1 | Page Table of Contents ABSTRACT............................................................................................................................................ 2 THE DEBT CRISIS MATTERS BECAUSE…..................................................................................... 2 INTRODUCTION...................................................................... ............................................................ 3 EU FORMATION.................................................................................................................................. 4 UNFOLDING OF THE CRISIS............................................................................................................. 5 HOW DID THE PIIGS GO ABOUT...................................................................................... ................ 5 CAUSES OF THE SOVERIGN DEBT CRISIS WITH THE HELP OF GRAPHS .............................. 5 Debt as a percentage of GDP.................................................................................................................. 5 Interest rates ....................................................................................................................................... 6 The 'shadow economy' ....................................................................................................................... 6 Exports as a percentage of GDP .......................................................................................................... 6 Size of the public sector ...................................................................................................................... 7 FAULTS................................................................................................................................................. 7 POLITICAL IMPLICATIONS OF CRISIS........................................................................................... 7 PRESENT STATUS............................................................................................................................... 8 STEPS TAKEN TO CONTAIN CRISIS................................................................................................ 8 IMPACT OF CRISIS......................................................................................................................... ..... 9 IMPACT ON EUROPEAN ECONOMY:................................................................... ........................... 9 IMPACT ON U.S ECONOMY:............................................................................................................. 9 IMPACT ON INDIAN ECONOMY:................................................................................................... 10 SOLUTIONS........................................................................................................................................ 10 European Financial Stability Facility (EFSF) ....................................................................................... 10 European Financial Stabilization Mechanism (EFSM).........................................................................10 Breakup of the Euro zone ................................................................................................................. 11 Eurobonds........................................................................................................................... .............. 11 ECB interventions.............................................................................................................................. 11 CONCLUSION....................................................................................................................... .............. 11 ACKMOWLEDGEMENT................................................................................................................... 11 SUGGESTIONS................................................................................................................................... 12 BIBLIOGRAPHY.............................................................................................................................. ... 12 NEWSPAP ER CUTTI NGS.................................................................................................................. 13
What is the European debt crisis? As the head of the Bank of England referred to it in October 2011,it is “the most serious financial crisis at least since the 1930s, if not ever. In fact, the European debtcrisis is the shorthand term for the region’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 varyingdegrees, failed to generate enough economic growth to make their ability to pay back bondholdersthe guarantee it’s intended to be. Although these five were seen as being the countries in immediatedanger of a possible default, the crisis has far-reaching consequences that extend beyond their
borders to the world as a whole.
THE DEBT CRISIS MATTERS BECAUSE….
The debt crisis is not confined to especially troubled countries such as Greece. It has since spreadand affected other countries, such as Portugal, Spain, and Italy. Other countries could succumb tothe crisis if bondholders lose faith in their ability to repay debt.
If Standard and Poor's cuts its ratings of euro zone countries' bonds, as it has warned it mightdo, investors will likely be less willing to lend to these countries. And investors are alreadywary: Even Germany - regarded as the euro zone's strongest economy - has had difficulty selling
government bonds in recent weeks.
If a country fails to repay bondholders, banks that hold that country's debt would have to take
losses, possibly causing those banks to become undercapitalised.
This could then spur governments to bail out these affected banks, so that they are able to covertheir loans. These bailouts could, in turn, cause these governments to run huge deficits, causing thedebt crisis to spread.
Credit is the lifeblood of modern economies, and if banks are unable to lend because they are
insolvent, economies are at risk of sinking into recession.
The euro was introduced in 2002 as the single currency of the European Union, consolidatingthe largest trading area in the world and soon rivalling the dollar for global supremacy.However, the accumulation of massive and unsustainable deficits and public debt levels in a
number of peripheral economies threatened the euro zone's viability by the end of its firstdecade, triggering a euro zone sovereign debt crisis. The crisis highlighted the economicinterdependence of the EU, while also underscoring the lack of political integration needed to
provide a coordinated fiscal and monetary response. Germany--and, to a lesser extent,France--reluctantly stepped into this political vacuum. The euro zone's wealthiest memberscalled on weaker states to embrace strict austerity measures, inciting popular unrest andtoppling governments in Portugal, Spain, Greece, and Italy. Yet in spite of a number of eurorescue deals agreed upon by EU leaders, market volatility persisted into 2012, calling intoquestion the future of the euro.
European Union was formed to boost the relations between the governments of the Europeancountries and strengthen the trade and commerce ties between the countries of Europe. Allthe countries of Europe felt the need to have a unique European national identity in the
middle of the 20th century. It was the sole aim of the European continent to become aninternational and trading superpower that prompted the erstwhile West Germany, France,Italy, Belgium, the Netherlands and Luxembourg to form a strategic economic partnershipknown as the European Coal and Steel Community in July 1952.
The blueprint for the present-day European Union was made when these six countries signedthe Treaty of Paris in April 1951. It was previously known as the European EconomicCommunity or the Common Market (the British nickname of the EU.) A European customsunion was established in 1957, after the members signed the Treaty of Rome. It wasestablished on January 1, 1958. It was renamed the European Community (a pillar of theEuropean Union) after the members signed the Maastricht Treaty.
uphold the values thatEuropeans share, such as
sustainable development and asound environment, respect for
human rights and the socialmarket economy.
meet the challenges ofglobalisation and preserve the
diversity of the peoples ofEurope
promote balanced economicand social development
ensure that its people can livein safety
provide peace, prosperity andstability for its peoples
Euro was born when European Union became a single economic zone. EU comprised of strong (Germany, France) as well as weak (Greece, Portugal)
economies.
Euro being the single currency in the Union, there was no fear of local inflation, so banks lent indiscriminately.
World economy was in good shape, so direct correlation between economic andrepayment strength was not evident.
Weaker economies of EU (PIIGS) overspent using borrowed money. Now they are unable to pay back their debt.
HOW DID THE PIIGS GO ABOUT
Ireland, for example, underwent a massive real estate bubble, and its banks sustainedgiant losses. The Irish government wound up rescuing its banks, and now the countryis burdened under a huge debt load.
Spain also experienced a huge housing bubble. The country didn't indulge inexcessive borrowing -- rather, it ended up with high deficits because it couldn't collectenough tax revenue to cover its expenses.
Greece, on the other hand, not only borrowed beyond its means, but exacerbated the problem with lots of overspending, little economic production to make up thedifference, and some creative bookkeeping to prevent euro zone authorities fromrealizing the true extent of the situation.
Italy and Portugal have huge debt, to GDP ratios, high unemployment and are
struggling with a weak economy.CAUSES OF THE SOVERIGN DEBT
CRISIS WITH THE HELP OF
GRAPHS
Debt as a percentage of GDP
The maximum debt allowed bythe European Union is 60 percent of grossdomestic product. None of the countries
pictured meet that standard.
Deficit spending as a percentage of GDP Deficit spending occurs when a countryspends more than it generates inrevenue. The maximum deficitspending allowed by the EU is 3
percent of GDP. As shown here,countries sometimes approached zero,or even spent less than they took in, butnone of them are breaking even in
2011. Deficit spending has declined with the implementation of strict austerity programs across the EU.
Interest rates
Interest rates on 10-year government bonds are a stark illustration of the growing chances ofdefault. Governments have teetered, or even collapsed, when their interest rate approached 7
percent, deemed the unofficial cut-off for sustainable borrowing.
Before the euro zone was formed in 1999, rates averaged between 4.5 and 5 percent. Theexception: Greece, which was paying 8.5 percent to borrow.
By 2003, Greece and Italy were borrowing at 4.3 percent. France, Germany, Spain, andPortugal were at 4.1 percent – meaning Greek and Italian bonds were seen as only marginallyriskier than French and German bonds. Greece hit a low of 3.6 percent by 2005.
Interest rates began rising – and the spread began growing in 2009, with Greece registering a4.8 percent interest rate and Germany only 4 percent – as Europe neared the beginning of thecrisis.
In 201 0, Greece‟s rate jumped to 9 percent. Germany‟s was at 2.7 percent, with France‟s at3.1 percent. The rate of troubled Ireland and Portugal neared 7 percent.
By 2011, the picture was grim: France was at 3.7 percent and Germany at 3.3. Meanwhile,Greece was borrowing at a debilitating 13.5 percent, Portugal was at 8.7 percent, and Irelandwas at 9.6 percent. Three months ago, Germany was at 1.83 percent. At the otherextreme, Greece was at 17.78 percent. Italy and Spain hovered near 5.5 percent.
The 'shadow economy'
The "shadow economy," also known as the"underground economy," is largely untaxed
because transactions occur outside thenormal channels, which undermines thegovernment's ability to collect revenue. Theshadow economy is not just the blackmarket – it can include things like domestic
work that employers pay for in cash.
Exports as a percentage of GDP
Part of Europe' s problem is that todayfew of the countries have majorexport bases. Germany remains anexport-based economy, but that is notthe case in most of the euro zone
Europe's public sector workers havehistorically received generous pensions andhealth care, among other benefits of the
welfare system, which in some cases hasexacerbated the countries' debt problems. Akey facet of austerity plans has been cutting
both the size of the public sector and thegenerosity of the benefits public sectorworkers receive.
FAULTS
"Irresponsible" countries who borrowed too much, taking advantage of the lowinterest rates available to all euro member nations.
The Euro a single currency can‟t meet the needs of 17 different economies.a) Typically, a country's central bank can adjust a nation's money supply to encourage or
inhibit growth as a way of dealing with economic turmoil. However, the nationsyoked together under the euro frequently haven't had that option.
b) If Spain and Germany hadn't both spent the last several years on the euro, forexample, then they wouldn't have been able to borrow at the same low interest rates.
c) And if the PIIGS all still had their own individual currencies, they might be able toexport their way out of the mess they're in -- selling goods on the international marketuntil their respective situations were a little less dire.
The interconnectedness of the modern financial industry is to blame. That's certainly areason default by Italy or a departure of the euro zone by a fed-up Germany -- couldreverberate around the world.
POLITICAL IMPLICATIONS OF CRISIS
The political implications of the crisis are enormous. In the affected nations, the pushtoward austerity – or cutting expenses to reduce the gap between revenues and outlays – hasled to public protests in Greece and Spain and in the removal of the party in power in bothItaly and Portugal. On the national level, the crisis has led to tensions between the fiscallysound countries, such as Germany, and the higher-debt countries such as Greece. Germany
pushed for Greece and other affected countries to reform the budgets as a condition of providing aid, leading to elevated tensions within the European Union. After a great deal ofdebate, Greece ultimately agreed to cut spending and raise taxes. However, an importantobstacle has be en Germany‟s unwillingness to agree to a region -wide solution – such as theissuance of bonds by all 17 countries in the Euro zone – since it would have to foot adisproportionate percentage of the bill.
The tension has created the possibility that one or more European countries would eventuallyabandon the euro (the region‟s common currency). On one hand, leaving the euro wouldallow a country to pursue its own independent policy rather than being subject to the common
policy for the 17 nations using the currency. But on the other, it would be an event ofunprecedented magnitude for the global economy and financial markets. This concern
contributed to periodic weakness in the euro relative to other major global currencies duringthe crisis period.
PRESENT STATUS
Given the huge size of the PIIGS debt, investors are reluctant to buy bonds fromEuropean countries since many are in huge debts and others will have to assumeresponsibility for the black sheep.
We could be looking at depression for Europe and recession for the whole world. Uncertainty prevails as :-
a) EU may break up b) Some countries may pull out of EUc) Leading to a rash of ban failures
STEPS TAKEN TO CONTAIN CRISIS
Stronger economies are pushing for stringent spending control guidelines, where acountry‟s spending will be directly proportional to its economic strength.
Several options are being discussed, such as, issuance of Euro bonds, backed by theentire EU.
Restructuring of debt, with strict austerity measures placed on countries with risk ofdefault.
Troubled Euro zone countries are pledging to cut back government spending to show theycan be trusted.
TIME-LINE OF THE CRISIS
1999-2008
Euro is introduced, more countries join in.
In Dec‟08 EU leaders agree on a 200bn - Euro stimulus plan to help boost Europeangrowth following the global financial crisis.
2009
Slovakia joins EU, Estonia, Denmark and others make preparations to join. In April, the EU orders France, Spain, the Irish Republic and Greece to reduce their
budget deficits.
In December, Greece admits that its debts have reached 300bn Euros; 113% of GDP,nearly double the EU limit of 60%.
2010
Severe irregularities are found in Greece‟s accounting procedures. Talks start over austerity measures, sparking riots and protests. Euro countries to fall against Dollar and Pound. In May, EU members and IMF agree on a 110bn Euro bail-out package for Greece. Ireland, Portugal, Spain, Italy come under the review.
In Nov, the EU and IMF agree to a bailout package to the Irish Republic totalling85bn Euros.
The Irish Republic soon passes the toughest budget in the country‟s history.
In Feb, euro zone finance ministers set up a permanent bailout fund, called theEuropean Stability Mechanism, worth about 500bn Euros.
In Apr, Portugal admits it cannot deal with its finances itself, leading to a 78bn-euro bailout.
Greece approves fresh round of austerity measures, the EU approves the latest trancheof the Greek loan, worth 12bn Euros.
A second bailout of Greece is agreed upon, at 109bn Euros.
2012
S&P downgrades France and eight other Euro zone countries, blaming the failure ofeuro zone leaders to deal with the debt crisis.
Euro zone service sector shrinks unemployment rates hit all time high and EuropeanCommission predicts that the euro zone economy will contract by 0.3% in 2012.
Attention shifts to Spain and Italy, as they struggle to avoid going the “Greece way”.
IMPACT OF CRISIS
Stock market volatility. Financial institutions exposed to the debt, will write it down affecting their bottom
line. Borrowing will get costlier as interest rates will remain high. As a result spending will be less leading to a longer recession. Weak consumption and spending in Europe spells trouble for the rest of the world
economy that is struggling to get out of the downturn.
IMPACT ON EUROPEAN ECONOMY:
The Greek debt crisis has had a domino effect on Europe. It has reduced the confidence in European economies. Fiscal deficit and public debt
have gone beyond the ceilings regulated by the Stability and Growth Pact (SGP). On April 27, Standard & Poor‟s decreased the Greek debt rating to "junk" amidst
fears of default. Yields on Greek government two-year bonds rose to 15 percent following the
downgrade, and stock markets worldwide declined. On May 2 euro zone countries and the International Monetary Fund agreed to a €110
billion loan for Greece. On May 9, Europe‟s finance ministers approved a comprehensive rescue package
worth almost a trillion dollars aimed at ensuring financial stability across Europe.
IMPACT ON U.S ECONOMY:
An European sovereign debt crisis could at least affect the US economy in the followingtwo respects.
First, the devaluation of the Euro triggered by the debt crisis will make Americanexports more expensive.
Euro has depreciated against US dollar by nearly 15% (from 1.44 to 1.23). Government spending and exports have been the only two growth engines of the
American economy. With tepid consumer demand and very weak labour market, consumer- spending
recovery is less likely to be quick and robust. One way to spur corporate spending is to sell overseas. The second big worry remains with the banking sector. The financial markets across the Atlantic are highly integrated with each other and
hence affect each other.
IMPACT ON INDIAN ECONOMY:
A prolonged and widespread debt crisis in Europe could have a substantial negativeimpact on the Indian economy.
„if the solution of the Greece crisis takes longer than anticipated or if the confidencecrisis in Europe become more wide spread, there could be a more substantial negativeimpact to India.
If the debt crisis spreads to other nations in Europe and their banking systems,European entities could start Repatriation of funds from Indian stock markets.
This would negatively impact the Indian stock market and Lead to lower foreigncurrency reserves.
Severe macro-economic impact due to the turmoil. At least 27 percent of India‟s trade is with Europe and the crisis will impact India‟s
export to the region
SOLUTIONS
European Financial Stability Facility (EFSF)
Established on 9th May, 2010 this facility aims at providing financial assistance tocountries in need.
They can issue bonds or debt instruments in the market. Emissions of bonds are backed by guarantees given by the euro area member states. It has a lending capacity of 440 Billion Euros.
European Financial Stabilization Mechanism (EFSM)
It is an emergency funding program reliant upon funds raised on the financialmarkets.
It is guaranteed by the European Commission.
It has the authority to rise up to €60 billion. It runs parallel to the EFSF.
Economists always criticize Euro currency system because of lacked a central fiscalauthority
They recommended that Greece and the other debtor nations unilaterally leave theEuro zone, default on their debts, regain their fiscal sovereignty, and re- adoptnational currencies
Bloomberg suggested in June 2011 that, if the Greek and Irish bailouts would fail, analternative would be for Germany to leave the euro zone in order to save the currencythrough depreciation
Eurobonds
European Commission suggested that Eurobond issued jointly by the 17 euro nationswould be an effective way to tackle the financial crisis. Using the term "stability
bonds
ECB interventions
It began open market operation buying government and private debt securities in May2010, reaching €211.5 billion by end of 2011
It loaned €489 billion to 523 banks for an exceptionally long period of three years at arate of just one percent.
CONCLUSION
Europe‟s future path will not be straightforward. Even some years from now the monetaryunion may not have become fully sustainable. But as structural policies bear fruit andstructural characteristics converge, the union will become less prone to the sorts of problemsthat have been afflicting it, and better able to deal with new types of shock should they occur.This crisis may not be the last thing that Europe will overcome. But provided that politicalwill remains, Europe will probably continue to proceed stepwise to sustainability.
ACKMOWLEDGEMENT
I really enjoyed doing this project and learnt a lot from it. I would like to thank my
economics teacher Betty Ma‟am for giving us this opportunity, an interesting topic and forgiving us the freedom and liberty to exercise our creativity. I am also grateful to my father for
proof-reading the content and approving it before the final draft and for the help in organizingmy work properly. I am also thankful to the various sources (websites, blogs, books) used inmaking this project a success.
