High growth has not translated into a significantly lower debt
First, the good news. The Greek economic motor is working well and looks poised to surprise again and expand by 4.0 percent this year and grow faster next year. Now, the bad news. Despite this strong economic performance, the budget deficit is projected to swell, prompting fears of a developing debt trap down the road. A combination of buoyant investment and consumption spending helped the economy grow by an upwardly revised 4.5 percent year-on-year figure in the second quarter, making it possible to expand by 4.0 percent and even 4.1 percent this year. Although this positive development is likely to bring in more tax revenues, taking some pressure off this year’s budget, it will do little to meet the 0.9-percent goal set in Greece’s updated Growth and Stability Program. Assuming the revenue shortfall in the public investment budget, which is a component of the broader general government budget deficit, amounts to 600 million euros, mainly EU funds, and the country finally collects some 700 million euros in arrears tied to the Second Community Support Framework (CSFII), the general government budget deficit would most likely end up at about 1.2 percent of GDP in 2003. It could rise even further depending on the slippage in the these two areas. As a result, the general government debt-to-GDP ratio may not fall below the 100-percent mark. Persistent debt Even though Greece has made significant progress in putting its public finances in order in the last six years or so, counting on sharply lower interest expenses and satisfactory GDP growth rates in excess of 3.0 percent since 1996, it has been unsuccessful in arresting its public debt dynamics. The debt, which stood at 108.5 percent of GDP in 1997, declined slightly to 105.1 percent of GDP in 1999 before heading back up to 106.2 in 2000 and 107.3 percent of GDP in 2001 on Eurostat-induced revision of Greek accounts. The debt-to-GDP ratio eased to 105.3 percent in 2002 and is set to drop to 100.2 percent in 2003. Even government officials, who take pride in an economy growing faster than most other EU economies and with one of the smallest budget deficits, are ready to admit to insufficient progress in curtailing the public debt. However, bringing the public debt-to-GDP ratio to much lower levels may be a Herculean task. Higher deficit Even next year, when the economy is likely to grow by more than 4.2 percent and may approach 5.0 percent in the first half on the heels of an even stronger-than-anticipated pickup in spending linked to Olympic projects and election promises, the budget deficit target of 0.4 percent of GDP in the Stability Pact is certain to be missed. Finance Minister Nikos Christodoulakis admitted recently it will be around 1.0 percent of GDP, a figure considered too optimistic by many analysts in view of the extra spending required to finance recently announced tax cuts, pay increases and other measures. This extra spending is estimated at some 3.36 billion euros or 1.45 percent of GDP. This means the decline in Greece’s public debt-to-GDP ratio in a year of very strong economic growth should be smaller than expected, leading to less optimistic forecasts about its future trajectory even if one assumes healthy GDP growth rates for a few more years. Aside from the potential upward pressure higher euro interest rates will exert on Greece’s mainly euro-denominated public debt and budget expenditure, there are a few more threats. Threats to growth First, the possibility of a mild economic slowdown, which may force the authorities to take some restrictive fiscal measures to ensure the budget deficit is not derailed, will make it more difficult for the economy to grow and therefore the debt-to-GDP to decline as expected. Second, the considerable rise in the private sector debt, consumer, mortgages and corporate loans, which may bring it up to the EU average, will weaken one of the economy’s engines. This effect will be aggravated if it coincides with much higher euro interest rates. Third, the country’s social security problem may resurface in the form of higher financing needs. Last but not least, Greece may fail to convince international credit agencies to upgrade its sovereign rating to AA- or higher in the next couple of years as the New Basel Capital Accord of the Bank of International Settlements (BIS) comes into effect. In that case, although the details of the most recent version of the accord are being worked out, Greek government bonds may pay the price. Credit upgrade needed Under current rules, the government bonds of OECD countries are assigned zero-risk weighting, which means potential buyers, namely banks, do not have to set aside capital when they carry them on their books. According to the new rules being discussed, this will change and Greek government bonds will have to offer a higher yield to compensate potential foreign banks for the capital they will have to set aside. A credit upgrade is a must but will not come easy if the country does not do more on the fiscal front and public debt compression. Undoubtedly, the Greek economy has a number of things going for it. However, the inability of policymakers to take advantage of strong GDP growth rates to put a lid on public debt is a cause for concern. This is more so when one takes into account the potential threats to the rosy economic scenario along the road outlined above. Unfortunately, the debt trap is still there and should be avoided if Greek living standards are to rise to the EU average.