European Commission: The Economic Adjustment Programme for Greece

 

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EUROPEAN COMMISSION DIRECTORATE GENERAL ECONOMIC AND FINANCIAL AFFAIRS: The Economic Adjustment Programme for Greece - Fifth Review – October 2011 - DRAFT

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european commission directorate general economic and financial affairs the economic adjustment programme for greece fifth review ­ october 2011 draft this report has been prepared by the commission services in liaison with the ecb the box on the debt sustainability assessment will be finalised shortly and included in the final version for publication.

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outline of the report executive summary 1 2 3 4 introduction macroeconomic developments and outlook financial markets and financial sector developments programme implementation and policy discussions 4.1 fiscal policy 4.2 structural fiscal reforms 4.2.1 privatisation 4.2.2 tax reform and fight against tax evasion 4.2.3 public administration and social programmes 4.2.4 healthcare 4.2.5 pension reform 4.2.5 public procurement 4.3 growth-enhancing structural reforms 4.3.1 labour market 4.3.2 regulated professions 4.3.3 energy and transport 4.3.4 business environment 4.3.5 absorption of structural funds 4.3.6 judicial reform 4.3.7 education 4.4 fiscal financing and treasury management 4.5 technical assistance 1 5 9 15 21 22 29 29 30 31 31 32 32 32 32 34 34 35 35 36 36 37 40 appendix annex 1 annex 2 annex 3 41 assessment of compliance with the memorandum of understanding on specific policy conditionality fourth update 2 july 2011 43 macroeconomic forecast 91 statement by the european commission the ecb and imf on the fourth review mission to greece 97 list of boxes 1 the 21 july 2011 statement by the heads of state or government of the euro area and eu 2 greek banks in the eba stress tests 3 debt sustainability assessment 4 interest rates on euro area assistance loans 5 financing of the greek sovereign state since the start of the programme planned versus actual outcome 39 6 17 27 38 list of tables 1 disbursements under the economic adjustment programme 2 contributions by the euro-area member states to disbursements to greece so far i 6 5

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3 macroeconomic scenario main features 4 ratings 5 banking sector soundness indicators 6 summary of compliance with conditionality 7 fiscal quantitative criteria 8 medium-term deficit ceilings and projections 9 implementation monitoring estimated yield of measures agreed in june 2011 10 deficit and measures accounting from the deficit in one year to the next 11 arrears 12 staffing plans 13 privatisation plans transactions so far 14 planned privatisation receipts 14 16 20 21 22 22 23 25 26 27 30 30 list of graphs 1 real gdp growth 2 business and consumer surveys 3 equipment 4 housing investment 5 market shares performance of greek exports of goods and services relative to the imports of 35 industrial countries 6 exports and non-domestic industrial orders 7 industrial production and capacity utilisation 8 hicp inflation developments and projections 9 hicp inflation main drivers 10 employment and unemployment rate 11 nominal unit labour cost 12 current account and net external liabilities 13 yield spreads 14 buy/sell orders of greek bonds secondary market 15 monthly volume of trading 16 sovereign credit ratings 17 bank deposits 18 greek banks borrowing from the eurosystem 19 credit to private sector 20 non-performing loans 21 holding of greek government debt 22 loan to deposit ratio by bank 23 government revenue and expenditure ii 11 11 11 12 12 13 13 13 14 15 15 16 19 19 19 19 20 20 26 9 10 10 10

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24 state primary payments 2011 25 government primary balance ­ 2011 outcomes and quarterly criteria 26 total labour costs business economy 27 minimum wages 28 t-bills stocks 29 t-bill auctions since july 2010 30 maturing debt 26 26 33 33 37 37 38 iii

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acknowledgements the report was prepared in the directorate general economic and financial affairs under the direction of matthias mors director and mission chief contributors matthias mors giuseppe carone jakob e christensen fotini dionyssopoulou riccardo ercoli leila fernández stembridge luis garcía lombardero loukas kaskarelis daniel kosicki peter lohmus joão nogueira martins milda valentinait peter weiss rafal wieldek and ana xavier and markus zalewski christos zavos was responsible for the layout the report was prepared in liaison with the ecb comments on the report would be gratefully received and should be sent by mail or e-mail to joão nogueira martins european commission unit ecfin-f-3 bu 1 01-140 b-1040 brussels e-mail joao.nogueiramartins@ec.europa.eu v

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executive summary a joint commission ecb imf mission met with the greek authorities in athens on 21 august-2 september and 29 september-11 october 2011 the mission assessed compliance with the terms and conditions of the fifth review under the economic adjustment programme the contraction in economic activity is substantially deeper than previously projected in spite of encouraging positive quarterly growth rates recorded in the first quarter of 2011 economic activity has contracted substantially in the meantime for the first semester as a whole economic activity was 6 percent below its level a year ago demand contracted on account of fiscal consolidation the deterioration in the labour market uncertainties regarding political and financial prospects social unrest and industrial action as well as a deceleration in activity both within europe and worldwide slower than programmed progress in several areas of structural reform over the last year has also contributed to economic developments well below expectations these reforms have not yet reached the critical mass that is necessary to boost productivity and transform the investment climate in greece while the reshuffle of the government in june and the euro-area decisions of 21 july have been helpful in reducing the uncertainties economic agents are confronted with the recovery will be delayed the contraction in economic activity in 2011 now estimated at 5½ percent will be deeper than in 2010 the projections for 2012 are also revised downwards to a contraction of 2¾ percent and modest positive growth rates are delayed to 2013 competitiveness is slowly improving the constant-tax inflation rate is below the euro-area average while the overall inflation has come down as the impact of the several waves of indirect tax increases in 2010 are now fading out there are positive indications from the export sector exports are rebounding in both goods and services with the tourism sector in particular recording dynamic growth rates in the three months to july the value of merchandise exports increased by 20 percent compared to the same period a year before however shipping has been performing below expectations the relatively good results from the external sector partly stem from gains in cost competitiveness with labour costs declining as well as from the pressure on greek firms to shift their focus from the domestic market to exports however given the low export base of greece ­ exports of goods and services in 2010 made up only 21 percent of gdp ­ several years of very dynamic growth rates are necessary to bring external imbalances back to a sustainable level the medium-term growth prospects may need to be revised downwards in previous assessments the medium-term growth rate of the greek economy ­ from 2015 through 2020 ­ was estimated at close to 3 percent per annum several aspects need to be considered when discussing the greek medium-term prospects on the one hand the deep contraction in economic activity ­ economic activity is contracting by 15 percent during the four years 200912 ­ widens the output gap which paves the way for a strong recovery with several years of growth above potential on the other hand the ongoing contraction in economic activity is only partially of a cyclical nature for a sizable part it reflects a reduction in production potential in the context of a structural reallocation of resources from non-tradables to tradables overall the previous assumption on the medium-term economic outlook is viable only in case of a pronounced acceleration of structural reform efforts including privatisation in the absence of such acceleration the medium-term real gdp growth rate could be well below projections 1

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european commission the economic adjustment programme for greece while there have been deficiencies in the implementation of fiscal measures the government made important progress in consolidation efforts in june greece adopted the medium-term fiscal strategy mtfs specifying a set of consolidation and fiscal structural reform measures through 2015 for 2011 the mtfs provided for fiscal consolidation measures quantified at that time at 3 percent of gdp and above 10 percent for the period through 2014 most measures provided for in the mtfs for 2011 have been duly legislated and are being implemented however in a number of cases the quantification of the measures had to be revised downwards because they were implemented with delay or with changes to their design reducing their impact in a few instances the agreed measures were not implemented moreover the recruitment rule which in 2011 allowed for one entry into the general government sector per ten exits has not been fully respected in spite of these deficiencies in the implementation of austerity measures the effective consolidation efforts of the greek government are very large well above other eu countries experiences since the previous review the deeper-than-expected contraction in economic activity the taxpayers liquidity constraints as well as other fiscal slippages e.g in the fight against tax evasion have also contributed to the reopening of a gap vis-à-vis the previously agreed annual fiscal targets the performance criterion for end-july for the fiscal primary deficit was respected but the criterion for end-september appears to have been failed by a small margin the government has prepared an additional package of expenditure and revenue measures on the expenditure side the main measures concern a frontloaded and reinforced implementation of the new wage grid for public employment that was already included in the mtfs and will substantially reduce the wage bill and ensure a more transparent remuneration system for the civil servants cuts in the highest pensions and adjustment in supplementary pensions and lump-sums paid on retirement with the aim of reducing overstaffing the government has established a labour reserve for excess staff and decided to move staff close to retirement into a pre-retirement scheme though the labour reserve and pre-retirement scheme are expected to absorb around 30 000 staff the effectiveness of these mechanisms in reducing costs depends on the ability of identifying the public sector units or entities that should be closed merged downsized or otherwise free workforce on the revenue side a special levy on real estate has been established and the personal income tax base has been widened through the abolition of a number of tax expenditures and a reduction of the income tax-free threshold these measures bring the 2012 deficit projection in line with the agreed ceiling but the 2011 fiscal gap will not be fully closed most of the new fiscal consolidation measures already apply in the last quarter of 2011 therefore they do contribute to improving this year s fiscal accounts however their full-year effect will only be reflected in the 2012 accounts since most expenditure budgeted for 2011 has already been spent or committed the margin for additional cuts in operational spending and investment is very limited if any moreover further tax increase measures in 2011 would not have been viable either the several tax and expenditure measures that are implemented in the last quarter of 2011 and first quarter of 2012 substantially compress the households disposable income and significantly tighten their liquidity constraints this also implies that the uncertainty around the 2011 fiscal projection is larger than one could expect at this time of the year the privatisation fund has been established but the programme targets for privatisation proceeds will be missed the government has identified several assets slated for privatisation a first batch of these assets has been transferred to the privatisation fund and the transfer of most of the assets that will be offered for sale over the next year is imminent however given lengthy administrative and legal procedures the targets established for the next quarters are now 2

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executive summary beyond reach on top of this the market conditions have significantly deteriorated over the last quarter with the athens stock exchange index losing more than 38 percent from june through september a delay of at least a quarter compared to previous plans is thus likely however since the greek government is one of the eu countries with the richest portfolio of assets the objective of collecting eur 35 billion by end-2014 and eur 50 billion by end-2015 remains viable all the more as the government stands ready to reduce its stakes in the companies by more than currently considered in the privatisation plan in a medium-term perspective the privatisation plan will have to be adjusted and effectively scaled up to take into account the reprivatisation of banks that might require recapitalisation by the greek state or the hellenic financial stability fund the financial sector situation remains fragile the liquidity of greek banks has tightened further as the level of deposits continues to contract despite some relatively large inflows in august in part this results from households and businesses liquidity constraints with the former reducing their deposits to finance and smooth consumption but also the uneasiness caused by the ongoing discussion about debt restructuring as well as the overall market uncertainty concomitantly the reliance of greek banks on borrowing from the central bank has remained very high several banks posted losses due to the psi-related impairments of greek government bonds and the continuation in asset quality deterioration amid a weak economic environment this is in spite of relatively strong pre-provisioning income and comparatively low provisioning levels several banks are under restructuring but the process has been slow so far some banks however have pursued domestic consolidation strategies to shield against the crisis the bank of greece will require additional capital buffers against potential further deterioration of the operational environment based on each bank s specific risk profile ongoing mergers will also result in stronger capitalisation the outlook for the greek financial sector is not independent from choices concerning private sector involvement the new bank resolution framework provides new tools to deal with ailing banks while the hellenic financial stability fund is being strengthened and stands ready to support the banking system the implementation of the growth-enhancing structural agenda continues but the pace of reform has so far been insufficient the adjustment programme contains a very wide-ranging programme of reforms covering practically all spheres of the economy in addition to measures that directly contribute to fiscal consolidation including public administration reform the fight against tax evasion healthcare and pension reforms there has been some progress in increasing labour market flexibility the liberalisation and deregulation of professions and services including utilities the simplification of investment licencing and the deregulation of the business environment however the pace at which these reforms have been legislated and implemented has by far not been commensurate to the needs of the greek economy a decisive implementation of structural reforms and confrontation of vested interests requires committed action not only by the whole greek government but also via a consensus of the main political forces government debt dynamics remain extremely worrying at the end of last year the gross debt ratio exceeded 140 percent of gdp if fiscal consolidation and privatisation targets are respected and growth responds to structural reforms the debt ratio may start declining from 2013 onwards the peak level depends on the technical features of the private sector involvement psi as well as on some accounting issues that are still under discussion however the debt ratio will remain at very high levels levels for many years and would be 3

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european commission the economic adjustment programme for greece vulnerable to adverse shocks when compared with the outlook of a few months ago the debt sustainability has effectively deteriorated given delays in the recovery in fiscal consolidation and in the privatisation plan as well as the perspective of bank recapitalisations the 21 july decisions by increasing official financing available to greece and reducing interest rates and the involvement of the private sector have reduced the financing costs of greece and more fundamentally have lowered substantially the financing needs of the greek government for a decade however in a scenario in which policy implementation going forward is weak this could not suffice for the debt dynamics to be described as sustainable the likelihood of such a situation depends on policy choices on the extent and persistence of fiscal restraint determining the medium-term primary balance path and structural reform implementation influencing the country s growth prospects to steer policy choices towards a sustainable path greece has to face strict institutional and political obligations to follow a durable and ambitious reform agenda the international assistance loan already disbursed to greece amount to eur 65 billion of this amount eur 47.1 billion have been paid by the euro-area member states and eur 17.9 billion by the imf the sixth disbursement would increase the overall amount of official loans to eur 73 billion the commission services recommend the sixth disbursement to greece to take place as soon as possible as soon as the agreed prior actions on fiscal consolidation privatisation and labour market reform which were announced by the government have been legislated this disbursement of an amount of eur 5.8 billion will take place under the bilateral loans pooled by the commission as agreed under the greek loan facility agreement of may 2010 the imf is also expected to contribute and additional eur 2.2 billion to this disbursement it is crucial to overcome administrative capacity constraints in implementing the adjustment programme the scale of the reforms that need to be prepared implemented and followed up is continuously testing the capacity limits of the greek administration technical assistance to be provided by the european commission the imf the eu member states or other organisations may therefore effectively give a contribution towards the adjustment programmes objectives the conditions of success of the economic adjustment programme remain the same the quick reduction in the fiscal deficit the implementation of the privatisation plan and unleashing the potential growth of the greek economy through structural reforms the deterioration in economic activity will make policy-making more challenging given the scale of the required reforms political coordination inside the government and consensus in the whole greek society remain as essential and decisive as ever a full implementation of the fiscal financial and growth-enhancing measures is indispensable any measures that are announced and not promptly implemented and followed up would simply deplete political capital and add to uncertainty a swift decision concerning a second programme could reduce uncertainty and help in restoring economic confidence 4

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executive summary 5

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1 introduction 1 this report assesses compliance with the conditions of the fifth review of the greek economic adjustment programme while the fifth review was initially expected to assess compliance until end-july the report assesses developments until end-september because of delays the assessment is based on the findings of the joint commission/ecb/imf mission to athens 21 august-2 september and 29 september-11 october 2011 the mission assessed compliance with conditionality associated to the sixth disbursement and progress towards the key programme objectives of securing fiscal sustainability safeguarding the stability of the financial system and boosting competitiveness potential growth and jobs it also revised the specific policy conditionality while keeping unchanged its main objectives 2 after five disbursements the euro-area member states and the imf have already paid eur 65 billion to greece eur 43.1 billion by the euro-area member states and eur 17.9 billion by the imf total disbursements so far have been used to repay eur 37.1 billion of medium and long-term bonds and loans that matured between may 2010 and september 2011 while the rest covered the greek government deficit or other financing needs including setting aside resources for the hellenic financial stability fund once the sixth disbursement has taken place the total disbursement will have increased to eur 73 billion table 1 disbursements under the economic adjustment programme eur billion past disbursements euro-area member states imf 1st tranche 18 may 2010 14.5 12 may 2010 5.5 2nd tranche 13 september 2010 6.5 14 september 2010 2.5 3rd tranche 19 january 2011 6.5 21 december 2010 2.5 4th tranche 16 march 2011 10.9 16 march 2011 4.1 5th tranche 15 july 2011 8.7 13 july 2011 3.3 total past disbursements 47.1 17.9 planned disbursements euro-area member states imf november 2011 5.8 november 2011 27.1 total 20.0 9.0 9.0 15.0 12.0 65.0 total 8.0 37.0 110.0 6th tranche remaining total programme 2.2 9.9 original amount to be provided by the euro-area member states as agreed in may 2010 the total amount available under the loan facility agreement lfa may be lower this is because slovakia decided not to participate in the lfa while ireland and portugal have stepped down from the facility as these two countries requested financial assistance themselves this situation of these three countries reduced the facility by eur 2.7 billion source commission services and imf during the review mission in athens the commission ecb imf staff teams met with the minister of finance and governor of the bank of greece as well as with the ministers for regional development and competitiveness and shipping labour and social security health and social solidarity administrative reform and e-governance education lifelong learning and religious affairs environment energy and climate change and infrastructure transport and networks moreover the teams met with staff of these ministries and the central bank as well as of the ministries of culture and tourism the hellenic parliament budget office public debt management agency hellenic statistical authority elstat hellenic financial stability fund and hellenic asset development fund privatisation fund meetings also took place with the main opposition party leadership some social partners think-tanks and several banks 6

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1 introduction 3 the adjustment programme will be facilitated by the lengthening of loans to greece on 21 july the euro-area member states decided that loans to be granted in future to greece will have maturities between 15 and 30 years this compares with average maturities of 7½ years that are currently in force and the initial average maturities of 4 years the amounts already disbursed under the greek loan facility agreement will also have their maturity substantially extended this means that the bilateral loans extended to greece by the euro-area member states will only start being repaid in 2020 this will provide a major improvement in the liquidity conditions of the greek state and of the greek economy at large for several years the imf loans granted under a stand-by arrangement have average maturities of 4 years and their reimbursement is expected to start already in the third quarter of 2013 table 2 contributions by the euro-area member states to disbursements to greece so far eur million may 2010 september 2010 january 2011 march 2011 july 2011 be 0.0 758.8 238.8 530.0 195.3 mt 14.8 5.0 6.2 13.8 5.1 de 4,427.9 1,495.9 1,864.4 611.8 5,050.5 nl 932.5 315.0 392.6 871.4 321.1 ie 0.0 347.4 at 454.0 153.4 191.2 424.3 156.3 es 1,941.6 656.0 817.5 1,814.4 668.5 pt 409.3 138.3 172.3 382.5 -fr 3,325.2 1,123.4 1,400.1 3,107.4 1,144.8 si 0.0 102.9 32.4 71.8 26.5 it 2,921.9 987.2 1,230.3 2,730.5 1,006.0 sk cy 32.0 10.8 13.5 29.9 11.0 fi 0.0 392.2 123.4 274.0 100.9 lu 40.8 13.8 17.2 38.2 14.1 total 14,500.0 6,500.0 6,500.0 10,900.0 8,700.0 may 2010 september 2010 january 2011 march 2011 july 2011 source commission services 4 a reduction in interest rates will contribute to fiscal adjustment and debt sustainability future loans to greece to be provided by the european financial stability facility efsf will be charged at low lending rates 5 a psi programme of debt exchange roll-overs and buy-backs is expected to substantially reduce the financing needs over the next decade however the precise contribution of the private sector to the financing programme depends on technical adjustments to be agreed as well as on the way bond holders will choose among available options box 1 the 21 july 2011 statement by the heads of state or government of the euro area and eu we reaffirm our commitment to the euro and to do whatever is needed to ensure the financial stability of the euro area as a whole and its member states we also reaffirm our determination to reinforce convergence competitiveness and governance in the euro area since the beginning of the sovereign debt crisis important measures have been taken to stabilize the euro area reform the rules and develop new stabilization tools the recovery in the euro area is well on track and the euro is based on sound economic fundamentals but the challenges at hand have shown the need for more far reaching measures 7

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