Euro Debt Crisis : Greece Reviewed by Kampamba Shula

The Euro Debt Crisis

The European sovereign debt crisis is a current financial crisis that has made it difficult for some countries in the euro region to repay or refinance their government debt without help from third parties. The structure of the Eurozone as a monetary union (i.e. one currency) without fiscal union (e.g. different tax and pension rules) added to the crisis and harmed the ability of European leaders to respond.
Greece
In the early mid-2000s, Greece’s economy was one of the fastest growing on the Eurozone and was associated with a large structural deficit. As the world was hit by the global financial crisis in the late 2000s, Greece was hit especially hard because its main industries which are 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.

The Origin of Greece’s Euro Debt crisis

Its starting point can be traced at the onset of the USA sub-prime crisis in the summer of 2007. Starting from a value of 25 basis points (b.p.), the spread of the 10-year Greek government bond yield against the German bund entered a moderately ascending path reaching 65 b.p. in August 2008. A second, much more intense, phase followed between September 2008 and March 2009. This marked the peak of the global credit crunch crisis, by the end of which the Greek spread had reached 285 b.p. Similar developments were observed in the rest of the EMU periphery countries; it was clear, however, that markets were distinguishing against Greek and Irish bonds. A brief period of de-escalation, between April and August 2009, coinciding with the partial easing of the global crisis, followed.

Nevertheless, although in August 2009 the Greek spread declined to 121 b.p., it was clear that, relative to other periphery EMU countries, markets continued to have Greek and Irish bonds on their bad books.

Greek Fundamentals

In the first-generation crisis model proposed by Paul Krugman (1979) the speculative attack against a currency peg is the deterministic outcome of an unsustainable fiscal expansion pursued by a myopic government and financed by excessive money creation depleting foreign currency reserves. When reserves fall below a critical threshold, rational agents, in anticipation of the peg’s future collapse, buy the government’s remaining reserves forcing an immediate devaluation. This restores the exchange rate to a value consistent with Purchasing Power Parity (PPP).

This story’s basic premise, i.e. unsustainable fiscal policy, is clearly present in the case of Greece. Also, since EMU accession in 2001 the country has experienced consistently higher inflation than the EMU average, resulting in substantial deviation from PPP, pronounced competitiveness losses and record current account deficits (see Arghyrou and Chortareas, 2008). Overall, there is little doubt that Greek fundamentals have deteriorated enough to justify a first-generation attack had Greece run a currency of its own.

But when compared to the collapse of a conventional peg, debt default is a much rarer and therefore much less likely event, particularly for a Eurozone member with additional access to IMF emergency cash. So, although the deterioration of Greek fundamentals plays a key role in current events, the crisis’ escalation in November 2009 is unlikely to have been caused by market fears of an imminent Greek debt default.

The proposed budget submitted to the EU in mid-November 2010 was a game changer, as it shifted the balance of expectations from credible to no credible commitment, putting Greece from the flat to the steep loss function (L2). This explains the steep increase in Greek bond spreads observed in mid- November/December 2009 in the absence of further negative news on fundamentals.

If the analysis above is correct, what we have observed in November 2009 was the mutation of a challenging crisis of deteriorating fundamentals into a full blown crisis of confidence in the Greek monetary regime. This explains the failure of the announced EU/IMF rescue plan to relieve the pressure on Greek spreads. The plan failed to do so because the Greek spread was not only driven by an increasing risk of default (to be fully explained below) but also increasingly strong expectations that Greece cannot bear, or is not willing to bear, the cost of reforms necessary to stay in the euro. In other words, the markets worry that Greece will eventually opt for a voluntary exit from the EMU causing Greek bond holders capital losses through currency devaluation.

Events then moved as follows: In the absence of an effective EU-sponsored mechanism of fiscal monitoring and imposing reform, Greek governments over 2001- 2009 did not implement sound economic policies, thus allowing further deterioration of fundamentals.

Current Events

On 23 April 2010, the Greek government requested an initial loan of 45 billion Euros from the EU and International Monetary Fund 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, in which case investors where liable to lose 30=50% of their money.

On 1 May 2010, the Greek government announced a series of austerity measures to secure a three year 110 billion loan. This was met with massive protests and social unrest throughout Greece. The Troika (EU,ECB and IMF), offered Greece a second bailout loan worth 130 billion Euros in October 2011, but with the activation being conditional on implementation of further austerity measures and a debt restructure agreement.

All the implemented austerity measures, have so far helped Greece bring down its primary deficit - i.e. fiscal deficit before interest payments - from €24.7bn (10.6% of GDP) in 2009 to just €5.2bn (2.4% of GDP) in 2011, but as a side-effect they also contributed to a worsening of the Greek recession, which began in October 2008 and only became worse in 2010 and 2011.The austerity relies primarily on tax increases which harms the private sector and economy. Overall the Greek GDP had its worst decline in 2011 with −6.9%, a year where the seasonal adjusted industrial output ended 28.4% lower than in 2005, and with 111,000 Greek companies going bankrupt (27% higher than in 2010).As a result, the seasonal adjusted unemployment rate also grew from 7.5% in September 2008 to a record high of 19.9% in November 2011, while the Youth unemployment rate during the same time rose from 22.0% to as high as 48.1%.

Some economic experts argue that the best option for Greece and the rest of the EU, would be to engineer an “orderly default”, allowing Athens to withdraw simultaneously from the Eurozone and reintroduce its national currency the drachma at a rebased rate.

However, if Greece were to leave the euro, the economic and political consequences would be devastating. According to Japanese financial company Nomura an exit would lead to a 60% devaluation of the new drachma. Analysts at French bank BNP Paribas added that the fallout from a Greek exit would wipe 20% off Greece's GDP, increase Greece's debt-to-GDP ratio to over 200%, and send inflation soaring to 40%-50%.Also UBS warned of hyperinflation, a bank run and even "military coups and possible civil war that could afflict a departing country". Eurozone National Central Banks (NCBs) may lose up to €100bn in debt claims against the Greek national bank through the ECB's TARGET2 system. The Deutsche Bundesbank alone may have to write off €27bn.

To prevent all this from happening, the troika (EU, IMF and ECB) eventually agreed in February 2012 to provide a second bailout package worth €130 billion, conditional on the implementation of another harsh austerity package, reducing the Greek spending with €3.3bn in 2012 and another €10bn in 2013 and 2014.[93] For the first time, the bailout deal also included a debt restructure agreement with the private holders of Greek government bonds (banks, insurers and investment funds), to "voluntarily" accept a bond swap with a 53.5% nominal write-off, partly in short-term EFSF notes, partly in new Greek bonds with lower interest rates and the maturity prolonged to 11–30 years (independently of the previous maturity).

On 9 March 2012 the International Swaps and Derivatives Association (ISDA) issued a communique calling the debt restructuring deal with its private sector involvement (PSI) a "Restructuring Credit Event" which will trigger payment of credit default swaps. According to Forbes magazine Greece’s restructuring represents a default. It is the world's biggest debt restructuring deal ever done, affecting some €206 billion of Greek government bonds. The debt write-off had a size of €107 billion, and caused the Greek debt level to fall from roughly €350bn to €240bn in March 2012, with the predicted debt burden now showing a more sustainable size equal to 117% of GDP by 2020, somewhat lower than the target of 120.5% initially outlined in the signed Memorandum with the Troika.

Critics such as the director of LSE's Hellenic Observatory argue that the billions of taxpayer euros are not saving Greece but financial institutions, as "more than 80 percent of the rescue package is going to creditors—that is to say, to banks outside of Greece and to the ECB. The shift in liabilities from European banks to European taxpayers has been staggering.

 One study found that the public debt of Greece to foreign governments, including debt to the EU/IMF loan facility and debt through the euro system, increased from €47.8bn to €180.5bn (+132,7bn) between January 2010 and September 2011, while the combined exposure of foreign banks to (public and private) Greek entities was reduced from well over €200bn in 2009 to around €80bn (-120bn) by mid-February 2012.

Economeka Recomendations by Kampamba Shula
The restructuring of Greek economy based on austerity alone is bound to fail unless it is inclusive of viable growth targets.Greece can not leave the Euro, the effects of such a move would be fatal to Greece and the periphery countries like Italy,Spain,Portugal.Time needs to be given to Greece for these reforms to be part of strategy that the Greek people believe is inclusive of Growth.This will in turn translate to business confidence which will help change investor perspective on Greek Bonds and bring yields down.

References

"Crisis in Euro-zone—Next Phase of Global Economic Turmoil". Competition master date =. Retrieved 24 February 2012.

Michael G. Arghyrou, J. D. (2010). THE GREEK DEBT CRISIS: LIKELY CAUSES, MECHANICS AND OUTCOMES. Cardiff: Cardiff University.