BoG Monetary Policy Report: High Taxation has recessional effects

In its Monetary Policy Report 2015-2016, the Bank of Greece urges for overhauling of the bailout agreement with 20-year extension of the loans, lower the Primary surplus target to 2%.  The report describes the high taxation as “recessionary” and calls for a shift of policy focus towards reforms and privatizations, which will bolster growth and counterbalance the recessionary effects.

In its 184-page report Bank of Greece hails the positive developments (reforms implementation, bailout tranche, perspective for participation in ECB’s Quantitative Easing) saying that:

“In general, the positive review is expected to have a favourable impact on the Greek economy, as it will strengthen confidence and remove the uncertainty that has weighed heavily on the economic climate and has led to a postponement of investment decisions.”

However it stresses that:

“What is urgently needed now is a shift of policy focus towards reforms and privatisations, which will bolster growth and counterbalance the recessionary effects of high taxation. For if we fail to achieve positive and rising rates of GDP growth soon, the targets set will become much more difficult to attain and the positive effects will fade away.”

BoG’s criticism to Eurogroup

The measures included in the Eurogroup statement have not been specified or quantified, and the relevant timeframe does not signal a decisive and frontloaded approach to public debt sustainability.

Thus, the public debt problem is not dealt with today, in the current favourable environment of very low interest rates, but rather is postponed to be re-examined in the post-programme period. The final decisions on debt are conditional on (i) a positive final assessment of programme implementation; and (ii) the outcome of an updated debt sustainability analysis to be produced in 2018.

Primary Surplus

Public debt sustainability is feasible even with a lower medium-term primary surplus target.

The Bank of Greece considers that there are important reasons to act now. First, global interest rates are at historical lows and the term structure is relatively flat, implying that, at the same cost, debt relief now could be much more beneficial to Greece than a few years down the road, when global interest rates might be higher. Second, debt relief now will contribute to improved confidence of international investors in the country, hence, to lower risk premia, lower cost of financing, stronger investment and improved growth prospects for the Greek economy.

Sensible debt relief measures may include (a) extension of maturities; (b) smoothing of interest payments over time; (c) restoration of transfers of ANFA and SMP profits; (d) swap of IMF loans with ESM loans.”

On the basis of an analysis presented in this report, debt relief measures should be accompanied by a lower medium-term fiscal target. Specifically, the final target for a general government primary surplus of 3.5% of GDP could be reduced to 2% of GDP after 2018, enabling a faster return of the Greek economy to robust and sustainable growth rates. Besides, past experience has shown that only few countries have been able to maintain high primary surpluses of 3.5% of GDP for relatively long periods, as required in the case of Greece from 2018 onwards.

Public debt sustainability scenarios explored by the staff of the Economic Analysis and Research Department of the Bank of Greece show that primary surpluses of 2% of GDP from 2018 onwards are consistent with public debt sustainability assuming (a) an extension of loan maturities by 20 years and (b) smoothing of capitalised deferred interest payments over a 20-year period.

Lower Taxation

Moreover, the easing of fiscal targets will allow a lowering of taxation, which is currently high. This would alleviate the consequences for the real economy, thereby strengthening growth in the medium-to-longer term, which could speed up the reduction of public debt.

Prospect of recovery in the second half of 2016, but risks remain

In the first months of 2016 economic activity was negatively affected by capital controls and by long delays in the completion of the first review of the new programme, which was initially expected in the fourth quarter of 2015. Against this background, financing under the new programme froze, government cash management came under strain, with government arrears accumulating, and uncertainty about the economic outlook was rekindled. These developments, coupled with the negative carryover effect from 2015, caused GDP to contract for a third quarter in a row. In particular, economic activity declined in the first quarter of 2016, both year-on-year (-1.4%) and relative to the previous quarter (-0.5%).

GDP growth rate

According to Bank of Greece estimates, for 2016 as a whole the GDP growth rate should turn out marginally negative, at -0.3%, as the positive growth rates expected for the third and fourth quarters of 2016 should partly offset the negative outcome of the first half of the year.

Risks

Tax increases

Nevertheless, risks to the outlook of the Greek economy remain. The greatest risk relates to the excessive − as the Bank of Greece sees it − emphasis on tax increases as decided in the context of the first review in order to cover the fiscal gap of 2016-2018: a stronger than expected recessionary effect from the higher tax burden could imply, as an indirect impact, a shortfall against revenue targets.

Refugee Crisis

An exacerbation of the refugee crisis could hurt tourism and trade, slowing economic recovery. At the same time, risks and uncertainties about the course of the global economy and the outcome of the upcoming British referendum still exist, which could slow the recovery of the Greek economy.

sources:

full press release & summary in English here Bank of Greece

full 184-page report in Greek here.

Governor Yiannis Stournaras is confident that positive developments of reforms and bailout tranche, will “encourage a return of deposits to the Greek banking system, which will allow an easing and ultimately lifting of capital controls.”