Government failed to seize the initiative at the right moment

A pro-active economic policy carries more risks, especially political ones, than a reactive policy, but it can be much more effective in attaining certain targets. The tougher-than-expected fiscal measures announced by the government last week to help close the budget hole are dictated by economic reality, but they should have been taken months ago when it became clear the fiscal imbalance was much larger than initially thought. In being late, the authorities showed they have fallen behind the curve, a major political and economic policy mistake, which has to be corrected as soon as possible, even if it means holding new general elections in the fall. Following last year’s general elections that brought the conservatives to power after a long stay in opposition, we had argued along with others that the government should take advantage of its fresh mandate to take all painful and unpopular economic measures in the first six months of its term. Given the fact that the deliberations for finding a commonly acceptable solution to both communities in Cyprus were under way, the elections for the European Parliament were coming in June and the country hosted the 2004 Summer Olympics, one would have expected the package of economic measures to be announced in the September-October period. Missed opportunity The unveiling of the 2005 draft budget and the revelations about the derailment of public finances offered the best opportunity to do so; but the government missed it. Some, at the time, thought it did so because it had in mind calling early elections in the first quarter of 2005, using as a pretext the election of the new President of the Republic. They, including us, were wrong again. By the end of 2004, it had become clear that the economy was still growing but that strong headwinds lay ahead. The boost from spending related to the Olympic Games was almost over, the EU was demanding that Greece take realistic measures to honor its commitment to reduce the budget deficit below the 3.0 percent of GDP goal by end-2006, and a growing number of firms were facing tighter liquidity conditions. Some of them in the hard-hit construction, textile, apparel and IT sectors had already fired thousands of employees and had stopped paying their suppliers and their remaining workers. Deteriorating business expectations just confirmed the trend, falling again in February 2005 after a temporary halt to a months-long slide in January despite better-than-expected GDP growth, estimated at 4.2 percent in 2004, compared to the government’s revised forecasts of 3.8-3.9 percent growth rate. Faced with the near collapse of the tax collection mechanism, reflected in a sharp drop of VAT (valued-added tax) in the first two months of the year as small and medium-sized enterprises and self-employed professionals stepped up their efforts to evade taxes, the government was forced to take action, resulting in the 1.0 percentage point increase in the VAT rates as well as other consumption taxes on tobacco and alcohol announced last week. These measures, aiming to shore up public finances, have understandably produced discontent in the general public since it is certain to fuel inflation and to hit growth negatively. The business community is also wary of the measures because they are seen as weakening domestic demand and therefore sales and profits, although the need to bring down the budget deficit is recognized. Privatizations Once again, the government’s best allies can be found among analysts, brokers, investment bankers and others who work for international banks, brokerages and institutional funds. It seems as if most of them take a much more sympathetic look at the measures, putting greater emphasis on fiscal consolidation as a means for ensuring long-term economic growth. This means speeding up the part-flotation of state lottery OPAP and Athens International Airport, picking the team of advisers for the part-flotation of the Postal Savings Bank (TT) seen later this year or the beginning of 2005; selling a large equity stake of telecoms incumbent OTE to a large foreign telecoms operator along with handing over the management will please them even more. Unfortunately for the government, although non-residents do not vote, Greeks do; and history tells us that Greeks pay more attention to economic growth and their personal pockets than whether their government is taking measures consistent with fiscal responsibility. Nevertheless, what appears to be an effort to revive a stalled process should be viewed as a welcome development for the Greek economy. However, it may not suffice to change the economic and political climate if efforts to revive investment spending fail and private consumption, the anchor of GDP growth, is hit harder than thought by the announced fiscal tax hikes and perhaps some new, restrictive fiscal measures to come. The task is getting harder because delays in public works and EU co-financed projects have already hampered economic growth and contribute to the deterioration of business expectations. The same holds true when it comes to public-private sector partnerships, seen taking off in the second half of this year at best, and forms of private-finance initiatives as well as the unblocking of hundreds of millions of euros in foreign direct investment projects pending for a decade or so. Putting more emphasis on measures to prop up development and control primary spending rather than taxes is necessary if the government is to improve the economic climate. The next six months or so will tell whether the government has managed to get ahead of the curve. History, however, is not on its side since it has spent more time than it should to come to grips with economic reality and act decisively. If the government fails to change the course of the economy in the next six to eight months, then the only way out may be what most people dislike: general elections.

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