Budget 2011: Greek Fiscal Deficit Seen at 7.0% of GDP in 2011

Yesterday, the Greek government presented its much-awaited draft budget for 2011, which shows fiscal policy remaining extremely tight next year. The big news is that the deficit in 2011 is expected to stand well below previous projections. Specifically, the general government deficit is expected to sit at just 7.0% of GDP in 2011, well below a previous target of 7.6% of GDP in the Economic Policy Programme agreed with the European Union (EU) and International Monetary Fund (IMF). In nominal terms, the shortfall is seen going down from 18.508 billion euro (US$25.496 billion) in 2010 to 16.285 billion euro in 2011.

The ambitious reduction of the budget deficit as a percentage of GDP is expected to be supported by better-than-projected results for 2010. Indeed, the fiscal deficit is seen standing at just 7.8% of GDP this year, down from 13.6% of GDP in 2009 and well below the 8.1%-of-GDP originally planned. This impressive result has been driven by a combination of higher nominal GDP resulting from higher inflation and weaker-than-projected military procurement spending. Meanwhile, the primary deficit—i.e., excluding interest payments—is expected to fall from 8.5% of GDP in 2009 to below 1.0% of GDP in 2011. Greece is expected to run a fiscal surplus, of 0.9% of GDP, in 2012. Consequently, Greece's debt-to-GDP ratio is expected to peak at 149% in 2012 and 2013 and then decrease modestly.

Given that most of Greece's fiscal adjustment was front-loaded in 2010, the draft budget for 2011 does not contain much news in terms of austerity measures. In addition to the measures implemented this year, spending is expected to be limited by diminishing operating expenditure and public investment. Meanwhile, revenues will benefit from the increases in value-added tax (VAT) this year, a broadening of the tax base, and higher taxes on properties. Moreover, the government's coffers are also expected to receive a boost from the introduction of new gambling licences and a one-off tax on profitable enterprises. The draft plan also makes it clear that the government will continue with its efforts to open up more closed-shop professions, such as architects and lawyers, and introduce more competition in the wholesale market for electrical energy.

All in all, ordinary revenues in 2011 are projected to increase by 6.9% year-on-year (y/y) to 56.4 billion euro. As a percentage of GDP, they are expected to rise from an estimated 39.6% in 2010 to 42.6% in 2011 and 43.0% in 2013. Meanwhile, higher interest payments will lead to an increase in total spending of 2.2% y/y to 67.7 billion euro. However, spending on salaries and pensions is expected to go down by 1.4% y/y in 2011. As a percentage of GDP, total spending is seen rising from 47.6% in 2010 to 49.2% in 2011—but it will then fall to 47.9% in 2013.

Fiscal consolidation will continue to be carried out under very difficult economic conditions: the budget is predicated on the economy contracting by 2.6% in 2011. The government then sees GDP rising by 1.1% in 2012 and 2.1% in 2013. Meanwhile, unemployment is seen increasing from 9.5% in 2009 to 11.6% this year and 14.5% in 2011. Inflation is expected to remain above the 2.0% European Central Bank (ECB) target in 2011. Specifically, it is projected to average 2.2%, following an expected reading of 3.5% in 2010.

Outlook and Implications

The draft budget did not contain any huge surprises: most of the big measures have already been taken this year, and no new measures were expected at this point in time. The deficit target for 2011 looks ambitious, but it is certainly feasible—if this year's deficit does indeed come in at the new lower figure. The latest fiscal figures are encouraging—particularly the large increase in VAT receipts recorded in September—while higher-than-expected inflation should also help the government's plans. The main risk stems from the economic situation: although the government's prediction of a 2.6% contraction in 2011 looks reasonable at this point in time, there are downside risks to this forecast. Encouragingly, the government has included a provision in the draft that would allow it to alter the fiscal targets if the economic environment happened to be worse than expected.

Initial reaction to the budget in the bond markets has been positive. The spread between the Greek and German 10-year government bonds, which gives a measure of how much investors are willing to pay to bear extra risk, stands at 791 basis points, its lowest value in around two months. However, this may also have been influenced by the announcement from the Chinese government yesterday that it will be prepared to buy Greek bonds once the government goes back to the markets.

It also remains to be seen how the political landscape will shape up following another year of fiscal consolidation. Since the Panhellenic Socialist Movement (PASOK) government assumed the helm in 2009 and announced a number of austerity packages, Greece has witnessed numerous waves of demonstrations on both a nationwide and sectoral scale. Many of the protests have been violent and they have affected many public services throughout the country, have had a negative impact on tourism, and have even claimed lives after violence escalated during the May protests. Although the demonstrations died down during the summer months, now that most Greeks have returned from their holidays, MPs are reconvening, and most of the austerity measures and cuts are coming into effect in the autumn months, the threat of yet another wave of protests is imminent. Although fiscal policy is set to remain stringent in 2011, better-than-expected results could increase public support for the PASOK government, assuring political stability in the short to medium term.