Despite inflationary headwinds, growth will remain strong

Before the Russia-Ukraine war, the Greek economy was expected to continue its remarkable post-pandemic recovery in 2022. The outbreak of the war and its associated effects on commodity markets will, however, result in significant headwinds and a noticeable downward revision to GDP growth in 2022. Although Greece’s direct dependence on Russian natural gas is relatively low (7% of the primary energy mix), its overall reliance on hydrocarbons is substantial (51% on oil and 21% on natural gas). Therefore, the Greek economy will feel the effect of higher energy prices. Companies will face increased cost pressures, lower margins, and higher uncertainty, which will take a toll on private investment. Nonetheless, thanks to the favorable growth momentum inherited from the 2021 boom and still significant public investment, GDP will still grow at a healthy pace. The EU’s Recovery and Resilience Facility, of which Greece will be the largest beneficiary in relative terms, with grants and loans amounting to roughly 18% of 2019 GDP over the 2021-2027 period, will remain a central pillar of economic growth. For instance, these funds will strengthen the electricity grid (particularly in the islands) and launch digitalization ventures, including the EUR 870 billion ultrafast broadband project. Private investment should therefore remain relatively strong despite the blow to confidence. However, despite some recent improvements, Greek banks will remain cautious in their financing as 20% of their total loans are non-performing. The labor market continues to improve, with unemployment below the 12% mark. However, wage growth remains lackluster. With inflation eating into purchasing power, the prospects for private consumption (70% of GDP) growth are modest, despite fiscal measures to soften the blow. A return of growth momentum in 2023 is conditioned by the outcome of the war, as uncertainty remains high. The tourism sector’s performance is expected to improve as the pandemic fades. The trans-shipping industry will continue to benefit from excess global demand in the transport and logistics market. The contribution of net exports is therefore expected to remain positive.

Delayed fiscal consolidation and ECB normalization will worsen the debt burden

The energy crisis will cause a setback in the government’s fiscal consolidation schedule. This will mainly come from subsidies designed to shield consumers and firms from the effects of energy inflation. Between September 2021 and the onset of the Ukraine crisis, subsidies for households increased from 9€/megawatt-hour to 42, and 180 for vulnerable families (the corresponding assistance is 65€ for businesses, regardless of the sector). This is combined with expanded discounts from the Public Power Corporation. In addition, the government announced further tax relief measures and a frontloading of the defense spending program. Trends in tax revenue are expected to remain favorable given the still strong GDP growth and reforms to reduce the size of the informal sector. Public finances still bear the scars of the Eurozone crisis, and Greece remains by far the most indebted state in Europe. Most of this debt is owned by official creditors, which have manifested their confidence in the reformist Mitsotakis administration. However, debt service pressures will be increasingly felt as inflation intensifies and the ECB is forced to normalize policy. Still, the ECB’s moves towards a tighter stance will be cautious, and vigilant of any bond market stress. Despite a worsening energy balance, the improving services surplus (boosted by tourism) and booming net official transfers from the EU will limit the widening of the current account deficit.

Racing against the clock to reform, tensions with Turkey

Commanding an outright majority in parliament (158 out of 300 seats), the center-right New Democracy administration headed by Prime Minister Kyriakos Mitsotakis enjoys strong popular support and is headed for re-election in 2023. The ordered pandemic response and the impetus for business-friendly reforms have been supported. The reforms have, for instance, strengthened independence and transparency in public sector recruiting and moved forward with key privatization projects. However, implementing their ambitious reform agenda could be more difficult in a second mandate. Indeed, it is usual for Greek governments to enjoy the majority, as the largest party receives a 50-seat bonus. However, this bonus was canceled by the former administration and will only apply in the next elections if reinstated by the present one. Therefore, necessary coalition-building will require compromises. On the geopolitical front, the big challenge will be avoiding an outright conflict with Turkey while managing migrant flows and asserting energy interests. The dispute over the Greek maritime claims based on the entitlement of its numerous islands to the exclusive economic zone (EEZ) and continental shelf (CS) has intensified after the discovery of hydrocarbon reserves.