Targetting future primary surpluses

Focus should not be just on this year’s budget, but on the next few years’ balance, to make debt sustainable

ANALYSIS The Greek government has made fiscal consolidation the cornerstone of its economic program, taking the view that it will contribute to the reduction of the public debt ratio and instill enough business confidence to help attract private investments. Although a positive surprise on the budget front is likely this year, it is doubtful whether public finances can put on the kind of performance envisaged in the adjustment program in the mediumterm. In this regard, the key is the attainment and sustainability of bigger primary surpluses in the next few years.

Chronic economic policy mistakes and the mismanagement of the crisis in late 2009-2010 may have forced Greece to seek an international bailout in May 2010 but the main problem has always been a system of governance generating budget deficits and more public debt.

Greece’s political economy in the post-1974 era, when democracy returned to its cradle, was defined by the notion that public finances were a pie for redistribution. The vehicle was the public sector which became bigger and bigger, more ineffective and a source of deficits, underpinning the economy’s loss of international competitiveness.

In this respect, fiscal consolidation cannot by itself guarantee the country’s return to a sustainable growth path without the implementation of a broad series of structural reforms in such diverse areas as the judiciary, education etc. However, it takes years for the fruit of structural reforms, such as a sizeable increase of productivity, to yield results, while the impact of measures to cut the budget deficit is felt immediately in economic activity.

We have argued repeatedly in the past that Greece has been administered an overdose of austerity, which, coupled with delays in the implementation of structural reforms in non-economic areas, has raised the cost of the adjustment for society.

Moreover, excessive austerity applied for a protracted period of time, now admitted by the International Monetary Fund (IMF) as well, has increased resistance to structural reforms, complicating the situation further.

Nevertheless, the Greek government continues to pin its hopes for a return to growth as early as the last quarter of 2013 to progress in fiscal consolidation, namely a primary budget surplus instead of a projected flat primary balance this year. Many analysts agree that the country’s revenues will exceed primary expenditures, which do not include interest payments on public debt, arguing that the official projection is pessimistic for two reasons.

First, spending cuts and tax hikes will amount to about 11 billion euros when the primary balance of the general government is forecast to be flat from a deficit of 2 to 2.5 billion euros or even lower in 2012. A number of analysts believe that a positive surprise is likely since the impact of the austerity measures on the primary balance should be much greater than the official projection despite the contraction of gross domestic product for the fifth consecutive year.

Second, the effectiveness of the measures on the fiscal balance is likely to increase because the mix of measures favors spending cuts rather than taxes in 2013.

Although a consensus seems to be emerging about a primary surplus this year, strong doubts remain whether the country will be able to achieve and maintain a primary surplus of 4.3-4.5 percent of GDP in coming years. It is reminded the attainment of such large surpluses is deemed necessary for the sharp decline of the Greek public debt-to-GDP ratio to 124 percent in 2020.

It is reminded that the country’s primary deficit stood slightly above 10 percent of GDP in 2009 so the turnaround will be about 14 percentage points of GDP – a huge adjustment by any means, especially if one takes into ac- count the internal devaluation.

Greece’s international creditors argue that such a large primary surplus is possible, citing the example of European countries, including Greece, which managed to run large primary surpluses for many years in the past. However, this argument seems to be a little bit weak in the sense that these countries ran surpluses either during good economic times or/and when they enjoyed full control of their monetary policy by having a national currency.

Generating a better-than-projected primary budget balance in 2013 is undoubtedly a step in the right direction. But it is a big leap for anyone to assume the surplus alone can become a game-changer for growth by restoring business confidence and attracting private investments to boost the economy and helping the country regain access to international markets.

The attainment and sustainability of larger primary surpluses in the coming years and not just in 2013 is more important. But this is easier said than done because it entails taking more recessionary measures in the next few years in an economy which is seen shrinking from 232 billion euros in 2008 to an estimated 184 billion euros in 2013.

So, the Greek government and others should not invest that much in the likely attainment of a primary budget surplus this year in the quest to turn the economy around. This is so because producing and sustaining larger primary surpluses in the future is more important than a positive surprise, however welcome, this year. In this regard, the sustainability of the required larger surpluses is the key to growth, along with the medium-term benefits of structural reforms.