Mission Concluding Statement 

Greece: Staff Concluding Statement of the 2023 Article IV Consultation Mission

November 14, 2023

Greece’s economic outlook has improved notably with real GDP expanding beyond its pre-pandemic trend level. The public debt-to-GDP ratio has declined below its pre-pandemic level with debt financing risks contained in the medium term due to the favorable debt structure. The banking system has remained resilient with improving balance sheets. However, the economy is facing macro-financial challenges amid the significant monetary policy tightening, persistent core inflation, and rising real estate prices. Structural imbalances arising from low household savings and still low level of investment as well as a structural shift from climate change are weighing on medium-term growth prospects. Achieving higher and greener growth and ensuring fiscal sustainability while safeguarding financial stability requires the right policy mix aimed at continuingfiscal consolidationin a growth-friendly manner, strengthening financial system resilience, and accelerating pro-growth reforms .

Robust Recovery amid High Inflation

1. Economic activity has remained robust in 2023. Real GDP continued to expand at a solid pace in the first half of 2023 by 2½ percent (seasonally adjusted annualized rate). Private consumption was buoyant on the back of increasing real wages and a gradual decline in pandemic-induced excess household savings. Fixed investment growth remained robust driven by the ongoing Next Generation EU (NGEU)-funded investment. High frequency data suggests that overall economic momentum remained robust in the third quarter despite a series of natural disasters (heatwaves, wildfires, and floods). The unemployment rate declined to 10 percent in September, a decade low. Headline and core inflation decelerated to 3.8 and 3.6 percent (y/y), respectively, in October due to normalizing energy prices and base effects, but remain high amid the tightening labor market. Residential real estate prices have increased by more than 50 percent since the trough in 2017 but still remain below their pre-Global Financial Crisis levels.

2. Much-needed continued progress in structural reforms has improved investment and productivity growth. Good progress has been made in the digital transformation of the economy, including the integration of various government services. Labor market reforms such as the modernization of labor legislations and of public employment services have facilitated labor market adjustment since the pandemic. The enhanced competition authority’s actions have contributed to increasing market competition. On the back of this progress, Greece’s potential growth is estimated to have turned positive in 2022, for the first time since the sovereign debt crisis.

3.The banking system has remained resilient underpinned by policy support and balance sheet strengthening.Asset quality further improved, with the NPL ratio declining below 5 percent in 2023Q2 in systemically important banks, supported by continued securitizations under the Hercules program. The lower NPL ratio, coupled with higher net interest margins, has contributed to a strong rebound in bank profits, bolstering capital adequacy. Amid continued deposit inflows on the back of strong growth, the banking system has also maintained sizable liquidity buffers despite substantial repayments of ECB’s targeted long-term refinancing operations (TLTRO).

4.Real GDP is projected to grow robustly by 2.5 and 2.0 percent in 2023 and 2024, respectively, before moderating toward the medium term.Private consumption will be supported by positive real wage growth, while investment activity will continue to expand with the implementation of the National Recovery and Resilience Plan (NRRP). However, against the backdrop of demographic headwinds, the expiration of NGEU funding in 2026, and still low potential growth, GDP growth is forecast to moderate to about 1¼ percent in the medium term. Headline inflation is projected to reach 2 percent by end-2025 as pressures on core inflation will dissipate only gradually despite continued normalization of food and fuel prices.

5.Risks are more balanced for growth but tilted upward for inflation.A potential escalation of Russia’s war in Ukraine and the conflict in the Middle East could disrupt trade and trigger renewed energy and food price pressures and undermine confidence. Higher-than-expected persistence in euro area inflation and higher-for-longer interest rates would weigh on regional and domestic demand. More frequent extreme climate events could disrupt tourism and overall activities. In contrast, acceleration of ambitious structural reforms, in tandem with stronger-than-expected market reactions to the investment grade upgrade, could further improve growth prospects. Inflation could remain high resulting from weather-related shocks as well as domestic pressures from recent and expected wage and pension increases.

Growth-friendly Fiscal Consolidation

6.Growth-friendly fiscal consolidation can further strengthen public debt sustainability while supporting inclusive and green growth.With still very high debt, continued fiscal consolidation with the primary surplus increasing to 2.1 percent of GDP in 2024, up from projected 1.1 percent in 2023, would help further reduce the public debt-to-GDP ratio, while limiting additional pressure on inflation. Amid strong revenue growth, maintaining a primary surplus of about 2 percent of GDP in the medium term would further improve public debt sustainability, while providing additional space for domestically financed public investment and critical social spending. This would contribute to narrowing Greece’s large investment gap while keeping the public debt-to-GDP ratio firmly on a declining path.

7.Containing spending pressures is critical to maintain fiscal space for crucial social and capital expenditure.Spending pressures should be resisted in non-discretionary areas such as public sector wages and pensions, which are still at elevated levels in cross-country comparison. In contrast, investment needs are large, including for green and digital transition. Critical social spending such as targeted social transfers, healthcare, and education should be protected or expanded for more inclusive growth. Ongoing efforts to strengthen the social safety net, including via a single portal for benefits, will better protect the vulnerable.

8.Advancing fiscal structural reforms would enhance fiscal governance and improve the efficiency of fiscal policy.The authorities’ ongoing efforts to address tax evasion, including targeted reforms for the self-employed, are important and welcome. Continued efforts to promote digital transactions and rationalize tax incentives would improve the efficiency of revenue collection. Given the planned large investment under the NRRP, public investment management should be further strengthened.

Safeguarding Financial Stability

9.The monitoringand managementof risks associated with interest rate, liquidity and funding, and credit exposures should be strengthened, underpinned by a strong bank capital base.In an environment of higher-for-longer interest rates, banks’ interest-rate risk and the appropriateness of their risk management strategies need to be closely monitored.Supervisors should monitor and stress-test bank funding and liquidity conditions as the replacement of TLTRO with more expensive market funding may pose challenges. Proactive management of credit risks is warranted to ensure that banks maintain comfortable capital buffers. Supervisors should also ensure that banks adapt their business models to ensure sustainable profitability, while temporarily elevated profits should be used to build capital buffers and restore quality of capital.

10.The macroprudential policy toolkit should befurtherstrengthened and more actively used to enhance resilience of the banking sector.Complementing organic bank capital accumulation and issuances, the activation of a positive neutral countercyclical capital buffer would help guard banks against potential systemic shocks. Borrower-based measures for mortgage loan borrowers—such as ceilings on loan-to-value ratio and caps on debt service-to-income ratio—would enhance household resilience and consequently contain vulnerabilities in the banking system against the potential housing boom.

Implementing Reforms for Higher and Greener Growth

11. Comprehensive reforms to address structural supply impediments would lift medium-term growth prospects while alleviating inflationary pressure.

• Accelerating regulatory reforms to support business.Regulations should be rationalized to facilitate firm entry and exit as well as job transitions in all sectors, which will help improve business dynamism and productivity. The authorities’ current efforts in digitalization could sharpen the focus in serving small- and medium-sized enterprises to maximize the economic and employment benefits.
• Ensuring higher labor participation and a better skilled workforce. Scaling up the lifelong learning system, including on digital and green skills, could reduce skill shortages and help address the bottlenecks for youth and women employment. More targeted policy support, such as improving the availability and affordability of childcare and reducing the marginal income tax of second earners, would help raise female labor force participation.
• Strengthening judicial system reforms and out-of-court proceedings. Further progress to accelerate debt resolution through restructurings under the out-of-court workout platform and through the formal proceedings under the new insolvency code would contribute to improving business dynamism. It will help increase financial sector resilience as well by further reducing bank NPLs and distressed debt recovered by credit servicers.

12.Concerted efforts are needed to achieve the authorities’ ambitious climate goals and green transition.Given the dominance of fossil fuels in energy, a strong implementation of the authorities’ policy framework for renewables, including measures to streamline the licensing framework for new investment and better integrate renewables in the electricity grid, would accelerate the progress while boosting energy security. The authorities should consider raising the carbon tax (including excise and feebates) in non-ETS sectors such as transport to further incentivize rapid and efficient green transition as energy price continues to normalize.

In closing, the mission would like to thank the Greek authorities for their kind hospitality and for the open and productive discussions.