10 March 2017

Yannis Stournaras: Recent economic and financial developments in 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 consensus-building, 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 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. 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 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. [...]

Full speech

© BIS - Bank for International Settlements