Summary:
KEY
ISSUES Context and Outlook. The economy has shown resilience through
the crisis, but faces a slow recovery. Three years of significant fiscal
adjustment have dampened activity. We project growth of 0.7 percent
this year and 1.4 percent in 2015, driven by stronger external demand,
improvements in profitability and investment, and a lesser fiscal drag.
Inflation is projected to stay just above one percent.
Apart from
cyclical weakness and a structural fiscal imbalance, the economy faces
employment and competitiveness gaps. Supply side measures and structural
reforms are expected to improve economic performance over the medium
term. Risks. Volatile and uneven leading indicators point to the risk of
a stalled recovery. Continued stagnation would, in turn, make it more
difficult to meet fiscal objectives. Financial stability risks, and
related outward spillovers, have abated considerably, as banks have
rebuilt capital and liquidity buffers at a brisk pace, although exposure
to wholesale funding remains high.
Policy Recommendations. Despite
substantial adjustment, mostly on the tax side, the government deficit
still stood at 4.2 percent of GDP in 2013, and debt rose to 92 percent
in 2013. The April 2014 Stability Program lays out a path of fiscal
adjustment, tax cuts and reform aimed at closing the structural fiscal
deficit over the medium term while boosting the economy’s growth
potential. The targeted pace of adjustment is right— about ½ a
percentage point a year. The simultaneous pursuit of tax cuts and
deficit reduction rests on an ambitious program of expenditure reduction
(2.2 percent of GDP). The emphasis should go to structural measures to
ensure that spending growth is curbed permanently. Tax cuts and
regulatory simplification are welcome measures to encourage investment.
The impact of supply-side initiatives would be boosted by better
functioning labor and product markets: reforms should aim to expand
competition in services and to deepen labor market reforms with a view
to creating more room for enterprise-level negotiations over working
conditions. Indexation of the minimum wage should be reformed to limit
the adverse impact on low skilled employment. Stronger liquidity and
capital buffers in banks, and an improved European bank resolution
framework, will better shield the economy and public finances from
banking shocks. Banks still face adaptation to the evolving regulatory
framework, and it will be important to ensure that the uneven taxation
of financial instruments does not constrain the key intermediation role
of banks.
