EURO ZONE CRISIS

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Euro Zone is an economic and monetary union of 17 member states of European Union (EU) that have adopted the euro (€) as their common currency.

Monetary Policy of the Euro Zone is laid out by the European Central Bank (ECB) and fiscal policy by individual states.

The euro was introduced on January 1, 1999.

Background

Single Market for free circulation of goods, capital, people and services.

Single currency to eliminate exchange rate transaction costs and risks.

Macroeconomic stability (e.g low inflation) and financial integration of the nations in the Euro zone.

Each member country to become stronger against other big economies.

Philosophy of Euro Zone

How Euro Zone Crisis Started

Transmission from the United States.

Housing Price Bubble adversely affected the highly leveraged banks in the Euro Currency Zone.

Governments in euro zones tried to prevent collapse of financial system by bail out of banks.

This caused pressure on financial resources of the governments and widened the gap of fiscal deficits.

The Euro Zone Financial Crisis

BNP-Paribas forced to close funds in August 2007

UK bank Northern Rock taken over by government

German state banks IKB, WestLB, BayernLB and SachsenLB bailed out by government

Irish banks given government deposit guarantees

Switzerland injects funds into UBS

Iceland’s banks unable to roll over short term borrowing, default on deposits of foreigners

European Financial Institutions under Stress

Continuous high % of debts to GDP

Large welfare budgets

High public debts

High external debts

Slow GDP growth rate

The major causes

Countries In Crisis

Portugal

Ireland

Italy

Greece

Spain

Euro being a common currency, the crisis in these countries badly affected the economies of other euro zone countries.

Automatic stabilizers of falling taxes, rising welfare and unemployment payments kick in as incomes fall and unemployment rises.

Discretionary fiscal stimulus enacted in most countries, depending on their fiscal positions.

European countries limited by Stability and Growth Pact to 3% fiscal deficits, except in time of “exceptional economic distress.”

Fiscal Policy Responses to Recession

{ A study on Greece

What happened in Greece?

Why is Greece in trouble?

Greece has been living beyond its means since even before it joined the euro.

Income hit by widespread tax evasion.

May 2010 – 110bn euros of bailout loans.

July 2011 – earmarked to receive another 109bn euros.

October 2011 – the Eurozone asked banks to agree to a 50% "haircut" on their Greek holdings, alongside an enhanced 130bn euro bailout.

2002 – Greece abandoned the drachma as its currency in favour of the euro in 2002, making it easier for them to borrow money.

Greece went on a big, debt-funded spending spree, including paying for high-profile projects such as the 2004 Athens Olympics, which went well over its budget.

Prime Minister George Papandreou quit the following year while negotiating the 110bn euro bailout package follow-up.

Lucas Papademos has negotiated a second bailout of 130bn euros, plus a debt writedown of 107bn euros. The price: increased austerity and eurozone monitoring.

The Impact

High interest rates on bonds

High unemployment

Foreign trade badly affected

Exchange rate of Euro was adversely affected

Downgrading of rating of euro zone nations

Low confidence of global investors

The financial crisis caused slow down in euro zone and global economy

Impact On Euro Zone

Credit in the Eurozone (% change)

Where will it end?

Financial markets have become much more reluctant to lend to euro area countries . . . . especially those with higher debt and deficit levels:

Portugal?

Spain?

Italy?

Belgium?

This has led to sovereign debt crisis.

Impact On India

Negative impact on foreign trade

Impact on financial/ capital market

Slowdown in foreign remittances and NRI deposits

Impact on jobs of Indians in euro zone countries

Euro zone crisis would impact global investor confidence

{ Possible Scenario and Resolutions

PSR

Once Greece defaults, banks having Greek debt will be at loss

Other countries will likely follow to default as investors become worried about risks in the region

Portugal is most likely to follow, followed by Irish Republic, Spain and Italy Generalized Banking Crisis likely will follow

Outright Defaults by crisis nations

De-evaluation of currencies of these nations would be certain

Collapse of financial system of these nations

International creditors would incur huge losses

Businesses would go bust and these nations face high Inflation

Mass emigration of skilled labor, towards other EU countries

New barriers to trade may come up

Greece and other crisis nations exit the Euro

Creation of common euro bonds which would allow weaker euro nations to share credit rating of stronger nations such as Germany and hence to borrow at lower rates.

This is unlikely as why Germany would guarantee debts of other nations.

Common European Bonds

In the past, ECB has bought bonds of weaker nations.

However, it cannot do so endlessly. As it would mean printing of new currency and buy bonds , leading to an inflationary flood of money, creating another crisis.

ECB buys bonds of weaker nations

To allow euro zone crisis nations to borrow at low rates with long maturities.

For this financing is needed from countries having a large foreign exchange reserves such as China.

Whether China would bailout euro zone nations and to what extent , is to be seen ?

International Monetary Fund (IMF) Rescue

Financial policy Regulation, supervision (micro- and macroprudentional)

Liquidity provision, capital injections, credit guarantees, asset relief

State-contingent exit from public support; audits, stress tests, recapitalisation, restructuring

Monetary policy Leaning against asset cycles

Conventional and unconventional expansions

State-contingent exit from expansion, safeguarding inflation anchor

Fiscal policy Automatic stabilisers within medium-term frameworks, leaning against asset cycles

Expansions plus automatic stabilisers, while respecting fiscal space considerations

State-contingent exit from expansion, safeguarding sustainability of public finances

Structural policy Market flexibility, entrepeneurship and innovation

Sectoral aid, part-time unemployment compensation

State-contingent exit from temporary support

Recently the Greece government has approved tough austerity measures to get bailout package from international creditors.

There are vast demonstrations in Greece for reducing minimum wages & welfare budgets.

Bailout packages for other crisis nations to be followed.

Recent Developments

Previous economic crises in Europe have led to large devaluations of currencies.

Within Eurozone, single currency prevents devaluation , provides automatic financial support through capital markets.

Non-euro currencies depreciated sharply in 2008, British pound sterling, Swedish kronor, Polish zloty, Hungarian forint.

The Role of the Euro

Changes in Budget Balances

Greece’s Debt Dynamics

Euro Zone crisis has been the combined result of US financial crisis and excessive debts with slow GDP growth rates.

This crisis has badly affected the financial market, capital market and global economy.

The crisis nations are in bad shape and are looking for bailout packages.

ECB, IMF, International creditors and stronger nations are considering various options to resolve the crisis.

The situation is grim and there is no immediate solution to the problem and it has long term affects on global economy.

Conclusions

A presentation by

Tamrish Sinha

Ganesh Nagarsekar

Aniket Chaudhary

Kshitij Jain

Aniket Pant

Sameer Pendse

Kushal Khandelwal

Thank You