Lax economic policies in 1989 and 1990.
Traditionally, macroeconomic policies in Greece are strongly influenced by the electoral cycle, but this has become more pronounced in the 1980s. The 1986-87 Stabilisation Programme, introduced after the general elections of 1985, succeeded in markedly reducing inflation, the current external deficit and the PSBR while stimulating a sharp rebound in profit rates , thus paving the way for the subsequent recovery. Foreshadowing the general election of 1989 the policy stance was relaxed in 1988. Despite the steady reversal of the earlier stabilisation gains, there was no change in policies up to April 1990 owing to the prolonged electoral period (three general elections between June 1989 and April 1990) and weak coalition governments during this period. It should, however, be noted that monetary policy has been restrictive since 1987, and its increasing tightness in 1989 and 1990 also reflected the need to offset the inflationary effects of lax fiscal and incomes policies.
With the advent of the liberal-oriented New Democracy government in April 1990, the macroeconomic policy stance shifted towards restriction and structural reforms started to be introduced. In the first few months of 1990 a major concern was the growing confidence crisis, the resurgence of destabilising speculative forces and the need to boost government credibility by correcting public finances. Fiscal and income policy measures were introduced in May, so that monetary policy stopped carrying unaided the brunt of the anti-inflation effort. Available indicators suggest that underlying economic conditions stopped deteriorating in the second half of the year, but this was masked by the the Gulf crisis, which severely affected Greece with its high oil dependency and fragile economic situation. Moreover, there seems to have been some delays in the implementation of announced policies and also because of the gross inefficiencies in the tax administration, fiscal policy was not as rigorous as was initially intended. Altogether, in response to the rising PSBR, the macroeconomic imbalances worsened further for 1990 as a whole.
The PSBR in 1989 again turned out to be much higher than budgeted, reflecting on the one hand unrealistic targets and on the other growing tax evasion and sizeable consumption overruns (Table 5). Even though the new government formed after the November 1989 elections was preoccupied by the worsening fiscal trends and their inflationary repercussions, the three coalition parties could not agree on a budget for 1990, and instead it was decided to prorogue expenditure authorisations up to April on the basis of 1989 trends. However, in the face of the growing deficits extraordinary taxes and increases in tax rates were imposed in December 1989 and, with a six-month delay, public utility tariffs were raised (the revenue-impact is officially estimated at 2 per cent of GDP) . [Tabular Data Omitted]
Worried by the strong upward trend of the PSBR and by the confidence crisis the new government presented a restrictive Budget for 1990 in May, combining action on both the revenue and expenditure sides. The low and standard VAT rates were raised by 2 percentage points to 8 and 18 per cent respectively. Indirect taxes on oil products, cigarettes and alcohol were again increased. A 7 per cent tax surcharge was imposed on self-employment incomes earned in 1989 and on non-distributed corporate profits of 1988, and public utility tariffs were again adjusted upwards. On the expenditure side, cuts in public sector wages and in grants and subsidies were announced. Furthermore, instructions were given to the tax administration to take severe measures against tax defrauders and speed up the collection of tax arrears. These measures were officially estimated to reduce the PSBR by almost 4 per cent of GDP .
On account of both tax shortfalls and expenditure overruns, exclusively due to higher interest payments, the outcome for the central government again diverged from budget estimates. Before central government and EC grants, the deficits of social security organisations and enterprises remained stable at about 5 per cent of GDP and 3.4 per cent of GDP respectively. However, the borrowing requirement of public enterprises increased as a result of the reduction of central government subsidies. In total, the net PSBR (on an accrual basis) increased in 1990 by 1 percentage point as a share of GDP, to 21 per cent, significantly above the official targets. As the increase of the PSBR in 1990 is more than attributable to the rise in interest charges, the primary deficit declined by some 3 per cent of GDP.
The increase in the net PSBR in 1990 as a whole reflected the carry-over from the first half-year. And although the 1990 measures succeeded in curbing the trend deterioration (without the May measures the PSBR might have reached 23 per cent of GDP in 1990), there does not seem to have been any significant progress in reducing underlying deficits. Revenues grew significantly faster than GDP, but, excluding the surcharge on taxes and other once-for-all measures, they grew roughly in line with GDP, suggesting that, while significantly higher than in 1988-89, tax elasticities remained low, slightly below the OECD average. Moreover, the collection of tax arrears did not proceed as planned. Excluding interest payments, the share of general government expenditure in GDP remained at about 42 per cent of GDP, which is a high level by international standards, particularly so for a country characterised by the poor standards of its public services.
Reflecting the difficulties in financing such a large PSBR advances by the Bank of Greece doubled in 1990. Foreign financing increased but fell somewhat as a proportion of the PSBR (Table 6). There was an appreciable increase early in the year in sales to foreigners of high yielding ECU-indexed bonds. However, in the last quarter of 1990 foreign institutions, pending the discussions of the Greek government with the EC, seem to have been reluctant to invest in ECU bonds or provide credit to the public sector. A positive development was the more than twofold increase in purchases of government paper by non-bank residents, who financed nearly two-fifths of the PSBR in 1990, up from one-fifth in 1989. Higher interest rates and a better term-structure have stimulated the demand for government paper by individual investors and companies in recent years. Nonetheless, one-third of the PSBR was financed by domestic banks in 1990, mostly by way of compulsory purchases of three-month Treasury bills, at below market rates.
Table : Table 6. Financing of PSBR
Per cent of PSBR
1988 1989 1990 Domestic financing 96.5 86.9 88.0 Banks 66.7 58.0 35.4 Non-bank residents 31.2 18.9 37.6 Bank of Greece advances -1.4 10.0 15.0 External financing 3.6 13.1 12.0
PSBR on a cash basis (Dr. billion) 1 201 1 595 1 966 (per cent of GDP) (16.0) (18.3) (19.0)
Source: Bank of Greece.
Financial liberalisation  and more importantly the excessive public sector claims on financial flows largely explain the significant overshooting of the credit and monetary targets and the substantial growth of liquidity in the three years to 1989. In 1990, for the first time for many years, the restrictive monetary and credit targets were closely adhered to and the trend increase in liquidity was arrested (Diagram 8). However, even before 1990 there was considerable tightening. The Bank of Greece initiated a real positive interest rate policy in 1987; ever since real rates have remained at historically high levels, compared with strongly negative rates in the preceding fifteen years. Exchange rate policy, by restricting the depreciation of the drachma to less than would be needed to offset inflation differentials, has also contributed to containing inflation since 1988. The restrictive interest and exchange rate impact has, however, been borne by the private sector. The public sector continues to have preferential access to credit at subsidised rates, even though the degree of subsidisation has considerably decreased in recent years.
With a view to reining in the excessive monetary expansion the Bank of Greece in November 1989 resorted to credit ceilings (5 per cent growth during the last quarter of 1989), which succeeded in stopping temporarily the acceleration in monetary growth. When monetary policy for 1990 was formulated in early 1990, monetary expansion was again gathering speed. The general perception was that the economy was drifting and there were frequent reports of speculative price rises and stockpiling of imported goods to insure against a possible devaluation of the Drachma. In this uncertain environment and in the absence of the 1990 Budget, the Bank of Greece announced (in February 1990) very restrictive monetary and credit targets for 1990. These targets implied a contraction of credit to the private sector of around 5 per cent in real terms compared with a sizeable real expansion in the previous couple of years.
Credit to the private sector continued, however, to grow rapidly in the first half of 1990 (by 21 per cent, annual rate), exacerbating inflation and balance-of-payments tensions. In order to restore confidence, stop speculation against the Drachma and drain liquidity the Bank of Greece engineered a rise in interest rates at the end of March and again in early July and also intervened in the interbank market. In this context the Bank of Greece, in July, auctioned government securities from its own portfolio for the first time. As a result, the effective cost of bank loans to the private sector reached almost 33 per cent in August 1990, and has since remained at this level (Diagram 9) .
High interest rates and the unwinding of the earlier speculative transactions, as confidence again started to improve, led to a marked slowdown in the rate of growth in credit to the private sector during the second half-year, bringing the growth in 1990 close to the target (Table 7). The Stock Exchange boom, permitting companies to raise substantial amounts of share capital even after the Gulf crisis, and the switch to foreign loans also contributed to easing demand for domestic bank credit . Accordingly, the deceleration of the latter overstates the slowdown in the overall financing of the private sector. Despite the higher PSBR, the growth of bank credit to the public sector also decelerated in 1990 as a whole, due to the successful sales of government securities to the non-bank public. [Tabular Data Omitted]
The slowdown in the growth of money supply (M3) in 1990 was even sharper than that of domestic credit, so that actual growth was considerably slower than targeted, probably for the first time since targets were introduced, and also much slower than GDP growth (Table 8). The drain of liquidity associated with the rise in the current external deficit no doubt contributed. More importantly, there was a shift in favour of government securities at the expense of time and saving deposits with financial institutions. Reflecting the steep increase in interest rates on government securities, this instrument is gradually becoming a serious competitor to bank deposits, which recorded a steep real decline in 1990. The average yield of 12-month Treasury bills has been around 24 per cent since July 1990 compared with 19 to 22 per cent for time deposits, and around 18 per cent for saving deposits (i.e. negative real rates). Moreover, high-yielding ECU-indexed bonds providing a hedge against devaluation also attracted foreign and domestic investors in the early part of the year . Even including Treasury bills, which have a relatively short maturity, overall liquidity grew at about the same rate as GDP (about 21 1/2 per cent) in 1990. In a phase of financial liberalisation the convergence in growth rates, after six years of much faster growth in liquidity, underlines the tightening in monetary conditions, especially in the second half of 1990. [Tabular Data Omitted]
Incomes and price policies
The automatic indexation system (ATA) was retained in 1990. Certain changes also were introduced so as to slow the significant compression in pay differentials under the ATA system . At the beginning of 1990 the coalition government not only gave very generous pay rises under the ATA (5.7 per cent for the first four-month period) but also granted additional increases, bringing the increase in the public sector to 8 per cent (18 per cent cumulatively between September 1989 and January 1990). Even though private sector wage negotiations were supposed to be independent of developments in the public sector, such large wage increases in the public sector could not but affect the wage negotiations in the private sector . Taking advantage also of the political instability the unions obtained about the same big pay rises in early 1990 for private sector employees as in the public sector.
In line with the overall policy tightening the new government decided not to give ATA increases for the May-August period so as to offset the extra pay increase of January. Nonetheless, private sector employers granted a pay increase of about 2 per cent in July in order to compensate in part for the increase in indirect taxation and public utility tariffs. In view of the worsening outlook following the Gulf crisis and in line with the policy in most OECD countries of limiting the pass-through of oil prices into wages, the government decided to deduct the impact of imported inflation from the ATA for all income categories for the September-December 1990 period. This new ex ante cut in real wages was imposed despite strong union resistance, accompanied by widespread strikes in the public sector. Reflecting the tougher attitude of the authorities and cash-flow problems in a growing number of companies wage advances in the private sector also fell behind the rise in prices in the last four months of 1990, thereby largely offsetting the earlier substantial real rises.
The coalition government, following the policy of its predecessor, considerably retarded the adjustment of public utility prices, so that when they were adjusted (December 1989) the increase was inevitably quite big, giving a strong twist to the price-wage spiral. Despite this, administered prices continued to lag behind costs so that the new government again increased them substantially in the second quarter of 1990. In particular, the price of water was raised by nearly 150 per cent (partly also in order to bring a better balance between demand and the shrinking water supply following the prolonged drought), followed by increases ranging between 40 per cent and 60 per cent for urban transport and Post Office tariffs. As mentioned above, indirect taxes on oil were raised considerably just before the Gulf crisis both for budgetary reasons and also in order to bring prices in Greece closer to EC levels. In order not to reinforce the already steep upward inflation trend, the authorities refrained from passing the imported oil price rises onto consumers after the end of August. Even so, mainly reflecting the earlier indirect tax increases, the price of many oil products almost doubled between end-1989 and end-1990.
PHOTO : Diagram 8. MONETARY TARGETS AND LIQUIDITY TREND
PHOTO : Diagram 9. INTEREST RATES
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|Publication:||OECD Economic Surveys - Greece|
|Date:||Jun 1, 1991|
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