Structural considerations for a prosperous Greece
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The main economic challenges that will define the Mitsotakis reign
Nobody can doubt that Kyriakos Mitsotakis is taking over control of Greece with the country in much better economic shape than in it has been for many years.
While many of the scars of the long crisis are still evident, the recovery has begun. Albeit modestly, the economy has been expanding continuously since the first quarter of 2017, while employment has grown by more than 300,000, which has taken the unemployment rate to 18.1 percent from 25.8 percent in 2015.
A number of key macroeconomic indices have been improving over the last years: Manufacturing has been expanding since 2017 as indicated by the PMI index, business sentiment and consumer confidence have improved substantially since 2015 and 2017 respectively, disposable income has grown continuously since the second quarter of 2017 and the wages index has grown in 13 out of the last 15 quarters. The property market, which started contracting in the first quarter of 2009 has been growing over the last five quarters.
The banking system has stabilised, with close to 15 billion euros of deposits having returned to the system and the Emergency Liquidity Assistance (ELA) that kept banks afloat in the tumultuous months of 2015 has been completely eliminated.
Also, Greece has been out of its third bailout programme for almost a year without any major economic hiccups, it has started to re-establish market access and has recently seen its bond yields drop, with the 10-year falling below 2 percent.
To top it all, debt repayments for the next 10-15 years are low and the outgoing SYRIZA government is leaving behind a cash buffer purported to be more than 35 billion euros. Even Mitsotakis admitted in a recent interview that he could not use the same line that many of his predecessors trotted out when they took over, about inheriting “scorched earth” from the previous administration.
In short, as far as the country’s recent economic history is concerned, Greece has never had it so good. This, though, does not mean that there are only blue skies ahead for Mitsotakis and his New Democracy government. There are several crucial factors that the new prime minister will have to address, all of which have the potential to upset his plans to get the economy to kick on and produce growth rates of around 4 percent rather than the predicted 2 percent or below.
Mitsotakis has presented a very ambitious programme of tax cuts, mostly focused on the corporate sector and lower incomes, to boost investment spending and private consumption.
Although his pledge has strong economic grounds, it creates significant fiscal gaps in the range of billions, especially as he proposed to reduce the lower tax band while leaving the tax-free threshold unchanged, as well as reducing the property tax and lowering corporate taxes.
And, as if the restrictive fiscal framework that Greece has agreed with its official lenders is not challenging enough, Greece’s creditors believe that after the latest round of expansionary measures the outgoing SYRIZA government implemented in May will lead to Greece missing its fiscal target this year by close to 900 million euros. They have already called for corrective action.
Considering that after years of chopping expenditure to meet fiscal goals, there is little room for substantial savings, the next finance minister will have a tough task reconciling fiscal commitments and pre-election pledges.
Mitsotakis is banking on higher growth to boost budget revenues and hopes that through the implementation of reforms he can convince official creditors to bring down the primary surplus target of 3.5 percent of GDP that is in place until 2022.
As much as faster growth is welcome, it will take time for this to be reflected in the budget and it is highly unlikely that any eurozone parliament would be willing to discuss lower fiscal goals for Greece to finance tax cuts at this stage.
Taxes v investment
Investment is central to Mitsotakis’s plans. It forms the basis of his tax plans and is the main driver for growth. The new prime minister wants to bring investment spending as percentage of GDP closer to the 20 percent seen in pre-crisis years.
However, a closer look into the composition of investment spending shows that the precipitous drop is due to property construction, while the rest of investment by business is actually recovering already.
Even if the new government manages to create a more business-friendly environment and attracts foreign direct investment, the gap between 2018 and 2007 is more than 40 billion euros. By way of comparison, FDI came to 4 billion euros last year.
A recent study by IHS Markit on the prospects of the Greek economy highlighted that tax cuts and lower social security contributions do have a positive contribution on growth but are nowhere near enough to fuel the desirable acceleration. The study makes it clear that Greece needs to attract much higher levels of FDI to increase its GDP.
The new PM will have a tall order to meet his economic aspirations and there will be much work on the structural front needed to move the needle on investments, which hold the key to what he wants to achieve.
Greece’s systemic lenders have covered significant ground since the depths of the crisis that had them closed for two weeks and capital controls were introduced.
A careful reading of the latest reports by the Bank of Greece on the financial stability and monetary policy outlines the challenges faced by the banking system.
The Non-Performing Exposures (NPEs) in the system are steadily declining, having dropped to 80 billion euros from over 100 billion at their peak and there is now a full framework in place to manage distressed debt though sales and securitisations, out-of-court workout and the protection of primary residences.
However, even if banks fully meet their goal of dropping the average ratio down to 20 percent by 2021, that is more than seven times the EU average and it will require systemic solutions to assist the effort.
At the moment there is an Asset Protection Scheme (APS) that is pending approval from DG Comp and the solution that has been devised by Bank of Greece (BoG) using Deferred Tax Credits, which will require Mitsotakis’s attention if bad loans are to be dealt with decisively.
The Public Power Corporation, Greece's largest company, is facing enormous challenges. Last year's losses exceeded half a billion euros, and in the first quarter of this year losses of more than 200 million were piled on. The company is continuously losing market share, dropping by 6 percentage points to 77 percent in Q1 this year, operating expenses keep rising as a result of high CO2 emissions charges and is selling electricity to third parties via NOME auctions at a loss.
The last round of trying to sell the lignite units in Melitis and Megalopolis unearthed many of the issues that make the company uncompetitive, as the units were loss making and overstaffed, the bids were disappointing and eventually the tender had to be relaunched.
The new energy minister will have his hands full to redesign the role of PPC in the Greek economy, the company's energy mix and the role of the Greek state. The previous New Democracy-led government had plans to spin off a minority part of the company.
Time to deliver
Fate and SYRIZA’s political misfortune has handed Kyriakos Mitsotakis a unique opportunity. He inherits a country that has stabilised after almost a decade of political, social and economic turmoil, giving him the opportunity to tend to the green shoots of recovery that have been appearing over the last couple of years.
Significantly, by veering towards New Democracy in large numbers, Greek voters have also shown that they are open to policies that would have been too toxic in years gone by. The centre-right party’s landslide victory on Sunday has given Mitsotakis a platform from which he can attempt changes that others shied away from because of the political cost, although it remains to be seen if his party will feel as emboldened.
Despite all these advantages, the new prime minister also has a series of big economic challenges to tackle. Strong leadership and creating the conditions for higher investment will be the nexus of his premiership. If he proves that he can keep his party in check, maintain the support of voters and make Greece attractive to investors, success should be guaranteed. If not, the next four years could prove messy. The time for the new prime minister’s plan to be tested has arrived.
Perhaps the new government should take a look at the report "Greece Ten Years Ahead" which was published by the Athens office of McKinsey back in 2011. I haven't read it since then but if I recall correctly, it proposed measures which would create 500.000 new jobs and about 50 BEUR in new GDP over a period of 10 years.
If the new government wants to make Greece a more attractive place for foreign investment, they could look up the latest Doing Business Report by the World Bank. It lists the 10 categories which contribute to giving Greece a very low overall ranking (I believe the lowest in the EU). Once could start with those categories which have the lowest ranking.