The recent, limited Cabinet reshuffle has unofficially signaled the beginning of the campaign leading to the next general elections. Given the lax fiscal policies applied by Greek governments in the runup to the elections and the swelling of the central government budget deficit in the first five months of the year, there is good reason to believe things may get worse before they get better. Although most analysts, politicians and others seem to be primarily concerned about economic growth and inflation after 2004, the real threat to the Greek economy may come from another source: the fiscal side. According to recently published central government figures for the January-May period, the deficit widened by 74.5 percent year-on-year to 6,747 million euros, which compares unfavorably with the 12.7 percent decrease to 5,303 million euros sought in the 2003 budget. The significant drop in EU inflows directed to projects funded by the public investment (PI) budget, one of the two main components of the central government (CG) budget, along with the strong rise in investment outlays by 43.1 percent, helps partly explain the widening of the gap. Even more important is the contribution of the second component of the CG budget, namely the ordinary budget (OB) deficit, to the significant deterioration in public finances in the first five months. The OB deficit swelled by 89 percent year-on-year to 4,046 million versus an annual target of 485 million euros. This is mainly the result of flat revenue growth and a large increase in expenditures. One-off revenues from the introduction of euro coins and notes in early 2002 boosted revenues last year, making a year-on-year comparison less favorable than it really is this year. Adjusting for this one-off item, revenues should have increased by 4.2 percent in the January-May period, that is close to the annual budget target of 4.9 percent. On the expenditure side, some base effects also played a role since family allowances, other benefits and salary increases to different categories of civil servants which were handed out from July 1, 2002, made a comparison less favorable. Almost certain overrun Although some smoothing out should be expected in the second half of 2003, few believe the 5.2 percent rise forecast in the 2003 budget will be achieved this year. Compensation to farmers for damages incurred from bad weather during the December 2002-March 2003 period, along with the regular increases in pensions and salaries, almost surely point to an expenditure overrun which may bring the year-on-year rise to almost 8.0 percent from 5.2 percent targeted in the 2003 budget. Assuming PI budget revenues recover but not up to 4,100 million euros forecast in the budget, then the CG budget deficit may widen to 6.0 billion euros versus 5.3 billion projected in the 2003 budget. This, in turn, may drive the broader general government budget deficit to 1.5 percent of GDP versus the 0.9 percent targeted by the government. If one adds the usual spending overruns associated with the pre-election period, then even a budget deficit of 2.0 percent as a percentage of GDP, or even higher, should not surprise, especially if the conservatives come to power. This development is certainly not the best, but it still does not put Greece in the camp of countries such as Germany, France and others seen running a budget deficit in excess of the 3.0 percent of GDP threshold stated in the Stability and Growth Pact. Still, it is worrisome that Greece, a fast-growing economy with a high debt-to-GDP ratio on the order of 100 percent, seems unable to capitalize on several years of strong economic growth to reduce its debt-to-GDP ratio to much lower levels and produce some budget surpluses. Given the fact that a good deal of fiscal consolidation is due to Greece’s paying less in interest expenses on its public debt, on the heels of much lower interest rates and the smoothing out of the maturity profile of its public debt, concern about the health of public finances in the next few years is well justified. This is more so because of Greece’s aging population and the likely strains this will place on its ailing social security system in the next few years. The reasoning is very clear. If Greece cannot use its years of strong growth to produce budget surpluses, reverse its public debt dynamics and help bring down the deficit, when will it do it? Even though its economy is projected to grow by more than 3.8 percent this year and next, there are doubts whether it will be able to sustain these growth rates from 2005 onward, despite the fact that the EU inflows from the Third Community Support Framework (CSF) are forecast to run up to 2008. Faster growth generates more tax revenues and puts less pressure on increasing expenditures to counter an economic slowdown. Global recovery dangers In addition to concerns about a likely economic slowdown past 2004, some analysts are worried about a rise in interest rates and bond yields ahead as the world economy and eurozone’s in particular recover. Higher bond yields, however, will definitely translate into higher interest expenses, neutralizing and even reversing one of the major motors of fiscal consolidation in the last few years. Things may be complicated more by the fact that large asset sales of state-controlled entities may have already run their course without having a tangible effect on public debt. Although there are some state entities which can be sold to raise a good amount of money, most large state-controlled companies, such as OPAP, PPC, and OTE have already been partly floated on the Athens bourse and few of the remaining ones are slated for privatization. Although the disappointing five-month budget figures have alarmed many analysts who see little room for improvement in the runup to elections, scheduled for spring 2004, few realize that the likely combination of slower growth, higher bond yields and interest rates represents a threat to Greece’s efforts to arrest the dynamics of its public debt. Unless Greek governments learn to tackle spending growth in an effective way, the fiscal side represents a clear danger to the country’s future economic prospects.