Recent GDP data point to a slowdown in the contraction of economic activity this year but the rebound may still be quarters away as the ongoing deleveraging of wages in the private sector and fiscal austerity measures continue to bite. Bank credit expansion to the private sector, considered by many a necessary condition for growth, could help. However, bank deleveraging is likely to go on for quite some time, making things more difficult. Perhaps large Greek companies could help solve the puzzle by facilitating the flow of credit to the rest of the private sector and prop up the economy while banks continue to deleverage.
The Greek economy contracted by 4.6 percent year-on-year in the second quarter compared to 5.6 percent in the first quarter, according to preliminary data provided by the Hellenic Statistical Authority (ELSTAT). The new figures suggest real GDP fell by 5.1 percent year-on-year in the first half of 2013, meaning real GDP will have to contract by an average 3.3 percent in the second half to meet the troika’s target of negative 4.2 percent for 2013.
So far, the external sector has been the only positive contributor to Greece’s GDP. The lenders and government policymakers think reforms in the labor market and a drop in unit labor costs will improve competitiveness and boost exports. However, it is depressed domestic demand cutting into imports rather than a strong surge in exports of merchandise goods which has accounted for the sharp drop of the current account deficit to about 3 percent of GDP in 2012 and the positive impact on GDP so far. Signs of recovery in the eurozone economy and a good tourist season should lift exports going forward but there are tentative signs of fatigue in the compression of imports.
The combination of fiscal austerity, albeit milder going forward, high unemployment and continuing wage deleveraging in the private sector has compressed private and public consumption, the biggest component of the GDP. It is expected to continue to do so for a few more quarters before it starts to level off as the direct and indirect negative effects start abating. In addition, private investment spending continues to be a question mark. Investment spending fell below 14 percent of GDP last year and is projected to fall further in 2013 to a new all-time record low. It is normal to expect a gradual rebound from such depressed levels but it hinges on a number of factors.
There is no question that fiscal austerity, the extent of further wage moderation in the private sector on the back of persistent high unemployment and the expansion of bank credit to non-financial private companies will play a significant role in shaping economic activity via demand.
We will focus on bank credit, which is widely regarded by many as a necessary condition for jump-starting the economy. It is interesting that a study by the European Banking Federation (EBF), spanning the period 1980-2010, found Greek GDP leads bank credit in the sense that higher economic growth has been accompanied by faster credit expansion in the future. This is likely due to the inclusion of the period prior to Greece’s membership in the euro.
But other studies by Eurobank and Costas Karfakis at the University of Macedonia in Thessaloniki have shown there is a significant correlation between credit supply and changes in the Greek GDP, going the other way around. In his study, Karfakis notes, “the recovery of the Greek economy requires a positive credit shock which will stimulate real output.”
Greek bank credit may lead GDP but it is questionable whether this is possible. The completion of the recapitalization of major banks and the dissolution of others has created the impression that bank credit will start flowing back to the economy in the months ahead. Credit to the private sector shrank by 4.1 percent year-on-year in June to about 224 billion euros from 248 billion at end-2011 and 258 billion at end-2010. In other words, the outstanding balance of loans has fallen by 13.2 percent since the end of 2010 when Greece sought the bailout. It has dropped by just 10 percent since the end of 2009. This is not a large drop if compared to the sharp contraction of economic activity over the same period.
However, the banks’ loan portfolios will be stress-tested again in coming months and will likely show a capital shortfall between 5 and 10 billion euros if pundits are correct. The credit institutions may be able to cover this shortfall without resorting to a new round of share capital increases but this will not make it easier for them to extend credit to the private sector. With nonperforming loans still on the rise and at high levels, one should expect banks to be very diligent in preserving capital and maintain high capital levels. So strict lending criteria will apply which will limit the availability of credit to the private sector.
However, there may be a catch which could both help banks’ orderly deleveraging and preservation of high capital adequacy ratios and keep the credit flowing to the economy, especially to medium-sized and small firms, at a satisfactory clip. This depends on the ability and willingness of large Greek corporations to tap the international capital markets and use part of the proceeds to repay their bank loans. Some companies, such as OTE, FAGE, Hellenic Petroleum, Frigoglass, Silver & Baryte and Intralot have already done so and some others are set to follow suit. This gives them the opportunity to diversify their funding sources and be less dependent on Greek banks albeit at a higher cost.
All in all, the large Greek corporations could help banks to deleverage while continuing to supply capital to credit-worthy private firms and households by tapping the capital markets and partly repay their short-term and other loans. With bank credit leading GDP according to studies, this development will be valuable.