Greece needs to balance pro-growth policies and fiscal discipline to enhance debt sustainability

Greece’s new government is well placed to bolster the country’s economic recovery and reduce public debt, partly by seeking a new balance between growth-enhancing measures and large primary surpluses, says Scope Ratings.

Scope’s analysis shows that achieving higher growth would be nearly twice as effective as relying on very high primary surpluses in further reducing the country’s 182% public debt-to-GDP ratio.

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Greece (BB-/Positive) is set to again meet its goal of a budget surplus before interest payments – the primary surplus – of 3.5% of GDP in 2019, after recording a larger-than-expected primary surplus in 2018 of 4.3% of GDP, well in line with the agreement that Greece reached with its international creditors.

“Meeting fiscal targets is fundamental for maintaining official creditor and market confidence,” says Jakob Suwalski, lead analyst on Greece at Scope Ratings.

“However, striking the right balance between growth-enhancing measures, such as higher public investment – the low level of which in part explains the large primary surpluses, fiscal discipline and policies to address social pressures may require the government to revisit the 3.5% primary surplus target,” says Suwalski.

Scope tested the sensitivity of Greece’s debt-to-GDP burden under IMF forecasts using different assumptions regarding real growth rates and primary surpluses, all other factors being equal. A 1% higher growth rate over the next six years would result in a further reduction in public debt of around 11pp of GDP by 2024 compared to the outcome in the IMF baseline scenario. By contrast, an extra one percentage point higher primary surplus-to-GDP would result in an additional debt reduction of only 6pp of GDP.

“Maintenance of primary surpluses is key to reducing Greece’s debt burden, but our concern is that if primary surpluses are too high for too long, they could prevent the spending needed to fill Greece’s persistent investment gap, with the risk of exhausting Greek’s taxpaying capacity,” Suwalski says. “This would ultimately work against growth and, in the long run, debt sustainability.”

Scope expects that Greece will seek to renegotiate previously agreed primary surplus objectives with the country’s European creditors amid the current low-for-long interest rate environment. Low financing rates help reduce Greece’s interest payments and gives the government more fiscal room for manoeuvre despite its high public debt. A delegation representing creditors is scheduled to visit the country on 23 September under the guidance of the fourth report of Greece’s post-bailout “enhanced surveillance framework”.

“Of course, running modestly lower primary surpluses will be beneficial only if the government undertakes a number of growth-enhancing measures and firmly accelerates fiscal and structural reforms,” says Suwalski.

For now, the outlook for the Greek economy is improving. Scope expects real GDP growth of around 2.5% in 2019, with the pace remaining robust over 2020-2024. This stands in stark contrast with economic developments in the broader European economy, which have seen growth slow materially. Scope’s next scheduled review date for Greece’s sovereign ratings is on 18 October.