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‘Shattering fragile confidence by a confrontation with
lenders was a costly mistake.’
Focus: The Greek Tragedy
Since the first edition of The Euro Plus Monitor appeared
in 2011, Greece has featured prominently in three separate
ways:
1. According to the analysis, Greece did face and
still faces the worst fundamental problems in the
eurozone, usually coming last in the Fundamental
Health Indicator (see, for example, The 2015 Euro Plus
Monitor).
2. Under the pressure of crisis, Greece adjusted fast from
2010 onwards. It slashed its fiscal deficit, external deficit
and labour costs faster than most other countries in the
sample while legislating serious structural reforms. As
a result, it usually took the top spot in the Adjustment
Progress Indicator.
3. We repeatedly criticised the composition of the Greek
adjustment programme. In its design – and even
more in its implementation – it focussed too much
on suppressing demand through front-loaded fiscal
tightening rather than raising supply through fast
labour, product and services markets reforms. In the
fiscal sphere, the emphasis was too much on hiking
taxes rather broadening the tax base.
Although Greece went through more pain than necessary,
its adjustment programme did work in the end. The
recovery set in over the course of 2014. In late 2014, Greek
corporate confidence had rebounded so fast that it even
exceeded that of Spain. In 2015, the Spanish economy
expanded by some 3.2%. Greece could have achieved the
same. Unfortunately, the risk of reform reversals, which
we had identified as the worst remaining risk for the
eurozone in The 2014 Euro Plus Monitor, materialised with
a vengeance in Greece.
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 versus the only
willing lenders Greek had, the new Greek government that
came to power in January 2015 exacerbated the situation.
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
payments system reached €66 billion, equivalent to 37% of
Greek GDP.
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 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 (see Chart 7
below).
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 contracted by 0.3%
in 2015. After a weak first quarter (-0.4% qoq), even
a modest rebound later this year will not lead to any
significant gain in annual real GDP. For 2016, Greek
real GDP will be roughly 6.5% below what it could have
been otherwise.
• Lost revenues: Lower tax revenues and extra spending
will likely lead to a cumulative fiscal shortfall of at
least €8 billion for 2015 and 2016 relative to a baseline
of unchanged policies and the absence of a political
confidence shock. Although tax hikes and an increase in
arrears hide a significant part of the fiscal damage, these
corrective measures in themselves pose a burden.
• Weaker banks: Te 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
Corporate confidence in Greece and the eurozone (excluding Greece).
Weighted average of confidence in industry, services, retail trade and
construction
Sources: European Commission, Berenberg calculations
Chart 7. The Varoufakis Effect
Greek versus eurozone corporate confidence
-50
-40
-30
-20
-10
0
10
20
30
2006 2008 2010 2012 2014 2016
Greece
Eurozone (excluding Greece)
18 The Euro Plus Monitor Spring 2016 Update
‘For countries thinking of reform reversals, the Greek
experience provides a stark warning.’
the banks probably amounts to a fiscal hit of at least €12
billion and possibly significantly more.
Lower real GDP, a slightly lower GDP deflator in response
to renewed recession, the extra fiscal hit and the sizeable
loss of potential privatisation revenues add up to the
equivalent of at least 25% of Greece’s likely 2016 GDP.
Without the confidence shock that derailed the Greek
recovery, the outlook for Greece’s debt-to-GDP ratio could
have been significantly less challenging.
Fortunately, 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 a chastened
Greek government without Mr Varoufakis has hesitated to
fully implement the obligations it signed up to in August
2015. As a result, the risk of a renewed confrontation with
creditors continues to weigh on confidence. We view this
pervasive uncertainty as the single most important obstacle
for an investment-led rebound in Greece. If Greece and
its creditors can now conclude the first review of the new
Greek programme successfully and in a way that inspires
confidence, a fading of such uncertainty may lay the basis
for a return to growth in Greece later this year.
Unfortunately, the compromise shaping up between
creditors and the current Greek government may once
again be biased towards tax hikes rather than a simpler tax
system and faster pro-growth structural reforms to unlock
the country’s significant supply potential.
To return to sustained growth and ease the heavy burden
that currently has to be borne by the Greek population,
Greece would need
• a firm political commitment to stay in the euro and work
with rather than against creditors; and
• substantial deregulation as detailed in the August 2015
agreement with creditors.
Like other countries with weak administrative capacities,
Greece could also benefit immensely from simpler rather
than higher taxes in order to improve economic efficiency,
growth potential and the tax take. It would have been and
still is an ideal candidate for a flat tax on income and sales
coupled with an offer to bring undeclared income and
assets into the open against a measured penalty.
Chances are that a new agreement between Greece and its
creditors can help the country return to growth later this
year. For other governments thinking of reform reversals,
the Greek experience should provide a stark warning:
in a still fragile situation, policy mistakes that shatter
confidence can be quite costly indeed.
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