Greek Central Bank Governor talks on Grexit to Grecovery
George Provopoulos, Governor of the Bank of Greece gave an interesting speech to the Official Monetary and Financial Institutions Forum (OMFIF) in London last Friday 7 February.
The full text of his speech as published by OMFIF can be found below:
“The Greek financial crisis: From Grexit to Grecovery”
Official Monetary and Financial Institutions Forum
London, 7 February 2014
Origins of the crisis
Five years ago the thought of a euro-area crisis seemed counter-intuitive. After all European monetary union was undertaken to make the kind of crisis that occurred impossible. However, when deciding on what architecture to give to the monetary union, policymakers settled on a “bare-bones” approach, resting on a single independent, price-stability-oriented central bank and fiscal discipline by the member countries.
This architecture proved inadequate for several reasons. First, the fiscal rules were poorly designed and under-enforced. Second, instead of increasing the pressure for structural reforms and policy adjustments needed to strengthen competitiveness in the periphery, market forces acted in the opposite direction by mispricing risk. Third, the founders of EMU underestimated the importance of financial stability in a monetary union — they made no provision to deal with private credit booms and busts or with the feedback loops between banking crises and fiscal crises.
A tale of two crises
Broadly speaking, the euro-area crisis has consisted of two separate crises — a sovereign-induced crisis (mainly in the case of Greece) and a banking-induced crisis. What the crisis countries — Cyprus, Greece, Ireland, Portugal and Spain — have had in common was large current-account deficits prior to the crisis.
The initial tremors of the euro-area crisis occurred in Greece in the fall of 2009 following news that the country’s fiscal deficit would be much higher than had been expected by the markets. The outbreak of the Greek sovereign-debt crisis took the markets by surprise. It should not have done so.
Greece joined the euro area in 2001. From that year until 2009, large and growing fiscal and external imbalances should have sounded loud warning alarms in the financial markets. Those years were characterized by high fiscal deficits, driven mainly by expenditure, high and increasing government debt and a steady erosion of competitiveness. Once the crisis started in late 2009, it rapidly became self-reinforcing. As a result of the crisis, real GDP contracted cumulatively by 25 per cent, intensifying the debt dynamics and contributing to the self-reinforcing nature of the crisis.
In the remainder of the periphery — especially Ireland, Spain and Cyprus — it was the banking sector that generated a sovereign crisis. The large size of the banks relative to national GDPs undermined confidence in the sovereigns, creating doom-loops between banking systems and the sovereigns. The lesson from this experience was clear; an effective economic and monetary union needs to include a banking union.
A crisis-induced economic adjustment
Greece has achieved a remarkable adjustment as a response to the sovereign crisis.
Consider, first, fiscal adjustment. From 2009 to 2013, the fiscal deficit was reduced by some 13 percentage points of GDP. The structural fiscal deficit has shrunk by 19 percentage points of GDP. The primary fiscal deficit has swung from 10½ per cent of GDP in 2009 into a small surplus last year.
What makes these achievements especially impressive is that they have taken place despite a contracting economy, which creates moving targets for fiscal consolidation. Greece’s fiscal consolidation is one of the largest ever achieved by any country under an IMF program.
Consider, next, external adjustment. Greece lost about 30 per cent in terms of cost competitiveness against its major trading partners in the period from 2001 to 2009. Between 2010 and 2013 the entire loss had been recovered. As a result of these improvements in competitiveness, a rebalancing of the Greek economy is taking place. The share of exports of goods and services in GDP rose from 18 per cent in 2009 to 28 per cent last year. The current account, which was in deficit to the tune of 15 per cent of GDP in 2008, moved into surplus last year.
Two factors about the improvement in competitiveness stand out. First, it has been achieved without the benefit of a nominal exchange-rate devaluation. Reflecting extensive labour-market reforms, it has been based on reductions in unit labour costs — an internal devaluation. Second, it has been achieved against a backdrop of low inflation in the economies of Greece’s trading partners, a situation that makes it difficult to attain improvements in competitiveness.
The banking sector
The restructuring of the Greek banking system has also been enormous. With the deepening of the crisis, the Bank of Greece stepped in to preserve banking system stability. Ample liquidity was provided to the banks. Viable banks were fully recapitalized using a combination of state and private funds. Non-viable banks, which were unable to raise private capital, were resolved. Before the crisis, the Greek banking system comprised almost 20 banks. Today we have four well-capitalized, pillar banks and a few smaller ones.
We are now implementing the second stage of our strategy, which involves policies to allow banks to repay state aid and finance the recovery of the Greek economy. Banks are now exploiting synergies and economies of scale, further eliminating excess capacity, and becoming more efficient. They are also refocusing on their core activities.
Late last year, we re-engaged BlackRock to update credit loss projections for banks’ loan portfolios up to 2016, and to study the efficiency of banks’ procedures in
managing non-performing loans. The efficient use of the backstop during recapitalization and resolution has left a buffer of around € 8 – € 9 billion, should additional capital needs arise. Moreover, the sale of non-core assets and the exploitation of synergies arising from mergers could add some €5 billion to the buffer.
A “code of conduct” for banks’ dealings with distressed borrowers is being drawn up and will be implemented as of 2015. Improvements in NPL management will lower capital requirements, freeing up resources that can be used to finance a new growth model for the Greek economy.
Initiatives at the EU level
Policy responses to the crisis have also included actions in both the ECB’s monetary policy and in EMU’s architecture.
The actions of the ECB have been decisive. The ECB has kept policy rates at historically-low levels; it has satisfied the liquidity needs of banks, and has expanded its collateral framework. The announcement of Outright Monetary Transactions has helped reduce tail risks of a euro break-up. Furthermore, under its forward guidance the ECB has made it clear that policy rates will be kept at present or lower levels for an extended period of time.
Changes in the architecture include both improvements in macroeconomic surveillance (through the “six-pack”, the fiscal compact, and the “two-pack”) and efforts to establish a banking union.
Banking union is being designed to break the negative feedback loops between banks and the sovereign, as well as to create an integrated, stable and well-capitalised banking sector. The Single Supervisory Mechanism, which will become fully operational this November, will lead to the transfer of the supervision of almost
85 per cent of total euro-area bank assets to the ECB. A necessary complement to a supervisory mechanism is a resolution framework to deal with non-viable banks. The first decisions on the Single Resolution Mechanism have already been made. Finally, the harmonisation of Deposit Guarantee Schemes will help prevent the emigration of funds in search of higher coverage. The scheme will begin operation in January 2016.
For too long, the countries at the euro’s periphery sacrificed long-term gains for short-term gratification. The policy reforms that the euro-area’s crisis countries are now implementing follow an established recipe. That recipe stresses the need to improve competitiveness, and includes fixing social security, strengthening employment incentives, privatisation, and streamlining the public sector.
Some of these measures take time to work. The gains do not come overnight. Supported by the ECB’s policies and the strengthening of the EU’s architecture, that recipe is now working. The case of Greece perfectly illustrates the progress that has been achieved. Since the peak of the crisis in mid-2012:
• Government bond spreads have fallen by around 1,800 basis points.
• The Athens stock exchange has risen by about 85 per cent.
• Bank deposits have increased by 9 per cent.
• Reliance of banks on Eurosystem financing is down by about 50 per cent.
• Economic sentiment has recently reached a 5-year high.
• The twin deficits have been transformed into twin surpluses.
• The recent release of the PMI for manufacturing for January 2014 points to expansion for the first time in 53 months.
It is now generally expected that 2014 will be the year in which growth returns to the Greek economy, supported by an improved export performance, the return of confidence and a considerably smaller fiscal drag than in the previous years.
Nevertheless, the storm clouds have not yet completely cleared. The economic and financial environment in Greece remains fragile and sensitive to negative developments. The very high unemployment rate led to social and political polarization. A surge in political uncertainty could undermine the recovery.
It is my hope that such an unfortunate scenario will not occur. Greek citizens have had to undergo tremendous sacrifices during the past few years. These sacrifices are now bearing fruit. This progress, which is now visible, makes me confident that Grecovery is on the way.