According to EC winter forecasts released on February 22, carry over from 2012 as well as the ongoing fiscal consolidation are projected to result in a further reduction of GDP by 4.4% in 2013, after a 6.4% drop in 2012. The return to positive quarterly growth rates is seen by end-2013 and will be followed by positive full-year growth of 0.6% in 2014. EC current short-term estimates are worse than previous autumn forecasts published on November 7, which were calling for a GDP contraction of 6.0% in 2012 and 4.2% in 2013.

EC notes that investment is likely to continue underperforming in 2013, as the majority of businesses still face liquidity constraints or wait to see more evidence of a pick-up of the economy. Though exports are projected to grow as the economy is improving its competitiveness, they are likely to remain subdued due to still weak external conditions. It is expected that these factors will continue to dominate for most of 2013, only partially compensated by the reversal of the liquidity squeeze, notably as the government plans to repay arrears for an amount of up to 4% of GDP.

The start of a recovery in 2014 reflects ongoing positive supply-side developments. Reductions in unit labour costs (due to far-reaching labour market reforms) and product market liberalisation are expected to create new business opportunities and to encourage job creation once the economy picks up. In addition, the bank recapitalisation process and the overall stabilisation of the country are setting the preconditions for a return of capital to the country and renewed credit flows to the private sector. With a large part of the fiscal consolidation effort already legislated, consumers and investors appear to start regaining confidence which should strengthen domestic demand in 2014.

EC forecasts private consumption to drop by 7.7% in 2013 and 1.3% in 2014, with public consumption retreating 3.5% in 2013 and 3.8% in 2014. On the contrary, gross fixed capital formation, which fell 19.1% in 2012, is seen easing by 4.9% in 2013 rebounding by 5.7% in 2014. Imports are expected to slip by 5.9% in 2013 and by a mere 0.8% in 2014, while exports growth is estimated to accelerate from -2.0% in 2012 to 2.7% in 2013 and 4.7% in 2014. Overall, domestic demand will retain a negative contribution to GDP growth (-6.8pp in 2013 and -0.8pp in 2014), inventories are expected to have zero impact on both years, while net exports are seen maintaining their positive contribution albeit at a decelerating pace (+2.4pp in 2013 and +1.5pp in 2014).

In line with contraction in demand in 2013, unemployment rate in now expected to peak to 27.0%, 3% above EC previous forecasts and is expected to remain elevated at 25.7% in 2014, 3.5% higher than November estimate. Although higher than previously, EC unemployment forecasts may prove conservative, particularly for 2013. Note that latest ELSTAT data pinpoint unemployment rate stood at 27.0% in November ’12, while Q1’13 figure is seen above 28%.

According to EC, greater flexibility in wage bargaining arrangements will drive the forecast for decreasing labour costs with compensation per employee projected to fall by 7.0% in 2013 and by 2.0% in 2014. Together with the effect of structural reforms in the product market, this is expected to translate into HICP deflation of 0.8% and 0.4% respectively in 2013 and 2014, leading to a significant inflation differential vis-à-vis the euro area average. This improvement in competitiveness, combined with euro-area recovery, should lead to export growth.

C/A deficit (as % of GDP) is expected to decrease from 7.7% in 2012 to 4.3% in 2013 and 3.3% in 2014. It is noteworthy that just a few days before EC forecast release, BoG announced that C/A deficit dropped by 72.9% y-o-y to €5.6bn in 2012, corresponding to 2.9% of GDP from 9.9% in 2011. Thus, EC latest estimate of 7.7% for 2012 is way above actual figure, while its forecasts for 2013-14 are still worse than 2012 official data.

Given interest payment reductions of almost 1% of GDP due to the debt-reducing measures adopted by the Eurogroup in late 2012 as well as a package of savings measures amounting to 7.2% of GDP over 2013-14 which was adopted in November, the overall government deficit in 2013 is now expected to be 4.6% of GDP dropping to 3.5% in 2014. EC new deficit estimates are almost 1% lower than autumn forecasts, which were calling for a deficit of 5.5% in 2013 and 4.6% in 2014.

Gross public debt is estimated at 161.6% of GDP in 2012, 15% of GDP lower than in the autumn 2012 forecast, mainly thanks to the debt buyback operation carried out in December 2012. The debt ratio is projected to increase to 175.6% of GDP in 2013 as the economy contracts, after which it is expected to fall at an accelerated pace, supported by an improving budget balance and stronger nominal GDP growth.

The report also outlines the risks to EC baseline outlook:

• On the upside, there is a distinct possibility for a stronger return of confidence and the start of the recovery earlier in 2013. This would in turn have positive spillovers on the fiscal balance. Additionally, the repayment of government arrears in 2013 and the reversal of the liquidity squeeze may have a stronger impact on private sector demand thereby offering a bigger offset to fiscal consolidation than projected.

• On the downside, any hesitation in programme implementation, in both the fiscal and the structural area, may deter investors and weigh on demand. Employment may respond more negatively than forecast to the depressed demand conditions expected in 2013. The one-off costs of measures related to the banking sector and tax refund arrears, whose recording is currently being assessed by statistical authorities, are expected to impact the deficit in 2012 and/or 2013, although at least part of this statistical recording would not affect programme targets.