The Greek government will table its 2006 budget in Parliament today, aiming to cut the deficit to below 3.0 percent of GDP amid political accusations that it contains unpopular economic measures and it is not credible. The EU Commission appears to share the view that the budget deficit will not fall below the Stability and Growth Pact’s 3.0 percent limit without additional measures. We think the EU Commission is right in its assessment but the likely increase in the special consumption tax on fuel by the Greek government starting next year has the potential to fill the budget gap and produce the desirable result while limiting the magnitude of revenues from one-off measures, such as sales of non-financial assets, to less than 700 million euros compared to about 1.0 billion projected in the 2006 budget. However, it would have been a big mistake for the government to have given up on its economic policy of smooth fiscal adjustment and to have embarked on the so-called cold turkey approach to meet the pact’s requirement had the Commission insisted on structural budgetary improvements to close the hole, as the costs on the economy and society could outweigh the benefits. It has been a little bit more than a year since the conservative government unveiled the 2005 budget, its first, after more than 10 years in opposition. The budget was met with plenty of criticism and skepticism, emanating largely from the realization that was based on a rather optimistic GDP growth forecast. A year later, we all know two things. First, the 2005 budget deficit target is likely to be missed if Eurostat does not approve the securitization of some 1.5 billion euros of taxes in arrears, despite the fact that the government was forced to increase the VAT (Value Added Tax) by one percentage point to 19 percent and up some other excise taxes to make up for the revenue shortfall. Second, the so-called at the time optimistic official growth forecasts turned out to be much more realistic than the projections of others, including the EU Commission, international rating agencies, well-known foreign investment banks as well as Greek banks. We should remember that most of them forecast GDP growth rates of between 2.5 and 3.3 percent in 2005 when the actual growth figure exceeds 3.5 percent in the first 9 months of the year. Most analysts and commentators agree that this year’s budget deficit will end up between 4.6 and 4.4 percent of GDP without the proceeds from the securitization and range between 3.8 and 3.6 percent of GDP if Eurostat finally gives the green light. Greece is following in the footsteps of Portugal, whose similar securitization on tax in arrears Eurostat approved in the past. According to a 2002 Eurostat ruling, the operation is treated as government borrowing when securitization concerns future flows not attached to preexisting assets. It is also treated as borrowing when the government grants a guarantee to the special purpose vehicle (SPV). It is noted that the government transfers the ownership of the securities to the SPV which finances itself through the issuance of asset-backed bonds. The operation is also treated as borrowing when the difference between the initial payment by the SPV to the government and the market price of the asset exceeds 15 percent. Since the structure of the Greek securitization takes into account the above ruling, it would be rather strange if Eurostat did not give Greece the green light to count the securitization proceeds as revenues in the 2005 budget. To this extent, this year’s budget deficit should end up between 3.8 and 3.6 percent of GDP. The government’s decision to start hiking the special consumption tax on fuels next year – something we mentioned last week – should cover any revenues shortfall. This, along with strict control on primary expenditures and a good deal of flexibility in cutting the public investment budget, should ensure that the structural improvements will bring the budget deficit close to 3.0 percent of GDP in 2006. Of course, this is based on the assumption of strong GDP growth next year which few doubt following last year’s miss by private forecasters. But no one can be sure whether the above moves will manage to slash the budget deficit to below 3.0 percent of GDP in 2006. Though it would be wrong to judge a 2.9 percent deficit as happiness and a 3.1 to 3.2 percent of GDP deficit as misery, recalling the Micawberesque approach. If Greece succeeds, as we estimate, in cutting a great deal of the budget deficit via structural measures next year, well in excess of 0.6 percent of GDP, it would be unfair for the EU Commission not to allow it recourse to one-off measures of limited magnitude to satisfy the Security and Growth Pact requirement. If indeed the EU Commission does not allow Greece the use of one-off measures of a limited scale to tip the deficit balance below 3.0 percent of GDP, especially given the fact that Greece was given the notification of excessive deficit procedure under the «old» pact which does not rule them out, it will succeed in sending the right message to other big EU violators but will risk failing to live up to its role of navigating countries toward the medium-term goal of a balanced budget. The Greek government should do its best to prove the critics wrong and implement the 2006 budget. If that means colliding with the EU Commission on the limited use of one-off measures to bring the budget deficit to below the 3.0 percent of GDP threshold, so be it. It is better, although undesirable, to do that rather than give up its economic policy of smooth adjustment and go for the cold turkey approach which could hurt more than heal the economy and the society in the middle of the political cycle.