ECONOMY

Euro getting too strong

With the euro hovering above $1.30 against the US dollar and the market consensus calling for even higher levels in the next 12 months or so, the likelihood of an economic slowdown in the eurozone next year should not be underestimated. Should this be the case, the growth rate of the Greek economy will be revised downward, causing the budget gap to widen by more than expected. This is something Greece cannot afford and it is therefore imperative that it move swiftly to address the potential problem by pushing ahead with privatizations, public-private partnerships (PPP) and private finance initiatives (PFI). No US intervention Following comments by Alan Greenspan, the chairman of the Federal Reserve, in Frankfurt on Friday, which suggested that US was not willing to step in and help arrest the dollar’s decline against the euro, the single European currency strengthened to trading around $1.3040. Although the strong euro helps ease inflationary pressures in high-growth and high-inflation countries like Greece, it undermines GDP growth in larger countries, such as Germany, a main export market for Greek products and services. The German economy depends on external demand to compensate for weak domestic demand hampering economic growth. The magnitude of the problem facing countries like Germany can be recognized by noting that final domestic demand, comprised of consumption, investment and government spending, was up a mere 0.2 percent on average in Germany from the 1999 through 2003, while exports grew by 6.4 percent in the same period, helping cushion the impact. The strong euro has also added to the loss of international competitiveness in other countries, such as Italy, where domestic demand grew by 1.6 percent on average from 1999 through 2003, while exports by a mere 0.9 percent. Impact on Greece muted Although the impact of the strong euro on economic growth has become a dominant theme in other EU countries, this is not so in Greece for a good reason. The Greek economy has been expanding at fast rates in the last few years on the back of healthy consumption spending and brisk investment spending as the country rushed to complete major infrastructure projects linked to the 2004 Olympic Games as well as being the recipient of a vast amount of EU structural funds. Moreover, the strengthening of the euro was regarded as a blessing in disguise due to its dampening effect on inflation, long regarded as the main threat to the country’s macroeconomic stability. This was more so with oil prices rising for most of the year. The fact that Greek imports lagged behind GDP growth from 2000 through 2003, reversing a trend observed in the 1990s, in which imports of goods and services grew faster than GDP (gross domestic product) by four percentage points also helped alleviate concerns. Of course, the more favorable trends in the last few years can be explained by the larger role played by the more introverted construction sector in the development of the economy. One must remember that a stronger currency is generally believed to favor imports at the expense of exports. The general picture of the Greek economy has changed considerably, however, over the last few months when it became evident that the budget deficit was much larger than expected. The deficit, which is projected to exceed 5.0 percent of GDP this year, depends a lot on achieving high growth rates to fall below 3 percent next year. According to official government estimates, the deficit will drop to 2.8 percent of GDP in 2005, counting on an optimistic GDP growth forecast of 3.9 percent. Given the fact that the official growth forecast for next year falls below the range of private forecasts ranging from 2.9 percent to 3.5 percent, the risk to Greece not be able to attain its budget target is not negligible. A blow to exports? With the Olympics over and the government pledging to EU officials to follow a more restrictive expenditure policy, the importance of the external sector to GDP growth becomes greater. This is more so because official forecasts incorporate a rosy scenario about tourist receipts next year, counting on the positive image of the country as a tourist destination after the Summer Olympics. It is understood that these forecasts may turn out to be optimistic, adding to growth and budget woes, if a strong euro and an economic slowdown in eurozone countries work the other way. In addition to tourism, Greek merchandise exports heading for countries of Old Europe, such as Germany and Italy, may feel the pinch, hurting in turn local producers. Moreover, Greek companies doing business abroad will see their sales in dollars and other currencies translated into lower sales and earning figures in euros, putting pressure in their stocks on the Athens Stock Exchange. It should be noted however that some companies using dollar denominated materials in their production process will benefit.