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Greek Tax: Greek Prices Point To Inflationary Recession

The puzzling picture of Greek macroeconomic statistics is raising increasing concerns about the country's ability to weather the storm of a debt crisis that morphed into a borrowing crisis and is now turning into an inflationary recession at the most critical point in time.

On Tuesday, Greek consumer inflation accelerated to a 5.4% annual rate in May, more than three times the average for the euro zone. The figure is the highest year-on-year inflation rate since August 1997.

However, the debt-laden Mediterranean country's gross domestic product is expected to contract by 4% this year, after falling 2% last year. It is hard to ignore that Greece is in an inflationary recession, which is worse than stagflation.

While Greece can partly blame accelerating readings on oil prices and import inflation due to a weaker euro, the austerity program imposed upon it by its EUR110 billion lenders, the European Union and the International Monetary Fund, are also responsible. The increase in VAT and excise tax is already feeding through significantly to the readings.

This tough austerity plan was supposed to lead to deflation and greater international competitiveness. But to date the opposite has happened. In fact the rising inflation rate is likely to lead to reduced consumer spending, lower economic activity and lead to slumping tax revenues - which are so precious for the country if it is to get out from underneath its EUR310 billion debt pile.

Consumption makes up about 70% of Greek GDP, but it has been stumbling due to higher unemployment which is expected to rise to 14.8% by 2012. Add to that tight credit conditions, government cuts to pensions and public sector wages, as well as poor sentiment - and then lump on top of that higher prices that are eating into spending power - and the growth engine of consumption could completely stall.

The only minor good news that inflation brings is that it leads to higher nominal GDP in the short term and reflects more positively on debt ratios. But this will be of little comfort if the government can't implement its deficit reduction program by collecting tax revenues.

And so far revenues do not bode well either. Just this weekend, Finance Minister George Papaconstantinou, admitted that while revenues were up provisionally 8% in May year on year, they missed the target of 11.7%. On the cost side the budget forecasts cuts of 4.8%, which would also fail to stimulate to a contracting economy.

While inflation is expected to decelerate next year, that forecast is highly contingent on not having new tax hikes. And those tax hikes could come as soon as September if Greece cannot prove to the IMF and EU that it is faithfully executing its budget in time for its August audit.

And more pain may lead to even less fiscal gains. This is a dangerous inflationary cocktail of recession, leading to more austerity, higher taxes, even lower consumption, even lower activity and in turn lower than budgeted tax revenues. A potential inflationary depression cannot be ruled out and the prediction of deflation for 2011 does not seem likely since most local economists predict that average inflation for next year will remain at between 1% to 1.5%.

The government's policy mix needs to balance austerity with a focus on growth, investments, privatization and liberalizing of monopolies and oligopolies. To date, they have only paid lip service to this wish list.

Let's hope the ultra austerity hawks of the IMF and the EU do not impose policy recipes and the government cannot resist as it has little negotiating power. Otherwise Greece could be pushed into the abyss of an inflationary depression, which may be the catalyst for yet another explosion of civil unrest.

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