Don’t do it like Portugal

Greece is heading into general elections next week with both major parties, that is, the socialist PASOK party and the conservative New Democracy party, seeking to convince voters they offer the best alternative on the economic front, even though a close look at their economic programs reveals more similarities than differences. Still, the biggest challenge for the winner will be to deal with the increasing fiscal imbalances without turning Greece into another Portugal. There is little doubt that public finances are in worse shape than they officially appear to be. Still, the new government can make them look even worse than they really are by including certain expenditure items that the EU’s statistics service, Eurostat, does not require be put in the budget. If these items are included and the existing official budget accounts are restated to reflect the true figures, it is very likely that Greece will find itself with one of the highest budget deficit and public debt-to-GDP ratios in the European Union at the same time it prides itself on the highest GDP growth rate in 2003 and promises one of the highest in 2004. Restating the deficit Analysts and others well aware of the Portuguese experience warn against the unnecessary swelling of the budget deficit to reap political gains, although they admit in private what everybody suspects, that Greece’s budget deficit will end up being larger than the latest revised official estimates want it to be. The current government forecasts a general government budget deficit-to-GDP ratio of 1.4 percent in 2003, which compares unfavorably with an earlier target of 0.9 percent and a budget deficit of 1.2 percent in 2002. It forecasts a deficit of 1.2 percent of GDP in 2004. The technocrats at the EU Commission have been even less optimistic, putting the Greek budget deficit at 1.7 percent of GDP in 2003 before rising to 2.4 percent in 2004 and slightly easing to 2.3 percent in 2005. Undoubtedly, Greece can count on better-than-expected economic growth last year to absorb much of the pressure, but still the restatement of the budget deficit figures may send it above 2.0 percent and perhaps close to 3.0 of GDP in 2003, confirming speculation that it is in worse shape than many thought a month or so ago. Even so, it would be unwise and very dangerous for the Greek economy should the new government revise the budget figures in such a way as to make the deficit exceed the 3.0 percent of GDP mark. Any government has some leeway in determining the actual size of the budget deficit. The Portuguese trap The case of Portugal is very interesting and very real and shows the trap a government may fall into should it choose to over-restate its public accounts. The new Portuguese government decided to revise the 2001 budget figures upon coming to power, driving the budget deficit to 4.2 percent of GDP, that is, above the 3.0 percent threshold of the EU’s Stability Pact. Reacting to the new fiscal reality and the demands of the European Commission, the new Portuguese government took restrictive measures to reduce the deficit. Although it partially succeeded in its goal to put public finances in order by bringing the deficit below 3.0 percent of GDP in 2002 – when the deficit ratio stood at 2.7 percent – and, perhaps, 2003, it definitely hurt economic growth. This made budgetary consolidation more painful and more costly in terms of lost GDP output since the Portuguese economy grew by just 0.4 percent in 2002 and is estimated to have shrunk in 2003. Of course, in addition to the parallels one may draw, some major differences between the Greek and the Portuguese economy have to be pointed out. First, the latter is more exposed to the cyclical fluctuations of the EU economy than Greece and the initiation of the fiscal adjustment started at a time that other major European economies were stagnant or in recession. Second, although most analysts and politicians expect the Greek economy to slow down once all the construction projects and other activities related to the 2004 Olympic Games are done, almost no one, at least in public, has expressed the opinion that the Greek economy will fall into recession or stagnate in 2004 and 2005. On the contrary, most analysts appear to be more optimistic now than they were a few months ago about the country’s economic growth, betting that low interest rates, generous pay raises in the public sector, huge capital inflows from EU structural funds and an improvement in the international economic and financial environment will keep the Greek economy going even after the Olympics. Greece’s debt vulnerability On the other hand, Greece is in a more precarious position than Portugal when it comes to public debt. Greece’s general government debt is estimated at a little bit over 100 percent of GDP in 2003 and this figure may be revised if the new Greek government chooses to restate the public accounts. It is forecast to fall to around 96-97 percent of GDP in 2004. Portugal’s public gross debt is estimated at around 57.5 percent of GDP in 2003 and is seen as rising to 58.6 percent in 2004, according to the EU Commission. This is also reflected in each country’s public borrowing program, with Greece seen as tapping the capital markets for some 28 to 30 billion euros this year, excluding T-bills, while Portugal is forecast to borrow only 7.5 billion euros. There is little doubt that Greece’s public finances are in much worse shape than official figures suggest. The fact that the Greek central bank’s figures show the 2003 budget deficit, calculated on a cash basis, as 50 percent higher than in 2002, exceeding 10 billion euros, provides hindsight. Still, it will be a big mistake for the new government to make the mistake of restating the official account in a way that mimics Portugal’s. After all, the lesson from Portugal is too serious to be ignored and the incoming Greek government should not shoot itself in the foot, hurting the economy along the way.

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