Public and private consumption bound to suffer from the end of the era of low interest rates

For an economy like Greece’s, which for about 20 years has had a public debt in excess of its annual gross domestic product (GDP), the era of low interest rates which was ushered in by membership in the European Economic and Monetary Union, while dollar rates also hovered around 1 percent, was indeed a godsend. Interest expenses were thus kept low and the government launched successful efforts to restructure the debt (80 percent of which is now at fixed rates and the repayment period has been extended). Today, we pay about 10 billion euros in interest annually, less than one-quarter of budget revenues. Clearly, had Greece been left outside the eurozone, on the basis of its domestic inflation and public deficits, it would now have to borrow at rates higher than 7 percent, with inevitable cuts in wages, pensions and investment. The recent increases in the European Central Bank’s benchmark rate, coupled with the US Federal Reserve’s warning of an inflationary threat and the general climate of uncertainty in money markets are probably signaling that the global economy will have to find a balance at higher interest rates in the coming months at least. This will have little impact on Greece this year, given that the government has completed its borrowing program. For 2007, however, Deputy Finance Minister Petros Doukas has estimated that for every increase of 25 basis points in euro rates, the country’s debt servicing will be burdened with an extra 70 million euros. This means that fiscal policy must become stricter, especially with cuts in public consumption, while efforts must be made to control tax evasion in order to boost revenues. But over and above the fiscal consequences, we should be aware that rate increases will affect private consumption and investment activity, particularly in housing, which has been favored by the low mortgage rates of recent years.