Special report: “The 2015 Euro Plus Monitor – More Progress, New Risks” conducted by the think tank Lisbon Council and the investment bank Berenberg.
Greece unfortunately fell into the trap in 2015, succumbing to a deep new crisis instead of enjoying the gains from its previous adjustment efforts.
This is mentioned by a new report entitled “The 2015 Euro Plus Monitor – More Progress, New Risks” conducted by the think tank Lisbon Council and the investment bank Berenberg.
In the first seven months of 2015, Greece sowed uncertainty and chased much-needed capital out of the country through actual or potential reform reversals at an alarming speed. That was the opposite of what the country needed, the report says.
Greece led the adjustment ranking in the last four editions of this study. But this time, its score for adjustment progress falls sharply by 1.2 points. This is the biggest single drop in the score the report has found in all five editions so far. By sowing uncertainty and chasing capital out of the country in record amounts between late 2014 and July 2015, Greece weakened its economic and fiscal position dramatically
That Greece still gets a No. 2 place in our overall adjustment ranking has only one reason: in the ranking, the study measures the aggregate progress since 2010. Greece had worked hard to improve in previous years. So far, the Syriza shock has undone only part of that progress.
The exception is Greece where the external adjustment has gone into reverse with exports in 3Q 2015 falling 11.4% below their year-ago level. The continuing small improvement in Greece’s external accounts reflects solely a further fall in imports (-19.9% year-on-year in 3Q 2015). Of course, the Greek trade data may be heavily affected by the turmoil including capital controls and the closure of banks that were caused by the government’s confrontation with its official creditors over the summer.
According to the study, whereas the progress in Greece still looks impressive on a five-year view, the disaster of 2015 shows up clearly in the data. Unfortunately, Greece will now have to endure significantly more fiscal pain for longer to make up for this accident even if creditors continue to reduce the country’s costs of servicing its public debt.
But even with respect to labour costs, Greece went the wrong way in 2015. While all other erstwhile euro crisis countries improved or at least maintained their scores, the Greek score slipped to 7.7, down slightly from 7.9 last year.
The fundamental health of Greece deteriorated sharply in 2015. By the standards of the slow-moving scores for fundamental health, the Greek drop by 0.2 points in 2015 is significant. It reflects the fiscal accident which Greece inflicted on itself in 2015 and which worsened its fiscal sustainability significantly. The accident shows up in a major worsening of Greece’s structural fiscal balance to an estimated deficit of 1.1% for 2015, down from a surplus of 2% in 2014. In addition, Greek public debt surged to almost 190% of GDP, up from 175%, mostly because the reckless policies caused capital to flee to such an extent that Greek banks needed to be recapitalised again. The Greek fiscal accident would have led to an even lower score for fundamental health if Greece’s creditors had not agreed to support Greece nonetheless, effectively reducing Greece’s future debt service. Also, the rise in the personal savings rate in 2014 supported the Greek score.
According to the study, unfortunately, successive Greek governments and their international creditors found it easier to implement and police tax hikes than structural reforms. The result was an unnecessarily deep adjustment recession. To make matters worse, creditors responded to the fiscal shortfalls caused by the depth of the recession by asking Greece to compress demand even more.
While Greece went through more pain than was necessary, its adjustment programme did work in the end. Although Greece took the medicine in the wrong dose and not in the optimal sequence, the medicine still did its job.
With the rise of political uncertainty in late 2014, capital started to flee the country. With threats to reverse many reforms and a confrontational approach towards the only willing lenders Greece has, the Greek government that came to power in January 2015 confirmed the worst fears. Until the end of the tenure of Yanis Varoufakis as finance minister in mid-2015, capital flight through the banking system as recorded in Greece’s balances in the Target2, the Eurosystem’s inter-bank payment system, reached €66 billion, equivalent to 37% of Greece’s 2014 GDP.
No country can withstand such a blow and the sheer fear which the antics of the Greek government had caused in the first seven months of 2015. The Greek economy fell back into recession as a populist coalition in Athens drove Greece’s fiscal outlook and its banks into the ground in 2015. That Greece’s structural primary balance deteriorated by 3.6% of GDP in one year is not the expression of any fiscal stimulus. For a country that had just emerged from one of the worst adjustment recessions on record in Western economies, shattering fragile confidence by a full- blown and futile confrontation with the country’s only willing lenders proved to be a costly disaster. Rarely before has corporate confidence plunged so fast and so badly in any self-inflicted disaster.
The damage is substantial. Counting only the fiscal costs, we come up with a rough guesstimate for 2015 and 2016:
• Lost growth. Instead of expanding by around 3% in 2015 and 2016, the Greek economy will probably contract by 0.5% in 2015 and 1.0% in 2016. For 2016, Greek real GDP will be roughly 7.5% below what it would have been otherwise.
• Lost revenues. Lower tax revenues and extra spending will likely lead to a cumulative fiscal shortfall of at least €9 billion for 2015 and 2016 relative to a baseline of unchanged policies and the absence of a political confidence shock.
• Weaker banks. The need to recapitalise the badly weakened banks and the prospect of much lower potential revenues from a future privatisation of banks after the massive dilution of the public sector’s share in the banks probably amounts to a fiscal hit of at least €12 billion and possibly significantly more.
7.5% less of real GDP, a slightly lower GDP deflator in response to renewed recession and an extra fiscal hit of €21 billion add up to a likely rise in the Greek debt-to-GDP ratio by around 28% of Greece’s projected 2016 GDP. Rarely have so few months as Greece’s January to July 2015 policy chaos been so expensive for the public purse while causing so much misery on top of that.
Of course, history moves on. After Greece ratified a new agreement with its international lenders in the summer of 2015, corporate confidence recovered somewhat. But shattered trust is difficult to rebuild. Even if a chastened Greek government without Yanis Varoufakis now stays roughly on the course agreed with its lenders, the road ahead will be rocky. Business investment will remain tepid for a while after such a near-death experience. Unfortunately, we cannot rule out a new Greek crisis as, due to the renewed recession, the social situation will take significantly longer before it can improve.
The Greek experience should provide a stark warning to other governments thinking of reform reversals. In a still fragile situation, policy mistakes that shatter confidence can be very costly indeed.