Greece...What is to be done? And who is going to do it?...The Greek economy needs significant struct

Greece has been deeply affected by recent changes in the international environment, on its borders, and within the country itself, and has become progressively more Western European in culture, shedding its “poor man of Europe” image. The increasing “Europeanisation” of Greece now sets nearly all of the country's external policy challenges within a multilateral and European construction. The debt crisis has also affected the country’s picture abroad and increased the importance of the EU for Greece’s stabilisation attempts...

Short-Term Outlook: The economy is still in desperate situations. Negative inflation will likely continue during the rest of the year...

Assumptions

A Eurozone exit does not form part of the reference point, although risks remain high. A Greek Eurozone exit stopped being part of the predictions (as previously indicated with a 15% chance of an exit in the next 12 months and 40% within the next five years). This is moderately advantageous for Eurozone growth as the economic outlook should be more steady, although a Greek exit was seen only having a modest effect on growth because of the policy measures taken (and expected to be taken) by policymakers...A more flexible approach taken by Brussels, improving business confidence, stronger than previously expected political support for the adaptation program have been the principal forces behind the revision. However, risks remain high. The economic outlook continues to be gloomy, unemployment is still rising, structural-reform implementation has been scattered, while political and social support for the necessary reforms to the economy is still doubtful...Worryingly, the political scenery could get importantly worse once the government starts encroachment in areas such as mandatory redundancies in the public sector or a deepening of the tax-administration reforms. Whereas it is unlikely that a Greek government will make a conscious decision to leave the Eurozone, the toxic mixture of an economic depression and a volatile social situation means that there is still a high risk of an exit by "accident." This could result from political efforts to put into effect additional austerity, or if social pressure to abandon the economic program becomes unbearable...

The European Central Bank (ECB) will eventually trim its key interest rate after taking it down...The ECB is not expected to take its deposit interest rate into negative territory. The government is expected to survive until the end of its term...

Alternative Scenarios

Greece eventually leaves the Eurozone...The overall hit to economic activities is seen limited by policymakers and banks having had abundant time to prepare for such an eventuality, with Eurozone policymakers stepping up progress towards increased banking and financial union as the exit looms...Greece leaves the Eurozone, and policymakers fail to put a strong enough policy foundation in place in the Eurozone in order to handle the event. Contagion would be much deeper and longer lasting, and there is an increased danger that more countries would end up leaving the Eurozone…Structural reform implementation is worse than expected...

Medium- and Long-Term Outlook

The economy faces long-term structural problems. An extended period of financial adjustment, the lack of external competitiveness of the economy, and inflexible domestic markets are likely to weigh down growth over the medium term...The long-term performance of the economy will depend on Greece’s success in implementing reforms to make the economy more balanced and competitive. Up until now, the signs have not been encouraging...Nevertheless, Greece will strive to remain in the Eurozone if results do not improve...

Private consumption is set to remain under pressure in the medium-to-long run. Since the country's accession to the Eurozone, private consumption has been the main driver of growth...However, these growth rates are unlikely to be repeated over the medium term...The past strong performance of consumption has been fueled by careless financial and monetary policy and strong credit growth. However, financial policy will have to be made stricter during the following years in order to lead the deficit down to EU-compliant levels, while growth rates in consumer credit are also likely to regulate...

Furthemore, it will take considerable time for the labor market to return to levels of pre-crisis, especially given that high unemployment may be one of the consequences of firms’ efforts to improve their productivity...Additionally, the combination of high unemployment with reforms aimed to remove nominal stiffness in labor markets should keep wage growth muted over the medium term. However, this will help exports to regain some of their competitiveness since the country’s accession to the Eurozone...

Urgent reforms are needed in order to achieve sustainable financial strengthening...In addition to the necessity of bringing the deficit down in the short term, it will be crucial to implement more reforms in order to ensure the sustainability of the financial accounts in the long term. The pension reform approved during the second half of 2010 is certainly a step in the right direction, but more needs to be done...Specifically, the government will have to redouble its efforts to improve mechanisms for tax-collection, fight tax escape, and introduce stronger budgeting controls. Even if these steps are made, public-debt levels are not likely to return to a sustainable path without a new, deeper, restructuring...

Demographics will become more and more adverse. Working-age population is expected to start decreasing (partly as a result of increasing emigration) while total population is projected to stagnate between 2018 and 2025 and then edge downwards by 0.1% during the remaining of the forecast horizon. Adverse demographics will not only restrict economic growth, but they will also put more pressure on the pension system and lead to higher healthcare bills...

The Greek economy needs significant structural reform if it is to reach its goal of converging with EU living standards. Despite having grown robustly during the last decade, average income levels in Greece still lag some way behind those of its Eurozone peers...Specifically, reforms are necessary for liberalizing product markets, enhancing competition policy, and supporting entrepreneurship...Moreover, there is immediate need for labor reforms in order to overcome the levels of structural and long-term unemployment...Access to higher education is also limited and provision is given emphasys by its failure to prepare graduates for the labor market. Spending on education as a share of GDP and graduation rates is low in comparison with the rest of the EU countries...Investment in the field of education will be key to increasing labor productivity in the medium and long term. Moreover, increasing the quality of education will also be key to achieving gains in productivity over the long term, especially when considering increasing global competition. According to the Organisation for Economic Co-operation and Development, educational attainment is below average and there is significant room from improvements, especially in tertiary education...

An exit from the Eurozone would have a significant impact on the economy. Should Greece exit the Eurozone, it is valued that the new currency is likely to depreciate around 70% against the euro and remain at that level over the medium term. Increasing inflation, combined with increasing uncertainty about the economy and rising unemployment, will result in domestic demand levels falling rapidly and rising social tensions...Moreover, external funding is likely to dry up for an extended period. This could leave Greece unable to pay for imports, causing supply shortages. Greece’s central bank will respond by raising interest rates into the double digits in order to achieve real positive interest rates to initiate financial stabilization, but rates should come down once inflationary pressures ease...Exports will become more competitive at first, but gains will be undermined over time because Greece will struggle to restrain input costs...

Unemployment will remain very high for an extended time. In the long run, unemployment will not be reduced significantly without structural changes...

Inflation: Inflationary pressures will remain weak. Greek inflation is structural in nature. Inefficiencies and stiffness in domestic markets make Greek inflation sticky to the downside...Moreover, the fact that self-employment represents a quite high percentage of total employment also makes inflation less likely to fall. Most of the self-employed are constituted by small enterprises, where prices charged are equated to household income, making small firms more unwilling to reduce their prices in response to falling demand...

External Trade: Greece relies excessively on imports from other European states for consumer durables and non-durable goods as well as natural resources (oil, gas, capital goods, etc). Greece has a heavy oil-import dependency to fulfill domestic energy purposes...Nevertheless, an important proportion of these resources, including petroleum, are transformed and re-exported. Greece is also a major importer of cars while the main export continues to be apparel and footwear, although its proportionate share of total exports is in long-term decline, because Greece is facing competition from cheaper production locations in Eastern Europe and Asia. Germany is Greece's largest trade partner, although its position has been challenged by the emergent trading relations with Greece's near neighbors to the north, with whom trade was restricted until the beginning of the 1990s...

The Greek economy needs significant structural reform if it is to reach its goal of converging with EU living standards...