Sick economy in need of funding
Greece will have to put a brake to its four-year economic slide as soon as possible if it does not want to face social upheaval and more wealth destruction down the road.
Since public and private consumption expenditures are bound to decrease further and exports are not big enough to pull the economy, the burden falls on investment spending to do the job.
For a heavily indebted country such as Greece, fiscal discipline is important. The lessons of successful fiscal consolidations from the past denote that most countries involved shared a common characteristic.
Primary budget surpluses contributed the most to past significant fiscal adjustments in advanced economies. Economic growth rates exceeding interest rates played a significant but still lesser role in just a few instances, namely Spain?s drive to reduce its government debt-to-GDP ratio to around 36 percent in 2007 from 67.4 percent in 1996 and Ireland?s from 1987 through 2002.
In Spain, the primary surplus contribution stood at 21.6 percentage points of GDP and the contribution of the differential between growth and interest rate at 11.5 points. In Ireland?s drive to reduce its debt ratio to 32.2 percent in 2002 from 109.2 percent in 1987, the primary budget surplus accounted for 53.3 points of the drop while the growth-interest differential for 31.1 points based on the IMF staff position note and BNP Paribas figures.
It should be assumed that the primary surplus, which occurs when revenues exceed expenditure without including interest payments on the public debt, helped boost investor confidence in the future prospects of these economies, beefing up growth. Of course other factors may have played a role.
We know now that a much bigger fiscal effort on Greece?s part in the last couple of years has failed to produce even the small primary deficit equal to 1 percent of GDP or less in 2011 envisioned in the first economic adjustment program agreed with the troika. If everything goes well, the primary deficit may fall to 2.5 percent of GDP or lower in 2011.
Undoubtedly, the effectiveness of the restrictive fiscal measures taken is low when compared to the budget deficit outcome. This has helped neither the social and political acceptance of the economic plan nor market sentiment.
We, like others, strongly believe the outcome could have been better, propping up economic and business sentiment if fiscal discipline relied more on downsizing the overstaffed public sector and less on spreading the costs and the pain in the form of tax hikes to the private sector.
With restrictive fiscal measures biting even more and the private sector under more pressure, as demonstrated by the increasing number of companies closing down or seeking creditors? protection and climbing unemployment, private consumption is bound to take another hit.
So, the only way for the economy to stabilize and start recovering is for the exports sector and investment spending to take up the slack.
Although exports have picked up steam, the country?s export base of goods and services is not large enough to make a difference. Moreover, it depends on economic growth in the eurozone and elsewhere and the outlook for next year does not look promising.
Therefore Greece has to rely on a resurgence in investment spending to make a difference and put a brake on the downhill slide.
It should start with the public investment budget spending which is the convenient victim any time a Greek government wants to cut spending to reduce the budget deficit. This kind of spending fell about 28 percent year-on-year in the third quarter, making a significant contribution to the GDP contraction in the same period.
The contribution is even bigger if one takes into account the impact from the continued impasse between the state and contractors over restarting works in the country?s four large highway projects. Mobilizing EU structural funds can also help a lot in boosting public investment spending but the infrastructure in doing so has to be improved fast.
Greece will also have to attract foreign direct investment to boost its economy and help improve economic sentiment. This will not be the case until the country convinces foreign investors they face no foreign exchange risk when they put their money in real estate or other big projects.
The best and easiest way to convince them is to conclude the negotiations for PSI+ with its private creditors to cut its public debt as soon as possible and proceed with the remaining steps before implementation.
An agreement on the terms of PSI+ is needed because it will be used as input in designing the second economic program. The actual PSI+ exchange will normally take place afterward.
If foreign and Greek investors know there is a backstop for the country, they will feel safer in investing their money here. Of course, lower taxes, deregulation, zoning and the removal of other hurdles could help but eliminating the forex risk from their risk-return calculations is of the utmost importance along with presenting them with ready projects to invest such as in public property.
At this juncture, the local economy looks set to contract between 5 and 6 percent in 2011 and another 2.5 to 3 percent in 2012, the first year of growth according to the first economic adjustment plan.
We are not sure this slump will have a happy end if Greeks continue to see no light at the end of the tunnel. The only way to see this light is for investment spending to pick up and exports to help alongside. The ball is in the court of Greek politicians and Greece?s partners.
