A week ago the European Commission released its spring economic forecast for 2005-06. It projects that the Greek budget deficit will stand at 4.5% of GDP in 2005 and 4.4% in 2006 -- still well above the euro-area's 3.0% limit. The New Democracy (ND) government has reformed the way that government deficits and debts were recorded.
The process drove up the 2004 budget deficit forecast level from 1.2% of GDP to 6.1%. However, the government released a revised fiscal package at the end of March, which the Commission projections do not take into account, aimed at conformity with euro-area rules by the end of 2006.
The centre-right New Democracy party (ND), while in opposition, repeatedly complained that the Panhellenic Socialist Movement (PASOK) government had used creative accounting to secure membership of the euro-area. Historical revisions by the ND government indicated that Greece had never properly met the criteria to be a member of the euro-area, while the 2004 budget deficit forecast of 6.1% was far in excess of the 3.0% limit imposed by the Stability and Growth Pact.
Government programme
The first ND government Stability and Growth Programme, outlining the government's fiscal projections and policy, was submitted to Brussels in December 2004 and predicted a 2005 budget deficit of 2.8% of GDP and 2.6% in 2006, based on growth rates of 3.9% and 4.0% respectively. The Commission expressed doubts over these numbers, as its own projection showed growth of no more than 3.3% in either year in Greece. ECOFIN accepted the Commission assessment and in March placed the Greek economy under surveillance under the 'excessive deficit procedure', which can lead to sanctions. The ND government was given two years to bring the deficit back in line to a level of 3.6% of GDP this year and 3.0% next.
At the end of March, the ND government published its revised Stability and Growth Programme for 2004-07. It continued to insist that high rates of GDP growth could be achieved: 3.9% this year, 4.0% in 2006 and 4.2% in 2007. It projected that the budget deficit would be brought down to 3.5% of GDP this
year, 2.8% in 2006 and 2.2% in 2007 with aggregate debt falling from 108% of GDP this year to 99.9% in 2007. The revised stability and growth programme will be debated by the ECOFIN Council this month.
Growth assumption
The government's assumption is that the high rates of GDP growth will be sustained through strong domestic demand, driven by increases in private consumption and in gross fixed capital formation. The revised programme suggests that private consumption will be sustained by several factors:
Strong credit growth is expected. The outstanding indebtedness of Greek households stood at 31.4% of GDP in December 2004, compared to an EU average of 50.3%, while interest rates are at historic lows.
Private investment is expected to be generated by improved profitability. The average rate of return for stock exchange listed companies in 2004 was just under 10%. Investment may further be enhanced by planned cuts in corporation tax, which is being reduced in phases from 35% in 2004 to 25% in 2007.
The government has also introduced a programme of generous investment incentives, including grants, tax holidays, and wage subsidies. It also plans to introduce legislation to promote investments under schemes such as public
private partnerships and private finance initiatives. The government expects that the external sector will begin to make a positive contribution, with exports accelerating as EU and world economies recover from their post-September
11 slump, while imports decelerate following the completion of investment projects for the Olympic Games held in Athens in 2004.
Increasing revenue
To increase revenues, the government has boosted taxes on tobacco and spirits and eased up the standard rate of VAT from 18% to 19%. These measures are expected to increase revenues by 1.1 billion euros (1.4 billion dollars) this year and by 2.1 billion euros in 2006. The government is planning a severe crackdown on tax and social security evasion.
The Ministry of Economy and Finance is also contemplating harmonising taxes on motor and heating diesel while offering a heating rebate to the poorest segments of the population. This would increase the tax take on heating oil and promote
conversion to natural gas, to allow the country to help meet its Kyoto commitments on carbon emissions, while lowering transportation costs -- thus reducing inflation and making Greek export products more competitive. The government has not yet fixed the details of this proposal. The measures already announced are forecast to add to current inflation forecasts, bringing the rate to an annual average of 3.2% in 2005 and 3.0% in 2006.
Expenditure plans
The government anticipates that spending on Olympic projects, which had reached 1.37% of GDP in 2004, will fall to 0.34% this year, reducing the deficit by 1.03 percentage points. To bring down the wage bill, the rate of public sector pay increases will be just 3.6%, while hiring policy will be restricted. Grants to public entities such as social security agencies will be cut back, and a special task force has been established to monitor health care payments. The government says it is contemplating the establishment of an independent body of fiscal inspectors to audit the internal auditing done by all ministries, local authorities and public entities. The revised programme also forecasts a modest decrease in debt servicing costs of around 0.25% of GDP.
Contingency scenarios
At the insistence of the European Commission, the government has run two alternative scenarios based on lower rates of GDP growth:
One such scenario projects constant growth of 3.3% throughout the 2005-2007 period.
Another such scenario projects lower growth still, starting at 2.9% this year, and rising to 3.0% in 2006 and 2007.
The published information related to these scenarios is scant. However, each sees the general government deficit falling to 2.9% of GDP by 2006 -- in line with the Stability and Growth Pact rules and ECOFIN demands. In both scenarios, inflation remains low, but unemployment rates do not move below 10% -- whereas they fall to 8.9% in 2007 in the high growth scenario. The low growth scenarios also mean that aggregate debt levels will come down more slowly, continuing to remain above 100% of GDP.
The New Democracy government insists that it can bring its budget deficit below the euro-area limit of 3% of GDP through a combination of indirect tax increases, expenditure cuts, and a clampdown on tax evasion. This plan is based on the assumption that annual GDP growth rates will remain at or above 3%
through 2007. Whereas growth has been driven by high rates of investment in recent years, current projections expect that private consumption will become the main driver, making this a risky policy in the long term.
By: N. Peter Kramer
