Economic Crisis in Greece - Atasi Das

The sovereign debt crisis in Greece is again making headlines and Greece has once again avoided default by a whisker. The European Union (EU) and the International Monetary Fund had set June 30, 2011 as the deadline for Greece, to pass the latest €28.4bn austerity package, which includes tax raises, spending cuts and privatizations, to be implemented within 2015. It was imperative for Greece to pass the austerity package to avail the fifth installment of the €110bn worth bail-out deal agreed in May, 2010. Greek Prime Minister George Papandreou won two crucial votes on 29th June and 30th June, 2011; the first one involved the main austerity bill, while the second one was important for implementing the concerned measures. Greece is in for a €12bn cash injection, which completes the bail-out amount of €110bn.
Greece’s total debt is estimated to be around €360bn, which is over 160 percent of its GDP. Bloomberg editorial points out that even after a second bailout package, Greece would have to achieve a budget surplus of 5 percent of GDP for about three decades to bring down its debt to 60 percent of its GDP, which is the maximum permissible limit allowed by Eurozone rules. The origin of the crisis can be traced back to 2001, when Greece adopted the Euro as its official currency. Between 2001 and 2008, Greece’s budget deficits averaged 5percent per year, compared to a Eurozone average of 2percent, and its current account deficits averaged 9percent per year, compared to a Eurozone average of 1percent.

In 2009, Greece’s budget deficit was calculated to have been more than 13percent of its GDP. The high budget and current account deficits were the result of high spending by successive Greek governments. These twin deficits were funded by borrowing heavily in international capital markets, resulting in high external debt for the country (116percent of GDP in 2009). Both Greece’s budget deficit and external debt level were well above the maximum limits permitted by the rules governing the EU’s Economic and Monetary Union (EMU).Greece’s dependence on external financing for budgetary resources exposed its economy to shifts in investor confidence.

In October 2009, investors became unnerved when the newly-elected Greek government revised government budget deficit estimates to nearly double the original figure. Over the next few months, the government announced several austerity measures and sold bonds in the international capital markets to raise the required funds. In late April, Eurostat, the EU’s statistical agency, further scaled up Greece’s 2009 deficit estimates. This was when the Greek bond spreads spiked and the credit rating agencies, Moody’s and Standard and Poor’s downgraded Greek bonds.The Greek debt crisis was now confirmed and the worst fears of the investors had finally come true. The Greek government wanted financial assistance from the 16 members of the Eurozone and the International Monetary Fund (IMF). A €110 billion package was announced on 2nd May, 2010 to prevent Greece from defaulting on its debt obligations and to minimize the spillover effects of Greece’s crisis to other European countries. On 9th May, 2010, the EU announced that an additional €500 billion that could be granted as aid to vulnerable European countries. Greece had escaped its first default.

The present situation in Greece is a culmination of the cumulative effects of a number of external and internal factors: on the domestic front, the government spending was high, whereas revenue collection was weak. There was rampant tax evasion and productivity in the public sector was poor. The Greek economy was suffering from declining international competitiveness because of high relative wages and low productivity. Greece’s adoption of the Euro as its national currency in 2001 is seen by some as a key factor for Greece’s debt buildup. Investors tended to view Euro members with increased confidence. The increased access to capital at low interest rates allowed Greece to build up huge volumes of debt. The lack of enforcement of the Stability and Growth Pact was also a contributing factor to Greece’s high level of debt. The pact in line with the 1992 Mastricht Treaty, ruled that government budget deficits should not exceed 3percent of GDP and public debt should not exceed 60percent of GDP. Last but not the least, there was manipulation of data by Greek authorities.

The implications of this debt crisis are well known. The burden of this huge debt has to be borne by the taxpayers of all the European countries, as well the private sector holders of this debt. The Greek crisis may well spill over to the entire European Union with disastrous effects. The bail-out package of 2010 reassured the investors temporarily. The present scenario calls for a second bail-out scheme to salvage the situation. The role of the complex financial instruments in Greece’s debt crisis is being investigated by the Federal Reserve. This has created tensions between the United States and the EU over financial regulations, with some European leaders recommending stricter financial regulations.

The crisis has given rise to a debate over the EU’s monetary union. The Eurozone has a single monetary policy in the form of a common currency but separate fiscal policies. According to some experts, this arrangement is the source of the problem.   The recommendations include a more integrated fiscal policy and stronger economic governance for the EU. Others have suggested that these vulnerable European countries should focus their policies to reduce their debt and increase savings. Greece’s debt crisis could have serious effects for the US economy. These include a worsening trade deficit because of a weakening Euro and financial instability for the US economy because of the strong trade relations between the US and the EU; $16.6 bn of Greece’s debt is held by U.S. banks and a Greek default would surely affect these creditors. The crisis once again highlights the financial integration of the globalised economies.