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Indian Journal of Economics & Business, Vol. 12, Nos. 2-4, (2013) : 163-178

* Graduate Student, Korbel School of International Studies, University of Denver, 2201, South GaylordStreet, 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]

AN ANALYSIS OF GREECE’S BALANCE OFPAYMENTS FROM 2000-2011

MEREDITH BROOKS* AND KISHORE G. KULKARNI**

Abstract

The main purpose of this paper is to review the Balance of Payments of Greece throughthe years 2000-2011. This includes a description and analysis of the Current Accountand Capital and Financial Account, including the relevance of running a currentaccount deficit and the role that increased access to capital has had in financing it.We find that Greece has had a chronic current account deficit, and that this deficithas had grave effects on the Greek economy. Furthermore, the increased capitalmobility has enabled Greece to finance increasingly larger deficits that were ultimatelyunsustainable in the face of a global recession.

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

The Greek economy has struggled in recent years as a result of the worldfinancial crisis, tightening credit conditions, and government’s failure to address agrowing budget deficit. Eroding public finances, inaccurate and misreportedstatistics, and consistent underperformance on reforms prompted major credit ratingagencies in late 2009 and again in 2010 to downgrade Greece’s international debtrating, 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 MonetaryFund and fellow Eurozone countries to stave off imminent default on debt paymentsand to prevent the debt contagion spreading to other countries. This was followedby an additional 120 billion euros in 2011. In exchange for these funds, the Greekgovernment has agreed to significant austerity measures, including cutting

164 Meredith Brooks and Kishore G. Kulkarni

government spending, decreasing tax evasion, reworking the health-care andpension systems, and reforming the labor and product markets (BBC).

This paper examines the Balance of Payments, including the breakdown of theCurrent Account and Capital and Financial Accounts as per the InternationalMonetary Fund’s Balance of Payments Manual. It discusses the relevant literatureon the significance of deficits in the current account as well as of the increasedfinancial integration on the sustainability of current account deficits. It analyzesthe Greek BOP through the years 2000-2011, and finds that Greece has had achronic current account deficit, and that this deficit has had severe implications forthr Greek economy and its policy. Furthermore, the increased capital mobility hasenabled Greece to finance increasingly larger deficits that were ultimatelyunsustainable 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 betweenresidents and non-residents of a given country, irrespective of the transactioncurrency, during a specified time period (Bank of Greece). Any transactionresulting in a payment to non-residents is entered in the balance of paymentsaccounts as a debit and is given a negative (-) sign. Any transaction resulting in areceipt 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 acorresponding debit and vice versa. The Balance of Payments, as per theInternational Monetary Fund’s (IMF) Balance of Payments Manual, is dividedinto two main categories, the Current Account and the Capital and FinancialAccount. Because any international transaction generates offsetting entries inthe balance of payments, the balance of payments must accordingly be looked atas a whole rather than in terms of its individual parts. In theory then, the currentaccount balance and the financial and capital account balances should sum tozero, where:

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

(a) The Current AccountThe 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 andservices, income, and current transfers (International Monetary Fund). Generallyspeaking, the difference between the exports of goods and services and imports ofgoods 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 accountdeficit. A country has a current account surplus when its exports exceed its imports(Krugman and Obstfeld 301).

An Analysis of Greece’s Balance of Payments from 2000-2011 165

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

Figure 1: Data used for this Graph Taken from WEO Database, 2012

Nonetheless, the literature on the implications of these imbalances are mixed.On one hand, there are those who believe that deficits are irrelevant under theright conditions. This camp of thought came about during the second part of the1970s, when most countries in the world experienced large swings in their currentaccount balances, partially a result of the oil price shocks (Edwards 4). Much ofthis literature focuses on the inter-temporal approach to the current account thatwas initially proposed by Sachs (1981) and thoroughly extended by Obstfeld andRogoff (1996). The main takeaways from this argument are based on the recognitionof two interrelated facts. First, from a basic national accounting perspective thecurrent account is equal to savings minus investment, whereby CAB = S-I(International Monetary Fund). Second, since both savings and investment decisionsare based on inter-temporal factors, such as life cycle considerations and expectedreturns on investment projects, the current account is necessarily an inter-temporalphenomenon. Sachs (1981) emphasized forcefully the inter-temporal nature of thecurrent account, arguing that, to the extent higher current account deficits reflectednew investment opportunities, there was no reason to be concerned about them(Edwards 4). This also includes those who advocate the “Lawson doctrine”, wherebyhigher current account deficits should not be a cause for concern if the fiscal accountsare 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 ofthe current account were subject to flaws. Indeed, some of the countries affected bythis crisis had run very large current account deficits in the presence of increasinginvestment rates, and/or balanced fiscal accounts (Edwards 10).

Alternatively, there are those who believe that deficits matter. According tothis view, “a country can run a current account deficit for a limited period. But nopositive deficit is sustainable indefinitely” (Corden 88). The argument is that largeaccount deficits are unsustainable, as they indicate a looming inability to makedebt repayments and put the economic prospects of a country at risk. In the yearsimmediately following the 1982 debt crisis, for example, the empirical evidence ofCline (1988) and Kamin (1988, p. 14), suggested that the trade and current accounts“deteriorated steadily through the year immediately prior to devaluation” (Edwards10). In their analysis of the Chilean crisis of 1982 Edwards and Edwards (1991)argued that Chile’s experience showed that the Lawson Doctrine was seriouslyflawed.

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 currentaccount deficits was decidedly mixed. One comprehensive study by Corsetti, Pesenti,and Roubini (1998) analyzed the period leading to the East Asian crisis, and arguethat there is some support for the position that large current account deficits wereone of the principal factors behind the crisis. According to them, “as a group, thecountries that came under attack in 1997 appear to have been those with largecurrent account deficits throughout the 1990s. (7).” Other analyses of the data show,however, that with the exceptions of Malaysia and Thailand the current accountdeficits were not very large (Edwards 13). Moreover, Calderon et al. (2002) andChinn and Prasad (2003) find that no single theoretical model captures the entirerange of empirical relationships affecting the savings/investment balance of acountry and, thereby, its current and financial account balances (De Santis andLuehrmann 9).

(b) The Capital and Financial AccountOn the other side of the BOP equation is the capital and financial account, which ismade up of two major components—the capital account and the financial account.

The major components of the capital account are capital transfers andacquisition/disposal of non-produced, nonfinancial assets. Capital accounttransactions generally result from nonmarket activities, or represent the acquisitionor disposal of non-produced, nonfinancial, and possibly intangible assets (such ascopyrights and trademarks) (Krugman and Obstfeld 308). Capital transfers consistof those involving transfers of ownership of fixed assets; transfers of funds linkedto, or conditional upon, acquisition or disposal of fixed assets; or cancellation, withoutany counterparts being received in return, of liabilities by creditors. Capital transfersinclude 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 specificeconomic territory but may include the purchase or sale of land by a foreign embassy(International Monetary Fund). For example, if the United States governmentforgives $1 billion in debt owed to it by the government of Pakistan, U.S. wealthdeclines 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 allinternational purchases or sales of financial assets. For example, when a Frenchcompany buys a German factory, the transaction enters the French balance ofpayments as a debit in the financial account (Krugman and Obstfeld 308). Thefinancial account can be further subdivided into direct investment, portfolioinvestment, other investment and reserve assets. Direct investment reflects thelasting interest of a resident entity in one economy in an entity resident in anothereconomy. Portfolio investment covers transactions in equity securities and debtsecurities. Additionally, other investment covers short- and long- term trade credits.Finally, reserve assets cover transactions in alternative assets that can be consideredused to fund imbalances, such as monetary gold, special drawing rights (SDRs),reserve position in the Fund and foreign exchange assets (International MonetaryFund).

The literature on the capital and financial account is inextricably linked to thetrends in the current account. This is primarily because if a country wishes tospend 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-Rull338). This is evidenced by the increasingly negative lending/borrowing ratio in Figure2, indicating that advanced governments have been borrowing at increasing ratessince data started being collected in 2001, with only a slight decrease in borrowingafter the global recession. Additionally, in recent years financial integration andcapital account liberalization have made it easier than ever to obtain internationalfinancing. This has led to both gross and net international capital flows that haveincreased markedly in recent years, and that have been a critical factor in thebalance of payments, leading to a significant widening in capital account deficitsas well as a rapid accumulation of international reserves (Edwards 11, Fischer118-119). Moreover, current account imbalances are primarily financed by net flowsin foreign direct investment, net flows in portfolio investment, net flows in bankloans and changes in foreign official reserves (De Santis and Luehrmann 43). Inaddition to the increase in financing, the type of financing also matters in its potentialimpact on the capital account deficit. For example, Fischer argues that deficitsfinanced by longer-term borrowing and in particular by foreign direct investmentis more sustainable while sizable deficits financed in large part by short-term capitalflows are a cause for alarm (123). Alternatively, De Santis and Luehrmann haveshown that external imbalances can be smoothed by net portfolio flows (43).


III. EMPIRICAL EVIDENCE ON GREEK BOPThe Bank of Greece (BoG) has been responsible for compiling and producing theGreek balance of payments statistics since 1929. The collection system was originallybased 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 capitalmovements were liberalized in May 1994 and, in March 1995, the BoG began itssearch both for new data collection system and methodology for the compilation ofits BOP (European Central Bank). It decided to employ a “mixed system”, withinwhich the basic source of Balance of Payments data is the resident MonetaryFinancial Institutions, including the Bank of Greece, which are obligated to providethe Bank of Greece with monthly detailed information on all transactions betweenGreek residents and non-residents that they carry out either on their own behalf oron behalf of their customers (Bank of Greece). Information pertaining to the GreekBOP is easily accessible through the BoG website, with detailed BOP data datingback to 2000, the year after Greece officially joined the Eurozone.

(a) Current AccountWithin the Greek BOP, the current account is comprised of four main accounts:goods, services, income and current transfers. The first, “goods”, is comprised ofexports and imports, and is commonly known as the Trade Balance. It is also theprimary source of debt for Greece. This debt stems mainly from the high level ofimports 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 toa peak level of 63,861.7 million euros in 2008, before dropping to its 2011 level of47,454.1 million euros. Exports, meanwhile, have increased from 11,098.6 millioneuros in 2000 to 20,233.0 million euros in 2011. The second, “services”, is comprisedof receipts minus payments for travel, transportation and other services, and has

Figure 2: Data for this Graph Taken from the WEO Database, 2012


historically remained the largest source of current account inflow, growing from8,711.1 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 -9,066.5million euros in 2011. Finally, “current transfers” refer to receipts less paymentsfor 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 eurosin 2011.

Figure 3: Data taken from WEO Database, 2012

Overall, Greece has maintained a significant current account deficit over theyears 2000-2011 as seen in Figure 4, reaching its highest deficit of -34,797.6 millioneuros 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 placedupon them. On average, over this time period, they have maintained the secondlargest current account deficit as a percentage of GDP as compared to other Eurozonecountries (see Figure 5).

(b) Capital and Financial AccountAs per the IMF Balance of Payments Manual, Greece decomposes its Capital andFinancial account into two main accounts, capital transfers and the financial account.In Greece, capital transfers reflect receipts less payments for the general governmentand other sectors. They have remained relatively constant from the years 2000-2011, representing a net inflow of 2,246 million euros in 2000, peaking at 4,332.3million euros in 2007, and returning to 2,671.8 million euros in 2011. The financial


Figure 5: Data taken from WEO Database

Figure 4: Data for Graph from the Bank of Greece


account has remained positive, with increasing net inflows of 8,906.3 million eurosin 2000 to 17,887.0 million euros as of 2011.

The financial account can be further broken down into the following fourcomponents: direct investment, portfolio investment, other investment and changein reserve assets. Between 2000-2011, Greece has experienced direct investmentranging from a 2,290.2 million euro net outflow in 2007 to a 1,420.7 million euronet 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 financialaccount.

Portfolio investments peaked in 2009, with net inflows of 22,663.8 million euros.Since then, they have reversed substantially to reflect net outflows of 17,778.3million euros in 2011. “Other investment” is comprised of assets less liabilities,including general government loans. In 2000, other investment comprised a 4,857.8million euro outflow, reversing and steadily increasing to a 12,094.6 million euroinflow in 2008, and then increasingly rapidly over the last two years, with 2011inflows of 35,621.2 million euros. Finally, Greek’s change in reserve assets hasremained relatively steady, from a decrease of 5,771.7 million euros in 2000 to a19.0 million euro decrease in 2011.

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

Figure 6: Data taken from Bank of Greece


(c) Savings and Household’s Consumption BehaviorGreece has experienced a shortfall of national saving relative to domestic investmentover the past decade that is attributable to the concurrent fast growth of consumptionand investment, spurred by the sharp drop in interest rates as a result of Greece’sparticipation in EMU, robust credit expansion, the over-optimism of householdsand firms and large fiscal deficits. This has resulted in expenditure for imports ofconsumer and investment goods at high rates, even higher than those of exportreceipts. Given that imports exceed exports in absolute terms, the trade deficitcontinued to widen. This continued until 2009, when overall levels of imports startedto decline (see Figure 6) (Summary of the Annual Report 2006 22).

Figure 7: Data for Graph Taken from WEO Database, 2012

The insufficiency of gross national saving and its continuous decline as apercentage of GDP over the past twenty years are clearly reflected in nationalaccounts data: gross national saving dropped from 18.5% in the five-year period1992-1996 to 14.0% (1997-2001), 10.5% (2002- 2006), 7.6% (2007), 7.1% (2008) andfurther to 5.0% in 2009. These percentages are the lowest in the euro area (Summaryof the Annual Report 2009).

(d) InvestmentIn addition to the decline in savings, there were large levels of investment before2008. Underlying the high levels of investment as a percentage of GDP from 2000-2007 were the improved macroeconomic environment and prospects (as a result ofthe country’s EMU entry and lower interest rates) and the availability of fundingfor the construction of infrastructure projects (due to inflows from the EU Structural


Funds) (Summary of the Annual Report 2007 12). Levels of investment have beensteadily 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 thanintertemporal factors playing a role, since investment rates decreased even in themidst of high expectations of return.

(e) Financing the Current Account DeficitAs mentioned above and highlighted in Figure 8, Greece’s financial account indicatesincreasing levels of capital inflow in the early 2000’s. As of 2006, there was noproblem regarding the financing of the current account deficit and the externaldebt, as approximately three-quarters of the current account deficit was servicedby external borrowing (Summary of the Annual Report 2006 21). This financingcame from portfolio investment and other investment. Within portfolio investment,liabilities were primarily composed of debt securities, and more specifically generalgovernment debt securities. Meanwhile, “other investment” showed liabilitiesexceeding assets, and was comprised largely of MFI loans/currency and deposits,then monetary authority loans/currency and deposits, with general governmentand other sectors making up the smallest portion of inflows (Bank of Greece).

When the global recession hit, however, this led to serious problems in financingthe current account deficit. Greece has experienced severe capital flight and nearly24 billion euros of private capital left the country between 2008 and 2010. TheEurosystem loans to Greece were small until 2007, but in the last few years therehas been a large increase in official inflows from the IMF and the EU that havecompensated for the capital outflows and enabled Greece to maintain stability(Tornell and Westermann 2011). This explains the sharp upshot in “other

Figure 8: Data Taken from WEO Database, 2012


investment” as compared to sharp decline in “portfolio investment” from Figure 6,and likewise the increase in Euro system loans and decrease in private financialflows delineated in Figure 10. Greece took advantage of its access to capital, andincreased capital inflows increased. Its use of short-term capital flows should havebeen a cause for alarm, as capital mobility enables quick inflows, but also quickoutflows.

Figure 9: Data Taken from Bank of Greece

Figure 10: Breakdown of Greek Capital Inflows


IV. CONCLUSIONThe 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 formost of the last decade. This has persisted due to a lack of savings and high levelsof imports, although the deficit has declined since the recession. Furthermore, therewere high level of investment because of low interest rates and confidence ininfrastructure projects. Finally, the current account deficit persisted because ofGreece’s access to international financing. There are two important takeaways fromthis analysis. The first is that the deficit did, and does matter. The deficit was notsustainable indefinitely, and Greece is showing itself to be unable to makedebt repayments and is putting its economic prospects at risk. Additionally,increased capital inflows made international borrowing easier led the currentaccount deficit to widen. However, the same capital mobility also led to outflows inthe latter part of the 2000’s, which was exacerbated by Greece’s use of short-terminstruments.

V. RECENT DEVELOPMENTSGreece received an additional 130 million euros in financial assistance in February2012 (The Guardian 2012). Similar to the other bailouts, loans from the EU, theECB and the IMF (also known as the “troika” of international creditors) areconditional upon a major austerity initiative involving drastic spending cuts, taxrises, and labor market and pension reforms. Additionally, the vast majority ofGreece’s private creditors agreed to write off more than half of the debts owed tothem by Athens. They also agreed to replace existing loans with new loans at alower rate of interest (BBC 2012).

The effectiveness of the austerity measures is controversial, and was the primaryissue in the June 17th elections. The main proponent of the austerity measureswas the Greek political party New Democracy. Led by Antonis Samaras, NewDemocracy voted against the first EU and IMF bailout for Greece before supportingan interim government and voting for the second bailout this year. As part of hisplatform, Samaras pledged to lower taxes and renegotiate parts of the accords withthe proposal of 18.5 billion euros of alternative cuts (Bloomberg 2012). The argumentmade by austerity advocates is that the debt burden must be reduced in order tocreate more jobs and achieve sustainable growth. Additionally, an inability to meetfinancial obligations means that Greek would default on their debt, which couldhurt its credibility with its lenders, its neighbors, and could ultimately lead to aGreek 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 fiscalconsolidation and would alleviate tensions between Greek politicians and theirEuropean partners. This could appeal to other European countries since a Greekexit would in all probability have a very damaging impact on their economies, whilea break-up of the euro zone would likely trigger a deep recession (The Economist2012).


Alternatively, the political party Syriza represented the anti-bailout party whichhas pledged to cancel the country’s bailout agreement. Led by Alexis Tsipras, Syrizacalled for increasing taxes for higher earners, delaying and cutting repayment ofthe country’s debt and trimming defense spending (Bloomberg 2012). Indeed,Tsiparas believes that “the austerity policy… is exactly what we should haveavoided” (Time 2012). In an anti-austerity-led government, Greece would haveattempted to renegotiate the terms of its loans from the EU and IMF. It also meantthat Greece may have frozen loan repayments to its creditors, which wouldundermine yet further confidence in the Eurozone banking sector and in other highly-indebted countries’ ability to repay their debts (BBC 2012). Needless to say, thiswas not a popular alternative for Greece’s lenders, and under an anti-austeritygovernment, a debt moratorium would have almost certainly precipitated a swiftexit from the Euro. All bail-out funds would be cut off. With Greece defaulting onits debt, the ECB would no longer be prepared to permit the provision of liquidityfor Greece’s tottering banks. If the Bank of Greece did not comply with the ECB’sruling… the Greek government would have to reintroduce the previous Greekcurrency, the drachma. In doing so, the drachma would immediately plunge invalue against the euro, creating further instability and potential for contagion (TheEconomist 2012).

The election on June 17th resulted in New Democracy narrowly defeating theSyriza coalition by 2.4 percentage points, which also shows the country’s majoritysupport for remaining within the Euro. Ultimately, “the Greek people voted for theEuropean 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 Democracywas elected on the premise that Athens would honor its commitments made inexchange for rescue loans from the EU and IMF (The Guardian 2012).

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

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