Greek economy shrinks more than expected in Q1

Seasonally adjusted figures released by Statistics Greece show Greek GDP slipping by 0.5% quarter on quarter (q/q) during the first quarter of 2016. The first-quarter contraction has been revised from a "flash" estimate of -0.4% released in mid-May. The economy had grown by 0.1% q/q during the final quarter of last year but shrank by 0.3% in 2015 as a whole. On a year-on-year (y/y) basis, GDP fell by 1.4% during the first quarter.

The quarterly contraction in activity was driven by domestic demand. Private consumption fell for the third quarter in a row and faster than in the previous quarter. Consumption has been under pressure from capital controls, still high unemployment, and falling nominal wages. Meanwhile, gross fixed capital formation, which had climbed during the fourth quarter, corrected during the first three months of 2016. But both inventories and public consumption rose at a strong rate during the first quarter. Meanwhile, the figures on the external side show exports of goods and services down 3.3% q/q during January–March. Despite a competitive euro, exports have now slipped, on a quarterly basis, for the sixth consecutive quarter. Weak domestic demand also prompted a decline in imports, although they fell at a less significant rate.

Outlook and implications

IHS expects economic conditions to remain extremely difficult for the rest of the year. In our May forecast, we predict GDP will contract 0.7% this year, although this may be slightly revised downwards in line with the new figures.

Tighter fiscal policy will take its toll on domestic activity. As part of the agreement reached last week with its official creditors, Greece increased several taxes. The value added tax (VAT) rate will go up from 23% to 24% while levies will rise on items including beer, coffee, and fuel (from October 2016). These measures, which are expected to raise 1% of GDP by 2018, follow tax hikes (including in income and dividend tax) legislated in April. All in all, the fiscal adjustment accounts for 3% of GDP.

In our view, higher taxes at this stage of the business cycle will not help support any recovery in activity. Domestic demand will also be under pressure from extremely high unemployment (which, despite its recent contraction, ran at 24.4% during the last months of 2015). Confidence levels in the economy have also been hit by the highly uncertain environment since the start of the year. The consumer confidence indicator published by the European Commission fell in April to its lowest level since August 2013, although it recovered somewhat in May. The industrial sector indicator from the same survey declined to a five-month low in May. Credit conditions will also remain extremely challenging, although we expect some easing over the coming months. Bank deposits fell for the third month in a row in March, while the last bank lending survey published by the Bank of Greece continued to show a marked tightening of credit conditions during the first quarter.

On the positive side, credit conditions may ease if, as a result of Greece's bailout agreement with its creditors, the European Central Bank (ECB) restarts accepting Greek collateral for its liquidity operations. We expect a decision during the ECB's board meeting on 2 June. The ECB might also grant Greece a waiver to take part in its quantitative easing programme. This would have a significant positive impact on credit and confidence. We also believe the capital controls implemented in June 2018 are likely to be gradually lifted during the second half of 2016, conditional on the ECB starting to accept Greek collateral. Low international commodity prices, despite the recent increase in oil prices, should also help support the economy.

Exports should also start stabilising once credit conditions begin to ease. Greek exporters' difficulties in obtaining trade credit have outweighed their benefits from a competitive euro. During the first quarter, exports have also been hit by road blockages caused by farmers' protests against government policy (a relatively large proportion of Greek exports go by road). We expect activity in Greece's main trade partners to accelerate modestly in 2016, also providing some boost for exports.