From Greek Crisis, to Turnaround

Structural reforms and increased competitiveness, not currency devaluation, are getting the economy back on track.

The Wall Street Journal

By GEORGE A. PROVOPOULOS

May 19, 2014 1:27 p.m. ET

Several years ago a chorus of voices predicted that Greece would have to exit the euro zone. The doomsayers had it that Greece would not be able to make the fiscal and economic reforms needed to keep the country in the euro, nor would it be able to save its banking system in the face of an unprecedented sovereign-debt crisis. According to the doomsayers, attempts to bring down the budget deficit and restore competitiveness would lead to painful and politically unacceptable consequences, while a collapse of the banking system was inevitable. Recently, however, the sirens of doom have been silenced. How did that happen?

Since the onset of the crisis almost five years ago, the turn-around of the Greek economy has been remarkable. Last year the government booked a primary fiscal surplus of nearly 1% of GDP, after the primary balance swung from a deficit of 10.5% of GDP in 2009.

Since then, competitiveness—as measured by labor costs relative to those of Greece's trading partners—has improved by more than 30%. Competitiveness is also being promoted through structural reforms, which have increased the flexibility of labor and product markets.

Greece's formerly chronic current-account deficit, equal to about 15% of GDP just five years ago, is now a surplus—the first surplus since World War II. A rebalancing of the Greek economy is under way. The share of exports of goods and services in GDP rose to 28% last year from 18% in 2009.

What makes these achievements especially striking is that they have come amid a 25% contraction in the economy over the last five years—a circumstance that has meant moving budget targets, and without the option of devaluing a national currency. I expect this record of progress to continue.

Nowhere has adjustment been more striking than in the banking system, which itself was a victim of the sovereign-debt crisis. With the support of the European Central Bank, the European Commission and the International Monetary Fund, our strategy aimed to recapitalize viable institutions using a combination of public and private funds. Non-viable banks that were unable to raise sufficient private capital were wound down. Throughout the Greek crisis, and, subsequently, the Cypriot crisis, all deposits in Greece were fully protected. Today, the banking sector comprises four well-capitalized, viable pillar banks and a few smaller ones. Meanwhile, banks are exploiting synergies and economies of scale, and eliminating excess capacity, while refocusing on their core activities, selling non-core assets and rationalizing their networks and activities abroad.

In March, the Bank of Greece published the results of its stress tests for the banking system. Based on those results, the country's four core banks had to raise some €6 billion in order to ensure that they have sufficient capital to absorb any losses they would incur under an assumed series of potential negative events.

Since then, all four core banks have re-entered the financial markets, raising a combined €8.5 billion in capital. Two of them have issued unsecured debt. All these issuances were oversubscribed; moreover, the majority of the purchases were by foreign investors, which suggests renewed international confidence in the banking system. The stress-test results and the opening of the financial markets to the banks helped pave the way for the Greek government to re-enter the markets in April.

Greece's reforms are producing results. Since the peak of the crisis in mid-2012, interest-rate spreads have dropped sharply, share prices on the Athens Stock Exchange have more than doubled, deposits have returned to the banking system, and economic indicators have turned positive. I expect positive growth to return this year, modestly at first, and then to gain momentum.

Important challenges, of course, remain. With the unemployment rate still above 25%, the biggest challenges are complacency and adjustment fatigue. Greece's recent successes should not detract from the effort that lies ahead. Further structural reforms and consolidation in some industries will be needed. These reforms, however, will be easier to implement against the background of a recovering economy.

Greece's financial storm compelled the Greek people to recognize that their country faced the following problem: Any short-term gain in competitiveness produced by the return to the drachma, as prescribed by the doomsayers, would have been quickly eroded as the country reverted to the bad old days of, at best, half-hearted reform and a renewal of high inflation, leaving it uncompetitive and recession- and crisis-prone. The Greek people saw what the doomsayers could not: that their future prosperity and security are inexorably tied to the euro.

Mr. Provopoulos is the governor of the Bank of Greece.