment of political and social forces, an understanding at the national level and the widest possible convergence of views.  Finally, the adjustment programmes are a necessary but not sufficient condition for exiting the crisis. A radical reorientation of the economy towards a new model requires a comprehensive National Plan for Growth, which will have far-reaching goals and will be implemented consistently. Adhering to these policy orientations, the Bank of Greece has performed its institutional functions, informed the citizens and advised the government. 3. Safeguarding financial stability In addition, however, to its advisory role in economic policy making, the Bank of Greece also had decisive powers and responsibilities for shaping a strategy for the banking sector, constantly geared to safeguarding financial stability. Although the crisis in Greece started in the public sector, contagion to the banking system was inevitable. The banking system was hit by the successive downgrades of the Greek government’s credit rating that led to corresponding downgrades of the banks’ credit ratings. This fact, on the one hand decreased the value of collateral available to banks for borrowing from the Eurosystem, and on the other hand made their access to the interbank market particularly hard and expensive, gradually leading to their exclusion. With the debt restructuring in 2012 the value of the bonds held by Greek credit institutions was severely impaired. Thus their capital position was eroded or even turned negative. At the same time, the recession was leading to a continuous increase in non-performing loans, while the surrounding uncertainty was encouraging deposit withdrawals. BIS central bankers’ speeches To safeguard financial stability, the Bank of Greece intervened by taking several targeted steps. I shall only briefly refer to the most important among them. First, the Bank of Greece ensured the uninterrupted supply of liquidity to the banking system, including by emergency assistance to the extent required. The provision of emergency liquidity assistance was reviewed every two weeks and the ECB Governing Council could put a stop to it for a variety of reasons (lack of collateral, low capital adequacy ratios of the banks, incomplete implementation of the programme, etc.). We therefore had to thoroughly prepare our positions and persistently intervene to prevent any negative developments. Second, to avoid a further shaking of the confidence of depositors we constantly had to supply the banking network with banknotes, so as to prevent cash shortages at bank branches or ATMs. In Chapter 8 of the book we release for the first time data on the increased demand for cash and the Bank’s cash management during the crisis, which I believe you will find very interesting. Third, we had to map out a strategy for the recapitalisation, restoration of soundness and restructuring of the banking system. The point of departure for this strategy was the first diagnostic assessment of Greek banks conducted with the help of BlackRock in 2011, and the viability study that followed in 2012. The Bank of Greece engaged foreign agencies to assist it in these efforts, having as a primary objective to consolidate international confidence in the objectivity and impartiality of the assessment of banks’ capital needs. The four credit institutions that were assessed to be viable were recapitalised through a combination of private and public funds. Non-sustainable banks that failed to raise private funds were resolved without any depositor suffering the slightest loss. Overall, there have been twelve bank resolutions, carried out according to the provisions of a new legal framework established in 2011, to the formulation of which the Bank of Greece had crucially contributed. The restructuring of the banking system continued with the absorption of subsidiaries and/or branches of foreign banks by large Greek banks. This way, we have reached 2014 having four large banks, plus a few smaller ones, instead of the approximately 20 banks that existed at the onset of the crisis. In 2013 we asked BlackRock to conduct a new diagnostic assessment. Based on the results of this new exercise, the Bank of Greece updated the banks’ capital needs. The credibility of the exercise and the markets’ confidence are evidenced by the successful capital increases recently carried out by the four core banks in a span of only two months, attracting the interest of foreign investors. In fact two of the core banks managed to not only cover their capital needs, as assessed by the stress test, but to also raise the funds needed to repurchase their preference shares. The contribution of the Bank of Greece in the fields of safeguarding financial stability and restructuring the banking sector will of course be judged by results. Thanks to the action taken by the Bank and the support provided by the Eurosystem through some critically important decisions, banks have continued to operate smoothly, even in periods of widespread uncertainty. This prevented an open banking crisis – which would also have had a direct impact on the country’s future within (or outside) the euro area. At the same time, the banking system, despite the heavy losses it has suffered, has managed to effectively deal with its problems and has been restructured on solid foundations through the guidance provided by the Bank of Greece as supervisory authority. To sum up, The Chronicle of the great crisis tells the story of the country’s efforts – at times successful, at times not – setbacks, risks, achievements and delays that marked these turbulent and eventful times between 2008 and 2013. It is my hope that this narrative will be of use to the historians of the future who will focus on this period. BIS central bankers’ speeches I would like to close by recalling that during these last few years the Bank of Greece had to cope with historically unprecedented conditions that required swift decision-making and difficult and delicate handling. The Bank responded to these heavy challenges outstretching its capacities, thanks to the hard work, ethos and dedication of its staff. It is to you therefore – members of the family of the Bank of Greece, who have successfully shouldered a heavy load – that I would like to say a big “thank you” and dedicate this book. BIS central bankers’ speeches

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Speech by Mr G Yannis Stournaras, Governor of the Bank of Greece, at the Eurobank Investor Forum, Athens, 7 July 2014.

Yannis Stournaras: Prospects of the Greek economy and the banking sector Speech by Mr G Yannis Stournaras, Governor of the Bank of Greece, at the Eurobank Investor Forum, Athens, 7 July 2014. * * * Ladies and Gentlemen, It is a pleasure to speak today at this Investor Forum, organized by Eurobank. I would like to share my thoughts with you on the prospects of the Greek economy and the banking sector. My speech will focus on three topics. First, what has been achieved so far during the difficult years of adjustment. Second, where does the economy and the banking system stand currently and what are the future prospects. Third, what are the challenges and the risks looking forward. What has been achieved so far Since the start of the crisis, four years ago, Greece has come a long way in adjusting its fiscal and external imbalances and implemented a bold programme of structural reforms. First, there has been drastic fiscal consolidation. In 2013, Greece returned to a primary surplus for the first time since 2002. Moreover, by achieving a primary surplus (as defined in the programme) of 0.8% of GDP, it outperformed the programme target of a balanced primary general government account. This outcome implies an 11.3 percentage point improvement in the primary budget as a percentage of GDP in the period 2009–2013, despite the deepening recession. Adjusting for the effect of recession, the improvement in the “structural” primary budget deficit over the same period reaches 18 percentage points. Second, competitiveness has been restored. Greece has now more than recovered all of the cost competitiveness it had lost relative to its trading partners since joining the euro area. According to the ECB’s Harmonized Competitiveness Indicators Greece has been the best performer in labour cost competitiveness after Germany. 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. Improvements in competitiveness on a price basis still lag due to relatively slower progress with product market reforms, higher indirect taxes and higher energy costs. However, it is gaining momentum and the inflation differential with the euro area has been negative since 2012. Third, external adjustment has been significant. The current account as a percentage of GDP posted a surplus of 0.8% of GDP in 2013, marking a significant turnaround of 16 percentage points since 2008. Adjustment came primarily through a decline in imports. However, after 2009, adjustment was equally shared between exports and imports. It is worth highlighting that, during the last three years, exports of goods have rebounded, with growth rates outpacing those of the euro area. Moreover, the share of goods exports in BIS central bankers’ speeches 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 largely as a consequence of uncertainty, which negatively impacted on tourism, and global factors, which affected the performance of the shipping industry. Fourth, the policy agenda has included structural reforms. A series of structural reforms were also implemented in labour and product markets and 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 relax employment protection (the index reflecting OECD Employment Protection Legislation improved significantly in the period 2008–2013). Progress with structural reforms in goods and services markets, by contrast, was relatively slower than in the labour market. Nevertheless, according to the OECD, Greece ranked first in responsiveness to structural reform recommendations made by the Organisation. Important progress was also made in lifting barriers to competition in various sectors, including building materials, food processing, retail trade and tourism. The closed professions (e.g. lawyers) were opened up, licensing procedures were overhauled and the cost of starting a business reduced. It can be noted that Greece shows the biggest improvement in World Bank’s Ease of Doing Business Report in 2014 vis-à-vis 2011. 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 25% or 200,000 employees. - New institutional reforms were adopted that lay the foundations for ensuring the better control of public spending and improving public financial management. The Fiscal Compact, which provides for the establishment of an independent Fiscal Council to oversee fiscal developments, was transposed into national legislation. - 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. Lastly, bank recapitalization and considerable consolidation has taken place. The landscape of the banking system has changed significantly with the number of banks being reduced though mergers, takeovers and resolution. Today the system comprises four core banks and a number of smaller banks. The four core banks, following recapitalization, are well-placed to meet the new challenges that the banking system faces going forward. Confidence has been restored, improving financial conditions in the economy The progress achieved so far has allowed confidence in the prospects of the Greek economy to be restored. This turnaround in sentiment was the result of the consistent implementation of the adjustment programme. The restoration of confidence has led to an improvement in BIS central bankers’ speeches financial conditions in the Greek economy, in particular with respect to financing through capital markets. - First, the Greek government has returned to international bond markets after three years, raising €3 billion through a five-year bond issue. - Second, core banks raised a combined total of €8.3 billion in new equity, with strong participation from foreign investors and €2.25 billion from senior bond issues. - Third, since December 2012, large Greek companies raised a total of €5.5 billion in foreign corporate bond markets. - Fourth, interest rate spreads have narrowed significantly both for the sovereign and the private sector. Over the past 18 months, sovereign spreads against bunds have narrowed by about 550 bps (from more than 1000 bps in early 2013 to 450 bps currently). Over the same period, corporate bond yields have declined from more than 9% to less than 5%. - Fifth, funding conditions of Greek banks have improved as ELA financing has fallen to zero and reliance on central bank liquidity has declined significantly. Wholesale markets have reopened to Greek banks and funding costs have declined. Encouraging signals from the real economy Encouraging signals are also present from the real economy, with both soft and hard data showing signs of stabilization and gradual recovery: - The recession has eased considerably since early 2013. If this trend continues, GDP should grow by about 0.5% in 2014. - Private consumption, the most important component of GDP, turned positive in the first quarter on a year-on-year basis, for the first time after fifteen quarters of steep declines. Exports increased significantly, driven by buoyant tourism receipts and upward trending shipping receipts, reflecting an upswing in world trade. - Industrial production also shows signs of stabilization and indicators, such as retail sales, travel receipts and new car registrations, suggest that the recession is gradually coming to an end. Soft data (such as the Economic Sentiment Indicator and the Purchasing Managers’ Index) indicate a more optimistic outlook for the months ahead. - Lastly, encouraging indications are emerging with regard to employment. Over the first five months of the year, dependent employment flows have been positive and significantly higher than previous years. However, unemployment still remains exceptionally high and is expected to fall only gradually. Recovery in 2014 is feasible Overall, recent developments in the Greek economy support the forecast of a gradual return to positive growth in 2014. By 2014: - the fiscal drag will be considerably lower compared to previous years; - competitiveness gains and higher external demand for Greek products and services will bear fruit in terms of better export growth; - liquidity constraints will loosen further; and - the benefits of structural and institutional reforms will be more evident. However, recovery hinges upon, first, a reversal of the decline in investment and, second, a faster growth of exports. BIS central bankers’ speeches Improvements in business and overall confidence strengthen the prospect of a recovery in investment as: (i) firms are gaining access to alternative sources of financing, such as corporate bond issues; (ii) the absorption of EU funds has increased (by April 2014, the absorption rates for the programming period 2007–2013 rose to 79.3%, bringing Greece to third place in the EU); (iii) the creation of a Greek Investment Fund will have a positive effect on foreign capital inflows; and (iv) the first quarter of the year marked the restart of major infrastructural projects. The second factor expected to contribute favourably to growth is a rise in exports. Historically, export performance has been closely related to cost competitiveness, in particular unit labor costs relative to trading partners. In fact, over the period 2000–2009, wage competitiveness has declined by about 25%. Exports of goods and services (excluding receipts from shipping) have underperformed exports of the EU17 by a similar margin. However, this close relationship between wage competitiveness and relative export performance broke down after 2009: while wage competitiveness has improved by more than 25% since 2009, exports of goods and services (excluding receipts from shipping) have outperformed EU17 exports by just 5%. Historical correlations would have predicted an outperformance of 25% instead. This pattern has been recently termed “the puzzle of the Greek missing exports” by some researchers. The fact that Greece ranks low in term of structural competitiveness – despite significant progress in the past few years – is certainly one of the main factors explaining the puzzle. Structural reforms with the aim to improve the quality of institutions will unlock export potential and allow competitiveness gains of the past to translate into export dynamic. However, there are other factors too, which explain why competitiveness gains have not impacted yet on exports to the extent one would expect based on historical correlations. One important factor is uncertainty, which peaked in mid-2012 with markets discounting a possible GREXIT. This has impacted on tourism, Greece’s biggest export industry. The second factor was the lack of credit. Exporters faced a significant credit squeeze which affected both trade credit and the financing of investment in new capacity. Looking forward, however, the negative effect of these two factors on exports will gradually dissipate. Tail risks have largely receded, allowing the tourist industry to rebound significantly in 2013 and in 2014. Also, financial conditions improve as markets open up to Greece and corporates gain access to funding and trade credit. This will allow investment to recover, which, in turn, will allow the country to broaden its export base and capitalize on its improved competitiveness. Challenges and risks, looking forward However, challenges remain. The cumulative decline in real GDP since the start of the crisis amounts to 25% and unemployment in 2014:Q1 stands at 27.8% with the long-term unemployed accounting for over 70%. Active labour market policies can mitigate the hysteresis effect and should be given priority, along with measures to strengthen the social safety net. Downside risks to the outlook exist. • The main risk is due to political uncertainty, related to the election of a new President in early 2015. BIS central bankers’ speeches • A second downside risk relates to a slowdown in the global economy and an increase in risk premia in international asset markets. Lower growth elsewhere would hurt exports and higher risk premia would worsen already tight financial conditions, with negative consequences for investment. • Finally, geopolitical risks in Russia and the Ukraine could weigh on exports. Oil prices are also a risk factor, which could derail the recovery. However, there are also upside risks. • First, exports could perform better. Tourism receipts may surprise on the upside this year, as they did last year. More importantly, shipping, which has acted as a drag on export revenues since 2008, could well perform better than expected as excess supply in the industry declines and world trade picks up. Receipts from shipping are an important component (ca 50%) of exports of services. Due to the crisis in the global sector, receipts from shipping have declined by 35% over the period 2009–2013, acting as a drag on Greece’s overall export performance. By contrast, in the first four months of 2014, they have rebounded sharply and are up by 22%. As the sector gradually returns to a normal level of activity, receipts from shipping will contribute significantly to overall export growth. • Second, figures for private consumption in the first quarter of 2014, at +0.7% yearon-year, were better than expected, implying consumption could surprise on the upside for the year. In the long term, the growth outlook of the Greek economy is expected to improve: • structural reforms in product and service markets will boost productivity, competitiveness and private investment; and • a better institutional environment – easier to do business, more efficient public administration – will add to potential growth. • The above will increase the economy’s openness, thus raising the contribution of net exports to growth. • Finally, a smaller public sector will produce positive crowding-in effects. Reforms must continue in order to ensure recovery Today, the central focus of economic policy should be to maintain and strengthen the emerging positive momentum. To this end, determined efforts towards the following objectives must continue: • A more efficient public sector offering high quality services and friendly towards business. Progress so far has been made in downsizing and rationalising the public sector. However, there are certain areas in which there have been delays and gaps that need to be addressed promptly. For example, creating an efficient judicial system, improving the quality of public sector services, establishing a national land registry and clarifying land use definitions. • Reducing public debt. Continued fiscal adjustment is required to put public debt on a downward path and ensure sustainable access to global capital markets. Over the medium term, efforts will need to be focused on a rationalisation of expenditures and the improvement of the tax administration. The better-than-expected fiscal adjustment achieved in 2013 paves the way for the implementation of the Eurogroup decisions of November 2012 regarding possible debt sustainability measures. This commitment from our European partners was recently reiterated in the Eurogroup statement released on 5 May 2014. BIS central bankers’ speeches • The third objective is the reorientation of the production model to ensure rapid and sustainable growth in the long term. The Greek economy is not simply emerging from a cyclical recession. At the same time, it is shifting towards a new growth model. Thus, economic policy needs to generate conditions that favour supply-side restructuring of the economy. This requires that structural reforms are stepped up to ensure the efficient and competitive functioning of product, labour and capital markets. At the same time, a recovery of investment requires a business environment with a low administrative burden for businesses, an efficient public sector and a stable tax environment that will ultimately facilitate the easing of the tax burden on businesses and individuals. A question that arises is the extent to which this growth model will be viable on the demand side. That is, will a rise in investment and net exports offset the gap in demand resulting from the squeeze on private and public consumption expenditure? Given the size of adjustment in the economy, such an outcome is in my view feasible in the long run, even under fairly conservative assumptions regarding the dynamics of exports and investment. Banking sector developments Let me now turn to issues related to the banking sector. Important and promising developments are taking place in the Greek banking system. The banking landscape today is very different from that prevailing at the start of the crisis. • Core banks’ capital adequacy ratios have been restored and excess capacity has largely been eliminated. The stress test exercise was well-received in the markets and the market capitalisation of Greek banks has been significantly boosted. • Funding conditions have improved. As I also mentioned, ELA has been eliminated and recourse to central bank financing has fallen sharply since its peak in 2012. Additionally, Greek banks have regained access to wholesale markets, allowing them to tap market funding. Private sector deposits have now stabilised and initially recorded a sharp increase in the wake of the elections in mid-2012. • Pre-provisioning operating profitability is improving. This can be attributed to cost containment, primarily, from the funding side and, secondarily, from the operating side. Positive developments are also present on the revenue side with Net Interest Income and Fees and commissions recording rises. • The deterioration of asset quality appears to have been slowing down. • Finally, consolidation has occurred. Fewer but stronger banks are in operation and the first benefits from the exploitation of synergies are already visible. More gains in both cost savings and revenue enhancement are expected in the coming years as a result of merger synergies and the improved macro environment. Synergies are expected to raise the efficiency of Greek banks to levels comparable to European peers. The rebound of economic activity will improve revenues and the quality of banks’ balance sheets. Challenges ahead The positive developments outlined above must not make us complacent. The banking sector still faces significant challenges, with the most significant one being the accumulation of non-performing loans. This, makes banks reluctant to extend new credit, deprives them of income that could otherwise be recycled into new loans and forces them to tie up more capital for future loan-loss provisions. The resolution of the challenges surrounding non-performing loans has two preconditions. BIS central bankers’ speeches First, the economy has to return to a positive growth path and falling unemployment that, in their turn, will improve the repayment ability of borrowers. Second, a framework has to be put in place at the level of individual banks to ensure a more pro-active management of non-performing loans. Emphasis should be placed, on the one hand, on the alleviation of the burden on borrowers facing temporary difficulties in servicing their debts and, on the other hand, the finding of a more permanent solution to loans which are unlikely ever to be fully repaid. Such a strategy will not only help individual borrowers, but in the long term will unlock funds for the financing of the economy. To this end, two important developments have taken place. The government has established the Government Council for Private Debt Management. The Bank of Greece has prepared a framework of supervisory requirements for banks’ NPL management, as well as a Code of Conduct for the management of private sector arrears. Both have laid the ground for the creation of a mechanism for resolving the issue of non-performing loans. Banks, for their part, must continue undertaking the necessary organizational actions to enhance the operating units that deal with these loans. They also need to continue implementing value-enhancing, capital-enhancing and fundingenhancing strategies in light of the latest stress test, the Basel III requirements and the slow pick-up in deposits. At the same time they face pressures to reduce their reliance on Eurosystem refinancing and are due to face pressures relating to the change in ECB collateral rules in early 2015. Up until now, the only sector in the economy to have undergone radical restructuring is the banking sector. Lessons learned from this experience can be valuable for other sectors and banks are in a unique position to contribute to the transformation of other sectors. Banks can advise and, when possible, actively participate in the consolidation of other sectors of the economy. In this way, they will contribute to the sectoral restructuring of the Greek economy. New credit must target dynamic, outward-looking enterprises with growth prospects. In other words, banks must channel credit into truly viable enterprises, whether new or old, encourage business partnerships and support initiatives conducive to bold sectoral restructuring. In this way, they will maximise the growth potential of the Greek economy. Let me summarize my main message to you. As investors, you will know very well that there are two main types of investments: those focusing on underlying value and those focusing on growth prospects of an asset. Both investments come with their specific risk characteristics and, at the end of the day, it is the reward-risk relationship which counts. Investing in the Greek economy is likely both a value and a growth trade. Value, because investors have turned their back to the country for a long time. Growth, because during this time, the country has gone a long way towards improving its fundamentals and, hence, future growth prospects. BIS central bankers’ speeches

bank of greece

Welcoming address by Mr Yannis Stournaras, Governor of the Bank of Greece, at EMS Managing Director Klaus Regling speech "Overcoming the Euro Crisis", Athens, 10 July 2014.

Yannis Stournaras: Responses to the euro area crisis and challenges ahead Welcoming address by Mr Yannis Stournaras, Governor of the Bank of Greece, at EMS Managing Director Klaus Regling speech “Overcoming the Euro Crisis”, Athens, 10 July 2014. * * * The euro area crisis stems from the fact that Economic and Monetary Union (EMU) is a complete monetary union but an incomplete economic and financial union. Indeed, the roots of the crisis are complex, resulting from an interaction between inadequate architecture and inadequate implementation of the structures that had been put in place. Five years after the start of the crisis, the outlook appears brighter. The euro area has moved out of recession, intra-euro area macroeconomic imbalances have been significantly reduced and the changes to the institutional framework underpinning EMU have been considerable leading to a stronger architecture. Response to the crisis (at national and EU level) In order to address the underlying economic and institutional challenges stemming from crisis, euro area countries had to respond with a comprehensive strategy. This strategy included both measures at the national level as well as at the level of European Union institutions. First, Europe responded with the creation of the necessary financial backstops. The establishment of the EFSF and, later, the ESM allowed euro area members to grant loans at favourable interest rates and under strict conditionality to countries that had lost market access. Second, the Governing Council of the ECB was innovative in its conduct of monetary policy, putting in place both standard and non-standard policy measures. These measures helped increase confidence and were directed at restoring the smooth operation of the monetary transmission mechanism. The downward adjustment of interest rates, the provision of sufficient liquidity and the Securities Market Programme all played their role. As a further step, the ECB announced in September 2012 the Outright Monetary Transactions (OMT) programme, which contributed significantly to the improvement in financial market conditions in the euro area, the decline in sovereign spreads and the gradual reversal of financial fragmentation. The latest non-standard measure, the targeted longerterm refinancing operations, is designed to support lending to the real economy. Third, there has been a significant correction of external and domestic imbalances in individual euro area countries, with significant progress having been achieved to regain previous losses in competitiveness and cut back fiscal deficits. At the same time, structural reforms have gathered pace and programme countries in particular have undertaken substantial reforms in order to make the economies more flexible and market-oriented. Fourth, significant steps have been taken to improve economic policy coordination. These measures included the strengthening of the Stability and Growth Pact, the establishment of the European Semester, stronger emphasis on macroeconomic imbalances and the Fiscal compact. Last but not least, crucial steps have been agreed to move towards the creation of a Banking Union. The Single Supervisory Mechanism will start operating in November 2014 and agreement on the Single Resolution Mechanism has been reached. These measures will BIS central bankers’ speeches work to reinforce the European banking system, reduce the negative feedback loops between banks and sovereigns and overcome fragmentation in EU financial markets, promoting growth. Results and challenges ahead The European strategy to deal with the crisis is delivering results, as interest rate differences between core and periphery countries have been reduced, programme countries have regained market access and the banking sector has been strengthened. However, many challenges remain. A key characteristic of the euro area economic recovery is the continuing decline in loans to the private sector. The recovery is so far “creditless” at both the euro area as a whole and, in many cases, in individual countries. Because the euro area economy is bank-based, bank lending is especially significant for companies and, in particular, for SMEs, which produce the bulk of goods and services and account for a large share of employment. Consequently, the on-going credit contraction raises the question: Can the recovery be sustained in the presence of negative loan growth? Personally, I doubt it. Looking ahead, there is a need to deal with limited potential growth in the euro area. To this end, euro area members are increasingly recognizing the need for joint efforts and coordinating national structural policies for growth and jobs, as reflected in the recent conclusions of the European Council. Today’s speaker Klaus Regling, as the first Managing Director of the European Stability Mechanism and Chief Executive Officer of the European Financial Stability Fund, has been at the centre of the euro area crisis. His career has spanned 35 years in senior positions mainly in the public sector. He worked at the IMF in Washington and Jakarta; he spent around 10 years at the German Ministry of Finance, working on preparations for monetary union; he then moved to the European Commission where he was Director General for Economic and Financial Affairs from 2001 to 2008. He is thus perfectly suited to address the issue of how we overcome the euro area crisis. BIS central bankers’ speeches

bank of greece

Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the IMF/Bank of Slovenia high-level seminar on "Reinvigorating Credit Growth in Central, Eastern and Southern European Economies", Portoroz, 26 September 2014.

Yannis Stournaras: Measures to revive credit markets: best practices and pitfalls Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the IMF/Bank of Slovenia high-level seminar on “Reinvigorating Credit Growth in Central, Eastern and Southern European Economies”, Portoroz, 26 September 2014. * * * The global financial crisis has impaired the ability of the financial system in the euro area to channel funds to the real economy, in particular for financing of long-term investment and SMEs. Banks in the euro area have been particularly affected as the financial crisis was followed by a sovereign-debt crisis, which has set in motion a negative feedback loop between banks and sovereigns. As a result, over the past six years, bank credit to the real economy and, in particular to SMEs, has fallen dramatically in the EU. Credit, which had been growing at double-digit growth rates before the global financial crisis, has contracted during the past few years. The crisis also hit banks in the Central, Eastern and Southern European region as foreign bank engagement in the region declined and the over-indebtedness of households and businesses, a legacy of the earlier credit expansion, led to a large and rising volume of nonperforming loans. In some cases, those have reached, or exceeded, 20 per cent of total loans. As a result, bank credit in the region declined from average growth rates above 30% in the period 2003–2008 to close to zero or even negative rates of growth in the recent years. Bank credit is particularly important for economic growth in the EU. This situation is attributable to the fact that European economies are heavily dependent on bank financing. This dependence on banks is in contrast to the US, where capital markets play a bigger role in financing the economy. Central, Eastern and Southern European economies are also bank-based financial systems in which capital markets remain relatively underdeveloped. Consequently, bank deleveraging, combined with increased risk aversion on the part of investors, has affected the ability to finance sustainable growth throughout the region. A key characteristic of the economic recovery in the euro area at the present stage is the weakness of bank lending to the private sector in general and to companies in particular. This situation applies at both the aggregate level and for many individual countries. The situation appears to be better in the Central, Eastern and Southern European region (perhaps with the exception of Turkey), as credit growth remains on average positive, but is nevertheless too weak to support satisfactory rates of sustainable growth. In particular, there are countries, like Bulgaria, Bosnia and Herzegovina and FYROM, where credit to the private sector is experiencing a moderate recovery but in other countries, such as Slovenia, Serbia and – to a lesser extent Croatia and Romania – bank credit growth to the private sector and in particular to enterprises is still negative. As Fabrizio Coricelli discusses in his presentation, creditless recoveries are not uncommon in the aftermath of financial crises, in particular when financial crises were preceded by periods of credit booms to the private sector. Calvo et al (2006), in a seminal paper published in the American Economic Review, describe creditless recoveries as “Phoenix Miracles”. The phenomenon of creditless recoveries has been documented mainly in Emerging Market and low-income economies but seems to also play a role in industrial countries. Empirical evidence suggests that creditless recoveries are more likely when the preceding recession was deep and when the recession coincided with a banking crisis. Several other factors also play a role: the openness of the economy to financial flows, the degree of export dependence, the degree of external adjustment during the recession and the stance and mix of fiscal and monetary policies. BIS central bankers’ speeches Several explanations of this phenomenon have been proposed in the literature. One explanation is that economies can rebound without bank credit because capacity utilization is low during a recession allowing GDP to recover mainly through the absorption of unused capacity rather than through investment. A second explanation is that, in the absence of bank credit, firms increasingly use internal finance and trade credit. Furthermore, even if bank credit is declining, bank credit may be reallocated toward more-dynamic sectors, thus allowing an economic rebound. Empirical research at the Bank of Greece suggests that the probability of a creditless recovery depends on two additional features of the economy: First, the saving – investment gap, in other words, the net financing needs of the private sector and, second, the degree of a country’s fiscal and external adjustment during the recession. In particular, the lower are the net financing needs of the private sector at the bottom of the recession, the more likely it is that the economy can recover without bank credit. Since the gap between investment and saving can be financed through either capital inflows from abroad (in other words via currentaccount deficits) or through lower budget deficits (in other words by freeing private saving to finance investment), saving-investment imbalances naturally correspond to fiscal and external imbalances. A second important implication of this research is that the degree of a country’s fiscal and external adjustment during the recession plays a significant role during the recovery. In particular, the probability that a country may experience a creditless recovery is higher in countries that have followed economic adjustment policies during the recession to reduce their external and fiscal deficits. This result has important implications for both countries of the euro area periphery and countries of the Central, Eastern and Southern European region. Nevertheless, creditless recoveries are suboptimal outcomes from an economic policy perspective since, as has been observed by several researchers, creditless recoveries are on average weaker than recoveries with credit. As Fabrizio Coricelli also points out, creditless recoveries may have negative effects on long-run potential growth by affecting investment and the stock of productive capital but also by increasing long-term unemployment. A number of actions may be undertaken in order to address the problem. I will confine my remarks to three areas: monetary policy, confidence in the banking sector and initiatives that target the mobilisation of funds from capital markets thus broadening the sources of financing the economy. I will focus on our recent experience in the euro area, in general, and Greece, in particular, where the banking system has undergone a significant transformation over the past few years. Overall, my emphasis will be on measures which aim to revive bank credit and to mobilize funds from capital markets. On monetary policy, the ECB has taken important actions to improve confidence and to restore the smooth operation of the monetary transmission mechanism. Credit growth would have been significantly more negative had it not been for these actions. The policy rate is now at an historical low of 5 basis points. Non-standard measures, including the Targeted Long-Term Refinancing Operations (TLTROs), the ABS Purchase Programme and the 3rd Covered Bond Purchase Programme will inject liquidity into both banks and markets. The establishment of the Banking Union is restoring confidence in the banking sector. The supervisory authorities are assessing the resilience of banks and requesting injections of capital, so that confidence in the quality of bank balance sheets will be restored. In this respect, the Comprehensive Assessment and the EU-wide stress tests, which are currently under way, will be key to improving confidence in the banking sector. Banking Union will also help reduce financial fragmentation. BIS central bankers’ speeches The faster banks clean up their balance sheets, the easier it will be for them to regain confidence, to attract fresh capital from private investors and to provide credit to the economy. At this point allow me to say a few words about Greek banks. Following the first recapitalization of our banks in 2012, we began to reform and consolidate the banking system. Banks sharply reduced reliance on central bank funding, while forming provisions for bad loans. As a result, they have been able to attract private investors. Early this year, we concluded follow-up stress tests that were exceptionally well received by the markets. Following the release of the results of the stress tests in March, core banks completed much larger than requested capital increases to the tune of €8.3 billion with issues being significantly oversubscribed. Two systemic banks have repaid state aid that has been in the form of preference shares. All four systemic banks are now under private management. These are the signs needed to restore confidence and lay the foundation for the healthy financing of the economy at a later stage. Returning to the broader picture, it appears that bank credit will remain constrained at least until the European stress-test is completed and banks adjust to the results of the exercise. The burden of NPLs in economies which have gone through a deep recession – and Greece is a good example here – will be a major factor constraining the supply of bank credit in the medium term. Given the limited quantity of resources, it is important that banks use these limited resources in a way that improves allocative efficiency. In other words, they have to be channeled to the most productive uses. Nevertheless, despite the important role that banks will continue to play, in the EU, particularly for SMEs, it has been clearly communicated by market participants that there is a pressing need to broaden the sources of long-term financing in Europe. Broadening the sources of financing of the economy toward capital markets should be viewed as one of the key priorities of economic policy. In this respect, the development of a deep, transparent and robust European securitization market for corporate loans would improve risk sharing and increase banks’ lending capacity to corporates and, in particular, SMEs. And this solution will probably serve its purpose better this time than previously, since the lessons of the inadequate regulation of some securitisation models in the past can be taken into account. The ABS and the Covered Bond Purchase Programmes will provide an initial boost, especially for the European ABS market which has lain largely dormant since 2008. However, in my view, if we are to move farther towards the development of a market for corporate loans, a concerted effort is needed in several directions. A list of key priorities in order to revive credit markets should include the following: First, further measures to revive the market for securitizations, in particular for SME bank loans. Securitization is an important instrument to promote bank credit. Allowing banks to securitize and redistribute SME loans to a broader investor base can provide banks with capital relief and allow them to lend to the real economy. This is not an easy task given the stigma attached to securitization following the global financial crisis, when the “originate to distribute” model led to excessive leverage and financial fragility. Of course, lessons have been learned since then, and the regulatory framework has been adapted in a way that makes a repeat of past mistakes unlikely. For this securitization to work in a way that does not endanger the resilience of the financial system, we must ensure that only high quality assets that are simple and transparent are used in securitizations. In this respect, it is important to develop a set of rules that allow the definition of a pool of “high quality securitizations” at the EU level. BIS central bankers’ speeches Second, changes to the prudential treatment of securitizations. It is essential, in my view, to adjust the regulatory framework for securitisations in a way that provides banks with incentives to engage in the market. Capital relief for banks’ holdings of Asset Backed Securities which are simple, transparent and robust could provide an answer. The second aspect of regulation relates to potential investors, such as insurers, pension funds etc. The regulatory framework should allow for a fair treatment of high quality ABS relative to ABS products with higher risk profiles, in order to provide long-term institutional investors incentives to trade in the market. Third, policies to promote better access of SMEs to capital markets. As is well known, corporate bond markets work well for large corporations while they are not attractive to SMEs, which remain largely dependent on bank loans for financing. Efforts should be undertaken to reverse this trend and promote the access of SMEs to capital markets. The development of “minibond” markets for SMEs in Italy and Germany could serve as examples to gain insights into best practices for the establishment of SME markets. The development of bond and equity markets for SMEs and mid-sized companies would also encourage more cross-border investment within the EU and from foreign investors. Fourth, measures to develop alternative financial intermediaries for young companies and SMEs. In this context, efforts should be intensified toward the creation of a risk capital market for non-listed companies such as a market for venture capital funds and markets for infrastructure financing. MiFID II is an important step towards improving the functioning of EU trading venues and setting the stage for the development of SME capital markets. However, further steps are necessary, in particular to correct differences throughout the EU in the tax treatment of these products both at the issuer and investor level. Fifth, measures to improve investors’ access to business, credit and financial information on SMEs. It is well-known that most SMEs are not rated by rating agencies. The lack of adequate and readily available information on the credit quality of SMEs is a structural problem in the EU as a whole and in the Central, Eastern and Southern European region, in particular. This is one of the major reasons that SMEs in the EU have historically faced significant difficulties to access funding from capital markets. There is, thus, the need of a harmonised EU approach to credit scoring comparability of SME data. Improving the availability of financial information is paramount in allowing investors to gauge the riskiness of securitized products. In this respect, it is important to develop national credit registers for SMEs, allowing for higher transparency, standardization and comparability of underlying assets. A final word of caution is in order. Most of the measures I discussed above will likely have only medium- to long-term effects in reviving credit markets in the EU because most of these measures constitute fundamental changes in the structure of the financial system. Such structures naturally change only gradually over time. In the short term, monetary policy will continue to play the major role in determining liquidity provision to banks and the cost of funding for the private sector. Non-standard monetary policy measures and progress towards a banking union are, thus, of prime importance, in order to reduce market fragmentation and allow the normal transmission of monetary policy to the most vulnerable areas of the monetary union. BIS central bankers’ speeches

bank of greece

Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the 2014 Multinational Finance Society Winter Conference "Global Financial and Economic Crisis: Challenges and Prospects", co-organized by the Centre of Planning and Economic Research and the Multinational Finance Society, Athens, 14 December 2014.

Yannis Stournaras: Global financial and economic crisis – challenges and prospects Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the 2014 Multinational Finance Society Winter Conference “Global Financial and Economic Crisis: Challenges and Prospects”, co-organized by the Centre of Planning and Economic Research and the Multinational Finance Society, Athens, 14 December 2014. * * * Ladies and Gentlemen, It is a pleasure to address such a distinguished audience, on a topic that unfortunately is not yet history. Governments and Central Banks certainly managed to safeguard financial stability in turbulent times. However, certain repercussions of the crisis have not yet been fully dealt with and some vulnerabilities may reappear. In this sense, looking back with a critical view may help us understand the factors that put at risk the global economic recovery. The global financial and economic crisis that was triggered by a distortion in the U.S. subprime mortgage market, highlighted serious weaknesses in the financial regulatory frameworks of the globalized and broadly interrelated national markets. As a result, the validity of the theory of self-correcting market mechanisms has been strongly contested. Global financial crisis • The roots of the global financial crisis can be traced back to both macroeconomic and microeconomic factors. On the macro level, global imbalances for over a decade before the crisis resulted in ample liquidity in world financial markets and in low interest rates, facilitating high levels of leverage, excessive dependence on unsustainable short-term financing and weak risk management. • At the same time, on the micro level, financial innovation and the investors’ “search for yield” led to the creation of complex financial instruments with an obscure credit risk distribution. The originate-to-distribute model, according to which loans are traded between investors, became widespread practice. This led, in effect, to a loosening of lending criteria and facilitated the creation of the aforementioned complex credit instruments. • Over time, excessive credit risk and liquidity accumulated in the so-called “investment vehicles.” The placement of credit institutions in such vehicles was not recorded on their balance sheets, and as a result, the associated risks slipped through the cracks of internal control mechanisms. Moreover, the opacity and the uncertain dispersion of risks of these instruments were further exacerbated by the rapid growth of the derivatives market, in particular of derivatives traded outside regulated markets (“over the counter”). • As revealed in retrospect, in many cases, banks and investors had failed to realistically assess the nature and extent of risks. The high degree of correlation between credit risk, market risk and refinancing risk had also failed to be properly assessed. As a result, the risks associated with certain credit instruments were not properly reflected in their price. When this was made evident in the US market for sub-prime mortgages in 2007, it led to a market-wide reassessment of financial risks and the collapse in the market values of credit instruments. This, in turn, affected negatively the net worth and profitability of banks which held such assets in their portfolios. The once believed “too big to fail” institutions rapidly became illiquid and insolvent. BIS central bankers’ speeches • In order to rebalance their portfolios, affected banks performed widespread liquidations of their assets and attempted to raise capital in an attempt to strengthen their capital base. Through the subsequent fall in asset prices and via banks’ balance sheet cross-exposures, the crisis quickly spread to the financial system globally. The euro-area was similarly affected. • Uncertainty about banks’ exposure to “toxic assets”, especially in Europe, led to mutual distrust between banks. As a result, the interbank market has been severely impaired causing liquidity problems, which required the necessary intervention by monetary policy authorities. • The crisis in the financial markets, aggravated by the pro-cyclicality of banks, where in times of economic downturn they tighten risk criteria and decrease lending, thus amplifying the contraction of the economy, quickly spread in the real economy, and economic conditions deteriorated globally. Euro-area crisis • The international financial crisis brought about the crisis in the euro area. However, here also, the roots of the crisis can be traced to the creation of serious imbalances. • According to the theory of monetary integration, as it had developed by the time of the inception of the euro in 1999, it was thought that nominal convergence along with a single monetary policy would gradually promote real convergence. Banks had no special role in transmitting financial market shocks to the real economy or in producing spillover effects across union members. • However, monetary union has to go hand-in-hand with financial integration. Indeed, financial integration did proceed apace with increasing capital flows among the member-states of the euro area, leading to increased interdependence between financial institutions and markets. • Such interdependence is necessary for the smooth operation of the single monetary policy, because it facilitates the transmission of monetary policy throughout the euro area. • The prevailing view was that persistent capital flows from the north to the south, which financed the current account deficits of the south during the early years of EMU, were an equilibrating force – capital moved from countries where the rate of return on investment was low to those where it was high. • The elimination of exchange rate risk was interpreted by markets and institutions as an elimination of all risks. Credit risk was essentially ignored. • With the outbreak of the global financial crisis in 2008 and the re-pricing of risk, the ample capital inflows to the EU periphery were suddenly reversed. • This sudden reversal led to a negative feedback loop between banks and public finances, exacerbating the effects of financial instability on the real economy. • In some countries, such as Spain, the sudden reversal led to a collapse in demand, a collapse in asset prices and bank distress. The bank distress then fed back into a fiscal and, ultimately, sovereign crisis. A similar narrative can be told for Ireland. In other member-states, such as Greece, the sudden reversal initially affected the refinancing of debt and subsequently inflicted damage on the banking system following the haircut of Greek government debt. • As a result, the crisis revealed important weaknesses in the EU architecture and inadequacies in the implementation of the structures that had been put in place. BIS central bankers’ speeches • First, the existing framework of economic governance was not sufficient to prevent the creation of imbalances. The Stability and Growth Pact was not properly enforced and there was no mechanism in place for monitoring external imbalances. • Second, the increased interdependence between financial institutions and markets, which was the result of the monetary union and the ensuing financial integration, was not accompanied by a more unified regulatory framework. • Third the link between financial stability and the financial cycle had been largely ignored. The architects of monetary union chose to keep financial sector supervision and regulation largely at the level of the nation state, with insufficient coordination of macro and micro-prudential supervision. Policy responses to the crisis • In this unprecedented global crisis, Governments, Central Banks and international organizations reacted with coordinated actions. These actions included first, direct monetary and fiscal interventions, aiming at enhancing liquidity to maintain system stability and support the economy; second, a broader mobilization to reshape the global financial architecture and mitigate the magnitude and duration of future financial crises. • Following the eruption of the crisis, it was understood that any kind of supervision should be exercised taking into account not only the behaviour of individual credit institutions but also the interconnections and interdependencies between financial institutions, markets and economies. The increasing degree of integration of economies and financial markets required more coordinated action between supervisory and regulatory authorities worldwide, as well as continuous, timely and accurate exchange of information between supervisory authorities. It was made clear that the new architecture of financial supervision required the strengthening of micro-prudential and macro-prudential supervision. Regulatory and supervisory efforts focused on financial stability and on trying to limit the build-up of systemic risk. Monetary policy response • More specifically, as a first response to the global financial crisis, central banks were quick to put in place measures that ensured adequate liquidity in the financial system by facilitating access to central bank financing. • Moreover, central banks largely adjusted their respective monetary policy stance to reflect the diminished risks for price stability. The size of interest rate reductions implemented by central banks pushed policy rates at historically low levels. • The ECB initially reduced its interest rates by 50 basis points in a coordinated move with five other major central banks [Bank of Canada, Bank of England, the Federal Reserve, Sveriges Riksbank and the Swiss National Bank] in October 2008. This was followed by successive reductions in the interest rates, resulting in a cut in the main refinancing rate by 325 basis points within seven months, between October 2008 and May 2009. • In addition, the ECB adopted temporary non-standard measures in order to reduce obstacles in monetary policy transmission and to address liquidity shortfalls in the interbank market. • First, the ECB switched to fixed-rate tender procedures with full allotment for all refinancing operations, ensuring unlimited access to central bank liquidity at the main refinancing rate. BIS central bankers’ speeches • Second, the ECB introduced longer-term refinancing operations (LTROs), initially at 6-month maturities, then at one year and finally, at three year maturities, aiming at reducing uncertainty and encouraging banks to continue to provide credit to the economy. • Third, during the global turmoil the ECB temporarily provided liquidity in US dollars through currency arrangements with the Federal Reserve in order to provide banks with adequate funding in US dollars. • Fourth, the ECB extended the eligibility of collateral that could be used for central bank financing, facilitating banks’ refinancing liquidity shortages caused by halts in interbank lending. • Fifth, the ECB introduced in May 2010 the Securities Markets Programme. By intervening in the secondary markets of public and private debt securities, the ECB could ensure depth and liquidity in dysfunctional market segments and restore the proper functioning of the monetary policy transmission mechanism. • Finally, in September 2012, the ECB announced the Outright Monetary Transactions (OMT) initiative, essentially the intention to purchase, if necessary, securities of euro area member-states in economic adjustment programmes from the secondary market. Although not activated, the announcement of the initiative has contributed significantly to the improvement in financial market conditions, the decline in sovereign bond spreads and the gradual reversal of financial fragmentation. Changes in the EU architecture • With the outbreak of the euro area crisis, it was made clear that both imbalances in the real economy and in the financial sector are sources of financial instability. • A more comprehensive policy framework was therefore necessary. • In this context, improvements in the policy framework aimed at completing the EMU architecture with more coordination of economic policies, sufficient backstops to address liquidity shortfalls and, last but not least, common supervision of the financial sector. • The Stability and Growth Pact was strengthened through a series of EU regulations in 2011 and 2013. The new legislation clearly defined debt reduction rules, sanctions in case of non-compliance and a new surveillance procedure monitoring the emergence of macroeconomic imbalances. In addition, fiscal coordination and surveillance was further strengthened through the ex-ante co-ordination of fiscal and structural policies of member states of the euro area. • Moreover, the “Fiscal Compact”, agreed by the euro area and some EU member states, in March 2012 further strengthened fiscal governance. The treaty, which entered into force at the beginning of 2013, requires structural deficits limited to 0.5% of GDP and the introduction of fiscal rules in each country’s national legislation. • Furthermore, the euro area, as well as some EU member states agreed in March 2011 on the “Euro Plus Pact”, a commitment to undertake additional reforms, on top of the EU-wide “Europe 2020” obligations, to promote competitiveness, employment and productivity. • In the meanwhile, the European Financial Stability Facility (EFSF) provided financial assistance to sovereigns which faced temporary liquidity shortfalls caused by the impairments in the sovereign bonds markets. The EFSF was succeeded in 2012 by a permanent backstop mechanism, the European Stability Mechanism (ESM). BIS central bankers’ speeches • Finally, let me turn a bit more at length, to, perhaps the most ambitious EU initiative, the Banking Union, which was finalized during the Greek Presidency of the Council of the European Union in the first half of the current year. • The Banking Union was initially agreed at the European Council of June 2012 in an effort to deepen Economic and Monetary Union. • Five years after the outbreak of the euro area crisis, it is important to understand why the interconnection between banks, the real economy and sovereigns were so strong in the euro area and why a banking union is necessary. • First, the size of the banking sector in the EU, measured either in absolute terms or as the share of banks’ assets in GDP, is about five times larger than in the US. These data underline the importance of banks as financial intermediaries in the EU. Firms in the euro area are much more reliant on bank credit compared to the US, where capital markets play a much more important role in the financing of investment. • Second, although large banks in the euro area and the US are of roughly similar size, large banks’ balance sheets in the euro area represent a much larger share of any individual country’s GDP in the euro area. This implies that bank failures in the euro area can easily call into question state solvency. • Third, euro area banks typically hold large volumes of national government bonds in their portfolios, making them more vulnerable to sovereign crises. And the capital flows from the core to the periphery that characterized the early years of monetary union also led to the concentration of peripheral sovereign risk in the core. • One of the consequences of the crisis and the negative feedback loops between banks and sovereigns was the so-called “Balkanization” of the euro area banking system, i.e. the retreat of banks behind national borders. As a result, financial conditions diverged between euro area member states. The fragmentation of financial markets deepens the gap between core and periphery, hinders the smooth transmission of the common monetary policy and is harmful to real economic convergence. • The foregoing analysis clearly highlights the need for a centralized, European responsibility for financial market and banking supervision; the establishment of the European Banking Union was perceived as a logical next step in the advancement of the Economic and Monetary Union. The three pillars of the Banking Union • The Banking Union is built on three pillars: The Single Supervisory Mechanism (SSM), the Single Resolution Mechanism (SRM) and a harmonised system of Deposit Guarantee Schemes. • The Single Supervisory Mechanism gives the European Central Bank (ECB) responsibility for supervision over banks in the euro area and the EU countries which participate in the banking union. This will ensure the application of a common supervisory model for all banks. • As of November 2014, the ECB assumed the direct supervision of 120 significant banking groups which represent 82% (based on the assets) of the euro area banking sector. For all other 3,500 banks the ECB will also set and monitor the supervisory standards and work closely with the national competent authorities on the supervision of these banks, ensuring a level playing field in the supervisory requirements to be met by banks. BIS central bankers’ speeches • The ECB ensures a truly European supervision mechanism that is not prone to the protection of national interests, will weaken the link between banks and national public finances and will take into account all risks to financial stability. • A necessary complement to the single supervision mechanism is the resolution framework to deal with non-viable banks. • The Single Resolution Mechanism constitutes the second pillar of the Banking Union. Orderly and prompt resolution of non-viable banks is essential in order to avoid costly rescues by sovereigns that may impact on their fiscal position. • The SRM Regulation creates a Single Resolution Board, responsible for the resolution of banks in the euro area and in the participating Member States in order to ensure swift and effective resolution decisions, especially in the case of large and complex cross-border banking groups. • From the 1st of January 2016 onwards, any resolution of a euro area bank will be decided within the context of the SRM. • Resolution also needs a credible back-stop. This back-stop is provided by the Single Resolution Fund. The Fund will be financed via ex-ante and ex-post contributions by the banking sector, which will be gradually mutualised. The SRM will thereby reduce the link between domestic banks and their sovereigns and it will contribute to a level playing field for banks. The use of the SRF funds is conditional on the application of the bail-in tool, thus ensuring that shareholders and creditors are the first to carry the costs of a failing bank. • A prerequisite of the Single Resolution Mechanism is the Bank Recovery and Resolution Directive (BRRD), which provides for a complete framework for the crisis management of banks in the EU and lays out specific measures for bank recovery and resolution. • The third pillar of the Banking Union is the EU harmonized framework for the European deposit guarantee schemes, which includes certain provisions to ensure the establishment of sufficiently robust national deposit insurance systems in each Member State, and an appropriate degree of depositor protection in the European Union. Where we stand now • Since the outbreak of the euro area crisis, policy makers have managed to correct considerably the internal and external imbalances of the past. Significant structural reforms and fiscal consolidation efforts have taken place at a national level. As a result, since 2010, the euro area fiscal deficit has improved from 6.1 per cent of GDP to 2.9 per cent of GDP in 2013. • Substantial fiscal adjustment has taken place particularly in member-states with economic adjustment programmes. In Greece, the fiscal deficit was reduced by 13 percentage points of GDP between 2009 and 2013, the largest fiscal consolidation recorded in history in such a short period. The primary budget deficit [10.2 as a per cent of GDP in 2009] turned into a surplus exceeding 1 per cent of GDP in 2013. The cyclically-corrected adjustment of the primary balance was close to 20 per cent of GDP at the same period. The rest of the programme countries have also undertaken substantial adjustment efforts. What makes these achievements especially impressive is that they have taken place in a contracting economy. • Member-states in economic adjustment programmes have also made substantial progress towards eliminating their external imbalances and improving their competitiveness. Between 2008 and 2013, the current account balances as a BIS central bankers’ speeches percentage of GDP of Ireland, Portugal and Greece improved by between 10 and 16 percentage points. Relative unit labour costs have also fallen significantly, since 2008 (in Greece by over 20%). • As a result, current account deficits in these countries have turned into surpluses in recent years. • Substantial structural reforms in the product and labour markets and in public administration have also been implemented by member-states in economic adjustment programmes, facilitating the gradual adjustment of euro area economies. Challenges and risks • Despite the considerable progress made since the global financial crisis, the economic recovery has been fairly slow. Global GDP growth is expected to be relatively low in 2014 for the third consecutive year. Meanwhile, the recovery in the EU has been sluggish and fragile, with low GDP growth and persistently high levels of unemployment, as noted by EU leaders in October. • Political and geopolitical risks will continue to negatively affect the recovery going forward. • However, the efforts made to improve the institutional framework and to promote productivity in the euro area have also created favourable conditions for a sustainable recovery. • The ECB’s accommodative monetary policy stance and the non-standard measures it adopted have helped to preserve financial stability, which is a necessary condition for growth. • The Comprehensive Assessment of banks’ balance sheets – which comprised the Asset Quality Review (AQR) and the stress test components – exposed the areas in the banks and the financial system that need improvement, helped banks to strengthen their balance sheets, enhanced transparency and built public confidence in the banking sector. • Growth will also benefit from the consequences of the Banking Union for the reversal of the fragmentation of EU financial markets, which was observed after the crisis. This reversal is necessary to create the conditions for further integration. Through common supervision, trust among cross-border banks will increase, enabling them to operate more efficiently across borders, to the benefit of consumers and firms. • Moreover, banking union may reinforce the consolidation dynamics in the EU banking system, leading to a restructuring of the European banking sector, while enhanced cross-border competition through integration in the retail banking sector will lead to better prices and services for the consumers. • However, key challenges remain. A key characteristic of the euro area economic recovery is the continuing decline in loans to the private sector. The recovery is so far “creditless” at both the euro area as a whole and, in many cases, in individual countries. • Because the euro area economy is bank-based, bank lending is especially important for companies and, in particular, for SMEs, which produce the bulk of goods and services and account for a large share of employment. • Consequently, the on-going credit contraction raises the question: Can the recovery be sustained in the presence of negative loan growth? BIS central bankers’ speeches • Throughout the crisis, the Eurosystem has adopted both standard and non-standard monetary policy measures with the objective of increasing confidence and further restoring the smooth operation of the monetary transmission mechanism. The latest such non-standard measures, the targeted longer-term refinancing operations (TLTROs), the purchase of asset-backed securities (ABSPP) and covered bonds (CBPP3) and the intention to bring the ECB balance sheet at the level observed at the beginning of 2012, aim at bringing inflation at levels consistent with price stability and support lending to the real economy. For a number of distressed economies potential lack of collateral could limit the usefulness of such measures. The ECB and the respective national Central Banks are paying special attention to this important issue. • Overall, there is still work to be done. This is where the Banking Union again comes in. The banking union represents a crucial step towards restoring confidence in the banking sector. • Restoring confidence in the banking sector will, in turn, greatly contribute to financial and economic stability in the future. Lower volatility in the real economy will have a positive impact on economic growth. This is in line with evidence of the growth theory literature which documents a negative correlation between growth and economic volatility. • One lesson of the global financial crisis is that disruptions of financial intermediation play an important role in business cycle fluctuations. Credit constraints amplify economic fluctuations and banking crises contribute to the deepening of economic recessions. This is particularly true in bank-based economies, where capital markets are less developed. • Eliminating the fragmentation of financial markets will loosen tight credit standards in the member states of the periphery, allowing banks to finance investment. Financing corporate investment is currently of outmost importance for economic growth both in the euro area as a whole and in the periphery countries, which have suffered particularly from deep and prolonged recessions. Remarkably, private investment in the euro area has declined from 20% of GDP in 2008 to 16% of GDP in 2013. The decline was much more pronounced in periphery countries such as Greece, Spain and Portugal, where private investment declined by between 6 and 9 percentage points of GDP. • In the longer term, economic growth will benefit from deeper financial integration and development. Financial market integration will boost long-term economic growth by broadening the pool of available funds and supporting an efficient credit allocation process. This will contribute to a better allocation of physical resources in the economy, boosting in the long term total factor productivity and potential output. Ladies and Gentlemen, Today we witness a containment of systemic stress, despite intermittent financial market turbulence. And this is the result of the aforementioned coordinated actions. However, this should not make us complacent. The search for yield in a very low interest rate environment, the growing use of leverage in the non-bank financial sector, the persistent pressures on bank profitability in a weak and uneven macroeconomic recovery, the reemergence of sovereign debt sustainability concerns amid low nominal growth, the wavering policy determination for reforms, and the signs that some investors may underestimate the potential for losses and volatility going forward, are issues of major concern. The probability of a systemic threat is currently low but increased vigilance is required. In this environment, macro-prudential policies need to ensure that financial intermediaries can withstand a potential reversal of risk premia, while at the same time further initiatives are BIS central bankers’ speeches needed to monitor and assess vulnerabilities in the shadow banking sector. I believe that the lessons we have learned so far will prove valuable in addressing those potential risks and in safeguarding financial stability. Finally, and with reference to the Eurozone, we should not forget one of its most pronounced characteristics: that it is almost fully integrated in the monetary side, less so in the financial side despite recent progress, and much less so in the fiscal and economic sides. Until this asymmetry is eliminated its overall economic performance will tend to remain below potential. BIS central bankers’ speeches

bank of greece

Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the 82nd Annual Meeting of Shareholders, Athens, 26 February 2015.

Yannis Stournaras: Exit from the crisis and return to economic growth Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the 82nd Annual Meeting of Shareholders, Athens, 26 February 2015. * * * Agreement with our partners to avoid a stalling of recovery and to bolster growth After six years of severe recession, the downturn in Greece came to an end in 2014, with economic activity resuming positive growth rates. This development, combined with the elimination of the high fiscal and current account deficits and with the implementation of significant reforms, arguably suggests that the necessary conditions are now in place for a definitive exit from the crisis and for accelerated growth in the immediate future. However, this optimistic outlook has been clouded by a protracted period of uncertainty that peaked in recent weeks. The Eurogroup’s decision on 20 February 2015 to grant Greece a loan extension and its approval on 24 February of the Greek government reform measures alleviate the uncertainty and give Greece’s new government time to complete the reforms still pending and to set its own priorities. This is a positive outcome, as it averts a rift between us and our partners that would have had dire consequences for the Greek economy and beyond. In order to seize this window of opportunity, however, we must pursue the negotiations in a spirit of cooperation and trust and promptly conclude a mutually beneficial final agreement with our partners. At this crucial time, what is needed is a coordinated national effort, in close collaboration with European and international institutions, to ensure that the sacrifices made by Greek citizens will not have been in vain and to facilitate the economic restructuring needed for sustainable growth. The Bank of Greece stands ready to contribute to this effort with all of its resources. Economic recovery in 2014 in a deflationary environment 2014 marked the return of economic activity to positive growth rates after six consecutive years of deep recession, during which GDP contracted by more than 25%. The available quarterly GDP data indicate that the recession has clearly been winding down since the first quarter of 2014, with year-on-year growth in 2014 returning to positive territory (0.8%) for the first time since 2007, driven by higher exports of goods and services and increased private consumption. More specifically, in the period from January to September 2014: • Exports increased by 8.4%, largely as a result of improved competitiveness, with a strong performance from tourism and shipping exports. • Private consumption increased by 1.5%, on the back of stabilised real disposable income, a declining general level of prices and reduced uncertainty. Other significant positive developments were the recovery of total employment by 0.3% and of dependent employment by 2.3%, while the number of unemployed decreased for the first time since 2008, by 3.3%. Nevertheless, the unemployment rate remains high and the highest in the EU. Another major concern is that the long-term unemployment rate continues to rise, which increases the risk of human capital depreciation. Unit labour costs decreased further in 2014 on the back of higher productivity and lower employer contributions, thereby helping the economy gain in competitiveness. Structural competitiveness in Greece has been showing signs of improving since 2013. More specifically, according to the World Economic Forum’s global competitiveness index, Greece moved up the ranking to 81st place, from 91st in 2012, while according to the World Bank’s ranking on the “ease of doing business”, Greece advanced to 61st place, from 65th and 89th, respectively, in the past two years. However, low access to financing, red tape and tax policy BIS central bankers’ speeches instability remain the biggest drags on the international competitiveness of Greek businesses. The over-performance against the primary surplus target set in the Economic Adjustment Programme by 1.2% of GDP in 2013 was a milestone achievement that provides a solid base for the attainment of the fiscal target in 2014 for a third consecutive year. However, the general government fiscal outcome in 2014 faces downside risks, largely associated with the uncertainties in the last weeks of the year, combined with a back-loaded revenue schedule. These uncertainties have increased following the completion of the state budget execution for 2014, which pointed to significant tax revenue shortfalls, especially in December. Despite an increase in public investment, total investment remains particularly low, reflecting a decrease in private investment mainly on account of limited bank lending and the high cost of borrowing. The fall in private investment was primarily concentrated in residential investment, whereas productive business investment has started to show signs of recovery. For the first time since 2008, the increase in investment in the third quarter of 2014, albeit moderate at 1%, may be signalling a longer-lasting recovery trend. Global financial markets Global financial market conditions continued to improve in the first half of 2014. Gradually, however, from the third quarter onwards, increasing investor uncertainty about the banking sector of euro area countries, signs of economic recovery losing momentum in the euro area and slackening growth in the global economy led to a surge in volatility in European capital markets. Against this background and given country-specific factors weighing on the rating of Greek government bonds (mainly associated with uncertainties about political developments), Greek government bond yields once again spiked, returning to levels not seen since the third quarter of 2013. Developments in the Greek corporate bond market were also negative in 2014. During most of the year, the yields on Greek corporate bonds moved broadly in line with the yields on bonds issued by European non-financial corporations, which have higher credit ratings. From the end of October, however, Greek corporate bond yield developments decoupled from those in European corporate bonds and followed the same sharp upward course as Greek government bond yields. Developments in the Greek stock market were also negative in 2014, albeit not throughout the entire year. The prices of shares on the Athens Exchange dropped significantly, especially bank shares, although the results of the ECB’s recent Comprehensive Assessment reconfirmed that the systemic Greek banks were adequately capitalised. The Greek banking system remains strong despite the turbulence The strengthening of banks’ capital bases and operating profits before provisions, the first steps towards addressing the issue of non-performing loans and the activation, as of 4 November 2014, of the Single Supervisory Mechanism (SSM) were the main developments for the Greek banking system in 2014. First, in early 2014, the Bank of Greece released the findings of its stress test of Greek banks. This, together with the downward trend of Greek government bond yields at the time, gave banks easier access to capital market funding. Towards the end of the year, the ECB completed its Comprehensive Assessment, which reconfirmed the capital adequacy of Greek systemic banks. Despite these favourable developments, the banking system continues to face serious challenges, first and foremost the need to address non-performing loans (NPLs). The BIS central bankers’ speeches ratio of NPLs to total loans remained particularly high (September 2014: 34.2%, December 2013: 31.9%). On the upside, however, the pace of new NPL formation has slowed down markedly and the NPL coverage ratio from accumulated provisions has risen significantly. Finally, the Single Supervisory Mechanism (SSM), which is the new banking supervision system composed of a supranational authority (the ECB) and the national competent authorities of the participating Member States, was activated on 4 November 2014. In order to ensure consistent supervisory practices and approaches, the ECB and the national authorities use a single rulebook, and a Joint Supervisory Team, formed of staff of the ECB and the national supervisors, is established for each significant bank. The ECB directly supervises some 120 significant banks, including Greece’s four systemic banks. This direct supervision will involve examining banks’ lending, borrowing and investment activities and overall compliance with European and national prudential regulation. The decision by the ECB’s Governing Council on 4 February 2015 (lifting the waiver of minimum credit rating requirements for marketable debt instruments issued or fully guaranteed by the Hellenic Republic) does not create liquidity problems for the Greek banking system: the banking system, now standing on sounder foundations after its recent consolidation, is well-capitalised and furthermore has access to liquidity, albeit at a much higher cost, from the Bank of Greece through the Emergency Liquidity Assistance (ELA) mechanism. This decision by the ECB’s Governing Council will soon be re-examined and should be revoked, as in similar cases in the past, so long as Greece fulfils its recent agreement with its partners. Positive outlook for 2015 Based on the latest available data, GDP growth is projected to be positive in 2015 and to pick up in 2016. The main elements of uncertainty weighing on the prospects for economic activity in the medium term refer to our ability to fulfil 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 can and should continue to recover 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. The favourable outlook for investment should be supported by: (a) the deployment by domestic credit institutions and businesses of resources from the National Strategic Reference Framework (NSRF) and the utilisation of co-financing and guarantee instruments available from the European Investment Bank (EIB) and the National Fund of Entrepreneurship and Development (ETEAN); (b) further progress in major infrastructure projects – especially Greece’s four main highways – and the potential of public-private partnerships, which have an immediate growth impact and can leverage investment capacity in the building materials industry and supporting services; (c) the Investment Plan for Europe jointly promoted by the European Commission and the EIB through the establishment of a new European Fund for Strategic Investments; and (d) the very accommodative stance of the BIS central bankers’ speeches single monetary policy which is expected to help improve financing conditions for sound businesses. A favourable impact will also come from the execution of projects under the Public Investment Programme with an overall budget of €6.4 billion for 2015. Another factor that could considerably boost the investment climate is the completion of major privatisations. As the Bank of Greece has mentioned in the past, insofar as privatisations involve productive foreign direct investment, they can deliver a number of benefits for the privatised businesses, in terms of knowhow transfer, modernisation and efficiency, and for the economy as a whole by enhancing competitiveness and extroversion, as well as by helping to reduce the government’s borrowing requirements and – ultimately – public debt in the medium term. The recovery is still fragile and leaves no room for complacency As mentioned above, the main uncertainties weighing on the prospects for economic activity in the medium term refer to our ability to bridge the time for discussions on an agreement with our partners, as well as to the onset of fiscal and structural reform fatigue. Signs of uncertainty are already visible in the economic sentiment indicators, which appear to have lost some of their upward momentum in late 2014 and early 2015, as well as in the budgetary slippages in December 2014 and January 2015. Lower-than-expected growth in the euro area and geopolitical risks are additional potential factors of uncertainty. On the other hand, the further decline in oil prices, the very accommodative stance of the ECB’s monetary policy conducive to improved financing conditions, the prospect of a rebound of private investment once economic uncertainty dissipates, as well as the depreciation of the euro are expected to impact favourably on domestic economic activity. Adoption of a national growth policy focused on reforms, for a definitive exit from the crisis and attainment of sustainable growth Greece’s positive macroeconomic performance in 2014 and optimistic prospects reflect the significant changes made in recent years with tangible benefits, but also serious negative side-effects. Key achievements include restored fiscal balance and the virtual elimination of the current account deficit, the latter reflecting a sharp contraction in domestic consumer and investment demand, but also an improvement in competitiveness. Also, headway was made with a number of structural reforms in the functioning of the State, while steps were taken to modernise the tax system and tax collection mechanism and broaden the tax base. On the downside however, these positive results have taken a heavy toll on the economy and society in terms of income, employment and human and physical capital. These hard-won achievements must be preserved and consolidated, as they provide a cornerstone for the desired shift towards a new, export-led growth model. This is why it is imperative to quell uncertainties and ward off the risks that could cancel out the substantial progress made and undermine growth. The tremendous sacrifices made by the Greek people must not be in vain. Amongst the crucial matters being debated at present are the ongoing negotiations with our partners and the securing of smooth financing conditions for the Greek economy as well as of unhindered bank funding. One key area that will facilitate the conclusion of a final agreement is the advancement of the structural reforms still pending. These reforms are much smaller in scope and would entail low cost compared with the huge changes made in recent years at a very high price for Greek society. Once these pending reforms are completed, there will be nothing but gains ahead for the economy. Needless to say, Greece would then have to implement its own programme of further reforms to solidify its basis for sustainable growth and social wellbeing. BIS central bankers’ speeches If we, on our part, adhere to our commitments, our partners can in turn be expected to reiterate their decision, as explicitly stated at the Eurogroup meeting of 27 November 2012, to consider further measures to alleviate Greece’s debt burden. This could be achieved by the methods envisaged in that Eurogroup statement or by other methods and would boost Greece’s growth prospects, provided that economic policy stays committed to fiscal adjustment, primary surpluses and reforms to re-launch the economy. This would also allow the required primary surpluses to be gradually reduced, freeing up more resources for the financing of the economy. Let us not forget that such further measures to ensure a reduction of Greek public debt were, back in November 2012, made conditional to, and meant as a reward for, fiscal adjustment. This adjustment is now a reality. Reaching a new agreement with our partners may be a necessary condition for the recovery to take root and gain traction. However, it is not an adequate condition for jump-starting the economy. At the present crucial juncture, what we need is a comprehensive and coherent growth plan geared towards strengthening the productive capacity through investment and, more importantly, through structural reforms. The first practicable measures that would pave the way in this direction include: (a) Completing the reforms already launched, pursuing structural reforms in the goods and services markets and developing a “smart economy”. The further opening-up of closed professions, as well as of those goods and services markets that, according to OECD recommendations, still lack effective competition, must be speeded up. The privatisation strategy needs to give priority to accelerating the processes presently in course that, as mentioned previously, would help increase the efficiency of the companies being privatised, improve competitiveness, make the economy more export-oriented and – in the end – reduce public debt. Meanwhile, the available EU funding resources (under e.g. the NSRF, the Investment Plan for Europe) must be harnessed towards supporting knowledge and innovation and towards exploiting our comparative advantages in sectors of the “smart economy”, including the culture and creative industries. (b) Consolidating fiscal achievements. The fiscal achievements must be preserved and consolidated. Efforts must focus on structural measures to strengthen the independence and efficiency of tax administration, with the aim to tackle tax and 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. (c) Reviewing tax exemptions and other favourable tax treatment. Tax exemptions and favourable tax treatment, including reduced VAT rates, need to be reviewed and streamlined. Actions that could start immediately include the scrutiny, cost analysis and gradual abolition of the various exemptions from the general tax rules, unless they concern: (a) social groups hard hit by the crisis or living in conditions of poverty or (b) growth incentives providing much-needed stimulus to economic activity. (d) Lowering tax rates and reviewing the efficiency of public spending. To the extent that action under the preceding point is implemented, a lowering of the direct and indirect tax rates will become possible, with positive impact on growth without jeopardising fiscal sustainability. 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. The strengthening of the financial framework for local governments needs to be completed, in order to curb the accumulation of arrears, while the newly established Independent Fiscal Council must assume an enhanced and effective role. (e) Increasing public sector efficiency. The remaining reforms in the public sector, mainly geared towards greater operational efficiency, transparency and equitability, BIS central bankers’ speeches must be taken forward. The generalised application of automated online procedures is an important means for improving the interaction of citizens and businesses with the State and can further serve as a backstop against corruption. 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. (f) Strengthening active labour market policies and reducing the number of unemployed. The absorption of the unemployed is expected to be a gradual process that will take time, given the current slack in the labour market. A deescalation of unemployment – particularly amongst youth and the long-term unemployed – and a gradual recovery of the employment rate are expected to benefit, in addition to growth, from active employment policies, as programmes and actions financed by the NSRF 2014–2020 are phased in. Actions that promote employment, for instance through the development of local employment partnerships and vocational training programmes, will also be instrumental in tackling unemployment, especially its structural component. However, this strengthening of active policies needs to be combined with eligibility controls and results-based assessment of programmes and with a fight against undeclared and uninsured work. (g) Effective management of non-performing loans (NPLs). The effective management of non-performing loans will have a positive knock-on effect on lending to sound businesses, given that banks’ ability to extend new credit is closely linked with the smooth and timely repayment of existing loans. The NPL management model to be chosen must: (a) not give rise to moral hazard; and (b) enable the identification of the most appropriate workout solutions and, where possible, ease the burden on cooperating borrowers facing temporary difficulties in servicing their debt. Apart from effective NPL management, the consolidation of positive growth rates will obviously contribute significantly to improving the NPL recovery rate, by generating a self-reinforcing process of NPL reduction as the debt servicing capacity of households and businesses increases. (h) Securing the smooth financing of the Greek economy. The capacity of the banking system to finance the real economy does not depend on capital adequacy alone, but also on its liquidity. Following the recent capital increases, Greek banks have a sufficient capital base, but their liquidity has come under considerable strain, especially in the last few months. The stock of outstanding deposits is significantly lower today than it was before the crisis, plus the banks still have no access to money markets. After the recent decision by the ECB’s Governing Council (4 February 2015) to exclude securities issued or guaranteed by the Hellenic Republic from the list of collateral acceptable for open market operations, the value of eligible securities held in Greek bank portfolios dropped significantly. Greek banks can still obtain liquidity from the Bank of Greece through the emergency liquidity assistance (ELA) mechanism, but, as entailed by the rules of the Eurosystem, at substantially higher cost. Hence, there is need for Greece to fulfil its recent agreement with our partners as soon as possible, so that this decision can soon be revoked. * * * In the past few years, we have covered some very rough ground at high cost to the whole of Greek society. If we can address the relatively few issues still pending and complete the first phase of the effort launched in 2010, we will then be able to move on to the next phase, in which the growth potential of the economy will be considerably enhanced. Rapid growth will enable the implementation of more effective policies for restoring social cohesion which has been eroded by the crisis. The priorities of these BIS central bankers’ speeches policies should be geared towards reducing unemployment and correcting inequality in the distribution of the burden from the adjustment effort. For this to happen, we must remain firmly committed to the country’s European course and fulfil the recently concluded agreement as soon as possible. BIS central bankers’ speeches

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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.

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. * * * 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. BIS central bankers’ speeches 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. BIS central bankers’ speeches 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 BIS central bankers’ speeches 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 BIS central bankers’ speeches 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 BIS central bankers’ speeches 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 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 –toGDP 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 ½ 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. BIS central bankers’ speeches 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. BIS central bankers’ speeches

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Speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the 33rd Meeting of Central Bank Governors Club of Central Asia, Black Sea Region and Balkan Countries (Shanghai, China), Shanghai, 21 May 2015.

John Mourmouras: Low inflation in the euro area – symptom or cause? Speech by Professor John Mourmouras, Deputy Governor of the Bank of Greece, at the 33rd Meeting of Central Bank Governors’ Club of Central Asia, Black Sea Region and Balkan Countries (Shanghai, China), Shanghai, 21 May 2015. * * * Accompanying charts can be found at the end of the speech. Governors, Dear colleagues, Ladies and Gentlemen, It is a great pleasure for me to be here in Shanghai and I would like to thank the Governor of the People’s Bank of China, Mr. Zhou Xiaochuan, for inviting me to this high-profile meeting attended by esteemed colleagues of the central banking sector. I would like to share my thoughts with you on the problem of low and persistent inflation (and the appropriate policy responses) in the euro area, which numbers 19 Member States sharing a single currency, the euro. I. Introduction As you all know, the 2008 global crisis – mainly a crisis of credit and confidence expressed in both bond and equity world markets – turned into a sovereign debt crisis in the euro area in 2010, heightening market concerns about the sustainability of public finances of governments in the so-called europeriphery. That, in turn, hampered the expectations of the private sector, gave rise to prolonged fiscal consolidation, contributed to an anaemic recovery, to problems with the smooth transmission of the single monetary policy and thereby the achievement of the price stability objective. Over the course of this period, the ECB naturally took action against the fragmentation of the financial system in the area and took measures against a severe bank credit squeeze and a deep economic recession by introducing a very accommodative monetary policy stance which resulted in its latest decision: the quantitative easing (QE) implementation, which is essentially my topic today. My remarks will focus on four areas. First of all, I will begin with a brief discussion of the recent inflation developments and prospects in the euro area. Secondly, I will briefly describe the QE practices of major central banks and, more precisely, those implemented by the Fed, the Bank of England and the Bank of Japan. Thirdly, I will discuss the ECB’s recent policy responses focusing in particular on its expanded asset purchase programme (QE). As you know, QE is rather a controversial idea. It has lots of critics. Opinions diverge across the board, from “one of the most radical monetary policy experiments of modern times” to “quasi fiscal policy”. And of course QE’s efficacy in Europe is of global significance, if only one takes into account the euro area’s big share in world output – not to mention the reactions of other central banks (e.g. in Switzerland, Denmark, Sweden, etc.). Last but not least, I will look into the challenges and risks that lie ahead for the overall stance of economic policy in Europe. II. Low inflation or deflation? Before starting to unfold these issues, please allow me to explain why it is that we talk about low inflation, rather than deflation, in the euro area. In February 2013, euro area inflation fell below the 2% mark and has since been on a continuous downward trend for more than two years. According to the latest report of the ECB survey of professional forecasters (SPF), low inflation is expected to be quite prolonged, but gradually rise to 2%. According to Eurostat’s flash estimate, euro area annual HICP inflation was zero last month, –0.1% in March, up from –0.3% in February 2015 and –0.6% in January 2015, despite the fact that both BIS central bankers’ speeches measures of money supply, the broad M3 and the narrow M1 have been picking up this year (by 4.5% and 9.5% year-on-year respectively in the first quarter of 2015). Inflation is expected to remain very low or slightly negative in the coming months, with an annual inflation projection of 0.1% on average for the year 2015, against a yearly average of 0.4% in 2014. It is also true that in advanced economies, the inflation rate will stand at 0.4% on a yearly basis in 2015, according to the latest IMF forecasts, which is the lowest level in the last 30 years. However, inflation rates are projected to rise consistently over the short- and medium-term and reach 1.5% by next year. Although in the euro area, there is more than a 50% risk of the inflation rate hovering below one percent in the short-run, the risk of deflation is quite low at less than 10 percent in the short term (in the next one to two years) and effectively zero (1% risk) in the longer term (in the next five years), as shown in Chart 1. Ultimately, the ECB’s mandate is expected to be achieved, as the Harmonised Index of Consumer Prices (HICP) is expected to reach 1.8% in 2017, namely its primary goal of price stability, i.e. maintaining the euro area inflation rate below, but close to, 2% over the medium term. The main factors for the relatively small probability of deflation in the euro area are three: the ongoing economic recovery, the effects of the euro’s depreciation and the fact that monetary policy plays a supporting role. In addition, we do not generally expect negative energy price developments to impact wage developments significantly. In a classic deflationary cycle, households and firms defer expenditures when monetary policy is at the effective lower bound and the central bank cannot steer the nominal rate down to compensate for lower expenditure. This does not seem to be the case in the euro area. It is worth pointing out that core inflation – that is, the inflation rate that strips out energy and unprocessed food prices – remains low, but is still on the positive side with the latest reading for March 2015 at 0.6%. Consequently, using the term “deflation” for the euro area would arguably be an overstatement, with the ECB not expecting the euro area to fall into deflation. However, the risks of low inflation appear to be linked to the risks of subdued growth or weak recovery (see also below). Quarter-on-quarter real GDP growth in the euro area was 0.3% in the last quarter of 2014, year-on-year change in 2014 was 0.9%, while the ECB’s March prediction for this year was at 1.5%. Euro area growth rates are still a full percentage lower than in the decade leading up to the crisis (2.5%), and are uneven across countries. It is true that domestic demand in the euro area has not yet reached its pre-2008 crisis levels. Particularly, business investment remained around 15% below its pre-crisis levels, which led to a sharp decline in the investment-to-GDP ratio. On top of that, the growth in government expenditure during the last five years was just 0.18%, against 1.8% in the period before the crisis. What is perhaps a more worrying feature is the fact that the euro area stands out among large economies for the depth and likely duration of its bout of low inflation. Particularly, the ECB staff macroeconomic projections in March this year show a downward revision by 0.8 percentage point to the inflation forecast for this year and a slight revision by 0.2 percentage point to the inflation forecast for 2016, compared with the December 2014 Eurosystem staff macroeconomic projections. Inflation is now projected to be 0.1% in 2015 and 1.5% in 2016. The annual rate of change in core inflation has been consistently below 1% over the past year, with the latest reading for March 2015 at 0.6%, their lowest levels since the start of the series in 1997. A low reading for core inflation for such a prolonged period of time indicates that it is not only temporary factors that are at work: underlying demand weakness also plays a significant role, as well as of course contained wage pressures and structural reforms undertaken during the same period. Empirical evidence from the Phillips curve suggest that the negative output gap will last until 2019, which is projected by the IMF to stand at –2.3% in the euro area this year. Falling energy prices and slowing annual growth rates of wages and salaries in the euro area obviously contribute to persistently low inflation. All in all, the inflation problem in the euro area is quite challenging. BIS central bankers’ speeches Low inflation is already hurting debtors in the euro area since their incomes are rising more slowly than what they expected when they borrowed. III. Other central banks’ QE programmes Allow me now to briefly review the programmes of large-scale asset purchases (LSAPs) implemented so far by the other major central banks, focusing mainly on their impact on the real economy. Fed used its balance sheet – with purchases of public and private assets – to provide stimulus to the economy amidst the credit crunch of 2008. To give you the whole picture of the size of the Fed’s balance sheet over the past several years: assets have risen from about 900 billion US dollars in 2006 to about 4.5 trillion US dollars today, accounting for 25 percent of nominal GDP from 6 percent of nominal GDP in 2006 (CHART 2). The net expansion of the Fed’s balance sheet over this period primarily reflects these largescale asset purchase programmes. But how effective was the Fed’s policy? After nearly 6 years of large-scale asset purchases, a substantial body of empirical work on their impact has emerged. According to the Fed’s own research, the large-scale purchases have significantly lowered long-term Treasury yields, which translated into reduced corporate bond and mortgage security yields. But was this ultra-expansionary monetary policy effective for the overall economy’s performance in the US? Model simulations conducted at the Federal Reserve generally found that the securities purchase programmes have provided significant help to the US economy. For instance, a study using the Federal Reserve Board’s model (FRB/US) of the economy found that, as of 2012, the first two rounds of LSAPs may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would be the case. In conclusion, as Stanley Fischer, the Fed’s Vice Chair, noted in his speech last February that QE programmes coupled with increasingly explicit forward guidance have reduced the unemployment rate by 1–1.25 percentage points and increased the inflation rate by half a percentage point, relative to what would have occurred in the absence of these policies. A similar policy was conducted by the Bank of England in response to the intensification of the financial crisis in the autumn of 2008. The aim of the policy was to inject money into the British economy in order to boost nominal spending and thus help achieve the Bank of England’s 2% inflation target. According to the reported estimates of the peak impact, the £200 billion QE programme implemented between March 2009 and January 2010 is likely to have raised the level of real GDP by 1.5% to 2% relative to what might otherwise have happened, and also to have increased annual CPI inflation by 0.75 to 1.5 percentage points. The Bank of England’s own conclusion is that the effects of its QE programme have been “economically significant”. Last but not least, the Bank of Japan’s large-scale asset purchases were primarily aimed at boosting money supply, asset prices and inflation expectations, while holding down interest rates. As regards asset prices as a result of the QE programme, stock prices are up and the yen/dollar exchange rate has fallen. But what about the Bank of Japan’s 2% inflation target? For the period leading up to the 2008 financial crisis, inflation expectations appeared modestly positive and rose significantly above their historical average. This suggests that the BOJ’s 2% inflation target might be gaining credibility. Lately, the Bank of Japan decided to expand its quantitative programme in order to act in an orderly manner against weak developments in demand. Whether this decision will eventually help the rate of inflation reach 2% remains to be seen. IV. The main features of the ECB’S QE Turning now to the euro area, the question is how exactly has the ECB acted and is still continuing to act? More specifically, what has been the ECB’s immediate response to achieve its primary goal of price stability? Let me quickly present the ECB’s monetary policy BIS central bankers’ speeches stance over the last eight years, which saw the euro area faced with particularly adverse circumstances: • The main refinancing rate was gradually cut to just over zero (0.05%) and the deposit facility below zero, to –0.20%, its lowest level since the launch of the euro; • The ECB’s second line of action was a policy of forward guidance and a more active use of its balance sheet; • All eligible financial institutions have unlimited access to central bank liquidity at the main refinancing rate, as always subject to adequate collateral with extended maturity of liquidity provision. A programme to provide targeted long-term funding (TLTROs) to banks is also implemented; • As part of special programmes, private sector securities such as covered bonds are purchased by both the ECB and the euro area’s National Central Banks (CBPP – Covered Bond Purchase Programmes 1 & 2) and asset-backed securities only by the ECB (ABSPP); • The asset purchase programme was expanded to include sovereign bonds, under the public sector purchase programme (PSPP), commonly known as QE, which entered into effect on 9 March 2015. In this context, let me remind you that in 2010 the ECB started purchasing securities under the Securities Markets Programme (SMP, outstanding amount €138 billion from a maximum amount of €220 billion), and in 2012 initiated the outright monetary transactions (OMT) in secondary sovereign bond markets in order to address the severe tensions in certain market segments and safeguard an appropriate monetary policy transmission. After the ECB President’s pledge “to do whatever it takes to preserve the euro” in the period following the OMT announcement, tensions in sovereign bond markets subsided, with Spanish and Italian ten-year government bond yields to fall significantly. In essence, the ECB reaffirmed its full commitment to our price stability mandate, sending a strong message to financial markets. Let me briefly explain the main objective and the key characteristics of the ECB’s expanded bond-buying toolkit. The explicit objective of the ECB’s programme is “a sustained adjustment in the path of inflation that is consistent with its aim of achieving inflation rates below, but close to, 2% over the medium term”. The key elements of the programme are the following: 1. Combined monthly asset purchases will amount to €60 billion of private and sovereign debt; 2. In total, the programme will amount to €1.1 trillion in asset purchases carried out from March 2015 until September 2016, but the programme may be extended if its objectives are not achieved. 3. Loss-sharing is reserved for those purchases that are carried out by the ECB or fall on securities issued by supranational European institutions, amounting in total to 20%. The remaining 80% of all purchases – falling on purchases made by NCBs – will not be subject to loss-sharing. This mix corresponds approximately to the current allocation of fiscal responsibilities in the euro area, thereby preserving needed fiscal discipline incentives for euro area governments. 4. The spectrum of securities covered by the QE includes: (i) nominal and inflationlinked central government bonds, and (ii) bonds issued by recognised agencies, international organisations and multilateral development banks, provided the issuers are located in the euro area. Of these, only securities with a residual maturity ranging from two (2) to thirty (30) years will be eligible. In terms of issuer breakdown, the ECB intends to allocate 88% of the total purchases under the PSPP BIS central bankers’ speeches to government bonds and recognised agencies and 12% to securities issued by international organisations and multilateral development banks. 5. Also, in order to ensure proper market formation, two limits are applied in terms of issues and issuers, calculated in nominal values. On the one hand, the ECB won’t buy more than 25% of each issue. The 25% issue share limit is applied in order to avoid a blocking minority in the event of a debt restructuring involving collective action clauses (CACs). On the other hand, the ECB won’t buy more than 33% of each issuer’s debt. The 33% issuer limit applies to the combined holdings of bonds bought under all of the ECB’s purchase programmes and to the universe of eligible assets in the 2 to 30-year range of residual maturity. It is a means to safeguard market functioning and price formation, as well as to mitigate the risk of the ECB becoming a dominant creditor of euro area governments. One last remark on the modalities of the programme. The ECB buys public sector bonds on the secondary market, refraining from asset purchases on the primary market in order to remain compliant with the Lisbon Treaty’s provisions on the prohibition of monetary financing (Article 123). An obvious question that might arise then is the following: Is there really any economic distinction between buying government debt in the secondary market from buying it directly from the government (i.e. monetising public debt)? The answer is a clear cut “yes” and the crucial point is that the central bank is not being forced to create money in order to cover the gap between the government’s tax income and its spending commitments. V. The main channels But how will the expanded asset purchase programme work in terms of boosting inflation, restoring economic growth, employment in the euro area and contributing to the attainment of the ECB’s objective? There are a number of potential key channels through which asset purchases may affect spending, inflation, and borrowing costs to the real economy. • First of all, a portfolio rebalancing channel can be identified where investors are likely to redistribute their portfolios by substituting lower risk assets with riskier assets such as longer-term assets, equities and possibly real estate. Bidding up the prices of assets bought leads to lower yields and lower borrowing costs for firms and households, thus stimulating spending. In addition, higher asset prices stimulate spending by increasing the net wealth of asset holders. Consequently, an improvement in net wealth, combined with a general improvement in economic prospects and hence future earnings, can expand the capacity of firms and households to borrow. This is an important channel in every single QE programme adopted so far, with its effect as a primary channel of transmission of monetary policy programmes centred on outright purchases. • Another important channel is the signalling effect whereby the central bank’s balance sheet expansion signals a turn towards an accommodative monetary policy stance over an extended horizon and pushes back the date on which a policy rate hike is expected. By introducing a QE programme, a central bank can send a strong signal that it will continue to be able to loosen monetary policy and stimulate demand even when monetary policy rates hit a lower bound, which could have had a strong impact on private sector’s inflation expectations and thereby lower real interest rates, boosting economic activity and inflation. • The third channel is of course the exchange rate which is not an objective in itself, but it reflects the market participants’ expectations of the ECB’s very accommodative monetary policy. The nominal exchange rate of the euro has already fallen by 11% since last December, while the programme’s expanded and open-ended nature will maintain the currency at its current low levels. BIS central bankers’ speeches • All these factors are short-term and this is consistent with traditional policies of central banks which are geared towards the short/medium term. However, QE by its very nature is an extension of the intervention horizon of monetary policy and as such it can create favourable conditions for long-term investment and hence boost the potential growth of the euro area. For instance, the weighted average remaining maturity of the securities purchased as part of ECB’s QE is currently 8.5 years (on 6 May 2015). So monetary policy in the euro area is having a more direct impact on long-term interest rates than ever before. VI. The ECB’S QE: an early assessment A number of analysts have already discounted the limited efficacy of QE in the euro area on the grounds that banks rather than capital markets dominate the provision of credit there. They claim that, for instance, US companies raise much of their funding in the bond markets and the main channel through which QE has boosted the US economy is by lowering corporate borrowing costs. This effect would clearly be much weaker in the euro area. Having said that, and although is still very early days, preliminary evidence (soft evidence if you like) on the impact of QE is really encouraging. The latest economic data and, particularly, survey evidence available up to March point to improvements in economic activity since the beginning of this year. The so-called indicators (industrial production, construction production, capital goods production, retail trade and car registrations) all signal a further rise in euro area activity and output in the first quarter of 2015. Moreover, compared with the December 2014 Eurosystem staff macroeconomic projections, the projections for real GDP growth in 2015 and 2016 have been revised upwards (Chart 3a), reflecting the favourable impact of significantly lower oil prices, the weaker effective exchange rate of the euro and the impact of the ECB’s asset purchase programme. Furthermore, credit dynamics also gradually improved. According to the latest data, the annual growth rate of total credit in the euro area increased to 0.4% in March, from 0.0% in the previous month. Among the components of credit to the private sector, the annual growth rate of loans increased to 0.1% in March, from –0.1% in the previous month. Loan growth in the euro area averaged 5.41% from 1992 to 2015 with a record low of –2.30% in November 2013 and shows the first positive signs for the first time since January 2014. All this shows an improvement in the credit channel, confirming a further recovery in loan growth. According to the April 2015 ECB staff macroeconomic projections for the euro area, annual real GDP will rise by 1.5% in 2015, 1.9% in 2016 and 2.1% in 2017. Furthermore, model-based estimates indicate that market-based measures of inflation expectations have reacted positively to the progressive expansion of our balance sheet over the last few months and have been revised upwards, as well (CHART 3a). Although euro area HICP inflation is at the same level as in 2009, the current level of inflation expectations is well above the historical low reached in 2009. Breakeven inflation rates – derived from five-year German government bonds – have overcome the lows recorded in early January (below zero) and currently stand at 0.85%. Having increased steadily since mid-February, they suggest that the decline of expectations was largely driven by temporary factors and that concerns about deflationary pressures have abated recently. This trend is confirmed by the evolution of inflation-linked swaps for a wide range of maturities, from which a euro area inflation curve can be drawn. Market-based short-term inflation expectations have recovered from the troughs they reached in January. For the short term, inflation-linked swap rates at the one year-forward one-year-ahead horizon stood at 0.9%. Swap rates at the three-year-forward-three year-ahead horizon would imply an average inflation rate of 1.5% (taken at face value). On a longer horizon, the widely watched five-year forward five-year-ahead indicator recovered strongly from its low point in January and at the time of writing suggests an inflation of 1.7%, a level which minimises concerns about a possible de-anchoring of inflation expectations. Having fluctuated around its long-term average of 2.3% for most of 2013, the five-year forward five-year ahead implied rate declined in 2014. Currently it is hovering around 1.7 %, slightly lower than the ECB’s SPF (2015Q1) results. BIS central bankers’ speeches As far as financial markets are concerned, the impact of the asset purchase programme accounts for most of the fall in euro area long-term sovereign bond yields since last December, as market participants anticipated the ECB’s QE programme. Government bonds across a wide range of euro area countries traded at historically low and often negative yields. The decline was most pronounced in the longest maturities, with yields on French and German 10-year bonds falling by around 60 basis points, while those on Italian and Portuguese bonds of the same maturity shrank by 70 and 90 basis points, respectively. Yields on corporate euro-denominated debt have also gone done while the major European stock markets have risen from the end of 2014 by 17% approximately (CHART 3b). [Note: Charts 3a and 3b do not capture the recent bond sell-off in early May, which was in my view a market reaction to an overshooting of euro area sovereign bond prices following the QE’s formal announcement by the ECB in January of this year.] A case in point is that from just before the announcement of the ECB’s expanded asset purchase programme on 22 January to the close of business the day after, German 20-year maturity yields fell by almost 25 basis points and Italian 20-year maturity yields fell by almost 35 basis points. Furthermore, as we mentioned earlier, the euro depreciated by 11% since last December, hitting a 12-year low against the dollar (CHART 3a). On the other hand, the effectiveness of the ECB’s QE programme in terms of contributing to a robust recovery in the euro area should have a significant final impact on the global economy and indeed in this part of the world. Such an accommodative policy that aims to raise ultimately consumer confidence in the euro area, obviously stimulates imports from the rest of the world. An illustration of this is that total EU trade with Asia reached €1.03 trillion last year, almost double the value recorded a decade ago and, at the same time, the EU accounted for 22,4% of Asian trade in 2014, with most of EU imports coming from China (6.7% of total EU imports). The EU is also a major investor in the Asian continent. Only last March the European Commission announced over €6.5 billion in new support for countries and organisations in Asia for the period 2015–2020. VII. Final remarks From the above analysis, there is a rather straightforward answer to the question posed in the title of my speech, if the euro area’s low inflation is a symptom or a cause of weak recovery: the current low inflation environment is rather a symptom than a cause of weak demand. The latter is the key effect of deflation on the real economy due to the deferment of private spending. The important question is of course if the policy proves effective at the end, what – and how certain – would be the final impact of QE on aggregate output and on anchoring inflation expectations. Moreover, if the monetary stimulus is not sufficient to achieve the policy objective, what role fiscal policy could play alongside monetary policy. I turn to these issues right now, and these will be my closing remarks. Verdict on QE To start with the first question the truth is that we cannot identify precisely how much of an impact on the economy is a direct result of QE or something else. Moreover, we will probably never know exactly the degree of efficacy of QE for the simple reason that we can never know with precision what would have happened in its absence. On top of that, we are living in an era full of uncertainties; the only certainty is that there is no certainty! Often our decisions are only as good as our last meeting. However, even if QE’s other effects are uncertain, I expect the signalling effect and the resultant boost in confidence to be quite strong. What more should be done If the euro area’s low inflation persists and recovery remains weak, then priority should be given to complementary fiscal policy, such as changes into the composition of government BIS central bankers’ speeches spending towards bringing forward public investment, especially if one considers the fact that long-term borrowing rates are so low today. Such a policy would boost aggregate demand in the short run, but also it would aim to improve productivity (TFP, the main driver of long-run growth, is moving at negative rates since 2007 in the euro area). In this context, the European Commission’s investment plan for Europe (also known as the Juncker plan) comprising a package of measures to unlock public and private investments in the real economy of at least €315 billion over the next three years (2015–2017) is undoubtedly in the right direction. This is quite presumably what President Draghi had in mind when he made the following remarks last August, speaking in another famous gathering of central bankers in Jackson Hole in Kansas: “It would be helpful for the overall stance of economic policy if fiscal policy could play a greater role alongside monetary policy, and I believe there is scope for this […]”. Of course, neither QE nor public investment should be seen as an alibi in postponing crucial, growth-enhancing structural changes, like for instance reforms to improve the functioning of product and labour markets, to reduce red tape and increase the efficiency of public administration, etc. As a matter of fact, given that Europe today faces a twin recovery and growth challenge (namely the quest for a robust recovery in the short run through demand stimulus measures and for a sustainable growth path in the long run through supply side reforms) we need to use all three policies jointly, and at the same time. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches

bank of greece

Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the London Conference at Chatham House, London, 2 June 2015.

Yannis Stournaras: Openness to trade and economic growth Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the London Conference at Chatham House, London, 2 June 2015. * * * The success and popular support for any government depends to a large extent on its ability to deliver economic prosperity. Yet tensions are rising between national interests that governments are elected to defend and economic integration that the global economy demands and which a successful economy requires. 1. Can governments sustain the past consensus that free-trade agreements and inward investment deliver economic growth in the aggregate even if they can exacerbate inequality in the short-term? There are several benefits to international trade, including the ability to use comparative advantage, the removal of domestic monopoly positions and provision of competition for producers, and diffusion of innovation and know-how to domestic companies. Moreover, as recent economic history and the development of global value chains have shown, greater openness to trade is usually associated with faster economic growth. Furthermore, openness itself induces governments to adapt their policies and institutions to best international practices so that they become more export and business friendly. This facilitates inward FDI which can further boost growth prospects through various channels, i.e., by improving competition, innovation etc. Of course, trade liberalization, outsourcing and the globalization trend observed in past decades might have widened inequality. Let me refer to two possible channels. First, if the biggest share of low-income workers is employed in low productivity firms that face tough import competition, then international trade could increase income inequality by lowering the relative earning of low-income workers. This can happen because growth may be concentrated in labor intensive sectors with low efficiency of labor and, consequently, low relative wages. Second, outsourcing usually implies the reallocation of low skill activities from high to low income countries. However, these activities are usually high skill in the context of the skill distribution of the low income country. Therefore, outsourcing can make labour demand more skill intensive in both rich and poor countries, leading to increasing income inequality. Nevertheless, the growth dividend from the greater openness to trade can and should be used in a way that addresses income inequality and poverty. One such way is to promote policies that facilitate the accumulation of human capital, i.e. increase tertiary educational attainment, while another possible option is to consider targeted cash transfers to those in need. On Greece One of the goals of the reform program that is implemented in Greece since 2010, besides correcting fiscal imbalances, is the improvement in competitiveness, the re-orientation of economic activity towards exports of goods and services and the improvement in the institutional framework and business environment in order to attract FDI and to boost the long term prospects of the Greek economy. Despite delays and mixed signals occasionally provided by domestic policy makers, there has been significant progress in terms of the export performance in recent years. • For example, nominal exports of goods and services increased by 29.4% in cumulative terms from 2009 to 2014 (while imports declined by 12.4%). This development reflects the significant rise in exports of goods (54% in nominal terms; BIS central bankers’ speeches 31% in real terms) which increased in line with our Euro Area peers, while the performance of services was rather sluggish (on account of global factors that affected the shipping sector until late 2013 and uncertainty that impacted tourism until mid-2012). • Net exports have been positively contributing to economic growth in the period 2010–2014 and are expected to continue so in the coming years. • Moreover, the share of total exports to GDP has increased from less than 20% in 2009 to more than 30% in 2014 and Greece’s export share in global trade has increased by 30% over the same period. However, exports as a share of GDP are still low compared to the European average of 44%. 2. Are current sovereign debt levels unsustainable? How can these be addressed whilst maintaining the support of national populations, and who should bear the burden? It is true that most advanced countries have seen their government debt to GDP ratios rising during the global financial crisis. This reflected their efforts to address financial sector vulnerabilities and to take discretionary action or let automatic stabilizers operate in order to contain the effects of declining economic activity during the great recession. However, most of the countries, including Greece, initiated fiscal adjustment programmes in order to correct fiscal imbalances and to address the debt overhang problem. In fact, Greece has done one of the biggest fiscal consolidations among developed economies during peacetime with cyclically adjusted deficts declining by more than 16% of GDP within four years. Although rising debt-to-GDP ratios are and should be a cause of concern for all countries because they can undermine economic growth, economic history and recent research (by the OECD, the BIS, and the IMF) suggest that the debt intolerance thresholds are state and country dependent. However, if this threshold is reached, countries immediately lose market confidence, face rising borrowing costs and explosive debt dynamics and consequently fiscal policy destabilizes (instead of stabilizing) the economy. As has been shown e.g., by the OECD, for higher-income countries, the debt threshold ranges from 70 to 90% of GDP, while for emerging economies the debt threshold is even lower at 30 to 50% debt of GDP, as they are exposed to capital flow reversals. Hence, countries facing fiscal challenges should design credible multiannual fiscal consolidation programmes, whose objectives should be clearly and openly communicated to the public. However, governments which apply austerity programs loose political capital. This is because fiscal consolidations hurt growth and deepen the recession, hence reducing living standards. Recent evidence and international research have shown that governments are more likely to succeed and maintain the support of the population when consolidations are introduced in the aftermath of an election, and when the party in office has a clear and strong mandate to reform. Therefore, governments with fresh political capital like the current one in Greece have a better chance in succeeding. At the same time fiscal consolidation programs should aim at increasing the efficiency and effectiveness of spending (e.g. ,health and education spending and spending on social policies) and eliminating distortions in taxation (broaden the tax base, cut expenditures rather than increase labour taxes, and increase property and environmental taxes). The use of certain fiscal instruments could have beneficial effects on equity leading to fairburden sharing and maintaining the support of the electorate. For example, • better targeting social benefits could have beneficial effects on equity. • Increases in effective retirement age would improve equity and lower inequality. BIS central bankers’ speeches • The reduction in tax exemption and tax credits will broaden the tax base and along with a more progressive income tax scale will exert a positive effect on equity and lower inequality. • Higher wealth and property taxes, if based on a progressive scale, will also lower inequality. Finally, it is essential to improve the institutional setting by improving budgetary procedures, introducing fiscal rules and independent fiscal councils and improving medium term fiscal planning. All these actions will enhance transparency, improve accountability and fiscal planning and will contribute to better spending control and improve the probability of successful fiscal consolidation. A better exploitation of government fixed assets through a targeted privatization programme and the adoption of growth promoting structural reforms will also facilitate the reduction of high debt ratios without increasing inequality. On Greek debt Last but not least, let me now refer to the case of Greece. The outstanding total amount of the Greek general government debt by end-April 2015 is €313 billion and the debt-to-gdp ratio is estimated at 172%. However, a few 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 loans and EFSF loans, as well as debt securities held by the ECB and NCBs. • Greek debt is benefiting from very low interest rates currently and quite extended maturities on GLF and EFSF loans. 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. • In addition, Greece has been receiving the profits made by the ECB and NCBs on 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, while the actual debt servicing cost on a cash basis is much lower, i.e. about 1.7% 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 until 2022. • Therefore, in view of the existing favourable debt servicing arrangements, the stock of debt need not pose such a big concern, conditional on there being a credible commitment to the reform program that will be agreed with our EU partners. • Of course, the timeline of the schedule of the debt’s repayments and interest payments may pose challenges in future years. In particular, while official loans have been supplied with low interest rates, there is a ‘hill effect’ from 2022 onwards, i.e., by the time that interest payments rise significantly due to the beginning of repayment of deferred interest for EFSF loans. • Taking into account that Greece will have to refinance maturing debt at higher market rates over the next few years, the interest-to-GDP ratio is projected to increase significantly from 2022 onwards to likely 6% of GDP under reasonable interest rate scenarios. This will impose significant challenges to debt sustainability looking forward. BIS central bankers’ speeches • Hence, smoothing interest payments over time (in particular over the period 2022– 2030), along the lines of the Eurogroup decision of 27 November 2012, will provide significant positive effects on growth and improve debt dynamics without imposing costs to creditors. • Research at the Bank of Greece suggests that smoothing the interest-to-GDP ratio over the critical period of 2022–2030 by gradually removing interest payments to future years may have a significant positive impact on growth of the economy and lead to a faster reduction of the debt-to-GDP ratio to sustainable levels by 2035. • In the short term, i.e. over the period 2015–2022, if a swap of IMF loans (which come at a higher cost) with ESM loans (which come at a low cost and have a much longer duration) could occur, this would have improved debt dynamic considerably. 3. Can ageing societies overcome the risks of stagnating economic growth? How will their governments bridge the generational gap without alienating either the young or the old? Advanced economies face increasing age related challenges. The decline in fertility rates and the increases in life expectancy have increased the share of old-age in total population. In the future the challenges will become more pressing – for example in the case of Greece, according to the 2015 Ageing Report of the European Commission, the share of elderly population (65 and over) as a % of total population is expected to increase from 20.3% in 2013 to 33.0% in 2060. While the share of very elderly population (80 and over) as a % total population is projected to increase from 5.8% in 2013 to 15.3% in 2060. This trend reflects increased life expectancy; • for men it is projected to be 84.9 year in 2060 from 78.0 in 2013, while • for women it is 89.0 years in 2060 from 83.3 in 2013. The fertility rate is projected to only marginally increase to 1.58 in 2060 from the very low of 1.34 in 2013. Given that labor supply and savings are higher among working age adults than among those aged 65 or above, it can be expected that a country with a large cohort of elderly is likely to experience slower growth than one with a lower elderly share. Nevertheless, future behavioral changes cannot be excluded – for example, individuals might decide to increase saving over their working-life in view of the projected increase in life expectancy. Ageing societies are expected to face mounting health and pension spending pressures putting at risk public finances which, in turn, will further reduce future growth prospects. There are various policy options to address the ageing related future growth challenges. First and foremost, it is important to fully utilize the labour input by taking actions to increase the employment rate. A low employment rate implies that a significant part of the working age population is either unemployed or inactive (outside the workforce). For example in Greece (according to the 2015 Ageing Report) the employment rate (for the age group of 15–64 years old) was 48.7% in 2013 on account of very high unemployment (about 28% for ages 15–64) and low labour force participation, in particular, for the age group 55–64 (42.4%). Therefore action should be taken to • First, address the very high unemployment because it can have severe long term repercussions, though the hysteresis effects, as it can induce people to drop out of the labour force. At the same time, long term unemployment leads to human capital erosion and a fall in potential growth – translating a cyclical problem into a structural one. BIS central bankers’ speeches • Second, action should be taken to raise the currently low participation rate by females and older individuals. For example countries facing these challenges should adopt policies that discourage age and sex discrimination by employers, promote life-long learning and education, allow for more flexible work arrangements for older workers and women, and increase state-funded child care provisions. Furthermore, policy makers should also consider increasing the statutory retirement age when this is low by international standards. Alternatively, an already high statutory retirement age might have to be made binding by limiting the early retirement schemes. In addition, a life expectancy component could be build into the social security system. Finally, migration policies might have to be reconsidered as a whole in Europe in view of the future demographic pressures. Besides the abovementioned policies aiming at better utilizing the labour input, additional policies should be put forward such as increasing infrastructure investment, facilitating business investment and adopting reforms that can permanently boost the level of potential output and its growth rate in the medium term. For example • adopt product market reforms, put greater emphasis on innovation, R&D and education, • facilitate the use of high-skill labour as well as ICT in order to boost labor productivity etc. Overall, ageing and shrinking working age population makes it even more pressing to boost innovation and productivity gains as a source of future growth. On Greek pension reform In the case of Greece, a very ambitious pension reform was introduced in successive waves in the years 2010–2014. The reform increased the statutory retirement age to 67 years and the minimum age for retirement to 62 years, strengthened the link between contributions and benefits to provide stronger incentives for labour force participation, applied a uniform pension calculation method among all pension schemes, reduced the generosity of benefits and enforced stricter eligibility conditions for those receiving invalidity pensions, while it also introduced a life expectancy component from 2021 onwards (to be adjusted every three years). In view of the adopted reforms (according to the 2015 Ageing Report of the European Commission) the public pension expenditure is projected to decline until 2060 by about 1.9% of GDP (the 5th best performance in the EU). While the participation rate of older individual (5564) is projected to increase from 42.4% in 2013 to 78.0 in 2060, raising the overall employment rate to 69.8% in 2060 from 48.7% in 2013. Nevertheless, the phasing out period of favorable retirement provisions for those with mature pension rights before the introduction of the reform and the remaining pockets of exemptions from general pension rules still create pressures in the social security system. 4. Can countries count on technological advances to deliver new routes to economic growth and social inclusion? Technological advances and innovation have not run their course and will continue boosting future productivity growth. The so-called pessimistic view holds that the recent slowdown in productivity is a permanent phenomenon because the types of innovation that took place in the first half of the 20th century (e.g. electrification, internal combustion engine etc) are far more important than those that took place latter (e.g. ICT revolution) and those that will occur in the future. BIS central bankers’ speeches Nevertheless, as correctly pointed out by the optimists the underlying rate of technological progress has not slowed and the ICT revolution will continue transforming the firms operating at the technological frontier. Moreover, big payoffs from general purpose technologies are fully realized only if organizational structures are re-organized to benefit from new technologies, while in many cases innovation arises from combination of previous innovations. Recent empirical work conducted by the OECD and focusing on the globally most productive firms has shown that productivity growth at the global frontier has been robust despite the slowdown in average productivity growth. For example, labour productivity at the global frontier increased at an average annual rate of 3 ½ % in the manufacturing sector over the 2000s, compared to an average growth in labour productivity of just ½% for non frontier firms. Nevertheless, technological advances (along-side with increased competition due to globalization) tend to raise income inequality as they benefit high-skilled workers more than other. This development could persist if it results to skill-biased technological change and to the extent that tertiary education attainment does not keep pace with technological progress. Therefore, in order for all actors of the economy to benefit from the technological advances at the global frontier policies should aim at: • Fostering innovation at the frontier by improving public funding and the organization of basic research, as well as • Properly designing innovation policies that they do not excessively favour applied versus basic research. • Facilitating the diffusion of new technologies to non frontier firms through trade openness, participation in global value chains and the international mobility of skilled workers. • Creating a market environment where more productive firms are allowed to thrive by promoting well-functioning product, labour and capital markets, so that they facilitate the penetration of new and existing technologies. • Improving skills through human capital investment (tertiary education, training, reduce school drop outs etc) to reduce inequality, improve employment opportunities and enhance social inclusion. Finally, the growth dividend from technological innovation can also be distributed with targeted cash transfers to those facing the risk of poverty. BIS central bankers’ speeches

bank of greece

Speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the session "The role of central banks today" of the XXIV International Banking Congress, St. Petersburg, 4 June 2015.

John Mourmouras: Divergent monetary policies and global capital markets Speech by Professor John Mourmouras, Deputy Governor of the Bank of Greece, at the session “The role of central banks today” of the XXIV International Banking Congress, St. Petersburg, 4 June 2015. * * * Governors, Ladies and Gentlemen, It is a great pleasure for me to be here in St. Petersburg and I would like to thank the Governor of the Bank of Russia, Elvira Nabiullina, for inviting me to this international congress attended by distinguished representatives of the finance industry and the central banking sector. I would like to make a few remarks on the potential financial consequences of divergent monetary policies, which remain a dominant theme in the global financial environment. Afterwards, I will be happy to answer any questions posed by the panel or the floor. 1. Introduction Global growth and inflation prospects, while not as dire as a few months ago, are far from robust. Notwithstanding the slow steps by the Federal Reserve (Fed) towards normalisation of monetary policy in the US, the central bank community today remains ultra-loose, with the certainty of further stimulus in Europe and Japan in the months ahead and the likelihood of monetary easing in China and elsewhere. The Greek debt crisis still remains pending and there are also downside risks on the geopolitical front, even in this region (e.g. the events in Ukraine, particularly with the Minsk II ceasefire under increasing strain). Several central banks (including all four major, i.e. the US Federal Reserve, the ECB, the Bank of England and the Bank of Japan) have engaged in unconventional monetary policies, including largescale asset purchase programmes, and forward guidance about the future path of monetary policy. We have also lately witnessed discretionary policy actions by an increasing number of central banks with direct effects on the foreign exchange value of their currencies, naturally raising concerns about a recourse to beggar-thy-neighbour policies and competitive devaluations. The consensus among analysts is that a period of divergent monetary policies among central banks will last for quite some time, giving rise to a number of important questions to be addressed, to mention but two: (a) what are the effects and the channels of the international transmission of monetary policy today, (b) what are the spillovers from the policies of major central banks to the rest of the world, including emerging markets, in terms of capital flows, bond markets and exchange rates, and if there is any scope for global monetary policy coordination. I propose to focus on the following three remarks. Firstly, I will discuss the ECB’s ongoing expanded asset purchase programme (QE) and its impact on the euro area economy. Secondly, I will discuss how divergent monetary policies among the world’s leading central banks may trigger excessive volatility in global financial markets. Last but not least, I will examine if there is any scope for global monetary policy coordination that can effectively address the risks that lie behind “asymmetric” monetary policies. 2. Draghi’s qe: an early evaluation First of all, I will explain why it is that we talk about low inflation, rather than deflation, in the euro area. Inflation is expected to remain very low or slightly negative in the coming months, with an average inflation projection of 0.3% for the year 2015, against a yearly average of BIS central bankers’ speeches 0.4% in 2014. In advanced economies, the inflation rate will stand at 0.4% on a yearly basis in 2015, according to the latest IMF forecasts, which is the lowest level in the last 30 years, and in EMEs at 5.4%, one of the lowest in the last 20 years. Although in the euro area, there is more than a 50% risk of the inflation rate hovering below one percent in the short-run, the risk of deflation is quite low at less than 10% in the short term (in the next one to two years) and effectively zero (1% risk) in the longer term (in the next five years). Despite recent monthly inflation “dips” to negative levels there is no deflationary bias embedded in wage contracts and consumer behaviour in the euro area, as opposed to the inflationary bias we have experienced over the past three decades (1980s-1990s-2000s). Ultimately, the ECB should fulfil its mandate, as the Harmonised Index of Consumer Prices (HICP) is expected to reach 1.8% in 2017, which is consistent with the primary goal of price stability, i.e. maintaining the euro area inflation rate below, but close to, 2% over the medium term. Let me now quickly refer to the key features of the ECB’s recent asset purchase programme and focus mainly on the impact of QE, which judging from preliminary evidence, is really encouraging. The key elements of the programme are the following: (a) Monthly asset purchases will amount to €60 billion of private and sovereign debt. The programme will amount to a total of €1.1 trillion in asset purchases carried out from March 2015 until September 2016. (b) Loss-sharing is reserved for those purchases that are carried out by the ECB, accounting for 20% of the total purchases. The remaining 80% of all purchases – i.e. purchases made by NCBs – will not be subject to loss-sharing. Since the announcement of the ECB’s QE on 22 January, projections for real GDP growth in 2015 and 2016 have been revised upwards (to 1.5% and 1.9%, respectively) compared with December 2014. Furthermore, model-based estimates indicate that market-based measures of inflation expectations have reacted positively to the progressive expansion of the ECB’s balance sheet over the last few months and have been revised upwards, as well. As far as financial markets are concerned, the impact of the asset purchase programme accounts for most of the fall in euro area long-term sovereign bond yields since last December, as market participants anticipated the ECB’s QE programme. Government bonds across a wide range of euro area countries traded at historically low, and often negative, yields. The decline was most pronounced in the longest maturities, with yields on French and German 10-year bonds falling by around 60 basis points, while those on Italian and Portuguese bonds of the same maturity shrank by 70 and 90 basis points, respectively. The major European stock markets have risen since end-2014 by about 17%. Furthermore, the euro depreciated by 11% since last December, hitting a 12-year low against the dollar (for a more detailed assessment of the ECB’s QE, see my earlier speech at the 33rd Meeting of Central Bank Governors’ Club in Shanghai on 15 May 2015, available at: http://www.bankofgreece.gr/Pages/en/Bank/News/ Speeches/DispItem.aspx?Item_ID=317&List_ID=b2e9402e-db05–4166-9f09-e1b26a1c6f1b). Following the ECB’s accommodative monetary policy (with standard and non-standard measures) other central banks adopted similar policies. For instance, in Europe, the Central Bank of Denmark cut its key policy rate, taking it to the negative territory of –0.75%, while the Central Bank of Sweden (Riksbank), with a base rate of –0.25%, has announced it will expand its quantitative easing programme (the Riksbank pledged to buy between SKr40 billion and SKr50 billion (US $4.8–6 billion) of government bonds, taking the total stock of Swedish sovereign debt held by the central bank to between SKr80 billion and SKr90 billion and its share of all Swedish government debt to 15%) in an effort to stimulate the economy. In total, from the start of the year, 22 central banks lowered their official rates (including the Bank of Russia, which, since last December’s drastic rise to 17%, lowered its interest rates three consecutive times, the last time being in April, when rates were cut by 1.5 percentage points to 12.5%). In light of all this, one can speak of a period of truly global monetary easing! BIS central bankers’ speeches 3. Divergent monetary policies and capital markets Some theory Many analysts believe that purchases by central banks are the dominant cause of low bond yields today. Apparently, this has to be a factor since a QE programme, by its very nature, is an extension of the intervention horizon of monetary policy and as such it has a direct impact on long-term interest rates (the average maturity of the securities bought by the ECB under its QE programme is 8.1 years). However, a far more important determinant of low bond yields today is the expectation that short-term rates will stay low, which in turn reflects expectations of low and persistent inflation and of a weak and uncertain recovery. Perhaps theory is useful here. Theory suggests that long-term interest rates should be a weighted average of expected short-term interest rates plus a term premium. The premium should normally be positive, even in the absence of default risk. Longer-term securities are riskier than short-term ones, because their prices are volatile. Expected short-term nominal rates should be determined by expected real interest rates and expected inflation, and expected changes in real interest rates should, in turn, be determined by the expected balance of savings and investment. Finally, other factors, such as risk aversion also affect the prices of long-term bonds. What do all the above suggest about the future path of yields? The sharp rises in expected short-term interest rates and hence in long-term yields (the term structure of interest rates in theoretical terms) are only likely to follow a strong recovery and subsequently a sharp rise in inflation expectations (in empirical terms, historically, sovereign bond yields and, to a lesser extent, exchange rates track nominal GDP growth rates). We are not there yet: only with a robust recovery in Europe and a monetary policy normalisation in the US can markets start pricing risk in a traditional manner. The recent bond sell-off It is true, though, that the last days of April saw the beginning of a sharp sell-off in sovereign bonds across the euro area bond markets, leading to soaring volatility in European bond markets, a sharp steepening in the yield curve and an appreciation of the euro. The figures are quite spectacular as is often the case with the markets: in just 17 working days, the global sovereign bond index lost more than €0.5 trillion of its value! This is an upward correction in bond yields from an early overshooting of bond prices (early undershooting of the exchange rate), which marked the first significant adjustment in European sovereign bond markets since mid-2013 (triggered in turn by the Federal Reserve’s tapering of its asset purchases). The 10-year Bund yield increased from a historical low of 7.5 bps on 20 April to over 80 bps by early June. As for the other euro area countries, yields in France and other core countries increased in a similar way, while the spreads of peripheral bonds over the Bund have narrowed. Turning to the US government bond market, and given the strong comovement of 10-year German and US government bond yields (with a high correlation coefficient of .80), the 10-year US Treasury yields rose substantially to reach their highest closing levels this year in the region of 2.30%, as the contagion from the European bond selloff was the main driver of their recent rise. Given the fact that recent US macro data were mixed and the uncertainty surrounding the Fed’s rate hike timing, there was additional volatility in US yields spilling over to Bunds and other euro area countries, with the interest rate differential set to remain in the region of 1.50%. In addition, the widening gap between US and euro area interest rates is also driving US companies to issue more eurodenominated debt as it seems cheaper in interest rate differential terms. In short, apart from some technical conditions (e.g. shorter-dated German Bunds which became eligible, while they were previously not, because of their negative yields, and hence there was less need to buy longer-dated bonds and/or volatility clustering in global bond markets, namely that volatility in itself generates further volatility), this recent bond sell-off reveals vulnerabilities in the current low-yield/low-inflation environment and can also be regarded as an evident financial implication of divergent monetary policies. One should not forget that there is still another trillion left from Draghi’s QE programme to be paid. Finally, BIS central bankers’ speeches some analysts claim that an issue of macroprudential policy arises here which, as is wellknown, addresses risks to the financial system as a whole. More precisely, the ECB’s implementation of the expanded asset purchase programme in the current juncture might necessitate the use of existing macroprudential tools to oversee any fallout from the credit expansion preventing or at least moderating asset market bubbles, or even the creation of new tools, for instance to address pressures in the insurance sector as a result of the lowyield environment in which they operate today. Capital flows The repercussions on the world economy of the redirection of a major central bank’s monetary policy and/or of divergent global monetary policies which sharply alter global exchange rates, is one of the oldest questions in international monetary economics and was posed again recently, when the Fed launched its Quantitative Easing (QE) programme. At the time, the Governor of the Central Bank of Brazil expressed his strong dismay at the loosening of the Fed’s monetary policy and its impact on emerging countries, in the form of large capital inflows triggering a sharp appreciation of their currencies and a decline in exports. It is indeed quite difficult to predict the precise form of (sometimes conflicting) spillover effects stemming from such a change in the monetary policy stance. For instance, the Fed’s Quantitative Easing 1 (QΕ1) programme was followed by capital flows out of emerging economies (EMEs) into US Treasuries, while the second round of Quantitative Easing (QΕ2) had the exact opposite effect. Since then, the Fed’s change of tack has once again spurred intense reactions in EMEs (see recent statements of the Reserve Bank of India Governor): the tapering of the Fed’s asset purchase programme has resulted in massive capital flows into advanced economies and a subsequent sharp rise in interest rates in emerging economies to prevent a sharp devaluation of their currencies (the currencies of Brazil, South Africa and Turkey were particularly hard-hit). Their large current account deficits are typically financed with short-term portfolio flows and in the case of Brazil and South Africa, falling commodity prices added further pressure. Up to now, there are no clear indications of international portfolio rebalances due to the upcoming interest rate hike by the Fed and/or the QE programme currently implemented by the ECB. 4. Monetary policy coordination? We have just looked into the negative spillover effects from divergent monetary policies. Of course, a central bank’s mandate is domestic, but its policy may have global implications. Furthermore, in an international macroeconomic environment of subdued and uneven growth and high unemployment, zero lower-bound interest rates and a tight fiscal policy stance, certain nations may attempt to use their monetary policies – through standard or nonstandard measures – in order to influence their exchange rate to bolster their economy and boost employment. The question thus arises whether monetary authorities should act in a coordinated manner during this final stage in the exit from the global crisis and at a time when foreign exchange rates are not an official monetary policy objective in advanced economies. ECB President Mario Draghi, answering a relevant question in an ECB Governing Council press conference on 6 February 2014, stressed that international monetary cooperation cannot be ruled out. Examples of international monetary policy coordination are not rare, but Olivier Blanchard captured reality with the caveat: “it is like the Loch Ness monster that is much discussed, but rarely seen” (15 December 2013). As a matter of fact, a recent notable example of monetary policy coordination among major central banks took place at the onset of the global crisis of 2008, when the world’s four leading central banks (the Federal Reserve, the ECB, the Bank of England and the Bank of Japan) took coordinated action, affirming the need to go beyond traditional ways of conducting monetary policy in order to continue to provide liquidity to the financial system and prevent a collapse of transactions and a global crash. Hence they established liquidity swap arrangements with the intention to provide foreign currency funding BIS central bankers’ speeches to the banking systems in their jurisdictions. The US Federal Reserve provided US $500 billion to other major central banks over the 2008–2010 period, while the others used liquidity swap lines to a lesser extent. While international cooperation between central banks has been quite common in the field of foreign exchange markets, this occasion marked the first multilateral central bank cooperation in the money markets field, which is central to the implementation of a central bank’s monetary policy. It is worth reminding that in the past, serious initiatives for coordinated monetary policy have been taken under the 1985 Plaza Accord and the 1987 Louvre Accord in order to stabilise the dollar exchange rate. If things move towards such a policy coordination, it should in my view take the following form: i) the Fed could perhaps extend a new swap line to the central banks of EMEs, like the swap lines it offered at the start of the global crisis (a kind of formal policy coordination), and/or ii) a commitment on the part of the four major central banks to communicate their monetary policies in a clear and timely manner within the context of their forward guidance policies, as was agreed in a G20 Meeting in 2014, (a kind of informal policy coordination, whereby major CBs are mindful of the consequences of their actions). Such forward guidance will enable emerging economies to promptly protect themselves against sharp and significant capital flows and develop policies to avoid exclusive dependence on speculative capital flows which render them vulnerable to excessive volatility in the financial markets. At the current juncture, major central banks should signal future interest rate changes in a timely manner, without any concerns about causing market panic, otherwise investors will continue to overborrow and this would potentially be destabilising. All in all, in the era of globalisation and especially against the background of low and persistent inflation today, some form of coordinated action between major central banks should perhaps be put on the table, particularly given the fact that governments are unable to protect themselves against central bank decisions, which trigger significant capital flows, and the available tools to limit such capital flows are not efficient. Thank you very much for your attention. BIS central bankers’ speeches

bank of greece

Text version of a powerpoint presentation by Prof. John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at a meeting with international investors and analysts, organised by Redburn Access, New York, 7 October 2015.

John Iannis Mourmouras: Some reflections on Greek and European capital markets Text version of a powerpoint presentation by Prof. John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at a meeting with international investors and analysts, organised by Redburn Access, New York, 7 October 2015. * * * This is the text version of the powerpoint presentation used by the author for his meeting with international investors and analysts in New York (7 October 2015) organised by Redburn Access. I am delighted to be in New York. Today, I would like to share my thoughts and exchange views with you on Greek and European capital markets in these particularly volatile times. First of all, I will talk about the third MoU in Greece, capital controls and the forthcoming bank recapitalisation and, secondly, I will offer some reflections on current developments and future prospects of Greek and European capital markets, looking into the main drivers behind them. I. Greece 1. Basic elements of the third MoU The key characteristics of the third MoU Following months of intense and rather overdue negotiations, the Greek authorities signed the third economic adjustment programme, worth €86 billion over the coming three years (2015–2018), out of which €54.1 billion will cover debt amortisation and interest payments (€37.5 billion in amortisation and €16.6 billion in interest payments), €25 billion will be disbursed to cover the upcoming bank recapitalisation and resolution costs and the remaining amount will be used for arrears clearance. The Hellenic Parliament ratified a set of upfront fiscal measures (a total package of around €8 billion), which are for the most part (80%) based on a fair balance between indirect taxation and pension cuts. The above fiscal measures adopted in the context of the third MoU are expected to offset the deviation of the 2015 fiscal outcome vis-à-vis the new primary balance targets of –0.25% of GDP in 2015, 0.5% in 2016, 1.75% in 2017, and 3.5% in 2018 and beyond. In addition, Greece has to implement more reforms, inter alia, the Hellenic Statistical Authority’s full legal independence, reform of the Code of Civil Procedure, the transposition into Greek legislation of the EU’s Bank Recovery and Resolution Directive and the introduction of quasi-automatic spending cuts in case of deviations from the primary surplus target, as well as labour market reforms particularly regarding collective dismissals, industrial action and collective bargaining, and liberalisation of a series of product markets and of restricted professions such as solicitors, actuaries, bailiffs. Finally, Greece has also committed to push forward the ongoing privatisation process and preserve private investor interest in key tenders. The privatisation agenda aims at annual proceeds (excluding bank shares) of €1.4 billion in 2015, €3.7 billion in 2016 and €1.3 billion in 2017. Debt relief A very important pending issue is debt relief. The creditors will make their decisions after the successful completion of the current MoU’s first review, scheduled towards the end of the year. Currently, the outstanding total amount of the Greek general government debt is €312.8 billion (or 175.4% of GDP). According to IMF projections, the debt-to-GDP ratio is expected to reach 170% of GDP in 2022. In addition, Bank of Greece research suggests that since the imposition of capital controls Greece’s public debt increased further by 15.3% of GDP to 163% until 2024. BIS central bankers’ speeches In any event, the total debt service interest burden is 4% of GDP in the coming decade, about the same as that of Portugal. Chart 1: Debt dynamics (2011–2024) Source: Bank of Greece. My guess – and this is only my guess – is that debt relief will move in one way or another along the lines of the November 2012 Eurogroup decisions (i.e. within the framework of “extend and pretend”). 2. Two preconditions for a third-time lucky (?) MoU Greece now has a new and stable coalition government with a pro-European stance, committed to the euro project. However, for a successful and hopefully final MoU, leading to Greece’s return to international capital markets, a smooth political cycle at least in the medium term (three years) is what is now needed in Greece. a. Political stability The imperfections of Greece’s political system (cronyism, short-termism, prone to recurrent elections, etc.) are long-standing and well-known. A credible and lasting way out of this state of affairs in order to protect the country’s economy against so many and frequent government changes is through constitutional reform, which at least in special and extraordinary times like the one we are experiencing over the past few years, should safeguard a more stable electoral cycle. The government’s term in office in Greece should be uninterrupted in order to have more time at its disposal to implement difficult but imperative policies. By way of indication, the presidential election, especially given that the President performs more ceremonial and official duties, should not be used as a pretext to push for early elections and cut short a government’s term in office (as was the case with the elections in January 2015, followed by a national referendum in July 2015). Last month, Mr. Tsipras was emphatically re-elected as Greece’s Premier, the Syriza parliamentary group now consists of moderate MPs, the vast majority of opposition parties are also in support of European compromise, and also no other election (regional, local or European) is expected in the foreseeable future. All the above provide reassurance to our lenders and the markets that Greece will finally stick to its bailout commitments. BIS central bankers’ speeches b. Removal of capital controls The second precondition is lifting capital controls as soon as possible. Such a timely removal of capital controls goes through a successful bank recapitalisation, but could also be spurred by the reinstatement of the waiver affecting marketable debt instruments issued or fully guaranteed by the Hellenic Republic in order to reduce and finally put an end to the expensive emergency liquidity assistance (ELA) and thus enable Greece’s participation in the ECB’s quantitative easing programme (QE). I will now give you my insights on how, when and which steps can be taken on the above issues in order to effectively and quickly return to the international capital markets. State of the economy after the imposition of capital controls It should be pointed out that the decision for the imposition of capital controls in Greece was taken on the basis of financial stability considerations due to potential huge deposit outflows after the July 5 referendum on the bailout conditions set by Greece’s creditors. Although initially European Commission forecasts suggested that Greece’s economic activity would be severely affected, real GDP growth increased in the second quarter of 2015 by 0.9% (1.6% on an annual basis). Preliminary data from the real sector suggest a negative impact of capital controls on the real economy and a sharp rise in uncertainty: • GDP is expected to contract significantly in the second half of the year with Bank of Greece estimating the annual real GDP growth at between –0.8% and –1.3%. • Economic confidence declined sharply in August (75.2 from 81.3 in July), almost reaching a historical low, mainly driven by a considerable decline in consumer confidence as a result of growing pessimism about the general economic situation and unemployment (over 27%). • The stock of arrears (suppliers and tax refunds) increased to €5.7 billion, surpassing by almost €2.0 billion its December 2014 level. • However, the worsening of GDP dynamics will be offset by tourist arrivals and receipts which are expected to reach record highs (+7% against 2014) and also the significant contraction of the trade deficit, as nominal goods imports fell by 32.0% (estimated at –25% in real terms) in July due to capital controls. • Greek banks closed for three weeks under the legislative act of 28 June 2015 providing for a bank holiday of short duration. Trading in the Athens stock exchange ceased on 29 June. On its reopening after 5 weeks, it recorded a decline of 16.23%, with banking shares plunging by more than 20%. • Bank credit contracted at an annual rate of around –3% in July 2015. The rate of contraction of bank credit to non-financial corporations deteriorated in July and reached –1.1%, reversing the gradual slowdown observed since February 2014. • The level of non-performing loans (NPLs) is likely to increase from the current 47%, as capital controls further erode the ability and willingness of borrowers to repay their loans. Bank recapitalisation We are now facing a fourth round of recapitalisation to be carried out for the first time under the newly adopted Bank Resolution and Recovery Directive (BRRD). It is now imperative to recapitalise the Greek banks by the end of this year in order to avoid use of the BRRD’s bailin tool, which will enter into force on 1 January 2016. The BRRD will be implemented under the precautionary recapitalisation tool or under the government financial stabilisation tool (GFST Articles 56–58 on extraordinary public support) depending on whether the private sector’s participation will be sufficient or not to cover the capital needs of Greek banks, as determined by the ECB’s comprehensive assessment. In both cases, the recapitalisation BIS central bankers’ speeches framework will be aimed at preserving the private nature of the recapitalised banks and facilitating private sector involvement. Of course, no effort should be spared on all sides to avoid unnecessary dilution of existing investors’ equity. The equities of the capital increase as part of the second round of recapitalisation worth of €8.3 billion and covered only by private investors, have been diluted by 88%, but also equities of the Hellenic Financial Stability Fund (HFSF) have been diluted. Note also that all four systemic banks have a CET1 capital ratio well above the minimum requirement with an average CET1 capital ratio close to 12% (based on data reported at end-June 2015). In addition, it is envisaged that any remaining capital requirements under the adverse scenarios of the ECB’s stress tests will be covered by the HFSF. There is an ongoing debate on whether the HFSF will participate through the issuance of common shares or through the issuance of contingent convertible securities (“CoCos”) in order to avoid a dilution of shareholders’ equity in case of recapitalisation under a highly stressed scenario. What such a CoCo instrument would look like is under discussion, but it would have to meet all the relevant criteria to be a CET1 equity-equivalent (if and when the Common Equity Tier 1 ratio falls below 8%, then CoCos will be converted into common shares). In short, there are three major pending issues as regards the planned recapitalisation of Greek banks: 1. The level and treatment of non-performing loans (NPLs), which are the “Achilles heel” of the Greek banking system, as pointed out by the IMF. The impaired loan ratios for the banks’ Greek loan portfolios averaged 45% at end-June, while coverage of impaired loans in Greece averaged 50%. As a matter of fact, the last seven years, loan provisions have increased fivefold from €8 billion to €41.2 billion. In the first quarter of 2015, impaired loan balances were broadly stable, but asset quality showed signs of deterioration in the second quarter. The stress tests may uncover marked increases in NPLs over the stressed horizon due to the rapid deterioration of economic conditions in Greece. The NPL ratio of Cypriot banks, after capital controls were put in place reached 45%. For our part, last week we appointed BlackRock as an independent advisor on NPLs, assigned with the main tasks of elaborating a report on NPL segmentation and tabling proposals on the management of NPLs. 2. Another important issue concerns macroeconomic forecasts on the recession, deflation and unemployment under which a baseline and an adverse scenario will be used for the stress tests in order to identify potential bank capital shortfalls. As I mentioned earlier, Bank of Greece forecasts that the GDP rate will range between –0.8% and –1.3%, with an average of –1% by end-2015, deflation will stabilise at –0.5% due to VAT increases and the unemployment rate will stand at around 26–27%. 3. There is also a strong intention among stakeholders to recapitalise and consolidate cooperative banks alongside bigger systemic banks and the same applies to one less systemic institution. C. Three more issues on rebuilding confidence and the economy’s potential 1. As President Mario Draghi pointed out in his last press conference in September, reinstating the waiver for Greek bonds will be on the ECB’s agenda, given that the country is in a programme for financial assistance and complies with it. We expect Greek banks to reduce their ELA funding worth €84 billion currently, regain access to the ECB’s normal financing operations. Once the waiver for Greek bonds is in place, Greek banks’ available eligible collateral will increase by around €15 billion, helping them to reduce their ELA dependence and find cheaper funding (through MROs, LTROs, interbank credit) and thus increasing their profitability. Furthermore, as a result of the upcoming bank recapitalisation, deposits will hopefully return after the large outflows recorded since December 2014 (estimated up to now at around €40 billion). 2. At the last ECB press conference, President Draghi hinted at the inclusion of Greek government bonds on condition that the first review of the third Greek financial assistance BIS central bankers’ speeches programme is successfully completed. Such a decision, as you understand, will help improve the outlook on the GGB market and subsequently corporate bonds and other financial markets drastically. The most natural corollary would be for Greece to be included in the ECB’s asset purchase programme (APP). This could happen towards the end of 2015 or in the first quarter of 2016. In terms of the specifics of the Greek PSPP, the Eurosystem could purchase approximately €3.5 billion before running into the 33% issuer limit. Furthermore, some additional funding could also be raised if Greek public sector non-financial institution bond issues were to be considered as eligible marketable debt instruments. Some could argue that the above amount is a mere pittance compared with the total Eurosystem’s purchased amount of €464 billion under the APP programme, with Greece’s participation being around €12 billion (PSPP = €9 billion, CBPP3 = €3 billion). Even in this respect, the signalling effect of Greece’s inclusion in the APP will be strong enough for GGB prices to recover accompanied by a significant fall in volatility, as the overall financial environment is normalised and Greece ceases to be the outlier in the euro area. It is worth simply reminding the sharp fall in the government bond spreads of peripheral euro area countries (Italy, Spain) vis-à-vis the yields of core euro area country bonds, when the ECB announced the OMT programme and their convergence after the OMT final approval from the European Court of Justice. 3. Last but not least, for a successful third and final MoU, namely one that will stabilise expectations and facilitate a sooner-than-later return to international capital markets, there is something that was missing from the first two MoUs and hopefully will be achieved this time around. As you know, there is a cumulative loss of 25% of Greece’s GDP as a result of the consolidation programmes and internal devaluation during the last five years. Capital formation has dropped by more than 60% in the last 7 years: from €20 billion in net investment in 2008 to –13 billion today (2008: €53 billion gross investment, depreciation €33 billion. 2015: €19 billion gross investment, depreciation €32 billion). So very few would disagree that the country now needs an investment shock. The question of course is where such a shock might come from, given that an adjustment programme is in place. Before going into more detail on this, let me say that there are technical ways to incorporate this investment dimension in an adjustment programme (see my article in the Wall Street Journal (2012), adding a new dimension to the two standard concepts of conditionality, namely fiscal and structural conditionality, that of investment conditionality). I will indicatively give you one idea (out of many more): there is a strong case today in Greece in favour of a drastic cut in corporate taxes. Greek companies operate in an adverse environment. More specifically, apart from high corporate tax rates, domestic firms are burdened with high energy costs (30% above the European average) and high funding costs (lending rates that are up to four percentage points higher than in the rest of the EU). Furthermore, they are faced with intense tax competition from countries in the broader area of the Balkans (with lower corporate tax rates: 10% in Bulgaria, 12.5% in Cyprus, 16% in Romania, 20% in Turkey against 29% in Greece). 3. Current and upcoming developments in the Greek financial markets Upon completion of the current agreement and Greece beginning to fulfil its commitments, financing and liquidity constrains for the Greek state and Greek financial and non-financial institutions will ease and Greek assets are expected to recover. My view on the direction for the Athens Stock Exchange (ASE) and the Greek government bonds (GGBs) over the mediumterm is they will follow a clear upside trend not only thanks to the recently improved prospects of political stability, Greece’s QE eligibility prospects and the upcoming bank recapitalisation, but also due to the current very low market price levels. BIS central bankers’ speeches Chart 2: Evolution of ASE Index Sources: Bloomberg and Bank of Greece. Since mid-2013 and following two rounds of Greek bank recapitalisation, the Athens Stock Exchange (ASE) index stood at 1400 index points, recording a return of around 75%. Unfortunately, since August 2014, the Athens Stock Exchange has lost all its gains against the background of elections, a referendum, capital controls and with the prospect of a third recapitalisation of Greek banks. As far as the Greek government bond market is concerned, undoubtedly, the news of a deal on the new three-year bailout programme on 14 August led to a sharp rise in Greek government bond prices (see Chart 3). Overall, judging by the upcoming positive developments surrounding Greece’s QE eligibility and ruling out the risk of Greece leaving the euro area, GGBs should highly benefit. Finally, it is worth noting that the GGB market has been relatively immune to recent global risk concerns, as investors are more focused on the political normalisation which opens up brighter prospects for Greece’s future in the euro area. Looking at the volatility index (VIX) as a proxy for global risk, its recent spike to five-year highs failed to trigger any serious reaction in either GGBs or even other euro area periphery markets (see Chart 4). Moreover, investors, due to the capital outflows from the emerging markets and the recent Chinese equity turmoil could consider entering or adding to long positions in GGBs as an investment opportunity as euro area peripheral credit risks are subdued in a QE environment, while at the same time additional policy response in the form of more QE remains at the disposal of European policymakers if needed (something similar happened in 2014 which then gave rise to an early successful first return of the Greek government to international bond markets – in April 2014 – through a tentative €3 billion five-year bond issue and three months later, through another €1.5 billion three-year bond issue. At the time, a single observation was made by the Chief Economic Advisor to the PM: as a result of Fed’s tapering, lots of liquidity was coming out of emerging economies into advanced economies, including the countries of the euro area periphery). BIS central bankers’ speeches Chart 3: GGBs yield curve after the July 2015 agreement Source: Bloomberg. Chart 4: Greek government bonds and volatility index (VIX) As shown in the above chart, Greek government bonds have shown significant correlation with the Volatility Index (VIX) in October 2014, when deflationary fears grew stronger (although weakness in GGBs was also related to the then upcoming elections). A strong correlation was observed after the national parliamentary elections in January this year and again in June when the Greek referendum was announced and capital controls were imposed. The recent spike in the VIX to five-year highs failed to trigger any serious reaction in either Greek government bonds or even other euro area periphery bonds. In my view, this illustrates that global risk sentiment has a limited pass-through to periphery bond markets at this stage. In GGBs, the market seems focused (rightly in my view) on the political normalisation that is already under way, which opens up brighter prospects for Greece’s future in the euro area. II. European capital markets and the rise in volatility Four are the main drivers behind heightened uncertainty and excessive volatility in European capital markets in the months ahead: the upcoming US rate rise, the possible extension of the ECB’s quantitative easing programme, the turmoil in Chinese markets together with EMEs capital outflows, and global geopolitical risks (Ukraine crisis escalation, Jihadi terrorist rise, etc.). As far as QE in the euro area is concerned, some voices in Frankfurt call for an increase BIS central bankers’ speeches in the ECB’s QE from €60 billion monthly to €80 billion or more. While ECB’s policy has been accommodative, it has been much less accommodative than other central banks. A pace of €80 billion per month, it would take until the end of 2017 for the ECB’s QE to reach the same levels relative to GDP with the Federal Reserve and the Bank of England. Others claim that the QE period should be extended beyond September 2016, implying a second round of QE in Europe. ECB President Mario Draghi himself, when asked at the last press conference in Frankfurt said: “Accordingly, the Governing Council will closely monitor all relevant incoming information. It emphasises its willingness and ability to act, if warranted, by using all the instruments available within its mandate and, in particular, recalls that the asset purchase programme provides sufficient flexibility in terms of adjusting the size, composition and duration of the programme”. The effects of divergent monetary paths (Fed rate hike 1 vs. Draghi’s QE) would normally strengthen the value of the US dollar against the euro and would also contribute to a fall in the German Bund and other European country bond yields and to a rise in euro stocks. The Chinese market turmoil 2 together with capital outflows from emerging market economies (EMEs) and the possible escalation of a currency war after the upcoming Fed rate hike might work at opposite directions, contributing to further market volatility for European capital markets. The volatility index (VIX), which measures stock market volatility, surged to 40, its highest level since 2011, while the rise in EMEs’ implied equity volatility (VXEEM) was its highest on record (see Chart 5). It should be recalled that the 3-month correlation between EUR/USD and VIX has reached its highest level since 2009. Chart 5: Implied volatilities in financial markets The dashed horizontal lines represent averages from 1/1/2012 to 31/12/2014. 3 Chicago Board Options Exchange- Traded Fund Volatility Index. 4 Implied Volatility of at the money options on commodity futures of Germany, Japan, the UK, and the US; weighted average based on GDP and PPP exchange rates. 5 Implied volatility of at-the-money options on long-term bond futures of Germany, Japan, UK and U.S. 6 JP Morgan VXY Global Index. Source: Bank of International Settlements (BIS) Quarterly Review 2015. Note: The JP Morgan VXY Global Index measures volatility in a basket of G7 countries’ currencies. For an analysis on this, see Appendix. For further insights on this, see Appendix. BIS central bankers’ speeches Chart 6: Widening interest rate differentials and FX 2 A decrease on an inverted scale indicates euro depreciation. Source: Bank of International Settlements (BIS) Quarterly Review 2015. Although the timing of the Fed’s first tightening move in many years has become more uncertain, interest rate differentials between the US and many other countries are still wide, with important consequences for foreign exchange markets. In particular, except for a brief hiatus in the second quarter of 2015, the US dollar has been on an appreciating trend since mid-2014. The effect of interest rate differentials on the US dollar was particularly strong visà-vis the euro: as the difference between US and core euro area interest rates began to widen again in the third quarter of 2015, the dollar resumed its strengthening path against the euro (see Chart 6). Towards the end of the period, as US short-term rates edged down, the euro recovered somewhat. In addition, foreign-exchange volatility now stands at its highest levels since 2011 (see Chart 7). Chart 7: JP Morgan Global FX Market Volatility Index Sources: Bloomberg and Bank of Greece. Note: The JP Morgan Global FX Volatility Index tracks the value of options of emerging and developed market currencies against the US dollar: New Zealand dollar, Norwegian krone, Swedish krona, Japanese yen, the euro, British pound, and Canadian US dollar. BIS central bankers’ speeches As far as bond markets are concerned, a volatility spike was evident especially in German Bund markets in May and June. German government bonds are the key driver of European government bonds, since they serve as a benchmark for a host of other government and corporate securities and thus have a systemic (European and global) influence on borrowing, investing and saving behaviour and also have spillover effects on other markets: commodities, foreign exchange and equities. Bonds with very long maturities showed the highest intraday volatility, while bonds with shorter maturities were also affected, albeit to a lesser extent (see Chart 8). The “Bund tantrum”, as some have termed the spike in German bond volatility, can be explained mainly by the deteriorated market liquidity. Measures of market liquidity, computed using firm prices for immediately executable transactions, corroborate the assumption that strained market liquidity conditions are at least partly to blame for the heightened volatility. The cost of immediately executable transactions in the Bund market increased in the period around the Bund tantrum as the bid-ask spreads have doubled in the relative bid-ask spread, from 40 to roughly 80 basis points. Also, the market’s order book depth also showed signs of deterioration over this period, falling by more than a third over the sixmonth period, from €25 million to roughly €16 million in ultra-long-term German bonds. Chart 8: Volatility and liquidity during the “Bund tantrum” Realised volatility is calculated as the daily (maximum midpoint–minimum midpoint)/average price. Intraday data from the MTS Euro Benchmark Markets (MTS-EBM) for benchmark bonds only.2 Data from January 2011 to June 2015, aggregated to a weekly average.4 Intra-daily data from the MTS-EBM for benchmark bonds only for January–June 2015. Both panels show daily averages.6 Depth is calculated as the (volume at bid + volume at ask)/2. Source: Bank of International Settlements (BIS) Quarterly Review 2015. It is fair to say that although it might be too soon to see if the Chinese turmoil will have a severe impact through trade and financial channels on the European and global economy, the Chinese turmoil remains the main challenge in the months ahead. Exports to China represent around 10% of total euro area exports in value-added terms, meaning that a significant decline in Chinese domestic demand would dent export growth. Germany, for instance, has Europe’s strongest trade ties with China, but exports to that country make up only 6.6% of total German exports, according to the German economics ministry. For the time being, however, there is not much evidence of a slowdown in exports. Apart from a potential trade impact, further Chinainduced turmoil on financial markets could lead to massive capital outflows from the Chinese financial markets to the European capital markets diminishing the positive effects of ECB’s quantitative easing programme. In the short run, emerging markets remain vulnerable to further declines in commodity prices and sharp appreciation of the US dollar. This could further trigger a reversal of capital flows and disruptive asset price adjustments. Between June 2014 BIS central bankers’ speeches and July 2015, capital outflows from emerging markets reached $940 billion (see NN Investment partners, FT 19 August), in contrast with $2 trillion inflows to these markets between 2008 and June 2014. Such outflows would impact on EMEs’ growth rates, thus lowering global demand. If the Chinese economy deteriorates further, lower demand will drive down oil prices which are also being translated into lower inflation rates for non-energy components and feed into inflation expectations, leading to a worsening inflation outlook and making the ECB’s inflation target more difficult to reach. If, on the one hand, the yuan depreciates further, this will add to deflationary pressures for the US and euro area, as China is the biggest import partner for both the US and the euro area. If, on the other hand, the yuan remains at its current levels, the disinflationary impact of cheaper Chinese exports will prove less than feared by some market participants, as an overall 2% depreciation partly offsets the real appreciation of the yuan over the past 12 months (more than 10%). More generally, in the current environment of short-term rates to near zero (or even negative) levels, potential adverse shocks or policy missteps could trigger an abrupt rise in global volatility and market risk premia (which are now compressed) and a rapid erosion of policy confidence. Shocks could originate in advanced or emerging markets and, coupled with unaddressed system vulnerabilities, could lead to a global asset market disruption, a sudden drying-up of market liquidity in many asset classes and a sharp tightening of financial conditions with negative repercussions on financial stability. BIS central bankers’ speeches Appendix Here are some further thoughts on the first US rate hike and on the Chinese turmoil. 1. Fed’s rate hike The most crucial question is: will the Federal Reserve (Fed) raise its rates this December or next year? My view is that it is not only a question of when, but perhaps more importantly a question of the trajectory of interest rates following the Fed’s rate hike, i.e. if the subsequent tightening will be shallow or steep. Of course, the exact timing is important, the last interest rate change was in late 2008, whereas the last hike was a decade ago (June 2006). However, unless you are a bond trader, the scale and length of the tightening cycle matter more. Here are some stylised facts from previous tightening cycles in the US (twelve cycles during the last 50 years): • the average tightening cycle duration is less than 2 years, although in the last twenty years the average duration is about one year; • the average increase in the base interest rate is 3 percentage points; • a recession follows about three years following the Fed’s decision to raises rates for the first time in years. It is the path of interest rates after the first hike that matters most because this path determines how much support the economy will be getting from the Fed. So the big question this time around is whether rates will rise quickly or slowly in 2016. The answer is pretty straightforward: slowly. In the past, each Fed rate increase was soon followed by other central bank rate rises. This time, given divergent monetary paths (mainly the QE programmes in Europe and Japan), a US rate hike is expected to be followed by a US dollar appreciation, given that foreign capital will take advantage of more attractive yields driving the US currency higher and also given the US dollar’s role as a safe haven currency. This will further tighten policy since a higher exchange rate will reduce the price of imports and hence inflation. Indeed, since early January, the US dollar appreciated against the euro by more than 7% (€/US $: from 1.20 to 1.12), while it appreciated against the yen by 4% (from 119 to 124) and the British pound by 3% (from 0.64 to 0.66). The above reasoning suggests that the next US tightening cycle will be shorter and shallower than in the past. In other words, I tend to be more on the side of futures markets than of Fed officials as far as the prediction about the level of the base rate at the end of 2016 is concerned. As shown in Chart 9, Fed officials think that a growing economy will allow the central bank to increase its target significantly over the following year or so and their median projection for end-2016 is 1.375%, while investor expectations derived from futures market prices hover around just 0.75%. BIS central bankers’ speeches Chart 9: Forecasts for end-2016 Fed base rate Of course, this first Fed rate rise in many years might have adverse effects on emerging market economies (EMEs) given the history of emerging market crises (1979–1982 in Latin America, 1994–1995 in Asia) coinciding with the early stages of US monetary tightening cycles. This time, a premature Fed tightening move would not trigger an emerging market crisis (since it has already broken out in China), but it would accentuate the crisis through spillovers to advanced economies. The most vulnerable countries are those with large fiscal and current account deficits or, to put it differently, those lacking political and policy credibility. A tightening of the Fed’s policy is likely to lead to further capital outflows from EMEs as investors search for rising returns in the US, which in turn might imply a depreciation of EMEs’ currencies, a rise in their interest rates, economic slowdown, etc. 2. The Chinese turmoil is the main challenge ahead One last word about China and the recent market turmoil: this latest episode may have the characteristics of a regime switch towards a permanent, lower output, driven by a structural real estate overhang, chronic industrial overinvestment (45% of GDP) financed by a (collapsing) shadow banking system. Since mid-August, financial markets have been facing substantial volatility, following China’s decision to change the methodology for setting the central fixing rate of the yuan, which led to a 2% devaluation in China’s currency, its biggest daily move since 1994. The decision was probably prompted by weakening economic activity, a decline in exports (July figures indicated a year-on-year decline by more than 8.5%), deflationary pressures and followed the depreciation of the yen and the euro, which are the major trading currencies for China. Recently released data on China’s PMI (former HSBC PMI), which dropped to 47.0 in September, its lowest level since 2009, and further deterioration in China’s activity indices (for instance, the crude steel output fell by 6.3% on a yearly basis in the first eight weeks of the third quarter) suggest that China’s official growth rate of 7% can be put under question. If macro data continue to weaken, China is not likely to maintain its recent growth rate, but it will be stabilised at a lower level, its slowest rate since 1991. BIS central bankers’ speeches Chart 10: Shanghai Stock Exchange Composite Index & Turnover Sources: Bloomberg and Bank of Greece. As shown in Chart 10, the Shanghai Stock Exchange Composite Index has experienced a sharp correction by roughly 40% since its June 12 peak, after it had risen around 150% in one year. Its turnover still remains below the average of US $25.2 billion. In addition, the fears of a Chinese slowdown affected emerging economies (see Chart 11) and commodity producing countries. Chart 11: VIX and MISCI Emerging Markets Index VIX MSCI Emerging markets index MSCI VIX 10.4.15 10.5.15 10.6.15 10.7.15 10.8.15 Sources: Bloomberg and Bank of Greece. Notes: VIX= Volatility Index. Composition: Implied Volatility of S&P 500 options, MSCI: Morgan Stanley Capital International. Data from 21 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. The Chinese slowdown affected emerging economies as it led to a massive sell-off in their equity markets and a rise in volatility which spilled over to other international markets. BIS central bankers’ speeches Spillovers were evident mainly in the foreign exchange market with emerging market currencies depreciating against the USD and safe-haven flows into the yen, Swiss franc and the euro. At the same time, high yield and emerging market bond yields widened significantly. Another important consequence was the impact of the Chinese equity crisis on commodity prices, particularly on oil (e.g. WTI Crude Futures lost as much as 36% over the last two months), which immediately triggered expectations of global disinflation with potential implications for future central bank actions. Nevertheless, it seems premature to conclude whether this, or a further, yuan depreciation would feed into imported disinflation in the US, Europe and Japan. Contagion spread to advanced economies’ equity markets and, despite some gains in late August, the overall levels remain lower than two months ago. BIS central bankers’ speeches

bank of greece

Address by Mr Theodore Mitrakos, Deputy Governor of the Bank of Greece, at the workshop co-organised by the Bank of Greece and EBRD on "Distressed loans in the Greek banking system - restructuring portfolios, reviving enterprises", Athens, 10 March 2016.

Theodore Mitrakos: Distressed loans in the Greek banking system – restructuring portfolios, reviving enterprises Address by Mr Theodore Mitrakos, Deputy Governor of the Bank of Greece, at the workshop co-organised by the Bank of Greece and EBRD on “Distressed loans in the Greek banking system – restructuring portfolios, reviving enterprises”, Athens, 10 March 2016. * * * Ladies and gentlemen, dear guests, It is a great pleasure for me to welcome here at the Bank of Greece Mr. Nick Tesseyman, Managing Director Financial Institutions of the European Bank for Reconstruction and Development (EBRD), the distinguished speakers and all the participants in today’s workshop, focusing on the management of non-performing exposures (NPEs). Let me take this opportunity to welcome the activity of the EBRD in Greece. The EBRD Governors, following a request of the Greek authorities, voted in February 2015 with overwhelming majority for the Bank to invest in Greece until the end of 2020. The Bank’s investments, backed by technical assistance and policy dialogue, are intended to strengthen progress in the reform of Greece’s economy and contribute to its recovery. In this vein, as you probably know, the EBRD Representative Office in Athens was recently established. Greece will benefit greatly from the expertise and the finance that the EBRD can bring to projects designed to contribute to sustainable growth and encourage trade. The EBRD has already participated in the recapitalisation of the four significant Greek banks in late 2015, which shows its confidence in the prospects of the entire Greek banking sector, and has invested overall around €300 million in Greece. Moreover, as of early March the EBRD is supporting the expansion of international trade with a facility to National Bank of Greece under the EBRD’s Trade Facilitation Programme (TFP). Through the programme, the EBRD provides guarantees to international confirming banks and short-term loans to selected banks and factoring companies for on-lending to local exporters, importers and distributors. The facility will help National Bank of Greece to scale up its trade finance activities, despite the financial market conditions, and reaffirm itself as a prime trade partner, supporting trade activities of exporters, importers and distributors of imported goods in Greece. It is anticipated that similar agreements will be signed with other Greek banks in the near future. More generally, the EBRD’s commitment to the country sends a strong signal to private sector investors that Greece is serious about reform and rebalancing its economy. I would like therefore to thank Ms. Sabina Dziurman, EBRD Director for Greece and Cyprus, for her contribution so far, as well as for putting forward the idea of holding a joint workshop on non-performing exposures. Ladies and gentlemen, The Bank of Greece, as you all know, has taken a series of initiatives to promote more rigorous and efficient management of non-performing exposures. It has also underpinned government efforts towards shaping and implementing a national NPL strategy. In this regard, let me very briefly mention some of these Bank of Greece initiatives: • The issuance of the Executive Committee Act 42/2014 on the supervisory framework regarding the NPE management by commercial and cooperative banks. • The activation of the Code of Conduct, which provides guidelines regarding the interaction of credit and other financial institutions with borrowers in arrears. • The conduct of several on-site inspections to monitor banks’ progress in implementing the supervisory framework. • The conduct, with the support of an external consultant, of a study on NPL segmentation and the preparedness and capacity of banks to deal with each NPL segment in a rigorous manner. BIS central bankers’ speeches • The issuance of the Executive Committee Act 82/2016 (under publication) regarding the framework for the licensing and operation of NPL servicing and acquiring firms. Last but not least, the Bank of Greece, in cooperation with the ECB Banking Supervision and the commercial and cooperative banks, is in the process of agreeing a set of operational targets for NPEs. Meanwhile, the Bank of Greece is setting up a Coordination Office to support the monitoring of the implementation of the national NPL strategy. • Against this background, in today’s workshop we will have the opportunity to extensively discuss three main topics: • Solutions for borrowers with exposure to multiple banks. The bulk of distressed large corporate borrowers have exposures to multiple banks rendering necessary a coordinated approach among creditors to agree comprehensive and sustainable solutions in a reasonable timeframe. The Hellenic Financial Stability Fund (HFSF) has recently launched a study regarding this pertinent issue of “common borrowers”. • Development of a secondary market for NPL servicing and sales. The recent Law 4354/2015 laid down the framework for the development of a secondary market for NPL servicing and sales. There will be two panels covering essential aspects in the process of setting up the local infrastructure for NPL servicing and sales respectively. • The banks’ internal workout: managing distressed SMEs. SMEs are the backbone of the Greek economy. The shift of banks towards long-term forbearance measures coupled with the restructuring of viable businesses with appropriate changes in their structure, business model and, if necessary, corporate governance would help stimulate an uptick in economic activity and assist the rebalancing of the Greek economy towards export-oriented sectors. Ladies and gentlemen, The successful completion of the recapitalization of Greek banks in late 2015 has been a decisive first step towards safeguarding financial stability and restoring the intermediation role of banks. The capital adequacy ratio of the Greek banking sector stands (pro forma) at around 18% and compares favorably with the average for European Union banks. The next milestones for the Greek banking sector relate to a return to profitability, a return of deposits through the restoration of depositors’ confidence and, more importantly, the supply of credit for working capital and investment. Undoubtedly, these goals are closely linked to the politically and socially sensitive issue of tackling non-performing exposures, which poses a real challenge for us all. As of September 2015, non-performing exposures stood at €107 billion, representing 43.6% of total exposures. Hence, the more effective management of non-performing exposures, avoiding the pitfalls of regulatory forbearance or overenforcement alike, will bring about multiple benefits for banks, households, businesses and the society at large. In the process, it will unlock funding to the real economy, bolstering investment and employment. This in turn will enable the Greek banking sector to protect and strengthen the productive fabric of the country, while concurrently enhancing its social role. I am confident that today’s workshop will show the significant progress that has already been made regarding the development of an appropriate institutional and supervisory framework for a more effective NPE management. Moreover, it will help to identify the appropriate tools and approaches to this end. I look forward to an exciting discussion and a very fruitful exchange of views. The overwhelming interest of market participants, from Greece and abroad, to join this workshop is, I think, a key ingredient for its success. Thank you again for being here today. BIS central bankers’ speeches

bank of greece

Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the 83th Annual Meeting of Shareholders, Athens, 25 February 2016.

Yannis Stournaras: Recent economic and financial developments in Greece Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the 83th Annual Meeting of Shareholders, Athens, 25 February 2016. * * * The completion of the review is essential for an exit from the crisis 2016: a year of pragmatism and adjustment According to Bank of Greece estimates included in the present report, the conditions shaping the path of the Greek economy in 2016 appear to be more favourable than a year ago. It is therefore reasonable to anticipate that the recession will bottom out and that the economy will see a slight recovery during the second half of this year, provided that political stability is maintained and uncertainty, which harms investor confidence, is eliminated. This outlook is subject to strong uncertainties and high risks, associated, on the one hand, with global developments and, on the other, with the pace at which the Greek economy will return to normality and adjust to the new conditions. The first set of risks relates to the refugee crisis and the manner in which the European Union (EU) as a whole will address it; a surge in geopolitical risks in the broader region; a slowdown of global economic growth and an overreaction of financial markets in this respect; a new Asian crisis originating in China; and finally, the possibility of a British exit from the EU. These risks in the global environment could reinforce centrifugal trends in the EU and undermine European cohesion, at a time when the stronger Member States of the euro area seem to have fundamentally different approaches to the architecture of the monetary union. On the domestic front, the prospect of recovery crucially hinges on a number of prerequisites, including reaching an agreement on the first review of the programme and the adoption of the agreed measures by the Hellenic Parliament, commitment to implementing the programme, and action to restore political and economic stability and foster a return to normality. In order to respond and adjust to the fast changing global environment, the Greek economy, integrated into a globalised economy and exposed as it is to international competition, must first of all consolidate its position by effectively addressing its own problems. The country that fails to keep up with European developments and lags behind will be the one hardest hit, in case the global environment takes a turn for the worse. Recent macroeconomic developments Between 2008 and the end of 2013, the Greek economy lost a cumulative 26% of its Gross Domestic Product (GDP). After a short-lived rebound in 2014 that continued until mid-2015, it fell back into recession in the third quarter of 2015 (–1.9%). The rate of change in GDP remained negative (–1.9%) in the fourth quarter, coming to –0.7% for 2015 as a whole. Underlying this new downturn were political instability from the end of 2014 onwards, the protracted negotiations with our creditors in the first half of 2015, the bank holiday and the imposition of capital controls, as well as the new fiscal adjustment measures under the new Financial Assistance Facility Agreement, considered necessary to achieve the revised fiscal targets. The strengths of the Greek economy and of the domestic banking system were tested. However, the economy showed remarkable resilience, and the negative impact was more moderate than initially expected. This resilience is associated with the implementation of the adjustment programmes since 2010, which – in spite of several delays and missteps – have succeeded in sharply reducing the major macroeconomic and fiscal imbalances. More specifically: BIS central bankers’ speeches • The high fiscal deficit has been reduced, covering three quarters of the adjustment path towards the ultimate fiscal target (for a primary surplus of 3.5% of GDP by 2018, compared with a primary deficit of 10.1% of GDP in 2009). • The current account deficit and the loss of competitiveness have been addressed, while labour market rigidities and constraints have been reduced, leading to an increase in exports. • There have also been signs of sectoral reallocation towards tradable goods and services and, more generally, towards the more productive businesses across all economic sectors. As opposed to the substantial progress made in recent years with fiscal adjustment, there have been delays with privatisations and the implementation of growth-enhancing reforms. These delays held back the beneficial effects on growth and employment, which only emerged in the course of 2014, with GDP growth returning to positive territory for the year as a whole (+0.7%) and in the first two quarters of 2015. The recovery would have gained traction and the overall outcome for 2015 and 2016 would have undoubtedly been positive and stronger, in line with the projections, if it had not been undercut by heightened uncertainty from the last months of 2014 until a new agreement was reached with our partners at the Euro Summit of 12 July 2015. After a primary surplus of 1.2% of GDP in 2013, well above the target for a balanced primary budget, Greece’s fiscal position deteriorated in 2014, on the back of political and economic uncertainty in the late part of the year. Nevertheless, the primary balance remained positive, albeit small and falling considerably short of the targeted 1.5% of GDP. In the course of 2015, fiscal aggregates showed strong fluctuations, reflecting developments in tax revenue, public investment expenditure and government arrears. Following a downward revision of the primary balance target to a deficit of 0.25% of GDP (from an earlier target for a 3.0% surplus) and the adoption of additional fiscal measures, the primary budget in 2015 is expected to have been balanced or slightly in surplus. The major challenge of 2015: safeguarding financial stability Against the background of uncertainty that prevailed in the first half of 2015, it became crucially important to safeguard financial stability under threat from a pick-up in deposit outflows, a spike in non-performing loans (reversing the picture that had begun to emerge in the course of 2014), the non-eligibility of Greek securities as collateral in Eurosystem monetary policy operations and, above all, the heated debate over a possible Greek exit from the euro area. At these most difficult of times, the Bank of Greece fulfilled its primary duty arising from its participation in the Eurosystem and from its Statute, namely to safeguard monetary stability and support liquidity in the domestic banking system, while at the same time safeguarding its independence and credibility helping to restore normality. In this respect: • it provided timely and reliable information to the government and political parties, while raising public awareness through its reports and public interventions; • it ensured the uninterrupted funding of the banking system through the Emergency Liquidity Assistance (ELA) mechanism; • it supplied credit institutions with banknotes, averting any cash shortages even in the remotest parts of the country; • it developed, in collaboration with the government and the Hellenic Financial Stability Fund (HFSF), a strategy on non-performing loans (NPLs); • it carried out the Asset Quality Review of banks; BIS central bankers’ speeches • it completed the successful recapitalisation of significant and less significant banks, without shocks to the credit system; • it engaged in close cooperation with the Single Supervisory Mechanism (SSM) through the participation of members of its staff in Joint Supervisory Teams; • it helped to minimise the impact of capital controls, with the result that the recession was much more moderate than expected; • it supported the work of the Committee for the Approval of Bank Transactions; • it provided support to government operations, always in compliance with the Treaty on the Functioning of the European Union, which, among other things, delineates the relations between national central banks and Member States’ governments. The bank holiday and the capital controls managed to contain the deposit outflows and the capital flight. The ensuing distortions in the capital market, as well as in the goods and services markets, have had indirect repercussions that cannot be precisely assessed as yet. On a positive note, however, capital controls have encouraged the use of electronic money. There is already strong evidence that the widespread use of e-money has supported private consumption and tax revenue, by reducing the informal economy. Thus, one first policy implication is that the use of e-money needs to be strengthened further, through appropriate, mainly tax-related, incentives. A stronger banking system in the wake of recapitalisation The recapitalisation of Greek banks was successfully completed in December 2015, with a substantial participation of private investors. This new recapitalisation became necessary against the background of a deteriorating economic climate, heightened uncertainty and increased outflows of deposits during the first half of 2015, as well as amid rising nonperforming loans. The four significant Greek banks managed to cover the capital needs identified by the ECB’s stress tests. The necessary funds came from (a) foreign investors, who placed around €5.3 billion; (b) capital mitigating actions amounting to €0.6 billion; and (c) liability management exercises (voluntary bond swap offers to bank bondholders) that yielded about €2.7 billion. For the two banks that did not fully cover their capital needs, based on the adverse scenario, from private sources (totalling about €5.4 billion), the necessary additional funds were drawn from the HFSF. Thus, the public resources used proved to be far lower than the amount of €25 billion foreseen by the Eurogroup in August 2015. Moreover, banks’ reliance on ELA has decreased, and the ceiling has been reduced by about €19.0 billion since end-August. The lower ceiling reflects the improved liquidity situation of Greek banks amid easing uncertainty and a stabilisation of private sector deposit flows, as well as, to a large extent, the progress with the recapitalisation of Greek banks. In 2015, the stock of non-performing loans increased. Non-performing exposures as a percentage of total exposures (NPE ratio) rose to 43.6% at end-September 2015 (up from 39.9% in December 2014). This deterioration was visible and similar in size (roughly 4 percentage points) across all loan categories. In particular, the NPE ratio reached 55.4% for consumer exposures, 43.3% for business exposures and 39.8% for housing exposures. This can in part be attributed to the postponement of the implementation of the Code of Conduct on the management of NPLs and to the less active loan portfolio management on the part of banks, which seemed to focus mostly on short-term solutions. However, from the third quarter onwards, especially after the recapitalisation, banks appeared to step up their efforts towards more active NPL management. BIS central bankers’ speeches The completion of the first review will enhance the prospect of recovery Contrary to what was the case in 2015, 2016 could mark a new beginning leading Greece out of the crisis and onto a path of sustainable growth. As mentioned previously, however, there are a number of major challenges, arising not only from unpredictable developments in the international environment but also, more importantly, from potential risks to the domestic macroeconomy, such as delays in the completion of the first review of the new stabilisation programme or failure to implement the programme’s actions. Real GDP growth is expected to be negative, at least during the first half of 2016, largely reflecting a carry-over effect from 2015. However, as already mentioned, the objective conditions are in place for Greece to exit recession and come closer to positive growth from the second half of this year. This is also conditional on a number of steps that will help to avert risks and strengthen the prospect of recovery, which is feasible. The first step, and the one with the most crucial bearing on future developments, is the successful completion of the first review of the programme, currently in progress. This will require, among other things, the completion of the social security reform and the alignment of farmer income taxation. These are not just prior actions for the review of the programme. They are necessary to ensure the sustainability of the social security system and of public debt and to restore social and tax equity both across generations and across taxpayer groups. A positive review would boost the real economy and open the way for discussions on debt relief A positive completion of the review would benefit the real economy in a number of ways: • by bringing about a major improvement in confidence, thereby contributing to a faster return of deposits to the Greek banking system; • by enabling a decision to reinstate Greek securities as eligible collateral in Eurosystem monetary policy operations, providing Greek banks with access to lower-cost funding from the ECB; • by allowing Greek government bonds to be included in the ECB’s quantitative easing programme; • by bringing forward the further relaxation – and ultimately lifting – of capital controls. All of the above, coupled with the successful recapitalisation of banks and the more efficient management of non-performing loans, will restore normality to the banking system: banks’ higher funding capacity will in turn boost their capacity to lend to the real economy, translating into lower borrowing costs for businesses and households. These more favourable financing conditions will bolster growth. Over the medium term, the successful completion of the first review will prove to be decisive, in that it will open the way for discussions with our partners on further debt relief measures. Such measures would ensure the sustainability of public debt in a manner that contains the government’s annual financing needs at manageable levels. Among other beneficial effects, this would directly ensue in a further relaxation of the ultimate fiscal target and free up funds that could be channelled into investment, supporting output and employment. Preconditions for an exit from the crisis towards sustainable growth As already mentioned, an end to the recession and recovery from the second half of 2016 are within reach, provided that the problems and risks outlined above are effectively addressed. However, moving further along from recovery to sustainable growth will require strong commitment to implementing the new financial assistance agreement and long-term policies towards a new extrovert and competitive growth model. The factors that will BIS central bankers’ speeches ultimately determine success are: acceptance and ownership of the programme; perseverance and consistency in implementing the necessary actions; open dialogue; and political and social consensus. Over the past years, the Greek economy has been following an arduous road of adjustment, at great social cost, but also with tangible results. Little remains to be done, compared to the bulk of the effort already made. Indicatively, ten steps are recommended in this direction: 1. Further strengthening of the banking system The strengthening of the banking system entails addressing the high stock of non-performing loans. The effort towards long-term solutions to this major problem should benefit from the high-level operational targets for NPL resolution to be set by the Bank of Greece, in consultation with banks and the Single Supervisory Mechanism (SSM), applicable as from June 2016 and subject to monitoring on a quarterly basis. The requirement on banks to achieve these targets, coupled with the newly enacted legal and institutional framework, concerning, among other things, the establishment of a secondary market for NPLs, the speeding-up of judicial proceedings and the streamlining of the real estate collateral liquidation process, is expected to contribute to a gradual decline in the NPL ratio. The strengthening of the banking system would be supported by: First, bold and innovative initiatives for a substantial reduction of non-performing loans on bank balance sheets within the next two years. This cannot be ensured by the current “business as usual” approach, despite any refinements. Second, a shift towards long-term workout solutions. The current practice of short-term arrangements only serves to perpetuate the problem. Third, promoting multi-creditor workouts. Progress in this respect has been limited. In most cases, definitive solutions cannot be reached without coordinated action by all creditors. Almost all large non-performing business loans involve more than one creditor. Fourth, an intervention to restructure viable businesses. Alongside loan restructuring, it is crucial to enable active initiatives to change uncooperative managements, structures and business plans of corporate debtors. Fifth, enhanced internal controls to ensure equal and transparent treatment of borrowers. 2. Acceleration of reforms The programmes implemented over the past years were focused on fiscal adjustment and succeeded in eliminating the twin deficits. However, there were delays in the implementation of reforms, which, if made from the very start, would have reduced the extent and severity of the recession. This is the area on which we now need to focus. Specifically, the reforms needed in the services sector and network industries (transport, energy, telecommunications, trade) involve lifting restrictive regulations that stifle competition. In the labour market, emphasis must be placed on establishing a new framework for encouraging apprenticeship and vocational education and training, tackling undeclared work and streamlining existing labour laws and consolidating them into a Labour Law Code. Finally, in the field of public administration, a reform programme needs to be implemented, geared towards modernisation and de-politicisation. Concrete steps need to be taken towards simplifying administrative processes, overhauling structures, expanding modern technology usage, optimising human resources, and strengthening transparency and accountability. 3. Privatisations and utilisation of public real estate The scaling-up and successful implementation of the privatisations and public real estate utilisation programme are decisive to economic growth, as they will have a multiplier effect, with long-lasting gains for the domestic economy. Privatisation proceeds can be used to BIS central bankers’ speeches gradually pay off public debt, supporting fiscal adjustment. Furthermore, when accompanied by a strong commitment to future investment, privatisations enhance the inflow of funds for productive investments that stimulate employment and aggregate active demand. As estimated by the Bank of Greece, privatisations hold a huge potential, which could yield far more than the quantitative revenue targets. The public real estate, if properly utilised through an upgraded land use and spatial planning framework that will fully respect the environment, can attract substantial foreign direct investment. 4. Continued consolidation of public finances and of the social security system, through a redefined economic policy mix The downward revision of the primary balance target for a surplus of 3.5% of GDP by 2018 frees up resources that can be channelled into the real economy. However, the current policy mix, focused on closing the remaining fiscal gap and ensuring the sustainability of the social security system, must become more growth-friendly. In other words, the emphasis should be on reducing non-investment government expenditure and raising productivity. The focus, so far, on increasing labour and business income tax rates, as well as social security contributions, provides incentives for tax and contribution evasion and encourages undeclared work, undermines the competiveness of Greek firms and discourages job creation. As a result, any improvement in the fiscal balance is self-defeating, preventing a lasting reduction of the debt-to-GDP ratio. Instead, the remaining fiscal gap can be covered more effectively and more permanently by rationalising public administration structures, introducing a modern performance assessment system, merging and reducing the number (currently about 1,800) of public sector entities, abolishing various exemptions from general tax and social security provisions for specific groups of taxpayers or workers, redesigning the regime of own resources of local government with a view to removing disincentives for costsaving, reducing tax expenditure, cutting back on non-investment expenditure, better targeting social spending to remove the bias against the new generation and improving labour mobility from overstaffed to understaffed parts of the public sector. 5. Encouraging business investment and protecting private investors Greece has been plagued by serious investment inertia. Between 2007 and 2014, total investment expenditure as a percentage of GDP fell by half. Underlying this disinvestment are anaemic demand, political and economic uncertainty, as well as financing constraints. The prompt rebound of business investment expenditure is key to sustainable growth. The restoration of economic and political stability that would strengthen investor confidence and encourage business investment plans, the rapid shift of the domestic production model from non-tradable to tradable goods and services and the easing of financing constraints are instrumental in stimulating business investment expenditure. A decisive contribution should also come from actions such as the enactment of a new development law with clear growth incentives, but especially initiatives from the financial system to address non-performing loans in the context of the new institutional framework, which also enables creditors to cooperate in restructuring productive businesses. Furthermore, the Greek State must help restore investor confidence and protect private investors by ensuring a stable, businessfriendly economic environment. This can be achieved through the establishment of a clearcut, simple and stable tax and legal regime fostering healthy entrepreneurship, and through initiatives to settle long-pending, and harmful for the country’s investment appeal, disputes with major international investors. 6. Increasing exports The competitiveness gains achieved by the Greek economy at considerable social cost do not seem to have been fully exploited. These gains, together with improved labour market flexibility, are strong incentives for investment initiatives. Despite the recouping of losses in international competitiveness, mainly in unit labour cost terms, exports have not yet recorded the anticipated upward dynamics. This can in part be explained by the lack of financing, the BIS central bankers’ speeches comparatively higher cost of long-term borrowing and the increased tax burden which weighs on the economy’s overall competitiveness. In part, however, it is also due to a number of inherent structural weaknesses that hamper the penetration of Greek products in international markets and relate to non-cost aspects such as product quality, protected designation of origin and branding, red tape, etc. 7. Combatting high unemployment The observed gradual decline in unemployment and the continued recovery of the employment rate have been supported by the active employment policies implemented through programmes and actions using resources from the National Strategic Reference Framework (2014–2020). In order to fight high unemployment, in particular long-term and youth unemployment, the active employment policies and the vocational training programmes in place need to be constantly improved and expanded, while their effectiveness also needs to be increased, which requires results-based review and monitoring. Moreover, the enhancement of employment support schemes should go hand in hand with action against undeclared and uninsured work. 8. Education reform The road to growth entails knowledge, research, innovation and lifelong learning. The exit of Greek society from the crisis can only be achieved through its transformation into a society of creative citizens, capable of preserving and expanding its human capital stock. In this context, the education reform currently being debated, which forms an integral part of the national growth strategy, must be based on five pillars: (a) evaluation of the Greek education system at all levels with a view to enhancing innovation and entrepreneurship; (b) rationalisation of curricula across all educational levels, as well as of the functioning and governance of higher education institutions, while enhancing the efficiency and autonomy of public educational units; (c) breaking the hold of corporatist interests on the education system; (d) increasing funding, which still remains low; and (e) transparency at all levels. 9. Halting the brain drain Soaring unemployment and the deep economic recession have caused part of Greece’s human resources to migrate abroad, with alarming implications for the country’s demographics, public finances, pension system and, to the extent that it involves high-skilled people, the quality of the remaining labour force. In order to reverse this brain drain, the Greek State must take measures aimed at: (a) redefining the types and forms of academic and vocational specialisation needed to improve skill matching for young generations; (b) supporting business start-ups; (c) combatting mediocracy, the lack of transparency and nepotism; (d) promoting excellence; (e) expanding apprenticeship and internship schemes; and (vi) fostering a business-friendly environment. 10. Supporting social cohesion and tackling poverty Sustainable growth hinges upon social cohesion, under threat at present from rising poverty, income inequality and social exclusion. Although based on the results of the latest EU-SILC survey (2014), both indices, namely the poverty gap and the relative risk of poverty in Greece decreased somewhat, the relative risk of poverty is still the third highest in the EU-28. Moreover, the number of households living below the poverty line has increased. Public debate should therefore focus on the need to redesign both the policy of social transfers, in order to increase their effectiveness in tackling poverty, and the education system, to ensure that it provides equal learning opportunities at all levels of education to those facing social exclusion. * BIS central bankers’ speeches * * The Greek economy has already come a long way, and it is only a short distance from here to an exit from the crisis. In order to avert any setbacks and obstacles on the path towards growth, all existing potential must be fully exploited, avoiding past mistakes that only led to vicious circles and impasses. Today, an exit from the crisis is within sight, but remains subject to prerequisites. In order to reach it, we must remain committed to honouring the terms of the agreement, which must not be seen as imposed upon us by our creditors, but as fundamental and necessary reforms that should have been implemented years ago. The Greek side must take ownership of the programme as a necessary means towards adjustment and reform. In addition, however, the ten steps mentioned above, which should ideally be incorporated into a national growth plan, are geared towards supporting (a) output and investment; (b) the “knowledge triangle” (education, research, innovation); and (c) the new generation. This national plan must be both a new growth and a social pact for the creation and mobilization of resources to support productivity, new businesses and jobs. These are the orientations that will enable the Greek economy to exit the crisis once and for all and return to a virtuous circle of growth and employment. BIS central bankers’ speeches

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Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Croatian National Bank "Financial stability and policy intervention by Central Banks in Europe - where do we stand and what challenges lie ahead", Zagreb, 23 March 2016.

Yannis Stournaras: Financial stability in Europe and how to improve it Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Croatian National Bank “Financial stability and policy intervention by Central Banks in Europe – where do we stand and what challenges lie ahead”, Zagreb, 23 March 2016. * * * Before I begin my presentation, please allow me to dedicate the following remarks to the late Vassiliki Zakka, who was an exceptional colleague at the Bank of Greece and a dear friend. Before passing away unexpectedly several weeks ago, Vasso had contributed to the drafting of this speech. She will be badly missed. Ladies and gentlemen, It is a great pleasure to be in Zagreb today and to have the opportunity to share with you some thoughts on financial stability in Europe and, in particular, how to improve it. Financial stability is a critical condition for achieving our common goals of prosperity and sustainable growth. Yet, the financial landscape on which both regulators and market participants operate, has been rapidly changing; it is very different today from what it was only ten years ago, and it will be very different ten years from now. I will begin by describing the present landscape on which efforts to strengthen financial stability have been taking place. Then, I will briefly discuss some developments in the EU regulatory framework relevant to the financial system and its stability. In particular, we can identify a new role for central banks in this framework that stems from mandates that have been revised to include the safeguarding of financial stability. I conclude by outlining the challenges ahead and I provide some thoughts on the way forward. A. The setting – a broader context Beginning with the initial efforts to forge closer European integration in the early-1950s, the European Union has faced a series of challenges that have, at times, tested both the coherence and the stability of the union. The responses to these challenges have shown that the EU is built on solid ground as the bonds among Member States have become stronger over time. To cite two notable examples: the breakdown of the Bretton Woods System in the early-1970s led to the creation of the European Monetary System – or EMS – in the late1970s; the breakdown of the EMS in the early-1990s led to the creation of the euro in 1999. Developments since the eruption of the 2007–08 international financial crisis have further strengthened the bonds among EU members. That crisis raised issues related to “too-big-tofail”, “too-big-to-save”, and “too-complex-to-resolve”. The Basel Committee on Banking Supervision, following the G20 agreement in 2008, took-on the task of comprehensively strengthening international bank-regulatory standards. Its updated report, presented to G20 Leaders last November, noted that substantial progress has been made towards finalizing post-crisis reforms and that the regulatory-reform agenda for global banks has almost been completed. Further clarification of these elements will provide regulatory certainty, supporting the banking sector’s ability to make long-term sustainable business plans. The euro-area financial crisis, which originated in 2009–10, provided another – more serious – challenge to the stability of the European Union. More recently, with the recovery in the euro area still fragile, a slowdown in growth in the Emerging Market Economies, along with a rise in geopolitical tensions, which have led to an unprecedented refugee crisis, and concerns about a Brexit, have led to an increase in uncertainty. Finally, different approaches among member states regarding banking union, and the slow progress in establishing a single European deposit insurance scheme, have been hindering further progress in securing the financial system architecture needed to enhance stability. A salient characteristic since the onset of the euro-area crisis is that shares of European banks have been trading at a discount to tangible book value, while those of the largest US BIS central bankers’ speeches banks have traded at a premium to book value. This situation cannot be explained by differences in capital-adequacy ratios since capital ratios for euro-area banks have risen from about 8 percent in 2008 to about 14 percent today (Cœuré, 2016). On the contrary, these differences are indicative of a European banking sector undergoing a transformation that demands a comprehensive and radical adjustment of the core business model of operation. The first two months of 2016 saw a sharp deterioration in market sentiment, related to not only a weakening of global economic activity, but also other concerns: • First, the threat of low nominal growth, generating not only high NPL ratios but also lower and flatter yield curves with potentially negative effects on banks’ profitability. • Second, concerns about the effectiveness of monetary policy, with some market analysts believing that central banks may be running out of ammunition. I can assure you that they are not. The monetary-policy decisions by the ECB Governing Council two weeks ago provide clear confirmation of this fact. • Third, regulatory uncertainty about the suite of capital and bail-in requirements – the Supervisory Review and Examination Process (SREP), the Minimum Requirements for Own Funds and Eligible Liabilities (MREL), the Total Loss Absorption Capacity (TLAC), and EBA guidance on the minimum distributable amount (MDA). Uncertainty as to the actual effects that can be expected from the newly introduced BRRD instruments seems to have played a role. • Fourth, negative feedback loops between equity and debt markets, amplified by low secondary market liquidity. B. The EU response The responses of the European Union to the weaknesses to the financial stability landscape that emerged have been effective, despite the initial lack of crisis mechanisms and the unfavorable and challenging environment – an environment in which fires were often being simultaneously fought on a number of fronts. Initially, the response came in the form of monetary policy and a significant easing of the monetary policy stance. Indeed, in October 2008, six major central banks, including the ECB, executed a coordinated and simultaneous cut in interest rates. Additionally, at that time the euro-area countries set out an action plan of coordinated measures to restore confidence and improve financing conditions in the economy. These measures included the granting of government guarantees on bank debt issuance and the recapitalization of banks. With the eruption of the euro area financial crisis in 2010, and during subsequent periods when the monetary transmission mechanism was dysfunctional, the ECB increasingly implemented nonstandard monetary tools. Additionally, to provide financial assistance to countries under stress, in June 2010 Europe created the EFSF, which was replaced by the ESM in October 2012. Perhaps the greatest challenge – and surprise – posed by the euro-area crisis was in the area of financial integration and banking. At the inception of the euro, it was widely-expected that the single currency would spur integration across previously-fragmented European financial markets. Economists believed that this integration would be stabilizing: portfolio diversification and access to credit markets were expected to encourage risk-sharing while making national demand less dependent on national income – that is, portfolio diversification was expected to encourage consumption smoothing. And for the euro’s first ten years, that scenario unfolded very much as expected. Then came a major surprise. The euro-area crisis revealed that countries within a monetary union can become subject to balance-of-payments crises – a possibility that had been almost completely overlooked by the architects of the euro. Moreover, once a crisis erupted – whether in the sovereign sector or the banking sector – a central feature of the crisis was the negative feedback loops between banking fragility and sovereign weakness. One factor BIS central bankers’ speeches contributing to those feedback loops was the following. Although the largest banks in the euro area and the United States are of roughly the same size in terms of euro-area GDP and U.S. GDP, respectively, the largest euro area banks represent a much larger share of any individual national economy in the euro area compared with the situation of U.S. banks. This circumstance implies that the fiscal consequences of euro-area bank failures could be large enough to bring state-solvency into question. Moreover, the fact that bank regulation and supervision prior to the crisis were mostly national was seen as having contributed to the crisis and as having impeded its effective resolution. Consequently, a key lesson of that crisis has been that a monetary union is not viable in the absence of a banking union. In response to these developments, in 2012 European leaders initiated the creation of the Banking Union – which is an integral part of a genuine Economic and Financial Union in Europe. The three pillars of the Banking Union are: the Single Supervisory Mechanism, the Single Resolution Mechanism and the still-to-be completed common deposit guarantee system. As of January 1st 2016, the Banking Recovery and Resolution Directive (BRRD), which sets common EU rules for failing banks, entered into full force. The BRRD aims, inter alia, to end the policy of bailing-out failing banks by introducing bail-in tools to ensure that losses are borne by creditors, including senior unsecured creditors. The BRRD, especially its bail-in tool, has been criticized – perhaps with some justification. However, the argument sometimes made, namely, that the activation of the BRRD has been a primary cause of the recent deterioration in market sentiment, including the large losses in European bank stocks, is far-fetched. The provisions of the BRRD have been widely known since 2014. What analysts, perhaps, failed to realize is that the new and stricter rules introduced with the BRRD will affect the volatility of the prices of banks’ shares should concerns be raised about the banks’ profitability, solvency and, most importantly, their viability. That said, we must keep in mind that the BRRD is a new and untested framework for failing banks, and it is not particularly suited to addressing a systemic crisis. As it will be revised by June 2018, we will have to closely monitor its implementation and identify any areas where adjustments and fine-tuning will be needed. While we may need tools for failing banks, our primary aim as supervisors is the prevention of bank failure, in order to foster financial stability and ensure that depositors remain protected. As John Vickers (2016) recently highlighted “Orderly bank failure is better than disorderly failure, but it’s best not to fail in the first place…Regulators… are adding usefully to the supply of fire extinguishers. With more fire extinguishers the average damage from a fire is materially reduced. But that is no good reason to economise on fire prevention”. C. Central Banks and macro-prudential policy Now let me turn to the issue of crisis prevention. The challenges facing EU financial sectors in recent years have significantly increased the responsibilities of central banks in the area of crisis prevention. Mandates have been amended to explicitly refer to financial stability – typically defined as avoiding rapid credit growth combined with increases in asset prices beyond those justified by the economic fundamentals – as a core central bank task. The toolbox for providing financial stability has been expanded to include macro-prudential policy tools and enhanced micro-prudential policy tools for both the national authorities and the SSM. Examples of macro-prudential tools include: a countercyclical capital buffer, a systemic risk buffer and the other systemically important institutions buffer along with measures to control, inter alia, leverage, liquidity and large exposures. In the past, it was not thought to be necessary to separate monetary policy from the task of providing financial stability. It was thought that price stability in the market for goods and services would be sufficient to ensure financial stability in the market for assets. The experience since the early-2000s has dispelled such beliefs. That experience has shown that the business cycle and the financial cycle are not necessarily synchronized; long periods of BIS central bankers’ speeches disconnect between the two cycles can materialize. In particular, the financial cycle tends to have larger amplitude and lower frequency than the normal business cycle. Macro-prudential policy bridges the gap between the micro-prudential supervision of individual banks and monetary policy. Its objectives are, first, to enhance the resilience of financial institutions and the entire financial system, and, second, to smooth the financial cycle. In this regard, macro-prudential policy allows monetary policy to focus on maintaining price stability so that real economic activity can flourish, while micro-prudential supervision focuses on individual institutions. In this way, macro-prudential policy enhances the institutional separation that is one of the principles of the architecture of the euro area. Indeed, I believe that a strong case can be made that, had macroprudential tools been available ten years ago, we may not have had a euro-area crisis. Ten years ago macroprudential tools to limit the excess borrowing that was taking place in the soon-to-be crisis countries were either not used or were too weak to dampen credit growth sufficiently in those countries. That said, the usefulness of coordinating policies should not be forgotten – whether that be coordination of specific policies across different countries (as happened in the wake of the failure of Lehman Brothers with the simultaneous cuts in policy rates) or coordination of policies within one jurisdiction. Respect for the independence of the various authorities involved in securing financial stability should not imply separation and a lack of coordination. Thus, I strongly agree with Danielle Nouy that “micro-prudential supervision needs to be complemented by a macro-prudential perspective”. It is imperative, however, that the macroprudential toolbox be further enhanced with innovative tools beyond those focused on capital requirements. Cyclical systemic risk can arise not only as a result of excessive credit expansion (an issue that can be addressed with the countercyclical capital buffer) but also because of inadequate channeling of credit that keeps the real economy under-financed for extended periods. A lesson drawn from the crisis is that we have focused on rather narrow areas of financial activity. Nowadays, it is important that we focus on the risks that might be missed at the micro level, that is the interlinkages between and among sectors, and thus explore how the financial system can influence, and be influenced, by the wider economy. In the euro-area, there is evidence of limited financing of the real economy, with the consequence that euroarea investment has not recovered to pre-2008 levels despite ECB policies directly aimed at increasing the lending of the banking sector. D. Developments in the EU financial regulatory framework and further steps ahead Apart from the elements of Banking Union and the BRRD, a number of other important regulatory initiatives have been taken, covering not only the banking sector, but also insurance, financial markets and infrastructures. Many initiatives are on-going and further steps are required for their completion. If macroprudential policy is to effectively curb the financial cycle, it is essential to have tools that deal with the credit-real estate relationship. There are two ways to deal with this relationship. The first is by imposing restrictions on credit institutions – that is, through capital-based measures. The second way in which the credit cycle can be moderated is by limiting leverage by households and non-financial corporations. With regard to the banking sector, the Capital Requirements Regulation (CRR) and Directive (CRD IV) play a prominent role in setting the prudential standards for credit institutions and investment firms in the EU. Implementation is ongoing and expected to be completed by 2019. From January 2016, the countercyclical capital buffer (CCB), the systemic risk buffer (SRB) and the other systemically important institutions (OSII) buffer have been operational. Given the need to diversify the available tools beyond regulations based on capital, tools based on liquidity, leverage and funding sources are also being introduced. BIS central bankers’ speeches With regard to the borrower’s side, instruments such as the loan-to-value (LTV), loan-toincome (LTI) and debt-service-to-income (DSTI) limits are considered to be among the most effective macroprudential instruments in curtailing excessive credit growth. In order to effectively moderate the financial cycle, a time-varying dimension is crucial in the design of the various ratios. For example, the loan-to-value ratio should be lowered during the expansionary phase of a financial cycle and it should be raised during the contractionary phase. Otherwise, there is a risk of pro-cyclicality since leverage constraints decrease as asset prices rise. Regulatory initiatives for financial markets and infrastructures and the implementation of the European Market Infrastructure Regulation (EMIR) include macro-prudential intervention tools (such as an enhanced and cooperative oversight framework for central counterparties). Thus indicators that will contribute to better monitoring the extent to which the system is assuming more risks, as well as tools which can contribute to maintaining financial stability are being developed. E. Challenges ahead and the way forward Challenges, of course, remain. I will highlight seven of these challenges. 1. The first challenge is the completion of the Banking Union. Questions surrounding the financial capacity of the Single Resolution Fund (SRF), both in the short and in the long run, have to be addressed. The size of the SRF has been criticized for being insufficient and its governance structure has been criticized as being overly complex. If a sound backstop is not in place, there will be pressure for stress tests to become softer, which would be a detriment to financial stability. The ESM could become an effective backstop to the SRF, safeguarding financial stability in the Banking Union. Another issue that requires further reflection concerns the implications of implementing a single vs. a multiple point of entry in developing resolution plans. With respect to deposit insurance, aside from the Deposit Guarantee Scheme Directive (DGSD), the transposition of which is still pending in some Member States, the proposed European Deposit Insurance Scheme (EDIS) is of paramount importance. Deposit insurance at the supranational level will contribute significantly to financial stability by providing a back-up when national schemes do not have the capacity to handle large shocks. Such insurance will be a decisive step towards breaking the diabolical link between banks and sovereign and, along with a sound backstop to the SRF, safeguarding stability across the Banking Union. It is also important to keep communicating with the markets. Thus, we have to provide consistent communication on regulatory initiatives and macroprudential policies to reduce regulatory uncertainty. It is necessary to revise the legislation and EBA Guideline regarding the definition of the Minimum Distributable Amount (MDA) to bring it into line with other countries. We need to harmonize the Minimum Requirements for Own Funds and Eligible Liabilities (MREL) and the Total Loss Absorption Capacity (TLAC), for example, by using the same definition of eligible liabilities for both tools and adjusting the relative thresholds. Close cooperation between the SSM and the SRB will be needed. One first area where this cooperation could be beneficial is at the level of the MREL. Finally, we need to promote strategies for banking sector restructuring while having a comprehensive strategy to tackle NPLs. This is particularly important for banks with high NPL ratios. 2. A second challenge ahead relates to the issue of the increased burden of complying with the new regulatory framework and assessing its cumulative impact. I am not referring to additional capital adequacy requirements. In the pursuit of making banks more robust, liquid, responsible and transparent, huge progress to regulate their operation and supervision has been achieved. However, there has been no estimate of the cumulative impact of these regulations. I welcome and look forward to the report on the impact of capital requirements on the economy; however, the impact of other regulations should also be examined. BIS central bankers’ speeches We need to keep in mind the principle of proportionality. As new regulation accumulates, we know that it can come with costs as well as with benefits. Policymakers need to be watchful that, in attempting to limit externalities, they do not inadvertently create new externalities. The financial sector ultimately exists to serve the real economy. It is very likely that there are trade-offs between ensuring financial stability and imposing such a burden on the financial sector that it ceases to be able to do its job, namely to intermediate between surplus and deficit units in any economy in order to encourage long-term investment and growth. Thus we have to develop methods to judge the appropriateness of indicators and tools. Since many of the regulations have been applied over the last few years, that is, in a period of acute financial stress, I expect that in the coming years there will be a need to reassess those regulations and perhaps conduct some fine-tuning. Similar arguments apply to the national options and discretion in the new regulatory framework. 3. Closely related to the previous challenge is the degree to which regulatory developments should be front-loaded. The regulations themselves often have long phase-in periods such that new versions of the regulations are developed before the previous versions have been fully implemented. Supervisors have tended to compensate for the long phase-in periods by front-loading all prudential requirements, a situation that sometimes can be considered excessively harsh. Of course the long phase-in periods are often a reaction to the expected impact of the regulation on bank behaviour and, in particular, on the lending to the real economy. Some middle road has to be found. 4. A fourth challenge is the need to reduce reliance on models. Recently conducted stresstests at the EU level followed a “single-model-fits-all” methodology, which left very little room for idiosyncratic and specific national characteristics. Moreover, according to some analysts, there is a risk that stress tests are becoming less effective as a supervisory tool. Instead, they may increasingly be seen as having been undertaken in order to calm the markets. Ideally, stress tests should be implemented in benign times in accordance with an old wisdom attributed to John F. Kennedy, that “the time to repair the roof is when the sun is shining”. In crisis times, there is the risk that crucial inputs such as macroeconomic variables are under or over-estimated and that adverse scenarios become unrealistic – either too benign or too severe. In consequence, there are ambiguous outcomes that are difficult to interpret. Additionally, the potential pro-cyclical effects of stress tests should be explored. More appropriately, stress tests should not only place emphasis on solvency, but they should explore the impact of the assumed shock on bank liquidity, the implications of applying the bail-in tool, the funds needed to meet any demand on deposit guarantee funds, etc. We should focus on harmonizing processes, while models should be enriched with constrained judgement as is standard practice in macroeconomic forecasting. 5. Fifth, there is a need to widen the scope of regulation. A crucial challenge ahead is related to recent disintermediation and the development of “shadow” banking as an alternative means of financial intermediation. The CRR/CRDIV legal framework covers mainly the banking sector, yet financial activity and the financing of the euro-area economy have increasingly shifted to non-banks. The need for macroprudential regulation of certain financial activities becomes clear if we consider that banks and non-banks are closely tied through market-based intermediation activities. These include a broad array of services related to securitization transactions, securities financing transactions, repos, collateral management and derivatives. The consequences of poorly-monitored risks in this area are unknown and the risk of a new crisis could be lurking, while spill-over effects are difficult to assess. Moreover, the more that policymakers are effective in using macroprudential tools to constrain excessive credit growth in the banking sector, the more likely it becomes that there will be excessive adjustments in the non-bank sector through leakages. Fortunately, “shadow banking” is high on the agenda of the relevant fora and there is a clear need to extend the regulatory toolkit. At this point I would like to mention also the Capital Markets Union. The Capital Markets Union aims at connecting saving more effectively to investment by funding projects in a BIS central bankers’ speeches transparent and ordered way. In this way, it could contribute to growth by providing alternatives to traditional bank intermediation for savers and investors. In pursuit of growth, Europe needs a financial system that is able to meet the financing needs of all economic entities (businesses and households) at different stages in their development. 6. A sixth challenge is one that the SSM has identified as a top priority for its supervisory action plan for 2016 – namely, banks’ business model and profitability. In particular, low profitability in a low (even negative) interest rate landscape is a key challenge that banks need to address. Moreover, European banks have to address the problem of radical restructuring which has been delayed in many cases. This observation, accompanied by frequent top management changes, stands in contrast to strategy implementation in the US. It is even more complicated now with the deterioration in market sentiment and the weakerthan-expected economic outlook. Part of the challenge in addressing a new business model relates to the increasing stock of Non-Performing Exposures (NPEs) and their management. These exposures are acting as a significant impediment to banks’ reorienting their business model as well as, more broadly, to growth and financial stability, particularly in the countries of the European South. It should be highlighted, however, that we are in a good position to deal with this challenging issue as, thanks to the Comprehensive Assessment and the Asset Quality Review, we are aware of the full picture and important knowledge has been acquired for both monitoring and managing troubled assets. At the Bank of Greece, our research on the issue of NPLs indicates that they are overwhelmingly driven by recession. Thus, additional capital requirements cannot always provide a remedy. Indeed, in some cases such a remedy is likely to prove sub-optimal. Instead, at my Bank we have concluded that active private sector loan restructuring, the improvement in the insolvency framework, more efficient judicial systems and the involvement of loan servicers and private equity funds with experience in restructuring sectors of the economy are crucial components of an overall strategy of dealing with NPLs. 7. A seventh challenge, the role of the central bank as a lender of last resort to the banking system, needs to be addressed on the basis of principles that are consistent with our mandate of preserving financial stability. The principle developed by Thornton and Bagehot is well-known. Central banks should lend freely to solvent but illiquid banks against good collateral at a high rate of interest. How is this tried and tested principle to be made operational in today’s environment with much larger bank balance sheets and fewer liquid assets? In the past, government bonds were automatically considered good collateral. Today, central banks accept a wider pool of collateral. By what criteria should collateral be judged? We know that liquidity problems can become solvency problems if liquidity is denied or not provided generously enough. Thus the seemingly simple principle developed by Thornton and Bagehot can be open to various interpretations. There is a need, I think, to revisit the question. Mervyn King’s pawnbroker concept (2016) provides some new ideas on the issue. The ultimate aim in meeting these challenges is to make finance in Europe more resilient and to enhance and safeguard financial stability. The role of supervisors of the financial system is to enhance harmonization while respecting proportionality. They should safeguard a levelplaying field among all participants and protect depositors while striking the right balance between “strictness” and “fairness”. Their mandate is to set clear boundaries within which financial intermediation can prosper while financial stability is maintained. F. Concluding remarks The financial sector is facing challenges on many fronts. Banks are no exception. Jonathan Hill (2015, 2016) recently spoke about “a brave new world for banks” and the need of a revolution in which banks are reformed and restructured with respect to both their business models and governance. Supervisors will also have to adapt to this revolution. BIS central bankers’ speeches Despite the progress made in the past few years, with Banking Union as the flagship of the reform effort, more progress is needed as Economic and Monetary Union (EMU) remains incomplete. Divergence across the euro area is significant and the crisis of recent years has further highlighted existing shortcomings and important differences that need to be bridged. With respect to the financial system, we should seek an approach that promotes proportionality, transparency and competitiveness. Regulatory consistency, coherence and certainty are crucial to investors’ decision-making process. While financial stability is a necessary condition for prosperity in the euro area, it is not a sufficient condition. To this end, Europe should build upon other proposals outlined in the Five Presidents’ Report (2015). As argued in that report, EMU will not be complete until the appropriate mechanisms to share fiscal sovereignty are in place. Monetary unions have to develop mechanisms for risk sharing. Mark Carney (2015) recently highlighted the stylized fact that, whatever happens to asset prices, debt endures. Reducing debt levels is difficult and he notes that it is unlikely that high debt in one sector or region can be reduced without at least temporarily increasing it in another. Fiscal integration can help in this respect. Allow me to remind you of Keynes’s view about the Bretton Woods System – it needed, he believed, to provide mechanisms to promote symmetric adjustment within the fixed exchange rate area so that there would not be a bias towards deficient demand across the system. A more-fiscally-integrated monetary union would help address the problems of asymmetric adjustment and the deflationary bias of our monetary union. Financial stability is a prerequisite for sustainable growth; it is also a fact, however, that financial stability on a sustainable basis cannot be achieved without economic growth. Failure to maintain sustainable growth has been the biggest threat to the long-term stability of the EU since the onset of the 2007 crisis. An appropriate balance between managing risk and enabling investment needs to be struck. In this connection, it is crucial that the regulatory framework does not impede, but provides a suitable environment, for sustainable growth. Ladies and gentlemen, ultimately, a sustainable recovery will need to be underpinned by higher investment. Yet, in the euro area we presently face a significant investment gap. The financial system and its stability have a crucial role to play in closing this gap. Central bankers and supervisory authorities bear an enormous responsibility in shaping a system that can deliver prosperity to the citizens of Europe. We have made important progress in securing the financial stability needed to deliver such prosperity, but we have not yet completed the job. As the ancient Greek mathematician, Archimedes, once said, “Give me a place to stand and I will move the earth, but first I need a place to stand, a foundation.” The completion of our financial-stability edifice will provide the necessary foundation for the citizens of Europe. Thank you for attention. Sources: 1. Bank for International Settlements (2015) “Making supervisory stress tests more macroprudential: Considering liquidity and solvency interactions and systemic risk”, BCBS Working Papers No 29, https://www.bis.org/bcbs/publ/wp29.htm, November 2015. 2. Banque de France and Bank for International Settlements (2016) “Ultra-low interest rates & challenges for central banks”, Farewell Symposium for Christian Noyer, Paris, https://www.banque-france.fr/en/economics-statistics/research/seminars-andsymposiums/symposium-a-loccasion-du-depart-de-christian-noyer-banque-de-france-etbanque-des-reglements-internationaux.html, January 2016. 3. Basel Committee on Banking Supervision (2015), Finalising post-crisis reforms: an update, A report to G20 Leaders, http://www.bis.org/bcbs/publ/d344.pdf, November 2015. 4. Carney, M. (2015) “Fortune favours the bold”, Speech given to honour the memory of The Honourable J. M. Flaherty, P.C., Iveagh House, Dublin, BIS central bankers’ speeches http://www.bankofengland.co.uk/publications/Documents/speeches/2015/speech794.pdf, January 2015. 5. Cœuré, B. (2016) “Time for a new Lamfalussy moment”, Speech at the Professor Lamfalussy Commemorative Conference, Budapest, https://www.ecb.europa.eu/press/key/date/2016/html/sp160201.en.html, February 2016. 6. Cœuré, B. (2016) “From Challenges to Opportunities: Rebooting the European Financial Sector”, Süddeutsche Zeitung, Finance Day, Frankfurt, http://www.ecb.europa.eu/press/key/date/2016/html/sp160302.en.html, March 2016. 7. Constâncio, V. (2015) Interview with Börsen-Zeitung, “We need more integration in Europe”, https://www.ecb.europa.eu/press/inter/date/2015/html/sp151230.en.html, December 2015. 8. Draghi, M. (2015) Monetary policy and structural reforms in the euro area, Prometeia40, Bologna, https://www.ecb.europa.eu/press/key/date/2015/html/sp151214.en.html, December 2015. 9. Draghi, M. (2016) Introductory statement during the Hearing at the European Parliament’s Economic and Monetary Affairs Committee, Brussels, http://www.ecb.europa.eu/press/key/date/2016/html/sp160215.en.html, February 2016. 10. EBA (2015) Risk Assessment of European Banking System, https://eba.europa.eu/documents/10180/1315397/EBA+Risk+Assessment+Report.pdf, December 2015. 11. ECB Financial Stability Review (2015), https://www.ecb.europa.eu/pub/pdf/other/financialstabilityreview201511.en.pdf?24cc5509b94b 997f161b841fa57d5eca, November 2015. 12. Five Presidents’ Report sets out plan for strengthening Europe’s Economic and Monetary Union as of 1 July 2015 (2015), Press release, Brussels, http://europa.eu/rapid/pressrelease_IP-15–5240_en.htm, June 2015. 13. Hill, J. (2015) “For a financial sector that promotes investment”, London, http://europa.eu/rapid/press-release_SPEECH-15–5380_en.htm, July 2015. 14. Hill, J. (2015) Keynote speech at the Eurofi Financial Forum 2015, “Capital Markets Union: Vital for Growth”, Luxembourg, http://europa.eu/rapid/press-release_SPEECH-15– 5624_en.htm, September 2015. 15. Hill, J. (2015) Keynote speech at European Banking Federation, “A Brave New World for Banks”, 2015 Annual High Level Conference, Brussels, http://europa.eu/rapid/pressrelease_SPEECH-15–5624_en.htm, September 2015. 16. Hill, J. (2015) Introductory remarks at the launch of the Capital Markets Union Action Plan, Brussels, http://europa.eu/rapid/press-release_SPEECH-15–5749_en.htm, September 2015. 17. Hill, J. (2015) Keynote Speech at the 2015 ECMI Annual Conference, “Europe’s Capital Markets Union: What is the ‘long-term- view?”, Brussels, http://europa.eu/rapid/pressrelease_SPEECH-15–5870_en.htm, October 2015. 18. Hill, J. (2015) Speech at the European Central Bank Forum on Banking Supervision, “Bank Supervision: Europe in global context”, Frankfurt, http://europa.eu/rapid/pressrelease_SPEECH-15–5985_en.htm, November 2015. 19. Hill, J. (2015) Speech at the European Chamber of Commerce and ASIFMA, Hong Kong, http://europa.eu/rapid/press-release_SPEECH-15–6076_en.htm, November 2015. BIS central bankers’ speeches 20. Hill, J. (2015) Press Conference on the EDIS Proposal at the European Parliament, Strasbourg, http://europa.eu/rapid/press-release_SPEECH-15–6154_en.htm, November 2015. 21. Hill, J. (2015) Opening speech on the overhaul of prospectus rules for the Capital Markets Union, Brussels, http://europa.eu/rapid/press-release_SPEECH-15–6202_en.htm, November 2015. 22. Hill, J. (2015) Opening statement on Structured Dialogue – European Parliament: Economic & Monetary Affairs Committee, Brussels, http://europa.eu/rapid/pressrelease_SPEECH-15–6206_en.htm, November 2015. 23. Hill, J. (2015) Speech at the Euromoney Capital Markets Union Forum – Building a Capital Markets Union, Brussels, http://europa.eu/rapid/press-release_SPEECH-15– 6244_en.htm, December 2015. 24. Hill, J. (2015) Speech at the launch of the Commission’s Green Paper on Consumer Finance, Brussels, http://europa.eu/rapid/press-release_SPEECH-15–6293_en.htm, December 2015. 25. Hill, J. (2015) Speech at the CRR Review Conference, DG FISMA, “The Impact of the CRR and CRD IV on Bank Financing of the Economy”, Brussels, http://europa.eu/rapid/press-release_SPEECH-15–6310_en.htm, December 2015. 26. Hill, J. (2016) Keynote speech at the European Banking Authority’s 5th Anniversary Conference, London, http://europa.eu/rapid/press-release_SPEECH-16–250_en.htm, February 2016. 27. King, M. (2016) “The End of Alchemy: Money, Banking and the Future of the Global Economy” Little, Brown. 28. Praet, P. (2015) Interview with La Libre Belgique, “Europe must show it can bring prosperity”, https://www.ecb.europa.eu/press/inter/date/2015/html/sp151221.en.html, December 2015. 29. Vickers, J. (2016) “Equity buffers are in the public interest” Letter to the Editor, Financial Times, http://www.ft.com/intl/cms/s/0/abac0ed0-d57a-11e5-829b8564e7528e54.html#axzz42IFSkp3i, February 2016. BIS central bankers’ speeches

bank of greece

Speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the "Asset and Risk Management Seminar for Public Sector Investors", organized by the Lee Kuan Yew School of Public Policy of the National University of Singapore in association with OMFIF, Singapore, 29 March 2016.

John Iannis Mourmouras: Global risks in an era of negative interest rates Speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the “Asset and Risk Management Seminar for Public Sector Investors”, organized by the Lee Kuan Yew School of Public Policy of the National University of Singapore in association with OMFIF, Singapore, 29 March 2016. * * * Views expressed in this speech are personal views and do not necessarily reflect those of the Bank of Greece. Ladies and Gentlemen, It is a great pleasure for me to be here in Singapore and I would like to thank the Lee Kuan Yew School of Public Policy of the National University of Singapore and OMFIF for inviting me to speak to you today. My speech will be structured in two sections. The first section looks into today’s negative interest rate world, dissecting the factors that have brought us here and also exploring the theory behind, and the limits of, a negative interest rate policy and its potential hazards. Section 2 analyses other downside risks for global markets, placing particular emphasis on China and its huge private debt, on the sharp fall in oil prices, and on Brexit. 1. On negative rates 1.1 Living in a negative interest rate environment After nine years of low interest rates and large-scale market interventions, the consensus is that this unconventional monetary policy is not temporary, while in most advanced economies the prospect for normalisation seems rather remote. Indeed, most of continental Europe (the euro area, Denmark, Sweden and Switzerland) and, as of last January, also Japan have moved towards a much more accommodative monetary policy by introducing negative policy interest rates, and/or negative central bank deposit rates. Together with forward guidance and quantitative easing, such measures have created an unprecedented situation, in which nominal interest rates are negative in a number of European countries across a range of maturities in the benchmark yield curve, from overnight to even five- or tenyear maturities! Indeed, 88 of the 346 securities in the Bloomberg Eurozone Sovereign Bond Index have negative yields, thus nearly $2 trillion of debt issued by European governments is currently trading at negative yields. Illustrative examples are those of Switzerland and Germany, in which 18 out of 19 bond issues and 14 out of 18 bond issues respectively are priced with negative yields. As a result, almost one quarter of the world’s GDP is produced in countries with negative interest rates. A chronicle Sweden’s Riksbank was the first central bank to experiment with negative interest rate policy, or NIRP as it has been commonly known, briefly moving the rate it pays on commercial bank deposits to –0.25% in 2009. In February 2016, it brought its benchmark interest rate even further into negative territory, to a record low of –0.5% from –0.35%, not having met its 2% inflation target for four years. The second central bank to have taken similar actions by setting its deposit rate below zero was the Danmarks Nationalbank (DNB), which in early July 2012, cut its certificate of deposit rate from zero to –0.20%, while in early 2015, it pushed this rate to as low as –0.75%. The Swiss National Bank (SNB) announced the introduction of negative interest rates (–0.25%) on sight deposit account balances in December 2014 (effective 22 January 2015). In mid-January, with pressure on the Swiss franc unabated, the SNB discontinued the BIS central bankers’ speeches minimum exchange rate and lowered the interest rate on sight deposit accounts further to – 0.75%. Last but not least, in January 2016, the Bank of Japan (BoJ), which has seen the effects of its last stimulus package dissipate as a result of tax increases and slowing demand from China, cut the rate it offers on new deposits to –0.1%, from 0.1%, adopting a three-tier system for interest rates on excess reserves. Under the planned three-tier scheme, the average outstanding balances of excess reserves that each financial institution held in 2015 will still have the current interest rate of 0.1%. This could be deemed the BoJ’s way of showing its consideration for financial institutions’ cooperation towards monetary base expansion via Quantitative and Qualitative Monetary Easing (QQE). A zero interest rate will be applied to the statutory required reserves plus the reserve balance corresponding to the credit provided through the BoJ’s various loan support programs. In addition, as the excess reserves increase alongside the BoJ’s continued buying operations of Japanese Government Bonds (JGB), a certain ratio of these new reserves (“macro add-on”) will be subject to the zero rate. Thus, the penalty rate of –0.1% will only be applied to a fraction of the excess reserves, as the BoJ is concerned about minimising the damage to banks’ earnings. The following figures (Figure 1, Figure 2) clearly show the current key negative rates for the central banks I just mentioned and the very low levels of the 10-year government bond yields of Germany, Denmark, Switzerland, Sweden and Japan. Moreover, Japan is the second country to sell 10-year bonds at a negative yield, after Switzerland last April. Tables 1–3 also provide detailed information about the impact of negative rate regimes on liquidity and retail rates. 1.2 The ECB’s recent policy stance Turning to the euro area’s case, let me quickly remind you of the ECB’s monetary policy stance over the last nine years as a response to the worst financial crisis since the Great Depression, leading to negative interest rates and entering practically unchartered territory (Table 4). 1.3 Some theory behind negative policy interest rates In theory, the transmission of negative policy interest rates to economic activity should be close, but not similar, to a standard rate cut that leaves policy rates positive. Let me explain. One thing is a drop in interest rates from 2% to 1%, from 1% to zero, but another thing is a drop from zero to –0.5% to –1% and so on. Economists used to think that policy interest rates could not fall below zero. They talked about nominal interest rates having a “zero lower bound” (ZLB), but we know now that the lower bound to interest rates is not exactly zero, but below zero! I focus here on the transmission mechanism and on cash hoarding. A. Targeting interest rates to negative territory will reduce the costs to borrow for companies and households, driving demand for loans and incentivizing investment and consumer spending affecting the outlook for the economy, influencing confidence. These changes will in turn affect the investment and saving decisions of businesses and households, which should raise demand for domestically produced goods and services. By discouraging capital inflows, there will be downward pressure on the exchange rate, which should support external demand. Here are the transmission channels related to negative interest rates. B. Holding cash is costly for people as it involves storage, insurance, handling and transportation fees (what macroeconomists call “shoe-leather” costs). In fact, the cost of holding cash is what defines the effective lower bound on policy interest rates (i.e. the real constraint on the ability of central banks to set negative interest rates). Central banks can, in effect, safely reduce their policy rates in the amount of storage and insurance costs of money holdings without triggering widespread switching to cash in the economy. But once policy rates fall too far into the negative zone, i.e. below the costs of holding cash, people will start BIS central bankers’ speeches to hoard money instead of holding the negative yielding deposits. At this point, cash will be held by people merely as a store of value, indistinguishable from bonds, banks will be left with less deposits and the economy with fewer loans. 1.4 Potential risks from negative rates policy There are, however, a number of concerns associated with the use of negative interest rates, each of which is considered in turn. I. Erosion of bank profitability: As negative deposit rates impose a cost on banks with excess reserves, there is a higher probability that the banks’ net interest margins (the gap between commercial banks’ lending and deposit rates) will shrink, since banks may be unwilling to pass negative deposit rates onto their customers to avoid an erosion of their customer base and subsequent reduced profitability. The extent of the decline in profitability will depend on the degree to which banks’ funding costs also fall. The central bank could reduce concerns about bank profitability by raising the threshold at which the negative central bank deposit rate applies, as the Bank of Japan recently introduced a three-tier system, a different way from the ECB’s negative interest rate policy. Doing so, however, it could reduce the transmission of negative deposit rates to market rates, namely the power of negative interest rate policy transmission through the credit and portfolio rebalancing channel. Moreover, compressed long-term interest rates also reduce profit margins on the standard banking maturity transformation of short-term borrowing and lending at a somewhat longer term. So far, lenders have been reluctant to pass on the costs of negative rates to customers and have taken almost all of the burden. But, as recent research by the BIS shows, the impact on profitability becomes more drastic over time, as short-term benefits such as lower rates of loan defaults diminish. II. Negative effects on financial markets: Money market funds make conservative investments in cash-equivalent assets, such as highly-rated short-term corporate or government debt, to provide liquidity to investors and help them preserve capital by paying a modest positive return. While these funds aim to avoid reductions in net asset values, this objective may not be attainable if rates in the market are negative for a considerable period of time, prompting large outflows and closures and reducing liquidity in a key segment of the financial system. For insurance and pension funds, a low-for-long interest rate environment poses challenges, which may even be exacerbated if rates enter into negative territory. They may find themselves unable to meet fixed long-term obligations. Life insurance companies will also be less able to meet guaranteed returns. III. Excessive risk-taking: Increased financial stability risks, stemming from search for yield and higher leverage. Keeping interest rates at negative levels for a long time increases borrowing attractiveness in key sectors of the economy and the risk of bubbles. This can not only lead to an inefficient allocation of capital, but leave certain investors with more risk than they appreciate, as investors in search of higher yields necessarily turn to excessive risky assets. IV. Disincentive for government debt reduction: With interest rates at negative levels, governments are under no pressure to reduce their debt. Negative rates actually encourage them to borrow more. And if government borrowing becomes a sort of free lunch, there is a clear disincentive for fiscal discipline. Ultra-low interest rates flatter the debt service ratio, painting a misleading picture of debt sustainability. For instance, persistent negative rates may potentially act as an “anaesthetic” to governments of eurozone countries, especially in the europeriphery, meaning that they will proceed only slowly with fiscal and structural reforms, given the fiscal space that they gain from lower debt servicing costs.. V. Operational risks: The issuance of interest-bearing securities at negative yields may face design challenges. Areas that are commonly mentioned as sources of concern are interestbearing securities, particularly floating-rate notes (renegotiating, collecting interest, use as collateral) in the context of negative interest rates. More generally, if negative rates were to BIS central bankers’ speeches prevail for long, they may entail the need to redesign debt securities, certain operations of financial institutions, the recalculation of payment of interest among financial agents, and other operational innovations, the costs of which may offset negative rate benefits. For instance, most option-pricing models either do not work or do not work well with negative interest rates, particularly entailing risks for the compatibility of trading systems and other market infrastructure. In brief, persistent negative rates may change expectations and create distortions (for instance, in terms of saving habits and, in that sense, they may be a topic for behavioural economists to look at). It is still unknown what their long-term effects will be (e.g. on the erosion of bank profitability). In contrast, QE has been tested successfully in the US and the UK and I would also like to remind you that monetary policy– conventional or unconventional – entails considerable time lags. It takes time to see the results at full length. However, there is definitely something positive about negative interest rates: it is a strong reminder that the time has come for other policy tools, including fiscal and structural ones. 2. Other global risks 2.1 China Let me now turn to other global risks, starting with a country in this region of the world: China. Three are the major risks concerning China, stemming from: a) its lower growth prospects, b) significant capital outflows, and c) rising private debt. China is beginning to rebalance and consolidate its economy. Services now account for 51% of GDP and consumption’s GDP share is rising, while the current account surplus dropped to 2.7% from 10% in 2007. Even if you accept the lower expected growth rate for China around 6% in 2016, trade flows to the rest of the world are not significant and this is in contrast with financial flows. Only recently I had been invited to give a personal verdict at an event in London and rank the above three downside risks facing China, namely lower growth prospects, capital outflows (almost US$160 billion exited the economy in December 2015, reaching an aggregate amount of almost US$1 trillion in 2015, see above Figure 6) and private debt (which accounts for about 210% of China’s GDP). I gave the following ranking from bottom to top. At the bottom, I would place capital outflows, since the instrument of capital controls is always available and these days indeed with the blessing of the IMF. I would then place in second position the rise in private debt, since only less than 1% of it is held by foreigners, and it can be easily turned into public debt, if it comes to the worst, and I mean by that, all these stateowned zombie companies which may lose their state guarantees, but whose debt may well be acquired by the government, thus increasing China’s public debt ratio, which is now low at 60% of its GDP. Leaving at the top, as the biggest risk, the rebalancing of the economy which, however, will take years and, in my view, markets will have to learn to live with this. 2.2 Oil prices Since June 2014, oil prices have declined by more than 70%, after having stabilised above US$100 per barrel for four years and, more generally, after rising almost continuously since early 2000. By January 2016, oil prices traded around US$30 per barrel, a level not seen in the past 12 years (see Figure 7 below). In the context of weak global growth and zero or negative rate monetary policies, lower oil prices are both a fiscal and monetary policy challenge for major economies. While the positive impact on oil importer countries, and especially households and corporates, should materialize in the medium term, the negative impact on oil exporter countries, particularly on fiscal balances and the exchange rates, is more immediate and could be amplified by the energy export dependence for respective countries. BIS central bankers’ speeches In a monetary policy context, the lower inflation observed in the euro area, for example, driven in part by the oil price decline, could de-anchor inflation expectations from the ECB’s target. Furthermore, in the US, the pressure on oil prices and subsequent pass-through to lower inflation levels could impact the economy in such a way as to delay the pace of normalisation of the Federal Reserve’s monetary policy. It should also be noted that (like in 1985) today’s low oil price is due to a combination of weak global demand and oversupply from oil-producer countries and hence, it is suggested, prices could stay stubbornly low for quite some time. Referendum on Brexit The UK has entered the final pre-election period for the referendum on Britain’s possible exit from the EU (Brexit), which will take place on 23 June 2016, the outcome of which is very uncertain at this stage. I will say a few more things on the importance of the British referendum for the rest of the EU tomorrow morning in my lecture on Europe’s political economy at the event hosted by the Singaporean-German Chamber of Industry and Commerce. Today, I will limit myself to only one comment. It seems that the weak pound is the only “certainty” across the spectrum of financial markets! Since the beginning of December, the British pound has lost over 7% and 5% of its value against the euro and the US dollar respectively (see Figure 8), with a portion of this decline in spot price being cited as a “Brexit” premium by market participants. However, in implying any direct causality between Brexit and the pound’s depreciation, we should remind ourselves that the recent pound depreciation has occurred in parallel with a reassessment of the likely rate path of the Bank of England, with expectations for the Bank of England to follow the Fed in raising interest rates, having decreased significantly over the same period with the market re-evaluating of the Bank of England’s potential interest rate path. Thank you very much for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches

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Text of the First HBA-HAA Lecture by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at Cass Business School, London, 23 March 2016.

John Iannis Mourmouras: Recent monetary and economic developments in Greece Text of the First HBA-HAA Lecture by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at Cass Business School, London, 23 March 2016. * * * Disclaimer: Views expressed in this speech are personal views and do not necessarily reflect those of the Bank of Greece. Ladies and Gentlemen, It is a great pleasure to be here. I would like to thank both associations, the Hellenic Academics Association and the Hellenic Bankers’ Association, for inviting me to speak to you today at the familiar premises of Cass Business School. Although I was in London only last January for a speech on European monetary policy at the Houses of Parliament, the newlyelected Chairman of HBA, Antonis Ntatzopoulos, managed to persuade me to come again so soon. Thank you also, Antoni, for your kind welcoming address. I am delighted to see in the audience many of my former students from my time as University Professor here in London, now as members of London’s banking and academic community. My lecture will be structured in two parts. The first part investigates the ECB’s recent monetary decisions and their impact on inflation dynamics, also exploring the benefits and limits of such policies. In the second part, I will offer some reflections on the current economic situation in Greece, its outlook and short- to medium-term prospects. A. The ECB’s unconventional monetary policy 1. The ECB measures announced on 10 March 2016 A brief look, now, at the ECB measures announced on 10 March 2016. Ten days ago, the ECB Governing Council decided in favour of a more accommodative monetary policy as follows:  The interest rate on the main refinancing operations of the Eurosystem has been cut by 5 basis points to 0.00%, the interest rate on the marginal lending facility has been lowered by 5 basis points to 0.25%, and the interest rate on the deposit facility decreased by 10 basis points to –0.40%.  The monthly purchases under the asset purchase programme will be expanded to €80 billion per month starting in April, from €60 billion per month currently, taking the total size of the asset purchase programme to €1,740 billion by March 2017.  Investment grade euro-denominated bonds issued by non-bank corporations established in the euro area have been included in the list of assets that are eligible for regular purchases (as of 11.03.2016, the ECB has purchased under the APP programme: €801.2 billion: PSPP Holdings: €620.5 billion, ABSPP Holdings: €19.1 billion, CBPP3: €161.6 billion. Breakdown: €46 billion on the primary and €115.6 billion on the secondary market.)  A new series of four targeted longer-term refinancing operations (TLTRO II), each with a maturity of four years, will be launched in June 2016. My short comment on the above measures is that they are a combination of quantitative easing with credit easing, namely a widening of QE as seen from the higher amount of monthly purchases, and credit easing as evident in the eligibility of corporate debt for ECB purchases, plus of course the second round of TLTROs, meaning literally that the central bank pays commercial banks to provide loans to businesses. BIS central bankers’ speeches Why did ECB President Mario Draghi decide to proceed even further with the above expansionary monetary policy, eleven months after the initiation of the program? 2. The current economic outlook of the euro area The answer to the above question lies in the euro area economic outlook.  Core inflation fell to 0.8% in February (flash estimate), down from 1.0% in January. According to ECB forecasts in March 2016, inflation in the euro area is now projected to be at a very low level (0.1%) on an annual average basis in 2016, before rebounding to 1.3% in 2017 and 1.6% in 2018.  Inflation expectations, as measured by the five-year inflation-linked swap rate, declined to a historic low of 1.37%, compared with 1.7% just prior to the start of the PSPP.  GDP growth has been revised downwards by 0.4 percentage point, to 1.4% for 2016; for 2017 and 2018, real GDP is expected to grow by 1.7% (revised downwards by 0.1 percentage point) and 1.8%, respectively. In short, it seems that up to this point the QE programme had a rather minimal impact on inflation or inflation expectations and growth in the eurozone. From my point of view, three main factors have contributed to the inability of inflation to increase. First, supply-side factors have been deflationary, as reflected in a decline in the price of oil (as measured in US dollars) of about 25% since early March. Evidence of a sustained rise in underlying inflation has yet to be seen, while falling industrial producer prices also signal weak inflation dynamics. Second, demand-side factors, as reflected in the persistence of the euro-area’s negative output gap, continue to exert downward pressures on prices. Third, under the Phillips curve relationship, inflation expectations are a main determinant of the present inflation. Consequently, to generate increases in present inflation, it is necessary to increase inflation expectations. However, inflation expectations have been declining since the initiation of the PSPP. 3. Some positive evidence from QE It is true that there is some encouraging evidence mainly from the M3 growth and the banking sector, such as the growth rate of loans.  M3 growth accelerated to 5.0% in January, compared with a 4.7% rise in December (M1 growth was 10.5% in January, compared with 10.8% in December).  The annual growth rate of loans to non-financial corporations increased to 0.6% in January, compared with 0.1% in December.  The verdict so far is that QE has reduced fragmentation in the eurozone financial markets. More specifically, bank lending rates decreased, with significant declines recorded in the nominal cost of bank borrowing for non-financial corporations (NFCs) and households (by 79 and 65 basis points respectively, see Figures 1 and 2). BIS central bankers’ speeches Figure 1 Euro area lending to the private sector Figure 2 Composite indicators of the nominal cost of bank borrowing for households (for house purchase) and non-financial corporations in the euro area Source: European Central Bank.  Cross-country heterogeneity in bank lending rates has declined further. For example, since last summer the average cost of borrowing for euro area nonfinancial corporations has fallen by around 70 basis points, and by 90 basis points and 110 basis points for NFCs in Spain and Italy, respectively.  Since the start of the QE programme in March the euro depreciated against the dollar by 2%, while since the beginning of the year it has depreciated by about 10%. BIS central bankers’ speeches  The purchase programmes have also greatly contributed to a significant decline in sovereign yields, a compression of intra-euro area spreads and a flattening of yield curves across all markets that were only partially offset by the bond market correction that began in early May. More precisely, Germany’s benchmark 10-year Bund is trading at 0.26%, while currently more than eleven two-year government bonds of euro area Member States are trading with negative returns (compared with 8% for Greece). B. Recent economic developments in Greece Let me now move on to Greece. After six years of austerity and reforms, the country is again at a crossroads and under heightened uncertainty as a result of the delay in the completion of the First Review of the 3rd MoU, the setbacks in the implementation of structural reforms and privatisations, and finally due to the mounting migrant crisis. B1. The state of the economy Coming now to the prospects of the Greek economy, I will try to make three quite important remarks, but before that I will give you a few figures on the Greek economy. Economic activity Although European Commission initial forecasts suggested that Greece’s economic activity would be severely affected (-4% in 2015), the final data suggest that recession in 2015 was milder than initially expected, i.e. –0.2% for the whole year. Figure 3 Average annual GDP growth rates and main components Due to the carry-over effect from the second half of last year, the Bank of Greece’s estimate for the growth rate in Q1 and Q2 this year is negative, turning to positive in the second half of the year. Money, inflation and credit  Inflation has been negative over the past three years (2013–2015) and stood at –1.1% on average in 2015 (see Figure 4). BIS central bankers’ speeches Figure 4 Inflation (percentages) Sources: ELSTAT and Bank of Greece calculations.  The completion of bank recapitalisation in December 2015 is a step towards the restoration of confidence in the Greek banking system that will facilitate the gradual recovery of bank deposits. Figure 5 Monthly flows of deposits from non-financial corporations and households (in billion euro) Source: Bank of Greece. BIS central bankers’ speeches  In January 2016, the rate of contraction of bank credit to non-financial corporations, which has been deteriorating since July 2015, speeded up to an annual rate of –1.6%. The respective rate of bank credit to households decelerated slightly to –3.0% (see Figures 6 and 7). Figure 6 Bank credit to households (in billion euro; annual percentage changes) Source: Bank of Greece. Figure 7 Bank credit to non-financial corporations (in billion euro; annual percentage changes) Source: Bank of Greece. Disinvestment: the long-term risk The most important upside risk to the growth outlook is related to the generalised disinvestment situation that Greece faces for a prolonged period. For example, in 2007, investment was 27% of GDP, whereas last year it was 12% of GDP, the lowest level since 1960, and, taking into account depreciation, we have effectively had negative net investment BIS central bankers’ speeches for all the previous years. No physical capital accumulation, the debasement of human capital due to the brain drain and lack of spending on skills, all these point to hysteresis effects on long-term growth in Greece. Figure 8 Investment growth Source: ELSTAT. Figure 9 Investment in the EU-28, US and Greece (as a percentage of GDP) U.S. EU-28 Greec Source: AMECO 2014. For 2016, European Commission forecasts that disinvestment in Greece will continue, albeit at a slower rate (-3.7%), before increasing in 2017, as shown in the following Table (Table 1). BIS central bankers’ speeches Table 1 EU Economic Forecasts (winter 2016) Source: European Commission. Figure 10 Greece’s GDP components BIS central bankers’ speeches Figure 11 Investment by asset (as a percentage of GDP) Figure 12 Greece’s disinvestment evolution (in million euro) Source: ELSTAT. BIS central bankers’ speeches B2. Three remarks I will now turn to my three remarks. First remark: Since 2010, I have been writing and speaking about this. Out of all the problems that the Greek economy is faced with, i.e. unemployment, recession, public debt, private debt, nonperforming loans, disinflation, etc., I would definitely place, in terms of importance, recession/lack of growth at the top, and not public debt, especially after the PSI, which some view as the number 1 problem and even go as far as to ask for a nominal haircut in public debt, something which is ruled out by the European treaties. A return to normality will only be achieved through growth that will create jobs, bring social cohesion and increase wages and salaries across the Greek population. All this is achieved by means of steady positive growth rates, which will in turn improve public debt dynamics and sustainability, but will also reduce unemployment, effectively tackle non-performing loans and private debt, and so on. If I may slightly rephrase US President Bill Clinton: “It’s the growth, stupid!” I have one further comment regarding private debt now, which exceeded €200 billion, and now accounts for 113% of Greece’s GDP. The breakdown is as follows: NPLs: €100 billion, tax arrears: €80 billion, overdue insurance contributions: €20 billion. Given its short- to medium-term effect on private consumption (which determines GDP growth by 75%), doubts arise about the growth prospects of the Greek economy in the next five to ten years. Given the disinvestment issue, which I discussed earlier, that is why I have been writing since 2010 that the country badly needs an investment shock. Second remark: Nobody, I am sure, in this room, but also outside of it, would wish for the unpleasant experience of last year’s backtracking to be repeated this year, i.e. the deposit outflow which destabilised the banking system and resulted in the introduction of capital controls, a bank holiday and bank recapitalization – only a year following the 2014 recapitalisation – and, of course, the recession in 2015 and 2016, from initially positive expectations for both years. The cost of last year’s backtracking was elevated, as we all understand, but what I would like to point out here today is that the cost of any further delays this year would be equally high. If the negotiations of the first review of the 3rd Memorandum are drawn out over time, then the risks of a destabilisation of the economy and its financing conditions would be heightened. Let me be more precise: I should mention that the cost of this delay is reflected in the deferment of voting major bills at the Hellenic Parliament which are at a stalemate for some time now, although they concern critical issues relating to the country’s growth, such as the development law, the new framework on public procurements, the modernisation of public construction works, scientific research and development. Without a timely review, all of the above bills are in the air. The price to pay for our economy will be heavy. I hope that the benefits of a timely review are clear to everyone. And for one more reason: the credibility deficit vis-à-vis both the markets and our creditors as a result of last year’s delays (2 elections in just 9 months, a referendum, the country coming to the verge of Grexit) which led to the signing of the 3rd Memorandum, can only be overcome, at this point, with deeds and tangible proof that agreements are kept in Greece: i.e. that fiscal adjustment measures and reforms are implemented, and privatisations are accelerated. Pacta sunt servanda, as the Latins say. Third remark: A question I am often asked in Athens, as you might suspect, is whether I am optimistic about the country’s economic prospects. Mark Twain said something along the lines: The man who is a pessimist before 50 knows too much; he is wise man; if he is an optimist after 50, he simply needs to visit a GP! So my answer to those who asked me whether I am optimistic is that if there is a timely conclusion of the first review, I see the glass half-full for BIS central bankers’ speeches the following reasons: in the short-term, immediately, confidence will be drastically restored, thus accelerating a return of deposits to the Greek banking system and this will, in turn, lead to a further relaxing of capital controls and, once again immediately, lead to Greek government bonds being readmitted as eligible collateral for Eurosystem operations, under the so-called ‘waiver’. Such a development will allow the provision of much cheaper financing for Greek banks by the ECB, hence boosting liquidity provided to the real sector of the economy. Furthermore, the successful conclusion of the First Review will be immediately followed by a start in negotiations with our creditors for public debt relief, and improvements in credit ratings for Greek government bonds and, in the end, our participation in the quantitative easing programme of the ECB, something which will become a catalyst for the drastic reduction in Greece’s borrowing costs, a return to international capital markets and finally a return to European normality for my country. Thank you very much for your attention. BIS central bankers’ speeches

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Intervention by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at a Panel Discussion with former Fed Chairman Paul Volcker on the euro crisis, organized by OMFIF, Washington DC, 18 April 2016.

John Iannis Mourmouras: The EU crisis – EMU, Brexit, the migrant crisis, and Greece Intervention by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at a Panel Discussion with former Fed Chairman Paul Volcker on the euro crisis, organized by OMFIF, Washington DC, 18 April 2016. * * * Views expressed here are personal views and do not necessarily reflect those of the Bank of Greece. Let me begin by saying how delighted and honoured I am to participate in such a gathering of distinguished central bankers and policymakers here at the Metropolitan Club in Washington DC, most pre-eminently among them, former Chairman of the Federal Reserve Paul Volcker, a giant in the world of central banking and public affairs over the last forty years. For this, I would like to thank David Marsh and the OMFIF Advisory Board for inviting me. A. On Europe 1. On the incomplete architecture of EMU I will restrict my comments today to the incomplete architecture of EMU, Brexit and the migrant crisis and I will refrain from remarks on current European monetary policy since the ECB’s quiet period – as I was told last week – applies to deputy governors too; and coming Thursday (21/4/2016) the ECB Governing Council meets in Frankfurt. Partly as a result of the crisis in the euro area and Europe’s relative global decline, the EU is currently finding it difficult to manage events even in its own neighbourhood (see the unfolding migrant crisis). The fog of uncertainty has become thicker on the other side of the little pond, also due to the migrant crisis and the British referendum. The time has now come for the European Union to take bold action. A plethora of policies and reports have been put forward to propose solutions to the euro crisis, from the Europe 2020 Strategy, the European Semester, the Six-Pack, the recently established “Structural Reform Support Service” specialised in technical assistance for Member States to assist them with implementing growth-enhancing administrative and structural reforms, the introduction of national Competitiveness Boards or even an advisory European Fiscal Board and, last but not least, the Five Presidents’ Report for completing Europe’s Economic and Monetary Union. Of course, these are all very nice acronyms and welcome ideas and proposals, but have yet to be tested in practice. All these initiatives reflect a shift towards more burden-sharing and this is undoubtedly very important and welcome news to me as a pro-European. The question of course remains how quickly Europe will complete its Economic and Monetary Union (EMU) – before it is really too late – and move, for instance, towards a common Deposit Guarantee Scheme, some form of sovereign debt mutualisation, or indeed put in place a Capital Markets Union. I would also like to see the ESM mutated to a truly European Monetary Fund in charge, among other things, of future debt restructurings in eurozone member countries. There is not much time left. The time has come for change, and I mean the full completion of EMU. “Nothing endures but change” to quote Heraclitus, a 4th century BC Greek philosopher. As long as Europe adapts, it will survive. There is an old saying in Brussels that the European project only advances in times of crisis, and Europe’s leaders have a tried-and-tested method of coming up with policy fixes only when asked to cope with emergency situations. I am pretty confident that this generalised crisis will not lead to Europe’s unbundling, but will inspire it to introduce long-term changes to the foundations of the European integration project. BIS central bankers’ speeches 2. On Brexit and the migrant crisis A very brief comment on the migrant crisis and Brexit – the two hot topics in Europe today – that both have been addressed separately by panellists earlier. In my intervention I will explain how these two issues could be linked to create a real nightmare scenario. The migrant crisis has triggered a debate about security that may reshape the European Union. Following last month’s terrorist attacks at Brussels airport which have hit the main arteries of the capital of the European Union (its airport and metro system), we see that the security threat is real if the integration of refugees and immigrants in the Western societies which host them is not successful. There are now mounting concerns and growing scepticism in host countries about the global terrorism threat (human shields) and how far this could go. For instance, an unexpected event might tilt the vote in the British referendum towards the ‘Leave’ camp, turning it into a single-issue referendum (that of security) and possibly leading to Brexit. Two shocks of this scale would be unbearable indeed. Coming at a time like this, Brexit could have disastrous effects for the European construction. B. On Greece 1. On what went wrong in Greece Taking over from Athanasios Orphanides and his earlier remarks on what went wrong in Greece, I would like to say a few words on that myself. The dramatic rise in the unemployment ratio, which almost tripled from 9% in 2008 to 26% today, due to the free-fall in output (more than 25% loss of GDP, comparable only to the US Great Depression of 1929), the dramatic fall in living standards and valuations of assets (real and financial), the accumulation of another mountain of debt (private debt of €200 billion in just 5 years), the ongoing exclusion from the international capital markets and hence the need for a 3rd Memorandum – currently under way – makes it evident even to the layman that adjustment programmes in the case of Greece have failed, at least so far (Ireland, Cyprus, Portugal all needed only one MoU and recently successfully exited from it). There are several reasons for that and I am quite certain that dozens of PhD dissertations will be written in future about the causes of Greece’s Great Recession. I name a few: the initialpoint argument (a huge deficit that required a bold adjustment effort); errors in the design of the programme that include the mix of adjustment measures (a greater reliance on tax increases than public spending cuts), the value of fiscal multipliers, etc.; the slow pace of implementation of structural reforms (due to a lack of programme ownership on behalf of Greek authorities, and this is our European lenders’ view); the fact that Greece is a relatively closed economy and, hence, internal devaluation may contribute negatively, in net terms, to economic activity; and finally, the fact that debt restructuring in 2012 should have occurred much sooner, i.e. at the beginning of the first MoU in 2010 (the IMF view), etc. On top of the above five reasons which are more or less commonly accepted, I would add a couple of extra – rather technical and more subtle – reasons on what went wrong in Greece. Firstly, as we know, fiscal consolidation took place through the targeting of a nominal variable, that of the overall fiscal deficit which is cyclical. Taking permanent austerity measures to reduce the cyclical deficit only deepens and prolongs a recession, it results in excessive austerity and over-taxation which is self-defeating (it raises less government revenues). Instead, the structural deficit should be the appropriate target variable, and the cyclical deficit would correct itself through the economy’s automatic fiscal stabilisers, provided that growthenhancing measures supplement fiscal consolidation {this is my FT article, January 2012}. Secondly, there is a certain misperception in the MoUs about how reforms would work in the economy. I identify three grey areas here: Firstly, reforms take time to unlock their growth potential and their results are also country-specific. A recent study by the OECD indicates that the above time period may extend to five years or more. Secondly, structural reforms work better and quicker when there is investment to take advantage of them and, more BIS central bankers’ speeches generally, demand in the economy, because the more the recession lingers on, the harder it is to get positive results by implementing structural reforms {see my WSJ article, March 2012}. An illustrative example from the recent Greek experience is the liberalisation in the freight transport industry in 2012. Despite the opening of the market which resulted in reduced freight transport charges, the industry did not grow as analysts had expected because of the recession and lack of demand in the economy. By contrast, the removal of cabotage restrictions in 2013 had a particularly positive impact on cruise-ship tourism in following years, because of strong foreign demand in this particular sector. Last but not least, as regards the sequencing of reforms, the appropriate strategy is: product market reforms come first and are then followed by labour market reforms (whereas in the case of Greek MoUs the exact opposite took place). {In my latest two-volume book “The Double Sovereign Debt – Banking Crisis”, 2015) I explain all the above in more detail.} 2. On how to revive the Greek economy In response to Paul Volcker’s earlier remark that Greece is a relatively small country and it wouldn’t be difficult to achieve a turnaround of its economy, I would like to say a few words. Indeed, Greece is a small country, only accounting for 1.76% of the euro area’s GDP [and just 0.38% of the world’s GDP]. My own personal view on how to revive the Greek economy from its current stalemate is the following: Firstly, it is imperative to stabilise expectations as soon as possible. Given the directionless economic governance of last year and the resultant huge cost of the economy’s backtracking (capital controls, etc.), this could be achieved through the timely completion of the first review of the 3rd MoU, if possible yesterday! Then this could pave the way for the following benign steps, a sort of roadmap: • Reinstatement of the waiver: that will release at least €5 billion from the current ELA programme (at 1.5% interest rate) to be channelled towards standard monetary policy operations (MRO) with zero interest charge, contributing to Greek banks’ profitability. • Debt relief negotiations from either of the two options on the table: the ESM plan or the IMF plan. • The country then will be getting the “certificate” of the DSA, which will open the door to credit rating upgrades for Greek sovereign bonds, bringing closer the date of Greece’s inclusion into the ECB’s QE programme which will help towards a lowering of spreads for GGBs and the gradual return to international capital markets. Secondly, an equal focus should be given to short- and medium-term growth prospects of the economy because there is evidence that by now recession in Greece has the characteristics of hysteresis, namely a persistent and long-lasting recession (and this is the long-run downside risk for the Greek economy). Let me explain. The initial, non-permanent (cyclical) effects of the recession have shifted into permanent, structural problems (lack of new physical capital due to disinvestment, depreciation of human capital due to both the skills deterioration of the longterm unemployed and the brain drain). To give you only one figure: in 2007, investment was 27% of GDP, whereas last year it was 12% of GDP, the lowest level since 1960. So very few would disagree that right now the country needs an investment shock within a new growth paradigm centred around the expansion of its export-oriented output base, aiming at internationally tradable goods and services with high value added. BIS central bankers’ speeches

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Keynote speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the 33rd International Financial Law Conference "Financial stability and growth: the role of central banks and the pre-requisites for sustainable growth in Europe", co-presented by the IBA Banking Law Committee and IBA Securities Law Committee and supported by the IBA European Regional Forum, Athens, 20 May 2016.

Yannis Stournaras: Financial stability and growth – the role of central banks and the pre-requisites for sustainable growth in Europe Keynote speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the 33rd International Financial Law Conference “Financial stability and growth: the role of central banks and the pre-requisites for sustainable growth in Europe”, co-presented by the IBA Banking Law Committee and IBA Securities Law Committee and supported by the IBA European Regional Forum, Athens, 20 May 2016. * * * Ladies and gentlemen, It is a great pleasure to be with you today and to have the opportunity to share with you some thoughts on financial stability in Europe. Systemic financial stability is a critical condition for achieving our common goals of prosperity and sustainable growth. At the outbreak of the international financial crisis in 2008, central banks and regulatory mechanisms lacked a well-tried toolbox for containing systemic instability and for preventing its build-up. With the measures taken and mechanisms established in subsequent years, that picture has changed substantially, as market participants, regulators, supervisors, macroprudential authorities and others quickly dealt with the challenges. Not only have we seen the transformation of banking supervision through the creation of the European Banking Union with its three pillars, the Single Supervisory Mechanism, the Single Resolution Mechanism and the still-to-be-implemented common deposit guarantee scheme, but we have also seen increased recognition of the importance of systemic stability and the role that macro-prudential policies can play in fostering it. Traditional banking supervision is more focused on individual institutions and the prevention or management of isolated instances of bank failures. Macro-prudential regulation, by contrast, focuses on the system as a whole and largely seeks to prevent systemic instability and to limit the consequence of systemic distress for the macro economy. But if financial stability is crucial for growth, the crisis has also taught us that growth is crucial for financial stability. Sluggish growth in the euro area, in spite of unprecedented monetary policy loosening, has weakened European banks, not least through the rise in NPLs, thus hampering their ability to finance the real economy. In order to explore these ideas, I initially examine this new role for central banks and the tools that have been – indeed, are still being – developed in an attempt to strengthen the resilience of the financial system. Developments in the EU regulatory framework in this area are discussed. I then outline some of the challenges ahead and, finally, provide some thoughts on euro area growth. A. Central banks and macro-prudential policy The challenges facing EU financial sectors in recent years have significantly increased the responsibilities of central banks in the area of crisis prevention. Mandates have been amended to explicitly refer to financial stability as a core central bank task. Thus central banks are charged with limiting system-wide distress and, ultimately, avoiding its negative consequences for the real economy. In the past, it was not thought necessary to separate monetary policy from the task of providing financial stability. It was thought that price stability in the market for goods and services would be sufficient to ensure financial stability in asset markets. Experience has dispelled such beliefs and has shown that the business cycle and the financial cycle are not necessarily synchronized; long periods of disconnect between the two cycles can BIS central bankers’ speeches materialize. In particular, the financial cycle tends to have larger amplitude and lower frequency than the normal business cycle. Macro-prudential policy bridges the gap between the traditional micro-prudential supervision of individual banks and monetary policy. Its objectives are, first, to enhance the resilience of financial institutions and the entire financial system, and, second, to smooth the financial cycle. In this regard, macro-prudential policy allows monetary policy to focus on maintaining price stability, while micro-prudential supervision focuses on individual institutions. In this way, macro-prudential policy enhances the institutional separation that is one of the principles of the architecture of the euro area. Whilst separation is important, the usefulness of coordinating policies should not be forgotten – whether that be coordination of specific policies across different countries (as happened in the wake of the failure of Lehman Brothers with the simultaneous cuts in policy rates) or coordination of policies within one jurisdiction. Respect for the independence of the various authorities involved in securing financial stability should not imply separation and a lack of coordination. B. The macro-prudential toolbox and developments in the EU financial regulatory framework If macro-prudential policy is to effectively curb the financial cycle, it is essential to have tools that deal with the credit-real estate (or whatever other asset) relationship. There are two ways to deal with this relationship. The first is by imposing restrictions on credit institutions – for example, through capital-based measures. The second is by limiting the degree to which households and non-financial corporations take on leverage. With regard to credit institutions, the Capital Requirements Regulation (CRR) and Directive (CRD IV) play a prominent role in setting the prudential standards in the EU. Implementation is ongoing and expected to be completed by 2019. From January 2016, the countercyclical capital buffer (CCB), the systemic risk buffer (SRB) and the other systemically important institutions (OSII) buffer, three important macro-prudential tools, have been operational. However, given the need to diversify the available tools beyond regulations based on capital, tools based on liquidity, leverage and funding sources are also being introduced. With regard to the borrower’s side, instruments such as the loan-to-value (LTV), loan-toincome (LTI) and debt-service-to-income (DSTI) limits are considered to be among the most effective macro-prudential instruments in curtailing excessive credit growth and the build-up of unsustainable debt positions. In order to effectively moderate the financial cycle, a timevarying dimension is crucial in the design of the various ratios. For example, the loan-tovalue ratio should be lowered during the expansionary phase of a financial cycle and raised during the contractionary phase, while respecting the mandate of financial stability and avoiding the build-up of systemic risk. Otherwise, there is a risk of pro-cyclicality since leverage constraints decline as asset prices rise. It is imperative, however, that the macro-prudential toolbox be further enhanced with innovative tools beyond those outlined above. Cyclical systemic risk can arise not only as a result of excessive credit expansion (an issue that can be addressed with the countercyclical capital buffer along with limits on borrowing) but also because of inadequate channeling of credit that keeps the real economy under-financed for extended periods. A lesson drawn from the crisis is that we have focused on rather narrow areas of financial activity. Nowadays, it is important that we focus on the risks that might have been missed such as the interlinkages between sectors, and thus explore how the financial system can influence, and be influenced, by the wider economy. In the euro area, there is evidence of limited financing of the real economy, with the consequence that euro-area investment has not recovered to pre-2008 levels despite ECB policies directly aimed at increasing the lending of the banking sector. BIS central bankers’ speeches C. Challenges ahead and the way forward Challenges, of course, remain. Let me point to some that are more relevant for macroprudential supervision and systemic stability. 1. A first challenge relates to the issue of the increased burden of complying with the new regulatory framework and assessing its cumulative impact. I am not referring to additional capital adequacy requirements but rather to the plethora of new measures being applied by more than one institution. In the pursuit of making banks more robust, liquid, responsible and transparent, huge progress in regulating and supervision their operations has been achieved. However, there has been no estimate of the cumulative impact of these regulations. I welcome and look forward to the report on the impact of capital requirements on the economy; however, the impact of other regulations should also be examined. We need to keep in mind the principle of proportionality, a general principle of EU law. As new regulations accumulate, they can come with costs as well as with benefits. Policymakers need to be watchful that, in attempting to limit externalities, they do not inadvertently create new externalities. The financial sector ultimately exists to serve the real economy. It is very likely that there are trade-offs between ensuring financial stability and imposing such a burden on the financial sector that it ceases to be able to do its job, namely to intermediate between surplus and deficit units in any economy in order to encourage long-term investment and growth. Thus we have to develop methods to judge the appropriateness of indicators and tools. Since many of the regulations have been applied over the last few years, that is, in a period of acute financial stress, I expect that in the coming years there will be a need to reassess those regulations and perhaps conduct some fine-tuning. Similar arguments apply to the national options and discretion in the new regulatory framework. 2. Closely related to the previous challenge is the degree to which regulatory developments should be front-loaded. The regulations themselves often have long phase-in periods such that new versions of the regulations are developed before the previous versions have been fully implemented. Supervisors have tended to compensate for the long phase-in periods by front-loading all prudential requirements, a situation that sometimes can be considered excessively harsh. Of course the long phase-in periods are often a reaction to the expected impact of the regulation on bank behaviour and, in particular, on the lending to the real economy. Some middle road has to be found. 3. A third challenge is the need to reduce reliance on models. Recently conducted stress-tests, a core macro-prudential tool, followed a “single-model-fits-all” methodology, which left very little room for idiosyncratic and specific national characteristics. Moreover, according to some analysts, there is a risk that stress tests are becoming less effective as a tool. Instead, they may increasingly be seen as being conducted simply to calm financial markets. Ideally, stress tests should be implemented in benign times in accordance with an old wisdom attributed to John F. Kennedy, that “the time to repair the roof is when the sun is shining”. In crisis times, there is the risk that crucial inputs such as macroeconomic variables are under or over-estimated and that adverse scenarios become unrealistic – either too benign or too severe. In consequence, outcomes become ambiguous and difficult to interpret. Additionally, the potential pro-cyclical effects of stress tests should be explored. Stress tests should not only place emphasis on solvency, but they should explore the impact of the assumed shock on bank liquidity, the implications of applying the bail-in tool, the funds needed to meet any demand on deposit guarantee funds, etc. We should focus on harmonizing processes, while models should be enriched with constrained judgement as is standard practice in macroeconomic forecasting. 4. Fourth, there is a need to widen the scope of regulation. Systemic fragility may arise from sources other than the traditional banking sector. A crucial challenge ahead is related to recent disintermediation and the development of “shadow” banking as an alternative means of financial intermediation. The need for macro-prudential regulation of certain financial activities becomes clear if we consider that banks and non-banks are closely tied through BIS central bankers’ speeches market-based intermediation activities. These include a broad array of services related to securitization transactions, securities financing transactions, repos, collateral management and derivatives. The consequences of poorly-monitored risks in this area are unknown and the risk of a new crisis could be lurking, while spill-over effects are difficult to assess. Moreover, the more policymakers are effective in using macro-prudential tools to constrain excessive credit growth in the banking sector, the more likely it becomes that there will be excessive adjustments in the non-bank sector through leakages. Fortunately, “shadow banking” is high on the agenda of the relevant fora and there is a clear need to extend the regulatory toolkit. 5. A fifth challenge, the role of the central bank as a lender of last resort to the banking system, needs to be addressed in the light of the mandate to preserve financial stability. The lender of last resort function is a crucial macro-prudential tool for managing financial distress. The principle developed by Thornton and Bagehot is well-known. Central banks should lend freely to solvent but illiquid banks against good collateral at a high rate of interest. How is this tried and tested principle to be made operational in today’s environment with much larger bank balance sheets and fewer liquid assets? In the past, government bonds were automatically considered good collateral. Today, central banks accept a wider pool of collateral. By what criteria should collateral be judged? We know that liquidity problems can become solvency problems if liquidity is denied or not provided generously enough. Thus the seemingly simple principle developed by Thornton and Bagehot can be open to various interpretations. There is a need, I think, to revisit the question. Mervyn King’s pawnbroker concept (2016) provides some new ideas on the issue. The ultimate aim in meeting these challenges is to make finance in Europe more resilient and to enhance and safeguard financial stability. The role of supervisors of the financial system is to enhance harmonization while respecting proportionality. They should safeguard a levelplaying field among all participants and protect depositors while striking the right balance between “strictness” and “fairness”. Their mandate is to set clear boundaries within which financial intermediation can prosper while financial stability is maintained. D. Beyond policies towards the financial sector As I stated at the outset of my presentation, financial stability is not only crucial for growth; growth is also crucial for financial stability. So let me close with a few remarks on growth in the euro area and the completeness of Economic and Monetary Union (EMU). Despite the progress made in the past few years, EMU remains incomplete. Divergence across the euro area is significant and the crisis has further highlighted existing shortcomings and important differences that need to be bridged. To this end, Europe should build upon other proposals outlined in the Five Presidents’ Report (2015). As argued in that report, EMU will not be complete until the appropriate mechanisms to share fiscal sovereignty are in place. Monetary unions have to develop mechanisms for risk sharing. Mark Carney recently highlighted the stylized fact that, whatever happens to asset prices, debt endures. Reducing debt levels is difficult and he notes that it is unlikely that high debt in one sector or region can be reduced without at least temporarily increasing it in another. Fiscal integration can help in this respect. Allow me to remind you of Keynes’s view about the Bretton Woods System – it needed, he believed, to provide mechanisms to promote symmetric adjustment within the fixed exchange rate area so that there would not be a bias towards deficient demand across the system. A more-fiscally-integrated monetary union would help address the problems of asymmetric adjustment and the deflationary bias of our monetary union. Sustainable economic growth can contribute to financial stability. Failure to maintain sustainable growth has been the biggest threat to the long-term stability of the EU since the onset of the 2007 crisis. An appropriate balance between managing risk and enabling investment needs to be struck. In this connection, it is crucial that the regulatory framework does not impede, but provides a suitable environment, for sustainable growth. BIS central bankers’ speeches Ladies and gentlemen, ultimately, a sustainable recovery will need to be underpinned by higher investment. Yet, in the euro area we presently face a significant investment gap. The financial system and its stability have a crucial role to play in closing this gap. Central bankers and supervisory authorities bear an enormous responsibility in shaping a system that can deliver prosperity to the citizens of Europe. We have made important progress in securing the financial stability needed to deliver such prosperity, but we have not yet completed the job. As the ancient Greek mathematician, Archimedes, once said, “Give me a place to stand and I will move the earth, but first I need a place to stand, a foundation.” The completion of our financial-stability edifice will provide the necessary foundation for the citizens of Europe. Sources: 1. Bank for International Settlements (2015) “Making supervisory stress tests more macroprudential: Considering liquidity and solvency interactions and systemic risk”, BCBS Working Papers No 29, https://www.bis.org/bcbs/publ/wp29.htm, November. 2. Banque de France and Bank for International Settlements (2016) “Ultra-low interest rates & challenges for central banks”, Farewell Symposium for Christian Noyer, Paris, https://www.banque-france.fr/en/economics-statistics/research/seminars-andsymposiums/symposium-a-loccasion-du-depart-de-christian-noyer-banque-de-france-etbanque-des-reglements-internationaux.html, January. 3. Basel Committee on Banking Supervision (2015), Finalising post-crisis reforms: an update, A report to G20 Leaders, http://www.bis.org/bcbs/publ/d344.pdf, November. 4. Carney, M. (2015) “Fortune favours the bold”, Speech given to honour the memory of The Honourable J. M. Flaherty, P.C., Iveagh House, Dublin, http://www.bankofengland.co.uk/publications/Documents/speeches/2015/speech794.pdf, January. 5. Cœuré, B. (2016) “Time for a new Lamfalussy moment”, Speech at the Professor Lamfalussy Commemorative Conference, Budapest, https://www.ecb.europa.eu/press/key/date/2016/html/sp160201.en.html, February. 6. Cœuré, B. (2016) “From Challenges to Opportunities: Rebooting the European Financial Sector”, Süddeutsche Zeitung, Finance Day, Frankfurt, http://www.ecb.europa.eu/press/key/date/2016/html/sp160302.en.html, March. 7. Constâncio, V. (2015) Interview with Börsen-Zeitung, “We need more integration in Europe”, https://www.ecb.europa.eu/press/inter/date/2015/html/sp151230.en.html, December. 8. Draghi, M. (2015) Monetary policy and structural reforms in the euro area, Prometeia40, Bologna, https://www.ecb.europa.eu/press/key/date/2015/html/sp151214.en.html, December. 9. Draghi, M. (2016) Introductory statement during the Hearing at the European Parliament’s Economic and Monetary Affairs Committee, Brussels, http://www.ecb.europa.eu/press/key/date/2016/html/sp160215.en.html, February. 10. Five Presidents’ Report sets out plan for strengthening Europe’s Economic and Monetary Union as of 1 July 2015 (2015), Press release, Brussels, http://europa.eu/rapid/press-release_IP-15–5240_en.htm, June. 11. Hill, J. (2015) “For a financial sector that promotes investment”, London, http://europa.eu/rapid/press-release_SPEECH-15–5380_en.htm, July. 12. Hill, J. (2015) Keynote speech at European Banking Federation, “A Brave New World for Banks”, 2015 Annual High Level Conference, Brussels, http://europa.eu/rapid/pressrelease_SPEECH-15–5624_en.htm, September. BIS central bankers’ speeches 13. Hill, J. (2015) Speech at the European Central Bank Forum on Banking Supervision, “Bank Supervision: Europe in global context”, Frankfurt, http://europa.eu/rapid/pressrelease_SPEECH-15–5985_en.htm, November. 14. Hill, J. (2015) Opening statement on Structured Dialogue – European Parliament: Economic & Monetary Affairs Committee, Brussels, http://europa.eu/rapid/pressrelease_SPEECH-15–6206_en.htm, November. 15. Hill, J. (2015) Speech at the CRR Review Conference, DG FISMA, “The Impact of the CRR and CRD IV on Bank Financing of the Economy”, Brussels, http://europa.eu/rapid/press-release_SPEECH-15–6310_en.htm, December. 16. Hill, J. (2016) Keynote speech at the European Banking Authority’s 5th Anniversary Conference, London, http://europa.eu/rapid/press-release_SPEECH-16–250_en.htm, February. 17. King, M. (2016) “The End of Alchemy: Money, Banking and the Future of the Global Economy” Little, Brown. 18. Praet, P. (2015) Interview with La Libre Belgique, “Europe must show it can bring prosperity”, https://www.ecb.europa.eu/press/inter/date/2015/html/sp151221.en.html, December. BIS central bankers’ speeches

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Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Conference organized by the Hellenic Observatory of the London School of Economics on "Getting Policy Knowledge Into Government", London, 19 May 2016.

Yannis Stournaras: Present situation and proposals to move forward Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Conference organized by the Hellenic Observatory of the London School of Economics on “Getting Policy Knowledge Into Government”, London, 19 May 2016. * * * Before I begin my presentation I would like to congratulate the Hellenic Observatory at the LSE, Professor Kevin Featherstone and his colleagues, for twenty years of valuable contribution to a better understanding of economic and social realities in Greece. The lectures, publications and research work of the Observatory allowed us to look at Greece through the lens of an outside, independent observer, detached from our everyday entanglements. On this happy occasion of your 20th anniversary I would like to thank the Hellenic Observatory for that contribution and wish you many more years of creative activity. Ladies and Gentlemen, dear colleagues, The speakers who took the floor in the preceding panels have covered the European and Greek experiences, giving us powerful insights into the respective patterns and methods used. All discussions converged in the assessment that, if governments recognize, accommodate and internalize outside knowledge and technical expertise, the efficiency of policy making mechanism, as well as the quality of the decisions should be greatly improved. This leads directly to the conclusion that, in order to move forward, we must improve and enrich this fruitful relationship, removing existing obstacles. Ladies and Gentlemen, Allow me now to share with you some general thoughts on the subject, based on the Greek experience. I will begin by describing briefly the nature and the characteristics of outside knowledge. Then I will focus on the supply and sources of knowledge and particularly on the dual position of the Bank of Greece. Finally, I will outline the attitude of Greek governments vis a vis external knowledge and their willingness to use it as an input into their decision making, concluding with some remarks on the formative factors shaping this attitude. Outside knowledge – technical expertise I understand outside knowledge and expertise as knowledge developed outside the Government policy mechanisms. In the long – run one can rightfully advocate that outside knowledge is the cornerstone of economic policies, which are based on theories developed outside politics, in the field of science. But, as we are not here to discuss the perennial question of the relationship of science and politics, I must confine the analysis to the short and medium run. In this time-frame, outside knowledge should be seen firstly as public knowledge, i.e. as the existing corpus of research results, publications, criticisms and proposals coming from a variety of sources but sharing a common element: they are relevant and potentially useful in the formulation of present-day economic policies. The basic characteristics of public knowledge is that it is a free good, available not only to governments but to the society at large. In that respect, it is an important factor shaping attitudes, ideas and conceptions that can legitimize or reject economic policies. External expertise on the other hand refers to the total of skills and technical abilities that are available on demand. The supply of outside knowledge In Greece, as in other European countries, the supply of outside knowledge and expertise comes from universities, individual academics, commercial banks, think-tanks and business associations. KEPE, the Centre of Planning and Economic Research, may also be included BIS central bankers’ speeches in the list, although institutionally is part of public administration. All of them publish studies on topical issues, regular reports on the state of the economy, policy recommendations, forecasts and evaluations of current policies. The Bank of Greece is an independent institution with specific tasks and responsibilities, which include safeguarding financial stability and implementing monetary policy. It is therefore an indispensable part of the policy making apparatus and its technical expertise on these issues should be considered as internal to the formation and implementation of economic policy. The institutional importance of the Bank of Greece is clearly demonstrated by the fact that all Memorandi of the crisis bear two signatures: that of the Minister of Finance, alongside with the Governor’s of the Bank of Greece. In the same context, according to its mandate, the Bank of Greece should assist and support general economic policy on condition that the Bank’s primary goal of safeguarding price stability is not jeopardized. It fulfils this role, acting as an outside source of knowledge on general economic policy issues. This is done mainly through its regular and extraordinary publications and/or public interventions including: • the Governor’s Annual Report on the state of the economy; • the biannual Monetary Policy Report, submitted to the Greek Parliament and the Cabinet; • testimonies by the Governor before the Greek Parliament; • articles, speeches, statements and interviews of the Governor; • periodical publications; • studies on economic policy relevant issues; • press releases, which provide information and communicate the Bank’s position on topical issues. All these activities communicate to the public the Bank’s stance on economic issues, which is the outcome of collective work carried out by all departments, particularly the Economic Analysis and Research Department, and endorsed by the Bank’s decision-making bodies. In the years of the crisis the Bank of Greece saw a need to enhance its public discourse and increase the frequency of interventions, with a view to: – warn about major risks which although clearly looming, had not been realized by the general public and were ignored by the governments. – raise awareness of the complexity of the situation and the need to change the course of the economy, thus contributing to the formulation of policies for a more effective management of the crisis. The Bank of Greece’s public discourse has been enriched with new elements since the Bank has sought to strengthen its role as an advisor to society, communicating directly with the public, which in that period was inundated with conflicting and inaccurate information and signals that often resulted in confusion and higher uncertainty. Through its statements and its participation in the public debate, the Bank of Greece has aimed to present the true facts in a comprehensible manner, dispel misconceptions and misunderstandings and provide all citizens with reliable and timely information on the available options and implications thereof. It should be noted that most central banks undertook similar changes regarding their communication policies, which – in response to the conditions of the crisis – have shifted away from the traditional communication model whereby their discourse was addressed to a close circle of experts and was often cryptic. To sum up, I am convinced that Greece has an abundant supply of public knowledge that can benefit our country. Non-domestic knowledge should also be added, as it is BIS central bankers’ speeches communicated to the public by numerous reports, studies, analyses, proposals and forecasts for Greece published by international organisations, think-tanks and research bodies. Thus, one can safely assume that Greek governments have at their disposal a bulk of knowledge that can be evaluated and used – if it is considered to be helpful – in the formulation of economic policies. The demand side Let me now discuss the demand side, i.e. governments’ willingness to recognize the usefulness of outside knowledge, particularly public knowledge as I have described it. Experience shows that governments are reluctant in general, with perhaps one exception, the Simitis government, who I am happy to see here tonight, to exploit public knowledge, even if the proposals and recommendations are potentially relevant and useful. A revealing example is the prolegomena of the present crisis: Many years before 2008, many independent observers, among them the Bank of Greece, had been warning that the Greek economy was vulnerable and if the large public and external deficits were not restrained, a severe crisis was unavoidable. They had also put forward concrete policy proposals and structural reforms that – if adopted – could have changed the course of events. The warnings however were not heeded and successive governments continued borrowing and spending, bringing the economy to the edge of disaster when the international crisis broke out. In general, governments in Greece are reluctant to accept outside expertise and they perceive the available supply with distrust. The reasons behind this attitude lie in the fierce partisanship of Greek politics. The political system is based on confrontation that breeds strong distrust for the “other”, leaving no ground for independent voices. The term “technocrat” carries derogative connotations and it is definitely considered inferior to the “political”. Independent proposals and/or technical expertise are not judged on their merits, but on their perceived position in the political spectrum. The preference for “political” decisions, as opposed to “technocratic”, is ever present in Greek politics and reflects an ideological system that gives precedence to the “political”, over all other considerations. This is clearly indicated by the methods Greek governments recognize the need for external knowledge and use it in their policy planning. The first method is by hiring individual experts as advisors and consultants to the Ministers. The fact however that all of them leave their positions together with the Government that hired them reveals a basic problem. A relevant case is the Chairman of the Council of Economic Advisors, which is the body of economic experts in the Ministry of Finance that participates vigorously in the formulation of economic policies. The Chairman of the Council is usually a prominent economist, but the person changes with every change of government. I would say also with ministers of the same government. Panos Tsakloglou can confirm that. When I left, the Minister who succeeded me, changed Panos as well. The position is termed political, meaning that academic excellence is not the sole criterion for the choice of the Head. Another example of this practice is the appointment of university professors as Ministers or in other high positions. Governments in this case do want the input from outside, i.e. the professors’ knowledge, on the condition that this knowledge is politicized. A second method Governments use in order to acquire expertise from external sources is by setting up extra parliamentary committees of experts to study and suggest policy guidelines on major issues. The participants are practitioners, academics, representatives of various social groups or individuals with a proven knowledge of the subject. Issues that committees of this kind dealt with in the past have been, among others: the social security system, fiscal policy and tax reforms, the system of national statistics, policies for growth. The Spraos reports was a famous example. The work of the committees ended up with detailed reports, extensive analysis of the facts and concrete policy recommendations. These reports, besides summing up the existing knowledge on the subject, reflected the interchange of different BIS central bankers’ speeches ideas and the consensus of the participants on what was feasible and desirable at the time. In that sense they constituted an ideal starting point for policy decisions that could be easily legitimized by the broad, non-partisan character of the committees. Governments however have missed that opportunity too. The findings of the committees, after going through a maze of political considerations, were eventually forgotten. It was again politics that won the upper hand. A third way governments internalize extraneous expertise in decision making is to commission consultant firms, think tanks, university centers and/or individual academics to carry out research projects on specific, mostly technical issues. The terms and conditions of such a project are set by the relevant authority and the selection of the candidates is done according to the provisions of the European and Greek law. There is no quantitative evidence to show to what extent this practice is used and the findings of these projects are not published. It seems however that undertakings of this kind are not rare and that they are often part of a larger project financed by European funds. This revealed demand indicates that public authorities recognize the need for external expertise and resort to it in an institutional framework. In the years of the crisis the importance of external expertise became paramount. Economic policies had to adapt to the directions specified by the agreements with the EU, the ECB and the IMF, and technical expertise was urgently needed to deal with new problems. Under these conditions the bulk of technical assistance came from outside, non-domestic sources (IMF, ECB, EU) as an indispensable, mandatory input in the formulation of economic policies. In Greece, the new situation had no visible effects on the way governments evaluate and use external knowledge. The response to the great challenge of radical reforms was planned in-house, with help from non-domestic consultants. Moreover, political criteria continued to weigh down on policy decisions, contrary to the obvious need of non-partisan solutions. I argue (from personal experience) that in the rare occasions when political criteria were set aside and decisions were supported by strong technocratic knowledge, the outcome has been positive and the policies successful. To conclude: There are two main reasons behind the distrust of outside knowledge: First, the overriding importance given to the “political” as opposed to the “technocratic”. Second, the partisan nature of Greek political life that polarizes opinions, minimizes the middle ground, excludes consensus and degrades expertise, unless it is partisan. As long as these attitudes persist, outside knowledge will have a marginal role in the formulation of policy decisions. And I am really very sorry to notice tonight that Nikos Theocarakis’ speech before mine was such an example of partisan politics, since I used to be a Finance minister in the government that he described as almost colonial in his partisan speech. He failed though to admit that the “brave” negotiations that he and Yanis Varoufakis led, which led to the change of the name of the Troika to institutions and removed the Troika from the ministries to the Hilton, had also a cost. If we assume that what he described were benefits, the cost of course was €86 billion: That was the third memorandum and the capital controls that have been imposed after €45 billion of deposit outflows. And these capital controls have been imposed in order to safeguard financial stability following the “brave” negotiations of Mr. Theocarakis and Mr. Varoufakis. I am sorry to say that, but I had the obligation to put the record straight. I believe however that even deeply embedded beliefs can change under the pressure of extraordinary conditions and that the traumatic experience of the last several years will help changing attitudes of the past. We have already witnessed a gradual convergence of political forces on the necessary policies to overcome the crisis and the sterile confrontations between anti-memorandum and pro-memorandum supporters to fade out. It is therefore reasonable to assume that, in the future, policies will be increasingly based on facts and knowledge and less on preconceptions and ideas. The long negotiations of successive Greek governments with the European partners and the IMF, in the years of the crisis, have left us a valuable legacy: analysis of the facts, technical BIS central bankers’ speeches expertise and accurate forecasts are indispensable and cannot be substituted by political will. I hope that this paradigm will not be forgotten, and governments in the future will see more clearly the need for and the advantages of independent, outside knowledge and expertise. BIS central bankers’ speeches

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Keynote speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the London Business School Greek Alumni Association and Stanford Club of Greece event titled "Breaking the Bottlenecks - Steps towards Sustainable Growth", American School of Classical Studies, Athens, 8 June 2016.

Yannis Stournaras: The impact of the Greek sovereign crisis on the banking sector – challenges to financial stability and policy responses by the Bank of Greece Keynote speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the London Business School Greek Alumni Association and Stanford Club of Greece event titled “Breaking the Bottlenecks – Steps towards Sustainable Growth”, American School of Classical Studies, Athens, 8 June 2016. * * * Ladies and gentlemen, It is a great pleasure to be here today and have the chance to share with you my thoughts on the impact of the Greek sovereign crisis on the Greek banking sector, outlining the challenges to financial stability and the policy initiatives taken primarily, but not only, by the Bank of Greece. At the outset, it is important to highlight that financial stability is a necessary condition for achieving the goals of prosperity and sustainable growth. That these goals are shared by all is amply reflected in the current mandates of central banks with their emphasis on price stability, support for the general economic environment and, more recently, the safeguarding of financial stability. I will begin by briefly outlining the global landscape on which the effort to safeguard financial stability has been taking place. Then, I will discuss developments in the Greek banking sector. In particular, emphasis will be placed on: (i) first, the significant worsening of the macroeconomic environment and the subsequent deterioration of Greek banks’ fundamentals, in general, and their asset quality, in particular; (ii) second, euro area monetary policy initiatives and their limited impact on Greece; (iii) third, the new role for the Bank of Greece that stems from its mandate that has been revised to address the current challenges. Finally, I conclude by outlining the challenges ahead and providing some thoughts on the way forward. A. The setting – a broader context Over the last seven years, the European Union has faced a series of unprecedented challenges; challenges that have tested the international financial system and the coherence and stability of the Union. The response to these challenges has shown that the EU is built upon solid ground as the bonds among Member States have become ever stronger. The global financial crisis, triggered in 2008, provided a first challenge to stability and raised major issues related to “too-big–to-fail”, “too-big-to-save” or “too-complex-to-resolve”. The euro area sovereign debt crisis rapidly followed and real economic activity deteriorated considerably in certain parts of the euro area. A key lesson of that crisis has been that the establishment of a banking union is a vital prerequisite to make a monetary union sustainable. More recently, with the recovery in the euro area still fragile, new geopolitical tensions have led to an unprecedented refugee crisis and increased uncertainty. Finally, matters such as the probability of Brexit, different approaches among Member States regarding banking union and the slow progress in establishing a single European deposit insurance scheme, have been hindering further progress towards securing a financial system architecture appropriate to ensure stability. B. The sovereign crisis in Greece caused the Greek banking sector crisis Unlike other recent experience with financial instability, the origins of the Greek crisis were not to be found in the banking sector. In the context of the unfavorable international BIS central bankers’ speeches economic and financial landscape that I outlined above, Greece has been undergoing a serious sovereign crisis that has required three adjustment programmes, including, inter alia, substantial reforms and tough austerity measures. The rapid deterioration in the macroeconomic environment, reflected in a cumulative loss of more than 25% of the GDP, has shown that the crisis facing Greece is both deeper and more protracted than initially expected. In terms of the overall deterioration of key macroeconomic aggregates and the duration of the crisis, one could say that the Greek crisis has proved to be more severe than even the Great Depression. At the outset, the deterioration in the macroeconomic environment, sovereign debt downgrades and rising sovereign spreads rendered access to international capital and money markets impossible for both the banks and the sovereign. Extremely tight liquidity conditions ensued and pressures on the banking sector grew. In this adverse macroeconomic landscape, unemployment increased to historic (post-war) levels, and disposable income dropped substantially. As a consequence, the adverse developments in the banking sector were unprecedented; in particular, Greek banks’ fundamentals and asset quality ratios deteriorated substantially. The extent of the deterioration may be described in terms of the impact of the restructuring of Greek government bonds held by the private sector (the so-called Private Sector Involvement or PSI): Greek banks suffered losses of about €38 billion in 2011, about 170% of their total Core Tier I (CT1) capital at that time. Due to the liquidity squeeze, the intermediary role of banks has been undermined and the channels for financing the real economy have been restricted. In addition, deposits declined by €117 billion (i.e. a drop of –44%) between September 2009 and December 2015. Mainly, this decline reflected depositor uncertainty regarding the prospects of Greece within the euro area. But additionally, the decline in deposits reflects the negative loan growth throughout the period. In normal times, deposits do not just create loans, but loans also create deposits via the money multiplier; declines in loans analogously lead to endogenous declines in deposits. The significant deleveraging that Greek banks have undertaken – between end-2010 and end-2015, loans to the private sector fell by €54 billion – was partly a response to tight funding conditions and partly a consequence of the need to set aside more capital since the potential for unexpected risks rose considerably. As a consequence it became ever more difficult for banks to play their natural role, that of financing the real economy. The considerable decline in household disposable income, a consequence of both wage cuts and the rise in unemployment, resulted in a significant increase of non-performing loans and impairments, thus undermining the prospects for bank profits. Banks from 2010 onwards began to experience losses, which eroded their capital base. Despite efforts to support profitability by reducing costs, the high level of loan loss provisions resulted in a series of loss-making results right up until the first quarter of 2016. C. European policy initiatives The response of Europe to the global and European financial crisis has been effective despite the initial lack of crisis mechanisms and the unfavorable and challenging environment – an environment in which fires were often being fought simultaneously on a number of fronts. The initial response came in the form of monetary policy and a significant easing of the monetary policy stance. Indeed, in October 2008, six major central banks, including the ECB, implemented a coordinated and simultaneous cut in interest rates. Additionally, at that time euro area Member States set out an action plan of coordinated measures (including, inter alia, the granting of government guarantees to bank debt issuance and the recapitalization of banks) to restore confidence and improve financial conditions. With the eruption of the euro area sovereign debt crisis the malfunctioning of the monetary transmission mechanism led the ECB to resort increasingly to nonstandard monetary tools. Additionally, Europe set up the European Financial Stability Facility (EFSF) to provide BIS central bankers’ speeches financial assistance to distressed Member States. The EFSF was replaced by the more powerful European Stability Mechanism (ESM) in October 2012. The sovereign debt crisis also revealed strong negative feedback loops between banks and sovereigns, irrespective of whether the crisis originated with the sovereign or the banks, as well as contagion among national financial markets. In response to these developments, in 2012, European leaders initiated the creation of a banking union – which is a complementary and integral part of a genuine Economic and Financial Union. Its three pillars are: the Single Supervisory Mechanism, the Single Resolution Mechanism and the still-to-be completed common deposit guarantee system. Apart from the elements of the banking union, a number of important regulatory initiatives have been taken, covering almost all aspects of financial sector and activities (namely the Bank Recovery and Resolution Directive – BRRD, Capital requirements regulation and directive – CRR/CRD IV for the banking sector, Solvency II for Insurance, European Market Infrastructure Regulation – EMIR for financial markets and infrastructure and so on). Turning to monetary policy initiatives, the ECB has been addressing the severe and persistent disinflationary forces in the euro area economy with a broad set of measures. Initially, it moved to refinancing operations at a fixed rate and with full allotment. It also extended the time horizon of refinancing operations, providing for 3-year maturities instead of the usual 3-month. More recently, with the so-called Targeted Long-Term Refinancing Operations (TLTROs), it seeks to incentivize banks to on-lend to the private sector by providing finance for up to 4 years. Finally there are the various asset purchase programmes where the Eurosystem purchases marketable assets including public sector/government bonds, corporate bonds, ABSs, uncovered bank bonds, etc. These non-standard measures are being implemented to meet a variety of goals. First, to support financial markets which are malfunctioning. Second, to provide liquidity to banks for longer periods. It should be recalled that in the wake of the international financial crisis, the interbank market dried up completely as counterparty risk rose; to this day, it remains fragile. Third, to kick-start lending to the real economy. Ultimately, of course, the goal is to prevent deflation and raise inflation in the euro area to target. To a great extent, these measures have helped to improve financial conditions in the euro area. Work done at the Bank of Greece shows that financial conditions have responded positively to the non-standard measures, even if the measures have not yet restored inflation to its target of below, but close to, 2 per cent. However, with respect to Greece, the anticipated positive effects of the expansionary monetary policy stance have yet to be realized. Financial conditions in Greece, whilst not at their lows of 2012, are still extremely tight by historical standards. Moreover, conditions have been virtually unchanged since the beginning of 2013, despite all the non-standard measures employed by the ECB. What factors might account for this outcome? The Eurosystem lends to commercial banks against collateral. The collateral framework defines what is eligible and this is related to an asset’s rating. Greek banks have often found themselves constrained by the amount of eligible collateral. Moreover, haircuts are applied to eligible collateral. That is, a €100 bond will not necessarily give a bank access to €100 of refinancing. Greek assets are now rated much lower than they were before the crisis. Thus some assets have become ineligible and, for those assets that are still eligible, the haircuts have increased. This has, on occasion, restricted access to refinancing operations. Since February 2015, Greek banks were unable to use Greek government bonds in refinancing operations, since they have a rating that is lower than the minimum acceptable under the collateral framework. A waiver was introduced for countries that are in an adjustment programme and completing the associated reviews successfully. In February 2015, the Governing Council decided that Greece did not meet these criteria and hence the waiver was withdrawn. Furthermore, Greek banks have at various times been suspended as eligible counterparties with the Eurosystem. This occurred after the PSI and before the banks were recapitalized. BIS central bankers’ speeches Under such circumstances, banks turn to the Emergency Liquidity Assistance provided by the Bank of Greece. But ELA carries a stigma, is more expensive and banks, through what are known as funding plans, have to explain how they plan to reduce their recourse to ELA over a reasonably short period. Suspension, for example, prevented Greek banks from participating in the second LTRO. Finally, Greece does not benefit from the asset purchase programmes. The covered bond and ABS programmes are aimed at banks. But Greek banks cannot issue covered bonds or ABSs that meet the rating criterion. Similarly Greek corporates issue limited bonds which again do not meet the rating criterion. With respect to the public sector asset purchase programme, Greek government bonds have been ineligible since the country was not “in a programme”. Thus financial conditions in Greece have not benefited significantly from the raft of nonstandard measures that have been introduced during the crisis. Conditions, however, can be expected to improve with the passing of the 1st review and the reinstatement of the waiver. D. The response of the Greek authorities, including the Bank of Greece I now turn to the response of the Greek authorities. The role of central banks throughout the EU has been considerably increased due to the challenges faced by banking systems in the wake of the Lehman Brothers’ failure. One manifestation of this increased role is that mandates have been amended to explicitly refer to financial stability as a core central bank task. At the same time, the toolbox available has been expanded to include macro-prudential policy tools and enhanced micro-prudential policy tools both for the SSM and the national authorities. The Greek authorities are no exception to this trend. Throughout the crisis, the Bank of Greece has been the guardian of financial stability, protecting fully all depositors (regardless of type and size) and supporting the economy and the public interest. Initially, this was accomplished through the 2008 Law which provided capital support to Greek banks and allowed banks to issue government guaranteed bonds which could be used in refinancing operations. Similar laws were enacted throughout the EU. With the onset of the sovereign debt crisis, however, the situation intensified requiring continuous action by the Bank of Greece on two broad fronts: ensuring adequate provision of liquidity and managing recapitalization, resolution and restructuring. With respect to liquidity provision, the Bank has been critical in ensuring continuous liquidity provision to banks using one of the oldest macro-prudential tools available, that of the lender of last resort. On various occasions, the Bank of Greece has extended ELA to the banking system. This has helped preserve financial stability by ensuring that liquidity problems do not turn into solvency problems. With respect to managing recapitalization, resolution and restructuring, the Bank’s strategy, in the context of the adjustment programmes, aimed at strengthening viable institutions and winding down non-viable institutions whilst safeguarding financial stability. To this end, viability assessments and capital needs assessments were undertaken. Those banks deemed viable were recapitalized. The first round of recapitalization, following the losses incurred from PSI, was completed in June 2013. A combination of both private capital and resources from the Hellenic Financial Stability Fund were used. The second recapitalization took place in 2014, following a macro-prudential stress test, but involved only private equity capital injections. A further recapitalization took place at the end of 2015, mainly due to the uncertainty that prevailed in the first half of that year, which had a negative impact on macroeconomic and financial fundamentals. Following agreement on the third adjustment programme, a financial envelope of €25 billion was provided for the banking system. In August 2015, the ECB launched an Asset Quality Review and stress-test exercise for the four systemic Greek BIS central bankers’ speeches banks. The ECB was the appropriate authority because, since November 2014, the four systemic banks have been supervised by the Single Supervisory Mechanism (SSM). The Bank of Greece undertook a similar exercise for the smaller banks. The result of this exercise was identification of capital needs under both a baseline and an adverse macroeconomic scenario. The actual amount of capital raised was that identified under the adverse scenario, namely €14.4 billion. Thanks to the coordinated efforts of the Greek authorities and the Bank of Greece, successful rights issues resulted in the full coverage of the shortfall by December 2015, with private investors subscribing about €9 billion. These efforts minimized HFSF participation and helped to restore confidence in the longer-term viability of Greek banks. As a consequence, Greek banks now have among the highest capital ratios of banks in the euro area. Those deemed non-viable were resolved with their ‘good’ part absorbed by systemic banks. The resolution tool used had to meet two main criteria. First, resolution had to be done in such a way as to ensure continued stability of the financial system. To that end, all deposits from resolved banks were transferred to systemic banks. This process also ensured a minimum of disruption for customers of resolved banks. The second criterion was to minimize the costs of restructuring for tax-payers. The Bank of Greece assessed that the costs of using the purchase and assumption resolution tool were lower than any alternative. With 14 such resolutions having successfully taken place since 2011, this process has also facilitated considerable restructuring of the banking system, eliminating excess market capacity. E. Challenges ahead, the way forward and concluding remarks Ladies and gentlemen, With the successful completion of the first review, a number of positive benefits are likely to ensue for the banking system. The reinstatement of the waiver will allow Greek government bonds to once again be eligible collateral in Eurosystem refinancing operations. Greek banks are expected to participate in the coming targeted long-term refinancing operation. These developments will considerably reduce funding costs for Greek banks. At the same time, later this year, Greek government bonds could also become eligible for the public sector asset purchase programme. Falling spreads will impact positively on the banking system since the sovereign effectively acts as a floor on the interest rates at which banks can do business and on their ratings. However, there is no room for complacency. The system still faces challenges. The SSM has identified banks’ business model and profitability as a top priority for its supervisory action plan for 2016. Yet the background against which this priority takes place is a challenging one. The macroeconomic environment is still fragile, market sentiment is volatile and capital controls are still in force. A large part of the challenge in addressing a new business model relates to the increasing stock of Non-Performing Exposures (NPEs) and their management. These exposures are acting as a significant impediment to banks’ reorienting their business model as well as, more broadly, to growth and financial stability, particularly in the countries of the European South. It should be highlighted, however, that we are in a good position to deal with this challenging issue. Thanks to the work that has been done over the past few years, we are fully aware of problems’ analytics and important knowledge has been accumulated both for the monitoring and managing of troubled assets. Moreover, as a recent Bank of Greece study indicates, domestic NPEs are primarily driven by recession. This finding leads us to the inevitable conclusion that pro-active loan restructuring and immediate involvement of loan servicers and private equity funds (gaining from the upside in the EBITDA) may add value. The Bank of Greece’s key priority at present is to contribute towards a sustainable solution for the management of NPEs. A number of initiatives are underway with the goal of setting up an accelerated and efficient framework of private debt resolution. These elements, BIS central bankers’ speeches amongst others, include: (a) the recently voted amendment of Law 4354/2015 which paved the way for the development of a secondary market for non-performing loans; (b) the establishment of an enhanced framework for out-of-court workouts and the pre-bankruptcy process; (c) the elimination of a series of taxation driven obstacles both for borrowers and lenders; (d) the re-drafting of the Code of Conduct to address issues identified in the early implementation phase; (e) amendments in legislation, which would ensure the cooperation of old shareholders in the restructuring of the underlying businesses; and, finally, (f) the launch of a comprehensive monitoring framework in relation to banks’ non-performing exposure resolution activities. The ultimate aim in meeting these challenges is to shape a banking system which will be in a position to undertake efficiently its main task, namely the financing of the real economy. To this end, the Bank of Greece and the SSM have to ensure an appropriate policy mix. Central banks today undertake monetary policy, macro-prudential policy and micro-prudential supervision. Macro-prudential policy bridges the gap between the micro-prudential supervision of individual banks and monetary policy. It is imperative that all these different policy areas are adequately coordinated. In the same context, it is important that the macroprudential toolbox be further enhanced with innovative tools beyond those focused on capital requirements. For instance, cyclical systemic risk can arise not only as a result of excessive credit expansion (an issue that can be addressed with the countercyclical capital buffer) but also due to inadequate channeling of credit that keeps the real economy under-financed for significant periods. I have focused in my remarks today on the banking system and the policy role of central banks. Other policy-makers, however, also have to recognize their responsibilities. I could refer to the completion of the banking union, the proposal for shared fiscal responsibility outlined in the Five Presidents’ Report and the continued implementation of structural reforms to enhance product market competition, improve educational systems, raise the efficiency of the judicial system, promote financial literacy and so on. The objective to restore confidence and enhance the resilience of credit institutions to withstand shocks in an uncertain economic environment has always been a challenging task. Yet we should not forget that this is a prerequisite to fulfill the ultimate objective of financing the real economy to promote sustainable economic growth, create jobs and ensure better standards of living for all citizens. Financial stability is a prerequisite for sustainable growth; it is also true, however, that financial stability on a sustainable basis cannot be achieved without growth. Failure to maintain strong growth has been the biggest threat to long-term stability in the EU. The appropriate balance between managing risk and enabling investment needs to be struck and it is crucial that the regulatory framework does not impede growth. The key to a sustainable recovery is higher investment, yet a significant investment gap exists. The financial system and its stability have a crucial role to play in closing this gap, and central bankers and supervisory authorities have a catalytic responsibility in shaping a system that can deliver future prosperity. Sources 1. Angelopoulou, E. Balfoussia, H. and Gibson, H. D. (2014) “Building a Financial Conditions Index for the Euro Area and Selected Euro Area Countries: what does it tell us about the crisis?”, Economic Modelling, vol. 38, pp.392–403, 2014. Also available as a Bank of Greece Working Paper: http://www.bankofgreece.gr/BogEkdoseis/Paper2012147.pdf. 2. Bank for International Settlements (2015) “Making supervisory stress tests more macroprudential: Considering liquidity and solvency interactions and systemic risk”, BCBS Working Papers No 29, https://www.bis.org/bcbs/publ/wp29.htm , November 2015. 3. Banque de France and Bank for International Settlements (2016) “Ultra-low interest rates & challenges for central banks”, Farewell Symposium for Christian Noyer, Paris, https://www.banque-france.fr/en/economics-statistics/research/seminars-and-symposiums/ BIS central bankers’ speeches symposium-a-loccasion-du-depart-de-christian-noyer-banque-de-france-et-banque-desreglements-internationaux.html, January 2016. 4. Basel Committee on Banking Supervision (2015), Finalising post-crisis reforms: an update, A report to G20 Leaders, http://www.bis.org/bcbs/publ/d344.pdf, November 2015. 5. Carney, M. (2015) “Fortune favours the bold”, Speech given to honour the memory of The Honourable J. M. Flaherty, P.C., Iveagh House, Dublin, http://www.bankofengland.co.uk/ publications/Documents/speeches/2015/speech794.pdf, January 2015. 6. Cœuré, B. (2016) “Time for a new Lamfalussy moment”, Speech at the Professor Lamfalussy Commemorative Conference, Budapest, https://www.ecb.europa.eu/press/key/ date/2016/html/sp160201.en.html , February 2016. 7. Cœuré, B. (2016) “From Challenges to Opportunities: Rebooting the European Financial Sector”, Süddeutsche Zeitung, Finance Day, Frankfurt, March 2016. 8. Constâncio, V. (2015) Interview with Börsen-Zeitung, “We need more integration in Europe”, https://www.ecb.europa.eu/press/inter/date/2015/html/sp151230.en.html, December 2015. 9. Constâncio V. (2016), International headwinds and the effectiveness of Monetary Policy, ECB Vice-President Speech at the 25th Annual Hyman P. Minsky Conference on the State of the U.S. and World Economies at the Levy Economics Institute of Bard College, Blithewood, Annandale-on-Hudson, New York, April 2016, http://www.ecb.europa.eu/press/key/date/ 2016/html/sp160413.en.html. 10. Draghi, M. (2015) Monetary policy and structural reforms in the euro area, Prometeia40, Bologna, https://www.ecb.europa.eu/press/key/date/2015/html/sp151214.en.html , December 2015. 11. Draghi, M. (2016) Introductory statement during the Hearing at the European Parliament’s Economic and Monetary Affairs Committee, Brussels, http://www.ecb.europa.eu/press/key/date/2016/html/sp160215.en.html, February 2016. 12. Draghi M. (2016), Statement by the ECB President at the thirty-third meeting of the International Monetary and Financial Committee, Washington DC, April 2016, http://www.ecb.europa.eu/press/key/date/2016/html/sp160415.en.html. 13. EBA (2015) Risk Assessment of European Banking System, https://eba.europa.eu/ documents/10180/1315397/EBA+Risk+Assessment+Report.pdf, December 2015. 14. ECB Financial Stability Review (2016), http://www.ecb.europa.eu/pub/pdf/other/ financialstabilityreview201605.en.pdf?b7c4d8d8e66d1c7c4851d64c37c72f38 , May 2016. 15. ECB Financial Stability Review (2015), https://www.ecb.europa.eu/pub/pdf/other/ financialstabilityreview201511.en.pdf?24cc5509b94b997f161b841fa57d5eca, November 2015. 16. Five Presidents’ Report sets out plan for strengthening Europe’s Economic and Monetary Union as of 1 July 2015 (2015), Press release, Brussels, http://europa.eu/rapid/pressrelease_IP-15–5240_en.htm, June 2015. 17. Hill, J. (2015) “For a financial sector that promotes investment”, London, http://europa.eu/rapid/press-release_SPEECH-15–5380_en.htm, July 2015. 18. Hill, J. (2015) Keynote speech at European Banking Federation, “A Brave New World for Banks”, 2015 Annual High Level Conference, Brussels, http://europa.eu/rapid/pressrelease_SPEECH-15–5624_en.htm, September 2015. 19. Hill, J. (2015) Speech at the European Central Bank Forum on Banking Supervision, “Bank Supervision: Europe in global context”, Frankfurt, http://europa.eu/rapid/pressrelease_SPEECH-15–5985_en.htm, November 2015. BIS central bankers’ speeches 20. Hill, J. (2015) Press Conference on the EDIS Proposal at the European Parliament, Strasbourg, http://europa.eu/rapid/press-release_SPEECH-15–6154_en.htm, November 2015. 21. Hill, J. (2015) Opening statement on Structured Dialogue – European Parliament: Economic & Monetary Affairs Committee, Brussels, http://europa.eu/rapid/pressrelease_SPEECH-15–6206_en.htm, November 2015. 22. Hill, J. (2015) Speech at the launch of the Commission’s Green Paper on Consumer Finance, Brussels, http://europa.eu/rapid/press-release_SPEECH-15–6293_en.htm, December 2015. 23. Hill, J. (2015) Speech at the CRR Review Conference, DG FISMA, “The Impact of the CRR and CRD IV on Bank Financing of the Economy”, Brussels, http://europa.eu/rapid/press-release_SPEECH-15–6310_en.htm, December 2015. 24. Hill, J. (2016) Keynote speech at the European Banking Authority’s 5th Anniversary Conference, London, http://europa.eu/rapid/press-release_SPEECH-16–250_en.htm, February 2016. 25. King, M. (2016) “The End of Alchemy: Money, Banking and the Future of the Global Economy” Little, Brown. 26. Praet, P. (2016) Interview with Público, “Monetary policy can’t do it alone”, http://www.ecb.europa.eu/press/inter/date/2016/html/sp160523.en.html, May 2016. 27. Praet, P. (2015) Interview with La Libre Belgique, “Europe must show it can bring prosperity”, https://www.ecb.europa.eu/press/inter/date/2015/html/sp151221.en.html, December 2015 28. Stournaras, Y. (2016) “Financial stability and policy intervention by Central Banks in Europe: where do we stand and what challenges lie ahead”, Speech at the Croatian National Bank in Zagreb http://www.bankofgreece.gr/Pages/en/Bank/News/Speeches/DispItem.aspx? Item_ID=345&List_ID=b2e9402e-db05–4166-9f09-e1b26a1c6f1b, March 2016. 29. Vickers, J. (2016) “Equity buffers are in the public interest” Letter to the Editor, Financial Times, 18 February 2016. BIS central bankers’ speeches

bank of greece

Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Federation of Industries of Northern Greece, Athens, 13 May 2016.

Yannis Stournaras: The Greek economy – developments, opportunities and prospects Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Federation of Industries of Northern Greece, Athens, 13 May 2016. * * * Recent developments and the current state of play In recent years, despite backtracking and, at times, political and economic uncertainty, significant progress has been made towards addressing certain chronic problems and weaknesses of the Greek economy. In particular, the economic adjustment programmes implemented in Greece since 2010 have succeeded in eliminating the major macroeconomic and fiscal imbalances, in spite of several delays and missteps. In more detail: • The high fiscal deficit has been reduced and almost 80% of the fiscal adjustment path towards the ultimate fiscal target for a primary surplus of 3.5% of GDP in 2018, compared with a deficit of 10.1% of GDP in 2009, has been covered. • The external deficit, the loss of competitiveness (in terms of unit labour costs) and labour market rigidities and constraints have been addressed. • There has been relative sectoral reallocation towards tradable goods and services. Still, despite the huge efforts to avert default and redress imbalances, Greece remains under an adjustment programme, unlike Cyprus, Ireland and Portugal, which have already completed their respective programmes, although they entered these programmes later than Greece did. This lagging behind was due to several factors, including: lack of ownership of the necessary reforms and lack of commitment, by part of the political system, to correct past errors, the anti-bailout rhetoric, rivalry and failure to reach an understanding among political parties, and the various – small and large – vested interests that have resisted reform. At the same time, however, the fact that our European partners have yet to deliver on their commitment to provide further debt relief, according to the Eurogroup decisions of November 2012, and the threat of default and euro area exit brandished against Greece by some of our partners whenever negotiations seemed to stall, even on account of technical matters, weighed heavily on market sentiment, further fuelling uncertainty and negatively affecting the economic climate in Greece. In addition, delays in the implementation of privatisations and reforms, in particular in the public sector and the goods and services markets, postponed the beneficial effects on growth and employment, which only emerged in 2014, after six years of recession, with GDP growing by 0.7% in 2014 and showing positive year-on-year growth rates in the first two quarters of 2015. However, GDP contracted by 1.7% year-on-year in the third quarter of 2015 and by 0.8% in the fourth quarter of 2015, driving the Greek economy to a slight recession of 0.2% for 2015 as a whole. Underlying this new downturn were political instability from the end of 2014 onwards, the protracted negotiations with our creditors and the rekindling of uncertainty in the first half of 2015, which triggered mass deposit outflows, the bank holiday and the imposition of capital controls (which succeeded in containing the deposit outflows, but had a negative impact on the financing of the economy), and the new fiscal adjustment measures under the new financial assistance facility agreement, considered necessary to achieve the revised fiscal targets. BIS central bankers’ speeches The strengths of the Greek economy and of the domestic banking system were put to the test. However, the economy showed remarkable resilience, with the negative impact proving more moderate than initially expected in the summer of 2015 (a 2.3% decline in GDP according to the draft State Budget for 2016). This resilience was associated with a number of factors, such as the gradual restoration of confidence after the agreement of 12 July 2015 that halted the adverse and uncertain course of the economy, the milder than expected impact on the economy from the imposition of capital controls thanks to their rapid relaxation, the buoyant tourism sector, the large drop in oil prices and the successful completion of the recapitalisation of Greek banks with strong private sector participation. Although the contraction of economic activity was smaller than initially expected, several macroeconomic indicators so far provide a mixed picture. Specifically: • Industrial production has been satisfactory since August 2015, rising by 0.7% in 2015, after falling by 1.9% in 2014. This trend was reversed recently, as industrial production fell by 2.4% year-on-year in February and by 4% in March 2016. • The retail sales volume index fell by 1.5% in 2015, it declined by 1.7% in January 2016 and showed a sharp fall of 6.6% in February. • According to data from the ERGANI information system of the Ministry of Labour, Social Security and Social Solidarity, net dependent employment flows in the private sector were positive (99,700 new jobs) in 2015, for the third consecutive year, marginally higher than in 2014. This development is fully consistent with the Labour Force Survey data of the Hellenic Statistical Authority (ELSTAT) for 2015, which point to a 3.7% rise in dependent employment and a respective decline in unemployment to 24.9% in 2015, from 26.5% in 2014. The positive picture of the labour market continued into the first four months of 2016, when, according to ERGANI data, net employment flows increased by 124,465, up by 16,078 jobs compared with one year earlier. • Exports of goods and tourism receipts increased by 4.4% and 6.6% respectively in real terms during 2015. However, receipts from shipping services fell by 28.5% in 2015 in real terms, which is largely attributable to the capital controls. As a result, total real exports of goods and services declined by 3.3% in 2015, after increasing by 7.8% in 2014. Meanwhile, the resilience of the Greek economy and the intensification of the fiscal effort through cuts in government expenditure and an increase in revenue (partly via one-off measures) in the second half of 2015 contributed to better than expected fiscal aggregates, as confirmed by the relevant Eurostat releases. Specifically, a general government primary surplus of 0.7% of GDP was achieved in 2015 (according to the economic adjustment programme definition), against a target for a primary deficit of 0.25% of GDP. The gradual restoration of confidence and the easing of uncertainty are reflected in the evolution of several leading indicators of economic activity, which improved considerably between September 2015 and January 2016. The positive trend of leading indicators continued into the first four months of 2016, except for a weakening in February. For example: • The economic sentiment indicator has been on the rise since September 2015, on the back of improvements in most business sub-indices. However, the consumer confidence indicator continues to decline, reflecting households’ uncertainty about their future economic condition. • Manufacturing PMI remained on an upward path between August 2015 and December 2015, when it exceeded the threshold of 50 (50.2), implying marginal expansion in manufacturing for the first time since August 2014. In February 2016 it fell below 50, but improved for two months in a row in March and April 2016. Meanwhile, the employment subindex remained in positive territory, pointing to an improved outlook for manufacturing employment. BIS central bankers’ speeches As a result of the July 2015 agreement, Greek government bond yields followed a downward path in the fourth quarter of 2015. However, the delays in the completion of the first review of the programme and turbulence in international capital markets reversed this trend in the first four months of 2016. Developments in the banking system – liquidity The aggravation of the economic climate and heightened uncertainty in the first half of 2015 led to mass deposit outflows, as well as a large increase in non-performing loans (NPLs). Against this background, a new recapitalisation of the banking system became necessary. Banks’ recapitalisation was successfully completed in December 2015 with strong private sector participation. The necessary additional funds for the two banks that did not fully cover their capital needs under the adverse scenario (about €5.4 billion) from private sources were drawn from the Hellenic Financial Stability Fund (HFSF). Thus, the public resources used proved to be far lower than the amount of €25 billion foreseen by the Eurogroup in August 2015. Moreover, Greek banks’ reliance on Emergency Liquidity Assistance (ELA) has decreased, and the ELA ceiling has been lowered by more than €21 billion since July 2015, to stand at €69.1 billion today. The lower ELA ceiling reflects the improved liquidity situation of Greek banks amid easing uncertainty and the stabilisation of private sector deposit flows, the gradual restoration of their access to interbank funding against collateral not eligible for the Eurosystem’s operations and their successful recapitalisation. However, the stock of NPLs rose in 2015. Non-performing exposures (NPEs) came to 44.2% of total exposures by end-2015, up from 39.9% at end-2014. In order to strengthen the banking system and unlock resources that can be used to finance the economy, it is essential to tackle the bulk of NPLs within the next two to three years. Effectively managing NPLs is key to the recovery of credit growth and to the restructuring of businesses and sectors in the real economy. The initiatives to be implemented in the next few months are expected to contribute to the restructuring and consolidation of the domestic banking sector. Specifically, it is necessary to step up efforts towards: 1. Establishing a secondary market for loans (both performing and non-performing) so as to bring in more stakeholders and enhance NPL management expertise, 2. Reforming the out-of-court debt settlement framework, to allow the rapid, effective and transparent settlement of arrears owed to private creditors and the public sector, 3. Enhancing infrastructures and capacities in the in the judicial system and 4. Addressing long-standing issues regarding the tax treatment of loan impairment charges, both for borrowers and lenders. The Bank of Greece will adhere to its commitments, in particular regarding the modification of the Code of Conduct and the implementation of a framework for target-setting and monitoring the NPL management strategies of all Greek banks. On their part, banks need to pursue a more active policy for NPL management, by promoting long-term solutions and multi-creditor workouts, as well as focusing on the restructuring of viable businesses. These lines of action, coupled with the economy’s path out of the recession and back to growth, should bring about a stabilisation and, subsequently, a decline in the NPL ratio. The outlook for 2016 The course of economic activity in 2016 crucially hinges on the successful completion of the first review of the programme and the implementation of the programme reforms. BIS central bankers’ speeches So far, important progress has been made towards completing the first review. Specifically, a fiscal package of 3% of GDP until 2018 has been agreed upon, which will be instrumental to achieving a primary surplus of 3.5% of GDP in 2018. Two thirds of the programme measures have already been passed by Parliament, including the necessary social security reform and the income tax reform. The remaining measures, which include changes in indirect taxation and reform of the public sector wage grid, are expected to be enacted in the next few weeks. The Eurogroup of 9 May took stock of the progress with the first review and the Eurogroup of 24 May is expected to make the final decisions on the review, the disbursement of the tranches and the methods of easing the burden of public debt. Consequently, most of the distance to the completion of the review has been covered – as acknowledged by the European institutions. The establishment of a reliable contingency mechanism, which will be triggered in case of deviations, will increase the confidence of our partners and ensure the attainment of fiscal targets. This is expected to have a favourable impact on international markets’ assessment of the prospects of the Greek economy and put in motion a virtuous circle signalling a definitive exit from the crisis. The rate of change in real GDP is expected, at least in the first half of 2016, to remain in negative territory, mainly due to the adverse carry-over effect from 2015. According to the ELSTAT’s flash estimates released today, GDP shrank by 1.3% year-on-year in the first quarter of 2016. The necessary conditions for a gradual recovery of the economy in the second half of 2016 are a further improvement in confidence, an enhancement in the liquidity of the banking system and a further relaxation of capital controls. However, a deterioration of the refugee crisis could have negative repercussions on tourism and trade. In more detail, household consumption expenditure is expected to decline in 2016, reflecting the increased tax burden. The recent data on the volume of retail sales are alarming, showing, as already mentioned, a 6.6% fall year-on-year in February. On the other hand, investment and exports are expected to pick up gradually and in line with the restoration of confidence and of credit flows to the economy. The successful completion of the first review is crucial for the gradual recovery of the economy in the second half of 2016 The successful completion of the first review of the programme will definitely improve confidence and the recovery prospects of the economy in 2016. It is the key to the return of deposits to the banking system and will pave the way to: (i) the reinstatement of the waiver for Greek government bonds by the Eurosystem, which will enable Greek banks to obtain low-cost funding from the European Central Bank (ECB) and (ii) the inclusion of Greek government bonds in the ECB’s quantitative easing (QE) programme. The reinstatement of the waiver and the ensuing cheaper refinancing of Greek banks, coupled with the inclusion of Greek government bonds in the ECB’s QE programme, are expected to have a significant positive impact (potentially amounting to about €400-500 million) on banks’ results over the next year. However, the indirect effects, such as the upgrading of the credit ratings of the Greek government and Greek banks, are expected to be much stronger. Furthermore, the completion of the first review could lead to the implementation of the Eurosystem’s commitment to pay Greece the profits from Greek government bond holdings excluded from the PSI. This commitment has been suspended due to the non-completion of the last review of the previous programme. The so-called ANFA/SMP revenue available to be released, in the order of €10 billion up to 2020, could play a decisive role in the financing of the Greek economy and in the reduction of public debt. All the above, following the successful recapitalisation of banks and coupled with a more effective management of NPLs, will contribute to a further decline in borrowing costs and will BIS central bankers’ speeches increase Greek credit institutions’ lending capacity, with a beneficial effect on the financing and, by implication, growth of the Greek economy. The successful completion of the first review should also be accompanied by the launch of substantive discussions with our partners on debt relief measures. Such measures could include longer bond maturities and grace period for principal and interest payments, so that the government’s financing needs remain at manageable levels. For example, deferred interest payments to the European Financial Stability Facility (EFSF) are scheduled to start from 2022 onwards. As a result, interest payments on a cash basis are expected to rise to 6% of GDP, from 2% of GDP in 2015-2021, given that public debt will then have to be refinanced at market rates after the completion of the programme in 2018. We, at the Bank of Greece, believe that the discussion on debt relief measures should include a downward revision of the ultimate fiscal target. Namely, lowering the ultimate target for a general government primary surplus from 3.5% of GDP in 2018 and beyond to 2% of GDP should be considered, in order to bring forward the return of the Greek economy to sustainable and relatively high growth rates. Besides, experience shows that only one country, i.e. Ireland, has managed to maintain a primary surplus of 3.5% of GDP for a relatively long time period, as required of Greece from 2018 onwards. According to the scenarios we have elaborated, a primary surplus of 2.0% of GDP from 2018 onwards, coupled with a smoothing out of future interest payments on loans from the EFSF, the European Stability Mechanism (ESM) and the Greek Loan Facility (GLF, i.e. the bilateral loans granted under the first programme) over a period of 20 years, and an extension of the maturities of the EFSF and GLF loans over a period of about 22 years, would: • Bring about a significant reduction in interest payments (by about 2.8% of GDP), • Reduce the government’s annual financing needs to manageable levels, i.e. well below 15% of GDP, which is the IMF’s ceiling in the assessment of public debt sustainability, and • Reduce debt-to-GDP ratio to below 100% in 2030 and to 89% in 2035 (compared with 126% without debt relief measures). In other words, these actions to restructure public debt, coupled with (a) a more effective and better-targeted policy for privatisations and for the utilisation of public real estate, (b) a reform effort focusing on opening up those goods and services markets that have not been fully liberalised yet and (c) a more aggressive management of the problem of NPLs by both banks and the Greek government, could directly lead to public debt sustainability, with the ensuing possibility of lowering significantly the ultimate fiscal target. This would be achieved, on the one hand, because these actions would reduce public debt servicing costs, thereby unlocking resources to stimulate the real economy, and, on the other, because privatisations would reduce the level of debt, while the speeding up of reforms and the effective tackling of NPLs would strengthen GDP growth. At the same time, initiatives to restore the sustainability of public debt within this year would lower the risk premium of the Greek economy and reduce the cost of capital, enhancing the credibility and acceptance of the policies pursued, which would improve confidence, with multiple positive effects: new domestic and foreign investment, return of deposits to the banking system and reinvigoration of economic recovery. Key conditions for a new, extrovert growth model In addition to lowering the ultimate fiscal target, for the reasons explained above, and restructuring the high public debt with a view to ensuring its long-term sustainability, what is needed today is the timely implementation of privatisations and reforms under the new programme, which are the cornerstone for the return to economic and financial normality and the shift to a new, extrovert and viable growth model. BIS central bankers’ speeches The implementation of reforms in the goods and services markets and the public sector will lead to higher investment and employment and is also expected to facilitate innovation and the introduction of new technologies through stronger competition. This will improve the quality of Greek exports, while helping to broaden the export base and improve total factor productivity of the Greek economy. In turn, this will make the reduction in the external deficit sustainable and increase potential output over the medium to long term. As already mentioned, together with the implementation of the necessary reforms, utilising the public real estate and pressing ahead with privatisations are the strongest tools not only for boosting investment and achieving sustainable growth, but also for supporting the fiscal adjustment effort, as they would help reduce public debt. Tackling the high stock of NPLs is the most important challenge for the banking system. Addressing this problem will not only alleviate the burden on cooperating borrowers, but will also allow banks to free up funds for lending to the more dynamic and extrovert businesses, thus supporting the shift towards tradable goods and services, which would lead to higher total factor productivity and potential growth, even over the short term. Alongside the necessary reforms, there is a need for active employment policies and training programmes in order to address high long-term unemployment, which leads to marginalisation of parts of the population and loss of human capital. Moreover, social policies need to be redesigned and better targeted, in order to tackle the increased risk of poverty and social exclusion of social groups harder hit by the crisis. As mentioned at the beginning, the restructuring of the Greek economy towards a new, extrovert growth model, based on tradables and a higher share of exports in GDP, is already underway. In more detail, the relative prices of tradable goods and services have risen by about 7% in the 2010-2014 period, making their production more profitable. As a result, the share of tradables in the private economy has risen in recent years. For example, in gross value added terms, the relative size of tradable sectors has grown by approximately 18% in the 2010-2014 period, while in employment terms it has grown by around 8%. Structural changes and improved financing and liquidity in the economy are expected to speed up the restructuring of the economy in favour of tradables. Moreover, thanks to the reforms implemented since 2010, the competitiveness losses (in terms of unit labour costs) of the 2000-2009 period vis-à-vis Greece’s main trading partners were fully recouped in 2015. As a result, the current account deficit fell substantially from its 2008 peak, to almost zero in 2015 (-0.1% of GDP). Despite the recouping of losses in international competitiveness, exports have yet to record the anticipated upward dynamics. This can in part be explained by the lack of financing, comparatively higher long-term borrowing costs, as well as the higher tax burden, which slows or even halts progress towards restoring overall competitiveness. However, it is also due in part to a number of inherent structural weaknesses that hamper the international market penetration of Greek products and involve non-cost aspects such as product quality, protected designation of origin and branding, red tape, etc. Nevertheless, the improvement in cost competitiveness in Greece in recent years provides considerable room for higher exports in the near future. However, new investment will be needed in order to strengthen the export base of extrovert firms. The further opening-up of international trade, the participation in global value chains and the closer trade links with countries and businesses with cutting-edge technology internationally will enable the adoption of new technologies by export firms and their diffusion across the Greek economy, strengthening its long-term growth prospects. BIS central bankers’ speeches Conclusions The Greek economy has the potential and prospects of returning to growth, relying on a new, extrovert growth model and taking advantage of the emerging opportunities. The successful completion of the first review of the new programme after Greece’s strong commitments, which is expected to be decided by the Eurogroup of 24 May, will contribute decisively in this direction. The Eurogroup should in turn live up to the circumstances and deliver on its own commitment, dating back to November 2012 and repeated twice since, to implement actions that will make public debt sustainable and the government’s annual financing needs manageable. The markets seem to have already started to price this in, as reflected in the narrowing in Greek government bond spreads. The Bank of Greece considers that the return of the Greek economy to sustainable and high growth rates will be supported by a lowering of the ultimate fiscal target from a general government primary surplus of 3.5% of GDP in 2018 and beyond to 2% of GDP, without compromising the sustainability prospects of public debt. At the current juncture, it is necessary to implement the privatisations and reforms included in the new programme, with a view to boosting growth. As already mentioned, we should draw on the experience of the other three Member States that have also been under adjustment programmes. These Member States entered the adjustment programmes later than Greece, but managed to exit them before us and, in some cases, their economy is growing impressively. For example, according to the recent spring forecasts of the European Commission, the Irish economy grew by 7.8% in 2015 and is projected to grow by 4.9% in 2016, while Portugal and Cyprus posted moderate but positive growth rates (1.5% and 1.6% respectively) in 2015 and are expected to remain in positive territory also in 2016 (1.5% and 1.7% respectively). The Greek authorities, following the enactment of the required fiscal measures and the expected completion of the first review at the Eurogroup of 24 May, should promptly shift their focus to implementing the reforms in goods and services markets, taking action to tackle the problem of banks’ NPEs and giving new impetus to the privatisation programme. Such actions will have a positive effect on international markets’ assessment of Greece’s prospects and put in motion a virtuous circle, signalling a definitive exit from the crisis. Today, there are big opportunities for Greece that should not be missed. To give one example, China, in an effort to rebalance its growth model, wants to invest abroad. One of the countries it wishes to invest in is Greece. I do not only mean investment in infrastructures and networks, but also in other sectors of the economy, such as industry and finance. To exploit these opportunities, we must appropriately adjust our growth strategy and adopt an extrovert growth model relying, among other things, on privatisations and the utilisation of public real estate, with a view to making Greece a growth hub in the broader region. And, above all, we must have the will to attract foreign investment and not to miss once again the opportunities opening up before us. BIS central bankers’ speeches

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Introductory remarks by Mr Yannis Stournaras, Governor of the Bank of Greece, at the European Bank for Reconstruction and Development (EBRD) workshop on "Sustainability in Banking", Athens, 12 July 2016.

Yannis Stournaras: Sustainability in banking Introductory remarks by Mr Yannis Stournaras, Governor of the Bank of Greece, at the European Bank for Reconstruction and Development (EBRD) workshop on “Sustainability in Banking”, Athens, 12 July 2016. * * * Ladies and gentlemen, distinguished guests, It is a great pleasure to welcome Ms. Sabina Dziurman, Director of the EBRD in Greece, to the Bank of Greece. I would also like to welcome all speakers and participants to today’s workshop on sustainability in banking. With this opportunity I would like to note the EBRD’s function and contribution in Greece. Since the establishment of its representative office in Greece a year ago, EBRD has invested around €340 million mainly through participating in the recapitalisation of the four significant Greek banks as well as financing energy and industry projects. In today’s workshop two perspectives regarding sustainability in banking will be juxtaposed:  The perspective of an international development financial institution, namely of EBRD.  The perspective of Greek systemic banks. The Bank of Greece acknowledges the importance of sustainability both for the financial sector and the economy at large. In this context, the Bank of Greece has been thoroughly studying since 2009 climate change with emphasis on the assessment of its environmental and social impact. At this juncture, as Greek banks gradually begin to restore their intermediation role, they surely need to consider environmental and social issues, such as funding of energy efficiency, renewable energy, and cleaner production methods. Moreover, sustainable banking also entails promoting sustainable restructuring solutions for non-performing exposures (NPEs) both for non-financial corporate entities and households. The efficient management of NPEs is one of the key challenges that the Greek financial sector faces and of utmost importance for the rebalancing of the Greek economy towards tradeable and export-oriented sectors. In turn, this will also free-up scarce resources for the financing of sustainable investments. I look forward to an exciting discussion and a very fruitful exchange of views. BIS central bankers’ speeches

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Speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the third OMFIF Main Meeting in North America, St. Louis, 14 July 2016.

John Iannis Mourmouras: A post-Brexit assessment of risks to debt sustainability in the euro area Speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the third OMFIF Main Meeting in North America, St. Louis, 14 July 2016. * * * Views expressed in this speech are personal views and do not necessarily reflect those of the institutions I am affiliated with. This is an abridged version. The 2008 global financial crisis has led to a rapid accumulation of government debt in most countries of the euro area. Indeed, the euro area government gross debt-to-GDP ratio is estimated to have risen by 28 percentage points from its pre-crisis level in 2007 to stand at 93% in 2015. However, financing concerns are currently mitigated by low sovereign funding costs for almost all sovereign rating categories and solid demand for government bonds against the backdrop of the Eurosystem’s ongoing asset purchase programme (QE). Total debt service of euro area governments for the next 12 months is around 16% of GDP (around €1.6 trillion), a figure which comprises 13.9% of principal and 2.1% of interest expenditure. It is true, however, that despite the fact that debt servicing is much easier today given that lower nominal interest rates worldwide are reflected in reduced coupon payments, risks to debt sustainability are on the downside, as reminded in the latest (pre-Brexit) ECB Financial Stability Review (May 2016). Our objective here is to examine if and how, after the Brexit vote, these risks are indeed heightened. I identify below three such downside risks to debt sustainability in the short- to medium-term, in the aftermath of the British referendum. 1. A low interest rate environment, the new global norm, due to persistently low inflation, increases the disincentive to fiscal consolidation and structural reforms. For instance, negative nominal yields, if applied too long, may act as an anaesthetic to euro area governments. The fiscal space gained from lower debt service costs may slow enactment of necessary fiscal and structural reforms. Brexit could well amplify the above downside risk. The initial market reaction to the Brexit vote was a typical risk-off mode – lower curves, wider spreads, flatter curves. The UK 10-year gilt yield fell under 1% for the first time in records, while German Bunds yields fell to all-time lows over the period, currently trading in negative territory out to a maturity of 15 years with the 10-year German Bund trades around -0.10%. In addition to the flight to safety, the first reaction by major central banks, in an attempt to calm financial markets, has been rather dovish and more accommodative monetary policies are expected in the near future. So, the Bank of England is widely predicted to cut by a quarter point its base interest rate in the August MPC meeting – while a new round of QE is also likely. The ECB may also ease further and its QE programme may be extended beyond March 2017. In Japan, there is even talk of ‘helicopter money’, while in the US, as a result of the Brexit shock a July hike is not on the table, and the market implied probability of a Fed rate hike in 2016 has declined from about 50% on the eve of the UK vote to roughly 10% today. As a result, the 4 major central banks’ divergent monetary paths, which have been the dominant theme in the financial markets since the start of the year, seem to be off the table for now. Indeed, at present, there is a shift from “monetary policy divergence” to “financial markets divergence” through stockbond markets. It is worth reminding a relevant comment made by ECB President Mario Draghi in a recent speech: “[low interest rates]… are not the problem. They are the symptom of an underlying problem, which is insufficient investment demand, across the world, to absorb all the savings available in the economy” (see also right below). 2. Of course the problem in the euro area is that inflation is persistently low, but so too is nominal demand (1% annual increase over the last seven years compared with 3.7% before the 2008 global financial crisis). Clearly, the denominator effect is a risk to public debt sustainability, while anaemic growth and/or a very low inflation are far from helpful. According BIS central bankers’ speeches to the latest ECB forecasts, inflation is now projected to be at a very low level of 0.2% on an annual basis in 2016. Real GDP growth is also expected to be lower than projected in June at 1.6% for 2016 and follow an even more downward trend due to the Brexit effect (the hit to the European economy is a real GDP decrease of around 0.5% over the next three years, but this is a very early forecast). 3. Last but not least, political risks have increased, posing a challenge to fiscal and structural reform implementation. Rising political uncertainty (especially in Spain, Portugal, Greece, Italy and France) and increasing support for populist political parties which seem to be less reform-oriented and with eurosceptic credentials contribute to the downside risks to debt sustainability in the euro area. Of course, in the aftermath of the British referendum the biggest political risk to the whole of Europe is Brexit. Brexit represents a shock to the institutions and norms that underpin markets. Thus, Brexit is different from the euro break-up fears of 2012, the global financial crisis of 2008 or the bursting of the high-tech bubble of 2001. It is not financial contagion, as in 1998, or this February. Instead, it represents a contagious political development. No matter whether we have a full-blown or a light Brexit, the political risk for the rest of the continent is that the referendums will mushroom across Europe in a tug-ofwar between populist forces and the political establishment and elites. This risk is particularly heightened for countries with strong anti-European sentiment such as Hungary, the Netherlands, Denmark, even France. There is an old saying in Brussels that Europe’s leaders are known to have a tried-and-tested method for coming up with policy fixes when forced to cope with emergency situations. PostBrexit Europe has the potential to become an emergency in the not-too-distant future. I only hope that this time is not different. Times will tell. BIS central bankers’ speeches

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Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Eighth ECB Statistics Conference "Micro data for monetary policy decisions: moving beyond and behind the aggregates", Frankfurt am Main, 6 July 2016.

Yannis Stournaras: The use of micro data to support monetary policy decisions Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Eighth ECB Statistics Conference “Micro data for monetary policy decisions: moving beyond and behind the aggregates”, Frankfurt am Main, 6 July 2016. * * * Thank you for inviting me to speak today on the use of micro data to support monetary policy decisions. A couple of years ago the topic would have looked surprising, to say the least. Monetary policy is about broad aggregates and the Eurosystem has a clear mandate to keep the eurozone’s general price level stable without taking into account the distributional effects of its decisions. Since micro data are all about the distribution of income and wealth, their usefulness for monetary policy is far from obvious. Indeed it may look anachronistic. I remember the monetary policies pursued in many countries and in Greece until the 80s, where credit policies and selective credit controls were designed so as to channel funds to particular economic sectors (and even sub-sectors) while excluding other sectors from bank lending altogether. The implementation of these credit controls required a significant amount of micro data. For example, banks had to report not just total loans to non-financial corporations but loans broken down into specific categories like export trade, import trade and tobacco trade. The abolition of those controls brought about the abolition of this detailed micro reporting and its replacement with the reporting of aggregate balance sheet items. No one is suggesting a return to the micromanagement of the economy. Central Banks should remain focused on achieving their aim of price stability for the economy as a whole. With the advent of the financial crisis, however, we have realized that aggregate data are not enough and policy makers need more granular data. This does not mean that there has been some sort of a change in the fundamentals of monetary policy objectives. Our focus continues to be macroeconomic variables and there is no going back to the detailed redistributive credit policies of the past. The use of micro data in today’s monetary policy making serves a rather different purpose. Micro data firstly improve our understanding of the transmission mechanism of monetary policy and secondly allow us to better understand the aggregate data and thus better forecast their evolution. These two aims actually imply that micro data do not only signify a move beyond the aggregates but also a look behind the aggregates. Micro data can either supplement existing aggregate data or replace aggregate data with new data sets of better quality. Micro data can enhance the versatility of aggregate data, as they can be adjusted to accommodate financial innovation, regulatory changes or behavioral reactions to a changing economic environment. Let me start by discussing how granular or disaggregated data can promote the flexibility of the data used for aggregate macroeconomic and monetary analysis. The main method for collecting monetary statistics is what we could name the ‘balance sheet’ method. Statisticians ask policy makers to specify their data needs. Once these needs are recorded, statisticians prepare templates that look similar to the balance sheets that banks publish. Users have to decide on these dimensions. For example, a template on loans can depict economic sectors on the columns and maturities on the rows. Users have to decide on the specific maturity bands they are interested in, enshrine them in regulations on the collection of statistical data and live with this decision for a long period of time. Changing the reporting templates is a difficult and costly process not only for central banks but for the industry as well. The Eurosystem is thus committed to keeping reporting templates fixed for at least five years. What can we do if we have reasons to believe that the instruments we include in monetary aggregates have to change, if the cut-off maturity band for money is not 24 months but 18 months? With aggregate data the only thing we can do is have patience, wait for the next round of amendments to regulations to take effect, by which time new changes may start becoming necessary. A good BIS central bankers’ speeches example of this occurred in my country in the years after 2000, when for various reasons, depositors moved away from ordinary bank deposits and started using repo agreements to an increasing degree. Eventually, this issue was addressed and corrected when repos were rerecognised as deposits, but there still remains an apparent break in the data that complicates the analysis and occasionally leads, even careful economists, to erroneous conclusions. But with granular data, policy needs can be met immediately. Let me give some examples, where I expect the move to micro granular data to make a positive contribution to the quality and timeliness of monetary policy analyses and decisions. Let me discuss specific areas where micro-data can enrich our analysis and improve the quality of decision making. Micro-data can be a way out of Goodhart’s Law. Goodhart’s Law states that as soon as the monetary authorities start targeting a monetary aggregate, this targeted aggregate starts misbehaving, as financial innovation leads to the creation of new financial instruments in an attempt to circumvent regulatory policies. With micro data, a policy maker should be able to follow such developments almost in real time and adjust the targets accordingly. Policy makers will have an easy way to check whether the altered behavior of macroeconomic aggregates is the result of fundamental economic changes or a form of regulatory arbitrage. From Jensen’s inequality we know that if behavioral responses to monetary policy are nonlinear, then the economy’s response differs from the average economic agent’s response as the variance of agents’ characteristics increases. A more diverse economy (or increased inequality) impacts on the transmission mechanism. If the monetary policy instruments’ impact on the distribution of agents’ characteristics is small or unpredictable, then we can assume, at least as a good approximation, that such distributional changes may add noise but have no systematic effect on the behavior of the economy. Recently, there has been increasing reason to believe that this may not be the case. There is now an expanding body of research on the impact of nonstandard monetary policies on asset prices and hence the distribution of wealth. If such a relationship does exist, and if wealth impacts nonlinearly on spending and saving activities, nonstandard monetary policies affect the transmission mechanism. Having a richer set of granular data can help internalize the impact of monetary policy actions on wealth distribution and ultimately lead to a more precise modelling of the transmission mechanism. A much longer line of research looks at the impact of wealth or credit constraints on the behavior of households and thus on the transmission mechanism. This is important in order to gauge how fast monetary easing will bear fruits by fostering demand growth. Micro data can help us go beyond aggregate Euler equations and have a richer analysis. We can identify the characteristics of households that are creditconstrained, but also how severe the constraints are. We can also examine the importance of various forms of wealth (housing or various financial instruments) and how closely households’ assets and liabilities are aligned. The Eurosystem has long understood the necessity of this kind of information and has organized the Household Finance and Consumption Survey that is conducted every 2 to 3 years. All euro area countries collect data at the level of the household on income, consumption, wealth and debt. The survey has considerably enriched our data on wealth. At the same time, answering the above questions requires micro data – at the level of the household and/or individual – since this allows for a more precise measurement of the impact of monetary policy on the real economy. Although we are still in the process of analyzing the results of only the second wave of this survey, we can see that we have the raw material that can help us answer a number of questions. How does wealth feed into consumption behavior? Does the effect of wealth on consumption differ across households, depending on their age, whether they are homeowners or not, whether they have debt? As we move forward and complete further waves of this survey, we shall be able to infer some information on the dynamics of micro-data, and relate them to macroeconomic variables. Thus, it is possible to investigate the differential effects of asset price changes, consequent on a monetary policy decision, on individual euro area BIS central bankers’ speeches households. Thus rises in equity prices raise inequality, rises in house prices reduce it and the impact of changing bond prices is largely neutral. The richness and diversity of economic structures across the eurozone has added complications, but also provided food for thought. An important outcome of conducting this survey simultaneously for the whole of the eurozone was that it forced us to align the operational definitions of micro variables across many countries, an exercise that will help us in the future when we collect other micro-data. It has also provided very concrete examples of how differences in economic structures have wider implications, like the impact of homeownership or population ageing on consumer and saving decisions. While continuing the Household Finance and Consumption Survey (HFCS), we should integrate its results with the rest of macroeconomic data. An often unacknowledged secret is that in most macroeconomic accounts the household sector is treated as a residual for lack of comprehensive information. The HFCS should help us fill this gap and get a better grasp on financial relationships in the economy. Another example of a micro dataset collected by the ESCB through the Wage Dynamics Network was a survey of firms in each country to determine their wage and pricing policies and their responses to shocks to demand. The first wave of data was collected before the crisis and sought to investigate wage and laborcost dynamics and their relevance for monetary policy. These dynamics have implications for how firms and ultimately the real economy in general respond to economic shocks. Thus, firms were asked how often they change wages, how they judge by how much wages should change, whether changes in wages then feed through into price changes, the institutional framework of wage bargaining along with the degree of competition in the sector in which they operated. The current wave is focusing on the labor market reforms that have occurred in a number of countries during the crisis in an attempt to determine whether reforms are associated with a change in wage-setting behavior. It can thus help us understand to what extent the crisis has affected microeconomic behavior, in particular by inducing greater price and wage flexibility, and to what extent such changes impact on the transmission mechanism. As a final example of the growing importance of micro-data, let me remind you of the Governing Council’s decision a few weeks ago to proceed with the collection of granular, loan-by-loan, credit data, the already famous AnaCredit project. This project, complementing the existing Securities Holding Statistics (SHS) database, will allow us to have a quite detailed view of the corporate sector’s liabilities and the way they are managed. This will allow a much more granular analysis of the impact of monetary policies and relate firms’ behavior to a host of microeconomic and financial variables, such as size, credit worthiness, sector of the economy and so on. We hope to be able to have a more complete and nuanced answer to questions that perplex us, such as what is holding back investment at the zero bound, and what is needed to kick start the investments. Having spent all this time presenting the potential benefits of micro data for monetary policy making, I feel an obligation to warn that it will not be plain sailing ahead. We have to work hard to resolve many issues that will unavoidably arise. First of all, we should deal with concerns that we are creating “Big Brother”. Granular data, almost by definition, cause concerns about safeguarding personal information. Most granular data of interest to central banks are about corporate entities. They do not contain sensitive personal information, but often they contain important market-sensitive information. Even so, improper use may be detrimental to some, or they may be used as a coordinating device in an oligopolistic setting. To some, such concerns may look like a nuisance that should not become an obstacle on the road to a bright new future of “big data”. This would be a mistake. It will only raise suspicions and lead to a worsening of the quality of the data. Central banks should be in the forefront of developing best practices and adequate safeguards that allow the use of such data without impinging on individuals’ privacy. BIS central bankers’ speeches Second, we should be aware of the risk of drowning in a sea of data. As Nobel laureate Herbert Simon put it: ‘A wealth of information creates a poverty of attention’. The rather obvious characteristic of micro data is their size: micro data by construction are an overwhelming amount of information. It is important to look not only at the benefits of micro but also at the risks for policy makers. The risk is that policy makers are bombarded with too many numbers and, as a result, decision making is delayed. A simple example can elaborate this point. Consider one of the key variables monetary policy monitors, M3 growth. The aggregate data on M3 is just one number or one time series, say 12 monthly observations. What are the corresponding micro data? One possible disaggregation of the aggregate is to look at the 6,000 numbers describing the evolution of specific types of deposits in every single credit institution. What can policy makers do when confronted with, say, 6,000 numbers? Not much. Perhaps they will set up a task force to examine the data and come back with a report in a month or two. It is important to note that policy makers do not and should not really use micro data. Consider, for example, the micro data collected through the Household Consumption and Finance Survey I have mentioned before. Are policy makers supposed to dig into these mass of data? Of course not. The idea is to channel these data into statistical models that can produce interesting and useful summary statistics and uncover relationships which are important for policy success. Policy makers should ask to see a picture of the whole forest, not a list of trees and should transfer to statisticians and economists the task of developing models and summary statistics that will follow developments and provide answers to their policy concerns. In order then not to lose sight of the forest, economists and statisticians must have clever tools that allow the proper manipulation of the micro data. Policy makers must demand useful information squeezed out of the micro data so as to gain a better insight on the aggregate data. Is M3 growth for real, or just the artifact of regulatory arbitrage? What is driving its growth? Is it a widespread phenomenon or a few special outliers? What is behind a surge in credit? A few large corporations or many SMEs? The point is that statisticians have their work cut out. We do not just ask them to collect the biggest amount of data and store them somewhere. We ask them to develop clever, versatile tools that can provide intelligible answers to policymakers’ queries. Clever tools are thus necessary, if policy makers are to profit from granular data. You are all familiar with the famous computer principle ‘garbage in, garbage out’. The problem with micro data is not to end up in a situation where lots of good quality information goes in but nothing comes out. In order to be able to manipulate micro data we need two things: common identifiers and reference databanks. These are necessary in order to organize all this huge information in an efficient way, so that it can be manipulated to produce the answers to the questions asked by policymakers. As I mentioned before, the extensive use of micro data by central banks is shifting the compilation burden from reporting institutions to NCB statisticians. It is thus necessary to provide to our statisticians adequate resources so that they can cope with the additional demands placed on them. I can see that we stand at the start of a period where central banks, like everyone else, will make use of “big data” and we should learn how to use them to maximize their benefits. While these potential benefits are large, the effort needed is equally significant. We need to invest in information technology infrastructure, but we also need to educate our statisticians how to deal with the new larger and more complicated data sets. The costs will be high and will fall mainly on the central banks. Instead of receiving readily usable processed information, we are beginning to demand from reporting agents huge amounts of granular information that is then processed in-house by our statisticians. There is a need to streamline the process of collecting data. In particular, we should exploit to the maximum synergies between the collection of supervisory and (traditionally) statistical data, by developing common definitions to the extent possible, or simple rules to transpose the ones into the others. BIS central bankers’ speeches Central banks are leaving the small safe harbor of simple, aggregate data and are opening up to the brave new world of granular big data. In order not to get lost, we need new skills, more crew, that is statisticians, and stronger vessels, that is better and more versatile models. We hope that in the end we shall reach the island of (price) stability. BIS central bankers’ speeches

bank of greece

Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, to the Standing Committee on Economic Affairs of the Hellenic Parliament, Athens, 11 July 2016.

Yannis Stournaras: Bank of Greece’s Monetary Policy Report 2015-2016 Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, to the Standing Committee on Economic Affairs of the Hellenic Parliament, Athens, 11 July 2016. * 1. * * The completion of the first review has a positive effect on confidence and enhances the growth prospects The completion of the first review has a positive effect on confidence and enhances the growth prospects, with direct and indirect benefits, including: • First, the disbursement of successive loan tranches totalling €10.3 billion. The first tranche of €7.5 billion has already been disbursed; of this amount, €5.7 billion will be used for public debt servicing and €1.8 billion will be used to settle part of general government arrears. The remaining amount of €2.8 billion (of which €1.7 billion will be used to pay general government arrears) will be released by autumn 2016, conditional on a number of prior actions in the following areas: the pension system; bank corporate governance; energy; privatisations; the general secretariat of public revenue; and the labour, product and services markets. This should have a positive impact on liquidity and economic activity in the second half of 2016. • Second, the recent decision of the ECB Governing Council to reinstate the waiver for Greek government bonds, enabling Greek banks to obtain low-cost financing from the European Central Bank (ECB). This development, along with a dissipation of uncertainty, the stabilisation of private sector deposits and the progress achieved in restructuring Greek banks, has contributed to the lowering of the emergency liquidity assistance (ELA) ceiling for Greek banks by €9.5 billion since late June, bringing it down to €58.6 billion. • Third, the eligibility of Greek government bonds for inclusion in the ECB’s quantitative easing programme towards the end of 2016. This, together with the reinstatement of the waiver for Greek government bonds and the resulting refinancing of Greek banks at a lower cost, should have a sizeable beneficial effect, potentially amounting to €400-500 million, on banks’ results. However, the indirect benefits, through e.g. upgrades of the credit ratings of the Greek sovereign and Greek banks, are expected to be even greater. The above developments are expected over the medium term to encourage a return of deposits to the Greek banking system, which will allow an easing and, ultimately, lifting of capital controls. Coupled with a more effective management of non-performing loans, this will contribute to reducing borrowing costs and will gradually increase the lending capacity of Greek banks, with positive effects on the financing, hence the growth performance, of the Greek economy. In general, the completion of the first review is impacting favourably on the Greek economy, by strengthening confidence and removing the uncertainty that has weighed heavily on the economic climate and led to a postponement of investment decisions. The gradual restoration of confidence as a result of the completion of the first review is reflected in several leading indicators of economic activity. For example: • The industrial PMI index, which had fluctuated below the growth/contraction threshold from February to May 2016, rose above that threshold in June 2016 (to 50.4, from 48.4 in May), indicating a marginal increase in manufacturing output and posting its highest value since May 2014. BIS central bankers’ speeches • The economic sentiment indicator stabilised in June (at 89.7), as the decline in service and retail confidence was offset by an improvement in industrial and consumer confidence, with the latter reflecting households’ more optimistic expectations about the overall economic situation and their financial condition over the next 12 months. At the same time, the completion of the first review contributed to a decline in the yields of Greek government bonds and corporate bonds issued by Greek non-financial firms on the international market. However, the global capital market turbulence in the wake of the UK referendum, in which a majority of British citizens opted to leave the EU, has contributed to a reversal of this downward trend and an increase in yields. Building on the elimination of macroeconomic and fiscal imbalances and the significant improvement of unit labour cost competitiveness over the 2010-2015 period, economic policy focus must now shift to the reforms and privatisations agreed upon between the Greek government and the institutions, as well as to the utilisation of idle state property, which can serve as a catalyst for attracting investment. These actions would support growth, while facilitating the achievement of future budgetary targets of the programme. 2. The Eurogroup’s commitment to take action on debt relief The successful completion of the first review is accompanied by a commitment from our partners to take action to reduce the Greek debt burden. The Eurogroup statement of 25 May describes the timeframe and outlines a number of actions to be implemented, if deemed necessary, in order to bring the gross financing needs of the general government down to more manageable levels, i.e. below 15% of GDP in the medium term and below 20% in the long term. The Bank of Greece takes the view that, in the first place, the expressed will of our partners to provide debt relief strengthens confidence in the future of the Greek economy. However, the measures included in the Eurogroup statement have not been specified or quantified, whereas the final decisions on debt will be re-examined after the completion of the programme and are conditional on (i) a positive final assessment of the programme implementation; and (ii) the outcome of an updated debt sustainability analysis to be produced in 2018. The Bank of Greece considers that there are important reasons to act now. • First, global interest rates are at historical lows and the term structure is relatively flat, implying that, at the same cost, debt relief could be much more beneficial to Greece now than a few years down the road, when global interest rates might be higher. • Second, debt relief now will contribute to improved confidence of international investors in the country, hence, to lower risk premia, lower cost of financing, stronger investment and improved growth prospects for the Greek economy. Sensible debt relief measures could include: (a) extending maturities; (b) smoothing interest payments over time; (c) restoring the transfers of ANFA and SMP profits; (d) swapping IMF for ESM loans. In the view of the Bank of Greece, debt relief measures should be accompanied by a lower medium-term fiscal target. Specifically, the final target for a general government primary surplus of 3.5% of GDP could be reduced to 2% of GDP after 2018, enabling a faster return of the Greek economy to robust and sustainable growth rates. Besides, past experience has shown that very few countries have been able to maintain high primary surpluses of 3.5% of GDP over relatively long periods, as required in the case of Greece from 2018 onwards. BIS central bankers’ speeches An important argument supporting this view is that, given the current debt dynamics, one percentage point higher growth is 80% more effective in reducing the debt-to-GDP ratio than a one percentage point of GDP higher primary surplus. Public debt sustainability scenarios explored by Bank of Greece staff show that primary surpluses of 2% of GDP from 2018 onwards are consistent with public debt sustainability, assuming: (a) an extension of loan maturities by 20 years; and (b) the smoothing of capitalised deferred interest payments over a 20-year period. Moreover, the easing of fiscal targets will allow a lowering of taxation. This would alleviate the consequences for the real economy, thereby strengthening growth in the medium-to-longer term, which could speed up the reduction of public debt. 3. Developments in the banking system: liquidity, non-performing exposures and capital controls (a) Liquidity The completion of the review will largely dispel the remaining uncertainties. Combined with the anticipated exit of the Greek economy from the recession onto a path of sustained growth as adjustment and reforms bear fruit, reduced uncertainty should lead to a return of deposits to Greek banks and the improved access of domestic credit institutions, as well as of healthy extrovert Greek businesses, to international financial markets. From the beginning of the crisis, the Greek banking system suffered the consequences of successive sovereign downgrades, followed by bank downgrades that forced Greek banks out of the global financial markets. Meanwhile, uncertainty led to large deposit outflows, amounting to some €90 billion, i.e. one third of the initial deposit base, in less than three years. Banks had to resort to a large extent to central bank funding, at first through Eurosystem monetary policy operations, but gradually, due to the lack of eligible collateral, to emergency liquidity assistance (ELA) from the Bank of Greece. It should be noted that ELA funding peaked at €120 billion in 2012, before gradually declining and coming to zero in the first half of 2014. Thanks to the broad liquidity support from the central bank, the decline in bank credit to businesses and households was much weaker than the contraction of the banks’ deposit base. The deteriorating economic climate and heightened uncertainty in the first half of 2015 led to widespread deposit outflows, totalling some €45 billion. Of this amount, about one third involved the withdrawal of banknotes (for hoarding “under the mattress”); one third was transferred to banks abroad; and one third was invested in foreign money market instruments. The bank holiday and the imposition of capital controls (including restrictions on cash withdrawals from bank accounts, cross-border payments and cross-border capital movements) managed to contain the deposit outflows and the capital flight. At the same time, capital controls encouraged the use of electronic payments. In fact, there is strong evidence that the widespread use of electronic payments have boosted tax revenue by reducing the informal economy. The recapitalisation of Greek banks was successfully completed in December 2015, with a substantial participation of private investors. The four significant Greek banks managed to cover the capital needs identified by the ECB’s stress tests. The necessary funds came from (a) foreign investors, who placed around €5.3 billion; (b) capital mitigating actions amounting to €0.6 billion; and (c) liability management exercises (voluntary bond swap offers to bank bondholders) that yielded about €2.7 billion. For the two banks that did not fully cover their capital needs, based on the adverse scenario, from private sources (totalling about €5.4 billion), the necessary additional funds were drawn from the Hellenic Financial Stability BIS central bankers’ speeches Fund (HFSF). Thus, the public resources used proved to be far lower than the amount of €25 billion foreseen by the Eurogroup in August 2015. Moreover, banks’ reliance on ELA has decreased and, since end-July 2015, the ceiling has been lowered by more than €31.5 billion to €58.6 billion. This lower ceiling reflects the improved liquidity situation of Greek banks amid easing uncertainty and a stabilisation of private sector deposit flows; the gradual and improving access regained by banks to interbank market funding (in fact using collateral not eligible for Eurosystem operations); and progress with the recapitalisation of Greek banks. It also reflects progress with the restructuring of Greek banks (with the sale of Finansbank by the National Bank of Greece), and the impact of the ECB Governing Council’s decision, on 29 June, to reinstate the waiver. With particular regard to deposits, more than €2 billion returned to the banking system between 20 July 2015 (when the bank holiday was abolished although capital controls remained in force) and the end of 2015. During the first half of 2016, deposits showed signs of stabilising. Meanwhile, there has been a gradual but steady return of banknotes, with a deposit inflow of about €4 billion since 20 July 2015. The acceptance of Greek government securities as eligible collateral for open market operations, through which the Eurosystem refinances euro area banks on highly favourable terms, will reduce funding costs for banks, which are expected to increasingly participate in the Eurosystem’s targeted longer-term refinancing operations (TLTROs) and in other nonstandard monetary policy instruments. More generally, the Greek banks have benefited from a number of monetary policy measures taken by the ECB, such as interest rate cuts and targeted longer-term refinancing operations (TLTROs). They have also benefited from the public sector purchase programme (PSPP), by selling to the Eurosystem notes (of up to an amount of €19 billion) that had been issued and contributed by the European Financial Stability Facility (EFSF) to strengthen the capital base of Greek banks. The sale of EFSF notes could bring capital gains of some €200 million to Greek banks. Now that the waiver has been reinstated, the ECB Governing Council will at a later stage also examine possible purchases of Greek government bonds under the public sector purchase programme (PSPP) (a nominal amount of about €3.7 billion after the end of July 2016), taking into account, as stated in a relevant ECB announcement, the progress made in the analysis and reinforcement of Greece’s debt sustainability, as well as other risk management considerations. More generally, as mentioned above, access to lower-cost refinancing from the Eurosystem, coupled with the participation of Greek government bonds in the ECB’s quantitative easing programme, should have a sizeable beneficial effect, potentially amounting to €400-500 million, on banks’ results. Even greater, however, would be the indirect benefits, through e.g. upgrades of the credit ratings of the Greek sovereign and Greek banks. (b) Non-performing exposures The major problem facing the Greek banking system today is the high stock of non-performing exposures (NPEs) in bank portfolios. Greece has the second highest NPE ratio in Europe (after Cyprus), with non-performing exposures at the end of the first quarter of 2016 reaching 45% of total exposures or, in absolute terms, €108.6 billion. In particular, the NPE ratio came to 67% in the SMEs sector, 42% for housing exposures and 55% for consumer exposures. The above NPE ratios have yet to top out, moving inversely to GDP. In the first quarter of 2016, NPEs increased further by €600 million. Yet, a trend towards deceleration seems to have set in, considering that the increase in 2015 as a whole surpassed €4 billion. BIS central bankers’ speeches Despite the size of the problem, the capital base of the banking system remains strong, with the provision coverage ratio standing at 50%. If one adds to this the value of collateral pledged, total risk coverage comes to 101%, one of the highest in the EU. Recognising the seriousness of the problem, the Bank of Greece, as early as in 2013, took a number of initiatives, either by conducting studies or by issuing legal acts and regulatory provisions to address NPEs. Following a thorough analysis of the situation (Troubled Assets Review), Executive Committee Act No. 42/2014 was adopted, establishing a supervisory framework for the management of loans in arrears and non-performing loans, whereby banks are required to report, on a quarterly basis, in the most detailed manner at European level, data on their NPEs and the actions they have taken for their management, as well as their internal reorganisation for this purpose. A few months later, in the autumn of 2014, the Bank of Greece introduced a Code of Conduct for Banks for the transparent, effective and, where appropriate, flexible treatment of cooperating borrowers facing difficulties in servicing their debt obligations. The Code ensures that borrowers are provided with timely and comprehensive information and are protected against unfair treatment by creditors, and is geared towards promoting permanent and sustainable arrangements, whether forbearance or resolution and closure solutions. The Bank of Greece has worked closely with the relevant ministries on the preparation of legislation enabling the effective tackling of NPEs, such as Law 4307/2014 (“corporate insolvency for SMEs”), amendments to Law 3869/2010 (“household insolvency”) and, more recently, amendments to Law 4354/2015 to permit the assignment of the management and the transfer of loan portfolios to specialised non-bank entities. By authority of that law, the Bank of Greece adopted Executive Committee Acts Nos 82/2016 and 95/2016 detailing the licencing framework for credit servicing firms, striking a balance between speed, transparency, efficiency and borrower protection. Last but not least, the Bank of Greece, jointly with the Single Supervisory Mechanism (SSM) of the European Central Bank, decided to set binding operational targets for all Greek banks with a view to ensuring a reduction of NPEs over a horizon of three years. On 24 June, as instructed, banks submitted their detailed targets by NPE category for the remaining two quarters of 2016 and their annual targets for 2017, 2018 and 2019. They also provided specific documentation on their NPE management strategies and the instruments that they plan to use to achieve the targets set. More specifically, according to the targets of the four systemic banks, NPEs should be reduced by 40% or €41 billion by 2019. This reduction is expected to result from: first, the economic recovery envisaged in the Programme and the ensuing return to profitability for a large swath of businesses; and, second, successful debt forbearance/restructuring whereby nonperforming loans will become performing again. A small percentage of non-performing loans (about 5%) are likely to be sold, while no more than 7% of total NPEs are likely to be subject to collateral realisation. The Bank of Greece evaluates and approves banks’ NPE management strategies on the basis of the following key priorities: • avoidance of short-term solutions and provision of sustainable long-term forbearance solutions or resolution and closure solutions; • promotion of multiple creditor workouts; • the restructuring of indebted viable businesses through new business planning and, if necessary, new management along with loan restructuring; • active use of the existing stock of provisions and collateral for the permanent removal of troubled assets from bank balance sheets; BIS central bankers’ speeches • development within banks of new organisational methods and processes for the objective and transparent selection of workout solutions. To sum up, the size of NPEs is the most critical long-term challenge for both the banking system and the real economy. However, under certain conditions, it can also serve as a catalytic opportunity to attract investment and remedy the unhealthy situations that have long hindered the restructuring of production and hampered the competitiveness of the Greek economy. (c) Capital controls Following the bank holiday and the imposition of capital controls on 28 June 2015, it became an utmost priority to ensure the smoothest possible functioning of the Greek economy. Since then, the restrictions have eased considerably, also on the back of progress in various areas, notably the recapitalisation of Greek banks towards the end of 2015 and the recent successful completion of the first review. This latter fact will allow us to proceed to a further, albeit always cautious, relaxation of restrictions. Throughout this period, the Bank of Greece has been working closely with the Ministry of Finance on developing a roadmap towards gradually lifting restrictions in line with progress in achieving important milestones for the Greek economy. In this context, a proposal was submitted today to the institutions, with a new set of relaxation measures, accompanied by relevant documentation, aimed both to facilitate the operation of Greek enterprises and to further enhance banks’ liquidity situation, thereby serving to improve sentiment among depositors, investors and businesses. The new relaxation measures include: • lifting the restriction on cash withdrawals in cases of new deposits in cash (“new funds”); • full lifting of the ban on early loan repayments; • increasing the percentage of cash withdrawals from deposit accounts to which funds are transferred from abroad, from 10% to 30% of the total funds transferred; • allowing cash withdrawals of up to €840 every two weeks. At the same time, our goal is to shorten the execution times for fund transfers abroad and to reduce the costs arising from the imposition of capital controls. The Committee for the Approval of Bank Transactions, which has played a substantial role towards achieving this goal, is currently in the process of amending its decisions in order to: • increase the limit up to which bank subcommittees may approve transactions (currently €250,000 per customer per day) and the amounts directly executable by banks in transactions without the requirement of prior history (currently €20,000 per customer per day). Our target is for businesses to be granted approval up to the next business day, in order to protect their reputation with their foreign partners; • increase the limits on the use of cards abroad, and re-open almost all international websites for online purchases, thereby facilitating the transactions of both legal and natural persons with foreign counterparties; • increase the monthly limit (currently €1,000) on fund transfers abroad from banks and payment institutions. Meanwhile, following an intervention from the Bank of Greece, banks have stepped up procedures for the supply of POS terminals not only to retailers but also to independent service providers, restaurants and cafés, etc. Apart from offering convenience to consumers, this also helps to curb tax evasion. BIS central bankers’ speeches In this regard, it should be mentioned that the fees charged by Greek banks on POS usage correspond, on a weighted average basis, to about 1.1% of the payment amount, compared with 1.8% in the US and 1.3% in the EU, and that the bulk of these fees goes to international card clearing houses and not the banks themselves. Finally, it is important to note that Bank of Greece inspections of compliance with the capital controls legislation have shown that the banks’ management and staff have effectively ensured the compatibility of their operations with the regulatory framework, despite the various implementation difficulties. In conclusion, the Bank of Greece is preparing the next steps and making every effort for the fastest possible return to normality. The next changes, like the ones made so far, will need to be well-designed, so as to effectively improve the functioning of the economy, without hampering liquidity in the system, and, once macroeconomic and financial stability has been consolidated, to ultimately remove the restrictions. 4. Prospects of economic recovery and potential risks In the first months of 2016, economic activity was adversely affected by the imposition of capital controls and by the delays in the completion of the first review of the new programme, initially expected in the fourth quarter of 2015. These developments, coupled with the negative carryover effect from 2015, caused GDP to contract for a third quarter in a row. Specifically, after the decline of GDP on an annual basis by 1.7% and 0.9% respectively, in the third and the fourth quarter of 2015, economic activity fell in the first quarter of 2016, both year-on-year (-1.4%) and quarter-on-quarter (-0.5%). The forecasts of the Bank of Greece point to a recovery starting from the second half of 2016 and continuing through 2017 and 2018. Specifically, GDP is projected to post a small decline of 0.3% in 2016, but then to grow by 2.5% and 3% in 2017 and 2018 respectively. These projections assume that the completion of the review in the first half of 2016 will, from the second half of 2016 onwards, bring about significant positive effects for the liquidity of the financial system, reduce uncertainty and improve the economic climate, with important implications for the evolution of key components of domestic demand. They also assume that the accommodative monetary policy of the ECB will continue. Regarding the inflation outlook, the downward trend of prices is projected to come to a halt in 2016, followed by a gradual increase in 2017 and 2018. For 2016, continued weak demand and low oil prices are expected to offset the recently enacted increases in indirect taxes. For 2017 and 2018, prices are projected to rise slightly as a result of expected higher oil prices, a gradual recovery of demand and the effect of indirect taxes. The downward trend in unemployment is expected to continue at a slower pace during 2016. The rise in employment, in conjunction with the expected dynamic return to growth during the period 2017-2018, should contribute to a faster reduction in the unemployment rate. Nevertheless, risks to the outlook of the Greek economy remain. Furthermore, any delay in the implementation of reforms and privatisations envisaged in the programme would dampen economic growth, thereby refuelling uncertainty, undermining confidence and weakening the prospects of a definitive exit from the crisis. In addition, an exacerbation of the refugee crisis could hurt tourism and trade, slowing economic recovery. Meanwhile, there remain risks and uncertainties regarding the course of the global economy, stemming, among other things, from the prospect of a Brexit in the wake of the recent referendum. These risks could slow down the recovery of the Greek economy, both through negative effects on tourism and trade and through the slower-than-expected decline in yields on Greek government bonds due to the risk aversion of global investors. BIS central bankers’ speeches In any event, the impact from the outcome of the UK referendum cannot be fully assessed and will depend on the next moves of the British government and the subsequent negotiations with the European Union. In the medium term, any impact from the UK referendum will depend on the decisions of the EU Member States and the relevant EU institutions and bodies with a view to further strengthening and deepening the Economic and Monetary Union. 5. Key requirements for a return to sustainable growth Based on the developments in the real economy and the expected positive impact of the first review, it is reasonable to predict that the end of the recession is close and that clear signs of recovery will become visible in the latter part of 2016. Moving on from this recovery to sustainable and strong growth will require a number of tangible and concerted actions, aimed to restore a “growth environment”. These actions comprise: 1st. Consolidating confidence and strengthening the view that the Greek economy has returned to normality and there will be no backtracking. To achieve this, reforms and privatisations need to be implemented with consistency and continuity. 2nd. Utilisation of public property. As suggested by the Bank of Greece long ago, together with the implementation of necessary reforms, putting idle public property to good use and speeding up privatisation processes are the strongest tools for boosting investment activity and achieving sustainable growth, but also for supporting fiscal adjustment, insofar as they serve to reduce public debt. 3rd. Tackling the high stock of non-performing loans, which is the greatest challenge facing the banking system. Addressing this problem will not only alleviate the burden on cooperating borrowers, but will also enable banks to free up funds for channelling into more dynamic and extrovert businesses. This would contribute to a comprehensive restructuring of the economy in favour of tradable goods and services, leading to a rise in productivity and potential output, even in the short run. The actions described above, together with an exit from recession and a gradual recovery of the economy, will bring about stabilisation and, subsequently, a decline in the NPL ratio, with beneficial effects on the economy as a whole. 4th. Gradual lifting of the capital controls. The relaxation of the capital controls described earlier, along with improvements in confidence and liquidity, are expected to contribute to the normalisation of economic conditions by facilitating both enterprises and individuals in their transactions. 5th. Reforms to support extroversion. The implementation of reforms in the markets for products and services and in the functioning of the public sector will lead to an increase in investment and employment, while it is also expected to encourage innovation and the introduction of new technologies by increasing competition. In turn, these developments will improve the quality of Greek exports and expand the export base and overall competitiveness of the Greek economy. This will ensure that the decrease in the current account deficit is sustainable, while also increasing potential output in the medium-to-long term. These actions will attract foreign direct investment and set in motion a virtuous circle signalling the definitive exit from the crisis and a sustainable increase in total productivity of the Greek economy over the medium-to-long term. 6. Conclusions The completion of the first review creates positive prospects for the recovery of the Greek economy in the second half of 2016. At the same time, 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. BIS central bankers’ speeches The Bank of Greece is of the view that 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. Moreover, the Bank of Greece considers that a return of the Greek economy to realistic and sustainable rates of growth would be further supported: First, by the unwavering implementation of the necessary reforms and privatisations described in the recent agreement between the government and the institutions, and the utilisation of idle public property through appropriate measures to improve land use. Secondly, by 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, through mild debt relief measures including an extension of loan maturities and a smoothing of capitalised deferred interest payments. This would allow taxation to be lowered and would free up resources for supporting economic activity, while making fiscal targets economically and socially feasible. BIS central bankers’ speeches

bank of greece

Welcome address by Mr Yannis Stournaras, Governor of the Bank of Greece, at the presentation of the book by Dirk Schoenmaker and Nicolas Veron: "European Banking Supervision: The first eighteen months", Athens, 14 July 2016.

Yannis Stournaras: “European Banking Supervision: The first eighteen months” Welcome address by Mr Yannis Stournaras, Governor of the Bank of Greece, at the presentation of the book by Dirk Schoenmaker and Nicolas Veron: “European Banking Supervision: The first eighteen months”, Athens, 14 July 2016. * * * We are really pleased and honored to have you here for the presentation of the study related to the first eighteen months of the European Banking Supervision. I strongly believe your work brings valuable insight in an era involving new policy regimes that have brought forward profound change to the European banking landscape. I also feel the work presented here today is essential as it provides an excellent overview related to SSM’s operations as well as the response to several challenges. Needless to say if we were having this discussion a couple of years ago it would have been hard to anticipate that a major organization of this size would be fully operational at such an early stage and truly competent in dealing with major issues in the euro-area. It is equally important to understand that these challenges have not changed much over the past few years: asset quality deterioration, market segmentation and business model viability are still issues to be tackled by monetary policy and supervisory decision makers in our days. It is worthwhile examining a persistent characteristic during these years, indicative of these considerations: shares of European banks have been trading at a discount to tangible book value, while those of the largest US banks trade at a premium to book value. A comparison of capital-adequacy ratios can no longer explain this difference in valuation multiples, as capital ratios for euro area banks have risen from about 8 percent in 2008 to about 14 percent today. On the contrary, they are indicative of a European banking sector undergoing a transformation that demands a comprehensive and radical adjustment of the core business model of operation. I feel that, eight years after the financial crisis, we are still witnessing a transition phase. Banks are definitely stronger than one decade ago, capital adequacy ratios do demonstrate that, but they are still adjusting their business models to a post-crisis world. At the same time, they also have to address legacy issues with problems of non-performing exposures adding to the overall assessment of investment considerations. The euro-area financial crisis, as originated in the end of the previous decade, provided the perhaps most serious challenge to the stability of the European Union; it is now well understood that a monetary union is not viable in the absence of a banking union. More recently, with the recovery in the euro area still fragile, new geopolitical tensions have led to an unprecedented refugee crisis and increased uncertainty. Finally, matters such as the consequences of Brexit, different approaches among member states regarding banking union, and the slow progress in establishing a single European deposit insurance scheme, have been hindering further progress in securing the financial system architecture needed to enhance stability. SSM has been the catalyst for the Banking Union of the EU. It provides a framework for common rules and policies across the euro area banking sectors; it enhances single supervisory treatment over segmented national practices. But it also has to cope with increased uncertainty in two areas: the possibility of major changes in the future regulatory framework and the way that new regulation is going to be applied. BIS central bankers’ speeches

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Introductory remarks by Mr Yannis Stournaras, Governor of the Bank of Greece, at the European Bank for Reconstruction and Development (EBRD) information session on its Trade Facilitation Programme (TFP) on financing foreign trade with Greece, Athens, 15 September 2016.

Yannis Stournaras: The EBRD’s Trade Facilitation Programme on financing foreign trade with Greece Introductory remarks by Mr Yannis Stournaras, Governor of the Bank of Greece, at the European Bank for Reconstruction and Development (EBRD) information session on its Trade Facilitation Programme (TFP) on financing foreign trade with Greece, Athens, 15 September 2016. * * * Ladies and gentlemen, distinguished guests, It is a great pleasure to welcome you all here today to this information session on the Trade Facilitation Programme of the European Bank for Reconstruction and Development. I would particularly like to welcome today’s speakers from the EBRD as well as representatives from the local banking community who will be participating in a panel discussion later on. The importance of the Trade Facilitation Programme for Greece cannot be over-emphasised. One of the features of the Greek economy on the eve of the crisis was its lack of openness. Economics textbooks talk about the economics of “small open economies” in contrast to that of “large closed economies”. Greece was best described as a “small closed economy” whose growth was largely driven by internal demand and, in particular, consumption. Exports and imports averaged 53 per cent of GDP in the period 2000-2009 compared to almost 70 per cent in the euro area as a whole. In 2008, the current account deficit had reached almost 15 per cent of GDP. This unsustainable growth model has been changing through the crisis. The competitiveness gap, which had opened up post entry into EMU, was eliminated through internal devaluation. The current account deficit is now close to balance. Whilst the majority of adjustment in the current account since 2008 has come about through a fall in imports, exports of goods and services (excluding shipping) have increased by 27 per cent in real terms. Moreover, Greek goods export shares have increased significantly since 2010, especially vis-à-vis non-EU countries. Exports and imports as a percentage of GDP now stand at just over 63 per cent. Crucial to continued rebalancing of the economy in this fashion is the provision of finance and, in particular, trade finance. The EBRD’s Trade Facilitation Programme was developed precisely to facilitate international trade by providing guarantees to international commercial banks. The Programme can thus help to support Greek companies in their endeavours to increase their exports to traditional markets as well as to open up new markets. I very much welcome this initiative by the EBRD to communicate the modalities of the Programme and how exporting and importing firms in Greece can benefit from it. I am sure that we will have a fruitful, informative and interesting discussion. BIS central bankers’ speeches

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Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at an event organized by the Young Presidents' Organization, Athens, 23 September 2016.

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 1/7 BIS central bankers' speeches 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 2/7 BIS central bankers' speeches 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 3/7 BIS central bankers' speeches 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 4/7 BIS central bankers' speeches 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. Sources: Baldwin, R and Giavazzi, F, 2015, The Eurozone crisis: A consensus view of the causes and a few possible solutions, 7 September 2015. w w w .voxeu.org/article/eurozone-crisis-consensus-view -causesand-few -possible-solutions Baldwin, R and Giavazzi, F, 2016, How to fix the Euroze: Views of leading economists, 12 February 2016. w w w .voxeu.org/article/new -voxeu-ebook-how -fix-eurozone Bank of Greece, 2016 Monetary Policy Report 2015–2016, June. CEPR, 2015, Rebooting the Eurozone: Step I – agreeing a crisis narrative, Policy Insight, No. 85, November. Cœuré, B. 2015, “Towards a political convergence process in the euro area”, Speech at the Interparliamentary Conference “Towards and Progressive Europe”, Berlin, 16 October 2015. w w w .ecb.europa.eu/press/key/date/2015/html/sp151016.en.html 5/7 BIS central bankers' speeches Cœuré, B. 2016 “Rebalancing in the euro area: are we nearly there yet?” Speech at the Danish Economic Society,Kolding 15 January 2016. w w w .ecb.europa.eu/press/key/date/2016/html/sp160115.en.html Cœuré, B. 2016, “Time for a new Lamfalussy moment” Speech at the Professor Lamfalussy Commemorative Coinference, Budapest, 1 February 2016. w w w .ecb.europa.eu/press/key/date/2016/html/sp160201.en.html Cœuré, B. 2016, “The future of the euro area”, Speech at Le Cercle Europartenaires, Paris, 21 March 2016. w w w .ecb.europa.eu/press/key/date/2016/html/sp160321.en.html Constâncio V. 2015, “Monetary Policy and the euro area problem” Speech at the 18th Euro Finance Week, Frankfurt, 16 November 2015. w w w .ecb.europa.eu/press/key/date/2015/html/sp151116.en.html Draghi, M. 2015, “Monetary policy and structural reforms in the euro area”, Speech at Prometeia40, Bologna, 14 December 2015. w w w .ecb.europa.eu/press/key/date/2015/html/sp151214.en.html ECB, 2016, “Increasing resilience and long-term growth: the importance of sound institutions and economic structures for euro area countries and EMU, Economic Bulletin, Issue 4, Art.3. ECB, 2016 “Update of economic and monetary developments”, Economic Bulletin, Issue 5. European Commission, 2015, Completing Europe’s Economic and Monetary Union, Report by Jean-Claude Junker in close cooperation with Donald Tusk, Jeroen Dijsslbloem, Mario Draghi and Martin Schulz, 22 June. European Commission, 2016, The Economic Outlook after the UK Referendum: A First Assessment for the Euro Area and the EU, Institutional Paper 032, July. European Commission, 2016, An Economic Take on the Refugee Crisis: A macroeconomic Assessment for the EU, Institutional Paper 033, July. IMF, 2016 Article IV consultation on Euro area politics, IMF Country report, No 16/219, July. IMF, 2016, “Uncertainty in the Aftermath of the UK Referendum, World Economic Outlook Update, July 16. Mersch, Y. 2015, “Advancing Monetary Union”, Speech at the Euro Exhibition, Osnabruck, 25 January 2015. w w w .ecb.europa.eu/press/key/date/2015/html/sp150125.en.html OECD, 2016, Euro Area, OECD Economic Surveys, June. Stournaras, Y. 2016 “Financial stability and policy intervention by Central Banks in Europe: where do we stand and what challenges lie ahead” Speech at the Croatian National Bank in Zagreb, 23 March 2016. w w w .bankofgreece.gr/Pages/en/Bank/New s/Speeches/DispItem.aspx?Item_ID=345&List_ID=b2e9402e-db05– 4166–9f09-e1b26a1c6f1b Stournaras, Y. 2016 “The Greek Economy: Developments, Opportunities and Prospects” Speech at the Federation of Industries of Northern Greece, Thessaloniki, 13 May 2016. 6/7 BIS central bankers' speeches w w w .bankofgreece.gr/Pages/en/Bank/New s/Speeches/DispItem.aspx?Item_ID=361&List_ID=b2e9402e-db05– 4166–9f09-e1b26a1c6f1b Stournaras, Y. 2016 “The impact of the Greek sovereign crisis on the banking sector: challenges to financial stability and policy responses by the Bank of Greece” Speech at the American School of Classical Studies in Athens, 8 June 2016. w w w .bankofgreece.gr/Pages/en/Bank/New s/Speeches/DispItem.aspx?Item_ID=362&List_ID=b2e9402e-db05– 4166–9f09-e1b26a1c6f1b Stournaras, Y. 2016, Monetary Policy Report 2015–2016, Speech to the Standing Committee on Economic Affairs of the Hellenic Parliament, Athens, 11 July, 2016. w w w .bankofgreece.gr/Pages/en/Bank/New s/Speeches/DispItem.aspx?Item_ID=373&List_ID=b2e9402e-db05– 4166–9f09-e1b26a1c6f1b in’t Veld, J. 2016, Public investment stimulus in surplus countries and their euro area spillover, European Economic, Economic Brief 016, August. 7/7 BIS central bankers' speeches

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Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Conference of the Greek Tourism Association (SETE) "The Greek economy and the contribution of tourism to growth", Athens, 17 October 2016.

Yannis Stournaras: The Greek economy and the contribution of tourism to growth Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Conference of the Greek Tourism Association (SETE) "The Greek economy and the contribution of tourism to growth", Athens, 17 October 2016. * * * Taking stock of the programme implementation We are now a third of the way through the extent of the programme agreed in July 2015 and ending in June 2018. This agreement reoriented economic policy towards realistic goals and came up as the only solution in view of the major risks that hanged over Greece in the summer of 2015. As an interim stocktaking of programme implementation, our assessment is that progress has been slow, but with expected positive results: The completion of the first review and the recent enactment of the second set of prior actions have strengthened confidence and the prospect of economic recovery. This development brought multiple benefits, which have a positive impact on liquidity and should boost economic activity in the second half of 2016. In particular, following the reinstatement of the eligibility of Greek government bonds as collateral for Eurosystem operations, Greek banks can now have access to lower-cost refinancing from the European Central Bank (ECB), which, combined with changes in the domestic banking system, can translate into lower borrowing costs for businesses. Moreover, the dissipation of uncertainty, the stabilisation of private sector deposits and the progress made with the restructuring of Greek banks have enabled since early June 2016 successive reductions of the emergency liquidity assistance (ELA) ceiling for Greek banks, by €16.3 billion in total, so that the ceiling currently stands at €51.8 billion. The above developments, coupled with the lifting of restrictions on cash withdrawals when the funds come from new deposits in cash (new money), should encourage, in the medium term, the return of deposits to the domestic banking system, which in turn will allow a further easing and ultimately the elimination of capital controls. The economy’s gradual improvement starts being reflected in the course of several macroeconomic indicators. Specifically: Industrial production rose by 2.0% year-on-year in January-August 2016, mainly due to a significant rise in manufacturing (+4.8% yoy). In July 2016, the retail sales volume index increased by 9.7% year-on-year, while the seasonally adjusted retail sales volume index increased by 4.9% month-on-month. According to data from the ERGANI information system of the Ministry of Labour, Social Security and Solidarity, the balance of salaried employment flows in the private sector in January-August 2016 was positive, with the creation of 237,817 new jobs, up by 51,793 relative to one year earlier. Data from ELSTAT’s Labour Force Survey for the second quarter of 2016 suggest a decline in the unemployment rate to 23.1%, from 24.9% in the previous quarter and 24.6% in the corresponding quarter of 2015. The forecasts of the Bank of Greece point to economic recovery starting from the second half of 1/7 BIS central bankers' speeches 2016 and continuing in the years 2017 and 2018. Specifically, a small reduction in the order of 0.3% in GDP is expected for 2016, followed by growth of 2 5% and 3% for 2017 and 2018, respectively. These forecasts are based on the assumption that the reforms and privatisations agreed between the Greek government and the institutions will be implemented and the relevant fund disbursements will be completed in time, so as to support liquidity in the Greek economy, and that the ECB’s monetary policy accommodation will remain in place. Regarding the inflation outlook, the downward trend of prices is expected to bottom out in 2016 and be followed by gradual increases in 2017 and 2018. The unemployment rate is expected to keep falling in 2016, although at a slow pace that should pick up in 2017–2018. However, risks to the path of the Greek economy remain. Any delays in the completion of the second review, and particularly in the implementation of reforms and privatisations, would dampen the increase in economic activity, resulting in a resurgence of uncertainty, undermining confidence and weakening the prospects for a definitive exit from the crisis. Meanwhile, there are still a number of risks and uncertainties surrounding the outlook of the European and world economy, relating to, among other things, the planned UK exit from the European Union (EU) and a possible worsening of the refugee crisis. Also, risks are posed by a potential surge of protectionism and more simplistic approaches to complex problems, on both sides of the Atlantic, based on isolationism rather than cooperation and coordination. These risks could slow the recovery of the Greek economy, through a negative impact on tourism and trade or a slower-than-expected decline in Greek government bond yields due to risk aversion among international investors. To address these risks and confirm the positive outlook, we need to promptly and effectively tackle a number of major issues lying ahead, which will ultimately determine the outcome of the programme as a whole and Greece’s ability to regain access to markets thereafter. 1st Speeding up the implementation of the programme The first and most important issue refers to commitment to the programme’s objectives, in particular the need to speed up the implementation of the agreed reforms. The next few days will see the start of the second review, which will be looking at a number of fundamental structural reforms, with expected positive effects on economic activity. The review must be completed without any delay. This will allow these positive effects to be felt soon, thereby strengthening the prospect of growth in the Greek economy at an accelerating pace from 2017 onwards. 2nd Non-performing loans The second, equally serious, issue that represents a challenge for banks, the government and the Bank of Greece alike, refers to the restructuring of the banking system, so as to restore normal financing conditions in the private sector. Strengthening the banking system and freeingup resources for financing the economy requires tackling the bulk of non-performing loans as soon as possible. Effective management of non-performing loans is key to both the recovery of credit expansion and the restructuring of enterprises and sectors across the economy. To this end, the Bank of Greece has stepped up its efforts by promoting, in cooperation with the government, a number of major initiatives, the implementation of which needs to be accelerated and completed in the coming months. Let me indicatively mention some of these initiatives: the development of a secondary market for loans (performing or non-performing); the reform of the framework for out-of-court debt settlements; the improvement of infrastructure and expertise of the judicial framework; 2/7 BIS central bankers' speeches the legislative reform to ensure that existing shareholders participate in the reorganisation of companies, or otherwise immediately withdraw. In parallel, however, banks need to adopt a more active NPL management policy, focusing on long-term solutions, multi-creditor workouts and restructuring of viable companies, with the participation of shareholders. During the protracted period of the crisis, the private sector has paid a high toll. Uncertainty, crumbling demand, funding constraints and high indebtedness as a legacy of the past have driven many companies out of business, thousands of workers to unemployment and the volume of NPLs to burgeoned levels. At the same time, though, we also see certain sectors of the economy that have suffered less or no losses from the crisis, but still do not reduce – as one would reasonably expect – their non-performing loan ratios. Regarding the industries that are directly related to tourism (accommodation and food service activities), during the crisis their shares in terms of both value added and employment have increased. At the same time, however, the non-performing exposures as a ratio of total loans to these sectors has also risen, to 54.3% at the end of the first half of 2016, a level much higher than the corresponding NPE ratio for the total economy (45.1%). This is a phenomenon that needs to be investigated and addressed. 3rd Debt The third major challenge lying ahead pertains to the launch of in-depth discussions with our partners on debt relief measures. Debt relief is crucial, in both the long and the short run. For, if the Greek debt is seen as unsustainable, the country’s predicted exit to markets in 2018 will not be feasible. Therefore talks have to begin now and conclude as soon as possible. Besides, the discussion of ways to alleviate the Greek debt is a commitment undertaken by our partners as early as in 2012, and reaffirmed last May, but not fulfilled as yet. *** The role of tourism in the new growth model Unquestionably, the problems I mentioned are large and hard to solve. But I believe that we can overcome them, if we act with prudence, determination and mutual understanding. I also believe that the Greek economy has the ability and the potential to return to a sustainable upward path through a new extroverted growth model, taking advantage of its strong comparative advantages and the opportunities presented. In this process, tourism has a key role to play, for the following reasons: It is by definition an extroverted industry. It has been comparatively less hit by the recession and has preserved its productive capacity. Especially from 2013 onwards, it has shown remarkable growth performance, as I already mentioned. Second, it represents a sizeable share of GDP. In 2015, travel receipts contributed directly about 8% of GDP, compared with 5% in 2008. In terms of macroeconomic multipliers, various studies estimate that every euro in tourist spending adds €2.2-2.6 to GDP. Research also suggests that the sectors which benefit the most from the development of the tourism product are trade, financial services, property management, construction and manufacturing. As regards the export performance of the economy, for 2014 tourism services represented roughly 43% of total receipts of the services balance, while net tourism receipts (receipts minus payments) accounted for 62% of the services surplus. In 2015, due to the negative impact of capital controls on shipping, the weight of tourism receipts rose to 50.6% in total 3/7 BIS central bankers' speeches receipts from services, while net tourism receipts accounted for about 71% of the services surplus. Third, tourism as a business activity is being modernised, and the quality of the tourism product is being improved: search for new markets, promotion and exploitation of the cultural product of Greece, new innovative units, promotion and development of the country’s cities. Surveys conducted by the Bank of Greece The Bank of Greece recognises the importance of tourism to the Greek economy and understands that timely and objective information on the development of tourism-related aggregates is essential for fulfilling its mandate. We attach great importance to the collection of reliable and comparable statistics over time on the tourism sector. For this reason, we go beyond what is required to meet our obligations to the ECB and international organisations, and collect more thorough and detailed data regarding this sector. Since 2002 the Bank of Greece conducts the Border Survey, aiming not only to record inbound and outbound traveller flows, but also, and most importantly, to calculate travel expenditure in Greece. The survey on incoming travellers is based on a very large sample, of at least 25,000 inbound visitors. The Border Survey is fully harmonised with the guidelines of international organisations (IMF, ECB, Eurostat). In particular, the relevant mirror statistics, compiled on an annual basis by Eurostat (in the context of the Travel Working Group), show Greece’s travel expenditure and traffic data to be fully consistent with the corresponding figures of the other EU28 countries, with differences of below 2%. The Border Survey, among the most comprehensive ones in the EU, is conducted at the 12 largest airports of the country, which cover around 95% of visitors, at all seaports of entry and at the six main road entry points. The resulting data are combined with administrative information and regularly cross-checked against respective data from the visitors’ countries of origin, so as to ensure compliance with the standards set for the quality checks carried out by the ECB. The Border Survey is conducted at the time of departure from Greece, when visitors know exactly how much they have spent here. To calculate expenditure, respondents provide an estimate of: (a) their total expenditure; (b) any relevant amounts they have paid in their home countries (e.g. through a travel agency, directly to an airline, etc.) for transport, accommodation, other services or a cruise package; (c) if possible and more specifically within the previous category, any amount corresponding to travel costs; and (d) the breakdown of the amount spent in Greece for accommodation, cafes and restaurants, transportation, entertainment, and shopping. The Border Survey is conducted according to a consistent methodology over time to ensure intertemporal comparability, but its content and scope are expanded and adjusted in response to changes in international rules and to the changing information requirements. Since the beginning of 2016, the Border Survey has included a specific question about the visitors’ geographical destination within Greece, and the first data should be published towards the end of this year. This information will be particularly useful in the development of the tourism satellite accounts, which is a long-standing demand. Further to the Border Survey, in 2012 the Bank of Greece launched a more focused Cruise Survey. This survey, unique in Europe, relies mainly on administrative data from 16 major ports that account for 85% of total cruise traffic, which – starting from this year – will be enriched with data from targeted sample surveys. Recent developments In 2016, Greek tourism faced a number of challenges after a record year in terms of arrivals and receipts in 2015. Let me recall that in 2015 Greece welcomed over 26 million tourists, 7.6% more than in 2014, while tourism receipts exceeded €14 billion, rising by 5.5%. In addition to economic weakness in Europe, where most visitors come from, the refugee crisis combined with 4/7 BIS central bankers' speeches geopolitical developments in our region and increased fears of terrorism have discouraged visitors from coming to Greece. It is estimated that during the first half of this year, when the impact of the refugee crisis was stronger, road arrivals decreased by 15%, while to date flight arrivals to the islands of the eastern Aegean are particularly reduced. The UK’s decision to leave the EU has been a further negative factor. In this respect, let me mention that in July, the first month after the British referendum, the decline in tourism spending by UK citizens in our country exceeded 35%, whereas previously the British had been one of the most robust categories of visitors. Without this reduction, total receipts in July would have increased instead of decreasing. Tourism stakeholders in our country have tried to respond to external challenges by redoubling efforts to attract visitors. The number of arrivals has thus remained on an upward trend in 2016 as well. To some extent, however, this was achieved by highly competitive pricing, something that ultimately had a negative effect on total travel receipts. For the year as a whole, prices are likely to show a decline, slightly faster than the average rate of decline observed in the last ten years. On a positive note, however, the downward trend in average stay in our country has bottomed out, and the first half of 2016 saw a slight increase. The differentiation of tourism demand The decline in tourism receipts despite the growing numbers of visitors is partly attributed to lower prices, as noted above. However, it also relates in part to a longer-term trend, namely the decline in spending per visitor and per night of stay, observed in the past few years. Since 2005 such spending has fallen on average by 2.5% annually, coming down to €598 per visitor in July this year, from €746 in 2005. To some extent this reflects the downward trend in the average days of stay in the country, from 10.7 days in 2005 to 7.2 in 2015. This is a result of changes in both the income situation of visitors, as Greece attracts fewer high-income visitors, and the mix of visitors’ countries of origin, as well as of long-term trends in the global economy, such as the entry of new competitor countries and the use of the Ιnternet that allows price comparisons and intensifies competition. Moreover, arrivals, mainly from traditional markets (UK, Germany, etc.) are close to a saturation point. This means that the tourism growth model has to be adapted, aimed towards a further improvement in product quality and higher specialisation. This would involve: Increasing the number of target markets through appropriate marketing policies and marketspecific advertising campaigns. Particular emphasis should be placed on countries with the highest expenditure per night. Extending the tourist season throughout the year, by developing the tourism product beyond the traditional “sun and sea” model, creating diversified products, focusing on alternative forms of tourism such as cultural, conference, religious and medical tourism and theme parks. Particular emphasis should be placed on attracting visitors for short stays (city breaks), which are typically associated with higher expenditure per day and are less concentrated in peak summer months. Establishing Greece as a homeporting and last port country rather than just a port of call for cruises. Reforms A crucial contribution in this direction, i.e. towards stimulating and diversifying tourism demand, will come in the future from the reforms undertaken in recent years. These reforms will strengthen long-term potential growth by removing existing barriers and increasing competition. Actually, by improving the long-term prospects of tourism, such reforms have already helped boost investment in high-quality hotels (for instance, between 2009 and 2014 the number of fivestar hotels increased by 34% and the number of beds by 32%). Therefore, the improved future prospects as a result of reforms should further encourage investment and speed up recovery. 5/7 BIS central bankers' speeches The positive experience of tourism should make all other sectors of the economy equally receptive to reforms that enhance competition and extroversion, and ultimately benefit the sectors themselves by increasing demand for their products. Here are some examples of the reforms already enacted: The privatisation of the 14 regional airports, which will strengthen their competitive position and enable the development of new tourist facilities with direct flight connections to the cities of departure. The simplification and acceleration of the tourist visa procedure for visitors from emerging market economies (Russia, Turkey, China). Regulatory reforms such as the removal of cabotage restrictions, which have already encouraged the development of cruise tourism. Setting up a “one-stop shop” service by the Greek National Tourism Organisation for the promotion and licencing of large tourism investments. Simplification of the licensing procedures of all tourism businesses in order to reduce administrative costs and licensing lead times, speeding up the procedures for starting a tourism business (which refers to any type of license, such as installation, operation, taking up of business and environmental permits), and processing of licensing applications electronically and, in some cases, on the same day. Development of a new form of integrated tourism companies, i.e. tourist complexes. These refer to five-star hotels constructed on land plots of no less than 150,000 square meters, together with (a) furnished tourist residences with a minimum surface area of 100 sq.m. available for sale or long-term lease as separate properties; and (b) special tourism infrastructure facilities, such as golf courses, conference centres, marinas, thalassotherapy and spa resorts, rejuvenation centres, etc. Liberalisation of the tourist guide profession, allowing archaeologists and historians to become tourist guides, which was not permitted in the past. Streamlining of procedures and elimination of restrictions on the operation of travel agencies and car rental companies. Introduction of extended visiting hours for museums and archaeological sites during the spring period. In addition to these reforms, there are a number of other actions that would further strengthen tourism, including: Modernisation and upgrading of the other regional airports in the country. Strengthening competition between airlines, as the reduction in air fares will stimulate tourism demand. Upgrading and development of infrastructures such as marinas, which can help to increase sea and nautical tourism, further boosting tourism traffic in Greece. Upgrading of port infrastructures and establishment of a national plan for the development of cruise tourism – especially home porting cruises. Overall, the enhancement of infrastructures is a prerequisite for the improvement of the tourism product. A lot needs to be done in this respect. In particular, I would like to refer to the utilisation of public property and the settlement of outstanding issues regarding land use planning. This will enable us to attract new investment, which will upgrade the tourism product. During the crisis period, the tourism industry – like all other sectors of the Greek economy – was forced to operate in an environment of increasing tax burdens, which affects competitiveness. The Bank of Greece has repeatedly pointed out this issue and has stressed that fiscal 6/7 BIS central bankers' speeches adjustment should focus on reducing public spending rather than increasing tax rates. Equally important, though, are the adjustment gains to be achieved through a more effective use of public property and through privatisation. If this happens, it will be easier to alleviate the tax burden by lowering the tax rates. This is essential for creating a business-friendly institutional environment and attracting new investment. *** In closing, I would like to point out that the structural reforms implemented in the past few years, coupled with lower prices, have supported the growth of tourism and mitigated the impact of the economic crisis, through a sectoral restructuring of the economy. Increased investment in highquality hotels and the upgrading of hotel capacity, combined with the tourism industry’s proven adaptability to the new economic conditions, must not be merely continued but intensified, so that tourism can be a driver and an example of the new growth model the country is in need of. 7/7 BIS central bankers' speeches

bank of greece

Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the OECD High-level policy seminar on "Open and orderly capital movements: does global co-operation matter?", Paris, 25 October 2016.

Yannis Stournaras: Open and orderly capital movements - does global co-operation matter? Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the OECD High-level policy seminar on "Open and orderly capital movements: does global co-operation matter?", Paris, 25 October 2016. * * * Thank you for inviting me to participate in this seminar and to share some thoughts on capital movements with you. The issue of open and orderly capital movements is particularly topical and one for which an exchange of views among policy makers across various economies is essential. Discussion, communication and debate are, after all, the first steps towards multilateral co-operation. It appears to me that the crisis has placed us at a crossroads with regard to many areas of policy-making. Confronted with unprecedented circumstances, we were forced to reassess our policy frameworks in order to better guard our economies against risks. I believe that, for the most part, we have managed to do so collectively and in a spirit of multilateral co-operation, a spirit that, I would suggest, is necessary in our globalised world. Policies with regard to capital movements fall into this category. We are called upon to decide how to find ways to harness the benefits from global capital flows, so as to avoid slipping back into protectionism and financial retrenchment, with potentially detrimental effects on global recovery. Benefits and risks of financial openness The benefits of free capital movements are well-known: efficient global allocation of resources; reduced cost of capital in capital-scarce countries; greater and more efficient investment; normalisation of consumption fluctuations in response to temporary shocks; international risk-sharing1; support for the transfer of technology and managerial knowhow; promotion of financial development and sound macroeconomic policies in recipient countries2. Nevertheless, the extent to which countries can realise these benefits presupposes certain conditions3: a developed financial system; sound institutions; prudent macroeconomic policies and sufficient macroprudential supervision; Additionally, the benefits will depend on the level and composition of capital flows. Absence of these conditions raises the risks associated with capital flow liberalisation, especially in the event of a negative shock, creating significant challenges for policy makers4. 1/3 BIS central bankers' speeches Managing capital flows In the face of risks, countries have at their disposal a range of policy tools for managing capital flows: exchange rate flexibility, foreign reserves accumulation, monetary policy action, macroprudential measures and, in some instances, even capital flow management measures5. These policies also come with their challenges and can have multilateral spillover effects on global economic and financial stability6. Policy co-operation is thus an important complementary tool for capital flow management. Multilateral co-operation can mitigate the cross-border effects of capital flows management measures and can provide economies with a useful framework for gradual capital flow liberalisation in line with their financial and institutional development. It is precisely in this way that the OECD Code of Liberalisation of Capital Movements makes its contribution. Through the Code, countries are provided guidance on the sequencing of liberalisation and the appropriateness of policy response to shocks. By fostering transparency, dialogue and accountability, adherence to the Code ensures non-discriminatory treatment of countries, provides reassurance to markets as to the scope and duration of measures and catalyses policy support for reforms and adjustments. Overall, the ever more interconnected international environment makes policy co-operation more necessary. To illustrate this point, I would like to draw on two examples: First, can coordination help moderate volatility in response to specific shocks, especially those emanating from global players? Second, can it prevent the emergence of global imbalances? Diverging monetary policies One pertinent example of the need for policy co-operation to avert large and volatile capital flows is in dealing with the effect of divergent monetary policies on global financial markets. It is broadly agreed that the impact of US monetary policy can have global repercussions, influencing exchange rates, risk premia and asset prices and causing valuation effects of US dollar-denominated liabilities. Thus, changes of stance can be associated with significant capital flows especially to/from emerging market economies. The taper tantrum that affected global financial markets in 2013 is one example7. Over the near future, it is widely expected that the US interest rate will be gradually raised, while those in the euro area and other advanced economies remain low. This divergence is likely to impact on global capital flows. Uncertainty about the pace is judged to be a source of volatility in financial markets. Thus, informal discussions between policy makers, if not closer co-operation, along with clear and coordinated communication and execution of policies, can be a useful tool for dampening volatility and preventing undue financial market turbulence. Euro area imbalances My second example which supports the case for greater co-operation is the lessons that emerge from the build-up of structural imbalances in the euro area before the crisis. A corollary of monetary integration is the elimination of exchange rate risk, which reduces transaction costs and increases the elasticity of substitution between financial assets issued by member states of the monetary union. In the euro area, financial linkages were greatly facilitated by the introduction of the single currency. A distinct feature of these linkages was the build-up of current account imbalances. Deficits accumulated in the periphery were mirrored by a build-up of surpluses in core countries. The financial account counterpart involved significant capital flows from the core to the periphery, with its counterpart in the accumulation of debt – whether public or private. These flows were directed 2/3 BIS central bankers' speeches mainly to non-tradable sectors (public consumption and residential investment). The crisis brought with it a “sudden stop” to these capital flows, resulting in sharp adjustment, largely in deficit countries8. Subsequently, much has been done to address what we now recognise as deficiencies in the design of the Economic and Monetary Union – the European Financial Stability Facility and subsequently the European Stability Mechanism; the banking union and its components. But more importantly for imbalances, the surveillance framework of EU Member States has been strengthened through new rules and procedures, among them, the Macroeconomic Imbalances Procedure. In short, co-operation is important also at the regional level. These changes are also supporting the reform process in Greece. Conclusions The course and magnitude of global financial flows and our own perceptions of financial openness are being continually reshaped in the 21st century. A period of relative abundance was rapidly brought to a halt with the international financial crisis of 2008. Our experience with free capital flows can help us ensure that in the future we harness their benefits and multilateral cooperation is key to achieving that. 1 (1) See Obstfeld, Maurice. Risk-taking, global diversification, and growth. No. w4093. National Bureau of Economic Research, 1992, Van Wincoop, Eric. “How big are potential welfare gains from international risksharing?.” Journal of International Economics 47, no. 1 (1999): 109–135 and Agénor, Pierre Richard. “Benefits and costs of international financial integration: theory and facts.” The World Economy 26, no. 8 (2003): 1089–1118. 2 (2) See Kose, M. Ayhan, Eswar S. Prasad, and Ashley D. Taylor. “Thresholds in the process of international financial integration.” Journal of International Money and Finance 30, no. 1 (2011): 147–179. 3 (3) See for instance, Kose, M. Ayhan, Eswar Prasad, Kenneth Rogoff, and Shang-Jin Wei. “Financial globalization: A reappraisal.” IMF Staff Papers 56, no. 1 (2009): 8-62 and Prasad, Eswar S., and Raghuram G. Rajan. “A pragmatic approach to capital account liberalization.” The Journal of Economic Perspectives 22, no. 3 (2008): 149–172. 4 (4) See Rogoff, Mr Kenneth, Mr Eswar Prasad, Mr M. Ayhan Kose, and Shang-Jin Wei. Effects on financial globalization on developing countries: Some empirical evidence. No. 220. International Monetary Fund, 2004. 5 (5) Ostry, Jonathan D. “Managing Capital Flows: What Tools to Use?.” Asian Development Review 29, no. 1 (2012): 82. 6 (6) See Beck, R., Beirne, J., Paternò, F., Peeters, J., Ramos-Tallada, J., Rebillard, C., Reinhardt, D., Weissenseel, L. and Wörz, J., 2015. The side effects of national financial sector policies: framing the debate on financial protectionism. ECB Occasional Paper 166. 7 (7) See Fratzscher Marcel, Marco Lo Duca and Rolad Straub. “A global monetary tsunami? On the spillovers of US quantitative easing”. CEPR Discussion paper No 9195, October 2012, Miranda-Agrippino, Silvia, and Hélène Rey. World asset markets and the global financial cycle. No. w21722. National Bureau of Economic Research, 2015 and Lim, Jamus Jerome, Sanket Mohapatra, and Marc Stocker. “Tinker, Taper, QE, Bye? The effect of quantitative easing on financial flows to developing countries.” World Bank Policy Research Working Paper 6820 (2014). 8 (8) See Lane, Philip R. “Capital Flows in the Euro Area.” Economic papers 497 (2013): 1-54 and Hobza, Alexandr, and Stefan Zeugner. “The ‘imbalanced balance’ and its unravelling: current accounts and bilateral financial flows in the euro area.” European Economy, Economic papers 520 (2014): 1-32. 3/3 BIS central bankers' speeches

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Speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at an event organised by the Hellenic American Association for Professionals in Finance (HABA), New York City, 5 October 2016.

John Iannis Mourmouras: Post-Brexit effects on global monetary policy and capital markets Speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at an event organised by the Hellenic American Association for Professionals in Finance (HABA), New York City, 5 October 2016. * * * Views expressed in this speech are personal views and do not necessarily reflect those of the institutions I am affiliated with. Ladies and Gentlemen, It is a great pleasure to be here. I would like to thank the Directors and the new President of HABA, Fanny Trataros, for the kind invitation and also Bob Savage for his welcoming remarks. Fanny, please allow me here to wish you all the best with your work for the Greek-American financial community. In the early days following the UK vote to leave the EU, most people were very apprehensive, even fearful, I dare say, about what the future would bring. Once again the end of the world has not come… yet. I decided to speak today about the implications of this seminal decision by the British people for themselves, but also for the rest of continental Europe, offering a more sanguine and all-around view. No matter if it is a light or full-blown Brexit, the surrounding uncertainty impacts political sentiment in other EU Member States and heightens pressure to adopt inward-looking policies. As a result, the future European and global economic and financial outlook remains inconclusive. My lecture will be structured around the following three questions. Firstly, a little bit of finance and, more specifically, which are the future post-Brexit prospects of global capital markets. I couldn’t avoid this question given the audience’s involvement in the financial industry. My second question is about monetary policy and, in particular, about the implications of the Brexit vote for what central banks do, including the ECB. The third question regards the dynamics of European integration following the Brexit vote, offering a Southern point of view on the subject. 1. The post-Brexit prospects of global capital markets It is true that financial markets have weathered the spike in uncertainty in the aftermath of the Brexit vote surprisingly well, while the IMF has downgraded from high to medium the risk for Brexit’s repercussions on the UK itself, the EU and the global economy. However, for market analysts, private investors and the official sector, the question remains pending: has the tail risk scenario really diminished? First, allow me to make two-three general remarks on the global financial markets’ latest developments before giving you my own insights on the prospects by year-end for the so-called G4 (US, UK, eurozone and Japan) major currencies, as well as equity and bond markets. • General remarks 1. Heightened policy uncertainty While the market outlook stabilises, political risks take center stage, as there is almost one month left (only 32 days) until November election day. After Brexit any ballot can bring disorder. Looking ahead, we will see a busy electoral agenda on both sides of the Atlantic. First is the US presidential election, it follows the Italian referendum on constitutional reform in early December, and in 2017 there are elections in the Netherlands, the Czech Republic, France and Germany. 1 / 15 BIS central bankers' speeches Italy is set to follow in early 2018. Given rising populism, there is a non-negligible risk that one of these events might produce a political “accident”. Moreover, the prevailing uncertainty is likely already to be acting as a headwind (Figure 1). Brexit, however, offers an interesting lesson. Rather than the dramatic event of imminent recession and financial turmoil feared, it looks set to be a prolonged, slow process driving structurally weaker growth. 2. Volatility remains low in fragile global markets Following the Brexit vote, implied volatilities followed a downward trend towards or below levels recorded at the start of the year. Stock market volatility quickly approached the lows last seen in July 2014 and FX implied volatility is trading today near historic lows. Volatilities in other markets were less subdued, fluctuating around their recent averages and are still far from their depths in 2014 (Figures 2, 3, 4). 2 / 15 BIS central bankers' speeches Although, markets proved resilient to a number of potentially disruptive political developments, questions linger as to whether the configuration of asset prices accurately reflected the underlying risks. The apparent contrast between record low bond yields, on the one hand, and sharply higher stock prices with subdued volatility, on the other, cast a shadow over such valuations. 3. Global growth is continuing along at a slow pace A range of indicators suggest that the euro area economy remained remarkably resilient after the vote. The negative impact of the UK’s vote to leave the EU on growth, in the UK and the euro area appears to have been materially less than initially expected. ECB’s President Draghi said recently that the effect of the Brexit vote on the eurozone’s growth is estimated at around 0.5% over three years. Despite an array of negative domestic and external events over the past two years – the Ukraine crisis, the fear of a Grexit, China’s currency volatility, banking sector volatility and the Brexit vote – the euro economy has sustained a remarkably steady pace of growth between 1.3% and 1.8%. Thus, the GDP growth for the euro area is estimated at 1.7% growth for this year, while for next year, the economy is seen slowing to a pace of 1.6%, as Brexit hampers investment and export flows in the region. As far as the UK is concerned, resumed political stability, a weaker currency and the Bank of England’s policy response look to have stabilised activity, after confidence fell sharply in the wake of the vote, and now the British economy is expected to exhibit significant resilience post-Brexit. That may be sufficient for GDP to avoid a modest contraction. According to the Bank of England’s latest Inflation Report, GDP is forecast to remain unchanged to 2% in 2016, whereas the 2017 forecast was slashed to 0.8% from a previous estimate of 2.3%, i.e. a drop exceeding the one seen during the 2008 financial crisis! Correction in asset prices, a housing market downturn, or a large decline in consumption, represent downside risks to the UK’s economy. As regards other advanced economies, the 2016 growth forecast was marked slightly down to 1.6%, while the global growth is projected to slow to 3.1% in 2016 before recovering to 3.4% in 2017. One of the more problematic features of the current cycle is its over-reliance on consumers, while business investment and trade continue to disappoint. • Foreign exchange markets 3 / 15 BIS central bankers' speeches I turn to foreign exchange (FX) prospects by end-year. The euro against the dollar Political developments on both sides of the little pond seem to be the major driver of FX price developments (US Presidential elections, referendums-national elections in Europe). As a result, the dollar’s strength is expected to be limited and the euro against the dollar to move in a tight range of 1.06–1.16 by year-end. British pound The pound sterling lost almost 10% in value after the referendum result was announced, by 16% since mid-November 2015 and has not recovered since. Of course, the Bank of England’s measures announced in August have also contributed to avoiding a shock wave in the face of great uncertainty. Still, the uncertainty surrounding the timing and the “type of Brexit” to be implemented, given the size of the current account deficit and the uncertainty around the continuation of foreign capital inflows, poses a big risk for the pound and further depreciation is expected, albeit, at a somewhat lesser extent than originally expected. Sterling investors thus face continuing pain for the foreseeable future. As a result, an expected range for the euro against the pound by year-end is between 0.83–0.90 (Figures 5, 6). 4 / 15 BIS central bankers' speeches Yen My personal view is that the most challenging currency the months ahead is the yen! Monetary stimulus has not achieved a lasting weakening of Japan’s currency and the reflation of the economy is still away. Since Bank of Japan’s last policy meeting, the new name of the game for its monetary policy is “QQE (qualitative quantitative easing) with yield curve control”. Although the Bank of Japan kept interest rates unchanged at minus 0.1%, it announced a new framework with two main elements: the first is a pledge to cap 10-year government bond yields at 0.0%. Second, the Bank of Japan has pledged to continue buying assets until inflation “exceeds the price stability target of 2% and stays above the target in a stable manner”. This is a new inflation overshooting commitment. Sounds to me a bit optimistic! An expected range for the EUR/JPY exchange rate by year-end is between 1.10–1.25 (see Figure 7). 5 / 15 BIS central bankers' speeches • Equities Global equity markets have also recovered from Brexit and by mid-July, despite flagging earnings, stock markets in the US had broken through all-time highs, while the emerging market equities experiencing strong performance, returning to levels last seen a year earlier. All three main equity indices (S&P 500, Dow Jones, Nasdaq) reached all-time highs around the middle of August. European stock exchanges have recouped the losses suffered as a result of the Brexit vote (Figures 8, 9). However, recent developments surrounding the banking system, clearly add to uncertainties making equity markets outlook rather foggy! Taking into account the recent Deutsche Bank’s troubles, I just wanted to mention that it is among the systemically most important banks in the world and the IMF concluded in its June Financial Stability assessment that it made the largest net contribution to global systemic risk. However, there are some reassuring factors. The global financial system is now much better capitalised and able to withstand shocks than it was in 2008. Even if the worse came to worst, it seems likely that the German Government would provide a bailout. And the German Government could easily afford a bail-out without raising concerns about its own finances. 6 / 15 BIS central bankers' speeches • Bonds Finally, on fixed income, core bond yields continued to probe historical lows after Brexit. More precisely, German 10-year bond yields hover in the area of –0.07% and the peripheral bonds have been the main beneficiaries of the hunt-for-yield environment along with the benign risk environment as reflected in declining volatilities across asset classes. Also, the US government bond yields declined further near 1.50%, mainly due to the Fed’s delay in raising rates (Figure 10). Thus, markets went through the Brexit vote with little or no disruption to functioning with ample liquidity. 7 / 15 BIS central bankers' speeches 2. Implications of Brexit for central banks a. Less monetary policy divergence The Brexit vote triggered a broad-based reassessment of the future path of monetary policy globally. With improving headline growth still perceived as fragile in most advanced economies, and inflation still persistently low, the distinct response from major central banks to the Brexit uncertainty can be described as dovish: policy rates would stay “low for longer”. Bank of England The Bank of England cut the policy rate by 25 basis points (it is now 0.25%), and expanded the government bond purchase scheme by £60 billion, bringing the total to £435 billion. It also established a new corporate bond purchase program of £10 billion, and launched a new Term Funding Scheme that will provide funding for banks at rates close to the monetary policy rate. Forward interest rates for December 2017 quickly dropped to the new level of the policy rate, reflecting the view that a quick policy reversal was not expected (Figure 11).The prospect of further Bank of England policy easing in the coming months cannot be ruled out, as the minutes from the September 14th Bank of England MPC meeting revealed that the majority of the policy members are expected to support a further rate cut in the course of the year if the UK’s economic outlook is judged to be “broadly consistent” with August projections (i.e. GDP growth is expected to slow to 0.1% quarter-on-quarter in Q3 2016 from 0.6% quarter-on-quarter in Q2 2016). 8 / 15 BIS central bankers' speeches Federal Reserve Following the Brexit shock in the US, a 2016 rate rise is not fully priced in the market with the implied probability of a Fed rate hike in December 2016 to be around 55% today (Figure 11, righthand panel). In addition, the Fed at the September policy meeting cut the longer-run federal funds rate to 2.9% from 3.0% previously, while, based on the updated dot-pot, the median path of appropriate monetary policy for 2017 shifted in a dovish direction. Bank of Japan The Bank of Japan in its last policy meeting launched a novel kind of monetary easing as it set a cap on 10-year bond yields and vowed to take action to overshoot its 2% inflation target. Its decision demonstrates that central bankers are still willing to experiment with new monetary policy ideas, as inflation remains too low. Some observers characterised this shift as probably the biggest innovation in monetary policy since the introduction of negative deposit rates by the Danish central bank in the summer of 2012! But what actually does this new monetary policy framework in Japan mean (we may call it long-term interest rate targeting) and what are its implications? There are two main issues here under consideration: firstly, this is another policy dilemma of the nature “prices vs. quantities” and secondly, it is a further accommodative monetary policy stance, but with an asterisk. Starting with the first, it seems that the role of quantities such as the monetary base is downgraded and becomes much less important than before. In other words, instead of committing to buy a fixed amount at a market-determined rate, the Bank of Japan will buy a potentially unlimited amount at a pre-determined rate (price). It is true that the package of measures allows a lot of flexibility for the Bank of Japan to determine long-term rates (in addition to short-term base rates), but also raises many questions. For one thing, the Bank of Japan is now attempting to control both prices and quantities, which is simply not feasible! On the other hand, fixing 10-year rates at 0% may require to buy whatever quantity of bonds necessary to deliver rate stability, which may mean buying more or less than its target pace of ¥80 trillion per year. In other words, the Bank of Japan could reduce the pace of QE purchases in the future if it thinks it can achieve its yield target with fewer bond purchases, for 9 / 15 BIS central bankers' speeches example in a scenario where markets perceive the Bank of Japan’s yield target as credible or yields turn negative! Any potential reduction in bond purchases would be equivalent to tapering. It is exactly this built-in tapering mechanism that explains the asterisk I mentioned above. In other words, it is conceivable in the future that the Bank of Japan could be forced to sell JGBs if markets challenge the central bank by pushing the 10-year JGB yield well below its 0% target. This selling would be equivalent to a reversal of QE, it could be self-defeating in the case where inflation is still too low. ECB At its latest GC meeting, the European Central Bank (ECB) announced that it will extend its QE programme beyond March 2017 if needed. Looking forward, markets expect the eurozone economy to need more stimulus from the ECB as the gap between current headline inflation (0.2% year-to-date average), the ECB’s inflation forecasts (1.2% in 2017, 1.6% in 2018) and its higher target justify further policy easing (Figure 12). So far, there is some encouraging evidence from the ECB’s ongoing QE programme. In more detail: Banking credit channel Loan growth continued to recover gradually as the annual growth rate of the monetary financial institutions (MFIs) loans to the private sector (adjusted for loan sales, securitisation and notional cash pooling) is expected to increase further in the second quarter of 2016 and in July (see Figure 13), particularly for private companies (non-financial corporations or NFCs in ECB jargon) (see Figure 14) which recovered substantially from the trough of the first quarter of 2014. Lending to companies grew by 1.9% year-o-year, while household lending grew by 1.8%. 10 / 15 BIS central bankers' speeches A significant improvement has also been observed in Eurosystem banks’ composite cost of debt financing, which declined in July to a new historical low, after broadly stabilising in the second quarter of 2016 (see Figure 15). Also, banks reported a further net easing of credit standards on loans to enterprises in the 11 / 15 BIS central bankers' speeches second quarter of 2016, suggesting a continued improvement in financing conditions for corporate loans. Across the largest euro area countries, overall terms and conditions eased across all larger countries except for Germany (Table 1). In most of the large euro area countries, in particular, France and Italy, banks continued to report a narrowing of margins on average loans in net terms. Margins on riskier loans widened in net terms in Spain and Germany. Furthermore, bank lending rates for the private sector remained on a downward trend in the second quarter of 2016 and in July (see Figure 16). Composite lending rates for NFCs and households have decreased by significantly more than market reference rates since June 2014, and between May 2014 and July 2016, composite lending rates on loans to euro area NFCs (corporate loans) and households (i.e. mortgages) fell by around 100 basis points. The reduction in bank lending rates was especially strong in vulnerable euro area countries, indicating reducing fragmentation in euro area financial markets. Over the same period, the spread between interest rates charged on very small loans (loans of up to €0.25 million) and those charged on large loans (loans of above €1 million) in the euro area followed a downward trend. This indicates that smalland medium-sized enterprises have generally been benefiting to a greater extent than large companies from the decline in lending rates. 12 / 15 BIS central bankers' speeches b. QE vs. negative rates Staying in the eurozone and taking as a given fact that we will move towards more accommodative monetary policy in the months ahead, a more open question is: which policy instrument will be used? More QE or further negative rates? This is the essence of the monetary policy debate in the eurozone today. Clearly, there are limits to persistent negative rates, namely the underlying question is how far and for how long they can actually go. There are a number of concerns including banks’ profitability, how negative rates may act as an anaesthetic to euro area governments especially in the euro area’s southern periphery, taking into account that the fiscal space gained from lower debt service costs may result in a slower implementation of necessary fiscal and structural reforms. Policy rate cuts to negative levels have generally been reflected in corresponding declines in money market rates and short-term government bond yields (see Figure 17). In turn, the fall in bank wholesale funding costs has helped lower lending rates, but to varying degrees across countries. The decline in rates on new loans has been particularly notable in the eurozone (Viñals et al. 2016, Jobst and Lin 2016). Inflation expectations have continued to decline in most economies with negative interest rate policies (also known as NIRP countries). 13 / 15 BIS central bankers' speeches In addition, there are concerns about the political and institutional feasibility of negative rates as their long-term effects are still unknown. Most importantly, their effectiveness is put under question during a recession, if this were to emerge in the near future. I would personally, in my professorial hat, prefer to see more QE rather than further negative rates. If this is the case, the next question is where could more QE in the eurozone come from? In other words, does the ECB have the tools for more QE stimulus? Well, there are several options. From changing the parameters of the current QE programme like, for instance, buying bonds below the deposit rate, increasing the 33% issue share limit, dropping the capital key allocation, or even adding new securities to the pool of eligible assets such as bank bonds or equity. Let me now turn to the effects of Brexit on the dynamics of European integration and indeed offer a southern point of view and, more particularly, make five points from the South on the Brexit vote. 3. A Southern view on Brexit’s implications for the EU1 The European Union is currently facing crises on multiple fronts (anaemic growth, high unemployment, persistently low inflation close to deflation, a debt crisis, an ongoing migrant crisis), but Brexit represents the biggest medium- to long-term challenge of all. I will focus here on a couple of rather important points. 14 / 15 BIS central bankers' speeches Euroscepticism is now a strong sentiment in Europe. Populist, authoritarian parties are in government or in a ruling coalition in nine (9) countries of the EU. This is an alarming figure. Referendums in Italy and Hungary, and national elections next year in the Netherlands, the Czech Republic, France and Germany, are expected to reinforce this eurosceptic mood. Beyond the obvious economic concerns which triggered the UK vote to leave the EU, everyone agrees that the EU needs to address the issue of its democratic deficit and accountability. In addition, it has long been argued that the European Union remains a ‘market without a state’. This quote perhaps summarises the debate on European integration over the last 40 years at least. The most frequent complaint regarding the way the EU works is that it is governed by an elite of unelected technocrats through several independent European institutions and bodies (including the ECB). In light of the above issues of democratic deficit and accountability, Europeans are increasingly disenchanted with the EU, as shown by the rise of populist, authoritarian parties. Support for populist political parties with eurosceptic credentials has been rising, that is, parties which are by nature more Eurosceptic and less oriented towards reforms, which of course the South badly needs. As a result, this is a major downside risk to debt sustainability in this part of the euro area. For continental Europe, Brexit represents a shock to the institutions and norms that underpin markets, albeit different from the euro break-up fears of 2012, the global financial crisis of 2008 or the bursting of the high-tech bubble of 2001. The origins of previous financial crises can be located in multiple factors that are linked with the financial system and the economic cycle, respectively. The risk today is not financial contagion, like in 2008. Instead, it represents a contagious political development. No matter whether we have a full-blown or a light Brexit, the political risk for the continent is that referendums may mushroom across Europe in a tug-of-war between populist forces and the political establishment and elites. Brexit has the potential to unleash centrifugal forces, leading perhaps to a breakup of the euro, especially if such a referendum were to be held this time in a major eurozone country. Perhaps such a referendum is more likely in a southern eurozone country. Thank you very much for your attention. 1 For a more detailed account, see my speech (September 2016) at Banca d’ Italia, Rome. 15 / 15 BIS central bankers' speeches

bank of greece

Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the EU-Arab World Summit "Partners for Growth and Development", Athens, 3 November 2016.

Yannis Stournaras: Prospects of the Greek economy after six years of adjustment Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the EU-Arab World Summit "Partners for Growth and Development", Athens, 3 November 2016. * * * It is a great pleasure for me to be here with you today and have the opportunity to share my thoughts on the prospects of the Greek economy after six years of economic adjustment. I will focus on four issues: First, the achievements made so far during the difficult years of economic adjustment. Second, the missteps and delays in the adjustment process. Third, recent developments and future challenges and prospects. And fourth, I will highlight the main reasons why Greek assets constitute a prime investment opportunity. 1. Economic adjustment over the past six years Since the beginning of the sovereign debt crisis, six 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. The fiscal consolidation effort contributed to an improvement in the general government primary balance as a percentage of GDP by more than 11 percentage points over the period 2009–2015, despite the deepening recession. In fact, in the period 2013–2015 Greece managed to maintain small primary surpluses (as defined in the programme) in the general government budget for the first time since 2001. Adjusting for the effect of the recession, the improvement in the “structural” primary balance over the period 2009–2015 reached 17 percentage points of potential GDP; twice as much as the adjustment in other Member States that were under EU-IMF programmes. Second, competitiveness has been restored. The cumulative loss in labour cost competitiveness vis-à-vis our trading partners recorded between 2000 and 2009 has been fully recovered. This development reflects the effect of structural reforms in the labour market, which allow for greater flexibility in the wage bargaining process, as well as the impact of the sharp rise in unemployment on labour costs. Third, the external adjustment has been significant. The current account posed a small surplus in 2015 (0.1% of GDP). This marks a significant turnaround of the current account balance by about 15 percentage points of GDP since 2008. Adjustment has come primarily from a decline in imports of goods, particularly in 2009, when world trade collapsed due to the global recession. However, since 2010, exports, excluding shipping, have contributed significantly to the improvement. Exports of goods in real terms have actually rebounded in line with those of our euro area peers and the shares of goods exports have increased significantly vis-à-vis non-EU countries. On the other hand, exports of services in real terms have underperformed primarily due to the weakness of the shipping sector. This was driven by domestic economic uncertainty and the imposition of capital controls, as well as global factors, such as the weaker growth of global trade, lower commodity prices and a supply overhang in the global shipping sector. 1/7 BIS central bankers' speeches In more detail, the share of exports in GDP increased from about 19% in 2009 to close to 30% in 2015, with about 2/3 of this increase stemming from goods exports and 1/3 from services exports and, in particular, receipts from tourism. It should be noted that goods exports stood at about 14% of GDP in 2015 compared with 7.5% of GDP in 2009. Fourth, the policy agenda has included bold structural reforms. A series of structural reforms have been implemented in the labour and product markets, as well as in public administration. These reforms are expected to boost the growth potential of the Greek economy in the long-term through higher productivity and employment growth. According to the OECD, the reforms implemented in the period 2010–2014 are expected to raise real GDP over a 10-year-horizon by about 5.6%. Adding the reforms currently being implemented or planned under the ESM programme, the overall increase in real GDP comes to about 13.4% over a 10-year-period. However, this estimate is a lower bound in the sense that additional reforms, for example improving the judiciary system, strengthening bankruptcy regulations, modernising the public administration and resolving the issue of non-performing exposures (NPEs) cannot easily be quantified. In-house work by the Bank of Greece points to similar estimates with the main effect coming from higher total factor productivity (TFP) growth. Fifth, the rebalancing of the economy has been remarkable. The restructuring of the Greek economy towards a new, extrovert, growth model based on tradable goods and services and a higher share of exports in GDP is already underway. In more detail, the relative prices of tradable goods and services rose by about 10% in the period 2010–2015, making their production more profitable. As a result, the share of tradable goods and services in the private economy has risen in recent years. For example, in gross value added terms, the relative size of the tradable sectors grew by approximately 12% in the period 2010–2015 in volume terms and by about 24% in nominal terms, while in employment terms it grew by around 8%. This development is attributed both to the structural reforms implemented so far and to the fact that tradable export-oriented sectors have gone through a milder recession and have thereby gradually gained some ground in terms of volume and employment shares. An additional aspect worth highlighting is that on account of the decline in domestic demand and the scaling back of construction in Greece, a great number of dynamic construction companies expanded their businesses abroad (Middle East, Balkans) transforming a previously thought to be a non-tradable activity into an internationally tradable one. Going forward, structural reforms and improved financing and liquidity in the economy are expected to speed up the restructuring of the economy in favour of tradable goods and services. Sixth, 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 having been reduced through mergers, takeovers and resolutions. Today the system comprises four core banks and a number of smaller ones. The banking system, following successive rounds of recapitalization involving significant private sector involvement and the implementation of restructuring plans, is now well-placed to address the major challenge posed by the high stock of non-performing exposures (NPEs). Effectively managing NPEs is key to the recovery of credit growth and to the restructuring of businesses and sectors in the real economy. 2. Missteps and delays in the adjustment process However, despite the huge efforts to avert default and address imbalances, Greece remains under an adjustment programme, unlike Cyprus, Ireland and Portugal, which have already completed their respective programmes, even though they entered these programmes later than Greece did. 2/7 BIS central bankers' speeches This lagging behind can be attributed to several factors, including: lack of ownership of the necessary reforms and lack of commitment, by part of the political system, to correct past errors, the anti-bailout rhetoric, rivalry and failure to reach an understanding among political parties, and the various – small and large – vested interests that have resisted reform. Meanwhile, the fact that our European partners have yet to deliver on their commitment to provide further debt relief, as stated in the Eurogroup decisions made as far back as in November 2012 (and iterated most recently in May 2016), and the threat of default and euro area exit brandished against Greece by some of our partners whenever negotiations seemed to stall, even on just technical matters, has weighed heavily on market sentiment, further fueling uncertainty and negatively affecting the economic climate in Greece. Certain miscalculations in the design of the economic adjustment programmes could also explain Greece’s lagging behind vis – a – vis the other countries, previously under programmes. Given the size of the fiscal imbalances back in May 2010, when the first economic adjustment programme was initiated, more emphasis was placed on fiscal consolidation, pension reform, streamlining budgetary procedures, increasing fiscal transparency, as well as financial sector restructuring. Less emphasis was given on growth-enhancing labour market reforms and, most notably, on product and services market reforms and reorganizing the public sector. In addition, growth forecasts were too optimistic and fiscal multipliers turned out to be higher than initially anticipated. As a result, the economy was trapped in a vicious circle of austerity, recession, rising unemployment and private debt overhang. Despite the recouping of losses in international competitiveness, exports have underperformed relative to what could have been anticipated based on historical correlations. This can in part be explained by the lack of financing, higher long-term borrowing costs, increased uncertainty, as well as the higher tax burden, which slows or even halts progress towards restoring overall competitiveness. In addition, this can also be attributed to a number of inherent structural weaknesses that hamper the international market penetration of Greek products and involve noncost aspects such as product quality, protected designation of origin and branding, red tape, etc. Hence, despite the improvement in structural competitiveness over the period 2013–2014 (according to a number of indices compiled by the OECD, the World Bank, and the World Economic Forum), Greece still ranks at the lower end of the advanced economies, and progress has stalled or even reversed slightly in recent years. 3. Recent developments and prospects In spite of the delays and missteps, progress in correcting past mistakes has been remarkable. For example, the new ESM programme in place since August 2015 builds on the successes of the first two programmes (i.e. the correction of fiscal and external imbalances and the improvement of labour cost competitiveness) and aims at prioritizing reforms that will increase potential growth in the medium-to-long term, i.e. reforms in product markets, public administration, institutions and the business environment, bank recapitalization and resolution of NPEs. Building on the progress achieved so far, the completion of the first review of the ESM programme had a positive effect on confidence and liquidity and is expected to boost economic activity in the second half of 2016. Most importantly, the reinstatement of the waiver for Greek government bonds enabled Greek banks to obtain low-cost financing from the European Central Bank (ECB). This, along with the gradual dissipation of uncertainty, the stabilization of private sector deposits and the progress achieved in restructuring and recapitalizing Greek banks, has contributed to the lowering of the emergency liquidity assistance (ELA) ceiling for Greek banks by about €40 billion since July 2015, bringing it down to €51.1 billion as of today. 3/7 BIS central bankers' speeches These developments are expected over the medium term to encourage a return of deposits to the Greek banking system, which will allow an easing and, ultimately, the lifting of capital controls. Coupled with a more effective management of non-performing loans, this will contribute to reducing borrowing costs and will gradually increase the lending capacity of Greek banks, with positive effects on the financing, hence the growth performance, of the Greek economy. The gradual economic recovery is already reflected in the performance of several key indicators of economic activity, such as: industrial production, retail sales, dependent employment flows in the private sector, and real exports of goods. The current forecasts of the Bank of Greece point to a recovery starting from the second half of 2016 and continuing through 2017 and 2018. Specifically, GDP is projected to post a small decline of 0.3% in 2016, but then to grow by 2.5% and 3% in 2017 and 2018 respectively. These projections assume that the programme implementation will remain on track, the relevant loan tranches will be disbursed on time, and that the monetary policy of the ECB will continue to be accommodative. Nevertheless, risks to the outlook of the Greek economy remain. Delays in the implementation of reforms and privatizations envisaged in the programme would dampen economic growth, thereby refueling uncertainty, undermining confidence and weakening the prospects of a definitive exit from the crisis. Meanwhile, there also are risks and uncertainties regarding the course of the global economy, stemming, among other things, from protectionist voices and actions around the world, the implementation of a hard Brexit, and a likely exacerbation of the refugee crisis. These risks could slow down the recovery of the Greek economy, both through negative effects on tourism and trade and through a slower-than-expected decline in yields on Greek government bonds due to the risk aversion from global investors. T h e containment of the abovementioned risks and the realization of the positive prospects of the Greek economy require a number of tangible and concerted actions. These actions, which will ensure the successful conclusion of the ESM programme and the return to financial markets, comprise the following: 1st Stepping up the pace of reforms and privatizations. The government should remain committed to the timely implementation of the structural reforms and privatizations that have been agreed upon with the Institutions. Particular emphasis should be placed on: simplifying investment licensing procedures, reducing administrative burden on businesses and facilitating competition, opening up the remaining regulated professions and network industries, scaling up the privatization and public real estate programme, and improving its governance, modernizing and strengthening public administration, enhancing judicial efficiency and speeding up court proceedings. In this context, the on-going second review should be completed without undue delays, so as to solidify the recovery prospects and the return to robust positive growth in 2017. 2nd Tackling the high stock of non-performing exposures (NPEs). Alongside the structural reforms, using idle public property to attract foreign direct investment through appropriate land use legislation and speeding up privatization, there is an urgent need to address the private debt overhang problem, in order to facilitate the recovery through a stronger pick-up in lending. On the one hand, the high stock of NPEs reduces bank profitability and thus constrains the supply of credit, which primarily affects bank-dependent SMEs. On the other hand, high NPEs 4/7 BIS central bankers' speeches 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 currently 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 45.1% of total exposures or €108.7 billion. A number of initiatives are underway with the goal of setting up an accelerated and efficient framework for private debt resolution. These initiatives, amongst others, include: the development of a secondary market for both performing and non-performing loans; the establishment of an enhanced framework for out-of-court workouts and pre-bankruptcy procedures, as well as the overhaul of bankruptcy legislation; 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; amendments to legislation to ensure the cooperation of old shareholders in the restructuring of the underlying businesses; the launch of a comprehensive monitoring framework in relation to banks’ non-performing exposure resolution activities, and, finally, a series of targets and key performance indicators that aim at reducing overall nonperforming exposures by 40% by the end of 2019. On their part, banks need to pursue a more active policy for NPE management, by promoting long-term solutions and multi-creditor workouts, as well as focusing on the restructuring of viable businesses. These lines of action, coupled with the economy’s path out of the recession and back to growth, should bring about a stabilization and, subsequently, a decline in the NPE ratio. 3rd Addressing the large public debt overhang The commitment of our European partners in May 2016 to take action in order to ensure the sustainability of public debt in the short and medium-to-long term, reaffirmed their November 2012 Eurogroup decision and is a positive step forward. However, the envisaged long-term public debt management measures have not been specified yet. Urgent action is warranted on the specification and quantification of the foreseen debt relief measures. This will enhance the credibility and acceptance of the policies pursued, thereby helping to further consolidate confidence, strengthen economic recovery, lower the tax burden and facilitate the return to financial markets after the end of the programme. 4th Easing and eventually lifting remaining capital controls. The gradual relaxation of capital controls, along with improvements in confidence and liquidity, are expected to contribute to the normalization of economic conditions by facilitating both enterprises and individuals in their transactions. 4. Final remarks: investment needs and opportunities in Greece Greece is poised to return to economic and financial normality and to shift to a new, extrovert and sustainable growth model, based on tradable goods and services. To this end, the improvements in cost competitiveness of recent years provide considerable room for higher exports in goods and services in the near future. However, new investment will be needed in order to strengthen the export base of extrovert firms. The further opening-up to international trade, the participation in global value chains and the closer trade links with countries and businesses with cutting-edge technology internationally will 5/7 BIS central bankers' speeches enable the adoption of new technologies by export firms and their diffusion across the Greek economy, strengthening its long-term growth prospects. New investment, by facilitating innovation and the introduction of new technologies, will both broaden the export base and improve the quality of Greek exports, raising total factor productivity of the Greek economy. In turn, this will make the reduction in the external deficit sustainable and increase potential output over the medium-to-long term. Therefore, Greece needs a substantial amount of foreign direct investment (FDI). The policy changes made in recent years are conducive to growth, thus creating profitable investment opportunities. For example, the implementation of reforms in the labour, product and services markets and in public administration, the enhancement of financial stability, the utilization of public real estate, the stepping-up of the privatization programme, and efforts to tackle the private and public debt overhang problem improve confidence and rebuild financial markets’ trust. Hence, they generate positive growth prospects and help attract foreign direct investment. In this context, prospective investors will also benefit from the presence of high-skilled human capital by OECD standards and a vast pool of idle labour resources. According to the Global Competitiveness Report 2016–2017 of the World Economic Forum, Greece ranks quite high in terms of workforce education and skills (38th out of 138), in higher education and training (45th), in the availability of scientists and engineers (10th), in technological readiness (42nd). Although, a large number of high-skilled youth have moved to other EU countries since the outbreak of the crisis, the opening-up of new jobs in Greece as growth returns and investment picks up will contribute to the repatriation of many of them, further improving the skill and knowledge content of the labour force. Furthermore, the new investment incentives law (L.4399/2016) provides a clear framework and a stable business environment for the commencement of a variety of individual investment projects. The new law envisages several aid schemes, for example: tax exemption, subsidies for the acquisition of new machinery and other equipment, subsidy of the cost of created employment, a stable corporate income tax rate for a period of 12 years from the completion of the investment project. In order to qualify for the aid schemes, the investment projects should entail initial investment, for example, investment in buildings, machinery, intangible assets, and should meet certain conditions (i.e. creation of new production units, expansion of existing production units’ capacity, etc.). On top of the above, the recent conclusion of a number of major privatization projects — such as the privatization of the port of Piraeus, which will upgrade its role as a shipping hub, the sale of 14 regional airports in key tourist destination islands and cities, the sale and real estate development of the old Athens Airport facilities at Hellinikon, as well as the participation of private investors in the recapitalization of Greek banks — constitute an important vote of confidence from major foreign investors, who decided to position themselves early on the Greek market, in anticipation of even better future prospects for the Greek economy. Going beyond recent policy changes, Greece provides significant investment opportunities on account of its geographical location in Southeast Europe and its close proximity to the Middle East and the Arab world. There are potential gains in the trade, logistics, transport and energy sectors as Greece aspires to become a transport and energy hub in future years, which implies significant infrastructure, networks and other investment needs. Moreover, significant investment opportunities exist in tourism as Greece is a major tourist destination, and at the same time it has a sizeable public real estate property that is available for utilization by private investors in order to expand capacity and quality of tourism infrastructure. 6/7 BIS central bankers' speeches Last but not least, Greece is both a member of the European Union and the euro area. Currency redenomination issues are off the table for good. Consequently, prospective non-EU investors will benefit from gaining access to the EU Single Market and will enjoy a stable institutional environment, investor protection, as well as access to a sound banking and financial system. Therefore, Greek assets in general can be regarded as undervalued, which, on account of all the recent policy changes, the improvement of labour cost competitiveness and the country’s competitive advantages, have great potential to perform much better in the future, generating substantial profits for new investors. * * * In conclusion, I would like to emphasize once again that economic adjustment and structural improvements over the past six years have rendered Greece more business-friendly and have opened up significant investment opportunities, in particular for those who will position themselves early in the Greek economy. At the same time, foreign direct investment is also essential for Greece, because it will set in motion a virtuous circle signaling investor confidence in Greece’s future prospects, a definite exit from the crisis and a return to sustainable and extrovert economic growth. Sources: Bank of Greece (2016), Annual Report 2015, February. Bank of Greece (2016), Monetary Policy 2015–2016, June. OECD (2016), Greece, OECD Economic Surveys, March. Stournaras, Y. (2016), “The Greek Economy: Developments, Opportunities and Prospects”. Speech at the Federation of Industries of Northern Greece, Thessaloniki, 13 May 2016. Stournaras, Y. (2016), “Greece and the Eurozone at a crossroads”. Speech at an event organised by the Young Presidents’ Organization in Athens, 23 September 2016. 7/7 BIS central bankers' speeches

bank of greece

Panel intervention by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the Bank of Italy-OMFIF Main Meeting, Rome, 22 September 2016.

John Iannis Mourmouras: Implications of the UK vote to leave the EU – a view from the South Panel intervention by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the Bank of Italy-OMFIF Main Meeting, Rome, 22 September 2016. * * * Intervention in a panel meeting with Lord (Norman) Lamont, former UK Chancellor of the Exchequer, Ambassador Antonio Armellini, and Philip Middleton, Deputy Chairman, Ernst and Young, OMFIFAdvisory Board, moderated by Fabio Pannetta, Deputy Governor, Banca d’Italia, at the Banca d’Italia-OMFIF Main Meeting in Rome (Italy) on 22 September 2016. Disclaimer: Views expressed in this speech are personal views and do not necessarily reflect those of the institutions I am affiliated with. Ladies and Gentlemen, It is a great honour for me to take part in such a distinguished panel. On this very important matter of implications of the UK vote to leave the EU, I would like to focus on a couple of issues: Firstly, on the potential effects of Brexit on the dynamics of European integration and indeed offer a southern point of view and, more particularly, make five points from the South on the Brexit vote. Secondly, I will examine the implications of Brexit on what central banks do in terms of monetary policy, including the ECB. 1. A SOUTHERN VIEW ON BREXIT’S IMPLICATIONS FOR THE EU The European Union is currently facing crises on multiple fronts (anaemic growth, high unemployment, persistently low inflation close to deflation, a debt crisis, an ongoing migrant crisis), but Brexit represents the biggest medium- to long-term challenge of all. Point number 1: A deeper look into some European failures that influenced the Brexit vote Euroscepticism is now a strong sentiment in Europe. Populist, authoritarian parties are in government or in a ruling coalition in nine (9) countries of the EU. This is an alarming figure. Referendums in Italy and Hungary, and national elections next year in the Netherlands, the Czech Republic, France and Germany, are expected to reinforce this eurosceptic mood. Eurocrats should take note of this reality. Beyond the obvious economic concerns which triggered the UK vote to leave the EU, everyone agrees that the EU needs to address the issue of its democratic deficit and accountability. This is obviously not resolved with a European Parliament that maintains two seats: a real seat in Brussels and a symbolic seat in Strasbourg, costing the EU, and thus European taxpayers, €114 million per year. The EU is perceived as a sclerotic and costly organisation that fails to adapt to the changing circumstances in a world of rapid upheavals. At the same time, persistent austerity policies – quite often ill-designed – adopted in Southern European countries increase the rejection of the European project even in countries such as Greece or even Italy, which had always been pro-integration and where public opinion was always in favour of the EU. In addition, it has long been argued that the European Union remains a ‘market without a state’. This quote perhaps summarises the debate on European integration over the last 40 years at least. The most frequent complaint regarding the way the EU works is that it is governed by an elite of unelected technocrats through several independent European institutions and bodies 1/5 BIS central bankers' speeches (including the ECB). In light of the above issues of democratic deficit and accountability, Europeans are increasingly disenchanted with the EU, as shown by the rise of populist, authoritarian parties. Support for populist political parties with eurosceptic credentials has been rising, that is, parties which are by nature more Eurosceptic and less oriented towards reforms, which of course the South badly needs. As a result, this is a major downside risk to debt sustainability in this part of the euro area. Point number 2: Mushroom of referenda and political contagion For continental Europe, Brexit represents a shock to the institutions and norms that underpin markets, albeit different from the euro break-up fears of 2012, the global financial crisis of 2008 or the bursting of the high-tech bubble of 2001. The origins of previous financial crises can be located in multiple factors that are linked with the financial system and the economic cycle, respectively: imbalances in trade or capital flows between EU Member States; a combination of decades-long excessive borrowing, risky investments, and lack of transparency in the financial sector; and the speculative mania around the shares of so-called “dot-com” companies and the subsequent collapse of the speculative bubble. The risk is not financial contagion, like in 1998. Instead, it represents a contagious political development. No matter whether we have a full-blown or a light Brexit, the political risk for the continent is that referendums may mushroom across Europe in a tug-of-war between populist forces and the political establishment and elites. Brexit has the potential to unleash centrifugal forces, leading perhaps to a breakup of the euro, especially if such a referendum were to be held this time in a major eurozone country. Perhaps such a referendum is more likely in a southern eurozone country. Of course, democracy is the very foundation of our civilisation, but sometimes even wellintentioned initiatives can produce unintentional consequences (as we have seen with the UK vote). The public not only in Europe (but also on this side of the little pond) seems to have lost confidence in the political and economic establishment to come up with visionary solutions that are also pragmatic and improve things for most people. In 2017 we will be celebrating 60 years of European integration. Europe has emerged as a standard-bearer of freedom, democracy, the rule of law. So we should not be complacent about populist parties using the refugee issue as a key fear factor for European voters and turning it into a major campaign theme to tell the EU to keep out of migration and human rights issues. It is particularly worrying to see Member State governments turning the EU into the enemy for domestic purposes. The agreed-upon migrant relocation scheme is founded on solidarity, the very basic principle of European integration that has helped the EU become the major trading bloc around the world that is has become. Point number 3: Duality and the way forward for the EU The theoretical debate about the EU’s post-Brexit future has seen three predominant scenarios: an EU that falls apart/disappears, an unchanged EU that continues to muddle through trying to cope with its underlying problems or an EU that integrates further, or at least some Member States moving forward, some others choosing to stay back. One idea that has circulated a lot in the context of the Brexit debate – which I concur – that a balance between national sovereignty and European solidarity and prosperity may be found in duality, i.e. two “Europes” coexisting in a broader European construct, independently from one another. One would be a political union (either taking the form of a federal state or a confederation of nations) to complete the EMU and beyond, which is the vision of the EU’s founding fathers (Jean Monnet, Robert Schuman, Altiero Spinelli). The other would be based on market liberalisation, forming an outer rim of a new European construct, in which Britain could obviously play a leading role, if it so wishes. 2/5 BIS central bankers' speeches For Southern European countries of course, the 1-billion-dollar question is the following: if this dual architecture becomes a reality in the EU (definitely not likely before the German elections) will the South of Europe be part of a “new eurozone” [a proper fiscal union, with a banking union , a defence and a political union], or will it be left behind in a secondary, outer circle of countries? This is something I would not like to speculate about here today, and to be frank with you not ever! But it’s not a matter of wishful thinking, it’s a matter of tough realism. Point number 4: Coup d’état in Turkey – Migrant crisis Clearly, Brexit is an issue for the whole of Europe and Southern Europe will not be immune to the implications of Brexit, for instance because of tourism, external demand, etc. However, coming from one of the countries located on the EU’s external border, which has received massive influxes of refugees from war-torn countries such as Syria (we have all seen the pictures of boats washed ashore in Lampedusa, Gibraltar, or the Greek islands of Northern Aegean), it would rather be an omission on my behalf not to discuss the more urgent problem for Southern European countries right now, which if it escalates further in the next 6-12 months may affect the rest of the EU and eventually present an existential threat to the European Union itself. Migration needs to be recognised as a major policy issue that will play a critical role in shaping the EU’s future and it is definitely an issue that should not be underestimated. We have seen last fortnight’s election results in Berlin and three weeks ago in the German Chancellor’s own constituency (Mecklenburg-Vorpommern) with the anti-immigration, right-wing (AfD) party gaining significant ground. It is urgent to tackle the migrant crisis and the linked labour mobility issue. I am particularly worried about recent developments in Turkey following the attempted coup and the impact this will have on the migrant crisis, as a major challenge for the EU’s future. Against the backdrop of an escalating migrant crisis, the UN Declaration adopted two weeks ago in New York which calls for a more equitable sharing of the burden for hosting the world’s migrants and refugees becomes even more relevant. Take, for instance, the recent EU deal with Turkey, which has promised to accept migrants back to its territory in exchange for financial aid. That was based on a premise that Turkey was a safe country for refugees. Lots of international analysts cast doubts on this after the latest bout of political instability and the heavy crack-down on suspected dissidents in the military, the judiciary and even higher-education in our neighbouring country. Point number 5: The British reform benchmark to be followed by South-eastern Europe Despite Brexit, the UK could be used as a reform benchmark by South-eastern European states to be emulated in a number of ways. According to the OECD, the UK has the least regulated labour market and is second to the Netherlands as the least regulated product market in Europe. The UK also has low taxation (a corporate tax rate of 20% and there is speculation that this will go down to 15% as an incentive to foreign firms to stay in Britain after Brexit). South European countries would stand to gain a lot by starting to resemble Britain in a number of areas, including the attraction of FDI, public sector accounting, transparency, rule of law and strong institutions including an efficient public administration plus credible government financial management. This should be the agenda for the whole of South Europe in the years to come, with or without adjustment programmes, namely using the UK as a benchmark, except one thing: Brexit! 2. IMPLICATIONS OF BREXIT FOR CENTRAL BANKS1 a. Less (?) monetary policy divergence The Brexit vote triggered a broad-based reassessment of the future path of monetary policy globally. With improving headline growth still perceived as fragile in most advanced economies, and inflation still persistently low, the distinct response from major central banks to the Brexit 3/5 BIS central bankers' speeches uncertainty can be described as dovish: policy rates would stay “low for longer”. The Bank of England cut the policy rate by 25 basis points (it is now 0.25%), and expanded the government bond purchase scheme by £60 billion, bringing the total to £435 billion. It also established a new corporate bond purchase program of £10 billion, and launched a new Term Funding Scheme that will provide funding for banks at rates close to the monetary policy rate. Forward interest rates for December 2017 quickly dropped to the new level of the policy rate, reflecting the view that a quick policy reversal was not expected. Following the Brexit shock in the US, a 2016 rate rise is not fully priced in the market with the implied probability of a Fed rate hike in December 2016 to be around 55% today. The Bank of Japan in its last policy meeting launched a novel kind of monetary easing as it set a cap on 10year bond yields and vowed to take action to overshoot its 2% inflation target. Its decision demonstrates that central bankers are still willing to experiment with new monetary policy ideas, as inflation remains too low. Some observers characterised this shift as probably the biggest innovation in monetary policy since the introduction of negative deposit rates by the Danish central bank in the summer of 2012! Finally, at its latest GC meeting, the European Central Bank (ECB) announced that it will extend its QE programme beyond March 2017 if needed. So far, there is some encouraging evidence from the ECB’s ongoing QE programme. In more detail: Loan growth continued to recover gradually. Lending to companies grew by 1.9% year-oyear, while household lending grew by 1.8%. A significant improvement has also been observed in Eurosystem banks’ composite cost of debt financing, which declined in July to a new historical low, after broadly stabilising in the second quarter of 2016. Also, banks reported a further net easing of credit standards on loans to enterprises in the second quarter of 2016, suggesting a continued improvement in financing conditions for corporate loans. Across the largest euro area countries, overall terms and conditions eased across all larger countries except for Germany. In most of the large euro area countries, in particular, France and Italy, banks continued to report a narrowing of margins on average loans in net terms. Margins on riskier loans widened in net terms in Spain and Germany. Furthermore, composite lending rates on loans to euro area NFCs (corporate loans) and households (i.e. mortgages) fell by around 100 basis points. The reduction in bank lending rates was especially strong in vulnerable euro area countries, indicating reducing fragmentation in euro area financial markets. Over the same period, the spread between interest rates charged on very small loans (loans of up to €0.25 million) and those charged on large loans (loans of above €1 million) in the euro area followed a downward trend. This indicates that smalland medium-sized enterprises have generally been benefiting to a greater extent than large companies from the decline in lending rates. b. QE vs. negative rates Staying in the eurozone and taking as a given fact that we will move towards more accommodative monetary policy in the months ahead, a more open question is: which policy instrument will be used? More QE or further negative rates? This is the essence of the monetary policy debate in the eurozone today. Clearly, there are limits to persistent negative rates, namely the underlying question is how far and for how long they can actually go. There are a number of concerns including banks’ profitability, how negative rates may act as an anaesthetic to euro area governments especially in the euro area’s southern periphery, taking into account that the fiscal space gained from lower debt service costs may result in a slower implementation of necessary fiscal and structural reforms. Policy rate cuts to negative levels have generally been reflected in corresponding declines in 4/5 BIS central bankers' speeches money market rates and short-term government bond yield. In turn, the fall in bank wholesale funding costs has helped lower lending rates, but to varying degrees across countries. In addition, there are concerns about the political and institutional feasibility of negative rates as their long-term effects are still unknown. Most importantly, their effectiveness is put under question during a recession, if this were to emerge in the near future. I would personally, in my professorial hat, prefer to see more QE rather than further negative rates. If this is the case, the next question is where could more QE in the eurozone come from? In other words, does the ECB have the tools for more QE stimulus? Well, there are several options. From changing the parameters of the current QE programme like, for instance, buying bonds below the deposit rate, increasing the 33% issue share limit, dropping the capital key allocation, or even adding new securities to the pool of eligible assets such as bank bonds or equity. c. The limits of central bank actions: a role for governments? In closing, it is worth reminding the words of President Mario Draghi , who said recently: “[low interest rates]… are not the problem. They are the symptom of an underlying problem, which is insufficient investment demand, across the world, to absorb all the savings available in the economy.” Along the lines of the previous caveat by President Draghi, one could add, for instance, that in countries with fiscal space, and/or at a eurozone-wide level, extra spending on infrastructure investment especially in today’s environment of extremely low long-term rates would clearly increase low demand in the eurozone, enhance its potential trend growth rate, make the task of monetary policy much easier and finally contribute to public debt sustainability in many countries. In other words, the time has come to use policy tools other than monetary policy, including fiscal and structural ones. Thank you very much for your attention. 1 A more detailed account on this can be found in my HABA-New York speech (October 2016). 5/5 BIS central bankers' speeches

bank of greece

Speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the SEACEN - OMFIF Joint Policy Summit entitled "Financial stability in an uncertain global environment", Bank Negara Malaysia, Kuala Lumpur, 23 November 2016.

“Central Bank Independence Revisited in the Era of Unconventional Monetary Policy” Speech by Professor John (Iannis) Mourmouras Deputy Governor, Bank of Greece Former Finance Minister at the SEACEN 1 - OMFIF Joint Policy Summit entitled “Financial stability in an uncertain global environment”* 2 Sasana Kijang, Bank Negara Malaysia Kuala Lumpur, Malaysia Wednesday, 23 November 2016 Ladies and Gentlemen, It is a great honour for me to be back to this part of the world. It’s certainly warmer over here! I would like to thank the organisers for inviting me to give a speech at this Joint Policy Summit on a topic that I have been revisiting lately, that of central bank independence. My earlier research on the subject goes back 20 plus years. My speech today revolves one single important question: if and how the concept of an independent central bank has been challenged, or perhaps even undermined, in an era of unconventional monetary policies, including their own exit strategies. Quite a few examples come to mind, especially looking at the latest developments. US President-elect Donald Trump criticised Fed Chair Janet Yellen for the Fed’s policy of low interest rates. In particular, the Fed has been accused of bias by President-elect Trump. British Prime Minister Theresa May came openly against the Bank of England’s policy under Governor Mark Carney saying that low interest rates deprive savers of interest income. Also, Germany’s “five wise men” (Council of Economic Experts) and German Finance Minister Wolfgang Schäuble criticised ECB President Mario Draghi for his negative interest rate policy. Against this background, the ultimate question is quite straightforward: is central bank independence sufficient for price stability when the tail risk of deflation is visible and unconventional monetary policies last too long? Opinions differ on this and I will give you my own view on this question in a minute, but before that let me make my view clear that The South East Asian Central Banks Research and Training Centre. * Disclaimer: Views expressed in this speech are personal views and do not necessarily reflect those of the institutions I am affiliated with. central bank independence is a necessary condition for price stability both in terms of mitigating a political business cycle, but also in terms of reducing the inflationary bias inherent in monetary policy. Central bank independence: theory The intellectual roots of central bank independence (or CBI) can be traced back to the rational expectations revolution, pioneered by the Chicago School in the 1970s. Rational expectations played a vital role in breaking the intellectual deadlock in the effort to address the stagflation phenomenon of the 1970s. With regard to monetary policy, seminal work by Kydland and Prescott (1977) and Barro and Gordon (1983) showed that under discretionary monetary policy the interaction of rational private agents with an equally rational government optimising a non-linear loss function whose arguments are deviations of inflation and output from socially desired target-levels, generates a Nash equilibrium involving an inflation bias whose size increases with the degree of output-gap aversion and which does not entail any sustainable output gains. To address the problem of inflation bias, monetary policy should be conducted under a technology of credible commitment to low future inflation rates so that private inflation expectations are anchored to equally low levels. Initially, this commitment took the form of intermediate policy targets, such as targets for money supply growth, introduced in the early 1980s by the Reagan and Thatcher governments in the US and the UK respectively; or exchange rate targets implemented, among others, by European countries in the context of the European Monetary System. Intermediate targets were successful in lowering inflation in major industrialised economies, thus introducing the Great Moderation era. However, the instability of money demand and the opaqueness of money supply targets rendered the latter’s implementation operationally difficult (see Mourmouras and Arghyrou, 2000). On the other hand, exchange rate targets rarely stood the test of time, thus preserving questions of credibility, as demonstrated by the literature on currency crises (see Obstfeld, 1996). CBI, along with the introduction of inflation targeting, was largely the profession’s response to the shortcomings of intermediate targets. Specifically, delegating monetary policy to an independent central bank, with a formal mandate to achieve price stability and granting discretion in the choice of instruments necessary to meet this objective, reduces the inflationbias problem as a result of the central banker’s objective function including an inflationaversion parameter higher than the government’s. Theoretically, this inflation gain may come at the cost of higher output volatility (see Rogoff, 1995). Empirical evidence, however, (see e.g. Alesina and Summers, 1993 and Cuckierman, 2008) suggests that CBI may operate as free-lunch, in the sense that it involves an obvious gain without causing an equally obvious loss. Empirical measures of central bank independence are found to be negatively correlated with the first and second moment of inflation, showing little, if any, correlation with output variability. Furthermore, CBI can be beneficial in ensuring sustainable public debt dynamics, as theoretically shown by Mourmouras and Su (1995) in a dynamic game set-up. As a result of its theoretical and empirical advantages, CBI was widely adopted (particularly in the 1990s) in major industrialised economies and beyond. The form of independence, however, varies between instrument (economic) and goal (political) independence (see Fischer, 1995). Under the former, the operational goals of the central bank are exogenously determined, either by legislation or by another official body such as the finance ministry. Under instrument independence, the central bank is free to choose without external interference the means (the policy instruments) best suited to meet its given goals: the Bank of England is an example of this form of independence. Under goal independence, the central bank chooses independently both the goals of its policy, as well as the instruments best suited to meet its self-selected goal: the ECB is an example of this type of independence. Delegating monetary policy to an independent central bank raises important questions of democratic checks and balances, i.e. questions of transparency and accountability. Accountability, in turn, is related to at least two dimensions. First, the type of central bank independence: the closer we move towards the independence goal, the higher the need for transparency and accountability. The second dimension is the number of goals set for the independent central bank. Perhaps non-intuitively, accountability declines with the number of policy goals, as given a set of policy instruments, increasing the number of goals results in trade-offs between goals. As the welfare ordering of policy outcomes under trade-offs is intrinsically more difficult than performance-ordering under a single policy objective, the scope for accountability increases when the central bank focuses on one policy objective. This accountability enhancement, combined with the theoretical and empirical advantages of inflation-averse monetary policy, resulted in the majority of the countries adopting central bank independence to define price stability as the overriding objective of monetary policy. The ECB is a characteristic example of this trend. On the other hand, the Fed, whose dual mandate includes price stability and maximum employment (plus moderate long-term interest rates), is a notable exception. Monetary policy in the post-crisis period The global financial crisis of 2008/2009 and the ensuing European sovereign debt crisis have fundamentally changed the operational framework of independent central banks. These changes relate to three levels. The first is methodological: We now have an appreciation of the potential real economic costs of financial crises that we previously lacked. This has motivated the development of a niche literature introducing a banking sector into DSGE models, thus allowing for financial crises (see e.g. Gertler et al., 2012 and Boissay et al., 2013). This literature promises to enhance the information available to policy-makers designing and implementing monetary policy. The second change is that central banks have been given new macro-prudential tasks, such as the supervision of systemic banks in the EMU, conducted by the ECB since 2014. On this frontier, central banks don’t know if they have failed until is too late. The costs of confusion and policy conflicts with multiple objectives may be too high, damaging the credibility of the central bank. And I refer to both types of costs: the costs of taking measures to avoid bank failures or the costs of doing nothing. The third change is the situation on the ground: Rather than preventing excessive inflation, price stability in the post-crisis era is about preventing deflation. Under low inflation, central banks largely lose the main policy instrument of conventional (standard) monetary policy, namely targeting short-run interest rates through open market operations, as short-term rates are restricted by the zero lower bound limit. As a result, all major central banks have employed non-standard monetary policy tools in recent years. These include the provision of emergency liquidity and credit support to banks and other financial institutions, extending the definition of assets accepted as eligible collateral when providing financial institutions loans on a short- or medium-term basis; and introducing quantitative easing (QE) programmes in the context of which central banks have been buying from the private sector sovereign bonds, corporate bonds and other corporate assets. Let me quickly remind you of the ECB’s monetary policy stance over the last nine years as a response to the worst financial crisis since the Great Depression, leading to negative interest rates and entering practically unchartered territory. Table 1. ECB’s non-standard measures Year Non-standard measures Oct-Dec 2008 ECB cuts the base interest rate from 4.25% to 2.50%, provides US dollar liquidity through foreign exchange swaps, expands the list of assets eligible as collateral in Eurosystem funding operations, introduces the 6-month longer-term refinancing operations (LTROs) and decides the main refinancing operations to be carried out through a fixed-rate tender procedure with full allotment. ECB cuts the base interest rate from 2.50% to 1.00%, and introduces the first Covered Bond Purchase Programme (CBPP1). ECB activates the Securities Markets Programme (SMP). The ECB launches the second Covered Bond Purchase Programme (CBPP2) and introduces the 3-year LTROs. The ECB announces the Outright Monetary Transactions (OMTs). The ECB cuts the base interest rate to 0.25% and introduces forward guidance. The ECB cuts the base interest rate to 0.05% and the deposit facility rate to -0.20%, bringing it for the first time in negative territory and introduces the Targeted LongerTerm Refinancing Operations (TLTRO) with a 4-year maturity. ECB introduces the expanded Asset Purchase Programme (APP) and cuts the deposit facility rate to -0.30%. ECB accelerates the expanded Asset Purchase Programme (APP) and cuts the Main Refinancing Operations (MRO) rate to 0.00% and the deposit facility rate to -0.40%. Indeed, the 10 largest central banks now own assets totaling $21.4 trillion, accounting for 29% of the world economy, up by 10% from end-2015, double what it was in midSeptember 2008 and almost half the value of all debt in Bloomberg’s global bond index (as shown in Chart 1)! Chart 1. The combined assets of the 10 largest central banks Finally, almost 75% of the world’s central bank assets are controlled by policy-makers in four regions: China, the US, Japan and the eurozone. The following six – that is, the central banks of England, Brazil, Switzerland, Saudi Arabia, India and Russia – each account for an average of 2.5%. The remaining 107 central banks tracked by Bloomberg, mostly with IMF data, hold less than 13% (see Chart 2). Chart 2. Central banks’ combined assets Chart 3. Stock of assets purchased by the four major central banks as a percentage of national GDP Source: Bank of Greece, European Central Bank, Fed, Bank of England and Bank of Japan. Note: The ECB’s purchased assets in the context of the SMP, CBPP1, 2 & 3, ABS and PSPP. As a result, central bank balance sheets expanded considerably: since 2008 the Fed’s balance sheet has more than doubled; the Bank of England’s balance sheet trebled; while the ECB’s balance sheet has also expanded considerably, particularly since the introduction of the ECB’s QE programme in 2015. QE programmes are designed to prevent deflation mainly through three distinct channels (see Demertzis and Wolff, 2016). First, the interest rate channel: this operates through lowering long-term interest rates to improve investment conditions and disincentivise savings. Second, the portfolio rebalancing channel: this operates through the purchase of relatively low-risk assets of long-term maturity, thus incentivising investors to take long positions in higher-risk (and thus higher expected return) assets. Third, the exchange rate channel, which as its name suggests works through a demand-boosting weaker domestic currency. The degree of success of QE programmes is under active research investigation Existing evidence, however, suggests that they have been successful in preventing large-scale deflation conditions, with the announcement effect of QE programmes being stronger than the effects of actual implementation (see e.g. Demertzis and Wolff, 2016 and Altavilla et al., 2015). Challenges for central bank independence in the low-inflation period The legacy of the great financial crisis of 2008 and the low inflation conditions that have since been observed bring new challenges for central bank independence. These challenges fall into two categories. First, the instruments’ independence of central banks has been put into question by external parties. Second, even if the instruments’ independence is not formally challenged, it may be effectively compromised as a result of the changed conditions. The two kinds of challenges are obviously interconnected. A formally independent central bank facing effective constraints in the conduct of its policy may find it harder to deliver on its mandate and may subsequently face calls for restricted independence. On the other hand, a central bank whose independence is under threat may be constrained in its policy (instruments) choices. All in all, current circumstances pose challenges for the successful regime of monetary dominance paradigm established in recent years. External challenges to the instrument’s independence mainly stem from political pressure. In the US, for example, proposals have been tabled to subject the monetary policy of the Federal Open Market Committee (FOMC) to unlimited congressional policy audits; adopt a specific equation in setting monetary policy and require from the FOMC to justify, through congressional hearings and investigations, deviations from the policy dictated by that equation; and use the Fed as a source of finance to monetize specific government initiatives (see Fischer, 2015). In the euro-area, on the other hand, the QE programme has been challenged both for being too expansive, as well as for being too limited. Similar criticism has been voiced regarding the effects of monetary policy in the UK. My own verdict is that the challenge should not be in the very concept of independence, but rather in the current economic policy mix: loose monetary policy plus tight fiscal policy. By keeping interest rates in negative territory for too long, the redistribution effects of monetary policy and the perceived degree of success of meeting the mandated objectives become more pronounced. Starting with the former, low interest rates redistribute wealth from savers to borrowers; and result in higher asset prices. Reduced real returns on savings have caused reactions from circles representing the savers’ constituency, both within and across countries, a point particularly relevant within the EMU; and as the distribution of asset holdings is highly uneven among sections of the population, the benefits of QE programmes may also be seen to be uneven. On the other hand, CBI independence may be questioned as long as recovery in major economies remains fragile; or is perceived as not achieving equally good performance across the board of its extended set responsibilities including, for example, financial stability. The independence of central banks may be scrutinised due to concerns as to whether a central bank with an extended mandate of objectives can operate transparently and with an appropriate degree of accountability in the context of a democratic political and economic system. All in all, an independent central bank that is subject to democratic accountability needs broader support from the public. Clearly, with persistent negative rates you are bound sooner or later to lose major parts of the broad constituency that you need as an independent central banker. Central banks have resisted challenges to their independence, pointing to the fact that political pressure onto monetary policy, mainly stemming from the fact that political cycles are shorter than the cycles faced by monetary policy design and implementation, introduces into macro-performance exactly the kind of pressure CBI was initially meant to address. For example, in the US, despite low inflation, survey-based measures of longer-term inflation expectations remain in the area of 2% (see Fischer, 2015). In the euro-area, the ECB’s decision to extend its QE programme has been taken in full independence, with a view to achieving the medium-term price stability objective within an environment of decentralised national fiscal and structural policies (see Cœuré, 2015). Similar clear statements of intent have been recently expressed by the Governor of the Bank of England in the wake of questions raised at high political level regarding the present course of UK monetary policy. Central banks’ opposition to calls for formally restricting their independence does not ensure that monetary policy may not face effective restrictions in its choice of monetary policy instruments. This risk mainly comes from the interaction of monetary policy with other policies, namely fiscal, structural and financial. Separate authorities charged with the conduct of these policies may be formally independent, they are, however, also interdependent. The risk raised by such interdependence is that if one independent policy authority does not take appropriate action to meet its mandated objectives, the remaining independent authorities may be obliged to over-react in a persistent manner in order to meet their own objectives. To provide an example, a direct way of identifying such a policy interdependence failure is in the field of nominal demand: e.g. in the eurozone, nominal demand in Q2/2016 was only 7% higher than in Q2/2008 (real domestic demand was 1% lower than it had been in the abovementioned periods), but much lower than the potential increase in its trend rate (roughly at 24% cumulatively, assuming a trend rate of real growth of 1% and a target inflation rate of 2%). Compare this number (7%) with the one for the US 23% of nominal demand growth during the same period. In brief, this may result in a regime of “weak dominance” of other policies over monetary policy, effectively destabilising the regime of monetary dominance that CBI is meant to establish. Another example of such potential weak dominance relates to the expansion of the balance-sheets of central banks in the context of QE programmes. This expansion may increase as a result of imperfections in the response of other policies to negative economic shocks. Such imperfections might pre-commit future monetary policy to lower than optimal for business cycle management interest rates, to prevent the central bank from registering large losses on its balance sheet caused by increased interest rates. This may have an important second round effect, as a low-interest rate bias in monetary policy could potentially render public budgets constraints less binding, causing a deficit bias in fiscal policy, threating price stability as explained by the fiscal theory of the price level. It follows, therefore, that the ability of central banks to exercise optimally their instruments independence and deliver their mandated objectives crucially depends on policy co-ordination between monetary policy and other policies, namely financial, fiscal and structural (see Cœuré, 2015). The importance of such co-ordination cannot be understated in the present conditions. The financial crisis of 2008/2009 has left a legacy of debt overhang and bank undercapitalisation, hindering the ability of banking systems to finance the real economy. To the extent that these undercapitalisation problems are not resolved satisfactorily, monetary authorities may need to take extra steps to increase liquidity (such as, for example, the LTRO programmes), thus creating a regime of financial-policy dominance over monetary policy. Fiscal policy may also be subject to the same financial dominance: If bank undercapitalisation problems result into direct or indirect banking support programmes (through, for example, the establishment of bad banks), fiscal space is reduced; and the ability of fiscal policy to operate as a shock absorber declines, placing even greater pressure on monetary policy to operate as such. European Banking Union (EBU), with the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM) at the heart of its operation, was designed precisely to offer a governance framework to separate fiscal and banking risks, so that the framework of monetary dominance is preserved in the euro-area, reverse the process of financial fragmentation observed following the global financial crisis and the European debt crisis; and restore the smooth operation of the transmission channels of the single monetary policy. Similar arguments apply to the field of structural policy. As suggested by the theory of optimum currency areas, limited flexibility in the goods, services and labour markets, restricts the ability of the economy to adjust towards its natural output following economic shocks, thereby increasing the pressure on fiscal and monetary policies to offset to operate as shock absorbers. This pressure is particularly strong under negative shocks, due to downward rigidities in prices and wages. Limited flexibility may therefore result into a structural10 dominance regime, resulting into sub-optimal, fiscal and monetary over-reactions in the event of shocks. In the context of the eurozone in particular, the problem of shock stabilisation takes an extra dimension, given that second-best fiscal responses may not be available at national level, due to the existence of rules restricting national fiscal policies, not to mention market constraints following the increase in government bond yields at the height of the European debt crisis. This has led to calls to revise fiscal rules, allowing greater fiscal discretion at national level. These calls have been partially endorsed following the revision of the Stability and Growth Pact, which compared to its original version now places greater emphasis on the stock rather than flow of fiscal liabilities; and has shifted the emphasis of the rules’ application from the short- to the medium-term. Concluding remarks In closing, it is true that during the Great Moderation period, central bank independence proved a highly-successful institutional innovation, primarily responsible for delivering the highly-valued public good of price stability. This policy objective, and the independence of central bank in its pursuit, should be maintained in the current period of low inflation, posing multiple challenges for central bank independence. Having said that, the lessons from the destabilising effect of financial crises cannot be ignored. Without any doubt, the information set under which central banks operate should be enhanced to consider risks to financial stability. Whether, however, central banks should be primarily responsible for ensuring financial stability is less clear - the jury on this question is still out. Some may call it independence, others may view it as autonomy; some may want to think of it as a misnomer, others may view it as something deeper in the end which affects a central bank’s operational independence. However, on the balance of existing theory and empirical evidence, I maintain that an independent central bank focused on price stability, along with structural adjustments, appropriate and sustainable fiscal policies and an enhanced technology ensuring macro-prudential stability offer the most promising path for restoring normal growth conditions and the creation of jobs, which is the ultimate objective. Independent central banks can exercise optimal policies towards delivering their mandated objectives only when they are well-coordinated with other policies, including fiscal and structural ones. Thank you very much for your attention! REFERENCES Altavilla C., Carboni G., Motto R. (2015). Asset purchases programmes and financial markets: lessons from the euro area. ECB Working Paper Series No 1864, European Central Bank. Barro, R, Gordon, D. (1983).Rules, Discretion, and Reputation in a Model of Monetary Policy. Journal of Monetary Economics, 12, pp. 101-22. Beetsma, R. and Guiliodori, M. (2010). The macroeconomic costs and benefits of the EMU and other monetary unions: An overview of recent research. Journal of Economic Literature, 48, pp. 603-641. Boissay F., Collard F., Smets F. (2013). Booms and Systemic Banking Crises. ECB Working Paper Series No 1514, European Central Bank. Cœuré, B. (2015). Lamfalussy was right – independence and interdependence in a monetary union. Speech at the Lamfalussy Lecture Conference, organised by the Magyar Nemzeti Bank (the central bank of Hungary), Budapest, 2 February 2015. Cuckierman A. (2008). Central Bank Independence and Transparency: Evolution and Effectiveness. European Journal of Political Economy, vol. 24, pp. 722-736. De Grauwe, P., Yeumei, J. (2015). Quantitative Easing in the Eurozone. It’s possible without fiscal transfers. CESifo Area Conference on Money, Macro and International Finance, 20-21 January 2015. Demertzis M., Wolff W. (2016). The effectiveness of the European Central Bank’s Asset Purchase Programme. Bruegel Policy Contribution 2016/10. Dotsey M., Ireland P., (1996). The welfare cost of inflation in general equilibrium. Journal of Monetary Economics, vol. 37, pp. 29-47. Driffill J., Mizon, G.E., and A. Ulph (1990). Costs of Inflation. Handbook of Monetary Economics, vol. 2, pp. 1013-1066. Fischer, S. (1995). Modern Approaches to Central Banking. NBER Working Paper Series 5064. Cambridge, National Bureau of Economic Research. Gertler, M., Kiyotaki N., and A. Queralto (2012). Financial Crises, Bank Risk Exposure and Government Financial Policy. Journal of Monetary Economics, vol. 59, pp. 517-534. Kydland, F.E, Prescott, E.C. (1977). Rules rather than discretion: The inconsistency of optimal plans. The Journal of Political Economy, 85, pp. 473-492. Leeper, E. (1991). Equilibria under “active” and “passive” monetary and fiscal policies. Journal of Monetary Economics, vol. 27, pp. 129-147. Mourmouras, I. and M.G. Arghyrou (2000), Monetary Policy at the European Periphery: Greek Experience and Lessons for EU Candidates, Berlin, Germany and New York, USA: Springer-Verlag. Mourmouras I. and D. Su (1999). Central Bank independence, policy reforms and the credibility of public debt stabilizations. European Journal of Political Economy, vol. 11, pp. 189-204. Mourmouras, I. (1994), Towards granting political and economic independence to the Bank of Greece [in Greek], To Vima, Athens Obstfeld, M. (1996). Models of currency crises with self-fulfilling features. European Economic Review vol. 40, pp. 1037-1047 Rogoff, K. (1985). The optimal degree of commitment to an intermediate monetary target. Quarterly Journal of Economics, vol. 100, pp. 1169-89. Svensson, L. (1995). Optimal inflation targets, conservative central banks and linear inflation contracts. CEPR Discussion Paper No 1249. Vujčić, B. (2016). The role of central banks and how to insure their independence. Speech by at the Symposium on “Central Banking in Central and Eastern Europe: Policy Making, Investment and Low Yields”, organized by the Czech National Bank and OMFIF (Official Monetary and Financial Institutions Forum), Prague, 10 June 2016.

bank of greece

Speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the Governors' Club, a forum comprising the Governors and Deputy Governors of the central banks of sixteen Southeast European and Asian countries, 30 October 2016.

John Iannis Mourmouras: developments in Greece Recent monetary and financial Speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the Governors’ Club, a forum comprising the Governors and Deputy Governors of the central banks of sixteen Southeast European and Asian countries, 30 October 2016. * * * Thank you Madam Chair, Governors, Ladies and Gentlemen, It is an honour to be here with you in the holy city of Jerusalem and I would like to thank the Governor of the Bank of Israel, Karnit Flug, for inviting me to this high-profile meeting. In the same Governors’ Club meeting in Shanghai in May 2015, I was given the chance to comment on the latest economic developments in Greece. Then I raised the alarm against the government’s delaying the negotiations with our lenders. Two months after my speech in China, Greece unfortunately witnessed the cost of backtracking, namely the deposit outflows which destabilised the banking system, called into question our country’s eurozone membership and resulted in the introduction of capital controls, a bank holiday, bank recapitalisation and, of course, the recession in 2015 and this year. A. The real economy However, it is fair to say that the situation has stabilised since the conclusion of the Third Memorandum agreement in September last year. Economic activity picked up in the last two quarters of this year, from a negative growth rate in 2015, to reach positive territory (+0.2% yearon-year) in 2016 especially if receipts from tourism remain buoyant. Bank of Greece estimates for next year show an increase in real GDP by 2.5% and 3% in 2017 and 2018 (Figure 1 and Table 1). The key drivers of growth are expected to be private investment and exports of goods and services. 1/9 BIS central bankers' speeches Both the economic sentiment indicator (Figure 2) and the industrial confidence indicator (Figure 3) have recovered in the second and third quarter of this year, while in the first half of July 2016 the number of tourist arrivals in airports in Greece increased by 7% and is expected to reach an 2/9 BIS central bankers' speeches unprecedented total of about 25 million visitors in 2016, which is more than double the Greek population. 3/9 BIS central bankers' speeches The unemployment rate remains elevated (23.2% in July 2016 and 23.1% in the second quarter of 2016), posing significant threats to social cohesion, while youth unemployment also remains alarming (at 38.1% in the age category of 15–29 years in the second quarter of 2016), intensifying the “brain drain” that deprives the economy of high-skilled human capital. Further deescalation of the unemployment rate and an increase in the employment rate depend to a large extent on the stabilisation of economic sentiment, economic growth as well as the implementation of structural changes. Active employment policies and training programmes will contribute to curbing the unemployment rate (Figure 6). The Greek banking system has undergone intensified liquidity pressures, following the massive deposit outflows recorded from October 2014 and until the introduction of capital controls in late June 2015. The completion of bank recapitalisation in December 2015, whereby private investors subscribed capital of about €9 billion, as well as the completion of the first review in June 2016 represent important steps towards the restoration of confidence in the Greek banking system which will facilitate the gradual recovery of bank deposits. In the period between the June 2015 capital controls and July 2016, a total of €6.8 billion of capital placed by Greek residents (firms and households) in financial assets abroad, i.e. deposits (worth €4.6 billion) and equities including mutual fund shares (worth €2.2 billion), has been repatriated. The rise in bank deposits now amounting to €123.9 billion stems mainly from the corporate sector, while the increase in household deposits was more contained. In addition, banks’ reliance on Emergency Liquidity Assistance (ELA) progressively declined in the first eight months of 2016, from €77.5 billion in December 2015 to €47.6 billion in September 2016 (Figure 9). In this context, liquidity conditions are expected to progressively improve as confidence is gradually restored, following the completion of the first review and the release of the sub-tranche of €7.5 billion. In view of the above, the decision of the European Central Bank on 22 June 2016 to reinstate the waiver of the minimum credit rating requirements for Greek marketable debt instruments, which entered into force on 29 June 2016, allows Greek banks to obtain funding from the ECB at a lower cost. However, the brighter outlook is depicted in the improvement of both fiscal and external imbalances. In particular, 2015 marked a turning point when Greek economy registered a zero balance in current account, and a primary surplus in the general government (GG) budget, while the decline in the primary budget deficit in the 2009–2015 period accounted for 10 percentage 4/9 BIS central bankers' speeches points of GDP! Moreover, in 2016 Greece’s fiscal balance and external position are both further improving as the general government primary budget should exceed the target set for the year (0.63% of GDP according to the draft budget, against a target of 0.5%), while the current account surplus is expected to stand at 0.9% of GDP (Figure 5). The materialisation of short-term debt relief measures, already agreed at the May 2016 Eurogroup meeting, is of great significance for boosting investors’ confidence. This is because it signals that the debt servicing burden will be moderate in the short term, thus releasing available resources needed for economic growth and alleviating the consequences of a strict fiscal adjustment. Last but not least, the Greek economy significantly benefited from improved competitiveness. In part, this development reflects the effect of structural reforms on the labour market, allowing more flexibility in the process of wage bargaining. More analytically, labour cost competitiveness has improved by 23.8% from 2009 to 2015 due to substantial labour market reforms and sizable declines in wage costs due to the prolonged recession. As a result, the cumulative loss in labour cost competitiveness between 2000 and 2009 has been recovered. Its improvement is estimated by the Bank of Greece at 3.7% in 2015 and at 0.5% in 2016. Improvements in price competitiveness are also evident and faster increases in the prices of tradables relative to nontradables provide incentives for producers to move into tradable sectors. Indeed, price competitiveness has been gaining momentum from 2012 onwards as the inflation differential with Greece’s main trading partners has been negative. Its cumulative improvement from 2009 to 2015 is estimated at 12.1%. Its improvement for 2015 is estimated at 4.5% by the Bank of Greece or 5.1% by the ECB (Harmonised Competitiveness Indicators (HCIs)) (Figure 6). According to ECB-HCIs, the price competitiveness index in 2016: Q1 was still 7.0% above its 2000 level. In 2016 Bank of Greece estimates price competitiveness to remain virtually stable (0.1% improvement). However Greece still ranks at the lower end of advanced economies and progress has since stalled or even retreated. In particular, the World Bank Doing Business report for 2015 ranked Greece 60th among 189 countries (a fall by two places) while according to the IMD World Competitiveness Yearbook 2016, Greece fell by six places and is ranked 56th among 61 countries. More recently, the World Economic Forum’s Global Competitiveness Report 2016– 2017 ranked Greece 86th among 138 nations, which corresponds to a fall by 5 places. But it should be noted that Greece has achieved high rates of responsiveness to OECD recommendations consistently since 2011 (OECD, Going for Growth 2013 & Going for Growth 2015). 5/9 BIS central bankers' speeches B. Monetary and Banking Developments On the other hand, HICP harmonised inflation was marginally negative in September (-0.1%), having remained negative for the previous fourteen consecutive quarters, despite some marginally positive monthly spikes (in July and August) as a result of VAT increases in a wide range of products and services (Figure 7). The convergence of HICP between Greece and the euro area is mostly attributed to the higher indirect taxes imposed on the Greek economy. 6/9 BIS central bankers' speeches Furthermore, according to Greek banks’ latest financial results for the first half of 2016, their capital adequacy was preserved at 18%, comfortably above the EU average. At the end of June 2016, non-performing exposures (NPEs) remained relatively flat around 45.1%, about eight times the European average which is around 5.7%, while in absolute terms the total amount of NPEs reached €108 billion, an 9% increase compared with the end of 2014. By sector, the highest ratios of non-performing exposures were recorded in the sectors of 7/9 BIS central bankers' speeches agriculture (59%), commercial properties (55%) and tourism (54%). Among the four main loan segments, the respective ratios for consumer, large business, SMEs and mortgage loans reached 55.3%, 29.1%, 59.9% and 44.7%, respectively (Figure 8). Loans in delay of more than 90 days accounted for 30% of NPLs, while this evidence is an early warning signal for credit risk developments in the banking system. Despite the size of the problem, the capital base of the banking system – as mentioned above – remains strong, while in terms of provision coverage Greek banks are well placed compared to peers (50.1% vs. 46.1% EU average). If one adds to this the value of collateral pledged, total risk coverage comes to 101%, one of the highest in the EU. Concluding, NPLs represent perhaps the most significant problem for the Greek banking sector along with liquidity (the two are of course interlinked). The Bank of Greece in its capacity as supervisor together with the SSM took a set of measures over the last two years including a code of conduct for banks for the effective and flexible treatment of borrowers facing difficulties in servicing their debt obligations. Moreover, the Bank of Greece adopted Executive Committee Acts Nos 82/2016 and 95/2016 detailing the licensing framework for credit servicing firms, striking a balance between speed, transparency and borrower protection. It also decided to set binding operational targets for all Greek banks with a view to ensuring a reduction of NPLs over a horizon of three years. More specifically, according to the targets of the four systemic banks, NPLs should be reduced by 40% or €41 billion by 2019. This reduction is expected to result from: firstly, the economic recovery envisaged in the Adjustment Programme and the ensuing return to profitability for a large majority of businesses and secondly, successful debt forbearance/restructuring whereby non-performing loans become performing again and a number of NPLs are sold to funds. C. One milestone-pending issue Looking ahead, in terms of economic policy, the steps forward are clear and dictated by the Memorandum between the Greek authorities and our official international lenders which goes through the completion of the second review of Greece’s Adjustment Programme by the end of this year, the specification of debt restructuring measures agreed-upon in the Eurogroup meeting of 24 May 2016 which are the precondition for Greece’s participation in the ECB’s public sector asset purchase programme (PSPP), best-known as the “QE programme”. In terms of the mechanics, and applying the ECB’s 33% issuer limit and subtracting the Eurosystem holdings of Greek government bonds, the maximum allowed purchases are €3.8 billion. Some could argue that the above amount is a mere pittance compared with the total Eurosystem’s purchases. Even in this respect, the signaling effect of Greece’s inclusion in the 8/9 BIS central bankers' speeches QE programme will be strong enough for GGB prices to recover, accompanied by a significant fall in volatility, as the overall financial environment is normalised and Greece is no longer an outlier in the euro area. D. Political stability as a crucial precondition for a sustainable recovery First of all, long-lasting political stability, strong governance and leadership are required to regain the confidence of foreign investors in my country, both in terms of portfolio and Greenfield investment. There should be no slackening of efforts on reforms and privatisations, but less austerity, and no complacency by the authorities. They should remain vigilant. Greece needs a new growth paradigm based on extroversion and innovation as major drivers of productivity and sustainable economic growth. Let me at this point draw a parallel between my country and our host country today, Israel, another small, open economy. It is known that during the period of 1973–1985, Israel had a chronic high inflation, fiscal and external imbalances, indexed contracts, etc. and an exorbitant public debt of almost 300% of GDP, which has now been reduced to a record low of 64.8%. It was the emergence of Israel’s export-based high-tech sector in the early 1990s that really put the country’s economy on track, with annual GDP growth accounting for at least 4%. Israel’s innovation laurels are several – the highest gross expenditure on R&D, the biggest number of companies listed on NASDAQ outside of North America, the highest level of venture capital as a share of GDP. Currently, Tel Aviv has evolved into one of the world’s leading hubs for technology and innovation and is a prime destination for entrepreneurs, investors, international R&D facilities and innovation centres. Between 1995 and 2004, Israel increased its spending on R&D, calculated as a percentage of GDP, from 2.7% to 4.6%, a rate higher than any other OECD country. Despite the brain drain, Greece still has a highly qualified human capital (mostly educated in UK, European and US universities), which is young and dynamic. Greece should resemble Israel, for instance, in terms of start-up high-tech companies, a sector in which Israel has shown the way as a true champion. This may be the solution for the Greek youth’s high unemployment problem, the poor job creation record and the subsequent problem of a jobless recovery. In closing, let me look forward into the future and end my speech on a note of optimism. It is less than five years until the milestone year of 2021, a year with lots of sentiment and symbolism for the Greek people. It will mark the 200th anniversary of the Greek war of independence against the 400-year Ottoman rule, which led to the creation of the modern Greek state. I am confident that if we persist with reforms in the next four years and take decisive measures, our country will come out of the woods and the Greek people will look to the future with confidence, being able to celebrate this important anniversary within a truly modern European state with jobs, prosperity and social cohesion that our great nation quite rightly deserves. 9/9 BIS central bankers' speeches

bank of greece

Keynote address by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the AMUNDI - OMFIF Asset and Risk Management Seminar nd Risk Management Seminar "Τhe risks and prospects for the global economy and capital markets in 2017", London, 24 January 2017.

“The risks and prospects for the global economy and capital markets in 2017” Keynote address by Professor John (Iannis) Mourmouras * Deputy Governor, Bank of Greece at AMUNDI - OMFIF Asset and Risk Management Seminar entitled “Risk and yield management for official asset managers in a multicurrency system” London, 24 January 2017 Disclaimer: Views expressed in this speech are personal views and do not necessarily reflect those of the institutions I am affiliated with. * Ladies and Gentlemen, Today, as policies and capital markets seem to be moving from the “Unconventional Era” and “Great Distortion” towards “Gradual Normalisation”, I would like to discuss not only the prospects, but also the challenges we face head-on. Let me start by offering my own insights into the global market outlook. 1. GLOBAL ECONOMIC OUTLOOK FOR 2017 The world economy 2017 will be very different from 2016, in many respects. If 2016 will be remembered as the year of Brexit and Donald Trump’s election, 2017 I foresee may well be remembered for developments in the European continent. I refer to the national elections and the associated political uncertainty that may trigger further changes in the eurozone and the broader European Union, as we know it today. Two other key topics will be the new US economic policy under President Trump and the end of the dominance of central banks, which will pass the torch to fiscal policy across the globe. In 2016, performance in the world’s major capital markets has been low by historical comparison, reflecting the salient events over the course of the previous year. I will show you only one figure depicting 2016 in six charts and refrain from any further comments about last year, as the Bank of England’s Chris Salmon will provide a thorough overview of financial market developments in 2016 later this evening. Figure 1. 2016 in six charts The IMF’s latest macroeconomic projections, released last week, suggest that recovery is on the way † this year once again. A pick-up in global real GDP growth is expected, from 3.1% in 2016 to 3.4% in 2017, driven mostly by a rise in emerging markets’ growth (4.1% in 2016 to 4.5% in 2017) and secondarily by a pick-up in advanced economies’ growth (1.6% in 2016 to 1.9% in 2017) (see Figure 2). Also, headline consumer price inflation in advanced economies is forecast to increase to 1.7% in 2017, up from 0.7% in 2016, mainly on account of higher oil prices and in line with the rebound in world economic activity. † IMF, World Economic Outlook, January 2017. Figure 2. Real GDP growth (year-on-year) in major economies The most astonishing fact about the world economy is that it has grown every single year since the early 1950s. It has very rarely grown by less than 3% since the early 1950s and only four times by less than 2% - in 1975, 1981, 1982 and 2009. The first three were the result of oil price shocks, triggered by wars in the Middle East and Federal Reserve disinflation. The latter was caused by the Great Recession after 2008’s global financial crisis. The following slides summarise the IMF’s January predictions for this year about the major blocks of the world economy. Let’s start with the US. The US outlook Output growth is projected to rise to 2.3% in 2017 and 2.5% in 2018. Both business and consumer confidence are at their 15-year peak, suggesting that the US economy is buoyant at the end of the Obama administration. In addition, after the latest FOMC meeting, the Fed’s expectations for CPI inflation in 2017 are at 1.8%-1.9%, slightly higher than the previous forecast of 1.7%-1.8%. The eurozone outlook Focusing on the economic developments in the euro area, the economic sentiment indicator for the euro area rose to 107.8 in December 2016, reaching the highest since June of 2011, while consumer confidence remains at negative territory of -5.10, but in the highest level the last 20 months. As far as inflation data concerned, according to Eurostat’s flash estimate, annual HICP inflation had continued to rise in December 2016, to 1.1%, after 0.6% in November, while core inflation (flash estimate) increased to 0.9% in December, up from 0.8% in November. Inflation expectations, as measured by the five-year inflation-linked swap rate, edged up to 1.77% at the beginning of December, close to the values recorded at the beginning of this year, slightly higher than prior to the start of the PSPP last year. Moreover, the December 2016 Eurosystem staff projections foresee the euro area HICP inflation at 0.2% in 2016, and 1.3% in 2017, while real GDP growth is foreseen at 1.7% in both 2016 and 2017 and at 1.6% in both 2018 and 2019, broadly unchanged from previous estimates. The UK outlook As far as the UK is concerned, stronger-than-expected performance during the latter part of 2016, led the IMF to revise upwards its real GDP forecasts for 2017 to 1.5%, from 1.1% previously. The average forecast for UK growth in 2017is now just 1.3%, down from 2% in 2016 and 2.2% in 2015. This reduction is due to the forecast impact of Brexit. But the average conceals a wide range underneath. At the optimistic end, growth is predicted to reach 2.7% while, at the pessimistic end, it is predicted to be just 0.6%. But the majority of forecasters seem to expect a significant slowdown next year a hard UK exit from the EU in 2019 is now a plausible scenario. Due to concerns over the general economic outlook, consumer spending is expected to slow significantly in 2017, amid weakening fundamentals. Living standards are also likely to fall, after two relatively good years. One reason is the slowing economic growth. This would mean declining growth of employment and possibly an outright decline. Furthermore, weak sterling and rising inflation will erode real wages. Growth of real earnings is forecast at around, or below, zero in the second half of 2017. High inflation will also aggravate the freeze on the nominal value of welfare benefits. A number of other factors may give rise to downside risks for the UK output. First, the UK is running an enormous current account deficit, forecast at 5.7% of GDP in 2016. Second, public sector net debt is forecast to hit 90% of GDP in 2017-18, which suggests a diminishing margin of manoeuvre. Third, productivity growth remains too weak. Finally, business investment remains too weak to shift the adverse productivity trend. The consensus of forecasters for consumer price inflation in 2017 is 2.5%, up from a mere 0.7% in 2016. The Japan outlook With regard to the Japanese economy, IMF has also revised upwards its real GDP forecasts to 0.8% for this year and to a relatively stable pace of around 1% in the years to come. According to the Bank of Japan, this is a rather moderate expansion with rising domestic demand, based on a rising domestic demand large-scale fiscal stimulus and growing exports. Inflation in Japan remains close to zero, almost four years after the Bank of Japan began an enormous monetary stimulus, as low oil prices and a period of yen strength dragged down prices. “The year-on-year rate of change in the consumer price index is likely to be slightly negative or about 0% for the time being,” said the Bank of Japan. Emerging market economies (EMEs) As regards emerging economies, economic activity is projected to reach 4.5 percent for 2017, around 0.1 percentage point weaker than previously forecasted. China’s economy is expected to have met the government’s target of at least 6.5% growth of GDP for 2016. It is expected to continue to grow at a slightly slower rate (6.2%) also next year. Two main risks are threatening such a robust economic performance by the Chinese economy, which, if materialized, will result in a sharp slowdown in the Chinese economy, will have effects that will be felt globally. Commodity exporters, like for instance Brazil, Australia and South-East Asia, would then be hardest hit. The first one arises from the high level of debt overhang. China’s total corporate debt load had reached 255% of GDP by the end of June, up from 141% in 2008 and well above the average of 188% for emerging markets, according to the BIS. The second one is China’s troubled shadow banking system, which lacks financial sophistication. They look at the yield, and they don’t pay attention to the risk. A hypothetical series of defaults would shatter the assumption of an implicit guarantee, sparking a run that would leave dozens of banks exposed to a funding crisis. Finally for 2017, watch out for India, which by the way marks 70 years since its independence from the British Empire. For the past two consecutive years, India has outpaced China in terms of growth rates and is expected to do so this year as well. The growth forecast for 2017 is 7.2%. Indeed, India seems to have gained a momentum despite the temporary negative consumption shock induced by cash shortages and payment disruptions associated with the recent currency note withdrawal initiative. Table 1 Real GDP and CPI Forecasts for Major World Countries Indicator Real GDP (YoY%) CPI (YoY%) Year United States 1.6 2.3 1.3 1.9 Japan 0.7 0.8 -0.2 0.0 Euro Area 1.7 1.7 0.2 1.3 UK 1.3 1.5 0.7 2.5 China 6.5 6.2 2.0 2.2 India 6.6 7.2 5.0 4.7 Source: IMF, ECB, Fed, Bank of Japan, Bank of England, and Bloomberg. 2. RISKS TO THE GLOBAL ECONOMIC OUTLOOK A. US policy uncertainty due to new fiscal and trade policy In the final months of 2016, financial markets responded to Donald Trump’s election in textbook fashion - not only at asset class level, with upward movements in stocks and government bond yields, but also within asset classes. Markets were responding to prospects for higher growth, inflation and market inflows following the US presidentelect’s policy announcements on deregulation, tax reform and spending on infrastructure. Even more impressive, this occurred in a remarkably orderly fashion, with little evidence of distress among investors. Trumponomics will remain an important market influence this year, with investors particularly interested in two things: the transition from announcements to detailed design and sustained implementation; and outcomes, particularly when it comes to the mix between higher growth and inflation. The anticipation of a more active fiscal policy is based on the assumption that President Trump will reinvent the package of policies known as Reaganomics. Not without reason. Most importantly, during much of his first administration loose fiscal policy collided with a tight monetary stance as Paul Volcker’s Federal Reserve sought to squeeze inflation out of the system. This resulted then in a seriously overvalued dollar. The strength of the dollar since the Trump election is justifiably based on that historic analogy. It seems that there are two differences, however, between the Reagan administration and the Trump one. Reagan was fortunate in taking office in 1981 just after the second oil crisis tipped the economy into recession. As well as a strong cyclical recovery, the economy received a windfall as the oil price collapsed. As inflation came under control, policy interest rates came down, laying the foundation for a 35-year bond bull market. President Trump, by contrast, makes his entrance at the tail-end of a mature, though fragile, expansion. Wages are rising and there is little slack in the economy. On some estimates, the potential growth rate is as low as 1.5%. In other words, the risk of witnessing more inflation than growth is real. Secondly, there are debt levels. Reagan started a long surge in public-sector debt. Yet gross public debt today, at nearly 105% of GDP, is more than twice its size when Reagan left office in 1989 - a level not seen before outside the context of war. On the external front, there is the question of foreign policy, both in terms of trade and geopolitical issues. There is a heightened risk on “trade protectionism” under the Trump administration. For several Asian economies, as well as Canada and Mexico with strong trade ties to the US, including the emerging markets, open borders and freetrade agreements are of paramount importance. But also, for the rest of the world, protectionism will have serious implications that will impact on the performance of their economies. Overall, a surge of protectionist measures would not only undermine the recovery in global trade, it would also disrupt global supply chains and limit international factor movements, for both labour and capital. A protectionist backlash would not just have an adverse near-term cyclical impact, but also a negative long-term structural impact on potential growth. Finally, two cautious remarks on the US economy: (1) A skyrocketing dollar may inhibit growth. The dollar is up 25% against the euro since 2014. (2) The recent big fall in real US yields (for 10-year Treasury notes to 0.38% today, from 0.74% one month earlier) may suggest that investors moderate their expectations for Trump’s economic agenda. Clearly, when optimism towards the economy brightens, investors typically demand a higher real yield to hold treasury debt, and the reverse also holds. B. Europe’s politics Political risks to the European order are on the rise after the UK vote to leave the EU and the unprecedented wave of migration from war-torn countries in the Middle East and North Africa that has fueled the rise of nationalist politics and populism and a backlash against mainstream politicians and political and financial elites. Euroscepticism is now a strong sentiment in Europe. Populist parties are in government or in a ruling coalition in nine (9) countries of the EU. This is an alarming figure. Elections this year in the Netherlands, France, Germany, and maybe Italy, four of the founding members of the European Economic Community back in the 1950s, are critical as they may provide gains to populist parties that would result in increased Euroscepticism across Europe and as political risks seem to come ahead of economics. But what exactly does populism mean? And why markets should care about it? There are three reasons. First of all, there is anti-globalism and blaming of free-trade agreements and global finance. Second is an embrace of state activism in the economic field, which implies less structural reforms, undoubtedly inhibits long-run growth and, in turn, jeopardises public debt sustainability which is at the heart of the south of Europe’s economic troubles. Third, populists are averse to policymaking based on rules and in favour of discretionary policymaking and interventionist policies. In short, the risk with the multiple elections and possibly a mushroom of referenda in Europe is that we cannot rule out that voters will once again turn against the mainstream parties, shifting towards less international cooperation, away from free trade and away from open borders and migration. Brexit is perhaps the best example. Prime Minister May’s powerful speech on 17 January set the agenda for a hard Brexit, on the ground that no deal is better than a bad deal, regardless of the short-term cost to the economy. Effectively, the Prime Minister will not seek for the UK to remain in the single market, but will negotiate a customs agreement and, in exchange, regain control over UK borders. Hopefully there won’t be any upsets and further complications from today’s decision by the Supreme Court of Appeal on whether the UK government can formally initiate Article 50 without parliamentary approval [the High Court has ruled that parliamentary approval is required]. If Article 50 is triggered in March I hope that at least part of the negotiation will be careful not to jeopardise the City of London’s role as a leading global financial centre. C. Geopolitical and other risks A third set of risks is geopolitical. To name briefly a few, the coming friction between President Trump’s US and China, but also Germany; friction between Iran and Saudi Arabia, and the real threat of ISIS hitting Western democracies. Last but not least, underlying vulnerabilities remain among some large emerging market economies, with high corporate debt, weak bank balance sheets, and thin policy buffers, implying that these economies are still exposed to tighter global financial conditions, capital flow reversals, and the implications of sharp depreciations, especially as a result of an unprecedented strength of the US dollar. All this heightens their exposure to severe external shocks. Indeed, the last time emerging economies faced monetary tightening and fiscal loosening in the US (in the early 1980s), many of them (notably in Latin America) slid into a lost decade. 3. CENTRAL BANKS’ MONETARY POLICIES In the beginning of 2017, it seems that the major advanced economies monetary easing cycle may be ending soon. Since August 2007, the average advanced economies’ policy rate has fallen by 377bp, ranging today from -0.75% in Switzerland to +1.75% in New Zealand. In addition, advanced economies’ central bank balance sheets have expanded dramatically, from an average of 11% of GDP in mid-2007 to 34% of GDP by end2016. Balance sheet increases were largest in Japan (from 22% of GDP to 91%) and Switzerland (19% to 111%) (Figure 3). Figure 3. Advanced Economies’ - Quarterly Average Policy Rate (%) and Central Bank Balance Sheet Size (% of GDP), 2000-2018 (Forecast) Fed In response to the US’s strengthening labour market and moderate expansion in economic activity, the Fed announced last December its widely anticipated increase in the federal funds rate target to 0.5%. The Fed has indicated that future increases would soon follow, possibly three times by the end of 2017. Federal Reserve Bank president Janet Yellen suggested that the Fed would need to “have time to wait and to see what changes occur” under President Donald Trump’s administration to factor those into the Fed’s future decision-making. At present, markets are priced for only two rate increases this year, one in the end of the first half of 2017 and another by the end of the year, while the market-implied probability for a rate hike in March is around 25% (Figure 4). Figure 4. FOMC projections and current market expectations In short, the Fed probably will not alter its gradual monetary normalisation plans until there is more clarity about the profile of US fiscal policy. ECB It is true that the critical indicator for the ECB remains core inflation. Indeed, core inflation has been incredibly persistent in the euro area, stuck below 1%, while inflation forecasts until 2019 remain under the target with downside risks, as I said earlier. Hence, at least for the first half of the year, the ECB’s stance remains accommodative as more evidence that inflation is self-sustaining is needed. Against this background, taking into account that, as I predict, the Fed will continue its monetary policy normalisation by raising key policy rates gradually, the so-called monetary policy divergence among G-4 central banks will remain a key theme in the 1st half of 2017. However, higher oil prices could feed into a gradual increase in inflation, (Figure 5). When inflation expectations are on the rise, the ECB’s forecasts could soon point to opportunity for the ECB to rebalance its stimulus by tapering QE and rely more on liquidity provision. Hence, any upcoming reductions in the APP could be seen as a gradual tapering. In this context, communication will be crucial, while to protect the periphery from what may be seen as a reopening of credit risk (sovereign debt is substantial), banks may be given another liquidity injection (TLTRO). We all recall the financial market effects from the Fed’s tapering in spring 2013, which largely contributed to a sell-off that drove the 10-year Treasury bill from just above 1.60% in early May 2013 to 3% only four months later. Figure 5. Euro forward inflation linked swaps (1-year-1-year & 5-year-5-year) Source: ECB. In the eventuality of such QE tapering, less monetary divergence between G-4 central banks will be on the cards for the second half of the year (Figure 6). Figure 6. Less QE from ECB, less monetary policy divergence BoJ Source: US Fed, Bank of Japan, ECB, and SG Cross Asset Research/Global Asset Allocation. Bank of Japan As you know since last September the Bank of Japan introduced a new monetary policy framework best known as “QQE with yield curve control” and shifted its key policy target from quantity (i.e. asset purchases) to interest rates, thus preparing the ground for its own QE tapering. While inflation is likely to remain much lower than the Bank of Japan’s 2% inflation target in coming years, (2017 Forecast: 0.6%), it is not expected by the markets any more monetary easing during Governor Kuroda’s term (ending in April 2018). Bank of England Although spot inflation will likely move higher over the coming year, (according to BoE’s forecasts, inflation will rise to 2.7% in 2017), the BoE has clearly stated that its stance now is neutral. However, there are enhanced concerns over the impact of the Brexit referendum on growth, together with the potential shock to real incomes expected as price pressure begins to build over Q1. At present, the market prices a 35% chance of a 25bp rise to Bank Rate by the end of 2017. Finally, Table 2 shows in detail the monetary policy front from the G-4 central banks in the year ahead and Figure 7 shows their median inflation forecasts. Table 2. Fed, ECB, BoJ, BoE monetary policies in 2017 Source: Bloomberg. Note: 1.The ECB announced that QE purchases would continue beyond March 2017 until end-2017, at €60 billion per month (dropping from €80 billion currently). Purchases are unlikely to stop altogether at that stage; rather, the ECB would announce a gradual phasing out of QE. 2. YCC: 10-year yield target of zero, negative policy rate. Figure 7. CPI Inflation (% YoY) and Central Bank Median Inflation Projections, 2010-2019 Source: Bank of Japan, ECB, US Federal Reserve, Bank of England, and Bloomberg. In a nutshell, my verdict on monetary policy in the year ahead is: more monetary policy divergence in the first half and less monetary policy divergence in the second half of the year, which, in terms of the financial market’s jargon, means less distortion from unconventional monetary policies, a gradual return to monetary policy normalisation and steepening yield curves. 4. FINANCIAL MARKETS PROSPECTS IN THE YEAR AHEAD A. THE US DOLLAR DOMINATES FOREIGN EXCHANGE MARKETS I turn now to foreign exchange (FX) prospects for 2017. 2016 was the year that shook up currencies: sterling took a beating, while the dollar continued to march ahead; in real effective terms it has appreciated by more than 6% since August (Figure 8). This year it is predicted that the dollar will once again dominate the FX markets. • Against the euro: Parity is on the way The main question is: How far can the USD run? The extent of monetary divergence between the Fed and the ECB will be the major driver for US dollar strength, together with a higher-than-expected budget deficit as a result of fiscal stimulus, which with higher long-term government bond yields will attract new capital inflows. In addition, a busy electoral calendar in Europe will be another source of concern for investors in light of the recent rise of populist movements and euro scepticism as the European political agenda looks busy in 2017. As a result, the dollar’s strength is expected to remain with the euro against the dollar to move near to parity and could break it by year-end. Figure 8. EUR-USD and real yields Source: Bloomberg. • Against the British pound: The Brexit risk overshadows everything The US dollar rose against the pound by more than 16% on a yearly basis last year. Downside risks for sterling remain significant this year, while periods of spikes are expected considering the recent sterling behavior after Prime Minister Theresa May $ announced the UK’s hard-line negotiating position. On Tuesday, 17 January, right after Prime Minister May’s speech, the sterling rose by almost 3% against the US dollar and by 2% against the euro, recording its biggest gains against the US dollar since 1993, to above US$ 1.24 (Figure 9). Figure 9. GBP-USD Spot Exchange Rate (above) and GBP-USD 3-month ATM Implied Volatility Source: Bloomberg. • Against the yen: further appreciation ahead As the market is expecting a notably more restrictive US monetary policy, whereas the Bank of Japan will remain rather expansionary, the outlook for both USD-JPY and EUR-JPY currencies is to appreciate during this year. • Against CNY: Weakness abroad The CNY has depreciated by more than 3% against the US dollar since the SDR inclusion in October and by around 10% on a yearly basis. A managed depreciation remains the key theme for the CNY in the foreseeable future as one of the Chinese authorities’ priorities is the currency credibility due to China’s aspirations for the CNY to become a global reserve currency. B. Sovereign bonds: more than usual volatility / rebuilding term premia/ steepening yield curves As the global policy mix is evolving towards more fiscal easing and less monetary easing, there is intrinsic uncertainty because effective implementation of such a policy shift is still very much an open issue. This would lead to higher yields, more volatility and higher term premia, especially on the long-end of the yield curve, which is overbought over the last few years due to low-for-long interest rates (Figure 10). As a result, the themes of rebuilding term premia in long maturity rates and steepening yield curves are gaining ground. Figure 10. Interest rates on, 2-year and 10-year sovereign bonds in the US, Germany, Italy, Spain, Japan, and the UK US government bonds market Increasing term premia effectively means that there is room for a steeper yield curve for a given level of short rates. The degree of US government yield curve steepening will depend on the pace of policy normalisation by the Fed, on the depth of tax cuts and the level of infrastructure spending. All this could lead to higher inflation expectations and a sharp repricing of term premia. Euro area government bonds market The outlook for European fixed income in 2017 requires a careful balancing act between expectations of less monetary policy support on the one hand and structural factors, on the other hand, such as unresolved banking sector issues as well as political developments (Figure 11). Figure 11. US-German Government 2-year and 10-year bonds spread (in basis points) Source: Bank of Greece and Bloomberg. Any widening in periphery spreads will depend on country-specific politics, the longstanding issue of economic non-convergence, but also given that the ECB’s APP will run throughout the year. Hence, a rise in the yields in the europeriphery is quite likely and the spread between core and peripheral yields will fluctuate throughout the year. • Equities Finally, one word about equities. Watch out once again for the correlation between bond yields and returns on equities. Since the 2008 crisis, this correlation has been systematically negative due to drastic non-standard measures with a few exceptions (Fed’s tapering in 2013 and the Bund tantrum in 2015, during which bonds and equities prices abruptly corrected). In my view, the bond-yield/equity market correlation will remain negative as a trend once more this year, albeit less pronounced and more volatile (Figure 12). Figure 12. Interest rate/ US equity market correlation (26-week moving average) vs. Fed cycle Source: Federal Reserve Bank of New York. Thank you very much for your attention!

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Introduction by Mr Yannis Stournaras, Governor of the Bank of Greece, to the presentation of the European Bank for Reconstruction and Development (EBRD) Transition Report 2016-2017, Athens, 25 January 2017.

Yannis Stournaras: Reforming and rebalancing the economy in Greece Introduction by Mr Yannis Stournaras, Governor of the Bank of Greece, to the presentation of the European Bank for Reconstruction and Development (EBRD) Transition Report 2016-2017, Athens, 25 January 2017. * * * It gives me great pleasure to welcome Artur Radziwill, Director for Country Economics and Policy of the EBRD, and his colleagues to the Bank of Greece. As you are aware, the Bank of Greece has on several occasions provided the venue for the presentation of the Transition Report and for many other EBRD initiatives. It this vein, we endorse the activity and positive role of the EBRD in Greece, in particular during the last couple of years following the establishment of its local office. Its commitment to the country sends a strong signal to private sector investors that Greece is serious about reforming and rebalancing its economy. The 2016 Transition Report is of particular relevance to Greece, since it deals exclusively with the important subject of inequality and economic inclusion. The Report focuses on a number of key aspects of inclusive growth: the distribution of income; the impact that the transition process has had on people’s well-being and happiness; equality of opportunity; and financial inclusion. These aspects are topical for Greece. The economic adjustment programmes that have been implemented since 2010 in Greece aimed at addressing the twin deficits (i.e. fiscal and current account) and structural weaknesses from which the economy has suffered for decades. The achievements so far have been remarkable: Unprecedented fiscal consolidation. Over the period 2013–16, the primary deficit was eliminated and, for the first time since 2001, general government primary surpluses were recorded. Moreover, the improvement in the “structural” primary budget balance by more than 17 percentage points of potential GDP between 2009 and 2016 means that, taking the impact of the economic cycle into account, the fiscal adjustment in Greece was more than double the one achieved in other Member States under similar programmes. A recouping of the sizeable cumulative loss in labour cost competitiveness vis-à-vis our trading partners between 2000 and 2009. An elimination of the external deficit, which exceeded 15% of GDP in 2008. An increase in the share of exports from 19% of GDP in 2009 to 32% today. Structural reforms, notably in the labour market, but also in the product markets and in public administration. Recapitalisation and restructuring in the banking system, enabling it to withstand the crisis and the flight of deposits, and ensuring that it now has adequate capital, provisions and collateral, i.e. that the necessary (though not sufficient) conditions are in place for the banking system to address the major problem of non-performing loans. A halting of the increase (and even a slight decrease) in the volume of non-performing loans in the second and third quarters of 2016, for the first time since 2014. A rebound of the economy in the second and third quarters of 2016, making it reasonable to anticipate a positive growth rate for the year as a whole, for the first time since 2014. These stabilisation policies in order to correct the unsustainable twin deficits inevitably came at an economic and social cost: even more recession, job and income losses. But as argued above, these sacrifices have not been wasted. 1/2 BIS central bankers' speeches Greece is currently on the road to recovery. It is therefore more topical than ever that the reforms that will be put forward in order to keep Greece on the track of a new, extrovert growth model will also safeguard social cohesion. This is a prerequisite to ensure that reforms will be politically sustainable, a key finding of this Report. The analysis of the 2016 Transition Report draws, inter alia, on the third round of the Life in Transition Survey (LiTS III), a household survey conducted by the EBRD and the World Bank. Crucially, the Life in Transition Survey also covered Greece, to which a whole chapter of the respective Report is dedicated. According to the Life in Transition Survey, the impact of the economic crisis on Greek households has been deep and widespread. Lastly, the Bank of Greece has repeatedly underlined the importance of investment in the revival of the economy. Therefore, tackling successfully the obstacles Greek firms are currently facing in the business environment, according to the key findings of the Business Environment and Enterprise Performance Survey (BEEPS) for Greece, will induce investment, boosting in turn the economic prospects of Greece. I am looking forward to today’s presentations and I am confident that they will contain many useful insights for Greece that will contribute to the constructive discussions on the way forward. 2/2 BIS central bankers' speeches

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Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the International Forum of Independent Audit Regulators (IFIAR) Inspection Workshop, Athens, 8 February 2017.

Yannis Stournaras: Prospects of the Greek economy and the role of supervisors in regulating the banking system Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the International Forum of Independent Audit Regulators (IFIAR) Inspection Workshop, Athens, 8 February 2017. * * * Ladies and gentlemen, I am deeply honoured to be here today and have the opportunity to share with you my thoughts on the impact of ongoing developments in the Greek economy in general and the domestic banking sector in particular. Before I move on, please allow me to highlight the importance of financial stability as a necessary condition for achieving the goals of prosperity and sustainable growth; these are common goals between market participants and central bankers. This precondition becomes really important, as our macro-prudential environment becomes stricter with the passing of each year. Regardless of any single initiative or project, the general macroeconomic framework and key financial stability conditions are absolutely necessary in order to achieve overall positive performance. These simple facts have become abundantly clear over the past few weeks in Greece, as we all look forward to reaching an agreement between the Greek Government and the institutions as soon as possible and bringing the second review of the current economic adjustment programme to a successful conclusion. I will briefly outline some of the most significant developments that have been made in the domestic economy. These developments were accompanied by positive changes in the Greek banking sector and, in particular, by a series of ongoing initiatives to achieve higher asset quality. In this context, it is worth adding some thoughts to the ongoing discussion between banks and supervisors, in terms of the medium-term impact of IFRS 9 implementation. Finally, a few remarks about cooperation between banking and audit regulation as well as the issue of mandatory auditor rotation are quite relevant for our discussion. Following a deep and prolonged recession, Greece is currently on the road to recovery. The rebound of economic activity in the second and third quarters of 2016 supports an expectation of positive growth rate for the year as a whole, for the first time since 2014, and much stronger growth in 2017. As you are aware, the economic adjustment programmes that have been implemented in Greece since 2010 aimed to address the large twin deficits (i.e. fiscal and current account) and structural weaknesses from which the economy had suffered for decades. So far there have been remarkable achievements: Unprecedented fiscal consolidation: Over the period 2013–16, the primary deficit was eliminated and, for the first time since 2001, substantial general government primary surpluses were recorded. Gains in external competitiveness: The external deficit, which exceeded 15% of GDP in 2008, was eliminated, underpinned by a substantial increase in labour cost competitiveness vis-à-vis our trading partners and an increase in the share of exports to 32% of GDP today from 19% in 2009. Structural reforms, notably in the labour market, but also in the goods and services markets and in public administration. Unlike in other Member States that also experienced similar crises, the Greek crisis did not come from the banking sector. In an adverse international economic and financial environment, Greece was hit by a serious sovereign debt crisis that required three economic adjustment programmes that included, inter alia, substantial structural reforms and severe austerity measures. The sharp 1/5 BIS central bankers' speeches deterioration of the macroeconomic environment that led to a loss of more than 25% of GDP over these years bears testimony to the fact that the Greek crisis is more far-reaching and lasted longer than initially foreseen. In this adverse macroeconomic environment, unemployment increased to historic high (post-war) levels, and disposable income dropped substantially. At the outset of the crisis, deteriorating macroeconomic conditions and sovereign downgrades blocked access to international capital and money markets, thus creating very tight liquidity conditions and pressures to the financial sector. As a consequence, banking sector developments were unprecedented including a large-scale deterioration of Greek banks fundamentals and of asset quality. The extent of the deterioration can be described in terms of losses due to the restructuring of Greek government bonds held by the private sector (Private Sector Involvement – PSI): Greek banks suffered losses of about €38 billion in 2011, which was close to 170% of their total Core Tier I (CT1) capital at that time. Due to the liquidity squeeze, the role of banks as intermediaries was undermined, and the channels for financing the real economy were severely disrupted. In addition, substantial deposit outflows took place from September 2009 to July 2015, primarily relating to the uncertainty of depositors regarding economic and financial developments. It is worth mentioning that the difficulties of credit institutions to provide liquidity to the real economy were further exacerbated by procyclicality, as their capital base had to be used as a buffer against unexpected risks. As a consequence, even higher capital adequacy ratios had to be met, rendering it even more difficult for banks to finance the real economy. The protracted recession, coupled with austerity measures, resulted in a significant increase of non-performing loans and impairment, thus undermining profitability. As a result, the banking system began to experience losses from the first quarter of 2010, and their capital base started to erode. Despite efforts to support operating profitability, the high level of loan-loss provisions resulted in successive negative results until the end of 2015. Moreover, due to the unfavourable macroeconomic environment, there has been a significant credit contraction since the end of 2010. The cumulative reduction of the outstanding credit to the private sector was about €54bn (or more than 20%) during the period December 2010 – December 2015. The demand for credit by both enterprises and households has dropped, due to the increased business risk and households’ uncertainty about their future finances and debt servicing capacity. In addition, the imposition of capital controls in late June 2015 has hampered economic activity. The effects seem to have been less severe than initially anticipated, due to a positive contribution of net exports and a lower-than-expected decline in consumer spending. However, substantial adverse effects have been observed in the business environment. Against this backdrop, the Bank of Greece has taken prompt and effective action to safeguard financial stability. The banking sector has undergone a profound restructuring through consolidation and recapitalisation, enabling it to withstand the crisis and the flight of deposits. As a result, it now has adequate capital, loan loss provisions and collateral. Hence, the necessary (though not sufficient) conditions are in place for the banking sector to address the major challenge posed by the high stock of non-performing loans. The authorities’ response to tackling non-performing loans is based on three pillars: First, enhancement of the supervisory framework for the management of non-performing loans (NPLs). The Bank of Greece, in cooperation with the ECB’s Banking Supervision (SSM), has issued supervisory guidelines for the internal management of NPLs and has recently agreed on NPE operational targets with banks for the period Q3 2016 – December 2019, entailing a reduction of NPEs by 38%. The Bank of Greece monitors on a quarterly basis the implementation of NPE targets and related key performance indicators through an enhanced prudential reporting framework. Moreover, the Bank of Greece has issued a Code 2/5 BIS central bankers' speeches of Conduct governing the relations between credit institutions and borrowers in arrears. Second, establishment of a secondary market for NPL servicing and sales. The licensing and supervisory framework for independent credit servicing firms has been established, thus allowing the Bank of Greece to issue the first license at the end of 2016, while there are many more in the pipeline. The sale of loans has also been largely liberalised and a current assessment initiative could lead to further relaxation of requirements and documentation for NPL credit servicing firms Third, removal of legal, judicial and administrative impediments to NPL management. In this respect, the household insolvency framework has been improved, the legal proceedings have been simplified and accelerated, and secured creditor rights have been enhanced. That said, some impediments remain, such as the legal protection of bank and public sector employees involved in the restructuring of NPLs; the design of an efficient out-of-court settlement framework; and the tax treatment of provisions and write-offs. As a result of these actions, the stock of non-performing loans gradually decreased in the second and the third quarters of 2016, reflecting among others, a shift of banks towards the offering of long-term loan restructuring. Looking forward, banks are expected to accelerate the restructuring of viable underlying business and resume their intermediation role in financing investment. The improvement in their operating environment and in their asset quality marked the return of banks to operating profitability in the course of 2016. At the same time banks proceeded with the implementation of their restructuring plans, which entailed the divestment of foreign subsidiaries and the shedding of non-core activities. Moreover, banks have reduced substantially their dependence on ELA funding by the reinstatement of the waiver for Greek bonds, the regaining of access to secured interbank funding, the slight increase of deposits and gradual deleveraging. In tandem, the capital controls framework has been gradually relaxed with an emphasis on facilitating the conduct of business activities. Further improvement in liquidity crucially hinges upon economic developments and the restoration of depositors’ confidence. It is now quite obvious that the domestic banking sector has experienced profound changes in the way it is structured, monitored and supervised. Some of these changes were costly and painful: for instance, resolving more than a dozen banks, or the completion of three rounds of recapitalisation, with substantial dilution of private and public equity shareholders. On the other hand, these initiatives helped both systemic banks and less significant institutions in Greece to build significant capital reserves and buffers. Moreover, on account of the ongoing crisis the Greek banking sector has undergone a series of stress tests. In fact, since the beginning of the current decade, Greek banks have undergone six stress tests, four of them accompanied by full-blown asset quality reviews. These exercises have been cumbersome to say the least: precious resources have been spent. However, this has had some major advantages: First, credit losses have been calculated repeatedly and the possibility of having unanticipated losses is now smaller than ever. Second, accountability of bank executives is now linked to specific quantitative and qualitative drivers and a comprehensive monitoring framework is being implemented. Finally, buffers against potential additional loan losses were specified as a result of a mandatory adverse scenario, and banks have raised high-quality regulatory capital to support these buffers. As we all know, eleven months from today, a new accounting standard, IFRS 9, will change the way banks deal with credit losses, as well as their daily routine in terms of loss calculation in a number of assets. We welcome this development; as we have repeatedly stated, it will bring accounting losses closer to loss calculation according to supervisory methodology. 3/5 BIS central bankers' speeches IFRS 9 represents a breakthrough in the way banks manage and report the asset side of their balance sheet, and could also have a material impact on regulatory capital requirements as well as their pricing methodology. It can also serve as a catalyst in the ongoing debate about hidden losses in European bank books vis-à-vis banking systems in other countries. However, it is important to keep in mind here that the IFRS represent a remarkable case of EU global leadership. In fact, it is arguably the single most prominent example of the EU successfully leading the way in international financial reform in the past two decades, with its initial adoption of IFRS in 2005 followed by an increasing number of jurisdictions in the ensuing years. There is little doubt that the delays associated with these reforms would have been significant without the initial impetus from the EU, with a relevant decision taken at the political level in 2000 and enshrined in EU legislation in 2002. Against this background, the EU has a stake in the continued success of the IFRS project. It is not surprising that Greek banks’ provisioning policies have radically changed since the AQR methodology was implemented and total losses were recalculated according to anticipated loss drivers. Let us recall that the Bank of Greece was heavily criticised back then simply for frontloading three-year or lifetime losses in domestic and foreign banking books. Ex-post performance apparently indicated our projected losses did not differ much from actual reported credit losses in subsequent years. European banks in general and Greek banks in particular, are currently preparing for their transition to the new framework. There are no grounds for anticipating any delays in these preparations. Domestic banks in particular have accumulated significant experience towards these goals. Moreover, it is worth noting that the largest part of their credit exposures has been tested according to IFRS 9-equivalent methodology. This can be seen as one of the benefits of having an Asset Quality Review exclusively designed for Greek banks like the one completed in 2015. In any case, we should all be in a better position to evaluate the medium-term impact of IFRS 9 implementation soon, as the SSM will complete a full review on that matter, ahead of the 2018 stress tests and the methodology supporting that exercise. Finally, allow me to add a few remarks about issues associated with the cooperation between banking and audit regulation, as well as the issue of mandatory auditor rotation. I believe that, so far, the debate over mandatory auditor rotation has mainly consisted of two competing arguments. On the one hand, proponents of mandatory rotation are concerned about the risks that long-term auditor-client relationships pose to the auditor’s mindset. By limiting that relationship, rotation would improve audit quality by helping ensure that auditors remain professionally skeptical and do not become overly trusting of their clients’ assertions. That is more or less the key idea behind requirements stated in the Memorandum of Understanding (MoU), as agreed last year, and it is incorporated within a number of changes in the corporate governance structure of Greek banks. On the other hand, it is more or less obvious that the know-how acquired by an auditor concerning the specific business, financial and operational aspects of a company would be lost with each rotation. Banks should hence support external auditors in understanding all key issues as soon as possible. European banks in general, and Greek banks in particular, are increasingly reflecting upon a series of key challenges for banking and audit regulators alike. The growth and diversity of nonperforming exposures across Europe, the width and complexity of derivative products and the rapid differentiation of shadow banking instruments and markets, present key risks for regulators in view of major changes in banks’ business models. The recent financial crisis not only exposed weaknesses in banks’ risk management, control and governance processes, but also highlighted the need to improve the quality of external audits of 4/5 BIS central bankers' speeches banks. External auditors can contribute to financial stability by delivering quality bank audits, thereby increasing market confidence in banks’ financial statements. Quality bank audits are also a valuable input in the supervisory process as our recent experience with the Asset Quality Review has demonstrated. We strongly believe that building effective relationships between prudential supervisors and external auditors, and between prudential supervisors and audit oversight bodies, can enhance banking supervision. It is also important to maintain effective communication between prudential supervisors and external auditors, as this provides significant insights and valuable market perspective. These are forms of cooperation we have repeatedly relied upon over the past few years for a number of issues and I must admit that they have enhanced our understanding of the strengths and weaknesses of each institution we supervise. Ladies and Gentlemen, I believe that we have come a long way towards addressing a number of challenges and tasks. For us, the ultimate goal in meeting these challenges is to shape the banking system into a position where it can undertake effectively its main task, namely the financing of the real economy. Let me conclude by saying that the improvement of the Greek banking sector landscape, the restoration of confidence and the elimination of certain risk factors are positive elements that are expected to be a prime driver for growth of the Greek economy. Moreover, all the changes to the institutional framework that we just discussed are key to ensuring that the growth potential of the Greek economy will be sustainable and will not be threatened by any form of structural weakness. 5/5 BIS central bankers' speeches

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Keynote remarks by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Conference on "Proportionality in European Banking Regulation", organised by the Bank of Greece and the University of Piraeus, Athens, 13 February 2017.

Yannis Stournaras: Proportionality in European banking regulation Keynote remarks by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Conference on "Proportionality in European Banking Regulation", organised by the Bank of Greece and the University of Piraeus, Athens, 13 February 2017. * * * Ladies and gentlemen, It is with pleasure that I welcome you to this conference on the principle of proportionality and its relevance for banking regulation, supervision and resolution. Of course, proportionality is a well-established general principle of European law. As a standard of public law, it has a long pedigree in both national and European law. And in more philosophical debates, it has always served as a point of reference for theories of justice. Indeed, the original formulations relating to proportional justice can be found in the writings of Plato and Aristotle. This arguably makes Athens an apt location for carrying on the debate in a contemporary context. But why should proportionality be discussed in specific relation to banking regulation? And why has this particular debate only recently flared up? The answer lies in the wide concept of proportionality, which informs the banking debate. The demand for proportional banking regulation goes beyond the technical legal use of proportionality as a standard of judicial review! Regarding the narrower legal use of the concept, it is quite clear that lack of proportionality can be invoked as a ground for impugning particular legislative or administrative measures of the European Union, or national measures of the Member States which implement European law. However, the intensity of judicial review on this basis will typically be low, since for measures which entail policy decisions or involve complex assessments of the technical and economic situation, the courts will recognize a wide margin of appreciation to the legislative or administrative authorities and only overturn a measure if they consider that this is ‘manifestly inappropriate’. Now, the elaboration of prudential standards in the banking field is likely to entail precisely such complex technical evaluations on the part of the Union’s legislative and regulatory decision-makers; the same applies to a very large extent to the making of individual supervisory decisions. For this reason, the actual decisions of banking regulators are likely to be overturned by the courts only in rare and exceptional circumstances. And rightly so! A cautious and rather sparing judicial interference in the practical working of the banking regulatory and supervisory system, is fully justified by the comparative advantages of administrative, as opposed to judicial, decision-making in this field. However, there is another, wider concept of proportionality that we should consider: that is, proportionality in the sense, not merely of a technical standard of administrative law, but of a broad constitutional ideal, which should guide all official actions in the Union. This wider notion, which is more congenial to the thinking of economists like me, is explicitly entrenched in the text of the Treaty on European Union. Indeed, article 5 of the Treaty states clearly that “[t]he use of Union competences is governed by the principles of subsidiarity and proportionality”. The same provision further clarifies that, “[u]nder the principle of proportionality, the content and form of Union action shall not exceed what is necessary to achieve the objectives of the Treaties.” The provision was inserted in the Treaty primarily with the intention to regulate the Union’s legislative and general policy-making measures, rather than the administrative decisions, through which the European rules, standards or policies are applied to individual cases at the supranational and national levels. 1/5 BIS central bankers' speeches This wider concept of proportionality as a regulative principle of European standard-setting, requires careful and responsive policy- and rule-making. More to the point, it requires the selection of the least burdensome or restrictive approach in order to achieve our regulatory objectives. This can only be achieved through a careful balancing of interests –the promotion of public objectives versus the rights and legitimate interests of private individuals and enterprises; the exercise of European competencies versus the preservation of the policy autonomy of the Member States– and the weighting of the potential costs against the benefits of particular policies and tools. To put it differently, proportionality requires properly calibrated European responses to well-identified problems and is inimical to heavy-handed, blanket, one-size-fit-all approaches to legislation and regulation. In this demanding but valuable sense, proportionality is closely linked to notions of equality and equity, also including the notion of proportional equality, which requires us to treat similar cases in the same manner, but to differentiate between dissimilar ones. It is also linked to the need for respect for fundamental rights and Treaty freedoms, including the right to property and the freedom of economic activity. Proportionality, then, stands here as a short form for a constellation of closely related principles and values, which, we, as regulators and supervisors, have a duty to serve: equality, legal certainty, individual rights, and good administration. This concept of proportionality has recently become a major theme in pan-European discussions of banking regulation – and for good reason. It subsumes more specific discussions on better regulation, simplification and the need for differentiation. And it provides a framework for the evaluation of existing rules and practices, and a compass for their elaboration and improvement. Why has this debate gained traction now, and not in the past? I believe that three specific aspects of the post-crisis regulatory architecture explain, and also justify, the emergence of proportionality as a core concern in European banking regulation. These three aspects of the post-crisis European regulatory architecture have greatly increased the significance of the matter: First, the shift from the old approach to prudential standard-setting for credit institutions, which was based on no more than a minimum harmonization at the European level, to a new system of almost full Europeanization of the applicable norms. The intensive legislative activity which followed the Global Financial Crisis, culminating in the enactment of the Capital Requirements Directive IV and the Capital Requirements Regulation, has resulted in much greater uniformity, verging to full harmonization, of the regulatory norms. The new state of things is epitomized in the construction of a Single Rulebook of pan-European applicability, with the EBA acting as the Rulebook’s custodian and key developer. Second, the considerable expansion of the prudential regime to cover new aspects of a bank’s organization and business activity. This thematic extension is evident both in the Basel regime, which, beyond the usual capital adequacy requirements, now encompasses global standards for liquidity and leverage, as well as in the host of European legislative initiatives of recent years. As a result, the net of supervisory controls over the activities of credit institutions and other financial intermediaries has become much denser than what it used to be. This makes the question of proportionality of the regulatory requirements all the more pressing. Third, the move from a system of national responsibility for supervision to the streamlined, and largely centralized, new supervisory architecture of the Banking Union. Under the pre-existing system, the European norms, such as they were, could be individuated and amplified at the national level, thus leaving the question of diversification and proportional implementation largely within the responsibility and discretion of national legislatures and competent authorities. In contrast, in the new environment of maximum harmonization, comprehensive prudential controls and centralized supervision, these concerns need to be addressed primarily at the European level. 2/5 BIS central bankers' speeches For this reason, the proportionality of the Single Rulebook’s primary directives and regulations and numerous delegated and implementing acts, has rapidly emerged as a key concern of the banking industry. In this context, a number of specific issues have come to the forefront over the past two years, concerning, for instance, the implementation of Basel III in Europe, the detail and frequency of the new reporting requirements, the timeframe and pace of the transition to the fullyfledged regime, the treatment of small banks with simple business models, the treatment of cooperative banks, and so on. It is a sign of the responsiveness of the new European regulatory structures that these concerns have gained the full attention of the EBA, which has examined the issue in two special supervisors’ workshops and a significant report of the Banking Stakeholder Group. The influence of the debate is also evident in the EBA’s consultation papers and RTSs. Ladies and gentlemen, In its dual capacity as central bank and national competent authority, the Bank of Greece is naturally fully cognizant of the financial industry’s strong and persistent demand for less burdensome, more proportionate and more fit-for-purpose, prudential requirements. And we recognize the justice of certain arguments concerning the difficulties and heavy costs of compliance with the new regime, especially for smaller institutions, characterised by simple business models, modest scale of business and non-complex systems and controls. Of course, our primary consideration is the safety and soundness of the banking system, both domestically and at the European level. The Bank of Greece is strongly committed to robust and effective prudential standards, which can deliver systemic safety, market discipline and proper incentives for banks’ internal decision-makers. For this purpose, it has been fully supportive of the post-crisis efforts to reregulate the banking sector and has sought unflinching commitment to the faithful and complete national implementation of the new standards, despite the acute difficulties presented by our country’s economic predicament and the need to support and repair the banking system, which has been gravely affected by the crisis. But at the same time we share with the banking industry the concern for proportionality. We consider excessive complexity to be part of the problem, not of the solution, in so far as it increases costs and uncertainty for the regulated institutions, without thereby generating additional benefits in terms of systemic or individual safety. We support regulatory approaches that allow for differentiation where appropriate, and apply criteria of materiality in order to determine the applicability or otherwise of particular rules to different classes of institutions. And we recognize the need for consistency across the various components of the prudential, resolution planning and reporting regimes, to avoid conflicts and duplication. More generally, we have all along expressed scepticism with regard the one-size-fits-all approach to regulation – an approach whereby uniform prudential standards are set at the same level for all credit institutions, as well as for other financial institutions such as investment firms. In particular, we have been sceptical of a uniform model-based approach to financial risk, based on the generic risks faced by a notional universal banking group, of unspecified (but probably large) size, carrying on mixed activities, including extensive securities and derivatives exposures, and displaying a relatively high degree of interconnectedness with other participants in financial markets. In all these respects, we consider that proportionality can enhance the effectiveness and efficiency of the prudential regime. We do not see it as a step back from the post-crisis commitment to high standards of prudence, or relaxation of the new regime. This is not a question of trade-offs between safety and market-friendliness, but a matter of optimal institutional design for safety and soundness. Last but not least, we consider that the further development of the prudential regime should take into consideration the implications of regulatory requirements –including the phasing in of their implementation– for the real economy. Especially in the euro area, with its largely bank-based 3/5 BIS central bankers' speeches financial system, the ability of credit institutions to extend credit is critical for the vigorous performance and growth of the real economy. The need to sustain bank financing to the real economy acquires added importance in the present environment, when the European recovery is still fragile and the banking systems of several Member States are still struggling with the legacy of the crisis. Moreover, even the capital market depends on the profitability and competitiveness of the banking sector for its smooth operation and deepening, because banks are involved as both service providers and users at various stages of the securities and derivative intermediation chain. In this sense, the Capital Markets Union should be seen, not as an alternative, but as a complement, to a well-functioning Banking Union. Ladies and gentlemen, This conference was conceived from the very start as a forum for discussing in depth these issues. As things have turned out, the discussion now takes place in the context of the European Commission’s banking reform package, which was made public on November 23. This includes proposals for the revision of the main (Level 1) instruments of the Union’s Single Rulebook, that is, the Capital Requirements Directive IV, the Capital Requirements Regulation and, in so far as the resolution regime and, especially, the resolvability and loss-absorbing capacity of credit institutions is concerned, the Bank Recovery and Resolution Directive and the SRB Regulation. The Commission’s package enhances and brings up-to-date the post-crisis prudential regime by transposing into European law those elements of the global Basel III standards which have been fully specified after the enactment of the Capital Requirements Regulation in 2013. It thus includes substantial new rules on a binding 3% leverage ratio, detailed provisions on credit institutions’ liquidity requirements, and provisions, requiring institutions that trade in securities in derivatives to maintain more risk-sensitive own funds. Moreover, it implements the Financial Stability Board’s new Total Loss-Absorbing Capacity (TLAC) standard for the 30 global systemically important institutions, almost half of which are European. In a very promising development, the Commission used this opportunity in order to introduce significant elements of proportionality in the Single Rulebook. Based on extensive public consultation and impact assessments relating to the CRD/CRR regime, it has included in its package a set of important proposals that are explicitly intended to make the prudential regime more proportionate and to reduce the burden faced by smaller and less complex credit institutions. The proposed amendments affect, in particular, the disclosure, reporting and tradingbook-related capital requirements. Furthermore, they differentiate the treatment of certain financial instruments, such as covered bonds, high quality securitization instruments, sovereign debt instruments and derivatives used for hedging, with a view to reducing the costs of issuing or holding such instruments, thus enabling the continuing participation of banks in the relevant securities markets. In this manner, the regulatory regime is differentiated to facilitate the deepening of European capital markets and the creation of the Capital Markets Union. One could argue that the inclusion of strong elements of proportionality in the banking reform package marks a move away for the traditional tendency of European law to regulate financial institutions through uniformly applicable rules, in the name of competitive equality. The Commission explicitly and forcefully asserts the relevance and significance of proportionality as a regulative consideration that informs its proposals. This is most welcome, and we should all work to bring the review of the Single Rulebook to rapid and successful conclusion. This, of course, will not exhaust the quest for more sophisticated, proportionate and cost-efficient regulatory solutions. Our regulatory job is to pursue simultaneously a variety of objectives – systemic stability and bank-level safety, equivalent and consistent treatment of the credit institutions and other regulated persons, appropriate differentiation and diversification of the regulatory and supervisory regime, and a financial environment conducive to economic growth. 4/5 BIS central bankers' speeches This is a demanding task – in fact, a permanent task, requiring continuous effort and adaptation. In all cases, it must be pursued under the light of the principle of proportionality, which should be incorporated into our forward-looking thinking and turned into a necessary consideration informing the design of all regulatory norms and policies in the future. 5/5 BIS central bankers' speeches

bank of greece

Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the 84th Annual Meeting of Shareholders, Athens, 24 February 2017.

Yannis Stournaras: Recent economic and financial developments in Greece Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the 84th Annual Meeting of Shareholders, Athens, 24 February 2017. * * * THE GREEK ECONOMY COULD START GROWING AGAIN EURO AREA MEMBERSHIP IS A PROTECTIVE SHIELD FOR GREECE Remaining in the euro area is a vital condition for Greece In a constantly changing globalised environment, the economic and monetary stability afforded by euro area membership provides the Greek economy with a protective shield against unanticipated risks. The sequence of political and economic external shocks that emerged last year demonstrated the resilience of the euro area and its capacity to prevent spillovers across member countries’ economies. For Greece, active participation in the euro area is of the utmost importance for economic, social as well as national reasons. It is a vital condition for surviving in a turbulent European and international environment; it provides an anchor of economic, social and political stability. And we must not overlook the fact that in the course of history no country has received more financial assistance than Greece, which would not have been possible outside the euro area. The credible implementation of the current financial assistance programme, which is generously financed by euro area member countries and contains actions that improve the competitiveness and creditworthiness of the Greek economy, creates the necessary conditions for Greece to return to positive growth, while participating on equal terms in the European crisis management arrangements and in the processes to improve the euro area architecture. The Bank of Greece is of the view that, if our partners, the institutions and the Greek government all show flexibility and pragmatism, substantial progress can be achieved very soon. The Eurogroup decision on 20 February to resume negotiations with the institutions shows the willingness of the Greek government and our partners to continue the effort towards consensusbuilding, overcoming existing differences. But if the negotiations drag on with no agreement in sight, then Greece will enter in a new cycle of uncertainty, deteriorating relations with our partners and creditors, and a backslide of the economy into stagnation. REINING-IN OF THE RECESSION IN 2016, GROWTH IN 2017 Over the past two years, the Greek economy has shown remarkable resilience: In 2015, GDP contracted by just 0.2% despite the particularly adverse conditions prevailing especially during the first half of the year, when uncertainty peaked about Greece’s euro area membership, but also during the second half, when strict – at least in their first phase – capital controls were imposed. In the first half of 2016, the recession turned out milder than expected, and in the second half the economy posted positive growth. For 2016 as a whole, GDP at constant 2010 prices increased by 0.3%, deflationary pressures were contained, employment picked up and unemployment decreased, though still remaining very high. These developments are a strong indication that the Greek economy has growth potential, which, after remaining idle for so long, stands ready to be tapped into, as soon as the right conditions are in place. Besides, despite the mistakes and the backsliding, despite the heavy economic and social costs of the crisis, the economic adjustment programmes implemented over the past 1/8 BIS central bankers' speeches years have succeeded in addressing chronic weaknesses and structural shortcomings of the Greek economy, thereby facilitating the improvement in the medium-to-long term growth potential. More specifically: the twin deficits, i.e. the primary fiscal deficit and the current account deficit, were eliminated; the substantial cumulative loss in labour cost competitiveness vis-à-vis our trading partners has been fully recouped; exports as a percentage of GDP have significantly increased (almost twofold); recapitalisation and restructuring have taken place in the banking system; and major structural reforms have been implemented in the labour and product markets. The reforms implemented so far have contributed to an emerging restructuring of the economy towards a new, extrovert growth model, based on tradables. Against this background, it is reasonable to anticipate positive growth of 2.5% in 2017, with the economy poised to move on to a new and more virtuous growth trajectory. The driving factors behind this outlook are: (a) an upward trend in private consumption; (b) a further strengthening of business investment and a rise in foreign direct investment, in terms of capital inflows and of reinvested profits by multinational firms; and (c) rising goods exports. Fiscal policy The year 2016 saw the enactment of a large number of fiscal measures, mainly related to tax and social security reforms and the establishment of an automatic fiscal adjustment mechanism. Progress with the new financial assistance programme was reflected in the successful completion of the first review, the disbursement of the second loan tranche, part of which was injected into the real economy through the payment of government arrears, and the finalisation of short-term debt relief measures. The new fiscal measures, together with the widespread use of electronic payments, broadened the tax base, contributing to a significant increase in public revenue. Based on data currently available, the primary surplus in 2016 is expected to turn out at around 2% of GDP, while the target for a primary surplus of 1.75% of GDP in 2017 appears to be within reach. Downside risks to this outlook are associated with uncertainties about: the carry-over of the strong revenue performance; the containment of non-productive public expenditures; and, most importantly, the immediate completion of the second review, given its catalytic effect on macroeconomic developments. Further uncertainties relate to the Single Social Security Fund (EFKA) and its funding, due to changes in the calculation method for the social security contributions of the self-employed. The banking system and private insurance companies The pressures on the banking system in 2015 eased in 2016, with a small net inflow of deposits and redeposits of hoarded cash, a repatriation of funds and some decline in bank interest rates. Capital adequacy ratios remained high, after the successful recapitalisation with the participation mostly of private investors in late 2015, and banks maintained a very prudent provisioning policy. Furthermore, based on data for the second and third quarters of 2016, banks returned, even if only marginally, to pre-tax profitability. Meanwhile, the deleveraging of assets continues, mainly in the form of shedding of subsidiaries as part of restructuring plans. Importantly however, the annual growth rate of credit to businesses showed signs of stabilising, for the first time after several years of decline. The downward trend in non-performing exposures (NPEs) continued into the fourth quarter of 2016. At year-end, NPEs were €106.3 billion, down from €107.6 billion at end-September 2016. 2/8 BIS central bankers' speeches This implies that the banking system as a whole once again in the fourth quarter attained the NPE reduction target jointly agreed by the Bank of Greece and the ECB. This reduction was achieved mainly through the implementation of more effective workout solutions, leading to a higher cure rate, as well as through write-offs of non-recoverable loans. The accumulated stock of NPEs, despite showing signs of stabilising and of even receding slightly, still remains the most significant source of risk to the stability of the domestic financial system and (together with the sharp contraction of the deposit base) an obstacle to the financing of the economy and to the fulfilment of banks’ intermediation role. A welcome development is that several steps have been taken in the area of legislation and regulation, but also action on the part of banks to address the problem. The most recent developments concern: the regulatory framework for the authorisation and supervision of credit servicing and credit acquiring firms; the modernisation of bankruptcy law; the shift of banks to long-term workout solutions and the requirement that banks meet specific operational targets in terms of non-performing loan management. The target is for non-performing loans to be reduced by nearly €40 billion by end-2019. Most of this reduction is expected to come from the corporate loan portfolio. The achievement of the overall target will rely initially on long-term forbearance and resolution and closure solutions, selective write-offs and collateral realisation, while loan sales should be brought into play mainly from 2019 onward. However, reaching this target will also require that several legal and other pending issues be addressed such as: (a) out-of-court settlement; (b) the legal protection of bank, public entity and special liquidations staff involved in corporate debt restructuring processes; (c) the accounting/tax treatment of losses arising from loan sales or write-offs; and (d) the establishment of an electronic auction system. These pending matters, coupled with the uncertainty associated with the slow progress of negotiations with the institutions on the completion of the second review, pose a risk to the attainment of the above target. Although the volume of non-performing loans declined in 2016, January 2017 apparently saw a pick-up in new non-performing exposures and a drop in borrowers’ responsiveness to offered workout solutions. Meanwhile, the situation once again seems to be favourable to strategic defaulters, since deliberate default on loan obligations does not incur the prescribed sanctions. Against this background, reducing non-performing loans is imperative, all the more so given its multiplier effects both on banks and on the real economy: banks would benefit from higher asset quality, higher liquidity, lower financial risk and hence lower funding costs; this would translate into higher loan supply, as well as demand; and ultimately a restructuring of the economy’s production model through the freeing-up of resources for financing productive investment. Turning to the private insurance sector, the main developments in 2016 concerned the transposition into Greek law of the Solvency II Directive and the conduct of an EU-wide stress test. The adjustment of the sector to the new framework is seen as overall satisfactory and, despite the adverse economic environment which obviously has negatively affected premium volumes, the insurance market is well-capitalised. However, there is no room for complacency, given the serious challenges posed by macroeconomic developments, low interest rates and the search for yields. Consequently, the managements of private insurance companies must continue to improve their governance systems, personnel training, and transparency through the solvency and financial condition reports they publish under the responsibility of their respective boards of directors. PRECONDITIONS FOR GROWTH (i) An immediate completion of the second review The Bank of Greece as well as international organisations forecast robust positive GDP growth 3/8 BIS central bankers' speeches for 2017. However, the realisation of these positive forecasts hinges upon the timely and effective implementation of the current financial assistance programme 2015–2018, which would signal a return to normality. This is why, as already mentioned, the successful completion of the second review is imperative. Among its numerous positive effects, it would: secure the financing of government borrowing requirements and a smooth execution of the 2017 budget; pave the way, together with the completion of the public debt sustainability analysis, for the inclusion of Greek government bonds in the ECB’s quantitative easing programme; bring about, in turn, a decline in borrowing costs for the real economy, facilitating restructuring in the private sector; restore depositor confidence and allow a further easing or even full lifting of capital controls, thereby providing a boost to the export sector of the economy; improve the confidence of global markets and investors in the growth prospects of the Greek economy and allow Greek firms to access international capital markets; provide fresh impetus to the reform effort, geared to restructuring the economy towards a new, extrovert growth model; and reinforce political and economic stability. (ii) Acceleration of reforms As indicated by OECD and Bank of Greece estimates, the reforms can substantially increase Greece’s growth potential. According to the OECD, the reforms implemented in Greece from 2010 through 2016, together with those planned under the programme, can be expected, ceteris paribus, to raise real output by about 13% over the next ten years. This estimate by the OECD is corroborated by relevant Bank of Greece research, indicating that structural reforms have positive effects, mainly in terms of total factor productivity growth. For the positive effects to materialise in the economy, an essential condition is that the agreed reforms are fully and consistently implemented without further delay. The cumulative gains from implementing only two thirds of the reforms in the services and labour markets over a 5-year horizon would fall short, during the first three years, by approximately 4% of GDP, compared to full implementation over the same 5-year period. (iii) Tackling the problem of non-performing loans (NPLs) The reforms are expected to further speed up the recovery and the restructuring of the economy. At the same time, however, the financing of the economy must be improved. This hinges crucially on the effective management of the high stock of non-performing loans (NPLs), which would impact positively on economic activity and productivity through two channels: by increasing bank credit supply and by restructuring the production model. This is why the relevant legislative framework must be complemented and completed as soon as possible. Bank of Greece analysis indicates that a reduction in NPLs would help reduce the financial risk of banks and their funding costs, while also boosting their capital adequacy ratios. This would result in higher loan supply as well as lower bank intermediation margins and borrowing costs for businesses and households. At the same time, the restructuring of overindebted but viable businesses could serve as a vehicle for attracting investment capital, thereby further stimulating investment demand. Finally, the resolution of NPLs will free up resources, which if redistributed to the more productive businesses and sectors will lead to an increase in total productivity. 4/8 BIS central bankers' speeches RISKS TO THE RECOVERY OF THE ECONOMY In 2016 the Greek economy found itself halfway between recession and growth. In 2017 it is expected to recover, although this outlook remains subject to risks. A first category of risks relates to a volatile global environment. Uncertainties related to the global environment in which the Greek economy is expected to operate are: (a) a series of crucial elections and a rise in euroscepticism across the EU. A strengthening of antiEuropean forces would influence the decisions of leaders of several EU countries, thereby threatening to weaken EU institutions; (b) uncertainties associated with changes in US foreign and economic policies under the new administration, which generate ambiguity about the future global role of the US; (c) emerging protectionist trends, accompanied by a shortfall of private productive investment and a decline in world trade; (d) possible adverse developments in the refugee-migrant crisis and a failure to properly address it could heighten public concerns about security and migration and make societies less inclusive; (e) a deterioration in global security conditions, with significant economic losses in terms of trade, transport and tourism; (f) geopolitical instability in the broader South-Eastern Mediterranean region; and (g) the new European economic landscape to emerge from the negotiations between the EU and the United Kingdom on their post-Brexit relationship. On the domestic front, the uncertainties and risks are mainly associated with the delays in implementing the programme, as reflected by the difficulty in concluding the second review. Allowing these delays to drag on would severely impede the anticipated growth, with negative repercussions on the overall climate and a new round of uncertainty regarding the completion of the programme. Uncertainty would be exacerbated if Greek government bonds were to remain excluded from the ECB’s quantitative easing programme. All of the above would undermine confidence and serve as a deterrent to foreign investment, which, as mentioned previously, is one of the fundamental conditions for growth. Risks also arise from delays and procrastination in implementing reforms already agreed on or from distortions to competition that could hurt crucial sectors of the economy. A case in point is the electricity market, where recently enacted legislation introduced distortions, causing major problems even to companies that form the cornerstone of the electricity generation system. STRATEGY FOR SUSTAINABLE STRONG GROWTH The performance of 2016 suggests that the projected recovery in 2017 is feasible under the strict condition that implementation of the programme will continue without delays. However, for the economy to move from recovery to sustainable strong growth, active mediumterm policies are needed to eliminate the existing obstacles to growth, as well as to establish an environment of stability conducive to the revitalisation of investor interest. These obstacles include: the excessive tax burden on an overstressed tax base; the volatile and unclear tax and overall legal regime of investor protection; red tape and cumbersome administrative procedures, which delay progress with investment projects already approved; long delays in the delivery of justice; banks’ low lending capacity and high lending rates; 5/8 BIS central bankers' speeches capital controls; and market distortions, notably in the electricity market, from ineffective regulatory interventions. Lifting these obstacles should be a top priority of the growth strategy, which should focus on four key areas: changing the fiscal policy mix; encouraging foreign direct investment; fostering innovation; and safeguarding social protection. (a) Changing the fiscal policy mix The most serious obstacle that needs to be gradually removed is the excessive tax burden on businesses and households. The overachievement of the fiscal target for a primary surplus in 2016 was predominantly driven by an overperformance of tax revenue and to a much lesser extent by a containment of public spending. The increase in tax revenue is attributed to increases in direct and indirect tax rates, but also to a broadening of the tax base as a result of the widespread use of electronic payments that reduced the scope for concealing income. However, the current fiscal policy mix weighs heavily on economic growth, contributes to the increase in private sector arrears to the government and encourages tax evasion and undeclared work. Steering the economy onto a growth trajectory calls for a change in the current “tax-centred” fiscal policy mix. Emphasis must be placed on: containing and systematically restructuring nonproductive expenditure; reducing the excessive burden of taxes and social security contributions on the productive economy; and a more efficient use and management of state-owned property. In other words, there is a need for a fiscal environment capable of supporting the growth effort. This fiscal environment would additionally benefit from the implementation of short-term debt relief measures, the specification of medium-to-long-term ones and a possible quantification of realistic fiscal targets for beyond 2018. More specifically, higher-than-targeted primary surpluses, together with the implementation of the agreed reforms, could facilitate the progressive easing of the tax burden without jeopardising fiscal sustainability. It should be noted that the benefits to economic activity would be maximised if the fiscal space generated by the overperformance of tax revenue or by the reforms is used towards reducing income tax rates. At the same time, fiscal policy should support growth by ensuring a stable, internationally competitive and equitable tax system. (b) Encouraging foreign direct investment Given, first, that private investment as a percentage of GDP currently falls far short of its precrisis level (11% against 24% of GDP) and, second, that chronically low domestic saving is insufficient to finance the level of investment required for strong growth, there is an urgent need to attract foreign capital for joint investments with domestic firms. Apart from tourism, the economy has a number of other sectors with noteworthy growth potential, export-orientation and highly-qualified human capital. Attracting foreign direct investment (FDI) will require: a stable, modern and favourable tax system; reducing businesses’ non-wage costs; encouraging innovation and exports; and a predictable, business-friendly economic environment. Attracting and maintaining FDI would support Greece’s exit from the crisis and sustainable growth. FDI would entail significant benefits for the Greek economy: introduction of new technologies and promotion of innovation; physical and human capital deepening; development of new higher-value added activities and products, notably in the tradables sector; higher competition; and job creation. More specifically, export-oriented FDI is an effective tool that can speed up the restructuring of the domestic production model. The integration of Greek firms into global supply chains, the transfer of knowhow and foreign market expertise, as well as the upgrading of production processes and technology content to catch up with foreign competitors would make Greek businesses more competitive and improve their export dynamism. 6/8 BIS central bankers' speeches Delays, procrastination and unwillingness to move forward with privatisations that have already been approved and planned are serious disincentives to the attraction of productive investment. (c) Innovation and education Fostering research, technology diffusion and entrepreneurship are key to harnessing human capital towards creating added value by linking the currently sidelined public research system to the productive economy, thereby contributing to Greece’s return to sustainable growth. Generally speaking, public policy intervention can encourage technology transfer, i.e. the commercialisation of academic and scientific research (licensing and patents), and at the same time open up career opportunities for talented young graduates. To attain this dual objective, it is necessary: first, to embed in society a culture of entrepreneurship and excellence and, second, to utilise the resources of the existing guarantee and financing funds. The use of the finance instruments available from the European Investment Fund (EIF), part of the EIB Group, and the National Strategic Reference Framework (NSRF) 2014–2020 offers a solution to the funding problems of innovative small and medium-sized enterprises (SMEs). (d) Reducing income inequality and tackling poverty The relative at-risk-of-poverty rate based on 2014 income fell for the second year in a row, but still remains the seventh highest in the EU-28 and significantly above the EU-28 average. As percentages of the total population, the number of people at risk of poverty or social exclusion edged down slightly, while the number of people suffering from material deprivation has risen. The fact that the largest increase was recorded among children under 17 years is a serious cause for concern. At the same time, the income inequality indicators for Greece, albeit unchanged, are worse than the ΕU-28 averages. The targeted planning of social transfers has proven to be effective in helping to reduce poverty. Actions taken in this direction include: (a) the implementation as from February 2017 nationwide of a Social Solidarity Income programme (succeeding the minimum guaranteed income scheme); (b) measures to protect the unemployed and tackle extreme poverty; and (c) an increase in the child support benefit. Furthermore, the composition of unemployment and its slow decline, coupled with the high percentage of young people “Not in Education, Employment or Training”, highlight a need to focus on life-long learning and a better matching of skills. The active employment policies and the vocational training programmes of the Greek Manpower Employment Organisation (OAED) can contribute in this direction, with appropriate planning and targeting and the optimal utilisation of available, mostly EU, funds. *** In an uncertain global environment marked by unpredictable and successive episodes of turbulence, euro area membership today provides Greece with a protective shield against emerging risks. This is why Greece must consolidate its position as equal partner and be part of the efforts to strengthen European cohesion. But for this to happen, Greece must return to normality, by successfully completing the economic adjustment programme. Greece must take ownership of the reforms, which are for its own benefit, and take immediate action to modernise and commit to the highest European standards of public administration, institutions and the rule of law, which no memorandum alone can achieve. Now that we have reached the final stretch, very little remains to be done compared to the massive changes made since 2010. The process of economic adjustment has largely been completed, as suggested by the latest available economic data. With specific regard to fiscal adjustment, since 2010 about 90% of the adjustment required by 2018 has already been completed. The Greek economy has made a strenuous effort and has succeeded in eliminating 7/8 BIS central bankers' speeches significant structural weaknesses and imbalances that had accumulated over decades, displaying remarkable resilience. Its growth potential and high-quality skills pool, so far unexploited, stand ready to be mobilised under the right conditions and to launch the economy back onto a virtuous circle of growth. 8/8 BIS central bankers' speeches

bank of greece

Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Delphi Economic Forum II "Greece and the euro area going forward", Delphi, 4 March 2017.

Yannis Stournaras: Greece and the euro area going forward Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Delphi Economic Forum II "Greece and the euro area going forward", Delphi, 4 March 2017. * * * Ladies and Gentlemen, It gives me great pleasure to be here today in Delphi to address an audience of such distinguished people, from academics to those involved in policy-making at the highest levels. In my speech, I want to focus on two main themes. First, Greece. What progress has been made? Where do we stand? What are the prospects for the economy not just over the short-to-medium term but also in the long term? Second, I want to say a few remarks about the euro area. In particular I want to discuss the steps taken by the ECB in order to lessen the impact of the crisis in the euro area, including changes to governance in EMU. However, looking forward, the challenge facing the euro area is to make it more resilient to shocks and I will outline how, in my view, resilience can be enhanced. Greece: the current juncture The Greek economy is at a turning point. Growth turned positive in the second quarter of 2016 and, contrary to initial forecasts, it turned out positive for the year as a whole. Some recent softening of economic indicators can be put down to uncertainty in the face of delays in closing the second review of the programme. Hopefully this is now moving forward. A rapid closure of the review will help the economy to build on the 2016 over-performance and move quickly to a faster growth path. 1 / 23 BIS central bankers' speeches It is important to emphasise just how far Greece has come since the onset of the crisis in 2009. Adjustment, particularly of the flow disequilibria which characterized the Greek economy on the eve of the crisis, has been considerable. The twin deficits have been eliminated. Between 2009 and 2016, the general government deficit is estimated to have shrunk by approximately 14 percentage points of GDP. The primary balance according to the programme definition is expected to have improved by 12 percentage points and is currently projected to reach a surplus of around 2 percent of GDP in 2016, against a target of 0.5 percent of GDP. Adjusting for the effect of the business cycle, the improvement in the primary balance comes in at more than 17 percentage points of potential GDP. This represents one of the largest fiscal adjustments ever undertaken. 2 / 23 BIS central bankers' speeches 3 / 23 BIS central bankers' speeches The current account deficit as a percentage of GDP has fallen by 15 percentage points. For the last two years the current account has effectively been in balance. Labour cost competitiveness has been fully restored and price competitiveness is almost back at its level of 2000 and can be expected to continue to improve with the implementation of further product market reforms that raise competition in various sectors of the economy. At the same time, sweeping structural reforms have been implemented covering the pension system, the health system, labour markets, product markets, the business environment, public administration, the tax system and the framework in which fiscal policy is conducted. The privatization programme is on-going, though there is a pressing need to speed up the process and actively attract foreign investment. Foreign direct investment would provide an additional boost to growth, not least by financing new investment. 4 / 23 BIS central bankers' speeches 5 / 23 BIS central bankers' speeches There is evidence that the economy has been undergoing a rebalancing towards the tradables sector. The size of the tradables sector relative to that of nontradables has been increasing since 2010 – whether measured in terms of gross value added, employment or the volume of output. The ratio of tradables-to-nontradables prices has also risen, encouraging resources in the economy to move into tradables. This rebalancing has been reflected in a rise in the openness of the economy. Exports of goods have also grown in line with our euro area partners. Underperformance in services is related to tourism and shipping. Tourism underperformed in 2011–2012 as a consequence of uncertainty, but has since seen a sharp rise. Shipping underperformed largely due to global factors and, latterly, the imposition of capital controls. 6 / 23 BIS central bankers' speeches In spite of these positive developments, I do not wish to underplay the fact that considerable stock disequilibria remain. Unemployment, though falling, remains high. The labour market reforms already enacted have contributed significantly to moving us into a recovery stage where there is a high elasticity between GDP growth and employment growth. Indeed, even in 2015, when growth was negative, positive employment growth was observed. However, the composition of unemployment, coupled with the high percentage of young people “Not in Education, Employment or Training”, highlight a need to focus on life-long learning and a better matching of skills. The active employment policies and the vocational training programmes of the Greek Manpower Employment Organisation (OAED) can contribute in this direction, with appropriate planning and targeting and the optimal utilisation of available, mostly EU, funds. 7 / 23 BIS central bankers' speeches Non-performing loans remain high and an efficient management of those loans is of utmost importance for the banking sector and economic growth. Many initiatives have already been taken, such as, the Bank’s Guidelines for an enhanced governance framework and the adoption of operational targets agreed by the banks and the Bank of Greece/ECB to reduce nonperforming exposures by 40% by 2019. On-going initiatives include the revision of the out-ofcourt workout and bankruptcy law. 8 / 23 BIS central bankers' speeches Finally, the ratio of general government debt to GDP is still high. In 2008 that ratio stood at around 110%. It is now around 180%. The debt path has been strongly affected by the so-called snowball effect – that arises from a combination of interest rates on debt being much higher than growth. Indeed, from 2010 to 2016, the snowball effect is estimated at some 82% of GDP. But whatever the causes of its rise, it is crucial that it is placed on a sustainable path. 9 / 23 BIS central bankers' speeches Prospects for the Greek economy 10 / 23 BIS central bankers' speeches What are the prospects for the Greek economy? Strong positive growth rates are expected over the short and medium term as the output gap closes. Consumption is expected to continue to rebound, driven by employment growth. Investment and exports are expected to increase as confidence is restored and financial conditions improve. At the same time, the fiscal outlook is promising. Over-performance in 2016 will be carried over into 2017. Indeed, we have already seen tax revenue over-performance in January of this year. Finally, the clearance of arrears accelerated in the second half of 2016 injecting much needed liquidity into the real economy. The recently published Winter Forecasts by the European Commission are in line with the above story. Growth is expected to accelerate to 2.7% in 2017 and to 3.1% in 2018, supported by consumption growth of 1.6% in both years, two-digit growth in gross fixed capital formation and export growth of around 4% in 2017, rising to almost 5% in 2018. 11 / 23 BIS central bankers' speeches What about the longer-term economic outlook? Labour force dynamics will support potential growth in the medium term. But in the long run, growth will come from increased productivity. In this respect, structural reforms will unleash the growth potential of the Greek economy, with the OECD estimating that the impact of implemented and planned reforms over 10 years would be to raise output by 13.4 per cent. Analysis done by my colleagues in the Bank provides a baseline scenario for a rebalancing of the economy from the demand side that has the following characteristics. Consumption as a percentage of GDP declines by around 10 percentage points, moving closer to the euro area average. Investment and exports fill the gap in domestic demand. From the supply-side, I have already noted the rebalancing towards tradables, supported by the shift in relative price inflation since 2010. 12 / 23 BIS central bankers' speeches The Bank of Greece has recently made a number of proposals in the area of fiscal policy and government debt which would go a long way to securing the performance outlined above and reducing these stock imbalances. Firstly, there is the issue of the fiscal mix. To a significant extent, the overperformance of fiscal policy relative to target in 2016 was due to increases in tax rates – both indirect and direct tax rates along with social security contribution rates. This emphasis on taxation needs to be reduced since it stifles growth, increases unpaid debts of the private sector towards the public sector and encourages tax evasion and undeclared employment. Rather emphasis needs to be placed on restraining and restructuring non-productive spending and making more effective and efficient use of the public sector’s assets, especially land. Second, there is the issue of the fiscal target. According to estimates from the Bank of Greece, a lowering of the general government primary surplus target from 2021 onwards to 2 per cent of GDP, from the 3.5 per cent that is envisaged now, would be consistent with debt sustainability if combined with some mild debt relief measures and structural reforms to raise potential growth. The easing of the primary surplus targets, together with the implementation of the agreed structural reforms, would put the necessary conditions in place for a gradual lowering of tax rates, with positive multiplier effects on economic growth. Finally, there is the issue of what debt relief measures. The short-term measures decided at the Eurogroup meeting of the 5th of December last year are a positive step and are expected to reduce public debt as a ratio of GDP by 20 percentage points by 2060. At the same time they also reduce the annual gross financing needs of the general government by around 5 percentage points of GDP. However, to ensure the sustainability of the debt going forward, additional medium-term measures are also necessary. When the debt-to-GDP ratio is above 100%, measures that reduce interest payments on debt can improve the ratio quicker than a rise in the primary balance. For example, with a debt-to-GDP ratio of 180%, a 1 percentage point reduction in the 13 / 23 BIS central bankers' speeches average interest rate on debt will reduce the ratio of debt to GDP by 1.8 percentage points. By contrast, a rise in the primary surplus as a percentage of GDP by 1 percentage point lowers the debt-to-GDP ratio by only 1 percentage point (assuming that the fiscal multiplier is 0 which, as we well know, it is not). A similar effect to lowering the interest rate can be achieved through a rise in nominal growth. For debt to be sustainable, it is important to look at the gross financing needs of the general government. The Eurogroup agreement of the 24th May last year set the goal for gross financing needs of the government to be below 15 per cent of GDP in the medium term and below 20 per cent over the long term. With a primary surplus goal of 2 per cent, gross financing needs are higher than they would be if the primary surplus were held at 3.5 per cent. 14 / 23 BIS central bankers' speeches However, mild debt relief could reduce them and keep them within the limits set by the Eurogroup. The interest burden is low until 2021 but increases substantially thereafter because of payments of deferred interest on the EFSF loans and interest on new debt issued in financial markets. An exercise done at the Bank looks at the impact of smoothing interest payments for EFSF loans. Looking at the right-hand-side diagram on the slide, the exercise entails that interest payments are smoothed, as in option 1, instead of remaining as they are now (the baseline scenario). What does such an exercise imply for the path of debt and gross financing needs? The baseline high surplus scenario assumes primary surpluses of 3.5 per cent of GDP until 2027 and a gradual decline to 2 per cent by 2037. The baseline low surplus assumes only three years of primary surpluses of 3.5 per cent of GDP and 2 per cent thereafter. Clearly the lower surpluses imply a smaller fall in the debt-to-GDP ratio and higher gross financing needs. However, the smoothing of interest can mimic the baseline high surplus case both on the path of the debt-to-GDP ratio and in terms of gross financing needs. On the basis of the definition of sustainability agreed by the Eurogroup, the debt is sustainable since gross financing needs remain under 15 per cent of GDP in the medium term and under 20 per cent in the long term. This exercise is indicative of how even a mild debt relief can have significant effects on the debt profile. Of course, were the interest smoothing accompanied by higher growth, as a consequence of lower primary surpluses, then the debt-to-GDP profile and gross financing needs would be even more favourable. Alternatively if interest rate smoothing were to occur and the costs shared equally between Greece and the ESM, this would also lead to more favorable outcomes. 15 / 23 BIS central bankers' speeches The euro area: steps taken to address the crisis and to strengthen the governance of EMU Let me now turn to the issue of the euro area and the steps that have been taken to address the sovereign debt crisis. The ECB forcefully lessened country risks in 2012 with the announcement of unlimited Outright Monetary Transactions (OMT) and the signal sent by ECB President Mario Draghi that the ECB would do “whatever it takes” to preserve the euro. More generally, the ECB has been addressing the severe and persistent disinflationary forces in the euro area with a broad set of standard and non-standard monetary policy 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. After the ad-hoc Greek Loan Facility that financed the first Greek bailout programme in 2010, 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 16 / 23 BIS central bankers' speeches 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 Imbalances Procedure and the Country Specific Recommendations are all contributing to stronger macroeconomic surveillance. The way forward The euro area is now recovering. However, the recovery faces headwinds, relating both to political uncertainty linked to the rise of populism and anti-EU rhetoric and the surge of protectionist voices. The populist voices around the globe ‒ and particularly in developed economies ‒ can be traced to the undesirable consequences of globalization and technical progress. Yet protectionism is not a first best response. Specific concerns include the failure to tackle high and persistent unemployment, worsening income distribution, the fear that the influx of immigrants will affect societies’ identities and living standards, and tax evasion by multinational companies ‒ mostly related to uncontrolled off-shore activities. Additionally, the refugee crisis, fear of rising terrorism and Brexit generate more uncertainty. Finally, there are considerable worries related to US policy and especially its policies in the financial sector. 17 / 23 BIS central bankers' speeches 18 / 23 BIS central bankers' speeches Moreover, the recovery in the euro area is slow compared to past recoveries, inflation remains persistently low, the output gap is still large in several Member States, investment as a share of GDP continues to be below its pre-crisis levels, and the rising current account surplus in the euro area as a whole reflects weak internal demand relative to production. Crisis legacies such as high and persistent unemployment, low total hours worked, high public and private debt are factors weighing negatively on recovery prospects. In view of the aforementioned risks and challenges, and given the fact that the ECB cannot maintain loose monetary policy for ever, the way forward should involve structural reforms to improve potential growth, reduce structural unemployment and make the euro area more resilient to future shocks. Greater economic policy coordination, convergence and risk-sharing inside the euro area are also necessary. 19 / 23 BIS central bankers' speeches Make the euro area more resilient to future shocks Euro area economies should strengthen economic resilience by reducing their vulnerability and fostering smoother adjustment to future shocks. To achieve this, it is imperative to address crisis legacies and macroeconomic imbalances. In addition, member states should improve their capacity to absorb shocks internally. Building such a capacity implies removing rigidities in labour, product and services markets. This will support economic adjustment through price flexibility and facilitate a smooth and speedy reallocation of resources. Price flexibility allows for the recovery of any loss in competitiveness, and fosters a faster adjustment of relative prices, which, in the absence of exchange rate adjustment, is crucial for the rapid reallocation of production resources to the most dynamic sectors and firms. According to a European Commission study, price flexibility and the rapid reallocation of resources require wage flexibility, ease of market entry of new firms, an effective and efficient insolvency framework including a second chance for entrepreneurs, a friendly environment for doing business, a well-functioning justice system, low levels of corruption, the availability of high quality public services and public infrastructure, and a regulatory framework conducive to competition. Such reforms, besides increasing the capacity of euro area economies to absorb shocks internally, increase productivity and long-term growth. Furthermore, some structural reforms (for example, cutting red tape) raise expectations of future income, and thus boost confidence, investment and domestic demand in the short term, supporting the recovery. In addition, policies that raise labour force participation and reduce structural unemployment are essential to boost future growth and employment. These reforms effectively make markets more flexible. But they can also make individuals’ lives more uncertain. To this end, it is important to improve social protection – a policy that has come 20 / 23 BIS central bankers' speeches to be known as flexicurity. Reforms to the institutional setting of EMU to improve economic policy coordination, convergence and risk sharing Euro area Member States should enhance real and cyclical convergence, which requires establishing closer economic policy coordination. Improved transparency and predictability in the interpretation and enforcement of fiscal rules (Stability and Growth Pact) and ownership and credible implementation of the country specific recommendations are prerequisites for successful policy coordination. Furthermore, the adjustment mechanism within EMU should be facilitated by ensuring that it works in a symmetric way, i.e. both for countries with sustained external deficits and for those with sustained external surpluses. To this end, the Macroeconomic Imbalances 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 as domestic demand remains insufficient and potential growth low. This lack of progress in countries with sustained current account surpluses puts further strain on the adjustment efforts of deficit countries as it implies that more internal devaluation is required to achieve sustainable competitive gains. Moreover, this is even more difficult in the current low inflation environment. Risk-sharing in EMU should be enhanced along the lines proposed in the Five Presidents’ Report in 2015 and other proposals, such as those released by the Jacques Delors Institute in the autumn of 2016. Private risk-sharing can be encouraged by actions that lead to a true financial 21 / 23 BIS central bankers' speeches union with fully integrated financial and capital markets. These actions 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, perhaps by strengthening the financial resources of the ESM. There are various options for the formation of a common Deposit Insurance Scheme, some involve a re-insurance mechanism and lending arrangements between national insurance schemes, while others the formation of a single European Deposit Insurance Scheme. The ESM could be upgraded in order to become the fiscal backstop for the Single Resolution Fund and the common Deposit Insurance Scheme. Such steps are necessary to improve confidence in the banking system, break the feedback loops between banks and sovereigns and improve risk-sharing. A genuine Capital Markets Union can be promoted through legislative changes that impose harmonization towards best practices on securitization, accounting, insolvency and company law, property rights etc. Such changes would allow for deeper integration of bond and equity markets and 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 individual Member States. Besides enhancing the channels of private risk-sharing, a fiscal stabilization tool to cushion large macroeconomic shocks, that is, public risk-sharing, is warranted in the euro area. Such a tool, possibly administered by a euro area finance ministry with parliamentary legitimacy and responsibility, would provide essential insurance against asymmetric shocks that induce regional disparities, while, in case of symmetric shocks, it would complement the single monetary policy in its role as a cyclical stabilization tool, in particular when policy rates are at the zero lower bound. Whilst there appears little appetite at present for fiscal union, there are alternative ways forward as proposed by both policy makers and academics alike. For example, building on the experience of the already-existing European Fund for Strategic Investments (the Juncker Plan), it would be politically feasible to strike a deal that promotes structural reforms in exchange for investment financed through a common pool of EU funds. These EU funds could come either from some intergovernmental investment fund or from the EU budget, while Eurobonds issued by the ESM could also be considered when conditions permit, using the appropriate conditionality. Such a “reform-for-investment policy” would provide the impetus for, on the one hand, more structural reforms that increase cyclical convergence and reduce macroeconomic imbalances and, on the other, more private and public investment that enhance productivity, spur convergence and foster social cohesion. Such a policy would thus strengthen both supply and demand. Public investment could be encouraged by including only amortization in the general government balance in exchange for reforms. 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. Such options could work to enhance the attractiveness of further integration in the euro area. 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. In the long run, a European Monetary Fund could be set up to replace the ESM. This Fund would act as a lender of last resort to member states. Governments in distress would be able to borrow from the Fund in exchange for ever tighter conditionality. The Head of the Fund would be the euro area finance minister and at the same time the EU Finance Commissioner. His/her remit would be to represent the interests of the euro 22 / 23 BIS central bankers' speeches area as a whole and he/she would be accountable to a Joint Committee of the European Parliament and the national parliaments. Conclusions Ladies and Gentlemen, In conclusion, I want to emphasize that, despite the progress achieved in recent years, both Greece and the euro area face several challenges and risks ahead. There is no time for complacency because Europe is not adequately prepared for a new crisis and the ECB cannot maintain loose monetary policy for ever. Further action is imperative. The completion of the EMU along the lines proposed in the 2015 Five Presidents’ Report is a prerequisite for its long-term viability and the long-term prosperity of its Member States. That this will inevitably require changes to the Treaty is surely clear. But Treaties should not be written in stone. Periodic revisions are necessary to adapt to changing circumstances. As regards Greece, the rapid completion of the second review and the consistent and determined implementation of the programme are prerequisites for ensuring a sustainable economic recovery. Moreover, following the recent approval of the short-term debt relief measures by the ESM and the EFSF, the completion of the second review would enable the adoption of decisions on medium- and long-term measures to ensure the sustainability of Greek public debt, and on the inclusion of Greek government bonds in the ECB’s quantitative easing programme. The actions described above, if implemented, will set in motion a virtuous circle paving the way to the full return of the Greek government and Greek businesses to international financial markets and the gradual relaxation and ultimately the lifting of capital controls. Such developments will signal the definite exit from the sovereign debt crisis, the return to financial normality and to sustainable medium-term growth 23 / 23 BIS central bankers' speeches

bank of greece

Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at an event hosted by Piraeus Bank, Athens, 28 March 2017.

Yannis Stournaras: Entrepreneurship, NPL resolution policies and economic growth prospects in Greece Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at an event hosted by Piraeus Bank, Athens, 28 March 2017. * * * It is a great pleasure for me to be here with you today and have the opportunity to share my thoughts on the growth prospects of the Greek economy and the role of entrepreneurship and NPL resolution policies. Today, the long-term growth prospects of the Greek economy are significantly improved compared to seven years ago as the economy has been undergoing significant rebalancing and adjustment, despite the missteps and delays that occur from time to time. The improved macroeconomic fundamentals open up significant investment opportunities. Entrepreneurship can transform these improved opportunities in actual economic growth, new jobs and social prosperity. Banks play an important role in providing finance to entrepreneurs to make this transformation possible. Greek banks have not been able so far to provide the necessary credit to companies as they are burdened with a high share of non-performing loans (NPLs). This may change in the future due to a number of ongoing initiatives. Resolution of NPLs may foster economic growth significantly as it will enable a productivity-enhancing reallocation of capital and employment from non-viable to viable companies and sectors. Since the beginning of the sovereign debt crisis, Greece has implemented a bold programme of economic adjustment that has eliminated fiscal and external deficits and improved competitiveness. Between 2009 and 2016, the general government deficit shrunk by approximately 14 percentage points of GDP. The primary balance, adjusted for the effect of the business cycle, improved by about 17 percentage points of potential GDP. This achievement represents one of the largest fiscal adjustments ever undertaken and is twice that of the adjustment in other Member States that were under EU-IMF programmes. On external adjustment, the current account also marked a significant turnaround improving by about 15 percentage points of GDP compared to 2008; in the last two years, it has effectively been in balance. Competitiveness has been restored, reflecting the effect of structural reforms in the labour and product markets. As a result, the share of exports in GDP increased from 19% in 2009 to 30% in 2016 with most of this increase stemming from exports of goods. In fact, according to Eurostat data, Greece’s exports of goods have increased by 43% since 2009 in real terms, compared to 42% for the euro area and 47% for Germany, Europe’s export engine. This rebalancing of the economy towards a new, outward-looking growth model has particular significance for the prospects for entrepreneurship. A few figures are indicative of the forces at work. Between 2010 and 2015, the relative price of tradables versus non-tradables rose by about 10%. Whereas both sectors have been hit hard by the recession, the tradable sector has performed better than the non-tradable sector as outward-looking companies increased their exports, taking advantage of the improvement in competitiveness. As a result, the relative size of the tradable sectors, measured by Gross Value Added, grew by approximately 12% in volume terms and by about 24% in nominal terms. Finally, in terms of employment, the size of the tradable sector increased relative to the non-tradable sector by around 8%. These figures would improve further if the already implemented reforms were to be enhanced by those planned under the ESM programme. Based on estimates of the OECD, the full implementation of all reforms, both those undertaken and those scheduled, is expected to boost 1/5 BIS central bankers' speeches real GDP over a 10-year-horizon by about 13%. And this figure excludes a further positive effect from structural reforms which cannot be easily quantified such as the modernisation of public administration and the judiciary system, the strengthening of insolvency regulations and the resolution of non-performing loans. In-house work by the Bank of Greece points to similar estimates of the effects of structural reforms with the main effect coming from higher total factor productivity (TFP) growth. The strengthening of the long-term prospects of outward-looking firms requires a further openingup of international trade, participation in global value chains and closer trade links with countries and businesses with cutting-edge technology. In this way, inherent structural weaknesses that hamper the market penetration of Greek products (such as product quality, protected designation of origin and branding, red tape, etc.) can be overcome. Additionally, improved financing terms and conditions would be forthcoming. But prospects for entrepreneurs are also closely related to the paths taken by the various programme reviews. After the successful completion of the first review, a positive momentum developed which affected confidence and liquidity. A number of key indicators of economic activity, such as industrial production, retail sales, dependent employment flows and private consumption, improved. Bank deposits stabilised and emergency liquidity assistance (ELA) for Greek banks fell. These developments pointed at that time to a recovery starting from the second half of 2016 and continuing through 2017 and 2018. This outlook is still possible in principle despite the deterioration in confidence and the weakening of short-term indicators in recent months, which is associated with the delay in closing the second review. For the time being, the delay in closing the second review has weakened but has not reversed the positive momentum of economic activity. However, any further delays could derail the recovery of the economy and put at risk the growth, fiscal and financial targets. But entrepreneurship does not just require confidence. Reforms, that are part of the programme measures, also need to be implemented. Particular emphasis should be put on simplifying investment licensing procedures, reducing the administrative burden on businesses and facilitating competition, opening up the remaining regulated professions and network industries, modernizing and strengthening public administration, enhancing judicial efficiency, speeding up court proceedings and of course reducing personal and corporate taxation. Emphasis needs to be placed on restraining and restructuring non-productive spending and making a more effective and efficient use of the public sector’s assets, creating in this way incentives to increase investment and employment which will contribute to increased potential output. For their part, the Institutions should show more flexibility in the area of fiscal targets and government debt relief. According to estimates from the Bank of Greece, a lowering of the general government primary surplus target after 2020 to 2 per cent of GDP, from the 3.5 per cent that is envisaged now, would be consistent with debt sustainability if combined with some mild debt relief measures and structural reforms to raise potential growth. The easing of the primary surplus targets, together with the implementation of the agreed structural reforms, would put the necessary conditions in place for a gradual lowering of tax rates, with positive multiplier effects on economic growth. Finally, there is the issue of what debt relief measures. The short-term measures decided at the Eurogroup meeting of the 5th of December last year are a positive step and are expected to reduce public debt as a ratio of GDP by 20 percentage points by 2060. However, to ensure the sustainability of public debt going forward, additional medium-term measures are necessary. When the debt-to-GDP ratio is above 100%, measures that reduce interest payments on debt can improve the ratio quicker than a rise in the primary balance. For example, with a debt-to-GDP ratio of 180%, a 1 percentage point reduction in the effective interest rate on debt will reduce the ratio of debt to GDP by 1.8 percentage points. By contrast, a 2/5 BIS central bankers' speeches rise in the primary surplus by 1 percentage point of GDP lowers the debt-to-GDP ratio by only 1 percentage point (assuming that the fiscal multiplier is 0 which, as we well know, is not). Now, the interest burden of Greek public debt is low until 2021 but increases substantially thereafter because of payments of deferred interest on the EFSF loans and interest on new debt issued in financial markets. An exercise done at the Bank looks at the impact of smoothing interest payments for EFSF loans over time. The results of these simulations suggest that, extending the Weighted Average Maturity of interest payments for EFSF loans by 8.5 years, while simultaneously allowing primary surpluses to decline to 2% of GDP after 2020, debt sustainability is safeguarded. This exercise is indicative of how admittedly mild debt relief measures can have significant effects on the debt profile with no cost for the creditors. Of course, were the interest smoothing accompanied by higher growth, as a consequence of lower primary surpluses, then the debt-toGDP profile and gross financing needs would be even more favourable. Alternatively, if interest rate smoothing were to occur and the costs shared equally between Greece and the ESM, this would also lead to more favourable outcomes. Turning now to the role of the banking sector in providing necessary credit to finance dynamic businesses, the issue of non-performing loans remains the greatest challenge. The stock of nonperforming loans (NPLs) has reached unprecedented levels, with the deterioration in asset quality being widespread. There is no doubt that one of the main drivers of the sharp rise of NPLs has been the deep and prolonged economic recession and its impact on the financial condition of households and the non-financial corporate sector. However, other factors related to structural impediments also played a role: the ineffectiveness of judicial procedures; excessive borrower protection; the preferential claims of the State and Pension Funds on the proceeds of liquidations as against other classes of creditors; the unfavourable tax treatment of provisioning and writeoffs; the lack of an out-of-court-workout framework; and the absence of a secondary market for distressed debt. The Bank of Greece and the government have implemented several measures to address the long-standing impediments that dampened banks’ efforts to deal with the problem. As a first step, the Bank of Greece conducted a troubled asset review to assess the operational preparedness and effectiveness of banks’ established policies and practices to deal with the large scale resolution of troubled assets. Following this, the Bank enhanced the supervisory and regulatory framework. It issued guidelines regarding NPL management with a key requirement being the establishment of a well-defined governance structure with an internal independent NPL workout unit. It introduced the Code of Conduct regarding the interaction of credit and other financial institutions with borrowers in arrears. Recently, the Bank of Greece, in close cooperation with the banking supervision arm of the European Central Bank, has designed an operational targets framework for the reduction of NPLs, supported by several Key Performance Indicators. The selected targets and key performance indicators are both action-oriented and results-oriented and provide a granular view of the key asset quality metrics of the bank, the management actions to reduce NPEs and the effectiveness of these actions. Banks have agreed ambitious but achievable targets, which were submitted at the end of September 2016, with a 3-year time horizon. The goal is to reduce NPLs by around 40 billion euros by end-2019. The targets set take into account the intrinsic characteristics of each bank’s portfolio, organization and capacity. At the same time, banks have developed tailored models to calibrate the operational targets, taking into account macroeconomic assumptions. The key performance indicators are monitored on a quarterly basis through extended prudential reporting, and the Bank of Greece, to enhance transparency and market discipline, has committed to publish a relevant progress report every quarter. Based on the first report already 3/5 BIS central bankers' speeches published, the targeted reduction of NPLs is on track, although the main reduction is not expected to take place before the end of 2018-beginning of 2019. The government, for its part, has improved the regulatory framework related to the law on overindebted households. It has amended the Code of Civil Procedure, with a focus, inter alia, on changing the hierarchy of creditors and how proceeds are allocated in cases of liquidation. The capacity and efficiency of the judicial system have been enhanced, albeit with implementation being somewhat behind schedule. In addition, the government and the Bank of Greece have developed a framework for non-bank credit servicing firms and the sale of NPLs, with two companies having received a license so far, while other applications are being reviewed. The above initiatives are about to be significantly enhanced by the implementation of further policy actions that are in the pipeline. Specifically, important steps are being taken regarding the revision of the out-of-court workout in order to facilitate coordination among banks and other creditors, including the State and social security funds. Significant focus will be on standardizing procedures for small business professionals and small and medium enterprises to ensure a rapid, effective and transparent resolution of arrears. In addition, the revision of bankruptcy law is expected to streamline procedures, allowing for creditor-led restructuring for companies with negative net worth, while the tax treatment of impairment losses and loan write-offs is in the final stages of being legislated. On the remaining steps, it is important that bank managers and employees acting in good faith in managing non-performing loans should be protected from criminal prosecution, while the platform for electronic auctions should become operational. Additionally, the full deployment of debt information / counseling centres across the country will facilitate borrowers’ understanding of the optimum solutions to managing their loans. The full implementation of the above reforms, in conjunction with a more active NPL management policy on the part of banks is beneficial from both a micro and a macro prudential perspective. It can improve the financial soundness of banks; it will free-up capital that can be directed to productive sectors of the economy, resulting in an increase in productivity and potential growth. Finally, it will diminish the power of strategic defaulters who, until now, see no immediate consequences from failing to pay. A conservative estimate, based on a sample of 13,000 firms with loans that exceed one million euro, indicates that, on average, one in six companies appear to strategically default, while anecdotal evidence suggests that this value is significantly higher for smaller businesses and households. On the macroeconomic implications of NPLs, the academic literature has established a strong two-way relationship between macroeconomic developments and asset quality. The profound and well-documented negative relationship between economic growth and NPLs is enriched by recent studies that also identify a negative feedback effect from the banking sector to the economy. The size of that feedback is related to the ability of banks to channel savings to investment, to allocate risks and to transmit monetary policy decisions to the real economy. This ability has also been found to be related to bank-specific drivers, such as management quality, the level of capital, cost efficiency and risk preferences. In particular, one of the main channels through which financial developments can have a feedback effect on the macro economy is through the capacity of banks to lend to the economy, the so-called “balance sheet channel”. The reduction in NPLs can weigh positively on the supply of credit by unlocking bank capital and funding for the financing of productive companies. The reduction in NPLs improves the profitability of banks through higher interest income, reduced provisioning or write-offs and reduced administrative expenses for the monitoring and management of NPLs. At the same time, by removing doubts about the bank’s future revenues, it allows banks to benefit from lower funding costs. Such developments positively affect loan supply. In addition, as impaired assets carry a higher risk weight, a lower level of NPLs allows banks to be more aggressive in funding investment opportunities, unconstrained by a scarcity of capital or the distraction of managements’ attention to the management of a large-scale troubled 4/5 BIS central bankers' speeches assets portfolio. In addition, a lower level of NPLs improves the allocation of credit from non-viable firms that are kept artificially alive to viable firms. According to research by the OECD, when more industry capital is sunk in non-viable (“zombie”) firms, the average viable firm undertakes less investment than otherwise1. Hence, a rise in the fraction of non-viable firms in the economy crowds out the growth of more productive firms, thus reducing the efficiency of capital allocation and causing a slow-down in multifactor productivity growth. Simulations by the OECD suggest that reducing the share of capital of non-viable firms in Greece to the minimum across OECD countries would be associated with a gain in investment for a typical viable firm of 4.7% per annum. This number is economically very significant. It is indicative of the potential gains of NPL resolution for corporate investment, aggregate productivity and long-term economic growth. The policy implication is that there is considerable scope for policy reforms that facilitate NPL resolution in order to improve productivity-enhancing capital reallocation in the Greek economy. On top of the above, the economy is also positively affected from the demand side, the so-called “borrower balance-sheet channel”. From a debt overhang perspective, non-financial corporations with loans in arrears might have less incentive to invest in new projects in order to avoid using the upside potential to service current debt. In addition, higher lending rates seen in countries with prolonged NPL problems weigh negatively on credit demand. Higher lending costs drive firms to utilise internal sources of financing, resulting, on average, in the avoidance of large investment projects. A reduction in NPLs has the reverse effect, improving the willingness, incentives and ability of economic agents to invest in new projects. The practical implications of NPLs for growth opportunities are evident when looking at European data on bank lending to non-financial corporations and households. The contraction of bank lending is particularly pronounced in countries suffering from high levels of NPLs. At the same time, Member States with high NPL ratios have also experienced below average GDP growth, consistent with the below-average propensity to invest that NPLs generate. The opposite picture is found for the Member States that exhibit a lower level of NPLs. Therefore, the effective management of NPLs is of the utmost importance for a country’s growth opportunities. Banks − benefiting from improved asset quality, profitability and liquidity − will be in a better position to reduce the cost of credit risk and lending spreads. This amounts to a pivotal development for the competitiveness of the non-financial corporate sector in an international environment of ultra-low interest rates. It also facilitates the reduction in the debt servicing costs of households that mitigate the impact of reduced household gross disposable income. The above is to the benefit of the real economy as the unlocking of funding and the improved business climate impacts positively on the setting-up of new businesses, investment, employment and growth. In sum, we would move to a virtuous circle where improved asset quality positively affects GDP growth, in turn leading to a further reduction of NPLs and so on. In conclusion, Greece is poised to return to economic and financial normality and to shift to a new, outward-looking and sustainable growth model, based on tradable goods and services. The economic adjustment and structural improvements over the past years have opened up significant investment opportunities. To reap the benefit of these opportunities though, there are certain preconditions: first, the completion of the second review with no further delay; second, the consistent and determined implementation of the programme in conjunction; third, a more realistic approach by all parties to the fiscal mix and government debt burden. Such developments, together with the cleaning-up of banks’ balance sheets will set in motion a virtuous circle, paving the way to the full return of the Greek economy to normality. 1 Adalet McGowan, M. D. Andrews and V. Millot (2017): The walking dead: Zombie firms and productivity performance in OECD countries. OECD Economics Department Working Papers No. 1372. 5/5 BIS central bankers' speeches

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Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at The Economist First Insurance Forum, Athens, 30 March 2017.

Yannis Stournaras: The metamorphosis of Greece and the role of the insurance industry - guardians of the future? Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at The Economist First Insurance Forum, Athens, 30 March 2017. * * * It is a great pleasure to be here today and have the chance to share with you my thoughts on the role of the insurance industry in the midst of challenging times lying ahead, not only in Greece, but in the entire world. Over the past seven years Greece has indeed undergone a profound change in form, as the Greek word metamorphosis succinctly describes. Policies implemented in the context of the three adjustment programmes since 2010 have helped address large fiscal and external imbalances, turning double-digit deficits to positive balances in recent years. I would like to draw your attention to just two of them. First, adjusting for the effect of the recession, the improvement in the “structural” primary balance over the period 2009–2016 reached 17 percentage points of potential GDP, twice as much as the adjustment in other Member States that were under EU-IMF programmes. Second, the current account in the last two years has been effectively in balance. This marks a significant turnaround of the current account balance by about 15 percentage points of GDP since 2008. Alongside this impressive performance, remarkable structural improvements have been achieved in labour and product markets, as well as in public administration. These reforms are expected to boost the growth potential of the Greek economy in the long-term through higher productivity and employment growth. The metamorphosis, however, is not complete. Greece has not as yet managed to return to sustainable growth and a prerequisite for this is the completion of the second review with no further delays and the consistent and determined implementation of the programme. This is the current challenge as the intense reform effort has taken its toll on society, making the implementation of structural reforms difficult and at times even leading to policy reversals. The long-suffering Greek pension system is a prime example in this respect: while at least three notable reforms have been legislated since 2010, many provisions remain to be fully implemented, while the system remains costly, distortive and unfair. This is the topic I would like to focus on during the first part of my speech, as I believe this is one of the areas where the insurance industry may have a major role to play in the future. In doing so, I will start by outlining the key characteristics of the Greek pension system and offer you a brief review of recent reforms. Although an institutional basis for the development of a multi-pillar system exists since 2002 (Law 3029/2002), the Greek pension system essentially remains single-pillar, with a mandatory first pillar providing main, auxiliary and other pension benefits; it works on a pay-as-you-go basis, with revenue shortfalls financed by the State budget. It is thus predominantly public in nature. Concerns over the long-term explosive path of pension expenditure alongside strong fiscal and financing pressures brought about a comprehensive reform of main pension schemes in 2010. The 2010 reform tightened pension entitlement rules (e.g. it increased the early and statutory retirement age to 60 and 65 respectively, raised the required years of contributions from 35 to 40) and also introduced a structural change via the specification of a unified, less costly, pension formula that was prescribed to be applied as of 2015. This formula specified a basic, essentially universal, component and a proportional one corresponding to the amount of insurance 1/6 BIS central bankers' speeches contributions pertaining to lifetime earnings (rather than the best five of the last ten years of service that was earlier the case). All in all, the reform strengthened the link between contributions and benefits and decreased the generosity of pensions. Further reforms in 2011 and 2012 were legislated in order to contain pension expenditure. These included: (i) abolition of the 13th and 14th pensions for all pensioners ; (ii) a freeze on nominal pensions up to 2016; (iii) pension cuts affecting monthly amounts over €1,000 ; and (iv) an increase in early and statutory retirement ages to 62 and 67 years, respectively. Furthermore, in 2012 auxiliary pension funds were merged into a single entity (ETEA), which was to operate on a Notional Defined Contribution (NDC) basis as of 2014. The NDC system included a sustainability factor, which under a full pay-as-you-go principle required maintaining a zero deficit every year. The 2010 and 2012 pension reforms were expected to lead to a substantial correction in the financial course of the social security system, reducing the projected increase in pension expenditure for the period 2010–2060 from 12.5% of GDP (2009 EC Ageing Report ) to just 1.3% of GDP (2015 EC Ageing Report ). The gross replacement rate (the ratio of the average pension of new retirees to the average wage at retirement) was expected to fall from 64% to 49% for main pensions and from 15% to 8% for auxiliary pensions in the period 2014–2060 . However, these reforms, as judged ex post, were not consistently implemented; neither the unified benefit rule for main pensions nor the zero balance rule for auxiliary pensions was applied as planned. The pension cuts (expected to yield 2¼% of GDP in gross fiscal savings) were ruled unconstitutional by a Council of State judgment in 2015. The increases in the retirement age thresholds lacked effectiveness in the presence of extensive grandfathering of previous early retirement options, which led to a massive wave of early retirements to take advantage of the previous more generous rules. Such spending pressures combined with falling contributions due to high levels of unemployment put the system under financial strain, requiring significant annual transfers from the State budget; according to Eurostat (ESA 2010 data), total payments made to social security funds by other sub-sectors of general government amounted to 7.1% of GDP in 2015 (compared with a euro area average of 3.3% of GDP). Alongside persistent costs, the system continued to face structural challenges, with merging funds retaining different degrees of autonomy (and own benefit and contribution formulas), while pension provision remained multiple-layer, with basic, contributory and minimum pensions in the main funds being topped up by auxiliary, lump-sum, dividend and/or targeted pensions (e.g. EKAS). As part of the agreement to close the first review of the current programme, all of the above were addressed afresh by the 2015 and 2016 reforms which, among other measures, legislated: (i) simplification of the social security system via the consolidation of main funds into a single social security entity (EFKA); (ii) a unified pension formula which calculates pensions as the sum of a basic component (€384, corresponding to the 2014 poverty level, at 20 years of contributions) and a contributory component applying marginal accrual rates to lifetime pensionable earnings; (iii) new rules for calculating supplementary pensions applying, among other measures, selective cuts and freezing pensions as long as the funds remain in deficit; (iv) a change of the contribution base for the self-employed and farmers from notional to actual earnings from selfemployment subject to a minimum income limit; (v) harmonisation of main pension contributions at 20% of earnings; (vi) an increase in health contributions for retirees to 6%; (vii) an increase in supplementary pension contributions until mid-2022; (viii) phasing out of the non-contributory social solidarity benefit EKAS by end-2019; and (ix) a new, less generous, formula for the calculation of lump-sum pension benefits. This brings us to the current juncture, in March 2017, with the second review in progress and the pension system still high on the reform agenda. Why? Because, despite the numerous interventions outlined above, the system remains costly. According to the 2017 Budget report, 2/6 BIS central bankers' speeches State budget transfers to social security funds/EFKA amounted to 7.6% of GDP in 2016 and are expected to reach 9.9% of GDP in 2017 as civil servants’ pensions are now provided by EFKA. This amounts to more than a third of ordinary budget expenditure in 2017. Note also that this forecast is subject to upside risks as (i) there is currently a significant number of retirees with outstanding pension payments not accounted for in the projections; and (ii) EFKA revenue collection so far faces numerous challenges and is likely to fall short of the 2017 target. Such budgetary pressures may inevitably have to be relieved via adjustments in certain pensions. This is because, on the one hand, in some cases pension benefits in Greece remain relatively generous both from a domestic and from an international point of view. Specifically: In several cases, they are high relative to the contributions that have been paid to acquire them. Recent research by the Policy Analysis Research Unit of AUEB shows that, prior to the various pension cuts legislated in the period 2010–2013, on average 50.7% of IKA pensions were financed by contributions, the remaining 49.3% being a social transfer, or else a State subsidy. Incorporating, the 2010–13 pension cuts the State subsidy falls to 35.8%. The relative generosity of the system is also reflected in high gross replacement rates compared with European peers: the gross replacement rate was about 81% at end-2013, the highest in the euro area, and almost 30 pp higher than the euro area average . More recently, data published by Eurostat showed that in 2014 expenditure on old age pensions in Greece is the highest among EU countries (13.3% of GDP, compared to an EU28 average of 9.8% of GDP). While the 2015 and 2016 reforms did attempt to further curtail pension benefits, they exempted old retirees until July 2018. As a result, the fiscal adjustment delivered by the latest reforms is borne by new generations of retirees with longer careers, thus worsening benefit-contribution links and raising issues of intergenerational fairness. On the other hand, the system can no longer finance itself through rising contributions; high social security contributions increase the tax burden on labour and lead to a fall in GDP in the medium term. Note also that under the current supplementary NDC scheme they generate future pension obligations too. This context of unfolding pension cuts shows that an adequate and, at the same time, sustainable “social security only” system is not affordable under the present circumstances in Greece. Ownership of reform efforts is difficult, but may be strengthened by policies that increase incomes for pensioners in the future, thus providing appropriate social safety nets and mitigating socio-political resistance or the risk of reversal . Such policies include extending working lives and improving the employability of older workers, encouraging private savings or, most commonly and to the point, supplementing pension accumulation from public first pillar schemes with occupational pensions of second pillar and personal pension of third pillar schemes. Retirement financial security should not, and cannot, be provided from one source: social security funds, employer-sponsored retirement plans and personal savings should all be seen as indispensable and complementary parts of a single system that secure its affordability, adequacy and sustainability. In order to form such an integrated system, all stakeholders should understand their respective roles: the State should not insist on retaining the monopoly of retirement benefits; employers should cease misinterpreting their role in providing security to their employees only during their labour time but should extend it, most importantly, after their retirement; and citizens should not forget about the role their personal savings play in ensuring their own retirement financial security. 3/6 BIS central bankers' speeches The benefits of an occupational pension system are obvious: first and foremost, it increases the post-retirement financial resources of the labour force. It increases the productivity of the workforce as it constitutes an efficient means of deferred remuneration and, finally, it increases the total investments in the country by being an alternative to banks, but very efficient, way of financing the real economy. Occupational pension funds (or else called IORPs) were introduced in Greece by Law 3029/2002. Unfortunately, the current legislation does not include the subtle, but very important, distinctions of the different components of an effective occupational pension system: that of a pension institution, a pension fund, a pension scheme and the entity that operates the funds. In addition, it misinterprets the role of the pension institution with regard to its responsibility towards its members, giving them the false sense of “social security-like” full protection, irrespective of the financial capacity of the sponsor. Finally, the current legislation does not recognise Greek economic reality, as the economic burden of establishing an occupational pension fund is excessive, even for the bigger employers, let alone small and medium-sized enterprises, which constitute the backbone of the Greek economy. The transposition, during the coming months, of the new EU Directive “IORPs II” to Greek legislation should be seen as an opportunity for a new metamorphosis, with a view to making the occupational pension system work properly and fulfil its purpose. I am confident that the Greek labour force could reap major benefits from the occupational pension system, should: - the role of each distinctive component be identified and duly recognised; - the role of the occupational pension institution be restored as a trustee of the employer’s promises to its employees, discarding any “social security-like” features; - in line with Greek economic reality, greater flexibility be introduced. For example, the law could allow more than one employers (even from different industries), each with its own pension scheme, to contribute to the same pension fund that is operated jointly with other funds by a single entity; - it be acknowledged that an authorised entity may be responsible for operating a pension institution; - due recognition be given to the very important notion of the mobility of pension rights; - procedures be determined for an orderly liquidation or disbursement of benefits in case of insolvency of an IORP, its sponsor undertaking or the entity that operates the IORP; and - last but not least, the unnecessary fragmentation of IORPs supervision be eliminated. It is only under such conditions that the occupational pension system would serve its purpose and that the private insurance sector could assume its role in operating IORPs by lending its expertise and experience to the IORPs (in areas such as underwriting risks, collecting contributions, disbursing benefits, designing and implementing liability-driven investment strategies) and provide actuarial and accounting services; that is, provide added value to the members and beneficiaries of the system. The third part of the retirement financial security system is related to the third pillar personal pension products. Since 2012, a debate has been initiated at EU level on developing an EU Internal Market for personal pension schemes or products. Currently, the discussion has intensified and the debate is now focusing on the development, with the active involvement of EIOPA , of a so-called pan-European personal pension product (PEPP). Unfortunately, this is an area where Greece does not have any significant progress to report, as it lacks a relevant legislative framework. I am confident that Greek citizens would surely benefit from the 4/6 BIS central bankers' speeches introduction of a tax-incentivised simple framework for personal pensions, allowing for reduced cost structures that will be managed using robust and modern risk management tools. Full transparency to its members and beneficiaries should be considered as a prerequisite. Finally, the Greek economy would benefit as a whole, as these products may focus on long-term investments, thus contributing to sustainable economic growth. I consider the following period to be very critical for the effective design of such a system, as it is aligned with the current debate at EU level that I mentioned previously. But pensions is not the only area where insurance undertakings are active. Another sensitive area that is related to the services of insurance undertakings and has undergone a major metamorphosis over recent years is the Greek health care system. All modern, well-developed health care systems share a common goal for those who depend on their services: hope for full and healthy lives. However, it is unrealistic – if not impossible – to aim to provide “all possible health care for everyone”. This is because not only the potential array of health care services grows worldwide, but also the cost of providing these services to everyone increases faster than economic growth. In this regard, governments increasingly reach fiscal limits on services they can afford to deliver. As publicly funded health care systems are forced to contract and will hence not be able to provide full services to everyone, the private sector is expected to play an increasingly important role in meeting citizens’ health care demand. If the first priority is to provide services to all, then not all health care services can be provided. An acceptable, but less comprehensive, standard would instead differentiate between medical care “needs” for citizens to achieve high-class outcomes and medical or non-medical “wants” that, while valued by patients, contribute only indirectly to population health. It is exactly at this juncture that private insurance is able to play a major role in the health system. Designing a health care system inevitably requires choosing between or mixing public and private approaches, particularly in terms of financing. I am confident that Greek citizens would benefit from the introduction of a Greek public universal health care system that covers population “needs” and leaves funding for, and coverage of, population “wants” to an adequately regulated private health insurance market. If we reach consensus on this concept of a two-tier health care system, the next step will be to agree upon the differentiation of “needs” versus “wants”. Of course, we should not forget that private insurance markets are characterised by information asymmetry as buyers (consumers) know much more about their risks than sellers (insurance companies) do. There are generally two alternative ways to overcome these market imperfections. The first approach makes participation voluntary and lets insurance undertakings cope with the above characteristics, by introducing, probably, aggressive risk management practices (e.g. rigid risk selection procedures or rate increase decisions). Under the second approach, participation is made mandatory: when the entire population is included in the risk pool, uncertainty about the level of risk caused by choice is totally eliminated. Of course, if the choice is a mandatory private insurance market, law and regulation must be geared towards minimising and properly compensating for remaining aspects of risk selection, risk rating and renewal risk management that run counter to the smooth functioning of a universal health insurance system. This must be done in a thoughtful manner, which ensures effective government stewardship of private-sector health insurers and their use of risk management tools. Last but not least, I would like to refer to natural catastrophes. 5/6 BIS central bankers' speeches The climate of Greece can be characterised as Mediterranean, having mild winters, with sudden and heavy rainfalls and dry summers. In addition, Greece lies in a land that the mythical Giant Enceladus shakes very frequently. All three situations constitute physical hazards that intensify the perils of flood, fire and earthquake. These perils, fortunately, do not materialise frequently, but when they do, they tend to create catastrophic damages. Historically, due to the characteristic low level of insurance penetration in Greece, the cost of damages is borne by citizens who suffer losses and whose compensation is dependent on politics and, most importantly, on available funds in the government budget. Undoubtedly, the State should care to protect its citizens. But its paternalistic services to citizens who suffer should be exercised in a way that protects taxpayers. One of the most efficient ways of achieving this goal is to create a mandatory, adequately regulated, private insurance market for these risks. Concluding, I would like to emphasise that all of the above – pensions, health care and natural catastrophes – constitute very sensitive areas for the policymaker. But what I hope I have highlighted in my speech is that, despite their idiosyncratic features, these are areas that will benefit from synergies between the public and the private sector. Needless to say, such collaboration should not depend on the short-term goals of each government, but rather be part of national policies designed with a long-term perspective. It is also imperative that the terms of this collaboration are clear to all participants and transparent to the members and beneficiaries of each system. Of course, such systems should be reinforced with minimum legislative requirements for bestclass standards with regard to the insurance undertakings that would be allowed to participate. Proper authorisation, adequate additional capital buffers, employment of best practices in risk management, high credit rating obtained from a recognised credit rating institution, all constitute effective gatekeeping tools that should be tailor-made, taking into account the specific roles that private insurance would assume. 6/6 BIS central bankers' speeches

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Speech by Mr Theodore Mitrakos, Deputy Governor of the Bank of Greece, at the 37th meeting of the Central Banks Governors' Club, Session III "Country Presentations - Recent Economic and Financial Developments", Belek - Antalya, Turkey, 3 April 2017.

Theodore Mitrakos: Overview of the Greek economy and financial sector Speech by Mr Theodore Mitrakos, Deputy Governor of the Bank of Greece, at the 37th meeting of the Central Banks Governors' Club, Session III "Country Presentations - Recent Economic and Financial Developments", Belek - Antalya, Turkey, 3 April 2017. * * * It is a great pleasure for me to be here with you today and have the opportunity to update you on economic and financial developments, and more importantly to share my thoughts on the growth prospects of the Greek economy. Allow me first to give you a brief overview of the performance of the Greek economy and financial sector over the last few years. Following the global financial crisis of 2007–2008, the Greek economy has entered a deep and prolonged recession. The sovereign debt crisis in Greece turned soon into a banking crisis: banks were gradually excluded from the interbank market, suffered significant deposit outflows and losses to the value of their assets as the sovereign debt was downgraded by rating agencies. What started as a liquidity crisis for banks, turned into a solvency crisis following the Greek debt restructuring (the so-called Private Sector Involvement – PSI) and debt buyback in 2012. Greek banks suffered losses in the order of €38 billion, which wiped out their entire capital base. Furthermore, the cumulative decline in real GDP by more than a quarter from its pre-crisis level and the surge in unemployment impacted negatively the financial condition of households and businesses and therefore the ability of borrowers to service their debt obligations. As a result, non-performing loans increased by around eight times from 5.5% in 2008 to 45.1% in June 2016. Against this backdrop, Greece has implemented a brave programme of economic adjustment that has eliminated fiscal and external deficits and improved competitiveness that, between 2009 and 2016, resulted in the shrinkage of the general government deficit by approximately 14 percentage points of GDP and to the improvement of the primary balance, adjusted for the effect of the business cycle, by about 17 percentage points of potential GDP. This achievement represents one of the largest fiscal adjustments ever undertaken worldwide. Significant improvement was also recorded on external adjustment, where the current account improved by about 15 percentage points of GDP compared to 2008, being in balance in the last two years. In addition, bold reforms in the labour and product markets helped towards the restoration of competitiveness, helping the share of exports in GDP to increase from 19% in 2009 to 30% in 2016, while the exports of goods in real terms have increased by 43% since 2009, compared to 42% for the euro area. The aforementioned developments helped the economy to show signs of stabilization, with real GDP remaining almost flat despite bouts of uncertainty surrounding the negotiations with our European partners, the imposition of capital controls (including limits in deposits withdrawals and cross-border transfers) and the implementation of further austerity measures. As far as the banking sector is concerned, the management of non-performing loans represents the most significant challenge as their stock has reached unprecedented levels, with the deterioration in asset quality being widespread. The Bank of Greece and the State have implemented a number of measures to address impediments in efficient NPL management. Following a troubled asset review, the Bank of Greece enhanced the supervisory and regulatory framework helping banks to enrich their policies and practices to deal with the large-scale resolution of troubled assets. The banks have to follow specific guidelines regarding NPL management, starting with the establishment of a well-defined and fully operational internal independent NPL workout unit and implement the Code of Conduct regarding the interaction of 1/3 BIS central bankers' speeches credit and other financial institutions with borrowers in arrears. Recently, the Bank of Greece, in close cooperation with the Banking Supervision arm of the European Central Bank ECB has designed an NPL operational targets framework, supported by several Key Performance Indicators (KPIs). The selected targets and KPIs are both actionoriented and results-oriented and provide a granular view on the key asset quality metrics of the bank, on the management actions to reduce NPLs and on the effectiveness of these actions. In addition, following an extensive consultation with authorities and the industry, the reporting framework of the Bank of Greece has been upgraded accordingly. Banks agreed on ambitious but achievable targets, which were submitted at the end of September 2016, with a 3-year time horizon. According to these targets, banks will aim at reducing their NPLs by 49% by the end of 2019. The reduction is mainly driven by curing of loans and write-offs and to a lesser extent by liquidations, collections and sales of loans. The largest part of the reduction will be effective in 2018 and 2019, since inflows of new NPEs will remain significant in the second half of 2016 and 2017. Banks managed to achieve the NPE targets for Q3 and Q4 2016, despite the headwinds in real GDP growth in the last quarter. The State, for its part, updated the law on over indebted households, amended the Code of Civil Procedure, enhanced the efficiency of the judicial system and developed a framework for a secondary market for bad loans and non-bank credit servicing firms. Turning to the most recent developments, following the Eurogroup of 20th March, the Greek authorities and the institutions have intensified talks on outstanding issues to reach a staff level agreement as quickly as possible. In the fiscal front, the state budget recorded a surplus of 0.2% of GDP in the first two months of 2017, while available data for 2016 indicate that the surplus will reach 2.0% of GDP, outperforming the Programme’s target by a large margin. It should also be noted that the European Stability Mechanism adopted a set of short-term debt relief measures for Greece on 23.1.2017. These measures, which were endorsed by the Eurogroup in December, are designed to reduce interest rate risk for Greece and to ease the country’s repayment profile. Looking forward, the Bank of Greece expects GDP to grow by around 2.5% in 2017, although a downward revision of the December 2016 forecasts is likely due to the negative carry-over effect of the sharp decline in output in Q4 2016 (attributed mainly to the decline in gross fixed capital formation and government consumption). Downside risks to the economic outlook exist related to delays in the conclusion of the second review of the Programme, the impact of increased taxation on economic activity and reform implementation. Downside risks connected with the international environment include increased uncertainty associated with forthcoming elections in several EU countries, the rise in protectionism worldwide and a slowdown in global trade and a possible resurgence of the refugee crisis. Upside risks are related to the inclusion of Greek sovereign debt in the ECB’s quantitative easing programme (QE) and an increase in tourist arrivals and travel receipts, as indicated in the bookings trend. Regarding the banking sector outlook, the out-of-court mechanism will focus on standardizing procedures for small business professionals and small and medium enterprises to ensure a rapid, effective and transparent resolution of arrears. On the remaining steps, it is important that bank managers and employees acting in good faith in managing non-performing loans should be protected from criminal prosecution, while the platforms for electronic auctions and the out-ofcourt mechanism are expected to become operational soon. Addressing the problem of non-performing loans in an efficient manner is important from both a micro and a macro-prudential perspective, since it would not only improve the financial soundness of banks, but also free-up funds to be directed to other more productive sectors of the economy, resulting in an increase of productivity and growth. The resolution of private debt is of utmost significance for the rebalancing of the Greek economy towards export-oriented sectors and the efficient allocation of resources. The identification of viable businesses, for which 2/3 BIS central bankers' speeches sustainable long-term restructuring solutions should be implemented, will preserve the productive fabric of the economy and lay the foundations for resumption in investment and growth. In a similar vein, restoring affordability of household debt can render many households once again bankable and reinforce social cohesion. In conclusion, Greece is about to return to economic and financial normality and to shift to a new, outward-looking and sustainable growth model, based on tradable goods and services. To this end, allow me to highlight the following pre-conditions: the prompt completion of the second review and a more realistic approach by all parties to the fiscal mix and government debt burden. Thank you for your attention. 3/3 BIS central bankers' speeches

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Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the Economist Conference "Greece: A comeback to the financial markets? Are we near the finishing line?", Frankfurt am Main, 31 May 2017.

TITLE SLIDE GREECE: A COMEBACK TO THE FINANCIAL MARKETS? Are we near the finishing line? Yannis Stournaras, Governor, Bank of Greece Economist, Frankfurt, May 31, 2017 It is a great pleasure for me to be here with you today and have the opportunity to share my thoughts on the prospects of the Greek economy. I will focus on three issues: First, I will present the progress that has been made so far. Second, I will address to the remaining challenges. Finally, I will discuss the preconditions for a sustainable return to financial markets. 1. Progress so far Since the beginning of the sovereign debt crisis, Greece has implemented a bold programme of economic adjustment that has eliminated fiscal and external deficits and improved competitiveness. SLIDE 1  The general government balance from a deficit of 15.1% of GDP in 2009 turned into a surplus of 0.7% of GDP in 2016. Between 2009 and 2016, the primary balance improved by about 14 percentage points. In 2016 the primary surplus was 4.2 percent of GDP outperforming not only the 0.5 percent target for 2016, but also the 3.5 percent target for 2018. Practically, the required fiscal adjustment until the end of the programme in 2018 has nearly been made. This represents one of the largest fiscal adjustments ever undertaken.  The current account deficit as a percentage of GDP has fallen by 15 percentage points. For the last two years the current account has effectively been in balance.  Labour cost competitiveness has been fully restored. Price competitiveness is almost back at its 2000 level and can be expected to continue to improve with the implementation of further product market reforms that raise competition in various sectors of the economy.  At the same time, sweeping structural reforms have been implemented covering the pension system, the health system, labour markets, product markets, the business environment, public administration, the tax system and the framework in which fiscal policy is conducted, while the privatization programme is on-going.  Recapitalisation and restructuring have taken place in the banking system, enabling it to withstand the crisis and the deterioration of banks’ asset quality. In addition, significant institutional reforms have been initiated aiming at reducing the volume of non-performing loans. SLIDE 2 On account of these developments, there is evidence that the economy has been undergoing a rebalancing towards tradable, export-oriented sectors. A few figures are indicative of the forces exerted.  The share of exports in GDP increased from 19% in 2009 to 32% in 2016 with most of the increase stemming from exports of goods. In fact, according to Eurostat data, Greece’s exports of goods have increased by 43% since 2009 in real terms, compared to 42% for the euro area and 47% for Germany, Europe’s export engine.  Between 2010 and 2015, the relative price of tradables versus non-tradables rose by about 10%. Whereas both sectors were hit hard by the recession, tradables performed better than non-tradables as outward-looking companies increased their exports, taking advantage of the improvement in competitiveness. As a result, the relative size of the tradables sector, measured by Gross Value Added, grew by approximately 12% in volume terms and by about 24% in nominal terms. Finally, in terms of employment, the size of the tradables sector increased relative to the non-tradables sector by around 8%. These figures would improve further if the reforms already implemented were enhanced by those planned under the ESM programme. Based on estimates of the OECD, full implementation of all reforms, both those undertaken and those scheduled, is expected to boost real GDP over a 10-year-horizon by about 13%. And this figure excludes further positive effects from structural reforms that cannot be easily quantified such as the modernisation of the public administration and the judiciary system, the strengthening of insolvency regulations and the resolution of non-performing loans. In-house work by the Bank of Greece provides similar estimates of the effects of structural reforms with the main effect coming from higher total factor productivity (TFP) growth. 2. Challenges remain In spite of these positive developments, considerable stock disequilibria remain:  Unemployment, though falling, remains very high (at about 23%); Job creation, although robust, is dominated by temporary and part-time jobs.  The general government debt to GDP ratio has risen to unsustainable levels (179% of GDP).  The private debt overhang hampers banks’ ability to support the recovery by granting new credit. In addition, despite the fact that structural competitiveness improved over the period 2013-2014 (according to a number of indices compiled by the OECD, the World Bank, and the World Economic Forum), Greece still ranks at the lower end of advanced economies, and progress has stalled or even retreated slightly in recent years. 3. Prospects for a sustainable comeback to financial markets SLIDE 3 In order to address the remaining challenges, to improve the future growth prospects of the Greek economy, and to ensure a comeback to financial markets in 2018, several conditions should be met. a. Implementation of 2nd review reforms First and foremost, following the closure of the second review, it is necessary that there is a smooth and timely implementation of the agreed growth enhancing reforms. Delayed closing of the second review increased uncertainty and reduced confidence which, coupled with the high tax burden, reversed the positive course of economic activity in 2016 Q4. As a consequence, following the mild recession in 2015, the economy stagnated in 2016. However, a positive medium-term outlook is still possible, conditional on a smooth implementation of agreed reforms. Consumption is expected to continue rebound, driven by robust employment, which is recovering faster than output, pointing to a job-rich recovery. Investment is projected to increase as confidence is restored and financial conditions improve. Exports are projected to benefit from the benign global economic outlook and past improvements in cost competitiveness. Finally, although the sizeable over-performance in 2016 is assessed to be mainly of a temporary nature, the 2017 target is expected to be met with a safe margin. Moreover, rebalancing the budget towards a more growth-friendly composition would support economic recovery. b. Implementation of further growth enhancing reforms to boost exports and attract FDI Second, further growth enhancing reforms are needed that will boost exports and attract FDI are needed. The economic adjustment and the structural improvements during the past six years made Greece more business friendly and have created significant investment opportunities. However, domestic savings are insufficient to meet the investment needs of the Greek economy that, after a long period of very low investment rates, are significant. Thus, besides restoring access of companies to capital markets, conditions should be encouraged to attract foreign capital, notably in the form of Foreign Direct Investment. In order to attract both domestic and foreign investment, further emphasis should be given to reforms that improve the business environment, enhance competition and reduce excessive regulation, protectionism, bureaucracy and complex legislation. For example, investment licensing procedures need to be simplified, the administrative burden on businesses reduced, the remaining regulated professions and network industries opened up, the public administration modernised and strengthened, judicial efficiency enhanced, court proceedings speeded up and of course personal and corporate taxation lowered. Additionally, a more effective use of the domestic high-skilled human capital (and the return of high-skilled scientists and executives who work abroad) requires the adoption of policies and reforms that encourage research, facilitate the diffusion of technology and boost entrepreneurship. Policies include providing incentives to increase investment in research and development (R&D), strengthening the links between enterprises and the academic/research community by allowing universities to commercially exploit research results and ideas, and effectively using available EU funds. Alongside structural reforms, and in order to facilitate the recovery through a normalization of financial conditions, as a matter of urgency the private debt overhang problem is addressed, since it is the greatest challenge the Greek banking system and the Greek economy faces. 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. According to research by the OECD, when more industry capital is sunk in non-viable (“zombie”) firms, the average viable firm undertakes less investment than otherwise. Simulations by the OECD suggest that reducing the share of capital of non-viable firms in Greece to the minimum across OECD countries would be associated with a gain in investment for a typical viable firm of 4.7%, improving productivity-enhancing capital reallocation in the Greek economy. A series of legislative and regulatory reforms have already been enacted as part of the strategy to reduce NPLs, such as the operational targets of individual banks, revisions of the insolvency law and the gradual setup of a secondary market for NPLs. In addition, a number of new measures have already been legislated as prior actions of the second review, such as the introduction of an out-of-court workout framework, the revision of corporate insolvency law and the launch of a platform for electronic auctions. Besides structural reforms and NPL management, growth prospects can also be improved by acting on the fiscal policy front in two ways:  First, a growth friendly fiscal policy mix can be adopted. The increased emphasis on taxation needs to be reduced in favour of policies that focus on restraining and restructuring non-productive spending and making more effective and efficient use of the public sector’s assets, especially land.  Second, the medium-term fiscal target can be reduced. According to estimates by the Bank of Greece, a lowering of the general government primary surplus target from 2021 onwards to 2 per cent of GDP, from the 3.5 per cent that is envisaged now, would be consistent with debt sustainability if combined with some mild debt relief measures and structural reforms to raise potential growth. The easing of the primary surplus targets, together with the implementation of the agreed structural reforms, would put the necessary conditions in place for a gradual lowering of tax rates, with positive multiplier effects on economic growth. c. Ensuring debt sustainability A final condition for return to financial markets is to ensure debt sustainability. The ratio of general government debt to GDP is still high. In 2008 that ratio stood at around 110%. It is now around 179%. The debt path has been strongly affected by the so-called snowball effect – that arises from interest rates on debt being much higher than growth. Indeed, from 2010 to 2016, the snowball effect is estimated at some 82% of GDP. But whatever the causes of its rise, it is crucial that it is put on a sustainable path. In the context of the above proposals in the area of fiscal policy making, the Bank of Greece recently made specific proposals to ensure the sustainability and manageability of public debt. The short-term measures decided at the Eurogroup meeting of December 5, 2016 are a positive step and are expected to reduce public debt as a ratio of GDP by 20 percentage points by 2060. However, to ensure the sustainability of public debt going forward, additional medium-term measures are necessary. When the debt-to-GDP ratio is above 100%, measures that reduce interest payments on debt can improve the ratio quicker than a rise in the primary balance. SLIDE 4 The interest burden of Greek public debt is low until 2021 but increases substantially thereafter because of payments of deferred interest on the EFSF loans and interest on new debt issued in financial markets. A simulation performed by the Bank of Greece defers interest on EFSF loans, extending their Weighted Average Maturity by 8.5 years – Option 1 in the right-hand diagram. SLIDE 5 If, in addition to interest deferment, we assume a primary surplus target of 3.5 percent in 2018-2020 and a reduction to 2 percent thereafter, we can see from the left-hand diagram that the debt path is close to that where a primary surplus of 3.5 per cent for 10 years is assumed. This exercise is indicative of how admittedly mild debt relief measures can have significant effects on the debt profile with no cost for the creditors. However, as the right-hand diagram shows, in terms of gross financing needs, option 1 makes debt sustainable at the margin. Hence, further debt relief measures are necessary in order to reduce gross financing needs significantly below the 20% threshold and bring debt to a sustainable path. Of course, were the interest smoothing accompanied by higher growth, as a consequence of lower primary surpluses, then the debt-to-GDP profile and gross financing needs would be more favourable. Alternatively, if interest rate smoothing were to occur and the costs shared equally between Greece and the ESM, this would also lead to more favourable outcomes. 4. Conclusions and final remarks The economic adjustment and the structural improvements during the past seven years have made Greece more business friendly, have created significant investment opportunities, and have generated positive prospects for the Greek economy. The realization of these positive prospects requires a consistent and determined implementation of the reform and privatization programme including tackling the private debt overhang problem. These enable the adoption of medium-term measures to ensure the sustainability of Greek public debt, which will pave the way for the inclusion of Greek government bonds in the ECB’s quantitative easing programme. Such developments will set in motion a virtuous circle leading to Greece’s return to international financial markets in 2018, the elimination of capital controls, the return to financial normality and the definite exit from the crisis. In order to capitalize on the macroeconomic and fiscal adjustment achieved so far, the institutions and our European partners must act now in a decisive and bold manner by specifying the medium-term debt relief measures for the sustainability of Greece’s public debt, which, as was agreed last year, will go into effect at the end of the current programme. This must be done because the markets on which Greece will need to borrow after the end of the programme in the summer of 2018 are demanding to know from now whether the debt will be sustainable or not. We are all aware of the fact that re-gaining access to financial markets after the end of the current programme is the only way forward. No one, neither the partners nor Greece, are in any mood for another memorandum. Sources: McGowan A. Andrews, M. D. and Millot V. 2017 “The walking dead: Zombie firms and productivity performance in OECD countries”. OECD Economics Department Working Papers No. 1372. Stournaras, Y. 2017 “Entrepreneurship, NPL Resolution Policies and Economic Growth Prospects in Greece” Speech at an event organized by Piraeus Bank in Athens, March 2017. http://www.bankofgreece.gr/Pages/en/Bank/News/Speeches/DispItem.aspx?It em_ID=424&List_ID=b2e9402e-db05-4166-9f09-e1b26a1c6f1b Stournaras, Y. 2017 “Greece and the euro area going forward” Speech at Delphi Economic Forum II, in Delphi 4 March 2017. http://www.bankofgreece.gr/Pages/en/Bank/News/Speeches/DispItem.aspx?It em_ID=416&List_ID=b2e9402e-db05-4166-9f09-e1b26a1c6f1b Stournaras, Y. 2017 “Macroeconomic developments and the contributions of investment, research and innovation of the pharmaceutical sector to the new growth model” Speech at an event organized by the Confederation of Pharmaceutical Companies in Athens, 15 March 2017. http://www.bankofgreece.gr/Pages/el/Bank/News/Speeches/DispItem.aspx?It em_ID=419&List_ID=b2e9402e-db05-4166-9f09-e1b26a1c6f1b Stournaras, Y. 2017 “Towards a new sustainable development model with a designation of origin” Speech at an event organized by the Hellenic Association of Industries of Branded Products in Athens, 22 February 2017. http://www.bankofgreece.gr/Pages/el/Bank/News/Speeches/DispItem.aspx?It em_ID=412&List_ID=b2e9402e-db05-4166-9f09-e1b26a1c6f1b

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Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the 23rd Annual Conference of the European Association of Environmental and Resource Economists (EAERE) Dinner, Athens, 30 June 2017.

Yannis Stournaras: Climate change - challenges, risks and opportunities Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the 23rd Annual Conference of the European Association of Environmental and Resource Economists (EAERE) Dinner, Athens, 30 June 2017. * * * It is a great pleasure for me to be with you today on this occasion and have the opportunity to share my thoughts on the environmental challenges that the world is facing. These challenges are now more important than ever before. In the World Economic Forum report1 for 2017, three out of the five top risks, in terms of impact, are environmental and all three of them relate to climate change2. Climate change and global warming are associated with human activities and in particular the use of fossil fuels and carbon dioxide emissions. The current and projected implications for the society and for sustainable development are such that we cannot continue with the «business as usual» scenario – we need to mitigate and drastically reduce emissions by adopting energy efficiency practices, financing "green" energy, promoting energy saving investments, using energy saving techniques, conducting energy management and finally by boosting low carbon circle economy. Yet, the character and severity of the impact from climate extremes depend not only on the extremes themselves, but also on exposure and vulnerability3. Therefore, apart from mitigating, we also need to manage risks and adapt to the changing climate. Traditional environmental problems have been dealt with only locally4. In the case of climate change, the “mother of all externalities”5, it is the emissions of all sources in all nations that determine the concentration of greenhouse gases in the atmosphere. Therefore, the problem is a public good one6 and solutions need to be universal. This provides motivation for collective global action, yet, as no independent action will solve the issue, this situation creates free-riding incentives and difficulties with the compliance to international climate agreements, as currently demonstrated by the Trump administration. As much of the impact of climate change fall on future generations, poverty, equity and justice are key issues for international climate change policy. Ethical issues are also raised as to how to allocate the remaining carbon budget7, how “the polluter pays” principle is implemented, and how to commit the current generation to sustain the environment for the future one. As my colleague, the Governor of the Bank of England, Mark Carney stated in his 2016 speech on the climate paradox “climate change is a tragedy of the horizon which imposes a cost on future generations that the current one has no direct incentive to fix” 8. In 2015 in Paris, countries committed themselves to cutting down carbon emissions and limit the rise in average global temperature9. The Paris Agreement that came into force in November 2016 brings nations into a common cause to undertake ambitious efforts to combat climate change and adapt to its effects, with enhanced support to developing countries. To date, 148 countries have ratified the agreement and although there are no legally binding targets, countries have agreed on a monitoring and reporting process that is binding and a 5-year reassessment of the collective progress10. Yet, research shows that more effort and commitment is required 11. There is a significant acceleration of climate action, however, current targets may not be enough to keep the temperature rise below the 2°C limit and the world needs timely revision of national contributions 1/4 BIS central bankers' speeches within a global framework of deep decarbonisation of national energy systems. There are definitely significant risks as well as opportunities along the way: Physical risks that arise from climate related events, and transition risks that arise from the decarbonisation process. In this process, companies might suffer costs, valuation losses and serious disruptions. But opportunities might also arise, related to the creation of new products of renewable energy and investment in energy saving and new infrastructure. Hence, in the transition to a low carbon economy, disclosure and transparency are very important. These will allow markets to lead the transition12, price the cost of doing business, price the risk that relates with climate change, as well as assess the value of new business opportunities. Working towards a solution to the problem of climate change, the work of environmental economists is of utmost importance. Environmental economics has had a major contribution towards understanding contemporary environmental and resource problems. Also, both theory and applied tools of environmental economics have been directing policies and informing decision-makers in addressing environmental challenges, such as the creation of markets for pollutants or the instruments for the conservation of ecosystem services. Yet, there is still a lot to be done and the work of environmental economists will provide valuable guidance along the way. It is this kind of guidance that we are also endorsing at the Bank of Greece, where we have set up an interdisciplinary committee of scientists to help us assess the impact of climate change and inform policy-makers. Since 2009, working alongside climatologists, physicists, biologists, engineers and social scientists, environmental and energy economists have assessed the impact of climate change for the Greek economy and studied the economic, social and environmental implications of climate change in Greece. This work highlighted the wealth of Greece’s natural resources but it mainly exhibited the risks to the country’s natural and human environment, as the impact of climate change on all sectors of the national economy was found to be adverse and, in certain cases, extremely adverse. In 2011, it was estimated that under a scenario of inaction regarding climate change, Greek GDP would drop by an annual 2% by 2050 and even more by 2100, while the total cumulative cost for the Greek economy over the period extending till 2100 would amount to €701 billion13 14. Successful international mitigation policy was estimated to reduce the cost of inaction by 40%, while adaptation policy, necessary as a damage control measure, would total €67 billion. However, the adaptation measures do not fully eliminate, but merely contain the damage from climate change. Thus, the cumulative cost for the Greek economy of the residual damage from climate change was estimated at €510 billion15 and as a result, the total cost for the Greek economy under the Adaptation Scenario is the sum of the cost incurred by the economy on account of the adaptation measures and the cost of the reduced damage from climate change; this sum was estimated at €577 billion16. According to a vulnerability assessment17 which attempted to quantify and rank the anticipated climate risks for the Greek territory, agriculture is the sector expected to be most severely affected by climate change in Greece, while the impact on tourism and coastal systems will have major consequences on household income and the economy as a whole. Of particular significance is also the water reserves sector, given its implications for agriculture and water supply. 2/4 BIS central bankers' speeches Our work to date has emphasized the need for a concrete adaptation policy that would cover all sectors and implemented in a timely manner so as to mitigate the likely adverse effects of climate change. It is for this reason that under a Memorandum of Cooperation signed with the Greek Ministry of Environment and Energy and the Academy of Athens, we have worked on Greece’s National Climate Change Adaptation Strategy and we are currently developing a proposal specifying its implementation. This Strategy sets out the general objectives, guiding principles and implementation tools of an effective and growth-oriented adaptation strategy in line with EU directives and international experience. Furthermore, it is the first step of a continuous and flexible process for planning and implementing the necessary adjustment measures at national, regional and local levels and aspires to leverage the capabilities of Greece’s public authorities, economy and society at large, with the ambition to address the impact of climate change in the coming years. Research so far confirms that there needs to be a robust strategy and an action framework in order to address current environmental challenges, climate change and sustainability as a whole. I believe that the work you are presenting these days in Athens has already shed some new light on these challenges and I would like to congratulate the European Association of Environmental and Resource Economists and the organizers for a successful conference. 1 reports.weforum.org/global-risks-2017/the-matrix-of-top-5-risks-from-2007-to-2017/ 2 Ibid, the three risks are extreme weather events (1), major natural disasters (2) and failure of climate change mitigation and adaptation 3 IPCC, 2012: Managing the Risks of Extreme Events and Disasters to Advance Climate Change Adaptation. A Special Report of Working Groups I and II of the Intergovernmental Panel on Climate Change (IPCC) 4 For example, the air pollution in a Chinese city had no direct impact on a European city. 5 Tol, R.S.J. (2009), The Economic Effects of Climate Change, in Journal of Economic Perspectives, Vol. 23, No 2, Spring 2009, pp. 29–51, www.ssc.wisc.edu/~walker/wp/wp-content/uploads/2012/09/Tol2009.pdf 6 IPCC Third Assessment Report: Climate Mitigation, www.ipcc.ch/ipccreports/tar/wg3/index.php?idp=383 Change, Working Group III: 7 IPCC (2007), Climate Change 2007: Working Group I: The Physical Science Basis, 7.3.2.2 Uptake of CO2 by Natural Reservoirs and Global Carbon Budget, www.ipcc.ch/publications_and_data/ar4/wg1/en/ch7s7-3-22.html 8 www.bankofengland.co.uk/publications/Documents/speeches/2016/speech923.pdf 9 The Paris Agreement at unfccc.int/files/essential_background/convention/application/pdf/english_paris_agreement.pdf available 10 unfccc.int/paris_agreement/items/9485.php 11 Spencer, T., Pierfederici, R. (2015), Beyond the numbers: Understanding the transformation induced by INDCs, Studies N°05/2015, Iddri – MILES Project Consortium, available at: www.iddri.org/Publications/Beyond-thenumbers-Understanding-the-transformation-induced-by-INDCs 12 “…financial disclosure is essential to a market-based solution to climate change. A properly functioning market will price in the risks associated with climate change and reward firms that mitigate them. As its impact becomes more commonplace and public policy responses more active, climate change has become a material risk that isn’t properly disclosed.” in Carney, M., Bloomberg, M., (2016), How to make a profit from defeating climate change, The Guardian, 14/12/2016, available a t www.theguardian.com/commentisfree/2016/dec/14/bloomberg-carney-profit-from-climate-change-rightinformation-investors-deliver-solutions 13 expressed as GDP loss relative to base year GDP, at constant prices of 2008 3/4 BIS central bankers' speeches 14 CCISC (2011), The environmental, economic and social impacts of climate change in Greece, Bank of Greece, p.454 available at www.bankofgreece.gr/BogEkdoseis/ClimateChange_FullReport_bm.pdf 15 at constant prices of 2008, over the period till 2100 16 total cumulative cost through 2100, at constant prices of 2008 17 the vulnerability assessment is presented on the CCISC (2015), National Climate Change Adaptation Strategy (NCCAS), Bank of Greece, pp. 9-13 at www.bankofgreece.gr/BogDocumentEn/National_Adaptation_Strategy_Excerpts.pdf 4/4 available BIS central bankers' speeches

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Introductory remarks by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at a meeting with members of the European Parliament's ECON Committee FAWG fact-finding mission (with an Appendix on the Greek economy), Athens, 27 June 2017.

John Iannis Mourmouras: Introductory remarks at a meeting with members of the European Parliament's ECON Committee Introductory remarks by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at a meeting with members of the European Parliament’s ECON Committee FAWG fact-finding mission (with an Appendix on the Greek economy), Athens, 27 June 2017. * * * 1. Introduction Mr. Vice President of the European Parliament, Mr. Chairman of the ECON Committee of the European Parliament, Distinguished members of the European Parliament, Advisors and other staff, Kalimera, Good morning to all of you, I, an unelected official, am very delighted today to welcome a group of elected representatives of the European Parliament, the guardian of democratic accountability and a major pillar of the European Union governance system. Gleaning the latest news for prime examples of the European Parliament’s influence and great contribution to current European affairs, the list is unlimited, I will name but a few such issues: from the successful abolition of roaming charges, to the Paris agreement, to Brexit, and even the latest developments in Turkey, I try to follow your actions as closely as I can, given my busy schedule. At a global level, leaving behind us the second worst global financial crisis of the last century and its significant fallout around the world (economic stagnation, high levels of unemployment, a widespread risk of deflation, etc.) and, sooner or later, all the relevant policy responses including fiscal austerity and unconventional monetary policies, the world is growing faster and a new global economic policy agenda is taking shape, determined, among others, by the UK’s decision to leave the European Union (Brexit), a differentiated policy framework in the US, the rebalancing of the Chinese economy, divergent monetary policies and a declining role of globalisation. Growth in the eurozone was more than twice faster in the first quarter of 2017 than in the US. Of course, we meet at a fortunate moment for my country. We now have a completion of the second review, perhaps not the best one, but I consider the completion of it very important, because it can stabilise expectations and can trigger, as I am going to explain in a minute, a positive narrative for my country and mark a real turnaround. Procedurally, I am going to offer a few introductory remarks, then perhaps the head of mission or the Vice President may like to say a word or two and then I am happy to answer your questions and have a productive discussion. Finally, we will take a group photo to send it to Governor Stournaras, who is away in Portugal for Bank commitments. I have three messages to you, ladies and gentlemen, two on the upside, one on the downside. Message#1: Getting Greece into ECB’s QE is a feasible scenario and there is still time to get the benefits of it, as I am going to explain in a minute. Message#2: The return to the markets is also within reach, subject to a number of qualifications, 1/4 BIS central bankers' speeches which I will refer to later on. This may imply the end of an era for Greece, the end of the Memorandums, as we know them today, but some sort of conditionality will be with us for many years ahead. And Message#3: I am going to wear my professorial hat for the third message and underline a long-run risk for the country which is coming from the brain drain and the depreciation of human capital and the huge disinvestment over the last 8 years that took place in this country, namely I worry about the long-run growth prospects for my country. 2. Greek economic and financial outlook 2.1 Some initial remarks Greece today is again at a crossroads, but this time may be different. Under some preconditions, which I will discuss later on, a case could be made for a strong turnaround of the economy. If the Greek authorities remain vigilant with no complacency (no delays, no back-tracking) and we ALL roll up our sleeves and stick to structural reforms and the privatisation agenda, and, on the other hand, our lenders, deliver on their promises about debt relief sooner rather than later, the ‘pacta sunt servanda’ principle that our President Pavlopoulos likes to remind all of us, should apply to both lenders and borrowers. Then, I’m quite optimistic that the return to European normality after the completion of the current programme in August next year is within reach. 2.2 Adjustment progress The Greek economy’s progress during the last eight years of adjustment has been unprecedented, both in terms of fiscal and external adjustment of more than 15 percentage points of GDP. The huge twin deficits turned into surpluses. Last year, the primary surplus was 4.2% of GDP, outperforming the target of 0.5%. The current account during the last two years had effectively been in balance from a 15% deficit eight years ago. At the same time, sweeping structural reforms have been implemented, covering the pensions system, the health system, labour markets, product markets, the business environment, public administration, etc. Recapitalisation and restructuring have taken place in the banking system and significant institutional reforms have been initiated aiming at reducing the volume of NPLs. Moreover, there is evidence that the economy has been undergoing a rebalancing towards tradable, export-oriented sector: the share of exports of goods and services in GDP increased from 19% in 2009 to 28.2% in 2016, with most of the increase coming from exports of goods. 2.3 Recent economic and financial developments See Appendix for an update on the macroeconomy and the banking sector. 3. BoG proposal - a mild debt relief exercise See Appendix for details. 4. Major pending issues Two quotes from the latest Eurogroup statement (15.06.2017): i) “The Eurogroup stands ready to implement, without prejudice to the final DSA, extensions of the weighted average maturities (WAM) and a further deferral of EFSF interest and amortization by between 0 and 15 years. As agreed in May 2016, these measures shall not lead to additional costs for other beneficiary Member States”. ii) “In view of the ending of the current programme in August 2018, the Eurogroup commits to 2/4 BIS central bankers' speeches provide support for Greece’s return to the market: the Eurogroup agrees that future disbursements should cater not only for the need to clear arrears, but also to further build up cash buffers to support investor's confidence and facilitate market access”. 4.1 Getting Greece into QE The person speaking before you was the first Greek economist to talk about the modalities and the benefits of getting Greece into ECB’s QE programme, in October 2015 talking to international investors in New York, and the programme – let me remind you that the QE programme started in March 2015. President Draghi, when asked about the eventuality of Greece’s participation in the ECB’s QE programme [on many occasions in fact, right after many Governing Council press conferences with Q&As, but also at his regular hearings before the European Parliament (his last hearing was on the 29th of May before your Committee), if I am not mistaken, he was also asked on this by Vice-President Papadimoulis], gave two preconditions: 1. The full completion of the second review and stick with the implementation of the programme, and 2. A DSA report by the ECB itself. Of course, the last precondition depends on the IMF’s role and report due on the 27th of July (next month) (rumours say that this will be delayed after the German elections in September). However, we have something in our hands: the last Eurogroup statement, which sets out a roadmap for this, not very much in detail, but it is a step forward compared with the decisions taken on 25 May 2016. I expect – sooner or later – perhaps sometime after the German elections, there is still time, that some sort of debt relief will be given to my country, along the lines of the Eurogroup statement of 15 June (“extension of maturities between 0 and 15 years”), here at the Bank of Greece, I just gave you the cut-off figure, 8.5 years according to our own DSA, which makes our debt sustainable and will be an enormous help for ECB President Draghi. In terms of timing, when could all this happen, given that the QE programme officially ends in December this year? The crucial parameter here is ‘tapering’, which means that for the first six months or perhaps more in 2018, the ECB will keep buying government bonds, but at a diminishing rate (from €60, to €50, to €40 billion, etc.) and during this period, it could – provided that the above preconditions are met – include GGBs. Why is it so important, you may say, to get Greece into QE? For one simple reason: because it is going to affect the cost of sovereign borrowing on capital markets. It is not so much the real demand issue, this is going to be around €3-4 billion, but it is the signalling effect that it is included in Draghi’s umbrella and the best evidence for what I am saying is the next figure (see page 18) that shows the powerful impact of signalling. [As you know,] the most powerful Roman after Julius Caesar and his three famous words “veni, vidi, vici” is President Draghi with his famous three words “whatever it takes” (to save the euro) announced in July 2012 in a speech in London, thereafter quantified with the announcement of the OMT programme in September of the same year, which resulted in a huge drop in Italian and Spanish yields as you can see from the following Figure (page 18). And you know how much money the ECB has spent for this?? 0€!! 4.2 Return to international capital markets There are two different issues here: one is a tentative return which may take place within this year, for instance, the recycling of the three-year bond issue of September 2014 or the reopening of the existing five-year bond issue which matures in 2019. For this, given the low interest rate environment and that Greece’s future is now firmly secured within the eurozone and there is so much liquidity out there and the recent upgrade in Greece’s ratings, this is something feasible, ladies and gentlemen. The government doesn’t need QE for this, probably, or the medium-term 3/4 BIS central bankers' speeches debt-relief measures. This is useful, as you understand. And the current financial outlook in our sovereign bond market is favourable – it compares to the outlook of 2014, when Greece for the first time returned tentatively to international capital markets (see Appendix). However, for a permanent return to the markets which would signal the end of an era for Greece, namely the end of adjustment programmes of this sort, and no need for a 4th Memorandum, which has various aspects and requires a number of small, steady positive steps, which might include a successful and timely completion of the third review, the full implementation of reforms and the privatisation agenda but, last but not least, as described in the last paragraph of the Eurogroup statement (15 June), which talks about the building up of cash buffers, or as it is also known a precautionary credit line, to facilitate market access during the first year after the end of the 3rd programme in August next year, to support investors’ confidence. This amount of money is there, will be given to Greece as part of the third and final review of the current programme, and of course, quite plausibly, it will come with some sort of conditionality; not perhaps a 4th Memorandum per se, not perhaps with any involvement of the IMF, it will be a first for the ESM, but we have every confidence as Europeans in Klaus Regling and his excellent team that they will do a brilliant job. Closing remarks In closing, I would like to stress that Greece belongs to the core of Europe. Its future is within the eurozone, within the group of solidary countries, to the people of whom we, the Greeks are grateful for their financial support. Despite all these years of uncertainty and austerity, this is the overwhelming wish of the majority of the Greek people still today, within the core of Europe. This is our legacy as a nation that goes back to our history and our tradition and, more recently, expressed by a visionary Greek politician, a great European statesman, who stood above political parties, Konstantinos Karamanlis, who showed the Greek people the way forward, the European way. I would now like to invite the Committee Chairman and head of this mission or the Vice President of the European Parliament to say a few words and then have a productive discussion with all of you on the Greek programme and beyond. Thank you very much. Appendix: The risks and prospects for the Greek Economy - June 2017 4/4 BIS central bankers' speeches

bank of greece

Speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the European Public Law Organization, Sounio, 30 August 2017.

John Iannis Mourmouras: The political economy of Europe's monetary union - an update Speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, at the European Public Law Organization, Sounio, 30 August 2017. * * * Introduction It is my great pleasure to be here with you today at the EPLO Academy, near Cape Sounion, where the famous ancient Temple of Poseidon, the god of the sea, rests (built in the 5th century BC). I am grateful to the President of EPLO Professor Spyridon Flogaitis for his kind invitation to deliver this inaugural lecture. It seems that Poseidon is in no good mood today, it’s quite windy in Sounio! My speech today will be structured in three sections: I will firstly talk about the political economy of the European Union, giving a more detailed picture of the EU’s political, institutional and economic landscape, as it has been shaped so far. In the second section, I intend to take a brief look into the EU’s major policies including monetary policy, with particular reference to the role of the ECB and the debate on an exit strategy from the ECB’s ongoing accommodative policies. Finally, I will offer some brief remarks about Greece’s place in the eurozone in the post-MoU era. As most of the participants in the EPLO’s Academy are of purely legal background, it is my intention to keep to the legal and institutional aspects of the topics of my speech and spare you the economic and financial ins and outs of the EU’s economic policies, which, as you may imagine, abound in technical complexity. 1. The political economy of the European Union 1.1 Incomplete architecture – institutional The euro area is emerging from a deep crisis that has challenged the ability of its macroeconomic policy framework to deliver stability and prosperity. The setup of the Economic and Monetary Union, as initially conceived and laid down in the 1997 Maastricht Treaty, has proven unsustainable and unstable. The global financial crisis which began 10 years ago and led to the European Union’s worst recession in its six-decade history, did not start in Europe, but EU institutions and Member States had to take unprecedented action to counter its impact and address the shortcomings of the original design of the Economic and Monetary Union. Important lessons have been drawn as a result of the crisis, with new legislation, policy instruments and institutions put in place to strengthen the governance of the euro area, as we will examine in more detail in the following sections of my speech. As robust as it may be today, the EMU remains incomplete. The “monetary” component of the EMU is successfully developed, as illustrated by the role of the European Central Bank (ECB). However, the “economic” component is still lagging behind, with less integration at EU level hampering its ability to support fully the euro area’s single monetary policy, but also national economic policies. There is a need to strengthen the political will across the board, among Member States, between Member States and EU institutions, and restore the confidence of the general public. There should be no complacency about the need to strengthen EMU architecture. 1 / 17 BIS central bankers' speeches 1.2 Union in diversity First and foremost, we need to remind ourselves that the political economy of the EU concerns a Union of 28 Member Stateswith different economic histories, diverse financial systems, credit and regulatory philosophies. Yet, the integration of financial markets and their corresponding regulation have been considered central to achieving a European single market since at least the 1980s. In this context, the governance of EU financial services has gradually moved from the national to the European level under the complementary dynamic of the effective internationalisation of capital. As banking and finance progressively internationalised, EU member state governments have had to open up to pan-European initiatives; otherwise, it was feared that European economies would become increasingly marginalised in global capital markets. Another force that pushed towards European financial integration is a recurrent theme in the history of the EU: crisis-driven regulatory responses, i.e. when Member State governments and economic actors look to Europe for solutions to comparative problems affecting them all. Under extraordinary circumstances such as the recent crisis that the EU experienced, the supranational regulation of financial services represents the best solution to deal with the challenges posed by the internationalisation of capital. Allow me here to make a small digression to remind you how important European law, and the contribution of legal experts such as yourselves, is for further integration in the creation of new law based on the two cornerstones of EU action. Indeed, any integratory step towards a fiscal and economic union must take heed of the subsidiarity and proportionality principles, which regulate the exercise of powers by EU. More specifically, in areas in which the European Union does not have exclusive competence, the principle of subsidiarity, as laid down in Article 5.3 TEU, defines the circumstances in which it is preferable for action to be taken by the Union, rather than the Member States. The criteria for applying those two principles are set out in Protocol No 2 on the application of the principles of subsidiarity and proportionality annexed to the Treaties. Article 5.3 of the Treaty on European Union (TEU) “The Union shall act only if and in so far as the objectives of the proposed action cannot be sufficiently achieved by the Member States, either at central level or at regional and local level, but can rather, by reason of the scale or effects of the proposed action, be better achieved at Union level.” Like the principle of subsidiarity, the principle of proportionality seeks to set actions taken by EU institutions within specified bounds. Under this rule, the action of the EU must be limited to what 2 / 17 BIS central bankers' speeches is necessary to achieve the objectives of the Treaties. Article 5(4) of the Treaty on European Union (TEU) “Under the principle of proportionality, the content and form of Union action shall not exceed what is necessary to achieve the objectives of the Treaties.” 1.3 Unemployment – growth In what follows I will give you very briefly some figures and charts about the current macroeconomic conditions in the euro area, more specifically about growth, investment and unemployment in the euro area. Today, the EU economy is expanding for the fifth consecutive year. Employment is getting close to its pre-crisis peak, as more than 5 million jobs have been created since early 2013 in the euro area. Banks are now stronger and better capitalised, investment is picking up, and public finances are in better shape. Eurozone growth reached an annualized pace of 2.1% in the last quarter, its best level in 5 years, which is considered high by recent standards. 3 / 17 BIS central bankers' speeches The unemployment rate has been slowly reduced and now stands at its lowest level since 2009 (at around 9% in the eurozone), compared with 12% after the region’s debt crisis (see Figures 4 and 5). 4 / 17 BIS central bankers' speeches 5 / 17 BIS central bankers' speeches It is true that the protracted economic downturn and divergences between euro area countries have been the result of pre-crisis imbalances and shortcomings in the way the EMU responded to major shocks. The diverging experiences of the Member States after the crisis have renewed the focus on achieving convergence across the EU. Convergence may indeed be important for the cohesion of the monetary union, as it helps to ensure that the gains from economic integration are shared. Countries such as Germany are now well above their pre-crisis GDP levels, but for other countries such as Italy, GDP is only expected to return to its pre-crisis level in the mid-2020s (last quarter GDP 1.5% on a yearly basis). While recent economic developments are indeed encouraging, a lot remains to be done to overcome the legacy of the crisis years. The euro area is finally witnessing a decent economic recovery, but it would be wrong to be complacent. The single currency remains vulnerable in its institutional architecture, and faces many unresolved problems at the national level. A lack of productivity catch-up – lower productivity growth in countries with lower initial per capita income and productivity – explains much of the lack of income convergence within the euro area. Countries with lower initial productivity levels can have larger productivity gains from labour and product market reforms than countries with higher initial productivity. In light of the above, structural reforms are critical to reducing productivity gaps to foster real income convergence. 6 / 17 BIS central bankers' speeches All in all, the current situation is much improved, but economic reforms in the goods, capital and labour markets which remove barriers to competition and increase market flexibility are essential for the smooth functioning of the Economic and Monetary Union (EMU). Such reforms are key to raising productivity and employment in the euro area, thereby supporting the growth potential of the euro area in the long run. What is also needed is investment in talent and human resources, on which the European Union is currently lagging behind its major competitors. 1.4 The political landscape: where is Europe headed? Unlike earlier in the year, when the prospect of a populist far-right turn of the French electorate in the presidential elections in May was a serious cause for concern, political instability is no longer at the top of the agenda for the Member States of the EU. Global markets have been nervous lately, but the source of their worries this time isn’t in the eurozone. Instead, political uncertainty has risen around the US, as the White House under President Trump is in turmoil. The UK, meanwhile, is struggling after the 2016 upset vote of the British people to leave the European Union to address the political and economic challenges of Brexit. From an economic point of view, such uncertainty tends to support the euro against the dollar and the sterling pound. From a political point of view, the centre electorate seems to have been unsettled by what is happening in the UK and US and has been frightened off the extremist-populist parties. There are of course seminal elections ahead in the European continent, in Germany, Europe’s biggest economy and the eurozone’s dominant power, in September. The likelihood that no major political upsets will come from Germany in September is indeed among a number of forces combining to generate fresh optimism for the European project, which has seen quite a few lows in the past few years. Of course, the German electoral result will influence everything from European relations with the US, China, Russia and Turkey and, certainly, the future course of the European Union and, in particular, the success of French President Emmanuel Macron’s initiative to reboot the eurozone through his proposals for a common budget and finance minister for the region. Macron is openly pro-European and keen to bolster support for the EU – reinforcing the idea that the bloc can help its citizens secure a better life – as a key part of his strategy to counter populism and Euroscepticism. Support for the EU, battered by long crises over debt and migration, has begun 7 / 17 BIS central bankers' speeches to recover. The EU’s own latest Eurobarometer report on public opinion, published this month, found that trust in the EU has risen to 42%, from 36% a year ago and 32% in late 2015 (see Figure 7). 8 / 17 BIS central bankers' speeches Outside the UK, dissatisfaction with the EU doesn’t translate into support for leaving. This is not to say that European citizens suddenly disregard the EU’s dysfunctional nature and efficiency problems. A survey of 10 EU countries published in June by the Pew Research Center found that Europeans remain critical of the bloc. A median of 46% disapproved of the EU’s handling of its long economic crisis, while 66% disapproved of its management of the refugee crisis. Any talk of Frexit, Dexit (and so on) is now definitely off the cards. Although support for the euro area is now higher, it is highest in countries with high income levels. Indeed, countries that have experienced high growth since the introduction of the single currency are more likely to have seen an increase in citizen support for the euro. Brexit will certainly bring a major upheaval in the EU’s economy, which cannot as yet be predicted. Improving economic growth in much of Europe, especially in the 19-country euro currency zone, has helped blunt some of the discontent of European citizens with the European Union, creating a unique opportunity to take action to make the institutional changes that are required if the EU wants to prosper. Improved opinion of the EU coincides with renewed economic confidence in most of the European countries surveyed. In recent years, many Europeans have been dispirited about economic conditions in their country. Now, as the economy in a number of nations has begun to recover, the public mood is brightening. There is now positive momentum for the EU and its Member States. The Franco-German axis is once again set to enter into operation and push ahead with reforms that will help the EU stand on its own two feet or “take [its] destiny into [its] own hands”, as Angela Merkel recently put it. After the Brexit decision, France and Germany seem to agree that a medium-term roadmap for deepening the EU, and eurozone governance in particular, is needed. French President Macron has proposed a “new deal” to help address Europe’s economic dilemmas to entice Germany and other northern eurozone countries to allow the currency bloc to pool financial resources to shield members from future crises. (Of course, President Macron first has to go through necessary labour reforms in his own country). Northern EU countries —which have long called for structural overhauls in France—may be unwilling to sign on to his proposals for the currency area, including increased spending by Germany and other wealthy economies and a shared crisis budget. Democratic accountability The EMU setup and the operation of the euro area has thus far been characterised by low democratic accountability, as it is based on “output legitimacy”, that is, legitimacy that depends on a system’s capacity to achieve the citizen’s goals and solve their problems effectively and efficiently. The higher its capacity, the more legitimate the system. Its operation prioritises results and output effectiveness over an input-oriented democratic decisionmaking (legitimacy derived from the way in which decisions are made and not by the results of these decisions produce) architecture that might be less effective. One of the lessons drawn from the crisis is that there is a need for more transparency to bolster support for the European integration project on behalf of the citizens. Europeans reacted to all the opaque decision-making made at the height of the crisis by unelected officials and technocrats away from the democratic center by massively and repeatedly turning to populist, anti-European parties. Accountability in EMU governance can indeed be improved through more transparency, but in order to fully address the existing shortcomings of EMU governance and thus set the conditions for the European economy to work, a political union and European federal-type institutions are needed. At the moment, there is little appetite on the part of member states for relinquishing their national sovereignty in fiscal matters and transfer it to the EU level, which would require a major institutional change in the European Union. So far, the European Commission’s proposed short9 / 17 BIS central bankers' speeches term measures to improve the democratic accountability of EMU are: setting up a strengthened and more formalised dialogue with the European Parliament, a proposal to integrate the fiscal compact into the EU legal framework and progress towards a stronger external representation of the euro area. Over the long term, steps towards ensuring the democratic accountability of EMU governance and decision-making could include: a full-time permanent chair of the Eurogroup, the Eurogroup established as an official council configuration, a fully unified external representation of the Euro area, the setting up of a euro area Treasury and a common finance minister (i.e. a common fiscal capacity), the setting up of a European Monetary Fund and the integration of remaining intergovernmental arrangements in the EU. Apart from the proposed agenda by French President Macron, who has argued that without institutional change, the euro could fail within 10 years, reform proposals have also been put forward by the European Commission in its White Paper on the Future of Europe under President Juncker. As there is still no political support for a fully federalised European Union, the European Commission’s five alternative scenarios reflect the current realistic choices that stand before the European Union. The table below shows the five alternative scenarios proposed by the European Commission in this White Paper, which focus on differentiated degrees of “deepening” cooperation. It should be pointed out that the “Those Who Want More Do More” scenario formally recognises for the first time the model of differentiated/multi-speed integration (already endorsed by the leaders of the four biggest Member States, i.e. Germany, France, Spain and Italy), an idea dating back to German Chancellor Willy Brandt in 1974. This White Paper reflects a significant shift in the European integration debate, since a “Europe at many speeds” had been mainly advanced by intergovernmentalist forces, but stumbled on the adamant opposition of pro-Europeans (federalists), in favour of centralised/supranational EU governance. 10 / 17 BIS central bankers' speeches Further progress on European integration issues will of course be slow ahead of the German elections on 24 September that will be decisive in many ways for the future path that the European Union, but the question is now all about whether EU affairs will take a turn for the better thereafter. In any event, the European Commission is set to present its first set of conclusions on the roadmap for the future of the EU at the December 2017 European Council. As should be expected from the European Union, there will not be any radical changes overnight, but rather a process ofincremental change to improve the political economy and governance of 11 / 17 BIS central bankers' speeches the EU and the eurozone. In my view, this is the best chance to restore faith in the European integration project and show that it is capable of protecting its citizens. 2. Towards a complete economic and monetary union/ an update of economic policies Future steps towards the completion of the EMU have been laid down in the well-known “Five Presidents’ report”, divided into two stages (short-term and long-term steps), as shown in the table below. 2.1 Monetary policy: towards an exit strategy According to Article 127 of the Treaty on the Functioning of the European Union (TFEU), the primary objective of the European System of Central Banks (Eurosystem) is “to maintain price stability. Without prejudice to the objective of price stability, the ESCB supports the general economic policies of the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 of the Treaty on European Union”. This wording suggests that the Treaty assigns overriding importance to price stability, as the most significant contribution that monetary policy can make to achieve the objectives of the European Union, i.e. favourable economic environment and high level of employment. Under the extraordinary circumstances of the crisis, the ECB went beyond its “price stability” mandate and already since 2008 used unconventional monetary policy tools such as large liquidity injections and the securities markets program to ensure that debt markets remain functional. Faced with the EU’s worst recession in its six-decade history, the ECB needed to act resolutely to counter its impact and address the shortcomings of the initial setup of the economic 12 / 17 BIS central bankers' speeches and monetary union. In 2012, ECB President Draghi pledged to do “whatever it takes to preserve the euro” and announced the Outright Monetary Transactions (OMTs) programme to allow the ECB to buy sovereign bonds of euro area countries. Apart from OMTs, the ECB launched a quantitative easing (QE) programme in 2015 (asset purchases of public sector bonds), which was expanded to asset purchases of corporate sector bonds in 2016 (now worth €2 trillion). We are now entering a debate on how to orchestrate the exit from the ECB’s QE, in terms of its timing and its sequencing. Against this background, last month’s ruling by the German constitutional court to refer to the European Court of Justice (ECJ) the case with regard to the ECB’s €2 trillion quantitative easing programme is of seminal importance. The action perpetuates legal ambiguity for at least another year – even though the ECJ is expected to decide in the ECB’s favour. Clearly at some point in time, sooner or later, there will be an end to these unconventional monetary policies. The crucial question will revolve then around timing and sequencing, namely ‘when these policies will end’ and ‘if tapering should come first and then be followed by a rate hike’ or the reverse. On the other hand, a premature normalisation of monetary policy (just like in 2008 and 2011), either in terms of interest rate hikes or in terms of proper tapering or according to the ECB’s preferred wording “orderly adjustment”, entails the following two risks: the first is the risk of a relapse, namely the ECB shouldn’t abruptly stop loose monetary policy as a result, for instance, of a temporary inflation spike and not supported by the economic fundamentals. The second risk is the risk of financial instability, once interest rates start to rise. 2.2 Fiscal Policy The idea of a Fiscal Union has gained new impetus and is again on the table and there seems to be a future towards integrated fiscal policies in the eurozone. It is true that integration within the eurozone has somewhat stalled since the creation of a Banking Union in 2014 (which I will analyse in the following section). However, the relevant debate has been given new impetus by the election in France of Emmanuel Macron, who has publicly advocated a common eurozone budget and a Finance Minister. Encouraging signs have been coming from the German side as well, as there is likely to be indeed readiness of the newly elected German government to push forward the European integration process. However, Germany has been accused of seeing fiscal union as a vehicle to achieve more austerity in the eurozone! It has in fact been argued that Germany has ‘no alternative’ to a revival of the Franco-German axis to reboot EMU governance and that is why it has put forward proposals for advancing European integration of its own, such as the proposal for transforming the European Stability Mechanism into a European Monetary Fund, as it builds expertise and takes on a continuous fiscal surveillance of Member States. This would understandably suit the German agenda which has long criticised the more lenient supervision of eurozone countries’ compliance with fiscal discipline rules (under the revised Stability and Growth Pact). The latest on the field of common fiscal policy in the eurozone is a proposal from the European Commission called European safe bond. The point is the following: investors can buy government debt into the euro area as a whole, rather than into one particular member state. This is different from a pooling of national government debt issuance, known as common Eurobond, which remains a political taboo in Germany. Sovereign debt across the eurozone could be bundled into a new financial instrument (ESB) and sold, if you like as a European brand, to investors. Such an idea could have potential benefits to many stakeholders, including the ECB. As you know, the ECB is a major buyer in the secondary market of the europeriphery. Issuing bonds backed by all 19 eurozone countries would be the best way to keep borrowing costs down if the ECB were to taper or indeed to end its QE programme at some point in time. Moreover, the ECB itself may want to replace national government bonds in its own balance sheet with European safe bonds. 13 / 17 BIS central bankers' speeches 2.3 Banking Union The crisis paved the way for a major paradigm change in the regulation of banks, i.e. the introduction of common prudential rules to create a level playing field for all the financial institutions of the EU (some 8,300 banks across the EU), also known as the Single Rulebook, comprising secondary law (Directives, Regulations, Decisions), regulatory and implementing technical standards drafted by the European Supervisory Authorities (ESAs) and soft-law rules such as guidelines and recommendations. The Single Rulebook applies to all 28 EU member states and marks a shift from the previously predominant regulatory philosophy of minimum harmonization of national rules and the provision of a European passport based on mutual recognition across the EU to maximum harmonization. Three of the most important single-rulebook pieces are directly related to banking. These are the Capital Requirements Directive IV (CRD IV) and the Capital Requirements Regulation (CRR), the Bank Recovery and Resolution Directive (BRRD) and the Deposit Guarantee Scheme Directive (DGSD), which lay down capital requirements for banks and create regulation to the prevention and management bank failures, including a minimum level of protection for depositors. To this end, along with the major regulatory change in the banking sector, there was swift progress towards institutional change with the creation of the Banking Union (BU): pan-European centralised bodies for the supervision and resolution of banks, indispensable to ensure financial stability in the euro area. The creation of the Banking Union comprises three pillars based on the single rulebook as the foundation (see Figure 10 below): a Single Supervisory Mechanism (SSM), a Single Resolution Mechanism (comprising a Single Resolution Board and a Single Resolution Fund) and a common deposit insurance scheme (yet to be approved). 14 / 17 BIS central bankers' speeches Under the first pillar, the Single Supervisory Mechanism (SSM) was established without treaty change. By unanimous vote the Council decided to confer “specific tasks concerning policies relating to the prudential supervision of credit institutions” on the European Central Bank, in accordance with Article 127(6) of the Treaty on the Functioning of the European Union (TFEU). But a treaty change in the future should not be ruled out. The European Central Bank now directly supervises 123 systemically significant banks and, at the same time, national supervisors work closely together within an pan-European supervisory system to supervise the so-called “less significant institutions” (around 5,500) in the 19 Member States of the euro area. A Single Resolution Mechanism (SRM) is the necessary complement of the first pillar. The rationale behind it is to avoid the risk of bank bail-outs by national governments, and for the private sector to bear the cost rather than the taxpayer. In the case of failing banks, the Single Resolution Board may decide on resolution, to be covered by funds drawn from a Single Resolution Fund (€55 billion by 2023) that banks themselves pay into. Any residual fiscal burden on sovereigns should be contained through a federal fiscal backstop. The missing link from the Banking Union structure is its third pillar. The Commission’s 2015 proposal for a European Deposit Insurance Scheme (EDIS) builds on the existing framework under the Deposit Guarantee Scheme Directive (2014/49/EU) which provides for a more uniform degree of deposit guarantee for all retail depositors. 2.4 Capital markets union Since 2015, the European Commission’s new flagship project is the creation of a Capital Markets Union to build a single integrated capital market for all 28 Member States. The Capital Markets Union (CMU) is a plan of the European Commission consisting of a mix of regulatory and nonregulatory reforms (33 measures in total), aiming to better connect savings to investments based on a single rulebook that will create a level-playing field for the provision of investment services and offer private firms the possibility to raise capital through issuance of equity and debt anywhere in the EU. I should remind you that the European economy has been traditionally bank-based. It is indicative 15 / 17 BIS central bankers' speeches that 70% of capital raised in the EU comes from the banking system, compared with just 20% in the US. So, the idea is to provide alternative sources of financing and more opportunities for consumers and institutional investors. For companies, especially SMEs and start-ups, the CMU means accessing more funding opportunities, such as venture capital and crowdfunding. The CMU also puts a strong focus on sustainable and green financing: as the financial sector begins to help sustainability-conscious investors to choose suitable projects and companies, the Commission is determined to lead global work on supporting these developments. A well-functioning, diversified and deeply integrated capital market is of key relevance for the European Central Bank for three reasons: first of all, the integration of capital markets facilitates the transmission of single monetary policy in the euro area, secondly it contributes to macroeconomic and financial stability and thirdly, it supports risk-sharing in the private sector across the EU. 3. Greece in the eurozone in the post-MoU era Finally, turning to my country Greece, this is a fortunate moment in the following sense. Greece today is again at a crossroads, but this time may be different. Under some preconditions, a case could be made for a strong turnaround of the economy. If the Greek authorities remain vigilant with no complacency (no delays, no back-tracking) and we ALL roll up our sleeves and stick to structural reforms and the privatisation agenda, and, on the other hand, our lenders, deliver on their promises about debt relief sooner rather than later, i.e pacta sunt servanda principal should apply to both lenders and borrowers, then, I’m quite optimistic that the return to European normality after the completion of the current programme in August next year is within reach. The Greek economy’s progress during the last eight years of adjustment has been unprecedented, both in terms of fiscal and external adjustment of more than 15 percentage points of GDP. The huge twin deficits turned into surpluses. Last year, the primary surplus was 4.2% of GDP, outperforming the target of 0.5%. The current account during the last two years had effectively been in balance from a 15% deficit eight years ago. At the same time, sweeping structural reforms have been implemented, covering the pensions system, the health system, labour markets, product markets, the business environment, public administration, etc. Recapitalisation and restructuring have taken place in the banking system and significant institutional reforms have been initiated aiming at reducing the volume of NPLs. Moreover, there is evidence that the economy has been undergoing a rebalancing towards tradable, export-oriented sector: the share of exports of goods and services in GDP increased from 19% in 2009 to 28.2% in 2016, with most of the increase coming from exports of goods. 16 / 17 BIS central bankers' speeches In closing, I would like to stress that Greece belongs to the core of Europe. Its future is within the eurozone, within the group of solidary countries, to the people of whom we, the Greeks are grateful for their financial support. Despite all these years of uncertainty and austerity, this is the overwhelming wish of the majority of the Greek people still today, within the core of Europe. This is our legacy as a nation that goes back to our history and our tradition and, more recently, expressed by a visionary Greek politician, a great European statesman, who stood above political parties, late President Konstantinos Karamanlis, who showed the Greek people the way forward, the European way. Concluding remarks The sovereign debt crisis in the Eurozone revealed how vulnerable the euro area’s economic and monetary framework was to external shocks, especially taking into account the constraints of no bail-out and no debt restructuring. The euro area was not equipped to tackle large crises and did not have the safety nets and institutions to respond promptly to the severe challenges that such crises entail. So it had to buy time and resort to quick fixes that would bring it back on a more table footing. The response to the crisis focused on the need to strengthen the fiscal rules, to prevent macro-imbalances and reinforce economic policy coordination and surveillance between Member States. Furthermore, there is an imperative need to deepen euro area economic governance (i.e. complete the Economic and Monetary Union) in order to strengthen the convergence of economic performances of Member States and reduce the degree to which financial fragmentation spreads in times of crisis. It is worrying somehow Europe’s declining international standing over the last twenty years. Today, Europe is no longer the world’s largest economy, it has been overtaken by China and, by 2025, the IMF predicts that China’s share will reach 16.5%, while the EU’s share will be almost halved. In the area of security and defence, the EU’s international role is also diminishing and it seems that Europe’s greatest and most sustainable source of political power is of the soft kind. But of course, Europe’s geostrategic outlook is essential in shaping the global order. Specifically with regard to global security, Europe must rise to the occasion and help address the modernday challenges of instability and turbulence in Islamic countries. In terms of world trade, as an open market economy, the EU has been a major player in efforts to bolster multilateralism and trade cooperation in the global system. It is worth mentioning the effort to promote global trade (for instance, by means of the TTIP). Over its long history, the EC/EU has traditionally managed to find consensus on the burning issues facing it. In the current juncture, and under the spectre of a ―previously inconceivable―exit of a Member State, the EU needs to smooth over disputes between Member States and establish mechanisms to address heightened uncertainty and unpredictable political developments, and also find solutions to ensure an evenly distributed economic recovery across its territory. There is an old saying in Brussels that the European project only advances in times of crisis, and Europe’s leaders are known to have a tried and- tested method for coming up with policy fixes when forced to cope with emergency situations. I only hope that this time is not different. As they say: “Times will tell”. Thank you very much for your attention. 17 / 17 BIS central bankers' speeches

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Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at an event organized by the British Hellenic Chamber of Commerce, Athens, 28 September 2017.

Yannis Stournaras: The Greek economy - challenges and prospects Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at an event organized by the British Hellenic Chamber of Commerce, Athens, 28 September 2017. * * * I am very pleased to be with you tonight. Let me share some thoughts about the developments, the risks, the challenges and the prospects of the Greek economy. 1. Greece and the United Kingdom are historically linked by close bonds of friendship and cooperation Greece and the United Kingdom (UK) are historically linked by close bonds of friendship and cooperation. These bonds are reflected in trade and in the increased weight of tourist flows from the UK in travel receipts. By way of illustration, in 2016 tourism receipts from the UK amounted to about €2 billion, while the respective tourist arrivals reached 2.9 million. The UK has a share of 15% in total receipts and 12% in total arrivals. Our trade balance versus the UK remains in deficit, but has improved significantly since 2009. This is due both to a rise in exports and a decline in imports. Specifically, exports of goods to the UK increased in nominal terms by about 47% during the 2010–2016 period, accounting for approximately 4% of total Greek exports. On the other hand, imports decreased in nominal terms by 31% over the same period, accounting for roughly 3% of total Greek imports. The long-standing ties with the UK are also reflected in the strong presence of Greek students and academics at UK universities and in general of Greeks working in UK firms, as well as in the notable presence of the Greek shipping community in London and, respectively, the large number of British nationals who live here, often having purchased holiday homes in our country. Among other Greeks, both my wife Lina and I completed our post-graduate studies in the UK and embarked on our professional and academic careers there. Against the background of the historical and multi-faceted links between our countries, we hope that Brexit negotiations with the European Union will lead to an agreement acceptable to both sides. Our wish is that the future relationship of the UK with the EU remains close. This will safeguard the interests of both EU citizens in the UK and British citizens in the EU, while at the same time the mutually beneficial trade ties which promote economic growth and prosperity in both economic areas will continue. The recent speech by Prime Minister May in Florence gave hope for an acceptable agreement, but it is only a first step. 2. The Greek economy on a growth track The Greek economy is currently on a growth track. This was made possible thanks to the completion of the second review and its positive effect mainly on confidence and liquidity. The fact that the economy’s growth dynamics has gained traction is primarily reflected in the positive path of GDP as well as in the improvement of short-term indicators: Real GDP grew y-o-y by 0.4% in the first quarter and by 0.8% in the second quarter of 2017. Overall, in the first half of 2017 real GDP increased by 0.6%, year-on-year. Real GDP growth in the second quarter was mainly driven by an increase of 9.5% y-o-y in exports of goods and services, as well as by a rise in public (3.3%) and private consumption (0.7%), whereas gross fixed capital formation had a negative contribution, largely on account of delays in Public Investment Programme disbursements. Industrial production increased y-o-y by 1.7% in July 2017 for the tenth consecutive month. Overall, between January and July 2017 industrial production increased by 5.3% relative to 1/6 BIS central bankers' speeches the corresponding period of 2016. The volume of retail sales in the first half of 2017 rose by 2.4%, year-on-year. The positive momentum of the economy is also mirrored in the labour market, which has been showing signs of improvement since mid-2014, on the back of structural reforms which allowed for a shift towards more flexible forms of employment. In more detail, employment rose y-o-y by 2.4% in the second quarter of the year, while the unemployment rate stood at 21.2% in June 2017, down from 23.5% one year earlier. The improved economic outlook and the completion of the second review contributed to a decline in Greek government bond yields to their end-2009 levels, thereby facilitating Greece’s return to international markets on 25 July. At the same time, the yields of corporate bonds issued by the non-financial sector declined considerably as well. Furthermore, Fitch upgraded Greece’s credit rating, citing sustained recovery and reduced political risk. Other key developments that should be pointed out are: the successive reductions in the emergency liquidity assistance (ELA) ceiling for Greek banks, the increase in deposits, the attainment of the operational targets set so far for banks to reduce the stock of their NPEs, and the rise in a number of leading indicators of economic activity and confidence. On 20 September the ELA ceiling for Greek banks stood at €33.6 billion, compared with €50.7 billion at end-2016 and €90 billion in June 2015. Deposits by the non-financial private sector increased by €1.4 billion to €119.4 billion in August 2017. In particular, from end-May 2016, when the first review of the programme was completed, until August 2017, deposits by non-financial corporations and households increased by 5.3% or €7.3 billion, while total deposits gained about €11 billion. The economic sentiment indicator rose to 100.6 in September, from 99.0 in August, also amid strong consumer confidence, which recorded a two-year peak. The manufacturing PMI suggests expansion for the third month in a row, and came to 52.2 in August, from 50.5 in July, reaching its highest level since August 2008. In the same vein, since the beginning of this year there has been progress with the issue of banks’ problem loans. More specifically, on the basis of June 2017 data, the stock of nonperforming exposures (NPEs), including off-balance sheet items, decreased by 3.2%, compared with end-December 2016, coming to €102.9 billion or 44.9% of total exposures. The NPE reduction was mainly driven by extensive loan write-offs and to a much lesser extent by collections, liquidations and sales of loans. Loan write-offs amounted to €3.3 billion in the first half of 2017. Lastly, significant headway has also been achieved in the area of reforms despite several delays. According to a recent report by the Lisbon Council (EuroPlus Monitor, September 2017 Update), Greece continues to rank first in the EU-28 in terms of the Adjustment Progress Indicator. Greece’s high score in this area is mainly attributable to its adjustment efforts in 2010–2013, but also to the fact that since mid-2015 there has been a reversal in the negative course that had started in late 2014 and peaked in summer 2015 amid heightened uncertainty and strong confrontation with the institutions, thereby weakening the country’s position. 3. Positive prospects for 2017–2019 In the light of the data I mentioned briefly, it is now safe to predict that economic activity will continue to pick up at a stronger pace in the near term. In 2017 as a whole, according to Bank of Greece estimates, GDP will increase by about 1.7%. In 2018 and 2019, growth is projected to gather pace and quicken to 2.4% and 2.7%, respectively, driven by rising investment, consumption and exports of goods and services. 2/6 BIS central bankers' speeches The forecasts of the Bank of Greece are based on the assumption that the reform and privatisation programme will be implemented consistently and according to schedule. In order to capitalise on the progress achieved so far, strengthen favourable prospects and enhance investor confidence in the future of the Greek economy, a strict adherence to the implementation of the structural reforms that have been agreed upon under the programme is warranted. This is expected to have strong positive effects on the liquidity of the financial system, the easing of uncertainty, the improvement of the economic sentiment and expectations, and the reduction of borrowing costs for the Greek State, thereby allowing for sustainable access to international markets in August 2018, after the programme’s completion. 4. Risks and challenges Despite the positive signs and the progress achieved so far, risks to the outlook of the Greek economy remain. The most significant and immediate risk relates to a delay in completing the third review of the programme, as was the case with the first and second reviews. This should be avoided, as it would trigger a new cycle of uncertainty leading to the suspension of investment plans, undermine the growth dynamics of the economy and weaken the prospects for sustainable access of the Greek sovereign to international capital markets after the end of the programme in August 2018. Moreover, there are significant external risks associated with a stronger euro and a possible slowdown in the euro area economy. A further rise in the euro exchange rate from its current levels could negatively affect goods exports as well as tourism receipts, dampening the economic growth outlook and slowing the pace of the exit from the crisis. There are also significant geopolitical risks that could increase the risk aversion of international investors. Other geopolitical risks relate to a possible exacerbation of the refugee crisis. 4.1 Medium- to long-term challenges In addition to the above domestic and external risks to the recovery, there are also some medium- to long-term challenges that need to be addressed in order to strengthen the positive outlook. In particular: Unemployment remains very high, while the new jobs created largely involve low-pay, parttime or intermittent employment. At the same time, the tax burden on dependent and independent employment has increased and social benefits continue to decline. As a result, household consumption is likely to weaken or remain subdued for a long time. Despite the progress made so far, banks continue to be burdened with the management of a high stock of non-performing loans, affecting their ability to adequately support economic activity with new lending. Investment remains at a very low level, and this is not only due to delays in financing the Public Investment Programme or the lack of bank lending, but also to the fact that the investment climate in the country is still perceived as unfriendly to private investment. Government debt remains very high and its servicing requires the commitment of significant public resources on a long-term basis. This can be achieved either by curtailing spending and downsizing the public sector or by increasing revenue. However, raising revenue by maintaining the existing high tax rates is a drag on growth and ultimately can have a negative impact on public finances and the manageability of public debt. This is because high tax rates discourage investment insofar as businesses know that part of their profits will, on a permanent basis, have to be spent for servicing the public debt. Moreover, high tax rates are a disincentive to work, while in the case of both businesses and households they create incentives to tax evasion and the strengthening of the shadow economy. Also, high taxes and social security contributions provide an incentive for businesses to relocate to European 3/6 BIS central bankers' speeches countries with a more favourable tax regime and, accordingly, contribute to brain drain. The lack of investment and the loss of human capital hamper total factor productivity and potential output growth. 5. Strengthening the growth potential 5.1 Boosting investment Economic adjustment and structural changes over the last seven years have made Greece more business-friendly and have created significant investment opportunities. However, domestic savings are insufficient to meet the investment needs of the Greek economy. Consequently, the great challenge today is to stimulate investment. And the only way to close the large investment gap is by attracting foreign direct investment, focusing on the most productive sectors of the economy. This requires, first, the rigorous implementation of the structural reforms outlined in the European Stability Mechanism (ESM) programme. At the same time, the Bank of Greece has repeatedly proposed changing the fiscal policy mix to make it more business- and growth-friendly. This can be achieved with more emphasis on reducing non-productive expenditure. This would, for example, entail an assessment of the structures of general government and the system of incentivisation for its various entities (e.g. local authorities) through a review of the manner in which they are subsidised by central government, as well as the expansion of Public-Private Partnerships (PPPs) in areas that are seen as taboo, such as education, health, social security. Together with a more efficient management of public property, notably real estate, through appropriate land-use legislation and by further enhancing the efficiency of the public sector and the tax collection mechanism in particular, a further reduction of non-productive public sector expenditure will enable the lowering of high tax rates, thereby supporting the growth process. In addition to the above, it is also necessary to decisively and definitively address the obstacles posed by various small or large vested interests and groups, which weigh on the business climate and hamper investment and the implementation of reforms and privatisations, even those already approved. Unless these barriers which in practice discourage investment are addressed, then the prospect of dynamic growth of the economy and its shift towards an extrovert growth model may not materialise, given that one of the key drivers of economic growth over the coming years is the expected rise in investment and the resulting impetus to the export base. 5.2. Pushing ahead with reforms and privatisations Despite the progress made so far, there is still a lot to be done in the areas of privatisations, efficient use of public property and structural reforms. For example, we need even greater ownership of privatisations; more public-private partnerships, even in areas that, as already mentioned, have so far been considered as taboo; several other reforms, e.g. in the energy market, the product market, the services market and in certain professions, in order to increase productivity and reduce the cost to consumers; measures to cut red tape across public administration; measures for the rapid delivery of justice; full respect for the independence of institutions; encouraging and incentivising private sector cooperation with universities and research institutes in order to promote innovation and the transition to a knowledge-based economy. 5.3 Reducing non-performing loans In the banking sector, a priority is to address the large volume of non-performing loans, in particular the problem of “strategic defaulters”, which is detrimental not only to the soundness of the banking system but also to the growth of the Greek economy. It is worth noting that all the necessary measures have now been legislated and that the regulatory framework has been put in place to tackle the problem of NPLs in an efficient and fast manner. Banks also possess 4/6 BIS central bankers' speeches adequate loan loss provisions, collateral and capital, which more than cover the outstanding amount of these loans, while the economy is recovering. Banks’ efforts are therefore expected to, and must, be stepped up, so as to accelerate the pace of NPL reduction, also taking into account that the targets for 2018 and 2019 are more ambitious than those for 2017. Particular emphasis should be placed on business restructuring, on providing liquidity support to viable businesses but also on the liquidation of non-viable ones. This will unlock resources that can support new or existing sound investment and business initiatives necessary to consolidate the growth dynamics. In general, banks have achieved significant improvements in their corporate governance and liquidity and solvency ratios in recent years and there is absolutely no reason for concern about their performance. 5.4 Tackling the high public debt Concrete actions are necessary to ensure the sustainability of public debt, as well as a more realistic adjustment of medium-term fiscal targets. The Eurogroup of 15 June 2017 reiterated in a clearer manner the lines along which further debt relief measures could be adopted, if deemed necessary, after the end of the programme. The Bank of Greece has already made specific proposals for a mild debt restructuring, for example by lengthening the weighted average maturity of interest payments on EFSF loans by at least 8.5 years. The calculations show that this could make a significant contribution to debt sustainability, even if primary government surpluses were to remain at 3.5% of GDP until 2020 only (rather than 2022 as envisaged in the agreement) and fall to 2.0% afterwards. These two proposals, if adopted, will certainly support both the recovery of the economy and the country’s creditworthiness. The growth impact of debt restructuring and the resulting reduction in its servicing costs will be higher if the fiscal space created by the lowering of fiscal targets, amounting to 1.5% of GDP, is used to reduce labour and capital taxation and is accompanied by appropriate policies to increase potential output and bring about a reversal of the brain drain, i.e. a repatriation of young graduates and professionals who left the country during the crisis. This mild debt reprofiling proposal is vital for Greece and entails only a negligible cost for its partners. This will pave the way to the inclusion of Greek government bonds in the ECB’s quantitative easing programme, which in turn will facilitate sustainable market access and further support the economic recovery. This will set in motion a new virtuous circle that will signal investor confidence in Greece’s economic prospects while encouraging the return of deposits to banks, a return to financial markets after the end of the current programme and, eventually, the full abolition of capital controls. 6. Conclusions The Greek economy is on a steady upward trajectory. However, despite the encouraging signs coming from the positive GDP growth figures for the first half of 2017, there is no room for complacency or a relaxation of efforts. We still have a way to go before the positive prospects of the Greek economy for the period 2017–2019 can be confirmed and before Greece can gain the full confidence of markets after the end of the programme in August 2018. This will be achieved if the country obtains a credit rating enabling it to refinance its debt at rates that are in line with its sustainability and if banks have sufficient collateral to be fully funded from the ECB’s refinancing mechanism and not only from the costlier Emergency Liquidity Assistance (ELA). Consequently, a sustained exit to markets requires: First, adhering to the objectives of the programme and accelerating the pace of implementation of reforms, both those decided as part of the programme and discretionary reforms to strengthen economic growth. The fast completion of the third review of the programme is absolutely necessary. Second, sufficient and timely specification of medium-term debt relief measures in line with Eurogroup decisions. Third, constructive cooperation between the Greek government and the institutions on the type and 5/6 BIS central bankers' speeches conditionality of support to the Greek economy after the end of the programme in August 2018, in order to ensure its return to financial normality after seven years of significant sacrifices of the Greek people. 6/6 BIS central bankers' speeches

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