Why balancing current accounts is key

Greece cannot remain in recession for much longer without experiencing adverse political and social consequences. The government hopes a pick-up in exports and investments will help pull the economy out of its six-year slump next year and beyond. However, this may become an impediment to the needed adjustment in the current account deficit, a key for a country with a large foreign debt stock.

Although it is still too early to make a prediction, the flash first-quarter estimate on the country’s gross domestic product and signs of a good tourism season ahead have increased the chances for the economy to contract between 4 percent and 4.5 percent, in line with the official projections for this year.

It is widely expected that government and consumer spending, as well as investment will decline further, as net exports (exports minus imports) provide support by being less of a drag to the economy than a year earlier. The flash estimate showed that the GDP contracted by 5.3 percent year-on-year in the first quarter, after dropping 5.7 percent in the last quarter of 2012. It fell for the 19th consecutive quarter.

On a more positive note, the current account deficit continued to shrink, falling 51 percent year-on-year to 2.3 billion euros in the first quarter, according to preliminary data. This makes it more likely that the external deficit will drop below 1 percent of GDP and may even be eliminated at the end of 2013, from 2.9 percent last year. This is a huge improvement from 2008 when the external deficit had ballooned to 14.9 percent of GDP.

If official forecasts prove correct and the current account deficit drops to about 0.3 percent of GDP at year-end, it will be a significant development. This is because the current account deficit has represented one of the two major imbalances of the economy for a long time and its shrinkage signals a diminishing need for foreign financing. The latter is of utmost importance for a country with a large foreign debt.

But the Greek economy’s return to growth after a protracted period of recession – resulting in an estimated loss of output of about 25 percent in real terms since 2008 – may not be compatible with a current account surplus envisaged from 2014 onwards.

Greece is projected to register positive GDP growth rates, starting next year, alongside a current account surplus of less than 1 percent of GDP.

A deficit in the current accounts signals that national savings are not enough to fund total investments, while a surplus is the flip-side of the same coin, meaning gross national savings exceed gross investment spending.

Greece has been running current account deficits for decades largely because of insufficient national savings.

Running current account deficits was normal for a country emerging with a small capital stock and an extremely low per capita income after the end of the Civil War in 1949.

The country’s entry into the eurozone aggravated the deficit as gross national savings declined sharply as a percentage of GDP, while investment spending rose, to peak at 26.7 percent of GDP in 2007.

The contraction in interest rate differentials among member states and the outperformance of the Greek economy vis-a-vis its Economic and Monetary Union trading partners largely explain the widening of the current account deficit in the previous decade.

Therefore, it is not surprising that the narrowing of the external deficit since 2009 coincides with both a continuous decline in the national investment-to-GDP ratio and the rise in the gross national savings-to-GDP ratio. The investment ratio fell to 13.6 percent last year from 18.6 percent in 2009, while national savings rose to 10.7 percent from 7.4 percent respectively. This has driven the deficit down to 2.9 percent of GDP in 2012 from 11.2 percent in 2009.

The savings ratio, which is largely due to the contraction of the general government budget deficit over this period, may climb further from about 13 percent of GDP this year to 16 percent in 2015 and 17.5 percent in 2016 in line with official projections, although some people have doubts about it.

However, the economy will have to get more help than projected from investment spending to achieve satisfactory GDP growth rates in coming years and to help make the public debt sustainable.

The Greek investment ratio had hit a low of 18-19 percent of GDP in the previous decades prior to 2009. There is nothing odd about assuming that this level can be attained in coming years, providing a much-needed boost to economic activity. This is more so since the economy cannot expect a boost from the fiscal side, consumer spending may well be flat or anaemic for some time and the push from the export side may be limited in the next few years as imports start picking up.

In this case, however, Greece will have to incur a current account deficit and not a surplus.

Some may argue that even a small current account deficit may be a small price to pay if it were for the economy to see high growth rates driven by investment. This is true to the extent that the deficit does not augment the Greek risk premiums given the country’s huge foreign debt.