Strong euro shields Greece from C/A deficit fallout

Greece’s large current account deficit demonstrates better than anything else the benefits to the country and the economy of joining the eurozone a few years ago, but it also points to the erosion of its international competitiveness. The strengthening of the euro appears to have aggravated the deficit but a closer look reveals it may be a blessing in disguise. No one could have imagined in the previous decades that Greece could have recorded a current account deficit of higher than 10 percent of gross domestic product (GDP) without provoking a currency crisis, which would have normally forced the government to depreciate the drachma and take restrictive fiscal and incomes measures to reign in aggregate demand. A deficit in the order of 5.0 percent of GDP would suffice. Today, Greece faces a much larger current account deficit – which is the sum of the balance of trade, net factor income and net transfer payments – but few seem to be noticing and/or worrying about the consequences. The reason is very simple. Being a member of the eurozone, Greece does not face any currency crisis, since its currency is the euro in which its GDP has a tiny effect given the small weight of its economy. In other words, Greece’s membership in the eurozone has not only brought the lowest interest rates in generations, it has also shielded the country from the kind of currency crises experienced in previous decades with a much smaller current account deficit than that at present. Joaquin Almunia, the commissioner for monetary and economic affairs, appears to be one of the EU officials who is concerned about the sustainability of this huge deficit and its medium-to long-term consequences on the country’s economy. In a speech to government officials and businessmen in Athens last week, Almunia pointed out that the current account deficit was the only macroeconomic figure which failed to improve in 2006 from a year later. Almunia linked the country’s huge deficit, amounting to 11 percent of GDP in 2006, to the erosion of competitiveness, attributing it to some extent to Greece’s faster rising unit labor costs, compared to its eurozone peers. He pointed out nominal wages increased by some 6.0 percent locally last year, while productivity grew by 2.75 percent, producing a unit labor growth figure in excess of 3.0 percent. On average, unit labor growth has surpassed the eurozone average by more than 1.0 percentage point annually the last few years, undermining the country’s price competitiveness. He also offered some advise about tackling the problem by modernizing the public sector, doing away with labor market rigidities and reforming the social security system in addition to slowing unit labor cost growth. Undoubtedly, Almunia is not alone. The Greek central bank and economists from local commercial banks have spoken openly or hinted at the problem of competitiveness and its roots. Still, some argue that the situation is not as dramatic as it sounds if one takes into account the cyclical factors. The economists of the National Bank of Greece pointed out in a recent report that buoyant fixed investment activity and the transitory effect of higher oil prices and increased payments for new ships account for about half of the country’s current account deficit in 2006. A pickup in merchandise exports and tourist receipts is not expected to have the same impact as the expected decline in fixed investment and payments for large ship orders but this will not be felt much before 2012. Even so, the country’s current account deficit is projected to be around 5.5 percent of GDP in 2015, that is, well above the long-run sustainable level of 4.0 percent of GDP according to their estimates. The Greek economy, like its other eurozone counterparts, faces another hurdle in exporting goods and services to third markets and this is the strong euro. The euro reached a new high of $1.3681 against the dollar last week, surpassing the previous record high of $1.3666 touched on April 25 and first set on December 30, 2004. It is noted that the euro debuted at about $1.17 in January 1999. The euro has been also strong against other currencies, such as the Japanese yen. Theoretically speaking, the strong euro aids imports by making them cheaper in the local currency and hurts exports by making them more expensive. Still, export growth has been one of the factors behind the eurozone economy’s stronger-than-expected performance in the last few months. A strong euro is also not good for corporations deriving a good deal of their revenues from the USA or other countries whose currencies have depreciated against the euro because these are translated into smaller euro sums. But a strong euro helps put a lid on inflation and in so doing makes it less likely that the European Central Bank (ECB) will raise its intervention rate higher than the 4.0 percent level discounted by the markets. Currently, the intervention interest rate is at 3.75 percent. This is helpful for a high inflation country such as Greece which relies on lower interest rates to boost loan growth and consumption. Given the fact that a small portion of Greek exports go to the USA or countries with a currency tied to the US dollar, the threat from the strengthening of the euro is small. This is so even if one takes into account the impact from the translation effect on local companies with operations in these countries. On the other hand, the effect may be more adverse in sectors such as tourism which face competition from lower cost neighboring countries, such as Turkey. Also, the changing composition of Greek exports toward high-tech products and the shift toward high-growth countries in Southeast Europe also helps to alleviate the effects of a stronger euro since they are less price sensitive and some of these countries have currencies that loosely track the euro. Perhaps, the biggest threat to Greece from the strong euro is the likelihood that growth in other eurozone economies may slow in coming quarters but there is no evidence of such a slowdown at this point. In this regard, the strong euro may be a blessing in disguise for the Greek economy as long as it does not hurt the growth prospects of its eurozone peers because it disciplines some of its exporters to become more efficient and keeps the economy going by compressing inflation and lowering interest rates. Still, the biggest benefit of the euro to Greece is giving it time to adjust its huge current account deficit lower while shielding it from the type of currency crisis it would have faced in years past.

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