Greece in Dire Need of Public Sector Reform, Investment

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 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 is not clear where the future drivers of growth will come from. Household consumption has recovered somewhat, but at an average 0.65% 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, Bloomberg reported.

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. 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% in 2017 from 27% in 2007 (which was higher than Germany’s 21% and France’s 24%). 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.

  Debt Relief a Problem

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 eurozone. With a 176% 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; and particularly for Greece’s small businesses, which account for 90% 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.