Greece: With the 2nd review concluded, improved confidence and a lower fiscal drag should support activity
The stage is set for a strong recovery in activity, following the completion of the 2nd review of the programme and the achievement of a large fiscal adjustment in 2016. The latter exceeded even the most optimistic estimates -- with the Greek primary surplus the highest in the EU. In addition to the direct economic effect, it also resulted in policy implementation credibility.
The Greek economy is expected to exit recession in 2017, capitalizing on the ongoing business rebalancing, the reduced fiscal drag, resilient consumption and supportive external demand conditions.
Indeed, the economy already returned to positive growth in Q1:2017 (+0.4% y-o-y), following a sharp weakening in Q4:2016, with domestic demand showing remarkable resilience to the relatively high uncertainty arising from the lengthy negotiations on the completion of the 2nd review.
Healthy export-oriented corporate activity is gaining momentum, with the more competitive subsectors of manufacturing and services leading the way, supported by favorable tourism trends and increased efficiency following a multi-year restructuring.
The fiscal overperformance continued in 4M:2017, mostly from the expenditure side, while revenue trends are in line with the targets of the Medium Term Fiscal Strategy (MTFS 2018-2021).
The completion of the 2nd review of the economic support programme will provide positive confidence and liquidity effects related, inter alia, to a resumption in clearing government arrears through programme funding. The effective fiscal drag is also expected to be significantly lower than in 2016 (an estimated 0.2% of GDP in 2017 compared with 3.0% of GDP in 2016).
Despite positive growth in private consumption in 2016 and Q1:2017, a significant share of households continue to be negatively affected by fiscal conditions, cash shortages and a further toll on disposable income from an energy-driven increase in inflation during the first months of 2017 (to 1.4% y-o-y in 5M:2016 from -0.8% in FY:2016). Some of these pressures are expected to ease over the course of the year on the back of improving labor market conditions (estimated average employment growth of 1.2% y-o-y in FY:2017), which are expected to be accompanied by a pick-up in average working hours and hourly wages.
The implementation of short-term debt relief measures in early 2017 have smoothed somewhat the long-term repayment profile and lowered future interest rates on Greek debt. A further specification of the medium-term measures so as to reduce longer-term debt servicing costs will support economic sentiment and contribute to a faster reduction of country risk premia, and thus an improvement in financial conditions.
In the event, the Greek State's debt servicing needs are limited until July 2018 and programme conditionality has been frontloaded, with the most demanding policy measures already legislated and implemented under the 1st and 2nd reviews of the ESM programme. Thus, the completion of the 2nd review and the disbursement of related funding is expected to be followed by a period of stability, which will support economic recovery, translating into average GDP growth of 1.7% y-o-y in FY:2017 (an estimated +2.6% y-o-y in H2:2017).