ESM releases annual report on Greece

The year 2018 was a landmark year for Greece, mostly because of the country's exit from the memorandum in August 2018, the European Stability Mechanism (ESM) said in its annual report on Greece.

The report, released on Thursday, presents the achievements of the Greek economy in recent years in the framework of the EMS programme and the challenges facing the country in the future.

The report said that after Greece exited its ESM programme in August 2018, the European Commission activated enhanced surveillance for the initial post-programme period and Greece rejoined regular European economic policy coordination.

Under Enhanced surveillance, Greece committed to completing all key reforms adopted under the programme and to specific actions in particular policy areas. To verify Greece's progress with its commitments and in line with the enhanced surveillance framework, regular missions are conducted by the European Commission in liaison with the ECB, in which the ESM participates under its Early Warning System.

The Commission's resulting quarterly enhanced surveillance reports also serve as a basis for euro area members' bi-annual decision to release funds related to the Eurogroup's June 2018 debt relief measures. Economic recovery continued for a second year, and Greece outperformed the fiscal target for the fourth successive year. To secure economic and financial sector improvements as well as to reestablish market trust, Greece needs to consolidate and continue the reforms pursued during the programme. The completion of the third and fourth reviews unlocked 21.7 billion euros of ESM financing between March and August 2018. During the three-year programme, ESM disbursed 61.9 billion of the up-to-86 billion envelope, of which 7 billion was dedicated to arrears clearance and 11.4 billion to the build-up of a cash buffer.

Greece’s end-2018 cash resources of 26.8 billion euros are sufficient to cover financing needs for at least two years. The country raised 3 billion euros with a 3-year bond in February, but challenging market conditions did not favour another issuance in 2018. In December 2018, the Public Debt Management Agency announced an up-to-7 billion euros 2019 issuance programme. Between January and March 2019, it raised 5 billion through the issuance of a 5-year and a 10-year bond. In 2018, Greece progressed further in clearing its stock of arrears to the private sector. Domestic resources and programme funds decreased the overall stock by more than 8 billion euros since the arrears clearance programme started in June 2016. To pay remaining arrears of 1.4 billion in December 2018 and stop creating new ones, Greece has needed to intensify efforts to further modernise its public financial management system.

Greek banks meet capital requirements as of end2018 and liquidity is much improved, but they still suffer from the highest euro area NPL ratio. Banks have broadly met supervisory targets on NPL reduction to end-2018 but the targets are becoming increasingly challenging. The government improved the efficiency of the out-of-court workout law and the electronic auction platform for asset sales. It also began assessing how it can further support the banks, for example through an asset protection guarantee scheme. The Hellenic Financial Stability Fund (HFSF) developed a strategy for the sale of its stakes in the systemic banks in the following years.

The Hellenic Corporation of Assets and Participations (HCAP) launched governance and operational reforms of state-owned enterprises, and restructured its real estate management entity.

The conclusion of the ESM programme in 2018 and Greece’s ongoing commitments helped to improve confidence, but challenges to sustainable growth remain. Economic activity rose by 1.9%, driven by net exports and consumption which compensated for weak investments. General government debt is still high at 181.1% of GDP. The primary surplus reached 4.4% of GDP, according to Eurostat. This implies a primary surplus of 4.3% in programme terms, outperforming the fiscal target of 3.5% of GDP in 2018, the fourth year of outperformance. While income taxes were robust, lower-than-envisaged public investment also boosted the surplus. The authorities legislated a new set of fiscal measures in 2018, cancelling the accelerated recalibration of pensions in line with the pension reform of 2016 that was scheduled to be implemented in 2019. The resulting higher expenditure reduces the financial scope for growthenhancing policies. For the future, it will be important that Greece combines its post-programme commitments with policies and public investments that support the economy’s recovery, strengthen market confidence, and sustain growth.

In August 2018, Greece exited its third financial assistance programme after a decade of adjustment. During these years, Greece implemented substantial reforms to restore sustainability to public finances, strengthen the banking sector’s resilience, and improve the economy’s competitiveness. During this time, Greece received almost 290 billion in official sector financial assistance and extensive debt relief. To enhance Greece’s long-term growth potential as well as to protect European partners’ large exposure, key programme reform successes must be preserved and prudent policies pursued. Greece’s still existing vulnerabilities and challenging reform targets will require closer post-programme country monitoring than the other euro area postprogramme countries for some time.

Labour market reforms – implemented mainly from 2010 to 2014 – reduced labour costs, removed rigidities, and introduced more flexible wage bargaining schemes. Further efforts helped to safeguard the opening clause in collective bargaining, allowing for rationalisation of the legal framework on dismissals and industrial action, tackling undeclared work, and strengthening active labour market policies. These reforms have contributed to job creation in recent years, reducing the unemployment rate from its peak of 27.8% in 2013 to 18.4% at end-2018.

Since 2008, Greece has lost almost a quarter of its GDP. Over recent years, however, output has stabilised and growth resumed in 2017 and 2018, with a positive outlook. Looking ahead, key reforms adopted throughout the programmes will translate into further output gains, supporting investment and exports. Reforms to improve the business environment focused on product markets and the privatisation of public assets and their improved management:

The ESM said that the Greek banking sector has undergone waves of stress leading to structural change. Four large banks control over 95% of the market as smaller players have been merged or liquidated. The four systemic banks have received three rounds of recapitalisation, 40% of which came from private investors, in 2013 to restore capital adequacy ratios from losses arising from the write-off of Greek government bonds and again in 2014 and 2015 to cover losses from the increase in NPLs. The banks also experienced large-scale deposit outflows, which made them reliant on emergency liquidity assistance and even required capital controls to safeguard financial stability. Deposit outflows peaked in 2012 and, after a short period of recovery, peaked again in 2015. Bank deposits stabilised in 2018, enabling the government to relax capital controls gradually.

As part of the 2015 recapitalisation, Greece introduced strict rules to reform bank governance. The ongoing reforms are focused on legislation to reduce the NPL ratio, which remains the highest in the euro area, and generate new bank lending to support the recovery. Banks met NPL reduction targets up to the end of 2018, and have reduced the stock of NPLs by more than 20 billion since 2016.

Greece received substantial debt relief both from private creditors in 2012 and from the official sector in 2011, 2012, 2016 and, just before the end of the third programme, in June 2018. All these debt measures have improved debt dynamics. Greece's debt is expected to remain on a declining path, with gross financing needs below 15% of GDP in the medium term and below the 20% threshold in the long-term under the baseline scenario. European partners also committed to providing additional debt relief measures in 2032, if needed and provided that the EU fiscal framework is respected, the report said.

"Public finances need to remain on a sustainable path, while incorporating more growth-oriented policies. Already implemented or adopted reforms, such as the labour market reform and the lowering of income taxes in combination with a broadening of the tax base, need to be safeguarded and should not be reversed. In the event of court rulings overturning key structural reforms, the recurrent fiscal impact should be largely addressed by reforms within the same policy field. Further structural reforms are necessary to boost productivity and enhance competitiveness, complementing the country’s growth strategy.

"These include reforms to make the economic environment more business friendly, reduce the time needed to resolve legal disputes, further improve the effectiveness of public administration while maintaining it at its current size, and enhance the efficiency of state-owned enterprises’ management. These institutional reforms, coupled with privatisations and improved management of state assets, are critical to attracting both foreign and domestic investment and strengthening future growth. Furthermore, Greece needs to support banks' efforts with a comprehensive NPL reduction strategy and improved legislative framework, which will help Greek banks’ ability to lend to the economy and support the economic recovery," the ESM said.

The Board of Governors of the European Stability Mechanism (ESM) on Thursday approved the terms of reference for the evaluation of the financial assistance to Greece as defined by Joaquin Almunia, who is leading the exercise. The evaluation will focus on stability support provided by the EFSF and ESM, including the 2012 private sector involvement and the post-programme monitoring period until the third quarter of 2019.

"An independent evaluation of the financial assistance to Greece is an investment. I look forward to the report that will be prepared under Mr. Almunia's guidance so that the ESM can draw lessons and be even more effective in fulfilling its mission and addressing future crises," ESM Managing Director Klaus Regling said.

"Striking the appropriate balance between adjustment, fiscal sustainability and growth objectives is a key challenge for any programme design and implementation. These terms of reference and the good practices of the international institutions will guide this evaluation’s approach," high-level independent evaluator Joaquín Almunia said.