| Research guide to European Monetary Union A first convergence programme for the 1993-95 period outlined a rather theoretical and unrealistic path and was abandoned after only a few months. The socialist government that was returned to office after the 1993 elections made a more serious effort to achieve convergence, preparing a revised programme with more feasible year-to-year targets, and prompt action bolstered its credibility. As the following table suggests, there was a long distance between the starting and targeted positions, and with a record of footloose policies and poor economic performance during the two previous decades, the project seemed unattainable at that time. Greece has consequently long been regarded as an outsider in the Emu context. The achievements to date are a relatively fast deceleration in inflation, stabilisation of the debt to GDP ratio at a level around 110%, and a growing primary fiscal surplus - 4.9% in 1996 compared to 2.1% in 1994 - which helped to halve the general government deficit to around 5% - slightly over the targeted 4.2% target, with the debt to GDP figure edging towards the 110% level. In reality, Greek convergence has turned out to be a back-loaded endeavour, implying that the process contains residual risks, as well as future opportunities. A key instrument in fighting inflation, apart from being a major achievement per se, is the successful implementation of a 'hard drachma' policy. The Bank of Greece set this target in 1994 and its credibility was immediately tested after the dismantling of exchange controls. The skillful defence of the drachma during the May-June 1994 crisis boosted the credibility of the policy, and the diminishing rate of depreciation since then has reaffirmed the strong commitment. This has encouraged international investors to take advantage of high yielding Greek securities, adding liquidity to the Greek market, and the compound effect of improved fundamentals and increased liquidity has resulted in a fast decline in interest rates, especially in the second half of 1996. The current situation is one of a flat yield curve at the level of 10%. A more relaxed monetary stance and collapsing spreads in other peripheral countries have also contributed to the upbeat mood. It appears that markets already assign quite a high probability to Greece's participation in Emu, as Greek Treasury yields have narrowed to some 100 basis points over Italian BTPs. There is a strong case to be made that Greece will join Emu in a second enlargement of the group of participants, likely to occur some time around 2002. If so, a new rally in drachma-denominated securities will take place, but the market needs a new injection of good news before spreads start trending lower. Convergence efforts to date have evolved around a macroeconomic strategy, and a quite successful one at that. Further progress, however, needs the implementation of a complementary strategy for structural reforms and, in our view, a downsizing of the public sector. As with most countries in earlier stages of their convergence efforts, Greek governments have tried to lead the electorate up the garden path, by putting forward the assumption that fiscal drag and stricter tax controls will suffice for the bulk of the necessary fiscal adjustments. It has become more and more evident, however, that the former mechanism loses its strength as disinflation continues while the latter appears to have reached some critical limits, at least in the short term. Cutting expenditure and accelerating privatization have, therefore, become inescapable next steps. With the present government's firm pro-European stance and an increasing public awareness that huge political as well as economic benefits are at stake, convergence has created a broad consensus on sound policies. Under all circumstances, the process entails healthier fundamentals, imparting a new viability to Greek investments and improving the outlook for Emu participation by the year 2002. 1Interest rate calculations are somewhat tricky because until mid-March this year the Greek Treasury did not issue long-term fixed coupon securities which are benchmarks for the Maastricht criteria. As an effect, the 19.7% rate in 1994 has been calculated by the Bank of Greece adding a spread on the 12-month bill rate, while the targeted 1999 rate has been projected on the assumption that long-term fixed income securities will have been issued by then. Indeed, the first five and seven-year fixed coupon bonds were issued on March 19, 1997, yielding 9.2 % and 9.8% respectively. 2The drachma depreciated by 5.9% against the Ecu in 1994, 3.05 in 1995 and only 1% in 1996.
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