On May 31, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the 2013 Article IV Consultation with Greece¹ and completed the Third Review of the country’s performance under an economic program supported by an Extended Fund Facility (EFF) arrangement (see Press Release No. 13/195). The Executive Board also discussed the Ex Post Evaluation of Exceptional Access Under the 2010 Stand-By Arrangement for Greece².

Background

Since the last Article IV consultation in mid-2009, Greece has been in a deep economic crisis. This crisis followed from the buildup by 2009 of extraordinary fiscal and external imbalances—the result of fiscal expansion after euro accession, financed by low-cost external borrowing. The re-pricing of risk associated with the global financial crisis, large government deficit and debt data revisions, and the deterioration in the fiscal balance triggered the crisis in Greece. The government lost access to capital markets in 2010, and an ambitious multi-year adjustment program was put in place with the support of the European Commission, European Central Bank, and IMF. The program aimed to make the fiscal position sustainable through significant front-loaded consolidation, and to improve competitiveness through comprehensive structural reforms, while safeguarding the financial system. Unprecedented international support was provided—first through a 3-year, €110-billion financing package jointly with euro area members under a Stand-By Arrangement in May 2010, and then through a €173-billion package jointly with euro area members under the Extended Fund Facility in March 2012 (of which about €136 billion was financing over and above the undisbursed portion from the first package).

Important progress has been achieved in stabilizing the Greek economy. The cyclically-adjusted primary balance improved cumulatively by about 15 percent of GDP during 2010–12, and the headline primary deficit is expected to be eliminated in 2013. Far-reaching labor market reforms put in place in early 2012 have contributed to wage corrections and a significant reduction of the competitiveness gap. The external current account deficit improved from about 15 percent of GDP in 2008 to 3.4 percent in 2012. Financial stability has been preserved, including through a large recapitalization of the system. Greece remained in the euro area, its key objective, and associated spillovers that may have had a severe effect on a fragile global economy were relatively well-contained.

But Greece has adjusted mainly through recession, rather than through productivity-enhancing reforms. Several adverse and mutually reinforcing factors contributed to worsening investor sentiment, large deposit outflows, and underperformance of growth in 2011–12; bouts of political turmoil left doubts about domestic support for the program; structural reforms fell well short of expectations; and concerns about the external financing strategy, debt sustainability and Greece’s future in the euro area undermined confidence. These factors amplified the negative output effect of the front-loaded fiscal consolidation and deepened the recession. As a result, Greece experienced one of the deepest peacetime recessions to afflict an advanced economy. Output contracted by 22 percent during 2008–12, unemployment has increased to about 27 percent, and youth unemployment now exceeds 60 percent.

The underperformance of growth made restructuring of the high level of sovereign debt inevitable. By involving both private and official creditors in such a restructuring in 2012, the debt burden was reduced markedly. But public debt still stood at 157 percent of GDP at end-2012. Thus, the commitment by Greece’s European partners to provide further conditional relief, if needed, to bring the projected debt-to-GDP ratio to 124 percent by 2020 and to substantially below 110 percent of GDP by 2022, is critical for ensuring sustainability.

Greece’s recovery is expected to be gradual. Although fiscal adjustment will remain a drag on growth, the lion’s share of structural fiscal adjustment is now behind Greece, and steadfast program implementation can help to turn around expectations, improve liquidity conditions, and lead to a recovery of investment and net exports. On that basis, growth is projected to contract by 4.2 percent in 2013, but to expand by 0.6 percent in 2014.

Executive Board Assessment

The Executive Directors commended the Greek authorities for the progress thus far in addressing deep-seated vulnerabilities amidst a sharp and socially painful recession. Fiscal adjustment has been exceptional by any international comparison, wage adjustment has facilitated a significant decline in the competitiveness gap, and financial sector stability has been safeguarded. Directors noted nevertheless that the recovery path remains very difficult, on the back of still high levels of unemployment, public debt, and non-performing loans. They urged the authorities to redouble their reform efforts to improve tax and public administration and enhance productivity, noting that these reforms would promote the efficient allocation of resources and boost output, facilitate remaining fiscal adjustment, and make the burden of adjustment more equitable.

Directors noted that Greece is well underway to complete its needed fiscal adjustment. They underscored that a priority now is to tackle tax evasion by reforming the revenue administration to improve collection efficiency and enhance its operational independence, and if necessary, consideration could be given to creating an independent tax agency. Directors encouraged the authorities to save any gains from better tax collection, continue to broaden the tax base, and press ahead with public administration reform, particularly the targeted reduction in staff and replacement of under-performing workers with better qualified staff.

Directors stressed that a critical mass of structural reforms is necessary to raise productivity, lower consumer prices, boost investment, and create much-needed employment opportunities. They observed that progress on labor market reforms has increased wage flexibility. Directors encouraged further steps to facilitate price adjustments commensurate with wage declines through the liberalization of regulated professions and other product and service markets, and to improve the business environment more broadly.

Directors welcomed a significant achievement in bank recapitalization and resolution. Noting that this process will leave the banking system largely under state ownership, they called on the authorities to reinforce the governance framework in the financial sector and, as soon as conditions permit, to re-privatize banks that are under state control. Further efforts are needed to repair balance sheets and restore credit growth, and in this regard, Directors looked forward to the completion of the reform of the insolvency and non-performing loan resolution frameworks.

Directors expressed concern that public debt is projected to remain high well into the next decade and concurred with the assessment that macroeconomic risks are on the downside. In this context, Directors welcomed the assurances from Greece’s European partners that they will consider further measures and assistance, if necessary, to reduce debt to substantially below 110 percent of GDP by 2022, conditional on Greece’s full implementation of all commitments contained in the program. Directors also welcomed the continued commitment of Greece’s European partners to provide adequate support to Greece during the life of the program and beyond until the country has regained market access, provided that Greece fully complies with the requirements and objectives of the adjustment program. Most Directors considered that, should debt sustainability concerns weigh on investor sentiment, even with the framework for debt relief now in place, and strong program implementation by the Greek authorities notwithstanding, consideration of a more front-loaded approach to debt relief would be needed. The macroeconomic and debt outlook must remain under close review.

Directors welcomed the candid assessment of the ex post evaluation of exceptional access under the 2010 Stand-By Arrangement (SBA), and agreed that it provides a good basis for all parties to draw valuable lessons. Directors emphasized in particular the importance of adequate financing, strong program ownership, and implementation capacity in the design of programs. They noted the finding that the SBA-supported program had made overly optimistic assumptions, including about growth, although some considered that to be the case only with the benefit of hindsight. Directors saw merit in better risk-sharing arrangements within the euro area, and noted the benefits of a timely restructuring of sovereign debt with the necessary safeguards to contain spillover risks and moral hazard. Mindful of the need to ensure equal treatment across the Fund’s membership, Directors generally saw scope for tailoring the Fund’s lending policies to the particular circumstances of monetary unions, including appropriate modalities for collaboration with the union-level institutions.