Europe’s debt crisis is a continuation of the global financial crisis and also the result of how Europe attempted to solve the global financial crisis that brought an end to a decade of prosperity and unrestricted debt. European attempts at defending itself against a deep recession, has now created a new crisis of unsustainable and un-serviceable sovereign debt. In early 2010 fears of a sovereign debt crisis, the 2010 Euro Crisis developed concerning some European states including European Union members Portugal, Ireland, Italy, Greece, Spain,(affectionately known as the PIIGS) and Belgium. This led to a crisis of confidence as well as the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other EU members, most importantly Germany. Concern about rising government deficits and debt levels across the globe together with a wave of downgrading of European government debt has created alarm in financial markets. The debt crisis has been mostly centered on recent events in Greece, where there is concern about the rising cost of financing government debt.
On 2 May 2010, the Euro zone countries and the International Monetary Fund agreed to a €110 billion loan for Greece, conditional on the implementation of harsh Greek austerity measures. On 9 May 2010, Europe’s Finance Ministers approved a comprehensive rescue package worth almost a trillion dollars aimed at ensuring financial stability across Europe by creating the European Financial Stability Facility. Europe’s heavyweights spent massively on stimulation packages. However such attempts at defending themselves against a deep recession, has now created a sovereign debt crisis. The crisis in Europe has to do with the fear that some countries may be unable to pay back their use more money than they earn. Governments were able to borrow so cheaply in the past decade that running a deficit was often used to stimulate economic growth.
One of the ways governments can raise money is through selling bonds, which are bought back after a number of years with interest added. Interest on government bonds has been low for most European countries because bonds were considered secure investments. The market worked on the assumption that governments would always be able to afford buying them back. But what if a country can’t pay back their loans? If a business or individual is in this position, they default and are found bankrupt. But countries can also default on their loans.
Argentina defaulted on almost $100 billion of debt owed to the World Bank in 2002. Unemployment soared to 25 percent, GDP dropped by over 10 percent and the Argentine peso lost half its value overnight. This is the scenario that European leaders wanted to avoid when in 2009 concern started to mount over Greece’s ability to pay off its debt. Should Greece default, it would probably be forced to pull out of the euro with unknown but potentially grave consequences for the global economy debt. But debt in itself is not always considered a problem and European governments often.
A DEBT CRISIS deals with countries and their ability to repay borrowed funds. Therefore, it deals with national economies, international loans and national budgeting. The definitions of “debt crisis” have varied over time, with major institutions such as Standard and Poor’s or the International Monetary Fund (IMF) offering their own views on the matter. The most basic definition that all agree on is that a debt crisis is when a national government cannot pay the debt it owes and seeks, as a result, some form of assistance.
In the real world, of course, things definitely get messy. People are optimistic, hence they offer themselves for jobs they are not quite qualified for; they borrow money on more of a hope that their business plan will work out than a real knowledge of the difficulties and the problems ahead. There is also the government, who has entered the credit system to borrow money to finance its wars. If the wars turned out well then the bond holders got their money back. If the war was a disaster then the credit system crashed and bond-holders were lucky to get anything back.
The causes of the current debt crisis are complex, rooted in economic policies and development choices going back to the 1970s and 1980s. When the Organization of Petroleum Exporting Countries (OPEC) quadrupled the price of oil in 1973, OPEC nations deposited much of their new wealth in commercial banks. The banks, seeking investments for their new funds, made loans to developing countries, often hastily and without monitoring how the loans were used.
Some of the money borrowed was spent on programs that did not benefit the poor, such as armaments, failed or inappropriate large scale development projects, and private projects benefiting government officials and small elite. Meanwhile, as inflation rose in the U.S., the U.S. adopted extremely tight monetary policies that soon contributed to a sharp rise in interest rates and a worldwide recession. The irresponsible lending on the part of creditors, mismanagement on the part of debtors, and the worldwide recession all contributed to the debt crisis of the early 1980s.
Developing countries were hurt the most in the worldwide recession. The high cost of fuel, high interest rates, and declining exports made it increasingly difficult for them to repay their debts. During the rest of the decade and into the 1990s, commercial banks and bilateral creditors (i.e., governments) sought to address the problem by rescheduling loans and in some cases by providing limited debt relief. Despite these efforts, the debt of many of the world’s poorest countries remains well beyond their ability to repay it.
AIMS AND OBJECTIVES
At the end of this assignment my aim is to learn:
▪ What a Debt Crisis is?
▪ The European countries affected by a Debt Crisis.
▪ In detail about the Greek Debt Crisis.
▪ The causes of the European Debt Crisis
▪ The effects of the European Debt Crisis
▪ The various solutions undertaken to resolve the European Debt Crisis
The European Debt Crisis
The European debt crisis is the shorthand term for Europe’s struggle to pay the debts it has built up in recent decades. Five of the region’s countries – Greece, Portugal, Ireland, Italy, and Spain – have, to varying degrees, failed to generate enough economic growth to make their ability to pay back bondholders the guarantee it was intended to be. Although these five were seen as being the countries in immediate danger of a possible default, the crisis has far-reaching consequences that extend beyond their borders to the world as a whole. In fact, the head of the Bank of England referred to it as “the most serious financial crisis at least since the 1930s, if not ever,” in October 2011. This is one of most important problems facing the world economy, but it is also one of the hardest to understand.
In the early mid-2000s, Greece’s economy was one of the fastest growing in the eurozone and was associated with a large structural deficit. As the world economy was hit by the global financial crisis in the late 2000s, Greece was hit especially hard because its main industries — shipping and tourism — were especially sensitive to changes in the business cycle. The government spent heavily to keep the economy functioning and the country’s debt increased accordingly.
On 23 April 2010, the Greek government requested an initial loan of €45 billion from the EU and International Monetary Fund (IMF), to cover its financial needs for the remaining part of 2010. A few days later Standard & Poor’s slashed Greece’s sovereign debt rating to BB+ or “junk” status amid fears of default, in which case investors were liable to lose 30–50% of their money. Stock markets worldwide and the euro currency declined in response to the downgrade. The downgrading of Greek government debt to junk bond status in April 2010 created alarm in financial markets, with bond yields rising so high, that private capital markets practically were no longer available for Greece as a funding source.
On 2 May 2010, the Eurozone countries and the International Monetary Fund (IMF) agreed on a €110 billion bailout loan for Greece, conditional on compliance with the following three key points: ▪ Implementation of austerity measures, to restore the fiscal balance. ▪ Privatization of government assets worth €50bn by the end of 2015, to keep the debt pile sustainable. ▪ Implementation of outlined structural reforms, to improve competitiveness and growth prospects. The payment of the bailout was scheduled to happen in several disbursements from May 2010 until June 2013.
Due to a worsened recession and the fact that Greece had worked slower than expected to comply with point 2 and 3 above, there was a need one year later to offer Greece both more time and money in the attempt to restore the economy. In October 2011, Eurozone leaders consequently agreed to offer a second €130 billion bailout loan for Greece, conditional not only the implementation of another austerity package (combined with the continued demands for privatization and structural reforms outlined in the first programme), but also that all private creditors holding Greek government bonds should sign a deal accepting lower interest rates and a 53.5% face value loss.
This proposed restructure of all Greek public debt held by private creditors, which at that point of time constituted a 58% share of the total Greek public debt, would according to the bailout plan reduce the overall public debt burden with roughly €110 billion. A debt relief equal to a lowering of the debt-to-GDP ratio from a forecast 198% in 2012 down to roughly 160% in 2012, with the lower interest payments in subsequent years combined with the agreed fiscal consolidation of the public budget and significant financial funding from a privatization program, expected to give a further debt decline to a more sustainable level at 120.5% of GDP by 2020.
The second bailout deal was finally ratified by all parties in February 2012, and became active one month later, after the last condition regarding a successful debt restructure of all Greek government bonds, had also been met. The second bailout plan was designed with appointment of the Troika to cover all Greek financial needs from 2012-14 through a transfer of some regular disbursements; and aimed for Greece to resume using the private capital markets for debt refinance and as a source to partly cover its future financial needs, already in 2015. In the first five years from 2015-2020, the return to use the markets was however only evaluated as realistic to the extent, where roughly half of the yearly funds needed to patch the continued budget deficits and ordinary debt refinance should be covered by the market; while the other half of the funds should be covered by extraordinary income from the privatization program of Greek government assets.
Mid May 2012 the crisis and impossibility to form a new government after elections and the possible victory by the anti-austerity axis led to new speculations Greece would have to leave the Eurozone shortly due. This phenomenon became known as “Grexit” and started to govern international market behaviour. Due to a delayed reform schedule and a worsened economic recession, the new government immediately asked the Troika to be granted an extended deadline from 2015 to 2017 before being required to restore the budget into a self-financed situation; which in effect was equal to a request of a third bailout package for 2015-16 worth €32.6bn of extra loans.
On 11 November 2012, facing a default by the end of November, the Greek parliament passed a new austerity package worth €18.8bn, including a “labor market reform” and “midterm fiscal plan 2013-16”. In return, the Euro group agreed on the following day to lower interest rates and prolong debt maturities and to provide Greece with additional funds of around €10bn for a debt-buy-back programme. The latter allowed Greece to retire about half of the €62 billion in debt that Athens owes private creditors, thereby shaving roughly €20 billion off that debt. This should bring Greece’s debt-to-GDP ratio down to 124% by 2020 and well below 110% two years later. Without agreement the debt-to-GDP ratio would have risen to 188% in 2013.
Many experts agree that the eurozone crisis began in late 2009, when Greece admitted that its debts had reached 300 billion euros, which represented approximately 113% of its gross domestic product (GDP). Meanwhile, the European Union (EU) had already warned several countries about their debt levels, which were supposed to be capped at 60% of GDP. In early 2010, the EU noted several irregularities in Greece’s accounting systems, which led to upward revisions of its budget deficits. The negative sentiment led investors to demand higher yields on sovereign bonds, which of course exacerbated the problem by making borrowing costs even higher. Higher yields also led to lower bond prices, which meant larger countries and many eurozone banks holding sovereign debt in troubled countries began to suffer, requiring their own set of solutions.
After a modest bailout by the International Monetary Fund, eurozone leaders agreed upon a 750 billion euro rescue package and established the European Financial Stability Facility (EFSF) in May of 2010. Eventually, this fund was increased to about 1 trillion euros in February of 2012, while several other measures were also implemented to stem the crisis. Countries receiving bailout funds from this facility were required to undergo harsh austerity measures designed to bring their budget deficits and government debt levels under control. Ultimately, this led to popular protests throughout 2010, 2011 and 2012 that culminated in the election of antibailout socialist leaders in France and likely Greece.
In January 2010 the Greek Ministry of Finance highlighted in their Stability and Growth Program 2010 these five main causes for the significantly deteriorated economic results recorded in 2009. ▪ GDP growth rates: After 2008, GDP growth rates were lower than the Greek national statistical agency had anticipated. ▪ Government deficit: Huge fiscal imbalances developed during the past six years from 2004 to 2009, where “the output increased in nominal terms by 40%, while central government primary expenditures increased by 87% against an increase of only 31% in tax revenues.” ▪ Government debt-level: Since it had not been reduced during the good years with strong economic growth, there was no room for the government to continue running large deficits in 2010, neither for the years ahead.
▪ Budget compliance: Budget compliance was acknowledged to be in strong need of future improvement, and for 2009 it was even found to be “A lot worse than normal, due to economic control being more lax in a year with political elections”. ▪ Statistical credibility: Problems with unreliable data had existed ever since Greece applied for membership of the Euro in 1999. In the five years from 2005–2009, Eurostat each year noted a reservation about the fiscal statistical numbers for Greece, and too often previously reported figures got revised to a somewhat worse figure, after a couple of years.
Many economists have argued that Greek should default and pull out of the euro. But according to a study released this September by UBS bank, Greece would suffer a painful economic contraction if it were to do so. According to its figures, a weak euro country such as Greece pulling out of the Euro would face a drop in GDP of between 40 and 50 percent, or a per person cost of between €9,500 and €10,500.
According to Diego Valiante from the Centre for European Policy Studies, the effects on global financial system could be more severe than we could imagine. “We have discovered that the financial system is enormous and is just too big and interconnected to fail. We have to save the financial system from a collapse which would have repercussions on the economies and competitiveness of countries.” Valiante argued that if Greece went down, it would inevitably affect the rest of the global economy due to intertwined the relationships of global banks.
If Greece defaults, then banks across Europe who bought billions of euros of Greek debt – because it was considered safe – would suddenly be left with worthless assets. This is where contagion kicks in. Other banks, unsure of who has bought Greek debt, will then start calling in debts out of fear that they cannot reclaim their loans. This then trickles down to businesses which would then be unable to raise the capital they need and Europe’s economies would inevitably experience another recession.
Sigurd Næss-Schmidt, from the think tank Copenhagen Economics, believes this process has already started. “Banks are losing trust in each other again. They don’t know who has enough assets and credit markets are freezing up,” he said at a recent lecture in Brussels.
The failure to resolve the eurozone crisis has been largely attributed to a lack of political consensus on the measures that need to be taken. Rich countries like Germany have insisted on austerity measures designed to bring down debt levels, while the poorer countries facing the problems complain that austerity is only hindering economic growth prospects further. Perhaps the most popular solution proposed has been the so-called Eurobond, which would be jointly underwritten by all eurozone member states.
The problem with this solution is mostly that of complacency. Some experts believe that access to low interest debt financing will eliminate the need for countries to undergo austerity and only push back an inevitable day of reckoning. Meanwhile, countries like Germany could face the brunt of the financial burden in the event of any Eurobond defaults or problems. With disagreements between rich and poor countries in the region, there is a risk that nothing will be accomplished and the situation will only worsen. In the end, there may not be any easy answer to the eurozone crisis, but financial markets continue monitoring the situation in hopes that a solution amicable to all countries arises.
My source of knowledge was mainly the INTERNET, through which I used various sites wikipedia and related sites.
In conclusion I would like to say that, the EU finance ministers in their latest efforts to turn things around, have reached a deal on cutting Greek debt and given the green light for the country to receive the next pot of bailout money. It’s been waiting since June for the cash and it means the government there will be able to pay workers’ wages and pensions in December. I also learnt that Greek debts will be cut by 40bn euros (£32bn) and the country will get another 44 billion euros (£35billion) of bailout loans.
Several countries in the eurozone have borrowed and spent too much since the global recession, losing control of their finances. Greece was the first to take a multi-billion pound bailout from other European countries, followed by Portugal and Ireland. Their governments had to agree to spending cuts before the loans were approved. Greece is still in trouble though and needs more money. Many Greek people don’t want any more tax rises and job losses, but tough spending plans have been pushed through so the government can receive its bailout cash. There have been angry protests on the streets and strikes at power stations. The Greek government is relieved at the latest deal, but the main opposition party, Syriza, doesn’t think it goes far enough and called it a “half-baked compromise”. If Greece is unable or unwilling to keep paying what it owes, the country will effectively go bankrupt and probably become the first country to leave the euro currency.
There are worries that other countries could do the same, threatening the strength of Europe. Life would also become even tougher for Greek people, who would feel much poorer as their money wouldn’t be worth as much. Governments in other eurozone countries like Ireland and Portugal would have to pay more to borrow money and might have to raise taxes and cut spending to balance the books
As the UK doesn’t have the euro, it hasn’t contributed to the bailout except through its membership of the International Monetary Fund, which lends to countries around the world. But some British banks have lent money to Greece and would lose billions if the country went bankrupt. They would lose even more if the problems spread to other countries like Spain and Italy. If the banks are hit hard there could be another credit crunch, making it much harder for British people and businesses to borrow cash for loans and mortgages. Companies in the UK also do many of their trade deals with firms in Europe, so financial problems overseas would affect British business too.