Greece Passes First Deficit Test as Budget Challenges Mount

Greece’s austerity drive may pass its first test this week as a European Union-led mission prepares to dole out more rescue funds for a government trying to cut the euro-region’s second-biggest budget gap and weather a recession.

In approving the second tranche of a three-year, 110 billion-euro ($145 billion) bailout, the EU and International Monetary Fund are likely to praise Greece’s progress and say more work is needed to lock in the gains, economists said. Greece is battling the highest inflation rate in the 27-nation EU, revenue is trailing targets and the bloc and the IMF forecast the economy will shrink as much as 4 percent this year.

Prime Minister George Papandreou has raised taxes, cut wages and overhauled the state-run pension system, while braving months of strikes against the measures that helped shrink the budget gap by 45 percent in the first half. Sustaining the effort and qualifying for another 9 billion euros of EU-IMF funds will be complicated by a recession that has been deepened by his steps.

“They’re implementing the structural reforms being demanded,” said Ben May, an economist at Capital Economics Ltd. in London. “We still remain a little concerned from a medium- term perspective in the sense the government is banking on a return to growth in 2012 that could prove optimistic given the scale of the fiscal adjustment going on.”

The EU and the IMF plan to hold a press conference between Aug. 4 and Aug. 6 to discuss Greece’s progress, IMF spokeswoman Jennifer Beckman said.

Brink of Default

Officials from the EU, the IMF and the European Central Bank, dubbed the “troika” in the Greek media, have been auditing the country’s progress since July 26 in the first official review since the loans were approved on May 2. The bailout was triggered after investor concern about the deficit led to soaring borrowing costs that pushed Greece to the brink of default on its 300 billion-euro debt.

Finance Minister George Papaconstantinou said last month he’s confident of drawing down the second loan payment and that Greece may beat this year’s deficit target of 8.1 percent of gross domestic product, down from 13.6 percent last year. He said the forecast of an economic contraction of 4 percent was “overly pessimistic.”

‘Very Satisfied’

Luxembourg’s Jean-Claude Juncker, who leads the group of euro-area finance ministers, said he is “very satisfied” with the deficit reductions Greece is making.

The cuts have been “beyond expectations,” he told reporters in Luxembourg. The euro-area nations “have further wishes as to structural reforms” to be undertaken by the Greek government, he said.

Greece’s benchmark ASE stock index has gained 20 percent in the past month on signs that the government’s deficit plan was working. Shares of banks, the biggest holders of Greek bonds, have led the advance as the default risk subsided. EFG Eurobank Ergasias SA, the second-biggest bank, has added more than 67 percent in the period. Alpha Bank SA and Piraeus Bank SA have gained more than 50 percent. Today the index rose 0.2 percent.

Still, the yield premium that investors demand to buy Greek debt over comparable German bonds remains at 750 basis points, more than five times the spread between Spain and Germany.

Credit-default swaps on Greek government debt fell 8.5 basis points to 718, according to data provider CMA. That means it costs $718,000 annually to insure $10 million of the nation’s bonds for five years.

Growth Focus

In interim reports last month, both the EU and the IMF said deficit-cutting was broadly on track, with risks seen in lagging revenue, the effect of tax increases on inflation and the impact of the finances of hospitals and state-controlled companies such as Hellenic Railways Organization SA on the budget.

Doros Constantinou, the chief executive of Coca-Cola Hellenic Bottling Co., the world’s second-largest bottler of Coke drinks, says the government needs to focus on aiding growth rather than raising taxes when it begins drafting next year’s budget, which targets a shortfall of 7.6 percent.

“If you don’t grow the top line, there’s no future,” Constantinou told analysts in a conference call on July 29. “The government has to come back with some measures that will boost growth.”

Greece’s economy shrank an annual 2.5 percent in the first quarter, with unemployment and consumer confidence both at the worst in 10 years. Even with the contraction, June’s inflation rate reached 5.2 percent, close to a 13-year high and more than three times the euro-region rate, as the tax increases boosted the costs of fuel, alcohol and tobacco.

Contraction Possible

The recession may deepen this year as austerity measures adopted in the second quarter kick in.

‘It’s very premature to argue that you’re not going to see a big contraction in the coming 18 months,” said David Mackie, chief European economist at JPMorgan Chase & Co. in London. “The measures in May are not feeding through till the second half.”

Government revenue grew 7.2 percent in the first half, trailing a 13.7 percent forecast. Finance Ministry officials said last week that new increases in sales taxes, which took effect in July, will help boost revenue in the second half. A 4 billion-euro “cushion” from spending cuts will help cover any shortfall in a plan to reduce costs at public companies and hospitals.

Opening Professions

For Papandreou, abiding by the EU-IMF recommendations may trigger further protests. Both institutions have said part of the inflation jump is from a lack of competitiveness that can be addressed in part by opening up professions deemed “closed,” such as trucking.

Truckers last week starved Greek gas stations of fuel as they opposed the government’s plan to issue the first new licenses since 1971. The strike was called off on Aug. 1 after the government commandeered trucks and said the drivers would be prosecuted. Papaconstantinou has pledged to push ahead with changes to open up professions ranging from pharmacists to architects.

“Closed professions will open,” he said in Parliament on July 28. “They will open because prices must fall. They will open because this will help the budget of each household and they will open because that is how the country’s growth will be helped.”

To contact the reporter on this story: Maria Petrakis in Athens at mpetrakis@bloomberg.net.

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