Greece Crisis: All is not well - hgsitebuilder.com · Greece Crisis: All is not well Authors Dr. Laila Memdani * Address For correspondence: Assistant Professor, IBS Hyderabad, India

International Journal of Applied Research & Studies ISSN 2278 – 9480

iJARS/ Vol. II/ Issue 3/Mar, 2013/356 1

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Research Article

Greece Crisis: All is not well

Authors

Dr. Laila Memdani *

Address For correspondence:

Assistant Professor, IBS Hyderabad, India

Abstract

The case, as the name suggests, discusses about the Greece Crisis. It discusses how it started, causes and

its impact on the world in general and India in particular. The main cause for the crisis was lack of prudent

fiscal policy and failure of common monetary and independent fiscal policy regime of Euro Zone.

Government’s prime sources of utilisation of borrowings were to pay for the imports from abroad which

were not offset by any exports. Trade deficits and the Budget of the government bubbled up during

2000’s and failure of the government in channelizing the borrowed funds to the productive arenas of

investment to reap future growth ,leading to creation of competitive economy and creation of new

resources to repay the debt.

Background of the Case

Early 2010 saw Euro zone (refers to the 17 members of the European Union (EU) that use the Euro as

their currency. They are Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Ireland, Italy,

Luxemburg, Malta, Netherlands, Portugal, Slovakia, Spain, Greece and other European countries) in the

midst of a major debt crisis. The government of all the countries in the Euro Zone had piled up what was

considered to be unsustainable levels of Government debt. Greece, Portugal and Ireland had turned to

other European Nations and the IMF (International Monetary Fund) for further loans to avoid default on

their earlier Debt. The crisis had spread across to Italy and Spain the 3rd

and the 4th largest economies in

the Euro zone (New York Times Nov. 2012)1.

Greece could be also termed as the epicentre to this epic crisis situation in the Euro zone having the

highest levels of public debt amongst the Euro zone nations and accounting for one of the highest budget

deficits. It was the first amongst the Euro zone members to come under intense pressure and set the trend

of turning towards the IMF in the crisis situation, .ECB (European Central Bank) and the Greek

government took substantial crisis response measures (Constâncio 2011)2

.

[email protected] * Corresponding Author Email-Id

mailto:[email protected]



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In July2011 at the orders of the European Leaders, Greek Bond Holders had also indicated that

they will be accepting losses on their Investments to mitigate Greece’s short run debt payments .If the

plans were carried out it would have seen Greece repeating its half a decade old history of default (1934-

64) (Exhibit 2).

The Greek economy survives on a history of defaults and the history dates back to 1932 when Greece was

the only country was at default. Almost after five decades or 50 years the Greek economy was in doldrums

and nearing to default.

Major contributors to the Greek default were:

Non – Chalant Control of the economy

Inefficient public administration

Endemic Tax Evasion

Widespread Political Influences

Low interest rates

2008-09 crises led to acceleration of these problems and public finances were stained to an unsustainable

degree.

Course of Events and Causes

In the 1990s as Greece started its preparations of adoption of Euro as national currency, the countries

borrowing costs dropped drastically. 10 year Greek Bonds interest rates had dropped by almost 18 %(

6.5% from 24.5%) between 1993 -99.The belief amongst the investors of a widespread convergence

amongst the Euro Zone nations was instated. The investor’s belief was reinforced by policy Target better

known as convergence criteria-(It is the criteria which a country has to meet to join the Euro Zone)

Common Monetary Policy being anchored by economic heavyweights which also included Germany and

France and is managed by ECB very conservatively. Additionally every member of the EU were bound by

the rules of Stability and Growth Pact which limits government deficits(3% of GDP) and the level of

public debt (60% of GDP).These entire factors combined together contributed to the new and regained

Investors Confidence in Greece and the other member states of Euro Zone with weaker traditional

fundamentals.

But things did not shape up as they were expected; even the influx of capital and the pursuit of meeting up

with the eligibility criteria to sustain the Euro zone eligibility did not show any changes in the traditional

way of the Greek’s economy and Investment policies thereby increasing the competitiveness of the

economy. Government’s one of the prime sources of utilisation of borrowings was to pay for the imports

from abroad which were not offset by any exports.

Trade deficits and the Budget of the government bubbled up during 2000’s and failure of the government

in channelizing the borrowed funds to the productive arenas of investment to reap future growth ,leading

to creation of competitive economy and creation of new resources to repay the debt.



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The cash generated through raising debt was primarily utilised for current consumption needs of the

country rather than being used for growth generating prospects.

Policies laid down by the EU for debt capacity check of individual nations had gone for a toss.35 cases

were initiated against members violating the Stability and Growth Pact .This helped the EU to take a

stand against the defaulting nations (Exhibit 3).

When any government rely only on the borrowing from International Capital Markets for their budget and

trade deficits, it is surely vulnerable to shift the investors’ confidence. This is what the situation Greek

Government exposed itself to was. The Loss of investor confidence in the fact of

Government’s intention of repaying debt or rather its ability to pay debts compelled the investors not to

lend anymore to the Government and rather if any lending was done it was done at a high rate beyond the

Government’s affordability. Lack of access of the new funds certainly made it difficult for the government

to meet their existing liability arising out of debt maturities as it became due (rolling over of debt),leaving

the government with an option to implement austerity .

From 2009 onwards the investors’ confidence in Greece regarding the nation’s capability to service its

debt dropped significantly. The Global Financial Crisis (2008-09) and the followed up economic

downturn strained public finances of many advance economies including Greece which was a result of

weakened because of increased spending on the unemployment benefits and lowering tax revenues.

Reported Public debt of Greece rose from 6% to 126% of GDP in 2009.

George Papandreou, the then elected prime minister stated that the earlier government had understated the

budget deficit. The new government revised the budget deficit to higher by 6.5%. In the major turn of

events major credit rating agencies downgraded the Greek bonds

As more and more decline in the Investors’ confidence was noticed it made evident more clearly every

time investors disbelief in the nation’s debt repayment capacity. This made the debt raising instruments

issued by the government i.e., Greek Bonds more and more costly i.e., with demand of higher interest

rates from the investors which compensated investors for their risk taking or act as a risk premium. It also

drove up Greece’s borrowing cost and increased the severity of its debt levels steering Greece more

towards default (Exhibit 4).

Policy Response

The ECB, European Leaders and the IMF came to a consensus on the matter that an uncontrolled and

disorderly default of the Greek Debt would eventually turn out to be very risky and all attempts should be

made to avoid it. The primary concern was that this default could give rise to a situation where there will

be a major sell-off of bonds of other Euro zone members with high debt levels and those European Banks

which were exposed to Greece and other Euro zone governments would not be able to bear losses on

investments .Financial Turmoil and fear of contagion drove home a major policy response by IMF,

Europeans and Greek Government in MAY 2010 to avoid a Greek default. A Second crisis response in

2011 was announced more than a year later from which Greece was saved from default.



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It can be said that till date crisis responses have been successful in keeping Greece economy away from

default but no clear path to recovery or containing the Debt demon has been worked out.

May 2010 saw the first round of crisis response in the form of austerity measures from the Greek

government and financial assistance from the Euro zone and IMF. Central Banks too played a crucial

reform and liquidity in this region.

Euro zone leaders along with IMF declared a 3 year Euro 110 billion package(about $158 billion) in loans

to Debt laden Greece a the market based interest rates. A contribution of Euro 80billion from the

European countries was pledged and Euro30 billion was pledged from IMF. Disbursements were made on

the condition of economic reforms.

The EU leaders in an attempt to prevent any such crisis in the Euro zone in May2010 decided on a new

mechanism of financial assistance to the members of the Euro zone

The Mechanism was:

Two temporary 3 year financial assistance to Euro zone members of loans totalling to

Euro500 billion facing debt crisis.

IMF could also provide additional support if required.

Portugal and Ireland also subsequently were provided the IMF and EU program

In March 2011, EU leaders agreed on establishment of ESM (European Stability Mechanism) to replace

temporary relief’s post their expiry in 2013. Implementation of healthcare and pension reforms by the

government played a vital role in consolidation of public finances. In July 2010 the pension reform

brought about the most sought reforms in the average retirement age and method of pension calculation in

the parliament which was much advocated by advocates of Greek Economic Reforms.

Healthcare reforms witnessed a reduction in total expenditures in healthcare and a consolidation in the

Industry per say. Structural reforms of 2010 were focussed on rigid and highly fragmented market to boost

competitiveness.

A vital role was also played by the ECB and the US Federal Reserve (the “fed”) in responding to the

crisis.ECB in May2010 announced for the first time start purchasing the European Government Bonds

from the secondary markets to reinstate the investors’ confidence and lower the Bond spreads for Euro

zone bonds under market pressure.

In between May 2010 and June 2011, ECB had purchased government bonds totalling to Euro 78 billion

of which more than half was Greek Bonds.

ECB provided more liquidity for the support of private banks in Greece and provided more flexibility than

it did before the Crisis.

The liquidity support climbed up from Euro 47 billion in 2010 to Euro 98 billion in May 2011 which is

roughly estimated to be 40% of Greece’s GDP.



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FED support to the crisis response was through re-establishment of temporary reciprocal currency

arrangements better known as swap lines, with a combination of several central banks to increase the

dollar liquidity in global markets.

Earlier swap lines were a tool used during Global Financial Crisis. Swap lines had an extended life till

August 2012 just when it was about to expire.

Advent of 2011 made it clear that the Greek crisis had led to severe and steady contraction of the Greek

Economy the severity was more than expected and more assistance would be required in lieu of avoiding

the default risk. After requirement of more austerity measures for adoption by Greek economy a second

package was debated upon by IMF, ECB and EU for several weeks.

Worsened economic conditions in 2011 compelled Greek Parliament to approve an additional round of

structural reforms through austerity measures. These were compulsory for the Greek government to get

the next round of disbursements of funds from original Euro zone and IMF financial assistance package.

Greece proposed a consolidation program the so called MTFS (Medium Term Fiscal Strategy) of the

Greek economy through 2015 worth Euro 28 billion (12%GDP), including

Euro 6.5 billion additional cut down on spending through:

Reducing the overstaffing of public sector

Streamline social transfers

By improving the performance of the public sector on a whole

These consolidation measures were expected to bring down the government’s deficit by around 0.9% by

2015

Another significant component inculcated by the Greek Government towards the newly woven fiscal

strategy and the most controversial as well was privatisation of the public real estate program which was

expected to generate Euro 50 billion.

Significant questions were being pointed at the Greek Government’s governing capabilities.

July 2011, saw Greece inching towards its second financial stimulus of approximately Euro 107 billion.

The 2nd

financial stimulus was more of in favour of Greece in respect of its terms and conditions which

entailed larger maturity periods and lower interest rates.

Offer of extension of maturity deadline of the earlier stimulus provided to Greece by the Euro zone

members was accepted as well.

IMF was not the contributor of the second stimulus despite repeated requests by the Euro zone. The terms

and conditions of the EFSF in the meantime were made to be more flexible, its dimensions were increased

from merely providing loan to even extending line of credit to those countries which were under the heat

of market pressures it also included financing of recapitalisation of Euro zone banks, buying bonds in the

secondary markets with the prior approval of ECB ratified by national parliaments.



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For lowering the Greek debt for a short term period European leaders in collaboration with IIF (Institute

for International Finance- which is an association of the Private Financial Institutions) made an

announcement regarding the contribution of EURO 50 billion from the holders of the Greek Bond.

The policy responses to drive out Greece of an expected default in lieu of debt crisis have not been taken

lightly by the IMF, Euro zone and the European leaders. The policies were aimed at:

Prevent the Greek economy from default

Restoration of debt sustainability in Greece

Prevention to be taken from spreading of this crisis in other Euro zone countries.

The above mentioned responses had been made by the Greek government, IMF, Euro zone and European

Leaders. All these crisis responses drew limited success in saving Greece from faltering into a debt default

crisis but it has thus failed to put the economy in a clear path of recovery and sustainability.

As per the IMF estimations:

There was a substantial increase in the Greek debt levels in 2010-11 ranging from

143% of GDP to 166% of GDP.

Forecasted Debt to GDP for 2012 would be172%.

It is estimated that the debt levels would start to decline only after 2013.

Lack of growth in the economy is the biggest hindrance being faced by Greece at this

point of time. It is for the growth levels that once it starts increasing, the tables will

turn and investors would be able to restore their confidence in the economy.

The Greek economy is contracting y-o-y basis. In 2010 it contracted by 4.5%, In 2011

by 2.9% and 2012 is expected to witness a contraction of 3.5%.Growth in the near

future seems difficult since the austerity performs have led to a depression of the

domestic economy.

Fostering of short – term growth in the Greek economy is what has been seen by the

Government at large as a response to government’s austerity measures which makes

the growth

Following are some of the issues which come across as a concern for the Greek economy:

Depressed Domestic Growth due to austerity measures

Non Reliance on exports for the Growth of the economy

Being a member of the Euro zone, currency depreciation is impossible

Policy responses of Greece Crisis have not come across as a stern policy thereby not

convincing investors to prevent its spread in the other Euro zone countries.

Weak Public finances due to lack of stern crisis response.



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Greece crisis has caused an increase in the Bond spreads for other Euro zone nations

as well.

2010 saw Ireland and Portugal following the suit of turning to the authorities i.e., IMF

and EU (BBC News, Sept 24 2010).

Greece crisis is considered to be a trendsetter of crisis in the Euro zone.

The policies and responses could not help the spread of the Debt Crisis beyond

Greece

European Leaders also can be blamed of not being decisive in the hour of crisis.

European leaders’ failure to act decisively during the crisis and their piecemeal

attitude to crisis response and their attitude to public disputes exaggerated investor’s

anxiety.

Not only Greece but the entire Euro zone’s fundamental fiscal challenges had become

unsustainable.

Spain is currently facing a severe housing bubble

Ireland has a bloated banking Industry

A decade of Anaemic Growth is being faced by Portugal.

The “roll-over risk” was another issue which had played a crucial role in the Greek crisis. We can also

call it as Greece debts had encountered a “bad – equilibrium”. This is that when a government has to meet

its public debt obligation that is they are nearing maturity. This happens when the countries in context are

exposed debt to such an extent that they get forced to depend on the market to roll over debt. This also

depends on the maturity structure of the debt. If the debt rollover has a longer maturity horizon then there

is certain time period available in rollover but if shorter maturity of debt is there the amount which has to

be rolled over entails large amount payable in a short span, may be even before completion of your

investment cycle (Cochrane 2001)3.

The Greece crisis was a living witness to the concern of the economists which proved to be valid as the

European Leaders and the EU failed to respond swiftly in the crisis situation. The primary concern of the

economist at the time of formation of the Euro zone was that different nations will be governed by

different sets of rules and regulations and same monetary policy but having individual fiscal policies how

will the governance be possible?

On a larger horizon in view Euro zone was sparked by a larger question of “how can one resolve tensions

between common monetary policies and national fiscal policies”



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Impact of Crisis in Global Market

Euro zone crisis continued to attract the eyeball of every individual as the centre of attraction as investors

still continued to be anxious that in zeal to curb down deficits and bring down debt growth will be killed if

any withdrawal of stimulus package takes place from Greece, Portugal and Spain. The anxiety of

investors was reflected in Wall Street (exhibit 7). US Stocks took the highest beating in the stock markets.

It took deepest plunge within a year and fears grew amongst the investors regarding the Euro zone crisis

around the world just when US was on its way to recovery.

Number of people who applies for unemployment benefits increased drastically

Casualties were taken by Euro as a currency week after week.

Post Crisis Euro had fallen to its lowest level ever.

The next week it fell by 0.1% @ $1.2334/ Euro

Earlier it rallied around $1.22377 which was its lowest level from $1.51 in previous

year of crisis

Questions by Investors on government’s ability to handle such debt were increasing

with time.

Impact on India

Indian markets saw a correction of 10%from its highs riding on the doldrums caused in the markets due to

speculations of reaction of Greece driven Euro zone crisis.

The question on Euro zone stability once again resurfaced when Spain was recently downgraded by Fitch.

India however did not see a major correction in the market due to the Euro zone debt crisis as much as the

global markets faced throughout. India was an out performer during the phase when global markets were

facing the Jitters of the Euro debt crisis. The recent corrections in the market can be said to be driven

somewhat by the Euro zone crisis but more on the chances of US facing a possibility of double dip

recession.

When it comes to Indian economy, it is an economy in the world which is hardly dependant on Europe for

its exports or Imports. Even the Indian IT sector has a lower exposure or a limited exposure to an extent of

a quarter of their revenues from Europe. Greece, Spain, Italy and Portugal combined together accounts for

4% of India’s Total Exports (Exhibit 9).

As per latest statistical data revelations and the latest figure from the government on Indian Imports and

Exports, India had a registered 5.1% in 2009, 3.7% in 2010 and 2.5% in 2011of total exports to the above

stated nations.

There are many parameters based on which Indian Stock markets have outperformed globally across stock

markets (Exhibit 8).

India primarily exports textiles, pharmacy products, Gems, etc to European countries which Euro zone

combined accounts for 21%. But the PIGS nation accounts for only 4 % of the total exports for India. So if

the debt crisis extends towards the entire Euro zone then there will be some chances of India to be tensed

about otherwise India has not yet witnessed any major hiccups due to crisis.



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Benefits to the Indian Economy from the Crisis

A sovereign debt crisis is not a small issue in the eyes of investors. Since investors started losing money

and along with money their confidence on the economy and started to drive out their money in the areas

they had parked it earlier in the Euro zone nations and found the next best place to be Indian markets

where they could park the money. As India was the second best economy of the world and growing at a

pace of more than 5% of GDP and the country’s policies welcomed FII’s with open hand.

Conclusion

The Greece Crisis was due to many factors and main amongst them were lack of prudent fiscal policy, non

– Chalant Control of the economy, inefficient public administration and Endemic Tax Evasion. Moreover,

the cash generated through raising debt was primarily utilised for current consumption needs of the

country rather than being used for growth generating prospects. Greece also has the history of defaults and

this time it became the epicentre of crisis. India however did not see a major correction in the market due

to the Euro zone debt crisis as much as the global markets faced throughout. India was an out performer

during the phase when global markets were facing the Jitters of the Euro debt crisis.

Exhibit 1



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Exhibit 2

Exhibit 3

Figure Representing “„Greece‟s Twin Deficit” Budget & Current Account Deficit

Exhibit 4



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Exhibit 5

Table 1: EU-IMF Assistance for Greece, Ireland, and Portugal

Source: IMF press releases. Source: IMF press releases.

Date Agreed European

Financial

Assistance

IMF Financial

Assistance

Total Financial

Assistance

Greece May 2010 €80 billion

(about $115

billion)

€30 billion

(about $43 billion)

€110 billion

(about $158 billion)

Irelanda

December 2010

€45 billion

(about $65 billion)

€22.5 billion

(about $32 billion)

€67.5 billion

(about $97 billion)

Portugal

May 2011

€52 billion

(about $75 billion)

€26 billion

(about $37 billion)

€78 billion

(about $112 billion)



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Exhibit 6

Exhibit 7

US MARKET REACTIONS



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Exhibit 8

Exhibit 9



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2012.

2) Constâncio (2011)"ECB Contagion and the European debt crisis."

http://www.ecb.int/press /key/date/2011/html/sp111010.en.html 30 Nov. 2012.

3) Cochrane 2001,“Long Term Debt and Optimal Theory of Fiscal Policy". Econometrica ,

Vol. 69, No. 1 January, 2001 , 69 116 - Faculty."

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some-other-major-countries.html 30 Nov. 2012.

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rm%20Debt%20(Econometrica).pdf 30 Nov. 2012.

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POLICY OPTIONS. Academy Of Accounting & Financial Studies Journal, 1687-96.

9) Ersi Athanassiou (2009). Fiscal Policy and the Recession: The Case of Greece, centre for

planning and economic research, No 103.

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Occasional Papers, Fourth Review 82.

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http://topics.nytimes.com/

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http://capitalogix.typepad.com/public/2012/06/debt-levels-relative-to-gdp-of-piigs-and-some-other-major-countries.html%2030%20Nov.%202012

http://capitalogix.typepad.com/public/2012/06/debt-levels-relative-to-gdp-of-piigs-and-some-other-major-countries.html%2030%20Nov.%202012

Documents

Greece Crisis: All is not well - hgsitebuilder.com · Greece Crisis: All is not well Authors Dr. Laila Memdani * Address For correspondence: Assistant Professor, IBS Hyderabad, India