COMMENT

A window of opportunity for the Greek economy

By Evangelos A. Calamitsis *

Greece faces major challenges, fraught with great risks, owing to a combination of adjustment fatigue, political uncertainties, increased disenchantment on the part of the country's partners, and a widening euro-area crisis. But the recent formation of a transitional unity government, with large political support, provides Greece with a window of opportunity to bring its economic reform program back on track and regain the confidence of its partners.

To be successful, this opportunity will have to be fully seized and focused on some urgent actions. In particular, in the period immediately ahead, all of the prior actions agreed upon under the current program supported by Greece's euro-area partners and the International Monetary Fund will have to be carried out in order to unlock the much-needed sixth tranche of program loans by mid-December. Moreover, negotiations will have to be completed on a credible new program for 2012-14 that would attract further official support, as well as private sector involvement (PSI) designed to substantially reduce the country's sovereign debt.

It should be remembered that since May 2010, when the current reform program was adopted, Greece has taken some significant steps toward macroeconomic adjustment and structural reform. However, program implementation and performance have been uneven. More seriously, over the course of this year, social tensions and resistance to reform have grown; program implementation has slowed, leading to significant policy slippages; and as economic conditions and market sentiment in Europe have weakened, Greece's overall economic situation have worsened.

Thus, for 2011 as a whole, it is estimated that the real gross domestic product will decline by 5.5-6.0 percent; unemployment will be around 16.0 percent; and the overall fiscal deficit of the general government will be of the order of 9.0 percent of GDP, well above the program target of 7.5 percent, contributing to a further rise in the already high public debt. The situation would have been even more dire if it were not for an increase in exports and tourism.

Against this background, Greece's euro-area partners and the IMF have continued to provide Greece with considerable financial assistance, as well as technical support. Indeed, through July 2011, their combined program loans have amounted to about 65 billion euros, or some 60 percent of the total (110 billion euros) pledged for the current three-year program. And on the basis of policy understandings reached with the Greek authorities, the EU-IMF agreed in principle to disburse the sixth tranche of program loans of about 8 billion euros envisaged under the program. As part of the decisions taken at the Euro Summit in Cannes on October 26, 2011, Greece's partners reiterated this agreement; and they set the stage for ?the conclusion of a sustainable and credible new EU-IMF multiannual program by the end of the year.?

As is well known, the Euro Summit also dealt with the broader issues regarding the monetary union, notably leveraging the resources of the European Financial Stability Facility, recapitalizing and funding European banks, strengthening economic and fiscal coordination and surveillance, and enhancing governance structures and integration. But rather unexpectedly, soon after the Cannes summit, political developments in Greece led to ambiguities and uncertainties about its commitment to the reform program and adherence to the summit decisions, thereby adversely affecting the country's policy credibility. In the circumstances, disbursement of the planned program assistance to Greece was delayed.

Immediate actions

The Greek unity government, headed by a highly respected economist and former vice president of the European Central Bank, has been widely welcomed by Greece's partners. Yet it has to build upon the improved sentiment by removing existing uncertainties and restoring the country's policy credibility.

For a start, the new government needs to put firmly in place all the policies and measures already agreed upon. These include adopting a sound budget for 2012; intensifying the fight against tax evasion and improving tax collection; reducing non-priority outlays, without accumulating payment arrears; streamlining and downsizing the public administration; increasing the pace of privatization; and giving full force to the structural reforms designed to foster labor market liberalization and open up the highly regulated professions. In addition, the new government as well as the political party leaders supporting the government need to provide adequate assurances to the EU-IMF that Greece is genuinely committed to pursuing its reform efforts and carrying out the obligations stemming from the euro-area decisions of October 26.

If sufficiently convincing, these assurances and actions would not only allow the disbursement of the critical sixth tranche of EU-IMF program loans but also facilitate the negotiations on a new medium-term program.

Medium-term orogram

The Greek program for 2012-14 should be ambitious but realistic, and its rationale should be well explained to the general public and the business community. The projected further contraction of the nation's output and the rise in unemployment in 2012 are most worrisome. Hence, as the program's macroeconomic framework and policy components are still being worked out, it is to be hoped that high priority will be given to reviving the economy and jobs by increasing investment and accelerating structural reforms.

To these ends, with the technical support of the European Commission's Task Force for Greece, the authorities should expedite preparation and implementation of a large number of identified investment projects that can be financed largely by European structural funds. They should also encourage both foreign and domestic private investment through the simplified procedures and other means already in place, as well as take concrete steps to meet the credit requirements of viable small and medium-sized enterprises.

At the same time, the program should vigorously pursue the basic goals of consolidating public finances, improving competitiveness, and safeguarding the financial system and monetary stability, while protecting the most vulnerable groups of society. In view of the need to put the public debt situation on a sustainable path, and quite apart from the expected private sector contribution to debt reduction, it will be most important to generate sizable primary fiscal surpluses (which exclude interest payments) over the medium term. In this respect, the 2012 draft budget now before Parliament represents a step in the right direction, envisaging for the first time in recent years a primary fiscal surplus equivalent to 1.1 percent of GDP, compared with large deficits in 2009-11.

The medium-term strategy will also need to focus on the following specific policies and measures:

Promote tax reform and combat tax evasion. Tax reform should aim at establishing a simpler, fairer, and more stable tax system. At this juncture, no new taxes or further tax rate increases would be advisable or tolerable; rather, some of the recent increases in VAT and other tax rates would need to be reconsidered and possibly rescinded.

Reduce the government wage bill and other outlays, while ensuring social safety nets for the poor.

Rationalize and downsize the public sector, particularly the loss-making state enterprises.

Accelerate efforts to make effective use of the large portfolio of state assets through privatization and real estate development.

Enhance liberalization of the economy to improve competitiveness, support the growth of exports, and help develop the key tourist and shipping sectors.

Recapitalize Greek banks and strengthen the financial position of social security funds.

Foster reforms designed to improve education at all levels, rehabilitate the national health system, and render the legal system more efficient.

Promote research and technology in priority areas, including renewable energy, with a view to boosting innovation and potential growth.

On the basis of such a reform program, Greece should expect to reach understandings for substantial debt relief from its private sector creditors. Indeed, as indicated in the Euro Summit Statement of October 26, PSI in support of Greece would be expected to be deeper than envisaged last July, involving a voluntary bond exchange with a nominal discount of 50 percent on national Greek sovereign debt held by private investors. Such a debt reduction, coupled with the previous decisions of euro-area member states to extend the maturities and lower the interest rates of their program loans to Greece, would significantly alleviate the country's debt burden. But it is to be hoped that the negotiations with private sector holders of Greek debt, which are likely to be controversial, will be satisfactorily concluded on a voluntary basis; that participation rates will be high; and that the specific options and terms of the enhanced PSI will not lead to any dilution of the expected debt reduction.

On their part, Greece's euro-area partners have pledged to contribute 30 billion euros in support of the PSI package. Moreover, the EU-IMF are expected to provide additional program financing of up to 100 billion euros in 2012-14, including the resources required to recapitalize Greek banks.

To sum up, barring any political mishaps in Greece and a worsening of conditions in the euro area, Greece now has a window of opportunity to reinvigorate its reform program and hopefully pave the way for resolving its economic and debt crisis with the support of its partners. The achievement of the country's basic goals will take time and continued efforts to ensure effective program implementation; it will also require national cohesion that will have to be sustained for many years beyond the life of the current administration.

* Evangelos A. Calamitsis is a former director at the International Monetary Fund.

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