Although the Greek economy looked like it was beginning to achieve liftoff in late 2014, its progress was set back in early 2015 by the newly-installed Tsipras administration’s effort to obtain major changes to the country’s bailout program. Greece’s compliance with the key provisions of that program was slipping even before the election, but the new administration reversed course on many reforms during renegotiations with its EU creditors.
The government pushed for concessions from the EU to ease its debt burden and rollback some of the harshest aspects of the austerity program. Unable to get the EU to budge, Mr. Tsipras called for a snap referendum in July 2015 to obtain a voter mandate to leave the euro, if necessary. After winning that mandate, the Prime Minister then agreed to comply with the bailout program after calculating the high cost to Greece of exiting the euro. But the episode sparked a new banking crisis and temporarily nipped the country’s budding economic recovery.
Since that time, Mr. Tsipras has largely followed through with his pledge. To date, Greece has met most, if not all, of its obligations under the bailout program, but at some political cost to the Prime Minister. The government continues to press for debt relief, but so far to no avail.
Greece’s economy, meanwhile, is poised once again for growth. After recording GDP growth of 0.7% in 2014, Greece’s GDP slipped 0.5% in 2015 and was flat in 2016. The government now expects modest growth of 1.8% in 2017, down from its earlier projection of 2.7%. First quarter GDP growth was revised upward to 0.4% from an initial reading of -0.5%.
Since peaking at nearly 28% in 2013, Greece’s unemployment rate has fallen steadily and was last reported at 23.3% in February. With a return to economic growth, Greece’s unemployment rate should fall further in 2017.
Yet, nearly a decade into one of the worst economic depressions suffered by any country in the modern era, Greece still has not completed the structural reforms necessary to foster sustainable economic growth. This is due to some of the unique aspects of Greece’s economy, its tax system and its public pension system.
According to the IMF, Greece still has two major structural problems: First, its pension system is “unaffordable and unsustainable.” Greece’s pension spending amounts to 17.5% of GDP. Annual transfer payments to the pension system equal 10% of GDP, which is four times the Eurozone average. The government has already made cuts to pension benefits and has agreed to more, but deeper cuts to bring the system within the EU average may be politically unfeasible. Second, Greece’s tax regime exempts more than half of its workers from paying any tax and thus places a disproportionate burden on higher income workers. The tax regime thus encourages widespread evasion.
The enactment of structural reforms to address these issues has been hampered by the weak condition of the economy, creating what some might characterize as a “chicken and egg” problem. Although government pensioners are generously compensated, many of them undoubtedly use some of their surplus income to provide financial support to their unemployed and underemployed relatives. The high income tax payment threshold likewise encourages households to avoid reporting income that would trigger the tax (which would result in a sharp drop in their disposable income). Some tax avoidance may also stem from the anger of citizens at the austerity program’s relentless series of budget cuts and layoffs that has been imposed upon Greece by outsiders. Under these conditions, it is likely that Greece’s underground economy has grown.
Greece’s economic recovery has also been hampered by the lack of formal resolution of its non-performing loans – residential and commercial – that still sit on bank balance sheets. Although the government has inched toward improving the processes for resolving defaults, as a practical matter it is difficult for the banks to pursue a final resolution of non-performing loans with unemployment still at 23%. It makes little sense, for example, for banks to foreclose on residential properties only to have the majority of them sit empty and deteriorate. House prices are down 50% or so from peak levels. With buyers scarce, any major effort by banks to unload foreclosed properties will drive prices lower. Banks have less chance of restructuring defaulted loans successfully when mortgagors have little or no income. Restructurings are therefore more likely to be successful when the economic recovery is underway and gaining momentum. More households should then be in a better position to meet payments on modified loans.
The same can be said for commercial loans. With average sales down by a third in this recession, widespread foreclosures on defaulted commercial loans would probably drive down business activity and asset prices. Postponing settlements of large numbers of defaulted commercial loans until the economic recovery is well underway may dampen their impact on the economy and allow lenders to achieve better recoveries.
Despite the logic of waiting to resolve defaulted loans, an extended delay can still impede Greece’s economic recovery by prolonging the uncertainty of final resolution for households and businesses. Many businesses, for example, have postponed rehiring workers or investing in new equipment until they know how their loans will be resolved. Homeowners who are behind in their mortgage payments may likewise avoid making major and even minor repairs to their property. Some borrowers may be skipping payments because they realize that they will not face any near-term consequences by doing so.
At some point, therefore, it may be better for the banks to proceed with loan restructurings and foreclosures in order to enforce their legal claims, eliminate the uncertainty and unlock more potential investment spending and hiring. After nine long years of depression, I believe that it is time for Greece to pick up the pace of resolution of non-performing loans and advance steadily toward a final resolution of the majority of its non-performing exposure backlog so that the country can begin to put the recession squarely in the rear view mirror.
At the present time, the Greek government, its EU creditors and the IMF have been at an impasse to resolve the key issue of reducing Greece’s debt burden. Finance Minister Euclid Tsakalotos has said that the EU has a “moral obligation” to grant Greece some debt relief because Greece has complied with the terms of the bailout program. Meanwhile, the European Stability Mechanism (ESM) has said that Greece still needs to comply with certain reforms in order to receive its next tranche of aide. Greece’s EU creditors, led by Germany, have said that they are willing to consider some type of debt relief when the current bailout program expires in August 2018.
The IMF, which is also a participant in the bailout program, has determined that Greece’s current level of debt is unsustainable. Under its rules, it is therefore not allowed to participate in the bailout program going forward until Greece’s debt is brought to a sustainable level. The EU wants the continued participation of the IMF, but it has been unable to agree with the IMF on a sustainable debt level for Greece.
On May 5, IMF Managing Director Christine Lagarde offered to resolve the impasse by proposing that the IMF would remain a participant in the bailout program, but would not disburse any funds until agreement had been reached on restructuring Greece’s debt.
A resolution to this matter is required within the next few weeks, in order for Greece to receive the next installment in the bailout program, which would allow it to meet an upcoming debt maturity of €7 billion due in July.
Under the circumstances, I believe that it would be wise for the EU to grant at least partial debt relief in recognition of the progress that Greece has made under its rehabilitation program. However, there may not be enough time to negotiate and approve a comprehensive reassessment of Greece’s sustainable debt level in accordance with IMF rules before the €7 billion debt payment is due in July.
Assuming that an agreement can be reached between all parties within the next few weeks, which seems likely, and Greece receives the next tranche of bailout funding in July, I believe that the chances are good that the Greek economy will show meaningful growth this year, perhaps even topping the government’s current 2017 GDP growth forecast of 1.8%. Greece should benefit from Europe’s improving economic recovery. If positive economic growth can then be coupled with meaningful progress on major reforms and especially towards a final resolution to the financial system’s large backlog of non-performing loans, Greece will take several giant steps toward putting both its economy and financial system on firm ground, even though it will continue to face significant challenges.
June 7, 2017
Stephen P. Percoco
Lark Research, Inc.
839 Dewitt Street
Linden, New Jersey 07036
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