Greece fails to take advantage of high growth to cut down on its enormous public debt

The Greek government does not worry about meeting the 3.0 percent of GDP budget deficit ceiling, sought in the EU Stability Pact, this year because it knows that strong economic growth, tax revenues from overdue cases and privatization proceeds should help contain the deficit well below that threshold. Even so, it is obviously worried about the outcome of next general elections and is therefore reportedly preparing a new package of «social» expenditures which threatens, along with other measures, to undermine public finances in the years to come. This reality did not deter Finance Minister Nikos Christodoulakis from calling on Germany and France not to violate the terms of the Stability Pact. Still, in light of the way the Greek fiscal situation is unfolding, the country should have been smart enough to call for the reform of the Stability Pact instead of coming out defending it. In an interview with the Financial Times, published last week, Christodoulakis warned Germany and France that excessive borrowing in violation of the Stability and Growth Pact could lead to higher euro interest rates. Christodoulakis came out defending the Stability Pact, saying that doing away with it would create problems in the big as well as the small countries in the eurozone. The Stability Pact has been criticized by many analysts and government officials in EU countries as being too rigid and lacking enough cyclical sensitivity when the economy goes into a downturn. Even Romano Prodi, the president of the European Commission, criticized it last autumn by calling it «rigid» and «stupid.» The Pact sets a budget deficit-to-GDP target of 3.0 percent and includes sanctions for those that violate it. The Greek Finance Minister may have won praise by some officials abroad for his position. These officials, however, probably do not know that Greece has embarked on an expansionary fiscal policy as demonstrated by the shrinking primary budget surplus, which does not include interest expenses on public debt. Most analysts see the primary budget surplus as a percentage of GDP between 3.5 and 4.0 percent this year; that is, much lower than the official 4.4 percent forecast or the 5.0 percent of last year. This in turn means that achieving the reduction in the public debt-to-GDP ratio to 87.9 percent in 2006 from 105.5 percent in 2002 sought by government officials is difficult, even if one assumes that the cost of borrowing will remain at low levels in the next few years. Missing deficit target Most private sector forecasts want the broader general government budget deficit to exceed the official target of 0.9 percent of GDP with estimates ranging from 1.2 to 1.6 percent. The key behind the emerging divergence is primary expenditure overruns and an expected shortfall in the public investment budget revenues. Primary expenditure rose by 16.9 percent in the first five months of the year compared with a 6.0 percent target for the year. The 2003 budget assumes an increase of 21.1 percent to social security funds this year and raises of 2.5 percent and 4.0 percent to civil servants’ wages and pensions. The government, however, has undertaken some new commitments toward public sector employees, which will add to expenditures. These will show up more in 2004, likely an election year, when public sector wages are estimated to increase by 6.1 percent on average and pensions about the same. Budget revenues seem to be heading in the right way in the first six months, aided by the collection of overdue tax revenues, but a shortfall in public investment budget revenues is likely, given that the State collected just a bit over 613 million euros in the January-May period versus a target of 4.1 billion for the year. All in all, it is likely that the general government budget deficit will exceed the 0.9 percent of GDP target this year. This by itself is not worrisome. What is, though, is the fact that the government, lagging behind in opinion polls and in keeping with the Greek tradition of giving favors and relaxing fiscal policy before elections to maximize political gain, appears willing to undertake permanent commitments. Salary and pension increases, hirings in the greater public sector and others appear to be in order. These commitments will undoubtedly burden future budgets and make fiscal adjustment under current Stability Pact rules more difficult. Let the good times roll With the Greek economy continuing to grow at a fast clip, and with GDP growth seen as surpassing the official 3.8 percent goal in 2003 – boosted by healthy increases in private consumption and investment spending on the heels of infrastructure projects related to the 2004 Olympics, and others co-financed with EU structural funds – one would expect a much better fiscal outcome. Nevertheless, this is not the case since Greece is falling in the same trap that other EU countries fell into a few years ago. Instead of taking advantage of the good times to eliminate its budget deficit and help speed up the reduction of its high public debt-to-GDP ratio, it acts as if everything is going well. This in itself, though, reveals one of the shortcomings of the Stability Pact which the Greek finance minister defended. The Pact has insufficient leverage on countries whose deficit is below the 3.0 percent threshold, but bites too much when times are bad, forcing them to take inappropriate measures. But increasing taxes or/and reducing expenditures in an economic slowdown is counterproductive. This does not, of course, mean one should pardon large countries which use their political power to violate the rules they helped write in the first place without being fined. It is right to criticize the large countries for wanting to play by their own rules, but wrong to base your criticism on the defense of a Pact in an urgent need of reform. Although proponents of the Pact would rush to support Christodoulakis by pointing out that there is enough room to cope with economic downturns in the sense that there is a medium-term goal for balancing the budget, and that things would be much better now if Germany and France had put their houses in order initially. Even if this is true, it does not make sense to continue making mistakes by tightening when the economies are slowing. Greece may find itself in the same position Germany and France are today a few years down the road with the additional burden of a much higher public debt. The signals are already here. The economy is growing fast, but the government appears to be adopting an easier fiscal policy to help it achieve its political aims. Either Greece will have to bite the bullet of fiscal discipline, which is unlikely, or join those who are calling for the reform of the Stability Pact. But it cannot go on having it both ways, as it will most likely find out in a few years’ time.