An analysis of Greece's balance of payments from 2000-2011.

Brooks, Meredith ; Kulkarni, Kishore G.

I. INTRODUCTION

Greece is a southern European country, bordering the Aegean Sea, Ionian Sea, and the Mediterranean Sea, between Albania and Turkey. It joined what is now the European Union in 1981, and became the 12th member of the European Economic and Monetary Union in 2001. It is a capitalist economy with roughly 10.7 million citizens (Central Intelligence Agency, 2011).

The Greek economy has struggled in recent years as a result of the world financial crisis, tightening credit conditions, and government's failure to address a growing budget deficit. Eroding public finances, inaccurate and misreported statistics, and consistent underperformance on reforms prompted major credit rating agencies in late 2009 and again in 2010 to downgrade Greece's international debt rating, and this has led the country into a financial crisis. In the spring of 2010, Greece received a bailout of 110 billion euros from the International Monetary Fund and fellow Eurozone countries to stave off imminent default on debt payments and to prevent the debt contagion spreading to other countries. This was followed by an additional 120 billion euros in 2011. In exchange for these funds, the Greek government has agreed to significant austerity measures, including cutting government spending, decreasing tax evasion, reworking the health-care and pension systems, and reforming the labor and product markets (BBC).

This paper examines the Balance of Payments, including the breakdown of the Current Account and Capital and Financial Accounts as per the International Monetary Fund's Balance of Payments Manual. It discusses the relevant literature on the significance of deficits in the current account as well as of the increased financial integration on the sustainability of current account deficits. It analyzes the Greek BOP through the years 2000-2011, and finds that Greece has had a chronic current account deficit, and that this deficit has had severe implications for thr Greek economy and its policy. Furthermore, the increased capital mobility has enabled Greece to finance increasingly larger deficits that were ultimately unsustainable in the face of the global economic downturn.

II. OVERVIEW OF THE BALANCE OF PAYMENTS (BOP)

The Balance of Payments is a statistical table that records transactions between residents and non-residents of a given country, irrespective of the transaction currency, during a specified time period (Bank of Greece). Any transaction resulting in a payment to non-residents is entered in the balance of payments accounts as a debit and is given a negative (-) sign. Any transaction resulting in a receipt from foreigners is entered as a credit and is given a positive (+) sign. Transactions are recorded in principle on a double-entry bookkeeping basis, meaning that each transaction entered in the accounts as a credit must have a corresponding debit and vice versa. The Balance of Payments, as per the International Monetary Fund's (IMF) Balance of Payments Manual, is divided into two main categories, the Current Account and the Capital and Financial Account. Because any international transaction generates offsetting entries in the balance of payments, the balance of payments must accordingly be looked at as a whole rather than in terms of its individual parts. In theory then, the current account balance and the financial and capital account balances should sum to zero, where:

Current account + (financial account + capital account) = 0

(a) The Current Account

The current account covers all transactions (other than those in financial items) that involve economic values and occur between resident and nonresident entities. There are three major classifications of the current account, which are goods and services, income, and current transfers (International Monetary Fund). Generally speaking, the difference between the exports of goods and services and imports of goods and services is known as the current account balance (or current account). When a country's imports exceed its exports, the country has a current account deficit. A country has a current account surplus when its exports exceed its imports (Krugman and Obstfeld 301).

The last twenty years have been characterized by steadily increasing current account imbalances in rich countries, predominantly in the US and the Euro Area, as can be seen in Figure 1 (Blanchard 3).

[FIGURE 1 OMITTED]

Nonetheless, the literature on the implications of these imbalances are mixed. On one hand, there are those who believe that deficits are irrelevant under the right conditions. This camp of thought came about during the second part of the 1970s, when most countries in the world experienced large swings in their current account balances, partially a result of the oil price shocks (Edwards 4). Much of this literature focuses on the inter-temporal approach to the current account that was initially proposed by Sachs (1981) and thoroughly extended by Obstfeld and Rogoff (1996). The main takeaways from this argument are based on the recognition of two interrelated facts. First, from a basic national accounting perspective the current account is equal to savings minus investment, whereby CAB = S-I (International Monetary Fund). Second, since both savings and investment decisions are based on inter-temporal factors, such as life cycle considerations and expected returns on investment projects, the current account is necessarily an inter-temporal phenomenon. Sachs (1981) emphasized forcefully the inter-temporal nature of the current account, arguing that, to the extent higher current account deficits reflected new investment opportunities, there was no reason to be concerned about them (Edwards 4). This also includes those who advocate the "Lawson doctrine", whereby higher current account deficits should not be a cause for concern if the fiscal accounts are balanced (Edwards 9). However, the eruption of the debt crisis in 1982 suggested that some of the more important policy implications of the inter- temporal view of the current account were subject to flaws. Indeed, some of the countries affected by this crisis had run very large current account deficits in the presence of increasing investment rates, and/or balanced fiscal accounts (Edwards 10).

Alternatively, there are those who believe that deficits matter. According to this view, "a country can run a current account deficit for a limited period. But no positive deficit is sustainable indefinitely" (Corden 88). The argument is that large account deficits are unsustainable, as they indicate a looming inability to make debt repayments and put the economic prospects of a country at risk. In the years immediately following the 1982 debt crisis, for example, the empirical evidence of Cline (1988) and Kamin (1988, p. 14), suggested that the trade and current accounts "deteriorated steadily through the year immediately prior to devaluation" (Edwards 10). In their analysis of the Chilean crisis of 1982 Edwards and Edwards (1991) argued that Chile's experience showed that the Lawson Doctrine was seriously flawed.

Finally, there are those who believe that current account deficits "may matter". In the aftermath of the 1990s Asian crises, for example, the importance of current account deficits was decidedly mixed. One comprehensive study by Corsetti, Pesenti, and Roubini (1998) analyzed the period leading to the East Asian crisis, and argue that there is some support for the position that large current account deficits were one of the principal factors behind the crisis. According to them, "as a group, the countries that came under attack in 1997 appear to have been those with large current account deficits throughout the 1990s. (7)." Other analyses of the data show, however, that with the exceptions of Malaysia and Thailand the current account deficits were not very large (Edwards 13). Moreover, Calderon et al. (2002) and Chinn and Prasad (2003) find that no single theoretical model captures the entire range of empirical relationships affecting the savings/investment balance of a country and, thereby, its current and financial account balances (De Santis and Luehrmann 9).

(b) The Capital and Financial Account

On the other side of the BOP equation is the capital and financial account, which is made up of two major components--the capital account and the financial account.

The major components of the capital account are capital transfers and acquisition/disposal of non-produced, nonfinancial assets. Capital account transactions generally result from nonmarket activities, or represent the acquisition or disposal of non-produced, nonfinancial, and possibly intangible assets (such as copyrights and trademarks) (Krugman and Obstfeld 308). Capital transfers consist of those involving transfers of ownership of fixed assets; transfers of funds linked to, or conditional upon, acquisition or disposal of fixed assets; or cancellation, without any counterparts being received in return, of liabilities by creditors. Capital transfers include two features: (i) general government, which is subdivided into debt forgiveness and other, and (ii) other, which is subdivided into migrants' transfers, debt forgiveness, and other transfers. This item does not cover land in specific economic territory but may include the purchase or sale of land by a foreign embassy (International Monetary Fund). For example, if the United States government forgives $1 billion in debt owed to it by the government of Pakistan, U.S. wealth declines by $1 billion and a $1 billion debit is recorded in the U.S. capital account (Krugman and Obstfeld 308).

Meanwhile, the financial account of the balance of payments records all international purchases or sales of financial assets. For example, when a French company buys a German factory, the transaction enters the French balance of payments as a debit in the financial account (Krugman and Obstfeld 308). The financial account can be further subdivided into direct investment, portfolio investment, other investment and reserve assets. Direct investment reflects the lasting interest of a resident entity in one economy in an entity resident in another economy. Portfolio investment covers transactions in equity securities and debt securities. Additionally, other investment covers short- and long- term trade credits. Finally, reserve assets cover transactions in alternative assets that can be considered used to fund imbalances, such as monetary gold, special drawing rights (SDRs), reserve position in the Fund and foreign exchange assets (International Monetary Fund).

The literature on the capital and financial account is inextricably linked to the trends in the current account. This is primarily because if a country wishes to spend in excess of national income, their accompanying trade deficit would increase, as would their current account deficit. In order to finance this excess spending, then, the country must borrow from international sources (Atkeson and Rios-Rull 338). This is evidenced by the increasingly negative lending/borrowing ratio in Figure 2, indicating that advanced governments have been borrowing at increasing rates since data started being collected in 2001, with only a slight decrease in borrowing after the global recession. Additionally, in recent years financial integration and capital account liberalization have made it easier than ever to obtain international financing. This has led to both gross and net international capital flows that have increased markedly in recent years, and that have been a critical factor in the balance of payments, leading to a significant widening in capital account deficits as well as a rapid accumulation of international reserves (Edwards 11, Fischer 118-119). Moreover, current account imbalances are primarily financed by net flows in foreign direct investment, net flows in portfolio investment, net flows in bank loans and changes in foreign official reserves (De Santis and Luehrmann 43). In addition to the increase in financing, the type of financing also matters in its potential impact on the capital account deficit. For example, Fischer argues that deficits financed by longer-term borrowing and in particular by foreign direct investment is more sustainable while sizable deficits financed in large part by short-term capital flows are a cause for alarm (123). Alternatively, De Santis and Luehrmann have shown that external imbalances can be smoothed by net portfolio flows (43).

[FIGURE 2 OMITTED]

III. EMPIRICAL EVIDENCE ON GREEK BOP

The Bank of Greece (BoG) has been responsible for compiling and producing the Greek balance of payments statistics since 1929. The collection system was originally based on exchange controls and the monitoring of foreign exchange flows. However, this system became increasingly ineffective as exchange controls liberalized. This, in turn, necessitated a change in the collection system. Short-term capital movements were liberalized in May 1994 and, in March 1995, the BoG began its search both for new data collection system and methodology for the compilation of its BOP (European Central Bank). It decided to employ a "mixed system", within which the basic source of Balance of Payments data is the resident Monetary Financial Institutions, including the Bank of Greece, which are obligated to provide the Bank of Greece with monthly detailed information on all transactions between Greek residents and non-residents that they carry out either on their own behalf or on behalf of their customers (Bank of Greece). Information pertaining to the Greek BOP is easily accessible through the BoG website, with detailed BOP data dating back to 2000, the year after Greece officially joined the Eurozone.

(a) Current Account

Within the Greek BOP, the current account is comprised of four main accounts: goods, services, income and current transfers. The first, "goods", is comprised of exports and imports, and is commonly known as the Trade Balance. It is also the primary source of debt for Greece. This debt stems mainly from the high level of imports as compared to exports, resulting in a chronic trade imbalance. For example, Greece imported 33,026.1 million euros worth of goods in 2000, which increased to a peak level of 63,861.7 million euros in 2008, before dropping to its 2011 level of 47,454.1 million euros. Exports, meanwhile, have increased from 11,098.6 million euros in 2000 to 20,233.0 million euros in 2011. The second, "services", is comprised of receipts minus payments for travel, transportation and other services, and has historically remained the largest source of current account inflow, growing from 8,711.1 million euros in 2000 to 14,630.8 million euros in 2011. The third, "income", involves receipts less payments for employee compensation and investment income, and has grown increasingly negative, from -955.3 million euros in 2000 to -9,066.5 million euros in 2011. Finally, "current transfers" refer to receipts less payments for general government and other sectors. These transfers have remained positive, but at a diminishing rate, from 3,553.3 million euros in 2000 to 560.8 million euros in 2011.

[FIGURE 3 OMITTED]

Overall, Greece has maintained a significant current account deficit over the years 2000-2011 as seen in Figure 4, reaching its highest deficit of -34,797.6 million euros in 2008, which has since decreased to its 2011 level of -21,096.1 million euros, which is due to the recession and the austerity measures that have been placed upon them. On average, over this time period, they have maintained the second largest current account deficit as a percentage of GDP as compared to other Eurozone countries (see Figure 5).

(b) Capital and Financial Account

As per the IMF Balance of Payments Manual, Greece decomposes its Capital and Financial account into two main accounts, capital transfers and the financial account. In Greece, capital transfers reflect receipts less payments for the general government and other sectors. They have remained relatively constant from the years 20002011, representing a net inflow of 2,246 million euros in 2000, peaking at 4,332.3 million euros in 2007, and returning to 2,671.8 million euros in 2011. The financial account has remained positive, with increasing net inflows of 8,906.3 million euros in 2000 to 17,887.0 million euros as of 2011.

[FIGURE 4 OMITTED]

[FIGURE 5 OMITTED]

The financial account can be further broken down into the following four components: direct investment, portfolio investment, other investment and change in reserve assets. Between 2000-2011, Greece has experienced direct investment ranging from a 2,290.2 million euro net outflow in 2007 to a 1,420.7 million euro net inflow in 2008, with a 25.1 million euro inflow as of 2011. "Portfolio investment" reflects assets less liabilities, and is an important determinant of the overall financial account.

Portfolio investments peaked in 2009, with net inflows of22,663.8 million euros. Since then, they have reversed substantially to reflect net outflows of 17,778.3 million euros in 2011. "Other investment" is comprised of assets less liabilities, including general government loans. In 2000, other investment comprised a 4,857.8 million euro outflow, reversing and steadily increasing to a 12,094.6 million euro inflow in 2008, and then increasingly rapidly over the last two years, with 2011 inflows of 35,621.2 million euros. Finally, Greek's change in reserve assets has remained relatively steady, from a decrease of 5,771.7 million euros in 2000 to a 19.0 million euro decrease in 2011.

The BOP for Greece does not sum to zero, which is not uncommon in BOP accounting. For this reason, the Greek BOP also includes a "Balancing Item", which shows the discrepancy that exists. For Greece, between 2000-2010, this ranges from--1,739 million euros to + 1,234.5 million euros (Bank of Greece).

[FIGURE 6 OMITTED]

(c) Savings and Household's Consumption Behavior

Greece has experienced a shortfall of national saving relative to domestic investment over the past decade that is attributable to the concurrent fast growth of consumption and investment, spurred by the sharp drop in interest rates as a result of Greece's participation in EMU, robust credit expansion, the over-optimism of households and firms and large fiscal deficits. This has resulted in expenditure for imports of consumer and investment goods at high rates, even higher than those of export receipts. Given that imports exceed exports in absolute terms, the trade deficit continued to widen. This continued until 2009, when overall levels of imports started to decline (see Figure 6) (Summary of the Annual Report 2006 22).

[FIGURE 7 OMITTED]

The insufficiency of gross national saving and its continuous decline as a percentage of GDP over the past twenty years are clearly reflected in national accounts data: gross national saving dropped from 18.5% in the five-year period 1992-1996 to 14.0% (1997-2001), 10.5% (2002- 2006), 7.6% (2007), 7.1% (2008) and further to 5.0% in 2009. These percentages are the lowest in the euro area (Summary of the Annual Report 2009).

(d) Investment

In addition to the decline in savings, there were large levels of investment before 2008. Underlying the high levels of investment as a percentage of GDP from 20002007 were the improved macroeconomic environment and prospects (as a result of the country's EMU entry and lower interest rates) and the availability of funding for the construction of infrastructure projects (due to inflows from the EU Structural Funds) (Summary of the Annual Report 2007 12). Levels of investment have been steadily declining, and dropped off significantly beginning in 2009, going from 20.5% of GDP to 16.1% of GDP. This indicates that there may have been more than intertemporal factors playing a role, since investment rates decreased even in the midst of high expectations of return.

(e) Financing the Current Account Deficit

[FIGURE 8 OMITTED]

As mentioned above and highlighted in Figure 8, Greece's financial account indicates increasing levels of capital inflow in the early 2000's. As of 2006, there was no problem regarding the financing of the current account deficit and the external debt, as approximately three-quarters of the current account deficit was serviced by external borrowing (Summary of the Annual Report 2006 21). This financing came from portfolio investment and other investment. Within portfolio investment, liabilities were primarily composed of debt securities, and more specifically general government debt securities. Meanwhile, "other investment" showed liabilities exceeding assets, and was comprised largely of MFI loans/currency and deposits, then monetary authority loans/currency and deposits, with general government and other sectors making up the smallest portion of inflows (Bank of Greece).

When the global recession hit, however, this led to serious problems in financing the current account deficit. Greece has experienced severe capital flight and nearly 24 billion euros of private capital left the country between 2008 and 2010. The Eurosystem loans to Greece were small until 2007, but in the last few years there has been a large increase in official inflows from the IMF and the EU that have compensated for the capital outflows and enabled Greece to maintain stability (Tornell and Westermann 2011). This explains the sharp upshot in "other investment" as compared to sharp decline in "portfolio investment" from Figure 6, and likewise the increase in Euro system loans and decrease in private financial flows delineated in Figure 10. Greece took advantage of its access to capital, and increased capital inflows increased. Its use of short-term capital flows should have been a cause for alarm, as capital mobility enables quick inflows, but also quick outflows.

[FIGURE 9 OMITTED]

[FIGURE 10 OMITTED]

IV. CONCLUSION

The analysis of the Greek BOP from 2000-2011 clearly delineates a few major trends. For one, Greece experienced a chronic and consistent capital account deficit for most of the last decade. This has persisted due to a lack of savings and high levels of imports, although the deficit has declined since the recession. Furthermore, there were high level of investment because of low interest rates and confidence in infrastructure projects. Finally, the current account deficit persisted because of Greece's access to international financing. There are two important takeaways from this analysis. The first is that the deficit did, and does matter. The deficit was not sustainable indefinitely, and Greece is showing itself to be unable to make debt repayments and is putting its economic prospects at risk. Additionally, increased capital inflows made international borrowing easier led the current account deficit to widen. However, the same capital mobility also led to outflows in the latter part of the 2000's, which was exacerbated by Greece's use of short-term instruments.

V. RECENT DEVELOPMENTS

Greece received an additional 130 million euros in financial assistance in February 2012 (The Guardian 2012). Similar to the other bailouts, loans from the EU, the ECB and the IMF (also known as the "troika" of international creditors) are conditional upon a major austerity initiative involving drastic spending cuts, tax rises, and labor market and pension reforms. Additionally, the vast majority of Greece's private creditors agreed to write off more than half of the debts owed to them by Athens. They also agreed to replace existing loans with new loans at a lower rate of interest (BBC 2012).

The effectiveness of the austerity measures is controversial, and was the primary issue in the June 17th elections. The main proponent of the austerity measures was the Greek political party New Democracy. Led by Antonis Samaras, New Democracy voted against the first EU and IMF bailout for Greece before supporting an interim government and voting for the second bailout this year. As part of his platform, Samaras pledged to lower taxes and renegotiate parts of the accords with the proposal of 18.5 billion euros of alternative cuts (Bloomberg 2012). The argument made by austerity advocates is that the debt burden must be reduced in order to create more jobs and achieve sustainable growth. Additionally, an inability to meet financial obligations means that Greek would default on their debt, which could hurt its credibility with its lenders, its neighbors, and could ultimately lead to a Greek exit from the Euro (commonly referred to in the media as a "Grexit"). Finally, advocates believe that continued support would help ease the pain of fiscal consolidation and would alleviate tensions between Greek politicians and their European partners. This could appeal to other European countries since a Greek exit would in all probability have a very damaging impact on their economies, while a break-up of the euro zone would likely trigger a deep recession (The Economist 2012).

Alternatively, the political party Syriza represented the anti-bailout party which has pledged to cancel the country's bailout agreement. Led by Alexis Tsipras, Syriza called for increasing taxes for higher earners, delaying and cutting repayment of the country's debt and trimming defense spending (Bloomberg 2012). Indeed, Tsiparas believes that "the austerity policy ... is exactly what we should have avoided" (Time 2012). In an anti-austerity-led government, Greece would have attempted to renegotiate the terms of its loans from the EU and IMF. It also meant that Greece may have frozen loan repayments to its creditors, which would undermine yet further confidence in the Eurozone banking sector and in other highly-indebted countries' ability to repay their debts (BBC 2012). Needless to say, this was not a popular alternative for Greece's lenders, and under an anti-austerity government, a debt moratorium would have almost certainly precipitated a swift exit from the Euro. All bail-out funds would be cut off. With Greece defaulting on its debt, the ECB would no longer be prepared to permit the provision of liquidity for Greece's tottering banks. If the Bank of Greece did not comply with the ECB's ruling ... the Greek government would have to reintroduce the previous Greek currency, the drachma. In doing so, the drachma would immediately plunge in value against the euro, creating further instability and potential for contagion (The Economist 2012).

The election on June 17th resulted in New Democracy narrowly defeating the Syriza coalition by 2.4 percentage points, which also shows the country's majority support for remaining within the Euro. Ultimately, "the Greek people voted for the European course of Greece and that we remain in the euro," Samaras declared. "This is an important moment for Greece and the rest of Europe." New Democracy was elected on the premise that Athens would honor its commitments made in exchange for rescue loans from the EU and IMF (The Guardian 2012).

Now well into July, doubts continue to abound about Greece's ability to make good on its debt payments. Greece must pay 3.1 billion euros in bond payments to the European Central Bank by the August 20th deadline. However, the country is burdened by debt that is 165 percent of overall economic output and an economy set to shrink by 7 percent this year. Additionally, the new government is proposing to cut 11 billion euros in spending without laying off any of its 150,000 or so public sector workers. Most economists see such promises as highly improbable given the bleak reality of Greece's situation, and believe that they are likely to default if the debt is not either significantly restructured and/or if Europe does not provide financial support once again (The New York Times 2012). As of July 26th, the troika is in Greece to continue talks and to further assess the sustainability of Greece's debt levels (Reuters 2012).

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MEREDITH BROOKS * AND KISHORE G. KULKARNI **

* Graduate Student, Korbel School of International Studies, University of Denver, 2201, South Gaylord Street, Denver, CO 80209

** Distinguished Professor of Economics and Editor, IJEB (visit: www.ijb.com) CB 77, P. O. Box 173362, Metropolitan State University of Denver, Denver, CO 8017-3362, E-mail: [email protected]