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The Inaugural Lecture of
The Behrakis Family Endowed Lecture Series
within
The Constantine G. Karamanlis Chair in
Hellenic and European Studies
From Grexit to Grecovery?
given by
George A. Provopoulos
Former Governor, Bank of Greece
5 October 2015
The Fletcher School
Introduction
I’d like to begin by saying that it is a pleasure to be with you today.
What I would like to do is to share some thoughts -- those of someone who had been an
active participant in crisis management and crisis resolution -- on the origins and lessons of
the Greek financial crisis.
That crisis has by no means been an ordinary crisis. By any yardstick of comparison, the
crisis has been an extraordinary one. Let me give you a few examples.
In terms of the effects on output, since the end of the 19th century only one other advanced
economy, namely the United States during the Great Depression of the 1930s, has
undergone a comparable contraction in national output.
During the 1930s, U.S. output fell by 28 per cent; Greece has undergone a contraction of
about the same magnitude.
The Great Depression in the United States lasted for four years. In the case of Greece,
output has declined in seven of the last eight years. The single exception was last year
when output grew only marginally. This year output growth is again in negative territory.
During the Great Depression, the U.S. unemployment rate peaked at 25 per cent in 1933
before turning downward the following year. In Greece, the unemployment rate has
remained near 26 per cent for three consecutive years.
The crisis in Greece spread to other euro-area countries, including Ireland, Italy, Portugal
and Spain. It also threatened to wreck Europe’s single currency, the euro, the creation of
which took decades to bring about.
What happened? How could a country with only about 2 ½ per cent of the euro-area’s GDP
bring Europe’s single currency to the edge of a break-up? Why has Greece’s economic
contraction been so deep and so prolonged? What lessons have we learned about the
requirements of a viable single-currency area? How has the euro’s institutional structure
changed as a result of the crisis?
The Onset of the First Crisis
To address these questions, I first want to take you back to the pre-crisis period, the period
during which the seeds of the Greek crisis were being sown.
On January 1, 2001, Greece became the 12th country to join the euro area. Entry into the
euro area was expected to provide a new, improved economic and financial regime for
Greece.
During the 1980s and 1990s, the country had suffered from very-low growth. Inflation, the
unemployment rate, and interest rates were all in the double digits.
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Membership in the euro club was expected to change that performance. And, indeed, from
2001 to 2008 it appeared that the initial expectations were being fulfilled. Inflation averaged
in the low single digits. Real growth averaged almost 4 per cent per year. Interest rate
spreads between Greek and German 10-year sovereign bonds fell from over 600 basis
points in the late-1990s to under 50 basis points.
There was, however, a major problem that went unaddressed: during the period from 2001
until 2009, unsustainable fiscal and external balances were building.
Fiscal deficits averaged more than 5 per cent of GDP, peaking at over 15 per cent in 2009.
The current-account deficit swelled, reaching 15 per cent of GDP in 2008.
Underlying the external deficits was a huge deterioration in competitiveness, amounting to
30 per cent (in terms of unit labor costs) during the period from 2001 to 2009.
A major crisis was an accident waiting to happen. All that was needed was a trigger
mechanism. That mechanism was a succession of fiscal surprises in 2009, under which
the announced fiscal deficits in Greece kept getting larger month-by-month -- far surpassing
expectations -- especially after the October national elections, which led to in a new political
administration.
As a result, spreads started an upward climb. By late-April 2010 and early-May, the 10-year
spread had reached 1,000 basis points. The euro-honeymoon effect was over. Greece
suddenly found itself in the midst of a severe sovereign debt crisis.
That crisis spilled-over to the banking system, creating a second storm front. In contrast, in
most other euro-area countries the crises originated in the banking sector and spilled-over
to the sovereign sector.
Response to the First Crisis
And so, in May 2010 Greece became the first industrial-country client of the IMF since the
late-1970s. The remaining members of the so-called troika were the European Central
Bank and the European Commission.
The May 2010 adjustment program amounted to € 110 billion. It consisted of 4 main pillars:
o
Fiscal adjustment
o
Structural reforms of labour and product markets
o
Effective measures to combat tax evasion and broaden the tax base
o
Privatizations
The government placed emphasis on the first pillar and especially on tax-rate increases.
The other pillars were -- at best -- only partially implemented. Experience, however, shows
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that programmes aiming for fiscal consolidation that are based on spending cuts lead to
smaller economic contractions than those based on tax increases.
For that reason, I had been calling for the opposite: 60 per cent spending cuts and 40 per
cent tax increases.
The particular mix that was adopted had several negative consequences. It reduced, for
instance,
investment.
the incentive of companies to invest by reducing the after-tax return on
The tax increases also reduced after-tax income, restraining private
consumption. As a consequence, the emphasis on the tax increases made the recession
much deeper than initially expected.
A contracting GDP, however, shrank the denominator in the debt-to-GDP ratio. As a result,
the debt dynamics became more severe, and the crisis became self-reinforcing.
A second adjustment program became soon necessary. It was agreed upon in the fall of
2011 and amounted to € 130 billion.
Nevertheless, during this time, Greece made
important progress in addressing its fiscal and external imbalances. Let me give you some
numerical examples.
From 2009 to 2014:
o
Fiscal consolidation was striking. The general government deficit fell to 3.6 per cent
of GDP in 2014 from 16% in 2009. The primary balance in 2013 was in surplus to
the tune of 1.9% of GDP and almost balanced in 2014. The structural deficit has
shrunk from 18% of GDP in 2009 to almost balanced in 2013.
o
Significant external adjustment had also been achieved. Between 2009 and 2014,
cost competitiveness improved by about 30 per cent, and the current account swung
into a small surplus.
The degree of fiscal and external adjustment led to a sharp fall in spreads.
These
developments facilitated the return of the Greek sovereign to global capital markets in mid2014.
Restructuring of the Banking Sector
I want to now turn to the situation in the banking sector. As I mentioned, in Greece the
banking sector was a victim of the sovereign crisis.
Prior to the outbreak of the crisis, the banking sector had sound fundamentals. For
example:
o
The average capital adequacy ratio was 12 per cent.
o
The aggregate loan-to-deposit ratio was only 104 per cent.
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Banks held essentially no toxic assets of the kind that triggered the 2007-08 global financial
crisis.
The banks were also highly competitive by international standards. They had expanded
into the South Eastern Europe (SEE), becoming major players in the Balkans.
With the outbreak of the sovereign crisis, Greek banks:
o
were hit by a series of downgrades
o
experienced substantial deposit withdrawals, €88 billion or (-37 per cent) in the
period June 2009 to June 2012
o
were cut-off from money and capital markets. At the same time that Greek banks
could not borrow, they had to pay back maturing debts (of more than €40 billion).
In these circumstances, the Bank of Greece stepped in, providing banks with access to
Eurosystem funding. Thus the liquidity problem was adequately addressed.
But at the same time Greek banks experienced significant capital losses. These losses
stemmed from:
o
The deep restructuring of sovereign debt, which took place in early-2012. Banks
suffered a €38 billion loss.
o
The significant increase in the cost of risk, in light of the deepening economic
contraction (non performing loans rose from 5 per cent in end-2008 to 24.5 per cent
in 2012).
Domestic banks responded by deleveraging. Cedit to the private sector contracted by 14
per cent between June 2010 - July 2014. But deleveraging itself contributed to economic
contraction and created negative feedback loops between the financial and real sectors.
What started out as liquidity problems for the banks, soon turned into solvency problems.
The stability of the banking system was at risk, with possible implications beyond Greece.
To deal with these problems, which were occurring simultaneously amid a contracting
economy, Bank of Greece needed to:
1. provide short-term emergency funding to the banks, while ensuring that the banks’
reliance on such funding would be subsequently sharply reduced;
2. consolidate in depth the banking system through mergers and closures, without
triggering a full-scale banking crisis in Greece and the Balkans (where Greek banks
have a large presence);
3. recapitalize the viable banks with public funds, while taking measures to ensure that
banks would again be in a position to raise private capital.
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During the years 2011 to 2014, a series of far reaching initiatives were completed to
safeguard financial stability. The Bank of Greece took the leading role in devising and
implementing most of these measures. The measures included:
First, an enhanced supervision framework: namely, improved prudential supervision, and
an upgraded onsite and offsite supervision of banks.
Second, creation of a comprehensive resolution framework, including the introduction of
new legislation involving state-of-the-art resolution tools and procedures. This framework
was subsequently followed by banking authorities in other European countries.
Third, formulation and implementation of a comprehensive viability assessment framework.
The framework was used to define eligibility for state aid.
Fourth, implementation of a new recapitalization framework that allowed for state aid
support, while providing incentives for private sector management and control of banks.
Two recapitalizations were implemented in 2013 and 2014, respectively. In 2013, the
recapitalization was completed using about € 25 billion in state aid and € 2.5 billion in
private-sector funds.
Finally, resolution of 13 banks with full depositor protection. One of the resolved banks was
Agricultural Bank, the largest bank ever resolved in Europe.
The results of these efforts were, I believe, impressive.
First, the number of banks had been reduced from about 30 to 4 systemic banks and just a
few smaller ones. By the end of 2014 the four systemic banks had average common equity
core tier 1 ratios above 12 per cent.
Second, during the course of 2014, banks had re-entered the international financial
markets.
Third, between mid-2012 and the end of 2014 deposits rose by about 10 per cent.
Fourth, by the end of 2014, emergency funding provided by the Bank of Greece to the
commercial banks -- which had at one time reached € 140 billion -- had been completely
eliminated.
Finally, it is important that not a single depositor suffered a loss.
The restructuring of the banking system was accomplished at a cost that was much less
than had been planned for. The total cost of recapitalizing and resolving banks amounted to
€ 41 billion, compared with the € 50 billion set aside for that purpose. The difference was a
direct saving for Greece’s taxpayers.
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The Second Crisis
Let me now turn to the onset of the second stage of the crisis, that began in late-2014.
The trigger mechanisms were the inability of the government to reach agreement with its
official creditors -- the IMF, the ECB and the European Commission -- on a program review
during the second half of 2014, and concerns that the country was headed to national
elections, concerns which materialized in January of this year.
Problems that Greece thought it had relegated to the past had returned. It was déjà vu all
over again.
Economic sentiment started declining in mid-2014. Spreads rose, deposit withdrawals
resumed, and both the sovereign and the banks were once again cut off from the
international capital markets.
Under a new government, the country found itself in protracted negotiations for a new, third,
bailout program, further increasing uncertainty.
The announcement of a referendum and the expiration of the second adjustment
programme led to a bank holiday (28 June) and the imposition of capital controls, further
undermining economic sentiment.
Finally, on 19 August, the European Commission signed a Memorandum of Understanding
(MoU) with Greece, accompanied by a third economic adjustment programme.
This paves the way for mobilizing up to €86 billion in financial assistance to Greece over
three years (2015-2018) under a third adjustment program.
The new program includes several key elements.
First, it includes policies for sustainable public finances:
o
Primary surplus targets (percent of GDP): -0.25 in 2015; 0.5 in 2016; 1.75 in 2017
and 3.5 in 2018 and beyond.
o
Sizeable revenue measures by impoving the tax and social security payments
collection and establishing an autonomous revenue agency.
o
Reform the VAT, simplify income tax and eliminate exemptions.
o
Contain expenditures through reforms in the health care sector.
o
Further reform the pension system; strong disincentives for early retirement.
Second, it emphasizes the need to maintain financial stability
o
Buffer of €25bn for potential bank recapitalization needs.
o
The European Central Bank launched in August 2015 an Asset Quality Review
(AQR) and stress-test exercise for the four systemic Greek banks to determine
potential capital needs over the June 2015 – December 2017 period.
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o
The timeline of the exercise is extremely tight. The objective is to complete the
recapitalization by end-December 2015. As made clear in a Eurogroup Statement,
there will be no haircut for depositors.
o
There is also an emphasis on NPL management.
Euro area – the response to the crisis
I now want to turn to the euro area’s response to crisis starting from ECB actions:
The ECB has taken a number of significant actions since the onset of the financial crisis in
2008.
o
It has brought interest rates at historically-low levels.
o
The ECB has also satisfied the liquidity needs of banks in full, while expanding its
collateral framework.
o
The Outright Monetary Transactions (OMT) essentially eliminated tail risks of a euro
break-up.
o
Furthermore, forward guidance was provided by the Governing Council, which
affirmed that policy rates will be kept at present or lower levels for an extended
period of time.
o
The Expanded Asset Purchase Programme (APP), initiated in March 2015,
addresses the risks of a too prolonged period of low inflation. It consists of: a third
covered bond purchase programme, an asset-backed securities purchase
programme and a public sector purchase programme.
Economic governance
o
The institutional framework of the Economic and Monetary Union is unique.
It
combines a single monetary policy conducted vis-à-vis a number of decentralized
economic policies, which remain within the remit of individual member states, albeit
subject to some degree of coordination.
o
Essentially it is a monetary union that lacks a genuine political, fiscal and economic
union. This architecture proved to be insufficient. Although the EMU framework
provided a solid setting for the conduct of monetary policy, the co-ordination of fiscal
and other economic policies has been lagging.
o
Much has already been done to improve economic governance in the EMU via the
strengthening of surveillance of national policies, and enhancing the economic
policy coordination. Such work has progressed along three major pillars: the first is
the “six pack”, the second is the “fiscal compact” and the third is the “two pack”. In
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combination, these pillars provide stronger macroeconomic surveillance, identifying
imbalances earlier, monitoring them effectively and ensuring their timely correction.
o
Other areas of institutional improvement comprised the establishment of financial
backstops. In this context, the European Systemic Risk Board was established in
2011 to exercise macro-prudential oversight of the EU-wide financial system. In
addition, the EFSF was established as a temporary financial backstop in 2011, while
its successor, the ESM, provides a permanent facility for responding to new
requests for financial assistance by euro-area member states.
Banking union
o
Another weakness of the EMU was that the Maastricht Treaty failed to account for
the strong inter-connections among markets and sovereigns. The negative
sovereign-financial feedback loop was largely underestimated.
When the crisis
erupted, governments had to step in to recapitalize failing banks, with substantial
fiscal repercussions. So, a Banking Union is being designed to break those negative
feedback loops. The Banking Union is the most important and far-reaching reform
in the European Union, since the creation of the euro.
o
The envisaged banking union consists of a single supervisor, a single resolution
mechanism and a harmonized framework for national deposit guarantee schemes
and is expected to create an integrated, efficient, well capitalized and stable
European banking sector.
o
Single Supervisory Mechanism (SSM). The SSM became operational in November
2014. The ECB directly supervises around 130 banking groups-- Almost 85 per
cent of total banking assets in the euro area are covered.
o
Single Resolution Mechanism (SRM). The SRM ensures the efficient resolution of
failing banks with minimal costs for taxpayers and the real economy. SRM became
operational in the beginning of 2015, and will hold a complete set of resolution
powers from January 2016. A Single Resolution Fund (SRF) will be available to pay
for resolution measures. SRF will be financed by all banks to the amount of €55
billion within eight years.
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Further Steps on Better Economic Governance in the Euro Area – The Five
Presidents' Report
In June 2015, the Five Presidents' Report1 was released which lays out a roadmap for
further integration of the euro area. The Five Presidents’ report focuses on:
First, completing the banking union: establish a deposit insurance guarantee scheme and
the Single Resolution Fund.
Second, creating a Capital Markets Union. Since the euro area doesn’t share a common
budget, a Capital Markets Union would be an extraordinary assistance in sharing risks
across the Union.
Third, reconsidering fiscal union, economic union and political union.
In the introduction of this Report it is recognized that “Europe’s Economic and Monetary
Union today is like a house that was built over decades but only partially finished. When
the storm hit, its walls and root had to be established quickly.
It is now high time to
reinforce its foundations and turn it into what Economic and Monetary Union was meant to
be: a place of prosperity based on balanced economic growth and price stability, a
competitive social market economy, aiming at full employment and social progress. To
achieve this, we will need to take further steps to complete Economic and Monetary Union.”
The Report sets out three different stages for turning the vision of the Five Presidents into
reality:
o
Stage 1 or "Deepening by Doing" (1 July 2015 - 30 June 2017): using existing
instruments and the current Treaties to boost competitiveness and structural
convergence, achieving responsible fiscal policies at national and euro area level,
completing the Financial Union and enhancing democratic accountability.
o
Stage 2, or "completing EMU”: more far-reaching actions will be launched to make
the convergence process more binding, through, for example, a set of commonly
agreed benchmarks for convergence, which would be of legal nature, as well as a
euro area treasury.
o
Final Stage (at the latest by 2025): once all the steps are fully in place, a deep and
genuine EMU would provide a stable and prosperous place for all citizens of the EU
Member States that share the single currency, attractive for other EU Member
States to join if they are ready to do so.
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The Five Presidents' Report has been written by the presidents of the European Council, the European
Commission, the European Parliament, the Eurogroup and the European Central Bank.
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In sum, the financial storm served an important purpose. It set in motion policy reforms
at both the individual-country level and the euro-area level that will help foster a
stronger and more secure Europe, improving the welfare of its citizens and enhancing
its position as a major player on the world stage.
Concluding Remarks
In Homer’s Odyssey, before being able to return to Ithaca, Odysseas was forced [by the
Gods] to first pass through the Hades underworld. To appreciate the beauty of Ithaca,
he had to experience the darkness of the underworld.
Greece has been on a journey which brought it to the edge of an economic underworld.
That experience, however, has served a vital purpose.
The country has restructured -- and continues to restructure -- its economic and
financial environment, so that it can be more competitive and increase its potential
growth.
With the new adjustment program and the reformed European architecture in place, it
has laid the foundations for return to Ithaca.
It is now a matter of implementation of the policies in the new program.
The current package for Greece, the third in a row, will cover Greece’s financing needs
until 2018.
The crucial question is; Are private investors willing to lend to Greece
against an interest rate that the country can afford to pay over longer periods of time? It
is obvious that there seems to be a risk of Greece not meeting these obligations, in
which case lenders will not be willing to extend these loans. And this brings us to the
issue of debt sustainability.
In my view, a strong growth programme is much more important for the country than
any debt relief. It is true that under current dynamics and with a definition of debt
sustainability that focuses more on gross funding needs, rather than at the debt ratio,
Greece’s debt load might appear marginally sustainable.
That is due to the long
duration of the country’s debt. Having said that, I do strongly believe that some debt
relief is necessary, as it will provide additional help to Greece, in order to get out of the
crisis in a faster and more decisive way.
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