Greece - Developments in Individual OECD Countries

OECD Economic Outlook, June, 1993

With a significant increase in public sector investment, partly financed by EC transfers, the Greek economy should achieve a rate of GDP growth of 1 per cent in 1993, accelerating to 1 3/4 per cent in 1994. Tight fiscal and monetary policies have boosted confidence and inflation has declined, but the differential vis-a-vis the EC is still over 10 percentage points. High real lending interest rates (14 per cent), in response to the still very large budget deficits (over 10 per cent of GDP), have continued to crowd-out the private sector, further depressing growth potential. Privatisation and deregulation are also proceeding slowly.

Recent developments. GDP grew by almost 1 1/2 per cent in 1992, in line with the average growth rate since 1979. The main driving force was public sector investment, which continued to expand by 10 per cent, partly financed by EC transfers. Reflecting a fall in real wages and in farm income, the other domestic demand components were weak, with residential investment declining by 12 per cent. Weak domestic demand and a TABULAR DATA OMITTED recovery in tourism boosted net export growth, so that the contribution of the real foreign balance to output stopped being negative. The indirect tax rises of mid-1992 halted the fall in inflation and the 12-month consumer price increase has bottomed out at around 15 per cent since mid-1992, despite a marked deceleration in wage growth to 13 per cent in 1992. The small increase in the current-account deficit seems to be mainly due to leads and lags and speculation associated with the turmoil in European foreign-exchange markets towards the end of 1992.

Policies and other forces acting. To avoid significant fiscal slippage, direct and indirect tax rates were raised in the summer of 1992. This, coupled with interest capitalisation, contributed to the fall in the government deficit from 15.2 per cent of GDP in 1991 to 10.6 per cent in 1992. The 1993 Budget is again restrictive, as it includes sizeable cuts in pensions and smaller ones in public sector wages, as well as increases in some social security contribution rates. As in 1992, privatisation will also boost government revenues somewhat. Substantial extra receipts from curbing tax evasion have also been budgeted for, but, as in previous years, these may not be realised. The net result is that the government deficit could well remain above 10 per cent of GDP in 1993, compared with the budget target of 8.6 per cent.

Monetary policy remains restrictive. Reflecting the need to finance the substantial budget deficit and to ensure a small real appreciation of the drachma in order to bear down on inflation, interest rates continue to be high (short-term lending rates were more than 30 per cent in the early months of 1993, or 14 per cent in real terms). Credit expansion to the private sector in 1992 was just above the target range of 14-16 per cent, accompanied by an increasing share of foreign-currency loans due to the large interest-rate differential. M3 grew by 15 per cent and M4 (the indicator of broad liquidity) slowed to 19.7 per cent in 1992, but velocity still continued to decrease. The targets set for 1993 -- M3 growth of 9-13 per cent and bank credit expansion to the private sector of 13-15 per cent -- and the authorities' intention to moderate the pace of depreciation of the drachma imply continuing high interest rates over the projection period.

Prospects. Public sector investment is, once again, expected to be the main driving force behind activity in 1993. Reflecting broadly stagnant real wages, a further fall in real farm incomes and the end of the fiscal incentives to replace old cars by new, less-polluting models, private consumption is likely to be weak in 1993. However, the deceleration in domestic demand is expected to be largely offset by stronger net exports, so that GDP growth is projected to be about 1 per cent in 1993. Because of redundancies in ailing public sector firms and efforts by firms with cash-flow problems to raise productivity, the unemployment rate is projected to reach 10 per cent. The growth in private wages is likely to remain around 13 per cent, which, combined with the pick up in productivity resulting from further labour shedding, should bring the growth in business-sector unit labour costs down to 11 per cent in 1993. As a result, consumer price inflation is projected to decline to around 12 per cent by the end of 1993. The slower growth in domestic demand and higher transfers from the EC, together with the unwinding of speculative movements, are expected to cut the current-account deficit to 2 per cent of GDP in 1993. Boosted by the recovery in Europe, the growth of GDP is projected to increase slightly in 1994 and to be accompanied by a decline in inflation and the public sector deficit.

The key to the projected slow improvement in macroeconomic performance is fiscal consolidation and wage disinflation. Pressures to ease fiscal policy and a more relaxed attitude towards wage settlements would risk affecting confidence, provoking a further rise in interest rates and thereby undermining the fragile macroeconomic balances.