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Greece's External Rebalancing Is Impressive but Also Deceptive

Greece's impressive external rebalancing has culminated in the current-account deficit narrowing to 2.9% of GDP in 2012 from almost 15% in 2008. However, this process has mainly relied on a collapse in imports as a result of an ongoing sharp contraction in domestic demand, driven by fiscal austerity.

Greece's impressive external rebalancing has culminated in the current-account deficit narrowing to 2.9% of GDP in 2012 from almost 15% in 2008. However, this process has mainly relied on a collapse in imports as a result of an ongoing sharp contraction in domestic demand, driven by fiscal austerity. This, in turn, has had major social and political costs, such as rising unemployment. Moreover, the reduction of interest payments following the write-down of Greek government debt held by the private sector boosted the current account in 2012. A more sustainable way to improve both the external balance and economic prospects more generally would be an export boom. However, export prospects are mixed despite enhanced competitiveness (boosted by structural reforms). Overall, we expect the current account to continue to improve gradually in coming years, albeit less sharply than in 2012, as imports contract further and export performance strengthens.

According to data from the Bank of Greece (the central bank), the improvement in the current-account balance in 2012 was primarily driven by a sharp narrowing of the merchandise trade and income deficits. These were partly offset by a modest rise in the surplus on the services account and a sharp increase in the current transfers surplus.

Imports collapsing, interest payments down sharply

Merchandise exports (excluding volatile items such as oil and ships) rose by a moderate 3.8%, but imports continued their collapse and were down by 15%. The export/import ratio of 1:1.6 in 2012 has contracted significantly since 2010, when it stood at 1:2.4. Meanwhile, the income deficit, which consists of interest, dividends and profits, also narrowed drastically in 2012 as a consequence of significantly lower interest payments following the write-down of more than 50% of the face value of Greek government bonds (GGBs) held by the private sector in March 2012 (so-called private-sector involvement, or PSI) and deferred interest payments on support-mechanism loans from the European Central Bank (ECB).

On the services account, net travel earnings (primarily from tourism) were down fractionally. Arrivals fell by 5.5% in 2012 and non-resident spending in the country decreased by 4.6%. But travel spending abroad by Greeks dropped even more sharply, by 18.4%. Meanwhile, net transport earnings (largely from shipping) recorded a modest increase. Again, while receipts were down by 5.7%, payments were down by an even higher rate of 12.6%. Meanwhile, the current transfers balance showed a net improvement largely as a consequence of increased transfers from EU structural funds.

Why is external rebalancing important?

The rebalancing is significant because it helps to reduce Greece's external debt (including private and public external debt). External debt still stood at a staggering 214% of GDP in the third quarter of 2012. Although the Greek debt crisis has been primarily about the unsustainable size of the government's debt (sovereign debt), the whole economy (including households and firms) has depended on external financing to fund high levels of imports as a result of a surge in domestic demand prior to the debt crisis. This dependence on external financing by peripheral countries such as Greece, combined with euro zone-wide financial interdependence, lies at the heart of the euro zone debt crisis. As external rebalancing continues, Greece's dependence on external financing lessens and the country's economic agents can focus on reducing their debt.

Stronger focus on export expansion?

So far, the rebalancing effort has focused on import contraction, and also benefited from lower interest payments in 2012. However, the concomitant collapse in domestic demand and GDP is unsustainable, brought about by horizontal cuts in wages and pensions as a consequence of the government's fiscal austerity agenda, which, in turn, is supervised by the country's EU/IMF creditors. The social and political consequences of austerity are reflected in a rapid fall in ordinary Greeks' standard of living, rising unemployment and growing risks to political stability and social peace.

A more sustainable path to economic recovery would be the expansion of exports of goods and services. But these have remained relatively sluggish. The structural reforms in the Memorandum of Understanding (MoU) agreed with the EU/IMF stress labour market measures to improve competitiveness in the hope that Greece can export its way out of its slump. Key measures include a steep reduction in the minimum wage, greater leeway for company-level labour agreements, a reduction in severance payments and more flexibility on working time. The reforms have already led to a substantial improvement in export competitiveness via lower inflation and labour costs.

However, "internal devaluation" alone is also unsustainable in the long term if economic recovery (which would revitalise suppressed household disposable incomes) fails to materialise. Hence, the EU/IMF lenders have also emphasised measures to boost productivity and open product markets. Moreover, other measures are supposed to improve the transport of Greek goods, including liberalisation of road haulage and privatisation of the railway system.

However, export recovery depends not only on developments in Greece itself, but also on prospects for the euro zone as a whole; around 60% of Greek exports go to fellow members of the currency area. We expect another economic contraction in the euro area in 2013, which will dampen Greece's export performance this year. Moreover, the resurgence of the euro since late July 2012 (which has made Greek exports outside the euro zone more expensive) weakens prospects for exports to non-euro area countries.

Another stumbling block to an export boom is the credit crunch, which means that exporters now face a lack of operating capital. A survey published in late 2012 by the Panhellenic Exporters Association (PSE) showed that 38.7% of export companies sampled faced severe liquidity problems and difficulty in gaining access to credit. This compared with 25.2% in 2011 and just 7.3% in 2010.

Further rebalancing ahead

Although the pace of the rebalancing is set to moderate as the effects of PSI on the income account fade, we expect further improvements in the current account over the coming months and years. First, the income account will still benefit from lower interest payments during 2013 thanks to another reduction (by around one-third) in the face value of GGBs held by the private sector in the wake of the government's debt buyback in late 2012. Second, we expect the collapse of imports to continue at least until 2014 as domestic demand contracts again amid further fiscal austerity measures implemented by the government (such as across-the-board income tax hikes). And third, we expect exports to continue to grow moderately (in line with the gradual improvement in competitiveness). In particular, the prospects for the important tourism sector--which contributes around 16% of GDP and provides around 18% of jobs--are improving as there is now less uncertainty about Greece remaining in the euro zone following the resumption of EU/IMF lending since late 2012. Indeed, according to press reports in early 2013, the general secretary for tourism, Apostolos Liaskos, predicts that tourism revenue will rise to €11bn in 2013 (from €10bn in 2012), with tourism bookings for 2013 reportedly up by 15-20% from last year from all markets.

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