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Greece: Debt Sustainability Analysis

October 21, 2011

Since the fourth review, the situation in Greece has taken a turn for the worse, with the economy increasingly adjusting through recession and related wage-price channels, rather than through structural reform driven increases in productivity. The authorities have also struggled to meet their policy commitments against these headwinds. For the purpose of the debt sustainability assessment, a revised

baseline has been specified, which takes into account the implications of these developments for future growth and for likely policy outcomes. It has been extended through 2030 to fully capture long term growth dynamics, and possible financing implications.

The assessment shows that debt will remain high for the entire forecast horizon. While it would decline at a slow rate given heavy official support at low interest rates (through the EFSF as agreed at the July 21 Summit), this trajectory is not robust to a range of shocks. Making debt sustainable will require an ambitious combination of official support and private sector involvement (PSI). Even with much stronger PSI, large official sector support would be needed for an extended period. In this sense, ultimately sustainability depends on the strength of the official sector commitment to Greece.

A.   Revised baseline      Recent developments call for a reassessment of the assumptions used for the debt sustainability analysis. Since the fourth review, the situation in Greece has taken a turn for the worse, with the economy increasingly adjusting through recession and related wage-price channels, rather than through structural reform-driven increases in productivity. The authorities have also struggled to meet their policy commitments against these headwinds, and due to administrative capacity limitations in the Greek government. The growth and fiscal policy adjustments assumed under the program individually have precedent in other countries’ experience, but experience to date under the program suggests that Greece will not be able to set a new precedent by realizing at the same time and from very weak initial conditions a large internal devaluation, fiscal adjustment, and privatization program.      To give the debt sustainability analysis a firmer foundation, the following set of more likely policy and macroeconomic outcomes has been assumed (the financing and other assumptions are discussed in more detail in Annex I):A slower recovery. In keeping with experience to date under the program, it is assumed that Greece takes longer to implement structural reforms, and that a longer timeframe is necessary for them to yield macroeconomic dividends (e.g. due to complementarities).  A longer and more severe recession is thus assumed, with output contracting by 5½ percent in 2011, and by 3 percent in 2012. Growth then averages about 1¼ percent per year in 2013-14, 2⅔ percent in 2015-20 (as a cyclical