Will prudence prevail over need for painful fiscal readjustment?

Most pundits believe the Greek Parliament will be able to elect a new president of the republic next year, sparing the country of a new round of general elections. They point to the signals sent by the main opposition Socialist party and the unwillingness of the Greek public to go to the ballot for the third time in a year or so. However, the ruling conservatives’ decisive win in the European Parliament elections on June 13, the greater-than-initially-envisaged fiscal imbalances, and the need to take measures to tackle them have increased, not decreased, the chances of holding general elections next spring. The conservative New Democracy party won the general elections in March, beating the Socialist PASOK party by 5 percentage points or so and had its lead widened to about 9 points in the elections for the European Parliament earlier this month. In the interim between the two elections, the government chose to put more emphasis on handling the Cyprus unification issue ahead of the island’s entry into the EU, ironing out the differences between prominent members of the Greek Church and the Patriarchate in Istanbul and carrying out the pre-announced auditing of the state’s public finances. By all accounts, this was a well-calculated stance in view of the elections for the European Parliament and the need to focus a lot of attention and resources in the Olympic Games. This stance appears to have paid off politically so far, but has resulted in no clear economic policy initiatives, and it is reasonable to expect that little should be expected on the economic front before September at the earliest. The ongoing auditing of the state finances, however, reveals an even worse fiscal picture than initially presented, calling for measures to stem the tide and putting Greece’s public finances in order. It is noted that Greece’s 2003 budget deficit was revised to 3.2 percent of GDP in early May versus an earlier estimate of 2.95 percent of GDP, which is a far cry from the 1.4 percent of GDP estimate found in the country’s most recent updated stability program in December 2003. Of course, this is not the end of the story as new figures come to light, perhaps driving the public debt up to 109 percent of GDP from an earlier estimate of 103 percent last year. This is worrisome because, as we said a couple of weeks ago, it looks as if the revision of the European Union’s Stability Pact will place more emphasis on the debt than the budget deficit reduction, making Greece more vulnerable. Although some relief should be expected from privatization and securitization proceeds as well as the end of spending linked to the organization and infrastructure projects of the 2004 Olympic Games, the gruesome fiscal reality requires unpopular measures. However, the government appears to place more emphasis on tax reforms, providing relief to thousands of companies and the new so-called «Development Law» that is expected to provide incentives for investments, leaving the rest to the closing of pending past tax cases and the elimination of waste in the public sector. These measures may indeed prove pro-growth in the medium term, bringing in more revenues to state coffers. It is likely, though, they may deprive the budget of much-needed revenues in the next six to 12 months, making it more difficult for the government to correct the imbalances at the same time the EU authorities may become even more demanding. Minimizing political cost Faced with this gruesome fiscal reality, the new government does not really have many options. It can embark on a pro-growth economic policy and opt not to take restrictive measures to address the fiscal imbalances in the near term, hoping GDP growth will accelerate and the fiscal house will be put in order without having to pay a high price in terms of political cost. This may or may not work since it makes an optimistic assumption about fiscal consolidation. The government has another option. It can go ahead with the already announced reform initiatives in the fall and take advantage of the election of the new president of the republic to provoke early elections next spring. This is more likely if it still enjoys a comfortable lead over the Socialists. This way, the government can renew its mandate and move to tackle the country’s fiscal problem in a more decisive way since it will have a four-year horizon and its pro-growth policy initiatives, to be enacted this fall, will already be in place. It is obvious that the political and economic advantages of such a move – which, of course, will not be advertised beforehand – outweigh the cons. Finance Minister George Alogoskoufis has already signaled that he does not favor the so-called cold-turkey approach in dealing with the country’s fiscal problem. In a statement, which stunned some in the market and sent the shares of Public Power Corporation (PPC) sharply lower last week, he declared a freeze in the price increases of state-controlled utilities. This step, along with his mild approach to addressing the country’s fiscal imbalances and the emphasis on a politically charged auditing of public finances, is compatible with the scenario of early elections next year. Of course, one may say it is too early to talk about early elections again in 2005 and the odds admittedly are not in favor of this scenario at this point. There are good reasons to believe, however, that key government officials understand both the importance of correcting the imbalances, even if it means taking restrictive measures, and the importance of business and political cycles.