Economy staring at recession again

The Greek state may be able to service its debt and pay pensions and salaries to civil servants in April. However, the limited progress in negotiations between the government and the official creditors on the conclusion of the economic policy program increases uncertainty, reduces credit availability and adversely affects domestic demand despite less austerity. The economic damage has increased the risk of recession.

The combination of a better-than-expected tax collection in March, the postponement of some budget expenditures and internal borrowing from some state entities and other sources made it possible for the government to pay both creditors and pensioners and civil servants last month. Greece paid an estimated 2.5 billion euros to the IMF and other creditors in March without including T-bills.

Assuming tax revenues remain on track and more general government entities lend part of their cash reserves to the state, we would expect Greece to be able to meet its obligations to creditors in April but it will face a tougher hurdle in May. It is reminded the state owes about 458 million euros to the IMF on April 9 and has to find an additional 700 million euros or so for T-bills maturing on April 14 which are held by international investors and most likely will not be rolled over. It will also have to pay 194 million euros to private bondholders on April 17 and 80 million euros to the ECB on April 20, according to Bank of America Merrill Lynch (BofA).

Deputy Finance Minister Dimitris Mardas, who is in charge of the General Accounting Office, assured recently that the state will make the payment to the IMF on time and pay wages to some civil servants in the middle of the month. This contrasts with leaks in the press, citing other government officials’ warnings that Greece would run out of money on April 9. Although no one disputes that the central government is in a tough financial position, some abroad suspect these warnings are also part of a Greek strategy to get some funding from the EU via the EFSF or indirectly from the ECB.

Even if Greece is able to overcome this hurdle in April, it will have to pass another test in early May, assuming it has not reached an agreement with its creditors by then. It will have to pay 200 million euros to the IMF on May 1 and an additional 763 million on May 12, according to a recent report by BofA. Of course, the country has shown that it intends to honor its obligations so far and could be able to continue doing so in the rest of April and even May to the extent that it is able to mobilize the cash reserves of state entities, collect more revenues than targeted in the adjustment program and postpone expenditures to suppliers and others for the future, building arrears.

However, this policy combined with deposit outflows from local banks, have tightened credit conditions and have started taking their toll on the real economy. This has prompted some economists to revise downward their growth forecasts for the year. A few do not rule out a contraction or stagnation of real GDP (gross domestic product) in the first quarter. It is reminded that GDP went into red in the last quarter of 2014, interrupting the recovery that had started early that year.

The economic climate, a leading indicator, has deteriorated while manufacturers recorded a third straight monthly drop in output in March, according to Markit. Investment spending has also dropped while consumption spending is a question mark since no austerity measures have been taken but uncertainty appears to have some effect. This was apparent in retail sales, which fell 2.6 percent year-on-year in January and 18.7 percent compared to December 2014.

The new government has vowed not to take austerity measures that would take the primary budget surplus to 3 percent of GDP as targeted in the adjustment program for this year from an estimated 0.3 percent last year. However, it seems to have conceded some ground as its leaked list of proposed reforms showed it aims at a primary surplus above 3 percent of GDP from a projected 1.2 percent in the baseline scenario where no new measures are taken. Although the list does not contain direct tax increases and does include higher social expenditures, it aims at raising more tax revenues, from 4.7 to 6.1 billion euros, in the next nine months or so mainly by combating tax evasion.

Some senior economists in international banks are puzzled. “They plan to raise nearly 2 percent of GDP through taxation in just eight months. This will have a massive impact on private consumption… rendering the assumptions of the baseline scenario pretty meaningless,” said Vassilis Gkionakis, head of global FX strategy at UniCredit. Others agree that this will have a recessionary impact, arguing there is a misconception that “tax evasion is a sort of free money pot, which can improve the fiscal balance without any other economic effects whatsoever.” This could be true for offshore accounts and global transfer pricing schemes but it is not true for other taxes because they are taken straight out of the domestic economy.

Greece may able to pay off its creditors in April. However, the prospects for the economy become more bleak as the standoff between Greece and its creditors continues. The government may be true in its intention not to raise taxes and cut pensions and wages. Nevertheless, raising so much revenue in so short a time will have a contractionary effect.

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