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March 15, 2012
- IMF approves €28 billion in new financing for Greece
- Private sector debt writedown important step toward restoring debt sustainability
- Restoring growth through improved competitiveness will be key
The IMF has approved a new €28 billion loan for Greece as part of the overall financing package agreed by Athens and its partners in the eurozone.
The IMF’s 24-member Executive Board agreed March 15 that the new loan will be made under the Extended Fund Facility, which is designed for countries undertaking reforms to address deep-seated structural weaknesses.
Approval of the new program will lead to the immediate disbursement of about €1.65 billion ($2.2 billion). The previous 3-year Stand-By Arrangement that was approved in May 2010 has been cancelled by the Greek authorities, which means that any undisbursed funds have also been cancelled and will not automatically become part of the new program.
“Greece has made tremendous efforts to implement wide-ranging painful measures over the past two years, in the midst of a deep economic recession and a difficult social environment. The fiscal deficit has been reduced markedly and competitiveness has gradually improved. However, the challenges confronting Greece remain significant, with a large competitiveness gap, a high level of public debt, and an undercapitalized banking system,” IMF Managing Director Christine Lagarde said.
“The new Fund-supported program will enable Greece to address these challenges while remaining in the Eurozone. The program focuses on restoring competitiveness and growth, fiscal sustainability, and financial stability,” she added.
Key element
A key ingredient in the government’s revamped economic strategy was the successful conclusion on March 9 of a substantial write-down of Greece’s bonded debt, which will dramatically reduce the country’s medium-term financing needs. The IMF has maintained that Greece must reduce its debt-to-GDP ratio to 120 percent by 2020 if its debt is to become sustainable in the medium term. The debt exchange, which saw private sector investors agreeing to write down 75 percent of their Greek bond holdings, is the largest and steepest debt reduction agreement in history.
Official sector support for the second Greek program entails €130 billion (about US$170 billion) in new financing, in addition to the remainder of the financing support for the first program of €34 billion (about US$44 billion). The IMF contribution of €28 billion will be disbursed in equal tranches over a four-year period.
Putting growth at the center of the agenda
The main goal of Greece’s economic program is to support a return to growth through a major improvement in competitiveness.
Greece continues to face steep challenges when it comes to its ability to compete in international markets. Wages have increased faster than productivity growth for years. Unit labor costs―which is a key measure of competitiveness―increased by over 35 percent during 2000-10, compared to just under 20 percent in the euro area. These numbers are a large part of the reason why Greece’s exports of goods and services amounted to only about 14 percent of the goods it produces.
Snapshot of Greece’s Economy
• A large public sector with generous pay compared to the private sector. The public sector wage bill as a percent of GDP in Greece averaged 12.6 percent from 2005-2009, compared to the EU average of 10.5 percent during the same period. Wages in the public sector are on average almost one and half times higher than in the private sector.
• A high minimum wage compared to other countries. The current minimum wage in Greece is 50 percent higher than in Portugal, 17 percent higher than in Spain, and 5-7 times higher than in Romania and Bulgaria.
• Wages have outpaced productivity growth for years. Unit labor costs (a key measure of competitiveness) in Greece increased by over 35 percent during 2000-10, compared to just under 20 percent in the eurozone.
• Large competitiveness gap. Greece’s competitiveness gap compared to its main competitors stands at around 15-20 percent of GDP.
• High levels of unemployment. As a result of the deep recession and the continued lack of competitiveness, unemployment is still climbing. The overall unemployment rate stood at more than 20 percent as of November 2011. For young people (those aged 15-29), it is close to 40 percent, according to the latest data.
• High level of public spending relative to tax revenue. Public spending in Greece as a percent of GDP is still close to the euro area average of 49-50 percent. Yet tax revenue, at 39 percent of GDP, remains significantly below the euro area average.
Currency devaluation is not an option for Greece because if its membership in the eurozone. This means that unit labor costs can only be improved through improved productivity—which is difficult to engineer in the short run—or through wage adjustments. The program focuses on labor market reforms to realize adjustment, aiming to also limit the rise in unemployment.
The labor market reforms include a substantial reduction in the minimum wage, which is intended to align it more closely with levels in other European countries. The minimum wage in Greece is much higher than that of its competitors—50 percent higher than in Portugal, and 18 percent higher than in Spain. A lower minimum wage will help reduce the competitiveness gap, and also help young people in particular gain a foothold in the labor market. Youth unemployment in Greece is painfully high at close to 40 percent.
But wage cuts will not by themselves solve the deep-rooted problems of the Greek economy. Many service professions that play a key role in the economy are insulated from competition, which means that prices are much higher than they should be. The lack of competition also impairs other parts of the economy that rely on these services for their products, holding back innovation and job creation. Tackling these reforms may lead to resistance from those who stand to lose, but will bring the benefit of greater price competitiveness to the economy.
As part of the effort to open up the economy and make it more competitive, the government remains committed to selling €50 billion in public assets. This should help boost investment. But the timetable has now been scaled back compared to the strategy under the previous IMF-supported program to better reflect market conditions and the time needed to prepare assets for sale. The full amount will now be achieved early in the next decade.
Achieving a viable level of public spending
The economic program also targets new reductions in public spending. These would come on top of deep cuts made during the previous three years.
On the surface, this seems harsh. Public spending in Greece as a percent of GDP is still close to the euro area average of 49-50 percent. But tax revenue, at 39 percent of GDP, remains significantly below the euro area average, reflecting endemic tax evasion and narrow tax bases.
The program puts a high priority on stemming tax evasion and expanding bases. Large numbers of self–employed people in Greece pay very little in taxes despite their high earnings. But this is a complex reform effort that will take time and strong political commitment, and some of the dividends do need to be devoted to reducing the high tax burden on the formal sector in Greece. Overall, better tax collections can only deliver a small portion of the 7 percent of GDP needed to attain the fiscal target of 4½ percent of GDP for 2014 that has been agreed under the program.
In fact, looking more closely at the recent historical record, tax revenue in Greece remains fairly close to its long-term average. It is a rapid increase in spending—in particular social transfers—that has been one of the main drivers behind the large deficits accumulated before the crisis. Indeed, since 2000, social security spending in Greece has increased by about 6 percent of GDP.
The focus of the program is therefore to restrain spending while strengthening the core social safety net. Social transfers will need to be better and more efficiently targeted so as to allow measures that protect the most vulnerable people in society to be strengthened. There is ample scope to do this: existing social benefit programs are unequally distributed and poorly targeted—for instance, 60 percent of all family benefits go to the 40 percent with the highest incomes.
Ensuring the solvency of the banking sector while protecting depositors
Since 2009, banks have lost about 30 percent of their deposit base. The recession is also taking its toll, with the number of non-performing loans rising to more than 15 percent of all loans by end-September 2011. On top of that, Greek banks must now recognize the losses on their government bond holdings because of the private sector debt exchange.
Under the new IMF-supported program, €50 billion has been set aside to help banks cope with these various challenges. Appropriate incentives have been structured to encourage private participation in recapitalization, while the framework for recapitalization and resolution has been overhauled to ensure funds are put to good use, and that political interference in bank management is minimized.
During the recapitalization process depositors will be protected. And the support has been designed to encourage continued liquidity support from the euro system.
Maintaining support for Greece
Renewed financial support from Greece’s international partners will help cover the funding gap for now and give the government time to implement further reforms. But even with the substantial private debt write-off that was just agreed, Greece’s debt will remain very high for some time.
Greece’s European partners have committed to provide adequate support, during and beyond the program period, for as long as it takes for the country to regain market access, provided the policies that have been agreed are implemented in full.
“Risks to the program remain exceptionally high, and there is no room for slippages. Full and timely implementation of the planned adjustment—alongside broad-based public support and support from Greece’s European partners—will be critical to success, Lagarde said.
