Current account surplus needs caution

Depression of domestic demand rather than gains in competitiveness have mostly helped wipe out deficit By Dimitris Kontogiannis

Greece registered its first current account surplus since 1948 last year, earlier than projected. Although this is very good news, it is not cause for celebration. The improvement largely reflects the depression of domestic demand and much less the much hoped-for gains in competitiveness. So, the current account surplus will likely turn into a deficit again as the economy picks up steam. This calls for serious reflection from policymakers and others alike.

Greece, like other europeriphery countries, experienced a sharp deterioration in its current account balance since entering the eurozone in 1999, on the back of strong consumption and, sometimes, investment growth spurred by low interest rates due to financial integration. The loss of competitiveness also contributed to the wider deficits as wage growth surpassed productivity gains during the same period. The current account deficits were almost matched by surpluses in the core countries. The deterioration in the external balance of the europeriphery culminated in 2007-2008, when the international financial crisis erupted, and has been completely reversed since then.

The Greek current account balance turned into a surplus of 1.24 billion euros in 2013, according to provisional data provided by the Bank of Greece, from 4.6 billion in 2012 and 20.6 billion in 2011. It had reached an all-time high of about 35 billion euros in 2008. The turnaround is certainly impressive and came at least a year earlier than official estimates had projected.

But we should not draw any conclusions before looking at the main drivers behind this significant improvement in the external balance. What are these? First, the large drop in interest payments on the country’s external debt since 2011, following the biggest-ever sovereign debt restructuring in history (PSI Plus), played a role since it accounted for several billion euros. This has been a good development because public resources are not flowing out of the country on a permanent basis.

Second, the significant increase in tourist receipts last year on the heels of a record-breaking number of arrivals. However, caution is suggested, and we definitely agree with the following note sent by a Greek bank analyst to clients last week. “Tourism is a good revenue source for Greece with indirect benefits for the economy but its capacity to drive economic growth should not be overestimated, e.g. last year receipts were up 15 percent year-on-year to 12 billion euro but that was helped by the low base (political turmoil/ Grexit risk in the summer of 2012). In fact, fiscal year 2013 tourism receipts were almost flat versus the 2008 peak in nominal terms.” We would add that travel receipts were also flat at around 10.4 billion euros in 2012 compared to a year earlier. Undoubtedly, the tourism industry’s importance to the Greek economy can be further enhanced in coming years but its capacity to propel economic growth should not be overestimated.

Third and more importantly, the key factor behind the improvement in the current account deficit was the reduction in the merchandise trade deficit by 2.5 billion euros year-on-year to 17.2 billion euros in 2013. It followed an even bigger drop by 7.6 billion euros in 2012 from a year earlier. But the narrowing of the trade deficit has been largely accounted for by the suppression of imports with a comparatively small contribution from export revenues over the same period. The drop in imports clearly depicts the impact of austerity policies on disposable incomes, employment and the decrease in investments, whereas the comparatively small to modest increase in the value of merchandise exports reflects limited competiveness gains.

We should note something else when looking at the trade balance. Whereas the so-called balance of other goods accounted for the biggest part of the improvement in the overall trade balance in previous years, it was the oil balance that made the difference in 2013. As the analyst mentioned above pointed out, “the biggest part came from the oil balance mainly due to lower consumption (high taxation, weak disposable income, good weather conditions may have contributed to this).” Assuming oil consumption is not compressed much further in 2014 and imports of other goods show signs of stabilization, the imports drop may approach its limits under current economic policies.

On another worrisome note on exports, a study separating the price from the quantity effect and authored by Nikolas Scholl at Bruegel last year claimed that Greece’s relatively small increase in export revenues was explained by an average 16 percent increase in export prices since volumes fell by 13 percent over the observed five year period from 2007 on. The same study found that Greek import prices grew by 21 percent on average while volumes fell by 44 percent assuming prices held constant.

To be fair, one cannot ignore Greece’s small merchandise export base, which will take years to expand significantly. However, the favorable effects on merchandise exports of policies aimed at driving down labor costs are not visible yet. This is despite the fact that the real effective exchange rate based on unit labor costs, used by policymakers to gauge the country’s international competitiveness, shows Greece has regained all lost ground since becoming a eurozone member.

All-in-all, Greece’s first current account surplus since 1948 is a positive development but it is based disproportionately more on the depression of domestic demand than gains in competitiveness. So, it may not turn out to be sustainable when the much hoped-for economic recovery arrives.