Greece must fight for relaxed Stability and Growth Pact rules

It is clear by now that Greece is in favor of the EU’s collectively binding budget rules, as stated in the Stability and Growth Pact. This is an easy stance for Greek policymakers to adopt at present, given that Greece is expected to run a small budget surplus this year and next on the back of strong GDP growth. It may be much more difficult for them to argue in favor of a pro-growth change in the 3-percent budget deficit ceiling rule a few years from now when they will need it the most. Under these circumstances, it is wiser for Greek policymakers to seek that change in the next few months, while they hold the EU presidency and a number of Eurozone countries are sympathetic to it, rather than wait for harder fiscal times to arrive post-2006. It is known that the Stability and Growth Pact was devised a few years ago to ensure fiscal discipline, help support the single European currency and avert a negative impact on euro interest rates. Although it is very hard to disagree with the general concept behind the pact, it is equally hard to agree with the idea that all countries should ensure that planned budget deficits stay below 3 percent of GDP, regardless of their economic situation. Following an early warning – Germany received one earlier this year – the EU Commission can start applying the «excessive deficit» procedure, as specified in Article 104.C of the Amsterdam Treaty. The country in question can be liable to stiff fines under the treaty clause if it fails to take sufficient measures to correct it. The provision was triggered for the first time this summer when Portugal recorded a deficit of 4.1 percent of GDP in 2001 as opposed to its latest official calculation of a 2.75-percent deficit prior to a change in government. Other EU countries, namely Germany, France and Italy, have faced problems with sticking to the 3-percent limit in the face of an economic slowdown. The eurozone finance ministers, apparently fully aware of the negative budgetary implications of slower growth, agreed to relax the previous deadline to balance budgets by 2004 in June. They watered it down even further recently, accepting a European Commission plan that would provide struggling countries with more time to get their public spending in line with the Stability and Growth Pact. The finance ministers agreed that Germany, France, Italy and Portugal – the four countries with the largest deficits – should cut their budget deficits by 0.5 percent annually, starting next year in a bid to balance their budgets by 2006. However, France did not go along, saying it would not begin implementing the 0.5-percent reduction until 2004, a move widely seen as posing a challenge to the budgetary discipline orthodoxy. Clearly, figures show that Greece does not fall into this category. The country is expected to produce a general government budget surplus equal to 0.4 percent of GDP this year, which is less than the 0.8-percent surplus envisaged in the 2002 budget but higher than the 0.1-percent surplus in 2001 and the 0.8-percent budget deficit in 2000. Moreover, the draft 2003 budget, unveiled recently, forecasts a general government budget surplus in the order of 0.5 percent of GDP next year. However, it is also quite clear that the vast improvement in Greek public finances is mainly the result of strong GDP growth rates and a sharp reduction in interest expenses on public debt. Indeed, the Greek economy grew 3.6 percent in 1999, 4.1 percent in 2000, 4.1 percent in 2001 and is projected to grow between 3.5 and 4 percent this year. The 2003 draft budget is based on the assumption that the Greek GDP will grow by 4.1 percent next year. However, Finance Minister Nikos Christodoulakis has left open the possibility that this growth rate may be revised downwards in case global economic and market conditions deteriorate in coming weeks. Even if that pessimistic scenario unfolds though, he sees Greek economic growth not falling below the 3.1-percent mark in 2003. Greece has also benefited vastly from the introduction of the euro. Its interest rates have been low since the beginning of 2001 and even earlier, thanks to its successful campaign for EMU membership on the heels of nominal economic convergence. Low euro interest rates and the convergence of Greek government bond yields to German Bunds have enabled Greece to service its public debt at lower rates. This, coupled with the extension of the average maturity for its public debt, have reduced its borrowing costs significantly in the last few years. Interest payments are on a downward path, accounting for 7.4 percent of GDP in 2001, estimated at 6.6 percent of GDP this year and forecast to fall further to 6.2 percent in 2003. Everybody knows, however, that large net EU inflows, estimated at some 5 billion euros per annum in the 2000-2006 period help explain a good deal of Greece’s impressive GDP growth rates. Significantly lower borrowing rates have also played a role in boosting investment and consumer spending. However, the large EU inflows are expected to shrink after 2006 as the Community Support Framework III comes to an end and more European countries with a lower per capita GDP than Greece are planned to join the European Union from 2004. Moreover, the initial positive impact from lower interest rates is destined to die out, pouring more cold water on Greece’s economic engine. Greece has only to look to Portugal in order to learn its lesson. After growing rapidly through 2000, Portuguese GDP growth slumped in 2001, helping its budget deficit breach the 3-percent limit. Greece is also a small country which has experienced strong economic growth for years, and it is reasonable for anyone to project an economic slowdown post-2005 or post-2006. However, Greece, unlike Portugal, can look forward to a few more years of economic growth ahead and has advance knowledge of what happened to its small, fellow-EU partner. It is therefore necessary that Greek policymakers learn their lesson and start lobbying the other countries for a simple, yet extremely important change in the 3-percent deficit limit of the Stability Pact that does not hurt its credibility among market people: Making sure that the 3-percent limit applies to each country’s structural, and not cyclical, budget deficit. That way, EU fiscal policy can become more pro-growth while preserving the stability of the euro and Greece can get credit for championing a reasonable change that will help its own economy in the future.