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The short-term prospects.

V. The short-term prospects

The Medium-term Adjustment Programme has established very strict targets for 1991 in order to set the economy on a steep disinflation path from the first year and create conditions for dynamic changes. All macroeconomic planks of policy are, therefore, very restrictive and their damping impact on activity in 1991 can be expected to outweigh the positive supply-side gains flowing from structural adjustment policies, which normally have longer lags. The slowdown in world trade, depressed conditions in some of Greece's main export markets in eastern Europe and the Middle East as well as the effects of the Gulf crisis on tourism will probably also affect the economy negatively in 1991.

Macroeconomic policies

The 1991 Budget

The PSBR (on an accrual basis) is budgeted to decline by 7 1/2 percentage points of GDP in 1991, or nearly 9 percentage points on a cyclically-adjusted basis (see Part IV). The improvement, largely accounted for by the reduction in the central government deficit, reflects an increase in extraordinary revenues, a higher tax burden and a fall in the wage bill and subsidies. By contrast, the trend rise in the interest payments/GDP ratio should continue, reflecting the growing share of the debt financed at market terms and the lagged response of interest rates to the fall in inflation. The operating deficit of the social security system is estimated to stabilise, but its borrowing requirement to increase because of the reduction in central government subsidies. The deficit of public enterprises is planned to be significantly reduced, helped in part by the sale of loss-making firms.

The policy of not passing onto consumers the recent unforeseen decline in oil prices is likely to result in a marked increase in indirect tax receipts, considerably more than originally estimated. Even so, the planned reduction in the PSBR seems optimistic, largely due to the likelihood of important revenue shortfalls. Growing slack, problems in the assessment of taxable incomes and tax collection, and possible delays in privatisation may make the realisation of the budget targets difficult. In addition, a few public sector enterprises, in particular Olympic Airways, have incurred sizeable revenue losses attributable to the the Gulf crisis.

Tight monetary targets

The authorities announced that the monetary policy stance will remain tight and, accordingly, the Bank of Greece set very low growth targets for 1991: 13 per cent for domestic credit and 14-16 per cent for M3 compared with 17 per cent for consumer-price inflation. The Bank of Greece also announced that high interest rates and non-accommodating exchange rate policy will remain the two principal instruments and, in order to enhance credibility, made clear that wage or PSBR slippages will be countered by even higher interest rates [42]. Rising real interest rates, as nominal rates decline more slowly than inflation, coupled with the projected increase in the share of the PSBR financed from private non-bank sources, suggest considerably tighter credit conditions than in 1990. In effect, the shift out of deposits and into government paper seems to have continued in the first couple of months of 1991, straining further the lending capacity of the banking sector. Interest rates on 12-months Treasury bills were reduced slightly in February.

The short-term outlook

Prospects in 1991

The government imposed a rise in basic wages of central government employees of 4 per cent in January and again in July 1991. Including seniority effects, the carry-over from 1990 and inflation-corrective adjustments the growth in average earnings of government employees is expected to be about 15 per cent in 1991 as a whole compared with some 25 per cent in 1990. Although public sector enterprises are, in principle, no longer strictly bound by the norms set by the government, average earnings in these enterprises are again likely to follow developments in central government closely. Reflecting the pace-setting nature of public sector wage norms and growing awareness of the critical situation of the economy, the unions covering private sector employees responded positively to the employers' proposal for a two-year wage pact entailing a de-escalation in nominal wage rises and sizeable real cuts. Wage increases will take place in January and July of 1991 and of 1992 in the following order: 7 per cent, 5.6 per cent, 5.4 per cent and 4 per cent. Furthermore, compensation is provided if the inflation targets of 17 per cent and 12 per cent through 1991 and 1992 are exceeded. Including the increase in the social security contribution rate, the growth of compensation per private sector employee is, on this basis, estimated to fall to 16 per cent in 1991, down by 4 1/2 percentage points.

In total, real wages should be reduced by nearly 4 per cent, which combined with a fall in dependent employment and an increase in the tax burden should result in a marked fall in household real disposable income. Nonetheless, cushioned by a shrinking saving rate, consumers' expenditure is projected to remain roughly flat in 1991 (Table 18). However, there is again likely to be a rise in car registrations as, in response to the fiscal incentives, owners replace their old by new less polluting cars. Government consumption is projected to decrease somewhat. By contrast, public sector investment should show a brisk growth. In order to improve infrastructure a multi-year programme of public works and other projects (mainly in the telecommunications and transport fields) is being prepared in collaboration with the private sector. These projects are expected to lend strong support to activity in 1991 and later years, in spite of significant import leakages. [Tabular Data Omitted]

High prices of apartments, the new taxation on real estate, high interest rates and shrinking personal incomes all point to a decline in residential investment in 1991 and probably beyond. After the significant recovery between 1987 and 1990, business investment is expected to be sluggish in 1991, influenced by the weak international and domestic conjuncture as well by high interest rates. Likewise stockbuilding in the non-agricultural sectors is projected to be modest. A swing from a negative to a positive contribution of the real foreign balance should broadly offset the slack in domestic demand, making for a small increase in GDP in 1991. Except for the pick up of agricultural production from the depressed 1990 level, output of the other sectors is likely to decline. Sluggish output, industrial restructuring and reduction in public sector employment combined with the long-term downward trend in agricultural employment may lead to a small fall in total employment. Official forecasts give a somewhat stronger GDP growth, largely attributable to higher investment.

The drop in average inflation is likely to be small in 1991 as a whole owing to the carry-over from the steep rise in public tariffs of 1990 and the increased tax burden of the business sector. However, the year-on-year consumer-price inflation may fall from 23 per cent at the end of 1990 to 16 per cent at the end of 1991 as the markedly slower advance in labour costs, under the wage pact, and in import prices work through the economy. In March and April 1991 the year-on-year inflation had fallen to nearly 20 per cent on average (Table 19). [Tabular Data Omitted]

Growing slack and a markedly smaller deterioration in competitiveness point to a pick up in merchandise export volumes, despite the depressed conditions in some important export markets. In addition to weak final domestic demand, slower inventory accumulation should moderate import growth in 1991. Furthermore, the oil bill should fall, contributing to a marked slowdow in the growth of the trade deficit. After the surge in 1990 the invisible surplus is likely to increase moderately in 1991. The negative effects of the Gulf crisis on tourism are expected to be largely offset by a further sharp rise in net EC transfers. The current account deficit may fall as a per cent of GDP. This coupled with a further, though modest, rise in net autonomous capital inflows suggest a small change, if any in foreign net indebtedness. The signing of the loan agreement with the EC at the end of February and the prospective improvement in underlying economic conditions should also boost confidence, facilitating the renewal of the large foreign debt coming due in 1991 (around 5 per cent of GDP, concentrated in the first semester).

Prospects in 1992

On the assumption that the Medium-term Adjustment Programme is closely adhered to and there is no slippage in the two-year wage pact, underlying conditions should improve considerably in 1992 [43]. A more favourable international environment and the prospective recovery in a large number of OECD countries should also contribute. This, coupled with the restoration of business confidence, is likely to lead to a sharp rise in investment both fro Greeks abroad and from foreign firms. In addition to lending strong support to activity, these capital inflows are likely to reinforce the improving current account developments, thus helping to virtually eliminate the deficit of the basic balance of payments.

A non-accommodating policy posture should continue to depress total domestic demand but considerably improve its composition. Even though residential investment is likely to be weak owing to the new taxes, total investment, after exports, is expected to be the main element of strength, stimulated by rising profits and improved confidence. The sluggishness of domestic demand coupled with the positive supply side effects of reforms should boost export growth. GDP is projected to grow by 1 1/2 per cent, close to its trend-rate in the 1980s. Following the cyclical fall in 1991, productivity is projected to increase markedly, reflecting restructuring. This and wage restraint could bring the growth of business sector unit labour costs below 10 per cent. Inflation could thus fall to around 10 per cent by the end of 1992, a rate not reached since 1973.

Reflecting the important reforms under way and the difficulties in evaluating the precise impact on nominal and real aggregates of the large discretionary policy changes, short-term projections are surrounded by more uncertainty than usual. Indeed, the full application of the Adjustment Programme may entail higher short-term costs in terms of output and employment than projected above. In such a case, the disinflation process may be steeper.

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Title Annotation:Greece; Medium-term Adjustment Programme
Publication:OECD Economic Surveys - Greece
Date:Jun 1, 1991
Previous Article:The adjustment programme and structural reforms.
Next Article:Conclusions.

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