Keynote speech by Dr. George Papaconstantinou, Minister of Finance, Greece

Jun 28th, 2010 | Category: Keynote speech by Greece's Minister of Finance Dr. George Papaconstantinou

Saturday, 12 June 2010

[Transcription of speech]

Many thanks for the invitation. It is a pleasure to be here. I see a number of faces around this room that I recognize, including my ex-boss. I will try to give you a sense of what has been happening from our perspective in the last eight months, where we go from here, and link this to the more general discussion about the challenges facing the EU at the moment. This is an eight month old government. It feels like eight years, but it has been only eight months. It has been a very interesting time, for the finance minister as well as for the rest of the government, but perhaps particularly for the finance minister.

We were elected back in October to discover a fiscal mess, a deficit having been budgeted for 2009 at 3%, having been reported in September one month before the elections at 6% and actually ending up to be 13.6 %. At the same time, a debt dynamic, one which was and is extremely worrying and dangerous, with a debt over 115 % of GDP. Obviously this was not just a result of one or two years, this is the kind of deficit and debt that we inherited, and has its roots further back. However, we can safely say that what happened in the last two years was pretty catastrophic in terms of upsetting a very delicate balance between the growth of the economy and the sustainability of public debt. Next to that were more deeply rooted problems, having to do with the competitiveness deficit of the economy. Double digits deficits in the external account, the last 5 years doubling of the deficit of the external account, and last but not least a terrible credibility deficit. Basically, we were in a situation where nobody believed our numbers, nobody believed our policy pre-announcements; nobody believed that we could actually turn things around.

What we started was a race against time, a race to convince that the new government had different priorities, had the will and the capacity to deal with the deficit, deal with the debt and do so in an honest and straightforward way. We knew that a lot of these problems, the root causes of these problems lay in the political structure, in the system of clientelism and patronage, a highly inefficient bloated bureaucratic state with structures that needed to be urgently changed. We knew that the competitiveness problems lay in the structure of an economy that for a long time had been producing things that the rest of the world was not particularly interested in buying. Where a growth paradigm based on construction had run its course, and needed a quick move to a new growth paradigm and with issues of transparency and accountability very high in our agenda.

Unfortunately, we did not have the time to address these things, we were not given the time, the markets didn’t give us the time to actually be able to consistently and slowly try to readdress these things. We were in a race to convince the markets that we were actually not going to be defaulting. And by March this year, the markets completely closed out on us. So, luckily, and of course it’s not just a question of luck but also preparation, by that time the EU had put together the 110 billion facility together with the IMF, to help Greece, on the basis of course of a very specific and very rigorous three year economic and financial programme.

This is where we are now, this is the programme we are implementing, and this is perhaps the first time after a very, very long period when I can actually be a little bit optimistic about where we are and how we are going. The cornerstone of this programme is of course fiscal consolidation, in a space of three-four years, we need to reduce the deficit from 13.6% in 2009 to less than 3% by 2014. And from 2013 the debt-to-GDP ratio is supposed to be on a declining trend. It’s a very aggressive programme and aggressively front loaded. In 2010 the reduction of the deficit is going to be 5.5 percentage points, on the back of measures which actually exceed 8 percentage points.

And if you look at the measures that have already been translated into law, they are unprecedented, certainly for this country and my guess is for most countries. You have a reduction in nominal wages in the public sector of roughly 15% in one year. If you add to that the reform in the tax system which abolished autonomous taxation and various exemptions public servants look at nominal wage reductions exceeding 20% before you incorporate inflation. You have a 10% reduction in pensions, in both public and private sectors. You have a 10 % across-the-board reduction in operating expenditures of government, VAT is up 4 percentage points, excess taxes are roughly up 30% in three successive steps in alcohol, tobacco and petrol.

This is a serious fiscal consolidation effort, with of course, as was to be expected an impact on growth, which is expected this year according to the programme – I’ll have more to say about that – to be minus 4% of GDP.

There has been a lot of discussion of “was there another way?” and the answer is no! We were up against a wall, to avoid bankruptcy we had to take these very difficult measures, what we tried to do is “cushion” parts of the population that were not at all to blame, for the mess that we are in, and which were particular hurt. […]

Now a programme like this may or may not be successful. This one is already and I’ll say something about that but if you don’t put it in a wider context and if you don’t supplement it with structural reform three years from now you are going to be in the same position. It will be very quickly undone.

So, a big component of the programme, perhaps, not what is immediate in the public debate but a big component of the programme has been the structural reforms that are in place. And when you’re facing a credibility deficit you start with the credibility issues. So one of the first things we did was to change the status of our statistics service making it to an independent agency guaranteeing full operational and administrative responsibility. We went on an international search and we will be appointing with a four-fifths majority of parliament its new head before the end of this month.

We embarked on a wide-ranging tax reform […] which makes the system fairer, more accountable, goes after tax evasion in a big way, introduces presumptive taxation, stiffer penalties, changes the way that corporate profits are taxed by making a differentiation between taxation of dividends and re-invested profits, and introduces a number of administrative changes which will be followed by a second wave of changes in the whole structure of taxes.

At the same time we pushed through a big change, a big reform in public administration with a complete overhaul of the architecture of the system. Basically we abolished one layer of administration, collapsed local administration from 1000 to 325 municipalities and in the process pledged to cut down about 4000 public entities in the broader public sector, from 6000 to 2000. This is a huge reform, which has very large potential savings but also which will allow the local administration and the services to be closer to the citizen.

At the end of this month we are bringing to parliament what we call a fiscal responsibility bill, which overhauls the budget process, a new procedure for preparing and following the budget. It introduces fiscal rules, we are one of the three EU countries, the other two are Malta and Cyprus, that do not have fiscal rules which brings more accountability, puts caps and tightens much more the control on spending, which has been going completely out of control in the last years.

Next on the agenda, is pension reform. At the end of this month we will be bringing to parliament a large reform of the pension system, which if left untouched, would have taken the expenditures for pensions to 25 % of GDP by 2050, obviously completely unsustainable, much higher than any other EU country. We are moving, we are abolishing all incentives for early retirement, increasing average retirement age, calculating pensions based on full life- time earnings rather than the best five years, as is the case, and getting rid of obvious injustices in the system, with blatant inequalities that have existed for a very long time.

Together with that there is labour market reform, trying to put some flexibility into what is in Greece a very dual labor market because in effect you have a very rigid part and you have a large part of the labor market which in effect completely ignores what is going on in the official market and finds ways around it, but we are trying to rationalise that.

And finally, privatisations. A privatisation agenda, which we unveiled a week ago, which spans everything from roads, ports, airports, water and real estate and which uses a very flexible approach; everything from concession agreements, strategic investors. We are keeping stakes in what we consider important sectors of the economy, we are withdrawing completely from others. It is the broadest ever agenda of privatisation which we have had in this country.

Last but not least, we are making it easier to do business in Greece. We are notorious for our bureaucracy, the difficulty in setting up business, the difficulty of attracting investments. There are a number of legislations coming to parliament in terms of reducing the steps of setting up a business, the steps to make it operational. We are repeating the Olympics experiment with a fast-track process for large investments, which seemed to work very well then, and we are repeating that now. And we seem to be seeing some first interest across a wide spectrum, particularly in energy, where there are a number of countries in the region which have been interested in large energy projects.

Now this is what we have tried to do, it has not been easy, it’s been fighting against a very hostile international environment; they didn’t want to hear about Greece and were convinced that whatever we did we were doomed. But there are a number of questions out there, which I think are very reasonable and I’ll try to answer those and then I will move to some European issues. People ask: how is implementation going? They ask: is it “doable” or are you going to buckle under social unrest? And of course they ask: does the math add up or will Greece – take your pick – leave the Eurozone, default, or restructure instead. These are all reasonable questions and they require answers.

Implementation: well, in the first five months of the year the budget deficit is down 40 % compared to last year – 40%, fully on target. Revenues are up over 8%, slightly below target, but that is expected because we are in a recession; and expenditures are down more than 10%, way above the target set. So we are fully on track.

That doesn’t mean that we’ve won the bet here but we all know that in the second semester of every year there are potential overruns in expenditures. However, remember that these numbers are before most of the measures that we’ve taken take bite, it’s before the additional 2 percentage points of VAT, it’s before the cut backs in the public sector salaries and pensions feed into the system. So there is a lot of potential that allows me to be reasonably optimistic that by the end of the year we will get to the 8.1% target that we have set.

At the same time, in all the structural benchmarks and the milestones we are ahead. Take pension reform; pension reform, according to the MOU that we have signed with the EU and the IMF, we are not supposed to be doing this before the fall. But we have decided to front load it, for very simple economic and political reasons. If you want to have a big reform effort you do it in the first 6, 8, 10 months of your government, and you get that out of the way in order to be able to then implement and show the progress. So we are ahead.

What is also interesting is that if you look at the macroeconomic variables at the moment the picture is better than what you would think. First quarter GDP was down by 2.5 % whereas over the year we are expecting a 4 percentage point drop. And in that period you see an increase in exports, you see an increase in private consumption, public consumption is down a lot so that brings down the overall consumption, you see a slight pickup or rather a smaller reduction in investment and you see an increase in the volume of retail trade. So, it’s too early to say that we have turned the corner, but we may say that we are at the bottom of the U curve faster than we thought. That is something which is interesting.

Second question; can you do this or are you going to be swamped by protests and have to back down? Well, I often say that obviously Greece has had a lot of problems – we have had this terrible murder of three bank employees by extremist groups. But I often say that a burning trashcan on Syntagma Square makes great CNN footage but it doesn’t reflect what is going on in this country. There are protests, understandably so, people are hurt by what’s happening.

But if you compare Greece with other countries, the severity of the measures are in complete disconnect with the kind of reactions that we are getting. Until now, and of course nobody knows how things will develop, but until now, we’ve managed to keep a balance.

And this for two very simple reasons; one, there is a very clear understanding amongst Greek citizens, that this is necessary, that there is no way that we could continue in the same way and that we are trying hard, not always succeeding, but we are trying hard to make it a fairly balanced approach. They are telling us a couple of things. They are telling us, one, make sure this is not in vain, and two, some people have to pay for what happened to this country in the past. Tax evaders: we have had a very high profile attempt to name and shame doctors that are evading and other professions that have clearly not been paying there dues.

If you look at the numbers, because every politician looks at poll numbers as well, 8 months after an election which was won with a landslide of 10 %, this is where we are again now. We are 10 percentage points ahead. I do not want to underestimate the real difficulty, the pain that is out there, the general distrust of the political system in Greece and everything that that means. But what I am saying is that this is a government with a very clear mandate for change, and that’s what it will do. And it will not turn back, it will not be distracted from what it has to do. We have an absolute majority of 10 seats in parliament. I talk to my colleagues in ECOFIN, who are in coalition governments that have to squeak through with one vote, have to get difficult coalition agreements. We decided the measures on Tuesday and on Wednesday we passed them through a fast track process in parliament.

So, we are going to do this!

Now, the third question has to do with the famous default, exit, restructuring: these are not the same questions. I think it’s much easier to dismiss the question and the issue of the default and exit. I think that people who seriously talk about these things really do not understand the way that the EU works. They do not understand the capacity of the EU, even with delays, (I’ll talk about that in a second) to actually rally around the troops and defend itself. So there is no issue of defaulting. There is no issue of getting out of the Eurozone, obviously.

We have 110 billion euro, assuming of course that we implement the programme, which means that we can stay out of the market if we chose to, up until the beginning of 2012. We are not choosing to stay out of the markets until then. Next month we will be coming out with Treasury bills, and we hope that much sooner than what the markets expect we’ll be out with normal issues, as soon as the situation is a little bit normalised.

The banking system which has been under tremendous stress has an unconditional liquidity support from the ECB for the time being. It’s not forever, but particularly 10 billion out of the 110 are to go to a stabilization fund that will help Greek banks. They obviously need to do their own moves, they need to think about how they make strategic moves as we go on, they cannot continue to operate in the way they are now. But it is clear that the fears, the worse in terms of erosion of the deposit base and the like is now behind us.

Perhaps the last question to answer is the question of restructuring. It’s completely off the table. It would be disastrous. It would be bad for the economy, it will be bad for those particularly weak and it will send a really bad signal and produce a flight-to-safety effect that would completely destabilize the eurozone.

The real answer to the question depends on parameters. The most notable of which is growth. Is growth going to resume faster? And therefore, will Greece be able in 2014-2015 to meet its debt obligations – because everybody can do the math and they can see that around 2014-2015 you have a hump. So the question is: can you go over the hump? Well whether or not you can go over the hump or not depends on how fast you are growing, and we think that through the programme there are tremendous opportunities that will increase the growth potential of the country. So, our sense is that strictly adhering to the programme, being able to re-invigorate a growth cycle that ended abruptly will be able to put to rest the fears of the scenarios that are being discussed.

Now, I want to turn to some European issues. Because as a member of the Eurogroup and ECOFIN in the particular seat that I am, meaning being behind a sign that says Greece, it’s been very instructive and there are some broader lessons. I have tried to codify what I have learned in four very simple lessons.

One; things tend to catch up with you. And this is true for a country like ours, that has had lax fiscal policies and weak institutions but it also has to do with EU. And an institutional framework that we all knew had a missing ingredient and at some point sooner or later would have to face it.

Two; even if you do everything right, you’re still not out of the woods. Because the markets work with different timetables, different agendas, different motives and I have been struck by the frustration of the EU institutions to not be able to be ahead of the markets. In fact if I look at us, the only time we were successful was back in March, when the markets and the EU were expecting us to do a correction and announce measures of an additional 1 percentage point. We actually trumped that by saying, well we will take 2 percentage points of measures. And there was a moment when the markets went “oh, ok these guys are serious” and were expecting then the EU to do the counterpart, which would be to create that backstop and it didn’t. So that’s my second lesson.

Third lesson, time is expensive. 110 billion in May was 40 billion back in February, March. 750 billion in May was much less before. You delay, and we all understand why there was a delay, but you delay at your own cost and sometimes you delay beyond the point of repair.

Finally, fourth lesson; ad hoc solutions are fine to put the fire out, but they are not enough. And this is what we have at the moment. We have an ad hoc solution for Greece and we have an ad hoc solution for Europe. And it’s been a very interesting discussion trying to balance between a community approach and the absolute determination of some countries to keep the inter-governmental approach.

There is as you know a discussion which has started around the Van Rompuy group. It has started with an agenda which is fairly narrow around the fiscal issues. Hopefully, it will expand. At least my understanding of the mandate is that it should expand to look also at financial issues and the growth question, because if we all get into a beauty contest about who is going to cut the fiscal deficits faster and the most then we will find ourselves in a recession.

As far as the first element, the discussion until now has some fairly obvious points, for example placing more importance to the debt criteria, with a number of countries around the table including us, saying let’s look at private debt as well as public debt because the last few years have shown that this is an important component. The issue of sanctions, where there is a lot of self-flagellation going on around the room. Sanctions, yes, economic possibly political in terms of no voting rights, although there is a very big question about how you are going to do that and why, but of course nothing in the direction of what has been very politely called an ‘orderly exit’. Which even if adopted as a potential element would send the absolutely wrong signal to the market, simply by telling people that if you push people, there is an exit door. This is what they have been doing for Greece the last few months and this is what they will do to any other country if we institutionalize this.

And then the broader issues having to do with financial reform and the growth agenda which as I have said have not really been discussed but clearly, to my mind at least, we have not collectively taken the lessons of the financial crisis. We have not moved fast enough, we have not had the courage to find solutions which are common solutions. […] As Greece we have supported for example the ban on naked CDSs by Germany, but we haven’t done the same because we are a small country and it’s not a very good idea if you are a small country with our kind of spreads that you have to do so. It’s something that Germany can do but it would be much more interesting to do in a common decision, in a common framework.

So there are a lot of issues around financial instruments, how you bring more transparency, how you stop certain practices without stifling the roles that they can play, and of course the discussion around things such as a transaction tax, carbon tax, the bank levy, are all very important.