THE BLOG

A Commentary on Greece's Economic Outlook

02/21/2014 04:13 pm ET | Updated Apr 23, 2014

For some time now, there has been an intense debate in Greece (and to some extent in financial circles around the world) on the state and outlook of the Greek economy. On the one side, many observers and the supporters of the Greek governing coalition have been emphasizing the emerging signs of progress under the country's current reform program, particularly the "green shoots" of economic recovery underpinned by fiscal consolidation. Greece's foreign lenders have generally welcomed this progress, based on the great sacrifices made by the Greek people; but they have also been saying that much still remains to be done, especially in the area of structural reforms, to overcome the crisis that erupted in 2009. On the other side, a number of commentators and most of the Greek opposition parties have been vigorously contesting the Government's claims of success, underscoring the need for a fundamental change in strategy in order to rescue the Greek economy.

Against this background of widely divergent views, a reality check of the Greek economy is in order and may be helpful, without rehashing old issues regarding the crisis and the euro. Clearly, after six years of deepening economic recession, the state of the Greek economy is dire. Greece's real gross domestic product (GDP) has shrunk by more than one quarter since its peak in 2007; and in October 2013 the unemployment rate was 27.8 percent (59.2 percent for the country's youth), the highest rate in the European Union. But in recent months there have been signs of a likely end of the recession that has so seriously affected the Greek population. The latest available data show that the recession has been bottoming-out; and the contraction of the domestic economy was of the order of 3.7 percent in 2013, somewhat below the 4.2 percent drop envisaged early in the year, and well under the 6.4 percent decline in 2012. Moreover, while there are downside risks ahead as described below, various forecasts point to a mild recovery of real GDP (of about 0.5 percent) in 2014, followed by a substantial growth (of 2.0-3.0 percent) in 2015, assuming increases in capital formation and exports of goods and services.

This expected recovery is attributable in part to the country's enormous and very painful adjustment and reform efforts. Although not as rapid as needed in light of the severity of the problems, structural reforms have been moving in the right direction: the liberalization of various sectors of the economy has been proceeding; the country's international competitiveness has been largely restored, and for the first time in many years the external current account showed a surplus in 2013; the planned recapitalization and restructuring of the banking system has been completed, and any additional bank capital requirements are being assessed in the light of the ongoing stress tests; and, after much delay, corruption is being tackled gradually through administrative and judicial actions. Other factors have also been helping the economy, including the recent bumper tourist season and the restart of construction works on major infrastructure projects. But to sustain the economic recovery, further progress on structural reforms will be required to give confidence to the private sector, encourage both domestic and foreign direct investment, and promote exports of goods and tourism services.

Meanwhile, the Greek authorities have been coming to grips with the country's long-standing budgetary problems. While weaknesses remain, notably the persistence of tax evasion and problems in streamlining the public administration, the authorities estimate that in 2013 Greece realized a primary fiscal surplus (before interest payments on the public debt); this surplus represented a major achievement relative to the deficit equivalent to 10.5 percent of GDP in 2009, and an even greater feat when cyclically-adjusted to take account of the decline in overall economic activity.

In accordance with the authorities' program, the 2013 primary fiscal surplus (realized a year ahead of schedule, and reportedly amounting to more than 1.5 billion euros) may be used in part to ease the burden of the worst-affected and most vulnerable groups of Greek society. Most important, by underscoring the Government's commitment to fiscal reform, it will help buttress Greece's case for obtaining much-needed official debt relief from its euro area partners.

Despite the recent signs of a turnaround, the depressed economic conditions still prevailing throughout the country and the very high rate of unemployment (especially of young people under the age of 25) remain major challenges, giving rise to worrisome social and political tensions. In this environment, most of the Greek opposition parties have been arguing that the economy is far from recovering and the human crisis is spreading; Greece needs to put an end to fiscal austerity and abandon the current reform program supported by its euro area partners and the International Monetary Fund (IMF); and there should be early national (i.e., general) elections to bring about a change in government that would demand a reversal of the prevailing European economic strategy and a major "haircut" of the Greek public debt.

Apparently, a majority of the population does not now favor early national elections (which in principle are due in 2016) because of the problems that may arise, such as the political paralysis experienced in the spring of 2012. There are also fears that an abandonment of the current program and a confrontation with the country's euro area partners could put into question Greece's commitment to the common currency. Still, a cloud remains in the horizon, because both local administration and European Parliament elections are to be held in May 2014, and their results may trigger other political developments.

In their recent contacts in Europe and the United States, Greek government officials have been encouraged to pursue the path of reform, with a view to reviving the economy and giving renewed hope to the Greek people. Furthermore, many observers have recently welcomed with some degree of optimism Greece's priorities and opportunities in assuming in January 2014 the six-monthly rotating Presidency of the Council of the European Union.

However, the way forward is politically difficult, as the Greek coalition government holds only a slim majority in parliament, the opposition forces have been gaining strength, and there is an evident fatigue of Greek society with fiscal austerity and structural reform measures. In the circumstances, the Government has tended to preclude taking any new measures that would be politically unpalatable. It has been emphasizing Greece's recent achievements, particularly on the fiscal side, the expected successful completion of the reform program, and a gradual return later this year to borrowing from international capital markets (similar to the recent successful experience of Ireland and Portugal).

From a different angle, Greece's partners have been focusing on the Government's policy shortfalls and its need to fully implement all the agreed structural reforms under the program, as well as a number of reforms recommended by the Organization for Economic Co-operation and Development. They have also been insisting on actions designed to close the program financing gaps which, according to their own estimates, are in prospect for 2014-15.

These differing positions have complicated the program review discussions between the Greek administration and the representatives of the European Commission, the European Central Bank, and the IMF (the so-called "troika"). Thus, after several rounds of unsuccessful talks since September 2013, the formal discussions have been stalled for some time.

This situation has not been to the benefit of either side. Although some observers have opined that Greece could "wait things out" and reach agreement with the "troika" after the May 2014 elections, several downside risks have to be borne in mind. First, such a delay in agreement (and a consequent delay in European and IMF loan disbursements) could present a problem for Greece as there are Greek bonds and bills maturing in May amounting to almost 11 billion euros, of which more than 9 billion euros are held by the European Central Bank (that does not agree to their rollover). Second, a delay in agreement would probably lead to a postponement of the expected consideration of official debt relief to Greece. Third, the intended return by Greece to borrowing from international capital markets (which in any event would not be a simple exercise) may prove more costly and even be compromised. Fourth, some of the opportunities and luster of the current Greek Presidency of the Council of the European Union may be affected. And finally, confidence may be shaken (possibly leading to a renewed outflow of domestic bank deposits), and damage the prospects for economic recovery.

It should also be noted, however, that a protracted stalemate in the review discussions would not be in the interest of Europe as well, since it could rekindle concerns about area-wide financial stability and increase the existing skepticism about the European project.

Therefore, the recent announcements that the "troika" will be returning to Athens shortly to resume the program review discussions are an encouraging development. But to be successful, these discussions will require strategic vision and pragmatic negotiating skills on both sides. The Greek authorities need to avoid overplaying some of their recent achievements; fully appreciate the fact that there are indeed no significant trade-offs between the fiscal and structural reform elements of their program; and exercise caution in their expectations regarding an early end to further reform, as well as the prospects of renewed access to the global bond market. As is well-known, Greece has continuing obligations within the euro area, and the current four-year arrangement with the IMF expires in March 2016. On their part, Greece's partners need to concentrate on the country's fundamental policy requirements for 2014 and beyond (rather than the unduly long check list of measures incorporated in the program); refrain from proposing actions that may endanger social stability and hence the economic recovery in Greece; and envisage taking credible steps to ensure the sustainability of the Greek public debt.

To support Greece's economic turnaround, understandings have to be reached between the Greek administration and its partners on three basic and inter-related issues: reviving growth and creating jobs; consolidating fiscal and banking sector stability; and ensuring public debt sustainability. In this regard, broad agreement will be needed on an updated medium-term policy framework, without any further cuts in wages or pensions. This framework should focus on the following policies: pursuing tax reform and strengthening tax administration; accelerating the pace of public administration reform and privatization; addressing the problems posed by the accumulation of large non-performing bank loans and reviving credit to the real economy; improving the public health system; and closing any prospective financing gaps. These are demanding but essential policies for the period ahead.

To sum up, while Greece has made significant progress in a number of areas in 2013, there are considerable uncertainties regarding the way forward. Greece's economic recovery is likely to be strongly influenced not only by its own reform efforts, coupled with European cooperation and solidarity, but also by domestic social and political factors.