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June 2013 IMF Country Report No. 13/156© 2013 International Monetary FundMay 20, 2013 January 29, 2001January 29, 2001 January 29, 2001 January 29, 2001Greece: Ex Post Evaluation of Exceptional Access under the 2010 Stand-By Arrangement This ex post evaluation of exceptional access under the 2010 stand-by arrangement on Greece was prepared by a staff team of the International Monetary Fund. It is based on the information available at the time it was completed on May 20, 2013. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the government of Greece or the Executive Board of the IMF. The policy of publication of staff reports and other documents by the IMF allows for the deletion of market-sensitive information. Copies of this report are available to the public from International Monetary Fund  Publication Services 700 19th Street, N.W.  Washington, D.C. 20431 Telephone: (202) 623-7430  Telefax: (202) 623-7201 E-mail: publications@imf.org Internet: http://www.imf.org Price: $18.00 a copyInternational Monetary Fund Washington, D.C. GREECE May 20, 2013EX POST EVALUATION OF EXCEPTIONAL ACCESS UNDER THE 2010 STAND-BY ARRANGEMENTEXECUTIVE SUMMARY The primary objective of Greece’s May 2010 program supported by a Stand-By Arrangement (SBA) was to restore market confidence and lay the foundations for sound medium-term growth through strong and sustained fiscal consolidation and deep structural reforms, while safeguarding financial sector stability and reducing the risk of international systemic spillovers. Greece was to stay in the euro area and an estimated 20-30 percent competitiveness gap would be addressed through wage adjustment and productivity gains. There were notable successes during the SBA-supported program (May 2010–March 2012). Strong fiscal consolidation was achieved and the pension system was put on a viable footing. Greece remained in the euro area, which was its stated political preference. Spillovers that might have had a severe effect on the global economy were relatively well-contained, aided by multilateral efforts to build firewalls. However, there were also notable failures. Market confidence was not restored, the banking system lost 30 percent of its deposits, and the economy encountered a muchdeeper-than-expected recession with exceptionally high unemployment. Public debt remained too high and eventually had to be restructured, with collateral damage for bank balance sheets that were also weakened by the recession. Competitiveness improved somewhat on the back of falling wages, but structural reforms stalled and productivity gains proved elusive. Given the danger of contagion, the report judges the program to have been a necessity, even though the Fund had misgivings about debt sustainability. There was, however, a tension between the need to support Greece and the concern that debt was not sustainable with high probability (a condition for exceptional access). In response, the exceptional access criterion was amended to lower the bar for debt sustainability in systemic cases. The baseline still showed debt to be sustainable, as is required for all Fund programs. In the event, macro outcomes were far below the GREECEbaseline and while some of this was due to exogenous factors, the baseline macro projections can also be criticized for being too optimistic. The report considers the broad thrust of policies under the program to have been appropriate. Rapid fiscal adjustment was unavoidable given that the Greece had lost market access and official financing was as large as politically feasible. Competivenessboosting measures were also essential, as were fiscal structural reforms to support deficit reduction. However, the depth of ownership of the program and the capacity to implement structural reforms were overestimated. Greece’s SBA suggests the need to explore the case for refining the Fund’s lending policies and framework to better accommodate the circumstances of monetary unions. A particular challenge is to find ways to translate promises of conditional assistance from partner countries into formal program agreements. There are also political economy lessons to be learned. Greece’s recent experience demonstrates the importance of spreading the burden of adjustment across different strata of society in order to build support for a program. The obstacles encountered in implementing reforms also illustrate the critical importance of ownership of a program, a lesson that is common to the findings of many previous EPEs. Other lessons drawn concern the need to find ways to streamline the Troika process in the future and for Fund staff to be more skeptical about official data during regular surveillance. The detailed nature of the structural fiscal conditionality in the Greek program also bears scrutiny given the premium attached to parsimony in Fund conditionality.2INTERNATIONAL MONETARY FUND GREECEAuthorized for distribution by the European Department and the Strategy, Policy, and Review DepartmentPrepared by an interdepartmental staff team consisting of J. Gordon (head, OBP), I. Karpowicz (OBP), S. Lanau (SPR), J. Manning (EUR), W. McGrew (EUR), M. Nozaki (FAD), and M. Shamloo (EUR), with assistance from A. Shtuni (OBP) and C. Piatakovas (EUR).CONTENTS BACKGROUND TO THE CRISIS ___________________________________________________________________5  A. The build-up of imbalances _____________________________________________________________________ 5  B. Crisis triggers ____________________________________________________________________________________ 6  C. Crisis response __________________________________________________________________________________ 7  AN EXCEPTIONAL FUND PROGRAM _____________________________________________________________9  PROGRAM STRATEGY AND IMPLEMENTATION ______________________________________________ 10  PROGRAM OUTCOMES _________________________________________________________________________ 12  A. Macroeconomic outcomes ____________________________________________________________________ 12  B. Fiscal policy outcomes _________________________________________________________________________ 14  C. Debt and financing outcomes _________________________________________________________________ 16  D. Structural reforms _____________________________________________________________________________ 18  E. Financial sector ________________________________________________________________________________ 18  PROGRAM DESIGN _____________________________________________________________________________ 20  A. Should the fiscal adjustment path have been more gradual? _________________________________ 20  B. Should the adjustment path have been more flexible? ________________________________________ 21  C. Should the larger economic downturn have been expected? _________________________________ 21  D. Were structural reforms sufficient to restore competitiveness and growth? __________________ 22  E. Was the mix of fiscal measures appropriate? __________________________________________________ 23  F. Was there sufficient ownership and capacity for reforms?_____________________________________ 24  G. Was the financing of the program likely to be sufficient? _____________________________________ 25  H. Should debt restructuring have been attempted at the outset? ______________________________ 26  CONSISTENCY WITH FUND RULES AND PRACTICES _________________________________________ 29  A. Was exceptional access justified? _____________________________________________________________ 29  B. Was the SBA consistent with other Fund programs with countries in currency unions? _______ 30 INTERNATIONAL MONETARY FUND3 GREECEC. How well did the Troika arrangement work? __________________________________________________ 31  D. Should the EFF have been introduced at the beginning? _____________________________________ 31  POSSIBLE LESSONS _____________________________________________________________________________ 32  BOXES 1. A Chronology of Events _______________________________________________________________________ 2. Progress with Internal Devaluation under the SBA-Supported Program ______________________ 3. Pension Reform ________________________________________________________________________________ 4. Revenue Administration Reform during the SBA-Supported Program ________________________ 5. Structural Benchmarks: Design and Implementation __________________________________________35  36  38  39  41 TABLES 1. Selected Economic Indicators, 2009–14 _______________________________________________________ 42  2. Quantitative Performance Criteria, 2010–13 ___________________________________________________ 43  3. Structural Conditionality _______________________________________________________________________ 44  REFERENCES References _______________________________________________________________________________________ 47  APPENDIX I. Views of the Authorities ________________________________________________________________________ 49 4INTERNATIONAL MONETARY FUND GREECE1. An Ex-Post Evaluation (EPE) of Exceptional Access under Greece’s 2010 Stand-By Arrangement (SBA) is timely. The Fund’s rules require an EPE of exceptional access decisions within a year of the arrangement ending. This requirement is intended to ensure uniformity of treatment across members and that no large program escapes evaluation. Greece’s SBAsupported program, approved in May 2010 and cancelled in March 2012, was an exceptionally large program with access of €30 billion and warrants evaluation even though the SBA was immediately succeeded by an extended arrangement under the Extended Fund Facility (EFF). As with all EPEs, the purpose of the report is (i) to review performance against program objectives; and (ii) to evaluate program design encompassing the macroeconomic strategy, program architecture, adequacy of financing, and the case made for exceptional access.BACKGROUND TO THE CRISIS A. The build-up of imbalances 2. Euro accession led to an economic boom in Greece. Adoption of the euro and loose global credit conditions in the 2000s allowed Greece easy access to foreign borrowing that financed a significant expansion of government spending. Robust private credit growth following financial liberalization also served to boost household 30 30 consumption. Real GDP growth averaged 4 percent Long-term Government Bond Yields (Percent) Germany from 2000–07, higher than in all euro area countries 25 25 Greece save Ireland and Luxembourg. Although asset price Ireland 20 20 Spain inflation and household indebtedness remained Portugal 15 15 moderate, government debt mounted rapidly. 10103. Fiscal policy was pro-cyclical. Some argue that 5 5 Greece was the country that gained most from euro adoption (Fernandez-Villaverde et al, 2013) with 0 0 1993 1995 1997 1999 2001 2003 2005 borrowing costs falling sharply. As a direct fiscal Sources: ECB; and Eurostat. dividend, government interest expenditure dropped from 11½ percent of GDP in the mid-1990s to 5 percent of GDP in the mid-2000s. However, these savings were more than swallowed up by increased spending on wages and pensions. The economy turned down in the wake of the Lehman crisis and the general government deficit reached 15½ percent of GDP (after incorporating data revisions), up from 4 percent of GDP in 2001. Public debt was 129 percent of GDP at end-2009, with 75 percent held by foreigners. There were also significant contingent liabilities due to public enterprises borrowing under state guarantee, while the pension system had become underfunded as a result of increasingly generous entitlements and an aging population.INTERNATIONAL MONETARY FUND5 GREECE65General Government Operations (Percent of GDP) Revenue Expenditure General government balance (rhs)60 553 0 -330 25Social benefits-9 45252000 200520-6 5030General Government Expenditure (Percent of GDP)202009 1515Wage bill1010-1555-180-1240 35 200020022004200620080 EU avg EA avgGRCEU avg EA avgGRCSources: Eurostat; and IMF staff estimates.4. The current account deficit deteriorated. The counterpart to the decline in government saving was a sharply widening 4 current account deficit that reached 15 percent Current Account (Percent of GDP) of GDP in 2008. The sustained economic boom 0 Total and a lack of competition in domestic goods Trade balance -4 and services markets kept wage and price inflation consistently above euro averages. -8 Competitiveness, as measured by the unit labor -12 cost (ULC) -based real effective exchange rate (REER), declined by 20-30 percent in the decade -16 following euro adoption. -204 0 -4 -8 -12 -16 -202000 2002 2004 2006 2008 5. There were also serious doubts about Sources: Bank of Greece; Elstat; and IMF staff calculations. the quality of Greek deficit and debt statistics. Data concerns had flared up in 2004 when upward revisions to the fiscal deficit numbers raised questions about whether Greece had ever met the Maastricht deficit criterion of an annual fiscal deficit of 3 percent of GDP. The European Commission (EC) attempted to coax Greece into reducing its deficit via the Excessive Deficit Procedure of the Stability and Growth Pact.B. Crisis triggers 6. The global financial crisis endangered Greece’s government-led growth model. Greece’s economic boom was propelled by large foreign-funded fiscal deficits that enabled demand to outpace output. The global crisis threatened the continued financing of this growth model. After the Lehman shock in September 2008, spreads on Greek government bonds over 10-year bunds jumped to 300 bps compared to about 50 bps before the crisis. Standard and Poor’s downgraded Greece from A+ to A in January 2009 citing a loss of competitiveness worsened by the global financial crisis. Against this backdrop, Greece had become extremely vulnerable to a stop in private capital flows.6INTERNATIONAL MONETARY FUND GREECE7. Data revisions unsettled markets. In October 2009, a new government took office and announced that the fiscal problem had been significantly understated. The projected budget deficit for 2009 was revised up from 4 to 12½ percent of GDP (still 3 percentage points short of the final estimate). Public debt estimates were also marked up sharply. Fitch responded by downgrading Greece's sovereign rating from A- to BBB+. Global markets, already roiled by events in Dubai in November 2009, sold off further. Scrutiny of Greek high sovereign indebtedness was extended to other euro area countries.C. Crisis response 8. Initially, the authorities sought a European solution. In December 2009, Greece committed to achieving fiscal consolidation via a Stability Program with the EC. At the same time, the Greek authorities ruled out the possibility of seeking Fund help. The euro area authorities seemed of like mind, indicating that financial assistance from the Fund was not “appropriate or welcome” (see Mackenzie, 2010). Nonetheless, the new government recognized that tax administration and expenditure management were extremely weak and sought technical advice from the Fund. Missions that visited Athens in early 2010 provided initial roadmaps for fiscal structural reforms. 9. Greece agreed to a fiscal consolidation plan with the EC. Greece’s 2010 Stability Program submitted to the EC in January 2010 aimed to cut the deficit from 12½ percent of GDP to 8¾ percent of GDP in 2010 and by a further 3 percentage points in 2011 and in 2012 (the “43-3” plan). To begin the process, the authorities announced the freezing of public sector wages, partial cancellation of civil servant bonuses, and 30 30 Sovereign Amortization Falling Due increases in indirect taxes. 10. Markets, however, doubted whether these steps would be adequate. Financing conditions became progressively more difficult. Greece was able to raise €5 billion on two occasions in March 2010 at spreads of about 300 bps, but by the second issue, the foreign bid had dropped off appreciably. Spreads in the secondary market rose further in April, while large amortizations were coming due in May.25(Billions of euros)252020151510105500 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 Source: IMF Country Report No. 09/244.INTERNATIONAL MONETARY FUND7 GREECE11. Against this backdrop, a request for a Fund program was made. The euro zone decided in April 2010 that the Fund should be a formal part of Greece’s rescue. Following negotiations with the newly-established Troika (the Fund, the EC and the European Central Bank (ECB)), agreement on a program to assist Greece was reached in early May. Total financing was €110 billion, of which the Fund committed €30 billion under an SBA (approved May 9). The remainder of the financing took the form of bilateral loans from euro area countries to be pooled by the EC under the Greek Loan Facility. 12. The process of building a firewall began. Contagion from Greece was a major concern for euro area members given the considerable 700 700 Bank Exposure to Euro Area Periphery by exposure of their banks to the sovereign debt of Country, 2009Q4 (Billions of euros) 600 600 the euro area periphery.1 To prevent the crisis Spain Portugal 500 500 spilling over, the euro area initiated the creation Italy of a financial safety net for its member countries. Ireland 400 400 Greece In early May 2010, agreement was reached to set 300 300 up the European Financial Stability Facility (EFSF) 200 with €500 billion in financing.2 Euro area and Fund 200 officials confirmed that these resources could be 100 100 supplemented by an additional €250 billion in 0 0 lending from the Fund provided on a country by FRA DEU GBR NLD USA ESP JPN BEL IRL PRT ITA country basis. Source: Bank for International Settlements. 13. Additional assistance came from the ECB. The ECB’s contribution was to set up the Securities Markets Program (SMP) in May 2010 that would purchase public debt securities in secondary markets. The ECB also relaxed its eligibility requirements so that Greek government debt instruments remained eligible as collateral for central bank financing despite now being below investment grade.1The ECB argued that the financial integration associated with monetary union - a benefit during normal times – served to intensify systemic spillover effects during periods of stress. See ECB (2011).2The EFSF was incorporated as a company in Luxembourg on June 7, 2010 with a lending capacity of €440 billion that would be combined with loans from the European Financial Stabilization Mechanism (EFSM) of €60 billion. The EFSF was created as a temporary rescue mechanism; in December 2010, a decision to create a permanent crisis resolution mechanism, the European Stabilization Mechanism (ESM), was announced.8INTERNATIONAL MONETARY FUND GREECEAN EXCEPTIONAL FUND PROGRAM 14.Access was the largest in Fund history. Despite representing less than 30 percent of the financing, Fund access was €30 billion, or 3,212 percent of quota. This was the largest Fund program ever relative to quota.3,000125 10050501,000252500500MDA UVK JAM DOM KNA ATG MDV GRCUKR HUN ROM ISL LVA0ECU PHL RUS THA BRA URY MEX ARG IDN TUR KOR5000ARG, 20011,500TUR, 2000Previous crises, median: 649ROM75HUNWave 2, median: 5481,000752,000Selected Wave 1 ProgramsMEX, 1994 3/1,500100Burden Sharing (Percent of total official financing) Other E.U. IMF2,5002,500 2,000125KOR, 1997 2/3,0003,500Access (Percent of quota)GRC3,500LVA 1/Greece’s SBA-supported program was exceptional for a number of reasons:Sources: IMF country reports; and IMF staff estimates. 1/ Other includes €3.1 billion from EU, €1.8 billion from Nordic Countries, €0.4 billion from CZE, POL, and EST, and €0.5 billion from WB and EBRD. 2/ Other includes $5 billion from U.S., $10 billion from each WB and BoJ, $4 billion from ADB, and the rest from other G7. 3/ Other includes $20 billion from U.S., $10 billion from BIS and $1 billion from Bank of Canada.It was the first ever program with a member of the euro area. A Fund program supporting a member that had fixed its exchange rate was not unprecedented (for example, Latvia), nor was a program with a continuing member of a currency union (recent examples are St. Kitts, Benin, and Burkina Faso). Greece stood out because it is a euro area member and the euro is a reserve currency. 200The Troika set up was novel. The Fund had recently joined forces with the EC in programs with EU members outside the euro area (Hungary, Latvia, and Romania). However, Greece was the first program in which the ECB was formally involved.150Public Debt at Program Request (Percent of GDP) GRC, 2010 LVA, 2008 TUR, 2001 ROM, 2008ISL, 2008 PAK, 2008 HUN, 20082001501005010050Public debt would remain exceptionally high during the program period. Despite a 0 large fiscal adjustment, public debt was t-2 t-1 t t+1 t+2 t+3 t+4 t+5 Sources: IMF country reports; and IMF staff estimates. expected to keep rising during the program reflecting the difficult trajectory that an internal devaluation implies for debt sustainability: under a fixed exchange rate, theINTERNATIONAL MONETARY FUND09 GREECEdisinflation or deflation necessary to restore competitiveness serves to increase the debtGDP ratio, a trend aggravated by the contraction in real GDP. This implied a public debt profile unlike other large Fund programs with the exception of Latvia which had also fixed its exchange rate. However, public debt in Latvia was appreciably lower. In Greece, debt would peak at 149 percent of GDP only in 2013. A pending data revision was expected to raise this projection by 5–7 percentage points. The program required the Fund’s rules for exceptional access to be modified. To justify exceptional access, four criteria had to be met: (1) exceptional balance of payments pressures; (2) a high probability that public debt is sustainable in the medium term; (3) good prospects of regaining access to private capital markets; and (4) a reasonably strong prospect of the program’s success. The sticking point for staff was Criterion 2: even with implementation of agreed policies, uncertainties were so significant that staff was unable to vouch that public debt was sustainable with high probability. But staff favored going ahead with exceptional access because of the fear that spillovers from Greece would threaten the euro area and the global economy. A proviso was therefore added to Criterion 2 that where debt was not sustainable with high probability, a high risk of international spillover effects provided an alternative justification for exceptional access. Unusually, although this is entirely legal, this change in Fund policy was made in the context of the Greece SBA Board meeting.PROGRAM STRATEGY AND IMPLEMENTATION 15. Greece embarked on a far-reaching program of reforms in May 2010. Under the program supported by the SBA, Greece adopted an ambitious multi-year adjustment program to lower the fiscal deficit and public debt ratio, reduce domestic demand in line with supply capacity, and increase supply and competitiveness so as to invigorate investment, exports, and private sector growth. A brief history of developments under the program is provided in Box 1 which views developments under the SBA-supported program through the prism of Greece’s sovereign spreads. 16. The first pillar of the program was to drastically shrink the fiscal deficit. Fiscal adjustment was complicated by an expected 3 percentage point of GDP rise in government interest payments over 2010-14 reflecting the replacement of low-interest debt with more expensive official (and eventually private) borrowing.3 For debt to start declining, the required adjustment in the primary balance by 2014 was 14½ percentage points of GDP. To achieve this adjustment, revenue and expenditure measures amounting to 11 percent of GDP were identified that would come on top of the 5 percent of GDP in measures implemented in the first half of3Interest rates on the loans by euro area member states were 300 basis points over the swap rate for up to 3 years’ maturity and 400 basis points above for longer maturities.10INTERNATIONAL MONETARY FUND GREECE2010. Reforms to tax administration and public financial management would support this effort. Major changes would also be made to the pension system to ensure its viability 17. The second pillar of the program consisted of structural reforms. Given Greece’s commitment to stay in the euro and the absence of an exchange rate lever, structural reforms were necessary to facilitate internal devaluation and boost economic growth. Specific reforms were identified to increase competition in labor and product markets, boost productivity, and improve the business environment. Positive GDP growth was projected from 2012. 18. The third pillar of the program was to preserve financial stability. The banks were viewed as vulnerable to the downturn and to an adverse feedback loop from the sovereign. The Hellenic Financial Stabilization Fund (HFSF) was set up to provide capital to banks as needed. The program included €10 billion that would be available to provide resources to the HFSF if and when such needs arose. 19. The program aimed to place Greece’s debt on a sustainable path. The combination of large fiscal adjustment and growth-enhancing structural reforms was projected to cut public debt to 120 percent of GDP by 2020. The program also envisaged a significant adjustment in the external current account, although this would be gradual since competitiveness would be regained slowly and external interest payments would rise. Program financing included €110 billion that was calculated as sufficient to cover the remaining fiscal deficit, the needs of the HFSF, and all government bonds falling due in 2010 and 2011. Market access was assumed to be regained in 2012. 20. The report is structured as follows. A review of program outcomes (page 12) shows that Greece’s SBA-supported program had some important successes, notably regarding fiscal consolidation and pension reform. Moreover, Greece was able to stay in the euro area and international systemic spillovers were relatively well-contained. However, the SBA also failed to achieve critical objectives, especially with regard to restoring growth, ensuring debt sustainability, and regaining market access. This mixed record raises questions about the design of the program (page 20) and about whether the Fund’s decision to modify its exceptional access rules to support the program was justified (page 29). The final section (page 32) reviews the possible lessons learned.INTERNATIONAL MONETARY FUND11 GREECEPROGRAM OUTCOMES Key objectives for Greece’s SBA-supported program were to eliminate fiscal and current account imbalances, regain competitiveness, maintain financial stability, and boost growth and employment.A. Macroeconomic outcomes 21. The economic downturn proved considerably more severe than projected. Data revisions complicate the comparison,4 but real GDP in 2012 was 17 percent lower than in 2009, compared to a 5½ percent decline projected in the SBA-supported program. The original growth projections were largely maintained until the fifth review (December 2011), but were then marked down with the expected recovery delayed until 2014. Projections for unemployment were raised in line with the severity of the contraction. The unemployment rate in 2012 was 25 percent compared to the original program projection of 15 percent. This huge rise in unemployment exceeded that which would be expected based on estimates of the Okun coefficient for Greece (see April 2010, WEO). 22. Other variables showed less divergence from projection. Inflation initially overshot the program projection due to the indirect tax increases, but subsequently came down as activity weakened. Prices fell by less than the decline in wages in part reflecting continued rigidities in product markets. Reductions in ULCs were wage driven with few indications that productivity had increased (see Box 2). The ULC REER is estimated to have declined by 9 percent during the period of the SBA. The current account deficit decreased broadly as projected, although by less than expected in cyclically-adjusted terms. There was a sharp compression of imports, but little pickup in exports.4Following large data revisions due to misreporting, with Greece being found in breach of its reporting obligations under Article VIII, Section 5, the authorities took actions to improve the published data (Box 2, IMFCountry Report No. 10/110). These methodological changes along with data revisions implied a shifting data landscape for the program. Eurostat did not validate the fiscal statistics until the second review (Box 1, IMF Country Report No. 10/372) and revisions to national accounts have been ongoing (a major revision in October 2012 implied that GDP in 2010 had contracted 1.4 percent more than previously reported).12INTERNATIONAL MONETARY FUND GREECE200200Real GDP (Billions of euros)8Real GDP Growth (Year-on-year percent change) SBA 1st review 2nd review 3rd review 4th review 5th review Latest6 4 17517528 6 4 20 150125 200620082010125 2012-2-2 -4-61500-4SBA 1st review 2nd review 3rd review 4th review 5th review Latest-6 -8-8201420062008201020122014Sources: IMF country reports; and IMF staff calculations. 3 2Greece: Evolution of Real GDP Growth Projections During 2010 and 2011 (Percent)351105Current Account Balance20-10-5-12012 2011-20-5-2-3-3-4-4 Consensus-5-5SBA-6-15-6-7 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11-7-20 2006Sources: Monthly Consensus Forecast; and IMF Country Reports.30SBA 1st review 2nd review 3rd review 4th review 5th review Latest20 15200820102012-10-15-202014Sources: IMF country reports.30Unemployment Rate (Percent)25SBA 1st review 2nd review 3rd review 4th review 5th review Latest-10256Average CPI Inflation (Year-on-year percent change)5 420 153 26 SBA 1st review 2nd review 3rd review 4th review 5th review Latest5 4 3 2105500 20062008201020122014110100-1-1 -2-2 20062008201020122014Sources: IMF country reports; IMF World Economic Outlook; and IMF staff calculations.INTERNATIONAL MONETARY FUND13 GREECEB. Fiscal policy outcomes 23. A large reduction in the fiscal deficit was achieved. The change in the primary deficit during 2010–11 was 8 percentage points of GDP, slightly above target, despite the deep recession. The authorities introduced additional measures in 2011 (Medium-Term Fiscal Strategy, amounting to 10½ percent of GDP during 2011–14) once it became clear that the initial set of fiscal measures was insufficient to deliver the consolidation target. In cyclically-adjusted terms, the primary balance improved by about 13 percent of potential GDP during the SBA.5 Estimates of the debt-stabilizing level of the primary surplus were reduced from the fifth review once private sector involvement (PSI) reduced the debt stock and lowered the average interest rate on public debt.6 24. Taxes were increased further. Revenue measures had already been taken in May 2010 under the 2010 Stability program including increases in VAT rates. Additional tax policy measures implemented during the SBA-supported program comprised increases in indirect tax rates, including further VAT rate hikes, a new property tax, and somewhat higher income taxes. Efforts were also made to strengthen tax administration and raise tax collections. 25. Expenditure measures focused on reducing public sector wages and social benefits. Public sector wages and pensions were cut through elimination of 13th and 14th monthly payments, but with safeguards intended to protect the most vulnerable. Measures implemented in 2010–11 included cuts in public sector salaries, bonuses, and allowances, and steps to reduce health care spending on drugs. Other measures included cuts in capital spending and a reorganization of subnational governments (Kalikrates). The authorities also adopted a new budget framework and put in place spending control mechanisms. Nonetheless, arrears and inadequate data reporting remained an issue throughout the SBA-supported program.5The performance criterion on the general government primary cash balance was met for end-2010 but this is exaggerated to some extent by a build-up in domestic arrears: during 2010, this performance criterion did not take account of the accumulation of arrears (monitored via an indicative target that was breached by €3 billion, or a bit over 1 percent of GDP). The definition of the performance criterion was subsequently modified to incorporate domestic arrears.6Debt restructuring in March 2012 led to a 60 percent reduction in privately held debt. Public debt fell by €62.4 billion to €305.5 billion. Some relief was also provided on official debt in March and December 2012 including a reduction in interest rates on the euro area loans. See Zettelmeyer et al (2013).14INTERNATIONAL MONETARY FUND GREECE1010General Government Interest Expenditure (Percent of GDP)8Average Interest Rate on Public Debt (Percent)78866766554 44 SBA 2nd review 4th review Latest21st review 3rd review 5th review20 2008201020124SBA 1st review 2nd review 3rd review 4th review 5th review Latest3 2 10 200683 2 1 0020142006 2008 2010 2012 2014 2016 2018 2020Sources: IMF country reports. 33General Government Overall Balance (Percent of GDP)00-3-6-9-98General Government Primary Balance (Percent of GDP)4400-4-4-3-68SBA request-124th review-15SBA request-122nd review-152nd review-85th review5th review -18-18 20092010201120122013-84th review-12-12 2009201420102011201220132014Sources: IMF Country Reports; and IMF staff estimates.General Government Operations, 2009–11 (Percent of GDP) 2009 SBA Request2010 Est.SBA Request2011 Est.SBA RequestChange, 2009–11 Est.SBA RequestEst.Revenue36.938.340.540.642.542.45.64.1Expenditure Primary Interest50.4 45.4 5.054.0 48.8 5.248.5 42.9 5.651.4 45.5 5.950.1 43.5 6.652.0 44.8 7.2-0.3 -1.9 1.6-2.0 -4.0 2.0Overall balance Primary balance-13.6 -8.6-15.6 -10.5-8.1 -2.4-10.8 -4.9-7.6 -0.9-9.6 -2.46.0 7.76.0 8.1Cyclically-adjusted primary balance 1/-16.0-14.0-7.8-6.3-5.8-1.310.312.7Sources: Eurostat; and IMF staff calculations. 1/ Percent of potential nominal GDP.INTERNATIONAL MONETARY FUND15 GREECE26. About half of the adjustment in the primary deficit reflected lower spending. As a result of the expenditure measures undertaken during the SBA-supported program, primary expenditure declined by 4 percentage points of 12 12 Changes in General Government Primary GDP in 2009–11, but still exceeded the 2005 level Expenditure (Percent of GDP) Other by about the same amount. Moreover, the wage 8 8 Non-pension social benefits bill remained high compared with other EU Pension Wage bill countries; programs for social protection remained 4 Primary expenditure 4 largely untargeted and inefficient (OECD, forthcoming); and health care reform had yet to 0 0 be completed. -4-427. Fiscal consolidation proceeded, but momentum on fiscal structural reforms flagged. -8 -8 2005–09 2009–11 2005–11 Measures taken contributed to strong upfront Sources: Eurostat; and IMF staff calculations. consolidation (wage and pension cuts, VAT hikes) and to improved long-term sustainability (pension reform). A far-reaching pension reform was approved by Parliament in July 2010 that was designed to substantially contain increases in pension benefits over the long run (see Box 3). Fund TA also led to improvements in expenditure and commitment controls and to better fiscal reporting and budgeting practices. However, tax administration reforms encountered setbacks due to political resistance and capacity constraints. Although TA led to improvements in on-time VAT filing, there were few signs by the end of the SBA-supported program that collection efficiency was being improved on a permanent basis (see Box 4).C. Debt and financing outcomes 28. Public debt overshot program projections by a large margin. The debt sustainability analysis (DSA) in the program request included stress tests but these turned out to be mild compared to actual outcomes. At the outset of the program, debt was projected to peak at 154156 percent of GDP in 2013 (depending on data revisions). However, by the fourth review in July 2011 (i.e., before PSI was in prospect), the end-2013 debt ratio was projected at 170 percent of GDP. As the program unfolded, the underlying debt dynamics worsened significantly because output contractions and deflation were more pronounced than expected. Lower nominal growth raised the interest rate-growth differential and led to progressively higher expected debt paths. Data revisions affecting both public debt and GDP exacerbated these trends.16INTERNATIONAL MONETARY FUND GREECE20020071801806160160140140Gross Public Sector Debt (Percent of GDP)5 4120 100 803SBA 1st review 2nd review 3rd review 4th review 5th review 1/ Latest1207Privatization Receipts (Percent of GDP)6SBA 1st review 2nd review 3rd review 4th review 5th review Latest5 4 3 210011802006 2008 2010 2012 2014 2016 2018 2020200 2006 2008 2010 2012 2014 2016 2018 2020Sources: IMF country reports. 1/ Already incorporated effects of debt restructuring.29. Privatization outcomes were disappointing. The authorities signaled a strong commitment to privatization in mid-2011 with parliamentary approval of a privatization and real estate development strategy. However, despite little progress having been made to date, the fourth review made extremely optimistic assumptions about privatization with envisaged receipts rising to €50 billion compared to about €10 billion in the original program. Such receipts became less important for debt sustainability from the fifth review once PSI was in prospect, plus equity prices had by that stage come down sharply. In the fifth review, much lower projections for privatization receipts were made and in general the DSA was cast with more conservative assumptions. 30. Weaker macroeconomic outturns and eventual PSI exerted opposite effects on debt sustainability. Adjusting the debt projections under the original SBA with the macro figures used in the January 2013 review of the EFF-supported program (and for subsequent data revisions to debt and GDP) show 220 public debt at about 180 percent of 220 Public Sector Debt (Percent of GDP) Optimistic inflation Optimistic Real GDP in 2020. The debt (GDP defflator 200 200 GDP growth change) restructuring, however, provided Data revision more than an offset and the latest 180 180 projections show debt declining to Factors unrelated 160 to real GDP growth about 120 percent of GDP by 2020. 160 31. Private creditors were able to significantly reduce their exposure. Non-resident holdings of government debt dropped sharply in 2010–12. Resident holdings of government debt initially rose, but then started to fall140 120 100or inflation, mainly debt restructuringOriginal SBA Third review Latest real GDP growth 1/ Latest nominal GDP growth 1/ Latest baseline 1/140 120 1002010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Sources: IMF Country Reports; and IMF staff calculations. 1/ As of the 2013 Article IV consultation.INTERNATIONAL MONETARY FUND17 GREECEas well. There was a large-scale substitution from privately-held to publicly-held debt. Part of this was by design―program financing was to be used to repay maturing bonds in 2010 and 2011―but the shift was intensified by market access not being regained in 2012, as well as by SMP. Purchases of Greek government bonds under SMP created rigidities when debt was restructured as a result of the decision to exclude SMP (and euro area national central bank) bond holdings from the PSI.D. Structural reforms250250 General Government Debt By Owner 1/ (Billions of euros) 200200150150 Residents Official creditors100100Non-residents505000 200220042006200820102012Sources: Greek authorities; and IMF staff estimates. 1/ Assumes that the stock of bonds in the ECB's SMP as of end-2012 was purchased evenly over 2010-1. Bonds held by Eurosystem central banks, EC, and EIB for investment purposes are not treated as debt to official creditors.32. Labor market reforms encountered resistance under the SBA-supported program. Labor market reforms were initially judged to be progressing well, but a more critical view was taken in later reviews. The wage bargaining system was reformed, but there were few firm level agreements and the Fund judged labor market reforms not to have delivered enough flexibility. The absence of early actions to reduce private wages may have aggravated the job losses from the economic downturn.7 33. The product market and regulatory environment also proved resilient to change. Although the initial momentum appeared strong, reforms to product markets and the business environment failed to generate a critical mass necessary to boost growth. Program reviews reported that progress was disappointing. For example, one-stop-shops and fast-track investment approval laws were passed, but implementation was delayed. While the law liberalizing regulated professions was also passed, the deadline for requesting reinstatement of justified restrictions was postponed thus delaying implementation. This slow progress militated against realization of the productivity gains that had been hoped for in the program.E. Financial sector 34. The banking system was perceived to be relatively sound when the program began. The bank capital ratio was 11.7 percent aided by a recapitalization in 2009, but balance sheets came under pressure from higher nonperforming loans (NPLs) once the economy weakened. Moreover, liquidity conditions tightened in 2009 due to banks losing wholesale market access and some deposit outflows.7It was only with the approval of the EFF in March 2012 that significant labor reforms took place including cuts in minimum wages in the private sector.18INTERNATIONAL MONETARY FUND GREECE35. As the recession intensified and liquidity tightened, the financial sector became increasingly vulnerable. Financial sector distress was a result of the protracted recession and sovereign debt problems. This was in contrast to Ireland and Spain where causality ran the other way. By 2011, deleveraging in the financial sector and restructuring of state-owned banks was perceived necessary. ATE, the largest state-owned bank and the only Greek bank to fail the Europe-wide stress tests in mid-2010, had to be recapitalized. Sizable deposit outflows began in the second half of 2011, fanned by fears of a Greek euro exit. 707060 504060Funding Structure of the Banking System (Percent of total liabilities)3050 Liabilities to Bank of Greece40Overnight and short-term deposits2020301010 0020201010-100-200 20082009201020113040Liabilities to credit institutions3040Credit to Households (Year-on-year percent change)20122013Greece Ireland Portugal Spain-10 -202004 2005 2006 2007 2008 2009 2010 2011 2012Sources: Bank of Greece; Eurostat; Haver; and Fund staff calculations. 150 125Eurosystem Borrowing and Emergency Liquidity Assistance (Billions of euros) ELA4036.6NPLs by Category (Percent)125200630Monetary policy operations1001501007575502524.519.1205025302012 20401000 2007200820092010201120122013107.6 4.94.7MortgageCorporate00 ConsumerSource: Bank of Greece.36. The ECB provided substantial and extraordinary liquidity support. As noted, from May 2010, the ECB suspended the link between sovereign credit ratings and eligibility of collateral for refinancing operations and intervened directly in the government bond market under the SMP. The ECB also began to accept uncovered bank bonds guaranteed by the government as collateral eligible for refinancing operations. 37. PSI served to eliminate the banks’ capital. Greek banks were heavily exposed to the sovereign, holding government bonds with a book value of about €40 billion (after some initialINTERNATIONAL MONETARY FUND19 GREECEJune 2011 impairments). By contrast, core capital was €22 billion, or about the same magnitude as the capital needs arising from the PSI. Only €1.5 billion was drawn from the HFSF during the SBA-supported program, but the banks’ capital needs subsequently dwarfed the HFSF provision. As of the fourth review the purpose of the HFSF changed from a means of topping up capital for banks that had tried and failed to raise private capital to providing a substantial injection of public funds for banks that had been severely affected by the PSI and the deep recession: the amount needed for the HFSF in the context of the EFF was estimated at €50 billion.PROGRAM DESIGN While significant fiscal adjustment occurred during the SBA, critical objectives such as regaining confidence and restoring growth were not achieved. This raises important questions about the design of the program.A. Should the fiscal adjustment path have been more gradual? 38. It is difficult to argue that adjustment should have been attempted more slowly. The required adjustment in the primary balance, 14½ percentage points of GDP, was an enormous adjustment with relatively few precedents,8 but was the minimum needed to bring debt down to 120 percent by 2020. Moreover, despite the starting point being slightly worse than thought to be the case when the 2010 Stability Program was drawn up,9 the SBA-supported program had already extended the period over which the Maastricht deficit target would be achieved from 3 to 5 years. Since the program only ran through mid-2013, the last part of this adjustment would occur after the program and the conditionality had ended.10 Moreover, debt would still be increasing when the program ended.Targeted Fiscal Adjustment: Overall Deficit (Percent of GDP) 200920102011201220132014SP, Jan., 2010 ("4-3-3")12.58.86.0≤ 3.0≤ 3.0≤ 3.0SBA, May, 201013.68.17.66.54.82.6Sources: Greece's 2010 Stability Program; and IMF Country Report No. 10/110.8Episodes of comparable large fiscal adjustments include Greece where in at least two instances (in 1978 and 1990) the annual contraction in the primary deficit amounted to over 7 percent of GDP (see Tsibouris et al, 2006). However, the required adjustment under the SBA-supported program would be undertaken in a very weak global growth environment.9In April 2010, the estimated fiscal deficit for 2009 was revised to 13½ percent of GDP from the 12½ percent of GDP estimate that prevailed when the 2010 Stability Program was formulated.10This raises the issue of why an EFF was not introduced from the outset – see discussion below.20INTERNATIONAL MONETARY FUND GREECE39. More importantly, a flatter adjustment path would have required more than €110 billion in financing. The Greek SBA was already the highest access loan in Fund history. While the euro partners could have provided more than €80 billion in funding (although this was already more than 35 percent of Greek GDP), this would have been politically difficult. Debt restructuring could also have provided the authorities with some leeway, but as discussed below, this option was not politically feasible.B. Should the adjustment path have been more flexible? 40. The scope for increasing flexibility was also limited. The fiscal targets became even more ambitious once the downturn exceeded expectations. In addition, the starting point moved.11 However, the automatic stabilizers were not allowed to operate and adjustments were not made to the fiscal targets until the fifth review in December 2011. While earlier adjustment of the targets could have tempered the contraction, the program would then have required additional financing. The date by which debt started to decline would also have been stretched beyond the program period.C. Should the larger economic downturn have been expected? 41. There were a number of reasons why the actual decline in GDP was so much greater than anticipated: The fiscal multipliers were too low.. The question that arises is whether underestimation of the size of the fiscal multipliers in the SBA-supported program caused the depth of the recession to be underestimated. The program initially assumed a multiplier of only 0.5 despite staff’s recognition that Greece’s relatively closed economy and lack of an exchange rate tool would concentrate the fiscal shock. Recent iterations of the Greek program have assumed a multiplier of twice the size. This reflects research showing that multipliers tend to be higher when households are liquidity constrained and monetary policy cannot provide an offset (see October 2012 WEO), influences that appear not to have been fully appreciated when the SBA-supported program was designed. Aslund (2013) has also argued that there is a habitual tendency of Fund programs to be over-optimistic on growth until the economy reaches a bottom (and thereafter to underestimate the recovery).12However, the deeper-than-expected contraction was not purely due to the fiscal shock. Part of the contraction in activity was not directly related to the fiscal adjustment, but rather reflected the absence of a pick-up in private sector growth due to the boost to productivity11The estimated 2009 fiscal deficit was revised again in December 2010 from 13½ to 15½ percent of GDP.12By contrast, the Fund’s 2011 Conditionality Review finds that growth projections for program countries do not display a bias in the aggregate (contrary to past studies, which found an optimistic bias). See IMF (2012a).INTERNATIONAL MONETARY FUND21 GREECEand improvements in the investment climate that the program hoped would result from structural reforms. Confidence was also badly affected by domestic social and political turmoil and talk of a Greek exit from the euro by European policy-makers. 13 On the other hand, the offset to the fiscal contraction from higher private sector growth that was assumed during the program period appears to have been optimistic (see Section D below), while some of the adverse political developments were endogenous and followed from limited ownership of the program (see Section F below). A larger contraction should probably therefore have been expected, although it should be noted that market forecasters were no more accurate.14 42. In any event, a deep recession was unavoidable. Greece lost market access in the first half of 2010 with a fiscal deficit so large and amortization obligations so onerous that it is difficult to see how a severe economic contraction could have been avoided. Indeed, if Greece had defaulted, the absence of deficit financing would have required primary fiscal balance from the second half of 2010. This would have required an abrupt fiscal consolidation, and led to an evaporation of confidence and huge deposit outflow that would have most likely made the contraction in output even larger.D. Were structural reforms sufficient to restore competitiveness and growth? 43. Structural reforms were critical to improving competitiveness. The program had to work within the constraints of the fixed exchange rate and engineer an internal devaluation. Part of the adjustment in ULCs would come from the economic slowdown that would exert downward pressure on wages. The rest would follow from structural reforms that would free up Greece’s rigid labor and product markets and raise productivity. 44. Actions were not taken to adjust private sector wages. While the program cut wages and bonuses in the public sector, there were no direct attempts to lower private sector wages. The EC took the view that forcing reductions in private wages, for example, through abolition of bonuses, was not critical: industry did not consider labor cost to be excessive and in any case exports were unlikely to be wage sensitive.15 Instead focus was on increasing the scope for wage13External demand also weakened during the program period: the April 2010 WEO projected cumulative GDP growth in the Eurozone in 2010-12 of 3.2 percent compared to an outturn of 1.0 percent. However, this would have played a limited role in worsening the contraction given the small size of Greece’s export sector.14The program growth projections (-4 percent in 2010 and -2.6 percent in 2011) were more pessimistic than the May 2010 Consensus Forecasts (-3.6 percent in 2010 and -1.6 percent in 2011). 15See European Commission (2010). Also see Papaconstantinou (2010): “Competitiveness is a broader issue than wages in Greece and also has to do with the oligopolistic nature of markets: wage cost is part of the discussion but not a main element.”22INTERNATIONAL MONETARY FUND GREECEbargaining at the firm level. The Fund agreed with the emphasis on bringing down public sector wages, noting the strong demonstration effect that this would have for the private sector. 45. A quick recovery in growth appeared optimistic. Internal devaluation was recognized to be a gradual process. In fact, the program projections implied that only about 3 percent of the estimated 20-30 percent improvement required in competitiveness would be achieved by 2013. 2 2 This assumption aided the debt sustainability Cumulative CPI Inflation Differential from 2011: 1 Greece and Euro Area (Percent) analysis by limiting the decline in the denominator 1 in the debt-GDP ratio, but also raised a 0 0 fundamental question about where growth would -1 -1 come from in the absence of an internal -2 -2 devaluation. The program emphasized confidence -3 -3 effects, regained market access, and completed -4 -4 structural reforms. However, even if structural -5 -5 October, 2010 WEO Proj. reforms were transformative, a quick supply -6 -6 October, 2012 WEO Proj. response was unlikely. Partner country growth was -7 -7 also expected to be weak. Nonetheless, the 2010 2011 2012 2013 2014 2015 Sources: IMF, World Economic Outlook; and IMF staff program assumed a V-shaped recovery from 2012. calculations.E. Was the mix of fiscal measures appropriate? 46. The adjustment mix seems revenue heavy given that the fiscal crisis was expenditure driven. As discussed earlier, the ballooning of the fiscal deficit in the 2000s was almost entirely due to increased expenditure. The large dose of revenue measures in the SBA-supported program can therefore be questioned, particularly since tax changes constituted almost half of the measures targeted for the first two years of the program.16 The case for indirect tax increases was that they were quick to take effect and faced less resistance than cuts in spending programs. Moreover, VAT rates were lower than the median level in Europe.16Composition of Measures (Percent of GDP) 2010201120122013Cum.Total2.54.12.42.011.1Revenue Excises VAT PIT CIT Property tax Other0.5 0.2 0.3 ... ... ... ...3.0 0.3 0.9 0.2 0.4 0.8 0.40.8 0.1 0.2 0.0 ... 0.1 0.3-0.3 ... ... ... ... 0.0 -0.34.0 0.6 1.5 0.2 0.4 0.9 0.4Expenditure Wages Pensions Social benefits Goods and services Subsidies Investment2.0 0.5 0.8 0.2 0.3 ... 0.21.1 0.2 0.3 0.0 0.4 ... 0.21.7 0.3 0.1 0.2 0.2 0.7 0.20.5 0.2 0.1 ... 0.2 ... ...5.3 1.2 1.3 0.4 1.1 0.7 0.7.........1.81.8Structural reformsSources: Greek authorities; and IMF staff projections.There is also evidence that expenditure-based fiscal adjustment is more durable (see Tsibouris et al, 2006).INTERNATIONAL MONETARY FUND23 GREECE47. The burden of adjustment was not shared evenly across society. The public sector wage bill was cut by lowering wages and bonuses, but specific plans to downsize the number of civil servants were limited to a commitment to replace only 20 percent of those who retired. The state enterprises also remained generously staffed. By contrast, the private sector sustained enormous job losses partly because wage setting mechanisms were not liberalized. Moreover, little progress was made in checking tax evasion by high income earners. While the program recognized that it would take time to show results from improved tax administration, the absence of quick progress in collecting evaded taxes came at the cost of any demonstrable improvement in the equity of the tax burden.3Government Effectiveness, 2011 1/ (Index) Entire Sample3 221.5IMF Arrangements1.01.5 GRC1.00.50-10.0-0.5-0.5 -1.0 -1.5-2.0-2.0-1 -2SOM MHL TGO AGO COK MDG NPL FSM WBG HND KSV ETH KAZ PER KWT TUN CHN PRI BWA LTU QAT SVN TWN MAC AIA LUX SWE-2COM AFG LBR SLE BDI MRT SLB STP KGZ MDA TZA BEN LSO MAR SLV JOR SYC MEX ATG POL PRT00.0-1.510.5-1.0GRC 1Source: World Bank, Worldwide Governance Indicators. 1/ Selected countries shown on the X axis.F. Was there sufficient ownership and capacity for reforms? 48. Ownership of the program was limited. Staff recognized that vested interests had fiercely opposed structural reforms in Greece in the past, but were encouraged by the authorities’ strong commitment to the program. The government also had a fresh mandate from the election and a strong majority in parliament. Staff argued that difficult actions, such as cutting public sector wage levels, were being taken as prior actions, while Fund and EC technical assistance would support the program of reforms. As it turned out, ownership of the program did not extend far and little progress was made with politically difficult measures such as privatization, downsizing the public sector, and labor market reforms. There was also limited bipartisan support in parliament for the program, while relations with unions were adversarial and there was little hope that that an incomes policy could be agreed. 49. The capacity to implement reforms was overestimated. The Fund had concerns that implementation capacity might be weak based on its history of providing fiscal technical assistance to Greece. However, the extent to which administrative capacity was lacking in the public sector seems to have come as a surprise. The depth of contact afforded by annual Article24INTERNATIONAL MONETARY FUND GREECEIV surveillance may not have provided much insight. Moreover, World Bank indicators do not show government effectiveness in Greece to be particularly low by global standards, although they are relatively low for an advanced country. 50. Structural conditionality became very detailed. In recent years, the Fund has moved toward concentration on macro-critical structural reforms in programs and more parsimony in setting conditionality. The number of structural conditions set under the SBA-supported program was relatively large (see Box 5), although there seems to be less of a case for parsimony when formulating competitiveness-boosting reforms in a case like Greece where the exchange rate is fixed. However, the number of fiscal structural conditions was also large, and became more so as the program progressed. By the fifth review, one of the fiscal structural prior actions had nine sub-prior actions. This proliferation of conditions reflected the realization of the extent of the weaknesses in administrative capacity. While, according to available government effectiveness indicators, Greece is far from an outlier in terms of weak capacity among countries with Fundsupported programs, administrative capacities in Greece do appear to be extremely weak. Moreover, fiscal technical assistance is delivered in cooperation with the EC, whose capacity building initiatives tend to be very detailed.G. Was the financing of the program likely to be sufficient? 51. The adequacy of the program financing required favorable assumptions. Markets were concerned about the problem of large repayment obligations in 2014 and 2015 after the program expired. The financing strategy assumed renewed market access from 2012 yet the composition of debt holders would now deter private lenders since official lenders tend to be senior creditors. Subsequent research also suggests that the market access assumption, assessed in terms of rollover rates, was sanguine compared to past experience in emerging markets facing exogenous shocks (see IMF, 2011). However, Greece’s advanced economy status and its membership of the euro area may have been considered as modifying factors. 100100100808060604040404020202020000080 60Projected Borrowing Need Under the Program (Billions of euros) Other Amortization Overall balance-20-20 200920102011201220132014Projected Financing Sources Under the Program (Billions of euros) Private financing Troika80 60-202015100-20 2009201020112012201320142015Sources: IMF Country Report No. 10/110; and IMF staff estimates.INTERNATIONAL MONETARY FUND25 GREECE52. The financing available for the capital needs of the banking sector was also all likely to be needed. The HFSF was established to safeguard the stability of the banking sector with up to €10 billion from program disbursements. The 2009 Article IV Consultation had reported results of banking system stress tests that showed that if a number of shocks considered were to occur Stress Tests of Greek Banking System simultaneously, new capital of (Percent, unless otherwise indicated) up to €2.9 billion would be Article IV Adverse Program Projections, required. However, these Scenario, June, 2009 May, 2010 shocks were fairly mild Macro-scenarios compared to the program GDP contraction 1/ -3.0 -6.6 Unemployment 2/ +4.0 +7.0 projections made in May 2010, Long-term interest rates ≈ 9.0 ... and as noted, the program Estimated capital need (billions of euros) 2.9 Up to 10.0 assumed a quick recovery in Source: IMF Country Report No. 09/244 growth that appeared 1/ Over 2 years. 2/ Compared to end-2008 level of 8 percent. optimistic. The €10 billion set aside for recapitalization under the HFSF was thus all likely to be needed.H. Should debt restructuring have been attempted at the outset? 53. The program was based on a number of ambitious assumptions. The preceding discussion has raised questions about whether the fiscal targets should have been less stringent and whether less optimistic projections should have been made about growth, deflation, privatization receipts, and regaining market access. Varying these assumptions would have materially affected the outlook for debt sustainability. 54. The risks were explicitly flagged. Staff made it clear that the program supported by the SBA was an ambitious program that was subject to considerable risks. The adjustment needs were huge, reforms would be socially painful, and commitment might flag. Debt was not judged to be sustainable with high probability and it would take little in the way of a deviation from program assumptions or an external shock to generate a less favorable debt trajectory. A combination of lower growth, greater deflation, higher interest rates, and larger contingent liabilities was shown to place public debt on a clearly unsustainable path (above 220 percent of GDP by 2020 and still rising). Since the shocks considered were fairly mild, this sensitivity analysis26INTERNATIONAL MONETARY FUND GREECEdemonstrated the precariousness of the debt trajectory. For example, the deflation shock considered in the DSA (3 percent more) would not have made much difference to the internal devaluation, but would have caused debt to jump to 175 percent of GDP.275 250 225 200 175Interest rate higher by 200 bps Primary balance lower by 1% of GDP Combined adverse shocks Growth higher by 1% per year Additional liabilities 1/ Growth lower by 1%SBA: Public Debt Sustainability Analysis (Percent of GDP)275 250 225 200 1751503% more deflation150125Baseline125100 100 55. Ex ante debt restructuring was not 75 75 2005 2007 2009 2011 2013 2015 2017 2019 attempted. One way to make the Source: IMF Country Report No. 10/110. debt outlook more sustainable 1/ Recognition of implicit liabilities and bank support. would have been to attempt to restructure the debt from the beginning. However, PSI was not part of the original program. This was in contrast with the Fund program in Uruguay in 2002 and Jamaica in
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