Bank of Greece : ?he Bank of Greece Interim Report on Monetary Policy 2014

Today, in accordance with its Statute, the Bank of Greece submitted its Interim Report on Monetary Policy 2014 to the Speaker of the Greek Parliament and the Cabinet.

In its previous Report on Monetary Policy in June 2014, the Bank of Greece, based on information available at the time, had assessed that the Greek economy was stabilising, making the return to positive growth very likely.

This assessment has subsequently been confirmed, with GDP posting positive year-on-year growth rates in the second and third quarters of 2014, after six years of steep decline. GDP grew by 0.6% in the first nine months of 2014 relative to the same period of 2013, driven by buoyant exports and the recovery of private consumption and investment in transport and machinery equipment.

More specifically, in the period January-September 2014:

• Exports of goods and services increased by 8.4% year-on-year, with tourism services and shipping displaying strong performance.

• Private consumption rose by 1.5% year-on-year.

• Investment in transport and machinery equipment rose by 8.4%, after five consecutive years of contraction.

Other positive developments worthy of note are an increase of 1.5% in dependent employment and a decrease of 1.6% in the number of unemployed in the first half of 2014, relative to one year earlier. However, the unemployment rate remains particularly high, despite having decreased.

Unit labour costs in total economy continued to fall in 2014, bringing the cumulative improvement in cost competitiveness since 2010 to 20%. Structural competitiveness is also showing signs of picking up, as suggested by indicators compiled by the World Bank and other international organisations.

Based on the data currently available, GDP growth is projected to reach 0.7% in 2014 and to strengthen to 2.5% or slightly more in 2015, if the recent decline in oil prices in the international market is taken into account. In addition, the current account is expected to continue to improve, posting a surplus of approximately 1.5% of GDP in 2014.

Additionally, it is estimated that the fiscal target of the general government according to the Economic Adjustment Programme is also likely to be overachieved for the third year in a row, indicating that the improvement in fiscal aggregates is sustainable.

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Global economic growth is expected to remain modest in 2014, before picking up slightly in 2015. This forecast is subject to considerable downside risks and uncertainty. Despite the gradual improvement in financial conditions since the beginning of this year, rising geopolitical risks to global growth (from Ukraine-Russia and the Middle East) have dampened foreign demand and the rebound of world trade. Turning to the euro area, declining inflation, an anemic economic recovery, progressively lower inflation expectations throughout 2014, as well as subdued monetary and credit expansion led the Governing Council of the ECB to adopt additional non-standard monetary policy measures. These measures are designed to avert the risk of too prolonged a period of decline in the general price level, as this would set in motion a vicious circle of recession and deflation.

The Governing Council of the ECB is unanimous in its commitment to intensify the use of non-standard monetary policy measures or introduce additional unconventional instruments within its mandate, with a view to averting the risk that inflation in the euro area remains too low for too long.

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As detailed in the present Report, the prospects for the year ahead are positive. More specifically, 2015 should see investment demand gain strength and export activity increase further, thereby allowing the growth path of the economy to take firmer hold.

The favourable outlook for investment in 2015 is supported by a number of factors including: (a) Greece's absorption of resources from the National Strategic Reference Framework (NSRF) and funding from the European Investment Bank (EIB); (b) satisfactory progress of infrastructure projects; and (c) the speeding-up of the privatisation programme.

The anticipated restoration of more normal financing conditions given the opportunity for Greek banks to obtain liquidity from the Eurosystem at low cost which would allow them to finance export firms with a comparative advantage is expected to complement the significant gains in the Greek economy's competitiveness over the past five years, giving exports of goods and services an additional boost.

Encouraging signs of a pick-up in private consumption in 2015 include the rise in employment, the improvement in consumer and retail confidence indicators, the deceleration in the rate of decline in consumer credit, as well as a projected stabilisation of earnings (net earnings will increase slightly).

This positive outlook is nonetheless subject to downside risks, domestic as well as global, and uncertainties, that could weigh on business sentiment in the months ahead and delay or even halt the recovery. This is why the focus of economic policy must be to maintain and strengthen current momentum towards a definitive exit from the crisis. Emphasis has to be placed on the following priorities:

(a) Speeding up structural reforms in the goods and services markets in order to enhance competition and innovation, increase price flexibility and improve competitiveness. These actions will render Greece more attractive to foreign direct investment and help to accelerate privatisations and foster job creation in competitive and viable businesses.

(b) Streamlining public administration with a focus on speeding up the administrative reform, ensuring the proper functioning of justice, slashing red tape, reducing the administrative burden on citizens and businesses, and eradicating corruption.

(c) Strengthening active labour market policies with particular emphasis on education and training, as a way to improve the job-finding chances of people on the sidelines of the labour market, such as the long-term unemployed and young people, who have borne the burden of unemployment.

(d) Pursuing fiscal consolidation in the years ahead. The primary focus should be to curb tax evasion by strengthening tax administration, with a view to broadening the tax base and fostering the sense of social justice. Direct or indirect tax exceptions, other than those granted on grounds related to social solidarity and/or economic growth considerations, need to be re-examined. Care should be taken to ensure the viability of social security funds by again reviewing the regime of various exemptions from the general provisions. All of the above actions would make it possible to gradually lower personal and corporate tax rates, in order to foster economic activity in a fiscally neutral manner.

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The recovery of economic activity is gradually being reflected in the aggregates of Greek commercial banks. Operating profits are improving slowly but steadily, and capital adequacy is now satisfactory, following successful capital increases and the implementation of restructuring plans by the four systemic banks. This was also confirmed by the results of the Comprehensive Assessment, including the EU-wide stress test exercise, conducted by the ECB in cooperation with the European Banking Authority (EBA), made public on 26 October 2014.

However, despite the increase in the banks' deposit base, the strong capitalisation and the regained access to the interbank market and the global capital markets, the banking system still faces important challenges. First and foremost is the constraint on banks' lending capacity arising from the large stock of non-performing loans on their balance sheets. This, combined with the weak demand for bank loans, has resulted in continued negative credit expansion to the real economy, impeding the revitalisation of economic activity.

Consequently, the effective management of non-performing loans (NPLs) is an immediate priority. Greek banks must now adopt an active management of distressed loans, in a manner that not only eases the burden on cooperating borrowers facing temporary difficulties in servicing their debt, but also enables banks in the long run to unlock funds tied up in troubled loans that are unlikely to be repaid.

Based on the above, it is estimated that banks could substantially reduce the troubled assets on their balance sheets by choosing to actively manage their non-performing loans through recourse to: (a) the supervisory framework for the management of loans in arrears and non-performing loans provided for in Bank of Greece Executive Committee Act 42/30.5.2014, and (b) from 1.1.2015 the workout options described in the Code of Conduct provided for in Law 4224/2013. Meanwhile, the recently enacted legislation on the settlement of non-performing business loans can be expected to motivate debtors and banks to seek viable solutions to the problem. In any event, the workout solutions available to banks for the management of non-performing loans must be selected in a manner that does not give rise to moral hazard.

The Greek banking system has emerged stronger from the stress tests and the comprehensive balance sheet assessment recently completed by the ECB. Against this background, the banking system should draw on its own recent experience with restructuring and take on an active role in the sectoral restructuring of the economy, by channeling credit to truly viable businesses. Funds should not be tied up in businesses with no prospect of survival, at the expense of healthy businesses, with a potential to generate economic growth and job creation. The banking sector must be assisted in this effort through improvements in the legal framework that would lift restrictions on, for instance, (pre-) bankruptcy procedures, out-of-court settlements or, as already mentioned, a speeding up of the judicial procedure.

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After six years of recession and five years of fiscal adjustment, the economy has stabilised and is showing signs of improvement. If this momentum is maintained, the economy is likely to return to a steady growth path in the next few years. For this forecast to be realised, however, the restructuring of the economy and the reforms (some of which have already been mentioned) must be pursued with determination in order to address all the challenges, risks and uncertainties for Greece's prospects once the ongoing financial support programme from the EU is over. Such an outcome is possible only in an environment of consensus and cooperation among the political bodies that will ensure continuity.

As indicated during the recent turmoil in capital markets which led to a spike in 10-year Greek government bond yields to above 9%, Greece still needs the support of a reliable precautionary credit programme from its European partners until it can sustainably cover its borrowing needs on international markets. In this context, of utmost importance is our relationship of mutual trust and cooperation with our partners. This relationship will be strengthened further if Greece is granted further debt relief in line with the Eurogroup commitment of 27 November 2012.

The immediate elimination of uncertainty on the domestic front and the commitment to advancing reforms are prerequisites for strengthening both economic growth and employment and for the country's definitive exit from the crisis.