International Journal of Applied Research & Studies ISSN 2278 – 9480
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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
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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.
International Journal of Applied Research & Studies ISSN 2278 – 9480
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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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