Mission Concluding Statement 

Greece: Staff Concluding Statement of the Second Post-Program Monitoring Mission

October 2, 2020

Washington, DC: The COVID-19 shock has interrupted Greece’s modest economic recovery. GDP contracted by 7.9 percent in the first half of 2020, a steep drop from 1.9 percent growth in 2019, as the lockdown weighed heavily on domestic demand and tourism. The unemployment rate has increased noticeably since March, despite significant employment support measures. The primary deficit for 2020 is projected at 6¾ percent, due to both lower economic activity and the government’s stimulus measures.

The government’s swift response to the pandemic is commendable. Timely implementation of travel restrictions, a ban on public events, and other social distancing measures helped contain the initial outbreak. Compared to European peers, the per-capita caseload and the fatality rate remain low, but the recent increase in reported infections merits caution. The authorities’ economic support package is sizable, timely, and appropriately composed mostly of temporary on-budget measures targeted to hard-hit households and businesses. Extraordinary European Union (EU) and European Central Bank (ECB) responses have allowed Greece to undertake needed fiscal support measures, while Single Supervisory Mechanism (SSM) accommodation is cushioning the pandemic’s immediate impact on banks.

The economy is expected to contract by 9.5 percent in 2020, before gradually recovering over the medium term. Greece’s heavy reliance on tourism makes it particularly vulnerable. A rebound is expected in 2021–22 to reach an average 5 percent growth annually, backed by the Next Generation EU (NGEU) funds and a recovery in foreign demand. As the NGEU gradually phases out, growth is projected to return to its long-term potential rate of 1 percent.

Substantial uncertainties and downside risks continue to cloud the outlook. A prolonged pandemic accompanied by a permanent slump in global tourism would significantly worsen the outlook, while an early vaccine discovery and its swift mass distribution could help boost the rebound. Contingent government liabilities could materialize from new and existing state guarantees, potential additional support to banks and firms in a downside scenario, and ongoing court cases that challenge key program reforms. A new wave of Non-Performing Exposures (NPEs) could emerge in the banking sector once government support measures and supervisory accommodation are unwound.

Greece’s medium-term public debt repayment capacity remains adequate. This reflects the manageable gross financing needs under the baseline, owing in part to increased support from the EU and the ECB, and a substantial precautionary cash buffer. Following a spike in 2020, Greece’s public debt is projected to decline gradually over the medium-term, albeit remaining at higher levels than previously forecast. Staff’s assessment of Greece’s long-term debt sustainability remains unchanged and will be updated during the next Article IV Consultation. The sovereign’s repayment capacity could be compromised if significant downside risks materialize, which would require a strong procyclical fiscal adjustment and/or further support from European partners.

Maintaining accommodation and making good use of fiscal space should be the near-term priority. Given the large output gap and in order to minimize the risk that the pandemic causes permanent economic damage, the authorities should avoid a sharp fiscal contraction in 2021 and target a primary deficit of at least 2 percent of GDP. Fiscal support should be frontloaded ahead of the release of NGEU resources (expected around the middle of 2021) and the fiscal policy mix should be improved by prioritizing health care spending, addressing coverage gaps in the Social Solidarity Income scheme, and expanding opportunities for reskilling the labor force. Public investment execution should be enhanced to boost the effectiveness of NGEU financing. As the impact of COVID-19 dissipates over the medium-term, fiscal support to firms should increasingly be based on viability assessments.

A broad range of support measures will cushion and delay the pandemic’s impact on banks, but a comprehensive strategy to address long-standing weaknesses remains a priority. In addition to the ECB’s monetary and supervisory accommodation, interest and mortgage payment subsidies introduced by the Greek authorities will help support both borrowers and banks in 2020-21. While the provision of state guarantees on bank securitizations (project Hercules) is welcome and progressing, it is not a comprehensive solution as it leaves a significant amount of NPEs on bank balance sheets and the weak quality of bank capital unaddressed. In this context, the Bank of Greece’s proposal to establish an Asset Management Company could be an important addition to the toolkit. The pandemic could add further strain to the banking sector and could undermine the improvement in firms’ balance sheets that occurred during the past decade, requiring effective tools to resolve corporate and household debt distress. In this regard, the authorities’ new draft bankruptcy code is a promising and timely initiative, although implementation to facilitate restructuring and minimize moral hazard will be critical to its effectiveness.

Structural reforms are ongoing and should be accelerated in areas that can be credibly implemented. The goals and ambition of the draft national growth strategy are laudable and could help boost productivity and promote innovation. The government’s push for simplification of business processes and digitization reform also deserves support. Additional structural reforms that can be delivered in the current environment should be accelerated, such as liberalizing product markets, facilitating female labor participation (through access to childcare and early childhood education, for example), and enhancing active labor market policies.