The risk of fiscal propriety

Economy and Finance Minister Giorgos Alogoskoufis is absolutely right when he says the country’s national accounts should be transparent and reflect the real fiscal situation without resorting to any kind of window-dressing. After all, how can any government take the right economic policy measures if it relies on the wrong budget and public debt data? But this requires that the accounting treatment of certain expenditure and revenue items is free of political considerations and is not disputed. However, this is hardly the case here. In the process, the country’s reputation has been damaged, making the attainment of economic growth rates needed for fiscal consolidation more difficult to achieve. Discrepancies The government claims it did the right thing in disclosing the real magnitude of the fiscal problem and points to a number of discrepancies between stock changes (public debt) and flows (deficits) in public finance accounts over the last few years to justify its position and show that is not motivated by politics. To some extent, some of these discrepancies were taken care of a couple of years ago when Greek public figures were restated, bringing the public debt-to-GDP ratio to 107 percent from 102.7 percent in 2001 and turning the 0.1 percent of GDP budget surplus into a 1.2 percent of GDP deficit. The 2002 budget and public debt figures were also revised upward accordingly at the time. Reclassification The revisions reflected the reclassification of capital transfers, which were essentially subsidies to state-owned corporations, as expenditure items in the budget, and the inclusion of proceeds from securitization, convertible bonds and privatization certificates, called prometocha, in the calculation of general government public debt. Prior to the revision, capital transfers were matched by equal equity participations and treated as below-the-line financial transactions. The government was able to retire public debt by issuing new debt through convertible bonds and securitization operations that Eurostat did not include in the calculation of public debt. Following that reclassification, the public debt was burdened by some 3.7 billion euros from the securitization of future revenues expected from the Third Community Support Framework (CSFIII), the state lottery and other entities. Also, an amount of more than 1.7 billion euros raised from convertible bonds and privatization certificates was added to the public debt. Defense spending High-level Finance Ministry officials fiercely defend the highly disputed accounting treatment of defense spending, which was the main factor behind pushing the budget deficit to above 5.0 percent of GDP, saying it was in accordance with Eurostat’s rules. Moreover, they point out that there is no legal means to take Greece out of the eurozone and stress that preliminary estimates of the 1999 budget deficit show it was clearly below the 3.0 percent of GDP level, meaning Greece satisfied the relevant Maastricht criteria at the time. Moreover, they say other eurozone countries had their budget deficit-to-GDP figures revised upward, surpassing the 3.0 percent threshold after joining EMU. So if the worst comes to the worst, Greece has nothing to fear. Still, Greece has received massively bad publicity for the major revisions of its fiscal accounts in the last week or so, prompting a growing number of analysts and commentators to express concern about the medium- to long-term implications of the apparent damage done to the country’s reputation. They are right. Although financial markets seem to be downplaying the whole affair, as evidenced by the net inflows into Greek equities in the last two weeks or so and the negligible impact the bad news about the widening budget deficit and spiraling public debt has had on Greek government bonds, there is reason for concern. Despite the issue of accounting treatment, Greece appears to have lied to its EU partners about the real status of its public finances. This is bound to haunt government officials, whoever they are, in their dealings with Eurostat and other EU bodies in the years to come. There should be no mistake about this: EU bodies will be much tougher and more demanding toward Greece when it comes to dealing with public finances. In turn, this means the Greek government officials will have less space to maneuver than in the past. This is likely to translate into more difficult and politically unpopular budget choices for the government, which may undermine the main goal of keeping the economy growing for a number of years after the Olympics. To this extent, even the short-term political benefits enjoyed by the government on fiscal transparency may turn out to be a major political liability mid-term, assuming no elections are held next spring, because it will be more difficult to deliver on its pre-election promises. Damaged reputation Moreover, the damage to Greece’s reputation from this fiscal affair is likely to transcend party lines and reflect badly on Greek individuals and corporations doing business abroad, especially given the low reputation the latter enjoyed in the business circles of Western Europe just a few years ago. In this regard, the real cost to the economy on the road to instituting fiscal transparency may turn out to be greater than some government officials think. In an article last March, we wrote, «It will be a big mistake for the new government to restate the public finance accounts in a way that mimics Portugal… the lesson from Portugal is too serious to be ignored and the new Greek government should not shoot itself in the foot, hurting the economy along the way,» referring to the Portuguese conservatives’ similar approach to fiscal accounts a few years ago. The Greek government did not do just this, it went further. But in doing so, the Greek government risks finding out that it cannot follow the smooth route to fiscal discipline it had in mind. It may be forced to take the kind of restrictive fiscal measures that it never intended to take. Portuguese conservatives did take them, and undermined economic growth.