Initiatives needed for return to growth

Greece won the praise of the European Union, the International Monetary Fund (IMF), the European Central Bank (ECB) and others for sticking to fiscal consolidation and being ahead of the curve in the implementation of structural economic reforms. However, everybody agrees the challenges ahead are big and will be more difficult to meet without the engine of the economy starting up again. The country has made a strong start in complying with the program of economic and structural reforms, which aims at bringing the budget deficit below 3.0 percent of gross domestic product (GDP) in 2013 and boosting its competitiveness in order to create more jobs in the future and put its economy on a sustainable growth path. Although the bulk of analysts and other market participants still doubt whether the country will be able to attain the fiscal targets set out in the program, there are a few encouraging first signs in the far end of the bond market, namely the 15- and 30-year segments, where some players are willing to quote bid and ask prices. Of course, this is the result of the positive reception of the news from the bond market but it is by no means indicative of its future behavior toward Greek bonds. Undoubtedly, one of the biggest question marks of the program has to do with the depth and the endurance of the recession in the Greek economy. The program projects a 4.0 percent drop in real GDP this year but a much higher-than-anticipated inflation has made nominal GDP look better than before. Since nominal GDP is the denominator in the budget deficit and public debt-to-GDP ratios, this favorable development means Greece has some leeway to meet this year’s deficit target set at 8.1 percent of GDP, despite some expected slippage in tax revenues. The same argument can be used for the expected upward revision of GDP next year. However, the members of the so-called troika and the government know that meeting the budget deficit goal by revising the GDP number will not be received well by the same markets they want to convince about Greece’s creditworthiness and adherence to fiscal orthodoxy. It is therefore necessary to cut the budget deficit first and then bring in the upward revision of GDP. However, cutting the budget deficit will not be easy next year without rushing to put the economy back on a growth path. The Greek economy is projected to contract again in 2011, although at a slower pace compared to 4.0 percent this year, but this has to change for the better. A source of strength may come from the external sector, provided scenes of violent demonstrations in the streets of Athens do not take place so that tourism recovers. Imports should also be down, which helps close the trade gap and current account deficit, while merchandise exports should grow. It is known, however, that the external sector, a traditional drag to the Greek economy, cannot pull the economy out of recession by itself. Investment could do it but a contracting economy and high taxes do not help – although there appears to be interest for investments in certain sectors, such as energy, health care and transportation. The government could help by making it easy for fast-track investments to be implemented but even this requires time and there is always a sizeable time lag between a decision to invest and its conclusion. In this regard, Greece should have moved faster to reap the benefits earlier and boost the economy. The EU could also help by easing conditions for disbursing funds for cofinanced projects in the country to help bridge the time gap. Still, one has to be realistic and recognize that the impact of such investment initiatives on the economy will not be felt before the fourth quarter of 2011, even if they were to be taken next month. In other words, the burden for pulling the Greek economy out of the woods as early as the second half of 2011, falls on consumers. This is not the best bet when they have been hit with a series of tax hikes, salary cuts and job losses. However, it looks as if consumption spending had started to suffer well before the recession became evident. This points potentially to a precautionary reduction in consumer spending in anticipation of adverse future events. This may have been also influenced by the prevailing negative psychology. If this is the case and Greece meets its fiscal targets without resorting to new austerity measures while the economy of the eurozone picks up steam aided by Germany, consumer sentiment could start to improve gradually. But Greece will still need to put some more fuel in the fire. Nothing will be better than bank loans to consumers and enterprises. In this regard, the troika and the government should perhaps come up with more packages of state guarantees to banks to get cheap funding from the ECB, since credit institutions cannot borrow in the interbank and wholesale markets. All in all, Greece’s good start to implementing the program should be immediately supplemented by initiatives and measures for implementing large fast-track investments and prop up consumer sentiment to cut short the recession and boost growth in 2011. If this does not happen and the authorities opt to continue on the road of fiscal orthodoxy, it will be more difficult to convince many people to stay the course.