Budget forecast of 3.9 percent growth next year too optimistic

The Greek economy is unlikely to grow by 3.9 percent next year, as projected in the 2005 draft budget, putting the government goal of budget deficit reduction to 2.8 percent of GDP at risk. In view of this, the government should start working on contingency plans to correct the resulting fiscal imbalances, before they get out of hand, in order to help avert the downgrading of the country’s credit rating and a new round of international criticism. Aiming at quieting down international critics of Greece’s reckless fiscal behavior ahead of his visit to Washington for the IMF and World Bank annual meetings, Finance Minister Giorgos Alogoskoufis unveiled last week the main figures of the 2005 draft budget. As expected, the budget will aim at a budget deficit of 2.8 percent of GDP, down from an estimated 5.3 percent this year. Unless one turns a blind eye to the increasing likelihood of early national elections in the spring of 2005 in conjunction with the presidential ballot – normally a budget deficit-boosting event – the odds are against a strong growth rate to the tune of 3.9 percent. Even assuming the economies of Greece’s major trading partners are going to recover next year, it is rather unlikely average GDP growth in the euro bloc will reach the 2.4 percent envisaged in the Greek budget. The consensus calls for economic growth of around 2.0-2.2 percent in the eurozone in 2005, with risks on the downside if the price of oil stabilizes around $50 per barrel in the next six months or so. Morgan Stanley estimates eurozone economic growth at 1.5 percent in 2005 if the price of oil remains at $50 per barrel. So, the 50 percent or so of Greek exports of goods and services heading into these markets in Western Europe will not get as much of a boost as assumed in the 2005 budget. Greece is likely to enjoy a significant increase in tourism next year, mainly thanks to the staging of successful Olympic Games this summer but also due to a natural rebound after receiving bad publicity in the international press for a year or so. Analysts, though, are quick to question whether the shipping sector, which has put on a great performance this year, will be able to contribute to the same extent in 2005 as well. Another drag on Greek GDP growth is likely to come from the Public Investment Budget (PIB). In the natural absence of Olympics-related spending next year, this budget is projected to fall to 8.05 billion euros next year, a decrease of about 16 percent compared to a year earlier. Since the bulk of the PIB money is used for financing infrastructure and other projects, the decrease should normally have a dampening effect on growth. What about consumer and private sector investment spending? It is not clear how they will play. Personal disposable income, that is, the income after taxes, should rise again this year, but to a lesser extent. Personal and consumer loans should continue to expand as consumer credit liberalization takes hold and the interest rate environment remains benign, but it is unclear whether double-digit growth rates can be maintained. Both of these factors should support consumer spending although less than before. On the other hand, the decline in Greek consumer expectations recorded in EU surveys does not bode well for consumer spending. These expectations may decline further if labor market conditions worsen – already there are signs of strain in the construction sector. More and more companies from other sectors are resorting to voluntary retirement schemes to get rid of excess personnel – and the price of oil remains at high levels, fueling inflationary expectations. Private sector investment spending should expand but to an unknown degree, for various reasons. By all accounts, residential investment spending appears to be robust, after a monthlong lull in the Attica region related to the Olympics, mainly thanks to borrowing at attractive mortgage rates. Still, building permits are on the decline for some time now, spelling trouble in the future if this trend continues. Non-residential investment spending is an unknown. First, business expectations appear to be on the decline as well. In private conversations, businessmen appear troubled by the lack of progress in certain areas such as privatizations, market liberalization and deregulation and initiatives to modernize the public sector and cut the red tape. Second, it is known that many local private sector firms rely on state procurements and other state-financed projects to do business. The decrease in the Public Investment Budget normally has an adverse effect on their investment spending. Still, the new development law may provide these and other companies with enough incentives to invest more, so it is difficult to gauge the final effect before the new law is revealed. The small reduction in the corporate tax rate should help, but only to a small extent. The outlook for private sector investments does not look brighter for another reason. A growing number of small and medium-sized firms reportedly face liquidity problems. Although interest rates are relatively low, these firms have seen banks become more alert to their financing difficulties, tightening up the screws. In addition, the Athens bourse, which should normally serve as a source of financing for these and other companies, is in a weak position to play this role, darkening the prospects for new investments. Foreign direct investments should have taken up the slack but there is little evidence of a significant rebound in non-resident investment inflows next year. All in all, the chances for Greece realizing a GDP growth rate of 3.9 percent next year are slim. This means there will be a shortage of revenues and expenditure overruns which may derail the effort to place public finances under control. If one takes into account the likely overestimation of revenues from the repatriation of funds by residents under the amnesty scheme, it is easy to see that the budget deficit goal of 2.8 percent of GDP is clearly at risk, to say the least. This means action will be warranted down the road to keep it from straying too far out.