Private consumption to determine whether robust growth will persist
If politicians from the ruling conservative political party were to have their way, 2006 would be the last year of belt-tightening ahead of the general elections scheduled for 2008. However wishes do not always come true. The chances are 2006 will most likely be another year of economic progress with the Greek economy growing by more than 3.2 percent and the budget deficit further compressed, though the improvement in numbers is unlikely to produce any great turnaround in the public’s mood, we think. In the new year, the Greek economy faces the difficult task of putting an end to the EU’s excessive deficit procedure by further compressing the budget deficit to below the 3.0 percent of GDP threshold via structural measures, namely spending cuts and permanent tax revenue enhancement measures, while also maintaining its strong GDP growth rates. A number of economists see a trade-off between the deficit reduction exercise and the need for a fast-growing economy but the experience of 2005 provides some comfort. The Greek economy surprised many analysts by growing faster than most forecasters predicted in 2005 and managed to close the budget hole to about 4.1-4.3 percent of GDP from a whopping 6.5 percent in 2004. We have to admit we also belonged in the pessimist camp early last year but changed sides in June when the presence of some previously unforeseen positive catalysts became obvious. Still, the successful combination of progress in fiscal consolidation and strong GDP growth failed to convince the majority of Greeks that better days lie ahead, according to the latest Eurobarometer survey. Whether this is due to the government’s poor communication policy, the limited diffusion of economic benefits to a wider portion of society, unfulfilled expectations or other reasons is not clear. Perhaps it is due to a combination of unfulfilled expectations and the ongoing restructuring in some sectors of the economy where the little guys fall victim to the superb pricing power of the big guys, including at some multinational giants. Needless to say, similar patterns in public opinion have been detected during periods of economic expansion under the previous Socialist governments. Positive prospects Looking to 2006, it is reasonable to expect that the Greek economy could grow faster than 3.2 and perhaps even 3.5 percent. On the positive side, the Greek economy can count on a stronger eurozone economy. If pundits are right, Greece’s main trading partners in the EU will grow faster than last year and this should provide a lift to merchandise exports and tourism. The latter also appears to be benefiting from the 2004 Olympics. Expected buoyant GDP growth rates in neighboring countries should also help the country’s external accounts, though it remains to be seen how Greek imports will behave if the economy expands at a 3.0 percent clip or better in 2006. Private investment spending is also likely to rebound in 2006 after a nearly flat 2005. The reduction in the corporate tax rate to 29 percent from 32 percent last year should help, along with a more flexible labor market after the legislative changes enacted last summer. The launch of some large FDIs (foreign direct investments), bogged down by bureaucracy for many years, and the speeding up of some others, which finally took off in 2005, will also contribute to the rebound in private investment spending. The implementation of public-private partnership (PPP) projects should provide another boost but this will not be felt much before the last quarter of 2006 as it takes time, usually six to 24 months to start the work on such projects, based on international experience. These projects, however, have the potential to mobilize private resources, even attracting foreign direct investment, and spread across different regions of the country, creating new jobs and contributing to the diffusion of economic benefits. Opportunities in the energy sector, which is gradually opening up, is also likely to lure companies ready to invest in capital intensive projects. Uncertainties On the negative side of the growth equation is the uncertainty about private consumption. The government sees it growing by 3.2 percent in real terms in 2006 but it may end up expanding at a lower clip that, if so, will most likely lead to slower GDP growth rate. Personal disposable income is the key and both the non-indexation of the personal tax income scale to inflation along with smaller pay rises in the public and parts of the private sector make private consumption spending vulnerable. Higher borrowing rates, assuming the European Central Bank sticks to its rate-hike campaign, will also weigh in since most Greeks take out variable-rate loans. Higher fuel taxes, as Greece starts the march to harmonize its consumption tax on fuel with the rest of the European Union, may also have a negative impact on consumption. Even more so if oil prices fail to decrease and the euro doesn’t appreciate against the dollar, taxing Greek consumers more than their counterparts in the EU-15. The possibility of higher excise taxes on tobacco and liquor should not be underestimated, given the government’s attempts to tidy up public finances. This should also have an effect, however limited, on private consumption. On the other hand, the expected increase in employment should help, along with the increase in household wealth, since the value of equities and real estate holdings has risen. Another source of uncertainty in the growth equation is the public investment budget (PIB). It is reasonable to assume the government may target PIB, as it did in 2005, if it needs a couple of hundred billion euros to push the 2006 budget deficit down to below the 3.0 percent threshold. This cannot be ruled out and it remains to be seen whether this will affect the much larger private investment spending component. Expected strong economic growth should help compress the budget deficit to lower levels but it is doubtful whether the government will succeed in bringing it to below 3.0 percent of GDP in 2006 without taking additional measures to limit expenditure growth and increase tax revenues. Given its willingness to slash the deficit without seriously denting economic growth as well as the European Commission’s unwillingness to endorse one-off measures to meet the budget deficit target, the government will have to decide whether to take new restrictive measures, risking public discontent, or not take action and fail by a relatively small margin to lift the country out of the excessive deficit situation in 2006. All in all, there are good reasons to believe that the Greek economy will grow by more than 3.2 percent in 2006 and make more progress on fiscal consolidation. It is questionable however whether the government will be able to cut the deficit to below 3.0 percent of GDP without additional measures. Even if it succeeds in both, it may find out, like its predecessors, that macroeconomic progress is not enough to make the majority of Greek households take a more positive view of the future.
