Louri-Dendrinou, Ε. (2014) “Economic and financial changes since the onset of the global and euro area crises“, LSE EUROPP Blog, Greece: Taking Stock, 06 November.
With the introduction of the euro and the mispricing of sovereign (Greek) risk, a flux of funding inundated Greece and helped fuel an impressive growth rate (averaging 4%) in 2000-2008. Growth, combined with low inflation since monetary policy was managed by the European Central Bank (ECB), produced a flattering picture of an economy suffering from serious reform resistance. Growing fiscal and external imbalances were thus left unaddressed. In 2009 the fiscal deficit reached 15%, while Greece’s competitiveness loss against its trading partners in 2000-2008 was 30%, leading to a current account deficit exceeding 15%. The government sector was crowding-out the tradeables sector.
The increase in sovereign risk that followed the outbreak of the global financial crisis and the realization of the flawed fundamentals led to Greece being cut off from the markets. Hence the need of an adjustment programme combined with a loan from IMF and European partners in 2010, subject to strict conditionality. The programme consisted of four pillars: fiscal adjustment, structural reforms of labour and product markets, measures to combat tax evasion and privatization. With the emphasis placed on the first pillar and a preference for tax increases instead of spending cuts, the recession took unprecedented dimensions, indicating a much higher multiplier than initially estimated.
The cumulative reduction in GDP in 2008-2013 reached 25%, while unemployment surpassed 27%. On the side of the fundamentals though, fiscal consolidation was striking, since a primary surplus (close to 2%, excluding? banks) was achieved in 2013 and the current account showed a surplus for the first time since WWII. Fiscal and structural reforms led to a re-balancing of the economy with the non-tradeables sector shrinking and leaving space for the tradeables sector to develop. Positive growth is expected in 2014 based on: the decline in fiscal drag, competitiveness gains affecting export performance, loosening liquidity constraints and supply-side effects of structural reforms.
Before the crisis, the Greek banking system was sound (capital adequacy ratio 12% and loans/deposits 104%) with a large presence in South Eastern Europe and no toxic assets related to the US subprime crisis. In 2008 private debt/GDP was 97% (vs 220% in Ireland, 202% in Spain and 173% in Portugal). With the outbreak of the sovereign crisis Greek banks were hit by a series of downgrades (following the sovereign), experienced substantial deposit withdrawals (lost €88bn, or one third of deposits, between June 2009-June 2012) and were cut off from money and capital markets (while having to pay back maturing debt).
Relevant posts:
- Foroohar, R. (2014) “Where the Next Financial Crisis Will Come From“, Time Magazine, 03 November.
- Dixon, H. (2014) “A New Euro Crisis?“, Reuters Breaking Views, 20 October.
- Verney, S., Bosco, A. & Lobo, M. C. (Eds.) (2014) “Southern Europe and the Financial Earthquake – Coping with the First Phase of the International Crisis“, South European Society and Politics, Routledge Publications, October.