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Greece seems to be on the brink of achieving something of an economic miracle in the eurozone, by both beating its growth targets and reducing its budget deficit. The news in 2005 was positive, with the Greek economy estimated to have grown by about 3.7%, beating market consensus forecasts that expected GDP growth of between 2.8% and 3.3%. And the government achieved this in style, since it also managed to reduce its budget deficit to about 4.3% of GDP from 6.6% in 2004.
This means there’ll be more of the same in 2006.
“The government will stick to the policy of smooth economic adjustment that combines fiscal consolidation with strong GDP growth rates,” says Plutarch Sakellaris, chairman of the council of economic advisors at the Greek finance ministry. “We feel confident that we can bring the budget deficit below 3% of GDP and achieve economic growth of 3.8% in 2006.”
In its updated programme for 2005–08, the general government budget deficit is predicted to fall to 2.6% of GDP in 2006, underpinned by a GDP growth rate of 3.8%. But the European Commission and some economists doubt whether Greece’s excessive deficit can be eliminated before 2008. In its 2005 Autumn Economic Forecasts, the European Commission projects a deficit of 3.8% of GDP in 2006, including one-off revenues from a securitization of tax arrears that was subsequently cancelled by the government.
“The magnitude of the required fiscal adjustment is quite sizeable. I have doubts whether this can be achieved without hurting economic growth,” says Vincenzo Guzzo, economist at Morgan Stanley in London. “If the fiscal tightening is not large enough then the economy will have another good year. If it is significant, the economy will feel the pinch.”
Disparities
Jurgen Michels, an economist at Citigroup in London, also forecasts a higher budget deficit and slower GDP growth than the official forecasts of the Greek government: “We doubt whether the rebound in capital spending will be enough to offset an expected slowdown in consumption. We do not expect net exports to have a positive contribution to growth, and we expect a slowdown in GDP to 3.2% from 3.4% this year [2005].”
Michels says that private investment spending is likely to recover in 2006, coming off an almost flat year, aided by the gradual reduction in the corporate tax rate to 25% in 2007 from 35% in 2004 and a mild boost from public private partnerships. On the other hand, they both identify private consumption as the likely soft spot.
Private consumption spending weathered a 1% increase in VAT tax introduced in April 2005 to help close the budget gap, as well as higher oil prices, to grow 3.7% year-on-year in the first nine months of 2005, compared with 4.3% in 2004 and 3.2% in 2003.
Sakellaris says that developments in 2005 contradict the view that fiscal consolidation and strong economic growth cannot go in tandem: “The size of the fiscal adjustment in 2005 was much higher than the projection for 2006. Still, this did not affect domestic demand, paving the way for economic growth of more than 3.5% despite adverse external factors such as the sharp rise in the price of oil.”
Sakellaris says he expects private consumption to stay resilient in 2006 at around 3.2% growth: “Employment is increasing by more than 1% per year and unemployment will fall as the labour force is not growing. Total compensation of employees in the public sector, which constitute one-fifth of the workforce, is likely to increase in line with inflation or more, while compensation in the private sector is likely to increase by more than 5% in 2006.”
Sakellaris says that expected higher interest rates will not have a significant impact on credit growth in 2006 since Greek households remain underleveraged compared with average EU levels. Moreover, he stresses the positive wealth income effect from higher real estate prices and the equity market.
Yiannis Pehlivanides, deputy CEO at National Bank of Greece, the country’s largest commercial bank, says household borrowing should support a healthy rise in consumption: “We expect mortgage lending to grow by 20% to 25% in 2006 and consumer loans by 15% to 20%. Loans to small businesses will grow by 10% or more, but lending to large companies will grow much more slowly.”
Constantine Karatzas, the chairman of Aspis Bank, is also upbeat about consumer lending: “I see double digit growth in consumer credit, partly because some wage earners will try to maintain consumption levels in the view of lower than expected compensation.”
Crucial year ahead
Gikas Hardouvelis, chief economist at EFG Eurobank Ergasias Bank, thinks 2006 will be a crucial year for the Greek economy: “The next 12 months will be key for Greece. If the government manages to put its public finances in order without hurting economic growth, the economy will have made a big step in the right direction. If it fails to do so then the whole situation will unravel.”
Hardouvelis, who was economic advisor to the former socialist prime minister Costas Simitis, identifies the two major risks to the economy as being possible cuts in the public investment budget (PIB) to bring the deficit below 3% of GDP and insufficient growth in tax revenues.
The public investment budget has been an easy target for successive Greek governments striving to reduce the general government budget deficit without resorting to painful tax increases or expenditure cuts entailing significant political cost.
The largest portion of national funds under the PIB goes towards investment projects that are co-financed by EU funds while a smaller chunk is channelled into works financed solely by Greek resources. The latter sometimes aim at facilitating EU co-financed projects.
Already, Greece’s ability to absorb billions of EU funds earmarked for the country in the Third Community Support Framework (CSF) is questioned openly by many economists and business people. Under the 2000–06 Third CSF, which effectively ends in 2008, Greece was supposed to get €22.7 billion in EU funds, but delays related to the slow-moving Greek public sector and tougher rules imposed by the EC make the absorption of these funds a challenging task.
The government hopes the initiation of public private partnerships projects will help boost capital spending by the private sector. Although they share the view that PPP can contribute significantly to a pick-up in private investment spending many, like Hardouvelis, believe that PPPs will only start to bear fruit from 2007 onwards.
The second risk to the economic policy of smooth adjustment pursued by the government is to fall short of the target increase in tax revenues, with many economists sceptical that tax collection mechanisms will meet new efficiency targets.
