Greece Is Quietly Backsliding on Reform

Greece needs public sector reform and investment, not more debt-fueled consumption.

Fading attractions.

Photographer: Louisa Gouliamaki/AFP/Getty Images

Greece’s planned August exit from its third European Stability Mechanism bailout has triggered investor optimism. Its July 2017 bond issuance, the first in three years, was oversubscribed, as were subsequent issuances in February of this year. And yet financial investors should curb their optimism. Greece’s return to the markets, and its economic recovery, are likely to be a bumpy and slow -- especially if it continues to delay key reforms.

Greece’s growth appears to have stabilized at a low rate; some take that as a sign of normalization. The problem with this optimism is that it’s not clear where the future drivers of growth will come from. Household consumption has recovered somewhat, but at an average 0.65 percent growth in 2017, it remains weak by any measure. And with further tax increases and pension cuts planned, it’s hard to see any scope for further acceleration.

No news isn’t necessarily good news when it comes to Greece. Quietly, the government has backtracked on important reform efforts such as privatizing key industries, where it continues to miss its targets. In Athens I drive by the abandoned Ellinikon airport regularly, and its state is a sore reminder of how Greece has long failed to capitalize on its assets. A stalled recovery will mean no real boost in revenues to fund investments. Its debt dynamics will also continue to result in a higher cost of financing.

No wonder, then, that the biggest game-changer for Greece, investment spending, is the longest way off. Investment as a share of gross domestic product has more than halved to 11 percent in 2017 from 27 percent in 2007 (which was higher than Germany’s 21 percent and France’s 24 percent). Most of the funds for investment come from the EU at present; an ever-changing tax environment and weakness in domestic demand are, in part, dampening outside investor appetite.

Meanwhile, lack of clarity over debt relief will ultimately mean a costly re-entry into financial markets. Greece’s key borrowing costs will be a function of what kind of debt relief Greece receives from its creditors. The prospects don’t look promising. Europe is unlikely to agree to significant debt forgiveness as it will want to ensure that Greece’s over-borrowing does not repeat elsewhere in the euro zone. With a 176 percent debt-to-GDP ratio, and little prospects for growth acceleration or healthy capital inflows, investing in Greece is not for the faint of heart.

The recent effort to reduce Greece’s non-performing loans is a silver lining to this picture. At the Bank of Greece’s recent annual general meeting, there was discussion of forming a “bad bank” to consolidate bad loans. Such a model has worked elsewhere, including in Spain, where despite its losses, Sareb bank was instrumental in reducing bad loans and stabilizing its financial sector. A bad bank in Greece could boost banks’ capacity to provide liquidity through renewed lending, which would be crucial for investment -- particularly for Greece’s small businesses, which account for 90 percent of non-financial employment, according to the European Commission.

Despite progress with its primary fiscal targets and NPLs, rent-seeking and clientelism are still a feature of policymaking in Greece. Recent legislation by the Syriza government, for example, abolishes a 24-month limit to the renewal of short-term state labor contracts in favor of more permanent ones. Ultimately this type of legislation is problematic for growth, because a bloated public sector could continue to come at the expense of investments such as in infrastructure that Greece needs to boost potential growth.

Domestic overregulation and corruption have not been scaled back either. In fact, Greece’s shadow economy, the economic activity that is hidden from authorities in order to avoid tax and bureaucracy, has climbed to 27 percent of its GDP, according to recent estimates by the International Monetary Fund.

Greece is awash in red tape; the sheer quantity of paperwork required to comply with regulations takes up as much as 71 percent of the time and money borne by Greece’s key tourism sector, according to the Organization for Economic Cooperation and Development. Crucially, this deters much-needed foreign direct investment and means high value-added sectors, such as telecommunications, are starved of inward investment and significant knowledge transfer.

The leader of the New Democracy opposition party, Kyriakos Mitsotakis, has said that he wants to help Greece’s supply side by restructuring NPLs, cutting corporate taxes, and reducing bureaucracy for foreign investors. He has also declared that he has few qualms about having a leaner state in favor of boosting investment and jobs. That kind of governing program would be a welcome development. And yet the prospect of another general election next year, with a new set of policy promises and continued sclerosis in the public sector, could mean more uncertainty and compromised growth.

To change its fortunes, Greece needs to diversify away from debt-fueled consumption. The recent strength in imports is worrying in this respect. Promoting manufacturing and other high value added sectors should be treated as a matter of urgency. Experience has shown that reigniting bank lending is crucial for this, making Greece’s “bad bank” important. Establishing a one-stop shop for public contracting, licensing, registering and presenting tenders would also clear the way for Greece’s animal spirits.

When Greece exits its bailout in a few months it will have to contend with faltering growth, rebuilding its banking system, and invigorating a reform agenda that uproots its public sector for the sake of a more competitive economy, driven by investment and trade rather than government spending and EU handouts. In the absence of this, it will face unfavorable financing conditions and perhaps even worse, another lost decade.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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