PRESS RELEASE
Athens, 16 February 2009
Subject: The Report of the Bank of Greece on Monetary Policy
2008-2009
Today, the Bank of Greece submitted its Report on Monetary Policy
2008-2009 to the Greek Parliament and Cabinet in accordance with
its Statute. The Bank’s Governor, Mr. George Provopoulos, delivered
the report to the Speaker of Parliament, Mr Dimitrios Sioufas. In the
ensuing press conference, the Governor summarised the key
messages of the Report as follows:
“Last October, the Bank of Greece, in its Monetary Policy 2008 –
Interim Report, stressed that the factors that had supported economic
growth in Greece for a number of years were losing momentum; inter
alia, this was due to the deepening international crisis,. That report
also stressed that, with domestic demand growth outpacing the
expansion of potential output, inflation remained persistently above
the euro-area average, the current-account deficit continued to
widen, and the external debt of both the private and the public
sectors continued to grow. The size and persistence of these
imbalances suggested that the structural reforms implemented to
date had not been sufficient to correct the underlying weaknesses of
the economy, possibly reflecting, in part, a climate of complacency in
light of relatively-robust growth and euro area participation.
With the direct impact of the international crisis now affecting the
Greek economy, there is no longer any room for complacency.
During the good times, Greece did not put in place policies that would
have mitigated the effects of the crisis. Greece must adopt a multiyear strategy to implement reforms that were not put in place during
the past 15 years. Fiscal consolidation needs to be the country’s top
priority. Only by following a multi-year approach that gives priority to
fiscal consolidation will the international markets become convinced
of the economy’s favourable prospects. Such an approach will secure
reasonable domestic and international borrowing terms for the public
and the private sectors, and create the conditions that will set the
engine of growth firmly in motion when the international economy
returns to the expansionary phase of the cycle”.
MAIN POINTS OF THE REPORT
Α. The international environment: Trends and prospects
The world economy is going through the most severe
crisis since the early 1930s. The exit from the crisis will
not be easy or fast, despite extensive interventions by
national authorities. Countries with high levels of
public debt and current-account deficits face the most
difficult challenges.
2009 will be a very difficult year for the global economy. Uncertainty
and one of its consequences, falling confidence, have contributed to
a negative feedback loop between the financial system and the real
economy. In several advanced economies, production is falling
sharply. In emerging economies, growth rates are in sharp decline.
After several years of uninterrupted expansion, global trade is
contracting.
Inflation is falling globally, reaching very low levels in some advanced
economies.
The global economy is not likely to recover before 2010. The timing
and sustainability of a recovery will depend on the speed with which
capital flows, the credit system, and confidence return to normal. The
unprecedented interventions made by governments and central
banks to address the situation should significantly reduce the
negative effects of the crisis, but will not eliminate them. A reversion
to positive and robust growth will take time.
The plans of EU governments to reinforce the liquidity and capital of
monetary and financial institutions, amounting to a total value of €2.9
trillion (a sum equal to 23% of the EU GDP in 2008), are being
implemented. In addition, EU governments are carrying through the
European Economic Recovery Plan, a package of fiscal (and other)
measures, having a value of about 1.5% of EU GDP. The latter Plan
takes advantage of all the room for manoeuvre provided by the
Stability and Growth Pact. Countries such as Greece, however, with
high public debt and large current-account deficits, have almost no
room for manoeuvre. In such countries, any relaxation of fiscal policy
would be detrimental to the economy and to the fiscal outlook itself
since it would further increase the cost of servicing both public and
private debt.
Β. Monetary policy and the interventions of the Eurosystem
The primary objective of the euro area’s single
monetary policy is price stability in the medium term.
Maintaining price stability is the best contribution that
the Eurosystem can make to economic growth.
Moreover, with its flexible and unprecedented
interventions in the money market, the Eurosystem is
making a key contribution to the restoration of
financial stability.
In light of the outlook for inflation in the euro area, since last October
the Governing Council of the ECB cut the interest rate on its main
refinancing operations in a series of steps for a cumulative reduction
of 225 basis points. In addition, through substantial interventions in
the money market, the Eurosystem has been providing credit
institutions with considerable amounts of liquidity, in order to prevent
the dysfunctioning of the interbank market from jeopardising financial
stability. With these interventions, the Eurosystem contributes
decisively to the dampening of tensions, acting as an intermediary
between banks with liquidity surpluses and those in need of liquidity.
The Eurosystem is also actively participating in the substantial,
concerted effort of the international community to revise the global
financial architecture. This effort aims to eliminate the structural flaws
that were exposed by the current crisis, in order to minimise the
chances of another systemic financial crisis in the future. To this end,
the following elements are essential.
 Enhanced transparency across all facets of the credit system, so
that actors can base their decisions on up-to-date, reliable
information.
 Removal of incentives that lead to excessive focus on short-term
returns at the expense of the longer-term goals essential to
systemic stability and social welfare.
 Reducing the pro-cyclicality of the credit system and, therefore, its
potential to amplify the fluctuations of the economic cycle. In order
to achieve this objective, the system's proclivity toward excessiverisk taking in upturns and an excessively-conservative attitude
toward credit creation in downturns when credit to businesses and
households must be reduced.
C. The impact of the global crisis on the Greek economy
The Greek economy is being affected by external
shocks;
both shocks
that
stem
from the
dysfunctioning of financial markets and shocks that
stem from contracting global output and trade.
The international financial crisis is affecting the Greek economy. The
supply of credit is falling, because the markets to which banks have
recourse for funding are frozen while credit standards have tightened.
At the same time, demand for credit is weakening as a result of
heightened uncertainty that discourages households and businesses
from assuming debt obligations, especially those of a long-term
nature.
The slowdown in credit expansion to households and businesses is
affecting private consumption - - the growth rate of which is projected
to show a considerable slowdown in 2009 - - residential investment - which is projected to continue to decline in 2009 - - and business
investment - - which is expected to remain broadly unchanged. Two
other factors that are expected to affect business investment
negatively are reduced demand for goods and services and lower
profitability.
This year, the global crisis and the decline in international trade will
have a negative effect on Greek exports, especially those to the EU
and South-Eastern Europe. Transport (shipping) receipts will fall
because of lower freight rates and declining trade volumes. Travel
receipts from visitors from Western Europe, the US, South-Eastern
Europe, and Russia also could fall.
Euro area membership is a valuable shield that helps protect the
Greek economy from the strong shocks of the global financial crisis
to some extent. The single currency is a stepping stone for reaping
the benefits of monetary stability and the single European market.
Exploiting these advantages, however, hinges upon a number of
necessary adjustments and reforms.
D. Key projections for the Greek economy in 2009
Real GDP in Greece is projected to grow at about 0.5% this
year. The unemployment rate is projected to rise as
employment growth comes to a halt. Employment is
projected to contract for certain categories of workers and
in some sectors. Annual inflation is projected to fall to
1.8% or less, but core inflation should decline much less,
to about 3%. Reflecting the impact of cyclical downturn,
the current account deficit is projected to decrease.
Whereas real GDP in the euro area is projected to decline by about
2% in 2009, the Bank of Greece projects that the annual growth rate
of real GDP in Greece, which slowed to 3% in 2008, will be about
0.5% in 2009.
As a result of the economic slowdown, the upward trend of
employment experienced in recent years is expected to come to a
halt in 2009 and average hours worked in the non-agricultural private
sector are expected to decline. In some sectors (e.g., export import
trade, construction, tourism, financial services), and for certain
categories of the workforce (e.g., temporary workers, immigrants),
employment will fall. However, in light of the fact that the growth rate
of the labour force has fallen to relatively low levels over the past four
years, the total rate of unemployment may not rise dramatically.
Inflation has been declining since mid-2008. In December it fell to an
annual rate of 2.2%, the lowest level since June 2000. In 2009, it is
expected to keep falling until mid-year, perhaps reaching about 1%,
before rising again. The path of inflation will reflect base effects
connected to oil prices. Average annual inflation in 2009 is projected
to drop to 1.8% (or less), from an average of 4.2% in 2008. Core
inflation, however, is projected to fall much less, to 3.0-3.1% (from
3.4% in 2008), remaining higher than the corresponding euro area
figure. The smaller expected decline in core inflation than headline
inflation is attributed to the fact that the conditions of excess demand,
which had already weakened in 2008, are now being eliminated.
Also, the decline in profit margins experienced in 2008 is projected to
continue into 2009, while the increase in unit labour cost will
decelerate somewhat, though remaining strong.
In 2009 the current account deficit is projected to be affected
significantly by the deterioration of the international and domestic
economic environments; the deficit is projected to narrow appreciably
as a percentage of GDP, largely because the anticipated decline in
imports of goods is projected to be greater than that of the expected
decline in exports of goods and services. Imports of non-oil goods
should be negatively affected by the weakness of domestic demand
while the net oil bill should decline as a result of oil prices (in average
annual terms).
E. The persistence of the external deficit: causes and remedies
Despite its projected narrowing in 2009, the current
account deficit will remain large. It is projected to start
growing again once the recovery of the economy
commences. There is an urgent need for far-reaching
policy measures to address the chronic domestic
imbalances and the structural weaknesses that underlie
the external deficit.
The current-account deficit reflects the shortfall of domestic total
saving relative to domestic total investment (mainly a result of
negative public saving and very low private saving as a percentage of
GDP). The main causes of this serious problem are the continued
erosion of international price and cost competitiveness, and the low
level of the structural competitiveness of the Greek economy.
The current account deficit also derives from the imbalances in public
finances. Fiscal deficits and a significant part of private investment
are financed by foreign borrowing and other inflows from abroad,
given the low saving of households. In recent years, the negative
saving of the general government sector has added to the currentaccount deficit by an amount averaging 2 percentage points of GDP
per annum. Moreover, the chronically low productivity of the public
sector has been negatively affecting the competitiveness of the
overall economy.
F. Credit conditions: trends and prospects
The implementation of the government’s liquidity-support
package reinforces financial stability and will prevent a
shortage of loanable funds. Banks must utilise the
provisions of the plan, assessing economic conditions
carefully.
In 2008, the rate of credit expansion to the private sector
decelerated. Until October, the deceleration was small, and the rate
remained strong. However, a sharp drop was recorded in the last two
months of the year as the net flow of new loans was substantially
smaller than that of the corresponding period of 2007: the net flow of
new bank loans to non-financial enterprises fell by 62.7%, while
declines of 52.5% and 68% were recorded in the net flows of new
housing loans and new consumer loans, respectively.
Credit expansion to the private sector will continue to weaken over
the coming months. However, it is estimated that, for 2009 as a
whole, it can come to about 10%, subject to certain key conditions.
These conditions are as follows. First and foremost, banks need to
fully utilise the provisions of the € 28 billion liquidity support package.
Second, economic activity will need to be in line with the
aforementioned projections, maintaining households’ disposable
income at a level that can ensure a rise in deposits. Third, the
government’s shift to the issuance of securities at competitive rates,
securities that have recently become available on the domestic
market, should have only a limited impact on bank deposits.
The fundamentals of the Greek banking system have been affected
by the international crisis to a lesser degree than those of the
banking systems of other countries. Underlying this outcome are the
continuous supervisory controls by the Bank of Greece, the marginal
exposure of Greek banks to the so-called toxic assets (the exposure
of which is smaller than is the case in most other countries), the small
dependence of Greek banks on financial markets as sources of
funding and the satisfactory levels of their capital adequacy and
leverage ratios. This combination of factors has enabled Greek banks
to remain fundamentally healthy and strong, even during a time that
the international financial system is caught up in a storm.
In view of the increased risks ensuing from the economic slowdown,
the heightened volatility in money and capital markets, and the
prevailing conditions of low liquidity and falling profitability, the Bank
of Greece has called upon banks to implement policies that will
safeguard financial stability. In addition, taking into account the
evolution of indicators measuring banks’ profitability, loan portfolio
quality, liquidity and capital adequacy, the Bank of Greece has urged
banks to make a proper use of the resources available under the
liquidity support package. At the same time, it has requested banks
to limit bonus payments to their high-level staff and substantially
reduce the dividends distributed, so that the banks can strengthen
their capital and their provisions.
G. The yield spreads of Greek government bonds
The reservations of markets about Greece’s fiscal
prospects and the country’s current-account deficit are
causing a worsening in the terms of external borrowing for
the Greek government, the impact of which is diffused to
the entire economy.
Although other euro-area countries are projected to have higher fiscal
deficits (as a percentage of GDP) than Greece during the period
2008-2010, the yield spread of the government bonds of these
countries against the corresponding German securities is much
smaller than in the case of Greece. This situation pertains because
the fiscal deficits of the other countries are mostly of a cyclical nature,
reflecting the economic downturn, and their public-debt ratios are
typically much lower than Greece’s. In contrast, in the case of Greece
the markets are concerned about medium-term fiscal prospects
(including the future obligations of the pension system), the public
debt, and the current account imbalance. These situations are mainly
of a structural nature.
A significant narrowing of the yield spread between Greek and
German government bonds in the coming months seems unlikely. In
the same manner as the narrow yield spreads in the past reflected a
generalized underestimation of risks by international market
participants, the recent sharp widening of the spread reflects a
generalised tendency to overestimate risks as well as excessive risk
aversion on the part of investors. Furthermore, in the next few
months, the supply of government (and corporate) bonds in the world
market is expected to increase substantially as a result of the fiscal
stimulus and bank liquidity support packages in other countries. This
increase in the supply of securities should exert upward pressure on
bond yields and, possibly, on yield spreads for individual countries,
further increasing the Greek government’s borrowing costs.
The widening of the yield spread on Greek securities represents an
additional cost to the entire economy, given that banks and other
enterprises are financed from the international markets on terms and
conditions that are typically less favourable than those that apply to
the Greek government. Moreover, the increase in the yield spread
implies a heavier future burden on taxpayers.
H. Fiscal policy, the Stability and Growth Pact and the Lisbon
Strategy
If the confidence of markets and of domestic economic
agentsis restored, a prima facie restrictive fiscal policy
could have an expansionary effect. Conversely, under
the current circumstances, a prima facie expansionary
fiscal policy would ultimately turn out to be restrictive as
it would entail multiple costs, in both the short and the
medium terms.
While the conditions of economic slowdown would normally have
pointed to the necessity of a fiscal stimulus, a traditional fiscal boost
is not possible, given the initial large sizes of the fiscal deficit, the
public debt and the current-account deficit. A disciplined fiscal policy
is necessary - - for both meeting the requirements of the revised (and
flexible) Stability and Growth Pact and reducing the cost of borrowing
for the public and the private sectors. Changes in fiscal policy,
therefore, must be part of a broader approach to adjustment. This
approach should include the following key elements:
 An immediate reduction of the fiscal deficit to below 3% of
GDP this year and its further reduction by 1% of GDP per annum
over the next three years, so that the deficit is eliminated by
2012. Such a deficit reduction could be achieved by curbing part of
the huge tax evasion and, more importantly, by reducing substantially
the waste in government spending and increasing the efficiency with
which the government spends funds. According to a research paper
published by the ECB, the same level of public goods and services
could be provided in Greece with 30% less expenditure. Reallocation
of government spending and an increase in its efficiency would
release resources that could be used to support the more vulnerable
groups of society and strengthen public investment, which has been
shown to have a larger positive effect on growth than public
consumption. Economic activity could also be boosted by speeding
other reforms that do not entail a budgetary cost, but contribute
directly to productivity gains. Typical examples are reducing red tape
and strengthening competition.
• The implementation of a comprehensive set of reforms in the
public sector. Without extensive and radical changes to the
structure of the public sector, the public debt cannot be reined in.
Substantial primary surpluses (of about 4.5-5% of GDP) are needed
if the debt-to-GDP ratio is to be reduced substantially in a reasonable
time frame (i.e. within ten years from now) - - to below the reference
rate of the Maastricht Treaty (60%). This would also be necessary in
view of the increased budgetary costs stemming from population
ageing. A number of recommended structural measures that could
significantly improve Greece’s fiscal prospects are summarised in
Box I.1 of the Report.
• A faster implementation of the Lisbon Strategy. In addition to
the points made above, promoting fiscal consolidation in the medium
term will also require reforms in the areas of tax administration and
preparation and implementation of the budget, as well as of the
pension system. These reforms have also been identified as priorities
of the Lisbon Strategy; their implementation needs to be speeded up.
The same also applies to the reforms aimed at improving the
regulatory and control capacities of public administration,
implementing legislation faster, and effectively reducing red tape and
corruption. Progress in these areas would significantly improve the
business environment and the attractiveness of Greece as a hub of
business activities in the Eastern Mediterranean. An increase in the
quality and the yield of investment could also be achieved through
reforms that promote R&D, the more efficient use of resources from
the Structural Funds, and competition.
• The boosting of competition in the markets for goods, services
and factors. Typical examples are professional services, energy and
road transport.
• Upgrading human capital. The long list of relevant reforms
needed here includes: strengthening active labour market policies;
turning undeclared work into formal employment; reducing the nonwage cost of employing low-paid workers; accelerating reforms in the
fields of education, vocational training and lifelong learning;
facilitating the transition to work; improving childcare systems;
promoting equal opportunities for men and women; removing the tax
policies that discourage labour market participation of certain
categories of people, notably women and older workers.
• Modernisation of the pattern of energy production and
consumption. Oil dependence of the Greek economy remains high.
According to estimates, Greece, as a Mediterranean country, will be
hit more severely than other parts of Europe by climate change. The
new EU policy for energy and climate change has set the objectives
of reducing greenhouse gas emissions, improving energy efficiency
and increasing the use of renewable energy sources in all the
Member States. Implementation of this policy in Greece would
presuppose, inter alia, an energy-saving organisation of production
(through the introduction of technology which is less energyconsuming), and changing the quality of urban life (by improving
public transport and thus reducing the use of more energyconsuming means of transportation, as well as by encouraging the
use of new technologies and alternative energy sources in the
insulation and heating of homes and other buildings). Carrying out
these changes will require planning and incentives.
Progress in meeting the targets set by the new European policy is of
extremely great importance for Greece. Such progress is not only
imperative in terms of dealing with climatic change and improving the
quality of living; it can also lead to large, productive investments and
help strengthen competition in the energy sector, create new
businesses and a large number of new jobs, and appreciably reduce
Greece’s energy dependence (and thus also its current-account
deficit). The present economic conjuncture should not be seen as an
obstacle to such developments. On the contrary, investment in
energy and the so-called “green” investment can provide an
extremely useful stimulus to the recovery of economies, as pointed
out in the European Economy Recovery Plan.