The root-causes of the Greek sovereign debt crisis
Basil Manessiotis paper presented at the 2nd Bank of Greece workshop on the economies of Eastern European and Mediterranean countries Athens, 6 May 2011
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Introduction
To better understand the current sovereign debt crisis in Greece, a longer view is warranted The 20 year period 1989-2009 is bounded by two major fiscal crises in Greece: the 1989-1993 crisis, and the ongoing crisis.

In both crises deficits exceeded 15,0% of GDP. In between, Greece entered the Economic and Monetary Union and adopted the Euro To facilitate discussion the 20 year period will be divided into two parts: the 1989-1999 period, and the 2000-2009 period.
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1989-1999: securing EMU membership
The 1989-1993 sub-period: Macroeconomic developments
Weak economic activity (1.2% average growth) Very high inflation (16.8% annual average) Very high real and nominal interest rates Low fixed investment (1.5% annual average)

Fiscal developments
Very high general government deficits (13.6% of GDP average)
The 1990 deficit reached 15.9% of GDP

Primary deficit averaged 4.3% of GDP Fast accumulation of debt
Debt ratio increased from 69.0% of GDP in 1989 to 110.1% of GDP in 1993 Other reasons for debt accumulation

Very high interest payments
From 6.8% of GDP in 1989 to 11.4% of GDP in 1993
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TABLE 1 Selected Macroeconomic Indicators (annual average rate)
1989-1993 Real GDP growth Fixed investment growth Inflation (CPI) General Government deficit (% of GDP) Primary Deficit (-) or Surplus (+) (% of GDP) Total general government expenditure (% of GDP) Total general government revenue (% of GDP) General Government debt (% of GDP) Current Account deficit (% of GDP) 1,2 1,5 16,8 -13,6 -4,3 48,7 35,1 73,7 -2,6 1994-1999 2,8 6,1 6,8 -7,0 4,0 48,7 41,5 109,0 -3,0 -5,2 0,6 45,5 40,3 101,0 2000-2004 4,5 6,9 3,3
(-5,7)*

2005-2009 2,0 -1,9 3,0 -8,3 -2,9 47,5 39,1 109,7
(-9,1)* (-3,2)* (52,1)* (42,7)* (120,2)*

(0,7)* (49,9)* (44,2)* (110,7)*

-6,8

-11,9

*Numbers in parentheses show respective values prior to the GDP revision by 9,6%, which covers only the period 2000-2009.
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-3 0 1 2 3 4 5 6 7 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

-2

-1

Diagram 1 Real GDP growth

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Diagram 2 Elections and General Government Deficit (% of GDP)
18 16 14 12 % of GDP
Elections Elections

Elections Elections

Elections Elections

10 8 6 4 2 0
0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5

Elections

Elections Elections

Elections

6

7

8

9

0

1

2

3

4

5

6

7

8 200
6

198

198

198

198

198

198

198

198

198

198

199

199

199

199

199

199

199

199

199

199

200

200

200

200

200

200

200

200

200

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Securing EMU membership: 1994-1999
Fiscal developments
Tight fiscal policy stance General government deficit declined from 13.6% in 1993 to 1.8% in 1999 (although later it was revised to 3.4%) Consolidation exceeded 10 p.p. of GDP Primary surpluses appeared, reaching 4.9% in 1999. Interest payments reached an alarming 12.7% of GDP in 1995 and then declined to 8.4% of GDP in 1999

The “quality” of fiscal consolidation
Composition of fiscal consolidation was lacking Based on tax increases and falling interest payments Primary expenditure increased from 36.2% (1994) to 39.9% of GDP (1999) Personnel expenditure rising every year, exceeding budget targets 1995-1998: the central government wage bill increased by 70.7% 7 Pensioner’s Solidarity Allowance was introduced in 1997

Diagram 3 Primary General Government Deficit (% of GDP)
12,0

10,0

8,0

6,0

4,0

2,0

0,0

-2,0

-4,0

-6,0 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

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10,0

12,0

14,0

0,0 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 YEAR 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

2,0

4,0

6,0

8,0

Diagram 4

General Government interest payments (EDP definition) (% of GDP)

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Securing EMU membership: 1994-1999
Taking all these into account, fiscal consolidation was not sustainable Fiscal policy inside the Euro-zone should have been
More active, to correct macroeconomic imbalances and asymmetric socks More flexible and autonomous More disciplined Tax competition, migration of tax bases

Greece entered EMU with two fundamental weaknesses
The debt-to-GDP ratio was too high, exceeding 100% of GDP. Adversely affects growth prospects and sets severe limitations on fiscal policy The institutional fiscal framework which determines fiscal outcomes was extremely weak (not-existing)
Budget preparation Numerical fiscal rules Independent assessment

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100,0

120,0

140,0

160,0

20,0

40,0

60,0

80,0

0,0 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010**

Diagram 5

General Government gross consolidated debt (Maastricht definition) (% of GDP)

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Inside the euro-zone
The traps could have been avoided by:
Increased fiscal discipline Increasing the competitiveness of the economy

Greece did neither of them Macroeconomic developments in the 2000-2004 sub-period
Strong economic activity (4.5% real growth) Very low inflation (3.3% annually) but higher by 1.5 pp than the EZ High consumption, fuelled by rapid credit expansion High investment growth (6.9% average)

Inevitable easing of monetary conditions
Sharp decline in interest rates (end 1999-end 2006) Elimination of credit restrictions Reduction of reserve requirements from 12% to 2%
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Inside the euro-zone : 2000-2004
Fiscal developments
Fiscal policy should have offset the loosening of monetary policy On the contrary, fiscal policy loosened progressively Significant tax cuts from the first year Primary surplus declined and as of 2003 turned into deficit Repeated revenue short falls and expenditure overruns

Public debt remained broadly stable
Despite extremely favourable conditions the debt-to-GDP ratio remained broadly stable (high GDP growth, historically low interest rates, primary surpluses [up to 2003], revenue from privatizations)

Significant fiscal deterioration in 2003 and especially in 2004, despite the fact that in 2004 Greece was under the EDP
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Inside the euro-zone : 2000-2004
Greece was subjected to the Excessive Deficit Procedure (EDP) in mid 2004
Immediately after the March elections, Greek authorities notified Eurostat that 2003 deficit was 2.95% of GDP. Eurostat came to Athens on 26-27 April. The 2003 deficit was revised to 3.2% In May the Commission initiated the EDP against Greece On 5th July 2004 the ECOFIN Council decided that Greece was in excessive deficit

Greece was asked:
To put an end to the excessive deficit by end 2005 at the latest To take effective action and submit a package of measures by November 5th

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Inside the euro-zone : 2000-2004
Insufficient measures
Commission: Greece did not take effective action Over and above fiscal revisions and slippages related to the Olympic Games “…the fiscal policy stance further worsened in a situation of buoyant economic activity…” Thus Greece was moved to Art. 104, par.9 Greece took additional tax measures on 29 March 2005 (Updated Stability and Growth Programme)

As a result of the “fiscal audit”, deficit and debt figures for 2000-2004 were repeatedly and significantly revised The fiscal revisions created uncertainty about the true state of Greek public finances. finances
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Inside the euro-zone : 2005-2009
Fiscal developments
Given that Greece was in the EDP, fiscal policy was given. Reduce deficit below 3.0% by end 2006

Deficit declined to 2.6% of GDP in 2006 (later revised several times to 5.3% of GDP) As with the 1994-1999 consolidation, the new consolidation was not a sustainable one
Expenditure were not cut on a permanent basis In a year’s time deficit exceeded again the 3.0% reference value Good fiscal performance in the first semester of 2007

On the basis of 2006 outcome, the EDP ended on June 6th 2007 Fiscal magnitudes deteriorated in July-August 2007
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Diagram 6 Central government cash deficit 2006-2007 (% GDP)
6,0

5,0

4,0

% gdp

3,0

2,0

1,0

0,0 Jan-June Jan-July Jan-Mar Jan-Aug Jan-Feb Jan-Sept Jan-May Jan-Nov Jan-Apr Jan Jan-Oct Jan-Dec

2006

2007

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Inside the euro-zone : 2008
2008 was a pivotal year
GDP growth decelerated but remained positive Large deterioration in fiscal outcome

Revenue shortfall by 1.3% of GDP (3.3 bill.euro) Expenditure overruns by 1.2% of GDP (3.0 bill.euro)
Press reports: “…government gave up any effort to reign in waste…”(December 2007) IMF: “…the quality of expenditure adjustment in the 2008 budget falls short of what is needed to ensure sustainable consolidation.”

In April, Bank of Greece warned about debt dynamics In their Spring forecasts all international organizations projected a deceleration in GDP growth in Greece Despite continuous worsening of monthly fiscal data and 18 macroeconomic prospects no measures were taken.

Diagram 7 Central government cash deficit 2007-2009 (% GDP)
16,0

14,0

12,0

10,0

8,0 % gdp 6,0 4,0 2,0 0,0 Jan-June Jan-July Jan-Mar Jan-Feb Jan-Aug Jan-Sept Jan-May Jan-Nov Jan-Apr Jan Jan-Oct Jan-Dec -2,0

2007

2008

2009

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Inside the euro-zone : 2008
Rising spreads
Spreads began to rise since early 2008
5 March Triche warned Greece and Italy June, July debt issues had much higher yields

On 1st September 2008 Standard & Poor’s and Fitch warned that unless Greece managed to contain public spending and reduce public debt, its credit rating would be lowered As the international crisis intensified spreads rose (10 year bonds) considerably Following the December 2008 demonstrations in Athens spreads rose again At this juncture Greece should have sent a strong message 20 to the markets

2009 and the Crisis
The 2009 budget was outdated before the beginning of the new year
By 30 January, the 2009 budget had been completely revised The 2009 deficit was estimated at 3.7% of GDP

The execution of the 2009 budget went seriously off track
Every single month deficit was much higher than in previous year Monthly data were not published (only in April and July)

Revenue shortfall: 12,744 mill. euro or 5.4% of GDP Expenditure overruns: 6,176 mill. euro or 2.6% of GDP Deficit 30,102 mill. euro or 12.5% of GDP
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2009 and the Crisis
On 27th April Greece was subjected again to the EDP, on the basis of 2007 and 2008 deficits
The Commission clearly stated that these deficits were structural and were not due to the international crisis

Greece was asked to correct the excessive deficit situation by the end of 2010. In 20 months Greece was given 7 months time to submit measures to the Commission (27 October 2009)
Commission is responsible for this

Insufficient tax measures taken reluctantly in late June 2009 The package of measures for EDP was never prepared
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The crisis
The last opportunity to send a strong message to the markets was in the aftermath of the October election On 22 October the new deficit estimates were published by Eurostat (12.5% of GDP) The same day Fitch downgraded Greece The 3.6% of GDP deficit reduction provided by the 2010 budget did not satisfy markets Sovereign bonds downgraded again on 8,16 and 22 December by Fitch, S&P and Moody’s respectively
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The crisis
In the Updated SGP the decline in deficit was envisaged to 4.0 % of GDP
On 26th January 2010 spreads were at 369 pb

Significant fiscal measures taken on 9th February and 4th March did not appease the markets A new round of downgrading in April 2010 April 11 Eurogroup decided to help Greece

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Conclusions : Long term problems
The current sovereign debt crisis has deep roots: 1. Continuous deficits for the last 36 years 2. High and rising public debt 3. No systematic efforts to control expenditure or contain tax evasion

4. The three fiscal consolidations (1986-1987, 1994-1999 and 2005-2006) were not sustainable 5. Continuous worsening of competitiveness after EMU entry 6. Greece entered EMU without adequate preparation and fell into both traps: the debt trap and the competitiveness trap 7. The magnitude and the frequency of the fiscal data revisions dealt a serious blow to the country’s credibility

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2008-2009 developments and the crisis
1. Plenty of warnings since the beginning of 2008. Plenty of time to take measures 2. Huge expenditure overruns and revenue short falls. Unwillingness to take coherent significant fiscal measures to correct the situation 3. Huge current account deficits 4. When the international crisis hit the Greek economy (fall 2008), fiscal developments and outlook were bleak 5. Second EDP in April 2009, on the basis of 2007-2008 deficits. Structural not cyclical. Not related to the international crisis. 6. Commission granted a very long time for Greece to take action and submit measures 7. No action was taken according to EDP conclusions
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2008-2009 developments and the crisis
8. To deal with a debt crisis, decisive and immediate bold action is required. Later it would be much more difficult. A strong message to the markets is required 9. The October elections was the last opportunity for Greece to signal a turnabout of fiscal stance. Markets’ power was underestimated 10. 20% of total debt was created in 2008-2009 11. The international financial crisis did not cause the sovereign debt crisis in Greece. It revealed and aggravated existing macroeconomic imbalances and structural fiscal problems 12. The debt crisis adversely affected the liquidity of the banking sector in Greece, because Greek banks were cut off the interbank market
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Thank you

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