For Greece, Clouds Linger on the Horizon

by on 25 January 2019

Highlights

  • Greece’s economy is much more stable than it was five years ago, but ongoing political turbulence will weaken Athens’ commitment to economic reform this year. 
  • Domestic and foreign factors will moderate Greece’s economic growth, making it hard for the country to reduce its massive debt burden. 
  • The government’s failure to immediately implement economic reforms could delay the introduction of debt relief measures that Greece’s creditors promised Athens last year. 
  • Greek banks will remain vulnerable to capital outflows, as they are still dealing with high numbers of nonperforming loans. 

In many ways, 2018 marked a turning point for Greece. Its economy grew by around 2 percent – its strongest expansion in a decade. And for the first time since 2011, the unemployment rate among its active population dipped below 20 percent. More importantly, Greece’s third bailout program concluded in 2018, meaning that the country’s creditors will no longer keep Athens on such a tight leash (although they will retain some degree of oversight). It was also an important year in terms of foreign relations, as Greece finally reached a name deal with Macedonia in a bid to end decades of bitter relations. But 2019, however, will be a difficult year for Greece, as its economy still faces significant hurdles amid increasing turbulence in its domestic political scene. Greece might no longer represent an immediate threat to the continuity of the eurozone, but the risk of financial contagion, especially to other Mediterranean economies, is never far away. 

In many ways, 2018 marked a turning point for Greece. Its economy grew by around 2 percent – its strongest expansion in a decade. And for the first time since 2011, the unemployment rate among its active population dipped below 20 percent. More importantly, Greece’s third bailout program concluded in 2018, meaning that the country’s creditors will no longer keep Athens on such a tight leash (although they will retain some degree of oversight). It was also an important year in terms of foreign relations, as Greece finally reached a name deal with Macedonia in a bid to end decades of bitter relations. But 2019, however, will be a difficult year for Greece, as its economy still faces significant hurdles amid increasing turbulence in its domestic political scene. Greece might no longer represent an immediate threat to the continuity of the eurozone, but the risk of financial contagion, especially to other Mediterranean economies, is never far away. 

Macedonia’s parliament approved the name deal in early January, and now it’s Greece’s turn. The Hellenic Parliament is currently debating the agreement with an eye toward a Jan. 24 vote on the deal. But because it controls just 145 of the 300 seats in the legislature, Syriza will need opposition support to approve the motion. Greece’s main opposition party, the conservative New Democracy, has already said it will not back the Macedonia deal, although enough members of parliament from smaller parties have indicated they would to allow Syriza to just cross the finish line.

The Macedonia deal will contribute to stability in the Western Balkans, but it has also left Greece with a minority government. Greece must hold a general election by October, but an early vote is possible given that Syriza will struggle to pass legislation now that it no longer has a parliamentary majority. As a result, the government will find it difficult to implement meaningful structural reforms that would make the Greek economy more competitive, while the ruling party will also feel tempted to reverse some recent austerity measures to increase its popularity before the vote. As it is, current opinion polls give New Democracy the advantage with around 32 to 37 percent support, followed by Syriza at 25 to 27 percent. 

Another factor could foment political instability in Greece: imminent changes to the electoral system. Under the current system, the party that wins the most votes receives a bonus of 50 seats — a significant boost in a parliament that has only 300. While the top party in this year’s election will benefit from the mechanism, Syriza has passed legislation eliminating it for all subsequent elections. Accordingly, if no party manages to form a government in the coming general election — a real possibility despite the 50 extra seats — Greeks could return to the polls for a second vote, this time under the new electoral system. But given Greece’s fragmented political environment, parties would still struggle to cobble together a governing coalition in the likely event that no one wins a majority.

Overcoming a Fiscal Dilemma

Greece’s increasing political turbulence is occurring just as the country hopes to leave its economic woes behind. Under pressure from lenders, Greece has maintained a large primary budget surplus (that is, before the costs of servicing its debt) for the past three years. As part of its agreement with its creditors, Athens is required to keep a primary budget surplus of 3.5 percent of gross domestic product every year until 2022. The agreement is meant to boost market confidence regarding the sustainability of Greece’s economy and of Athens’ commitment to fiscal responsibility, but the large surplus also harms the real economy. That’s because the government is essentially achieving it by burdening the population with a massive tax bill (thereby encouraging under-the-table economic activities) and cutting public spending (thereby weakening GDP growth). 

This is a problem that Greece has faced for years, as authorities tend to focus too much on taxation and too little on the structural reforms needed to increase economic competitiveness. And given that 2019 is an election year, Athens is unlikely to introduce any reforms that could irritate voters, opting instead for more expensive promises likely to win over a disenchanted electorate. Last month, for example, the Greek government introduced a one-off Christmas bonus for pensioners, and it is likely to dole out similar goodies this year as well. Those kinds of handouts provide temporary liquidity for the economy, but they do not promote long-term growth. To complicate matters further, a Greek court recently ruled that austerity-induced pension cuts were unconstitutional, meaning that Athens could be on the hook for compensation for thousands of retirees. 

At the same time, the government has moved to postpone privatization of utility services such as water and sewerage, plus tollways, an oil company and the remaining stake in the Athens airport, until after the election so that the measures do not alienate Syriza supporters.

Greece’s banks, too, present a mixed picture. The European Central Bank’s stress tests last year revealed no capital shortfalls in any of the four “systemic” Greek lenders, which are central to the country’s banking system. But as a consequence of the country’s long crisis, Greek banks are still dealing with large amounts of nonperforming loans. Those loans represent roughly 40 percent of total loans in Greek banks, the highest rate in the eurozone. The government is investigating several options to address the issue, including plans to allow banks to sell the nonperforming loans to investors with a state guarantee, as well as proposals to create a special institution to purchase the loans, but political squabbles are likely to delay the implementation of any plans. Meanwhile, unfavorable credit conditions are also depriving the economy of an important resource for growth. In some cases, this is because businesses are reluctant to obtain bank loans; in others, it is because years of economic crisis have left many Greek households and companies unable to qualify for credit.

Navigating International Waters

Greece’s economic recovery coincides with growing international economic uncertainty. The country’s main export destinations in the eurozone, Germany and Italy, are showing signs of a slowdown, while its main trade partner outside the eurozone, Turkey, remains economically fragile. Additionally, issues ranging from Brexit to Italy’s fiscal policies to the trade disputes between the United States and China are all contributing to economic uncertainty in Europe. A completed Brexit will create an additional problem for Greece. The country is a top destination for British tourists, but a weaker pound or growing uncertainty about the future of the British economy (especially in the case of a no-deal Brexit) could reduce the number of visitors.

Domestic and international uncertainty could also increase the costs for Greece to borrow money from debt markets. Greece’s high bond yields remain susceptible to both fluctuations in international markets and skepticism about the government’s continued commitment to reform. The end of the European Central Bank’s bond-buying program will also test Greece, which could face higher borrowing costs now that the institution is no longer purchasing bonds from eurozone countries. On a positive note for Athens, it does not have to issue new debt in the coming months if it does not want to. With around 25 billion euros in its coffers, Greece should have enough money to cover its debt repayments in 2019 and 2020. However, the government said last month that it wanted to issue new debt this year to test the market reaction and to continue with the process of “normalization” after a decade of crisis.

Political and Economic Risk on the Rise

The Greek economy has grown stable enough that it no longer represents an immediate threat to the survival of the eurozone. Nevertheless, significant issues loom, including extreme levels of public debt, massive amounts of nonperforming loans in banks, high unemployment levels and weak public investment. Moreover, Greece’s economy is also dogged by other issues, such as a shrinking and aging population, as well as elevated levels of emigration, all of which will undermine the country’s growth potential over the long term. The end of the bailout program in 2018 and the creditors’ promises to alleviate Greece’s debt burden have brought some calm to the country after a difficult decade. But because Greece still faces an uphill battle to generate sustainable economic growth, it will continue to be one of the weak links in the eurozone. 

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