ATHENS – The Bank of Greece on Thursday announced a downwards revision of its forecast for GDP growth this year, to 3.2% from 3.8% initially, reflecting a further increase in uncertainty in the Greek economy due to the continuing war in Ukraine and a rise in prices and costs.

In its Monetary Policy Report, the central bank said that Russia’s invasion of Ukraine has undermined global security and stability and abruptly changed the international economic environment and outlook. Before the war in Ukraine, the global economy was dynamically recovering from the impact of the pandemic and the resulting disruptions of global supply chains. Today, it is faced with a double shock: on the one hand, a further rise in inflation, driven by energy, food and metal commodity prices, and, on the other, the risk of a major slowdown in economic activity or even recession amid heightened uncertainty and high geopolitical and financial risks.

In this unfavourable environment, the dynamic recovery of the Greek economy continued in the first quarter of 2022, but the war in Ukraine, the surge in inflation and the normalisation of monetary policy are expected to dampen growth thereafter. At the same time, the rise in average inflation above euro area levels is likely to worsen the competitiveness of the Greek economy, with negative repercussions on the current account balance. In this context, vigilance is needed to prevent a price-wage spiral. Domestic fiscal policy responded to the adverse conditions by introducing targeted and temporary income support measures for vulnerable social groups worst hit by soaring energy prices. This was done using the available fiscal space without compromising the primary deficit reduction target. In the medium term, ensuring fiscal sustainability is key to achieving sustainable growth rates, preserving the credibility of fiscal policy and upgrading the credit rating of the Greek sovereign to investment grade. The continuation of reforms and the implementation of the investment projects envisaged in the National Recovery and Resilience Plan are factors that will improve the economic outlook. At the same time, flexibility in PEPP portfolio reinvestments, as well as the policy interventions to be launched by the European Central Bank (ECB) to prevent fragmentation of the euro area financial system, should reduce tensions in bond markets.

According to the most recent baseline projections of the Bank of Greece, the growth rate of the Greek economy in 2022 is expected to be 3.2%, revised downwards from 3.8% in the Annual Report of April 2022. The revision reflects a further rise in uncertainty in the economy, due to the ongoing war in Ukraine, and increases in costs and prices in general.

Economic growth could turn out higher than the baseline projection of 3.2% if the strong performance of the first quarter continues in the next quarters of this year. However, the risks are tilted to the downside and relate to a further escalation of geopolitical instability, a worsening international economic climate, a disruption in energy supply and a consequent further increase in energy prices.

In 2023, growth is expected to pick up to 4.1%, while for 2024 it is projected to be relatively high, at 3.6%, provided that the geopolitical crisis abates by the end of 2022 and energy prices decline.

In the baseline scenario, consumption expenditure is projected to keep rising in 2022, but at a much weaker pace than in the previous year, due to lower real disposable income and higher uncertainty. In the following years, consumption expenditure growth will strengthen somewhat, supported by a projected rise in employment, as well as a decline in the high savings accumulated in the past couple of years mainly due to the postponement of spending during the pandemic.

Investment is expected to grow at high rates throughout the projection horizon 2022-2024, supported by high liquidity in the banking sector and by the utilisation of available European funds.

Exports of goods have shown resilience during the pandemic and are projected to grow at a satisfactory pace in 2022-2024. Exports of services are expected to rise. Travel receipts in 2022 should rebound to about 80% of their 2019 level, remaining on an upward trend also in 2023-2024. Finally, sea transport receipts should keep rising, benefiting from a strong freight market. At the same time, however, imports are also expected to increase in line with strengthening domestic – in particular investment – demand.

Headline HICP inflation is projected to reach 7.6% in 2022, mainly driven by energy and food prices, before weakening in 2023 and further in 2024. Core inflation will also be high in 2022 and, although declining in 2023 and 2024, will remain elevated and above the headline measure as the strong inflationary pressures of 2022 feed into underlying inflation.

Downside risks to the growth outlook of the Greek economy relate to: (a) a further escalation of the war in Ukraine, which would lead to a further increase in uncertainty and stronger and more persistent inflationary pressures; (b) a new wave of the pandemic; or (c) a low absorption rate of EU funds under the Recovery and Resilience Facility. A further tightening of global financial conditions and increased risk aversion on the part of international investors pose risks to the financing of the real economy, as well as to the Greek government’s uninterrupted and affordable access to international capital markets. However, the actions being planned by the ECB to prevent financial fragmentation in the euro area are expected to reduce such risks. In addition, significant risks to the inflation outlook are associated with a possible further increase in international energy prices coupled with a depreciation of the euro vis-à-vis the US dollar, as well as the possibility that inflationary pressures may become more permanent, leading to increases in nominal wages and thereby triggering a wage-price spiral. In the event of a fast and drastic tightening of monetary policy to rein in higher-than-expected inflation and/or a further deterioration in confidence and an economic downturn in Greece’s main trading partners, stagflationary phenomena could be observed in the Greek economy. Additional risks to the Greek economy stem from geopolitical tensions in the Eastern Mediterranean.

To address the challenges and uncertainties associated with a worsened global economic environment and higher inflation and to ensure that Greece’s credit rating is upgraded to investment grade, economic policy should, in addition to the necessary support to the more vulnerable social groups, depending on the fiscal space available, focus on the implementation of the investments and reforms envisaged in the National Recovery and Resilience Plan and on gradually restoring fiscal sustainability.

In particular, in order to safeguard fiscal credibility, permanent fiscal relaxation measures should be avoided, and any additional income support measures should: (a) target vulnerable groups of the population; (b) be of a temporary nature; and (c) not jeopardise the ambitious environmental targets set.

At the same time, the cash buffer should be maintained at a high level in order to limit debt refinancing risk. Based on the favourable debt repayment profile, it is assessed that medium-term debt sustainability is not at risk. In the longer term, however, the gradual refinancing of the accumulated official sector debt on market terms increases the exposure of the Greek government to interest rate risk. Therefore, in the medium term, fiscal policy should again focus on gradually reducing the primary deficit and returning to primary surpluses from 2023 onwards.

The utilisation of resources from the EU’s long-term budget 2021-2027 and the European recovery instrument NextGenerationEU (NGEU) will be key to addressing investment uncertainty in the new environment of high inflation and geopolitical instability. In the coming years, both public and private investment with European funding is expected to make a decisive contribution to economic growth and to strengthen the long-term productive capacity of the economy.

It is also necessary to restart the privatisation programme – after two years of pandemic-related delays – and to continue the reforms linked to the NGEU. The activation and utilisation of the new REPowerEU instrument proposed by the European Commission will be crucial for speeding up the EU’s energy transition in the medium term and weaning Member States off fossil fuel imports from Russia by promoting renewable energy sources.

Containing inflationary pressures, in particular input costs such as wages and energy, is essential in order to maintain the competitiveness gains achieved over the past decade. Reforms aimed at further deregulating goods and services markets and actions that can protect households’ income from the surge in energy prices could also help in this direction. Significant interventions are also needed in the labour market. Maintaining the growth momentum requires smooth financing of businesses by the banking system.