High Greek growth run looks like losing steam, unlike inflation

As if the war in Iraq were not enough, the most dynamic part of the world economy, Southeast Asia, is facing a new challenge in an epidemic called severe acute respiratory syndrome (SARS) and economists are again busy revising downward their GDP projections for 2003. Given this unfavorable external economic background, it is no surprise that most analysts have started trimming their own forecasts for this year’s Greek GDP growth rate and raising their inflation forecasts. Although it is still relatively early to gauge the precise impact of the war in Iraq on the Greek economy, it may be safe to say that the Greek economy experienced a slowdown in the first quarter, which reportedly had an adverse impact on some large banks’ loan growth rates. If this trend continues in the second quarter, it should come as no surprise if the first signs of the long-anticipated war on lending spreads among banks show up. According to the most recent update on Greece’s Stability and Growth Program for the 2002-2006 period, economic growth is projected at 3.8 percent this year and 4 percent in 2004 versus a preliminary 4 percent growth rate estimate last year. Still, the expected significant slowdown in the Eurozone economy along with the appreciation of the euro in trade-weighted terms is expected to have an adverse impact on Greek exports and services, especially tourism, and to become a bigger drag on the Greek economy via their combined increasing negative contribution to GDP growth. In addition, the sharp rise in world oil prices, even though partly neutralized by the strong euro, has helped fuel Greek inflation. In turn, this has partly canceled the positive contribution of personal income tax cuts going into effect from the beginning of this year, since higher inflation acts as a tax on private consumption, one of the two levers of economic growth along with investment spending. Concerns about an economic slowdown have also been raised by company executives, even in the booming construction and cement sectors. In private, they appear skeptical about the future and cite signs of a slowdown in fields such as residential construction activity in the first quarter. They contend this slowdown cannot be solely attributed to adverse weather conditions and attribute it mainly to the general economic climate. To some extent, they admit, this reflects uncertainty related to geopolitical events, mainly the war in Iraq, as investors and consumers put off plans awaiting the final outcome of the war. Still, they say the first signs of over-capacity in some booming industries are there, prompting concerns about price wars as more and more projects linked to the 2004 Olympic Games are completed. Even companies doing business with local authorities and the State complain about liquidity problems. They cite delays in payments for completed projects and other services rendered which have prompted them to take out bank loans to deal with the situation. Even so, no analyst seems to believe that Greek GDP growth will fall below the 3 percent mark this year even if there is a protracted conflict in Iraq, now considered a negligible possibility. This compares very favorably with eurozone GDP growth currently estimated at 1.1 percent in 2003. Still, the likely economic slowdown in the first quarter seems to have taken its toll on bank loan growth, according to some high level officials from large local banks. They say consumer loan and mortgage loan growth rates appear to have slowed down considerably compared to a year earlier but caution about drawing premature conclusions given the uncertainties related to the war in Iraq. Although the slowdown in mortgage loans should have been expected, given a government decision to limit the amount of interest first-time homebuyers can deduct from their taxable income starting this year, there is little doubt that the slowdown partly reflects economic reality. A spreads war? The slowdown in loan growth, coupled with the banks’ high reliance on loans to boost their revenues and earnings has prompted a few analysts to forecast the beginning of the long-anticipated war on spreads. They caution this is just the beginning of a cycle, which may take quite some time to become apparent and suggest that the squeeze on margins may take different forms such as pricing floating rate loans in more transparent ways, inevitably leading to tighter margins. Most Greek banks use their so-called «basic lending rate» as a benchmark for the popular variable mortgage loans. This gives them a leeway to set variable mortgage rates as high as 6 percent when similar loans in other Eurozone countries are set well below the 5 percent mark and some even below 4 percent. In a break with usual practice, EFG Eurobank Ergasias announced last week the creation of a new mortgage loan, the «EuroHome European,» whose interest rate is linked to the basic interest rate of the European Central Bank (ECB), currently standing at 2.5 percent. The new mortgage-lending product starts from 4.5 percent. Although Greek households and businesses have a long way to go before catching up with the rest of their Eurozone counterparts on leverage indicators, there is no doubt that loans extended by Greek banks to local households carry much higher margins, especially on popular variable mortgage loans and credit cards, than elsewhere in the eurozone. Whether the likely Greek economic slowdown in the first quarter is linked to the war in Iraq or not is still unclear. It is clear, however, that the economic environment has something to do with the fatigue experienced in retail bank lending. This may take a more permanent form and therefore lead to the long anticipated squeeze on bank loan rate margins if growth pessimists prove right.