National Law Institute University

Economics project on

GREEK SOVEREIGN DEBT CRISIS

Submitted By:Alok Mishra Roll No:B.A.LL.2011-`36

TABLE OF CONTENTS

S.No. Page No. 1 4-5

Topic Introduction

2 6-7

Causes

3 8-9

The Big Loan

4 10-11

Long Term Solutions

5 12-13

A uneasy calm

6 14

Meaning for Other Countries

7 15

Bibliography

ACKNOWLEDGEMNTS
I would like to thank my Economics teacher Mr. C. Rajasekhar for allowing me to pick up such an interesting topic. I would also like to thank my seniors as well my friends for providing valuable inputs during the course of this project.

Introduction
In early 2010, fears of a sovereign debt crisis, the 2010 Euro Crisis developed concerning some European nations, including European Union members Greece, Spain, and Portugal. This led to a crisis of confidence as well as the risk insurance on credit default swaps between these countries and other EU members, most importantly Germany. Concern across the about globe rising government deficits and debt levels

together with a wave of downgrading of European Government debt created alarm in financial markets. The financial crisis has driven up public debt in Europe's common currency zone to such heights that many economists fear the euro could collapse. The debt crisis has been mostly centered on recent events in Greece, where there is concern about the rising cost of financing government debt. The country's debt is already well over 100 percent of GDP and is still rising. Greece has borrowed its way into an unsustainable position, with a bigger national debt than the country's economic output in a year. Greece's main problem is that the huge debts must soon be refinanced. The country's budget deficit in 2009 was almost 13 percent of GDP, more than four times the 3 percent limit allowed in the euro zone. The rating agency Moody's calculates that the government will have to take on approximately 40 billion in new

debt in the first half of 2010, just to service existing debt obligations and to finance new spending. The government itself states that it will need to refinance around 10 percent of its public debt in 2010, mostly in April and May. That will be a difficult task for a country whose dire financial situation has been the subject of growing concern in recent weeks. Fears are growing that the state could soon go bankrupt, should it no longer be able to find buyers for its bonds. The key facts of Greece`s economy are as follows Debt ratio: 112.6 percent of GDP Budget deficit: 12.7 percent of GDP (2009) GDP growth: -1.1 percent (2009 estimate) Share of euro zone's GDP: 2.6 percent (2008) (Source: European union) According to eurozone rules total government debt should not exceed 60 percent of GDP. The country's budget deficit in 2009 was almost 13 percent of GDP, more than four times the 3 percent limit allowed in the euro zone .Thus, Greece would have to pay heavy fines as per euro zone guidelines for violating the rules of euro zone. There was a possibility that Greece would have been forced to default on some of its debt. A default would most likely have taken the form of a restructuring where Greece would pay creditors only a portion of what they were owed, perhaps 50 or 25 percent.This would effectively remove Greece from the

euro, as it would no longer have collateral with the European Central Bank.

CAUSES
The Greek economy was one of the fastest growing in the eurozone during the 2000s; from 2000 to 2007 it grew at an annual rate of 4.2% as foreign capital flooded the country. A strong economy and falling bond yields allowed the government of Greece to run large structural deficits. To ensure Greece`s entry into the euro zone, the Greek government borrowed money at very low interest rates. As these debts were not registered there was lack of regulation on the part of the Greek government. Initially currency devaluation helped finance the borrowing.. Successive Greek governments have, among other things, run large deficits to finance public sector jobs, pensions, and other social benefits.Also Greece has a huge population of old people and to ensure social benefits for them the government ran into huge debts. Estimated tax evasion costs the Greek government over $20 billion per year. Years of free spending, cheap lending and lack of financial constraints finally took their toll and Some of Greece's financial weaknesses which were hidden were exposed. When the global recession took hold and tourism and trade revenues fell, the country's fiscal freewheeling was exposed. Two of the

country's largest industries are tourism and shipping, and both were badly affected by the downturn with revenues falling 15% in 2009.Together both these industries accounted for approximately 19% of Greece`s GDP. To keep within the monetary union guidelines, the government of Greece has been found to have consistently and deliberately misreported the country's official economic statistics. In 2001, just after Greece was admitted to Europes monetary union, Goldman sachs helped the government quietly borrow billions, That deal which was hidden from public view because it was treated as a currency trade rather than a loan, helped Athens to meet Europes deficit rules while continuing to spend beyond its means. Greece paid Goldman about $300 million in fees for arranging the 2001 transaction, according to several bankers familiar with the deal. Although similar irregularities and "massaging" of statistics to cope with monetary union guidelines have also been observed in cases of other EU countries, Greece was seen as the worst case. In 2009 the government of George estimated Papandreou revised its deficit from to 5% to 12.7%.In May 2010, the Greek government deficit was be one of the highest in the world relative to GDP. On Dec 8 2009, Fitch Ratings, which had cut Greece to A- when the government revealed the higher deficit, cut Greek debt to BBB+ with a negative outlook, the first time in 10 years a ratings agency has put Greece below the A investment grade.On 27 April 2010, the Greek debt rating was decreased to the first levels of 'junk' status

by Standard & Poor's amidst fears of default by the Greek government.

The Big Loan

Without a bailout agreement, there was a possibility that Greece would have been forced to default on some of its debt. The premiums on Greek debt had risen to a level that reflected a high chance of a default or restructuring. A default would most likely have taken the form of a restructuring where Greece would pay creditors only a portion of what they were owed. This would effectively remove Greece from the Euro, as it would no longer have collateral with the European Central Bank. The overall effect of Greece being forced off the euro would itself have been small for the other European economies. Greece represents only 2% of the eurozone`s economy. The more severe danger is that a default by Greece will cause investors to lose faith in other European countries This concern is focused on Portugal, Ireland, Spain, and in some cases Italy, all of whom have high debt and deficit issues. Hence, on 5 March 2010, the Greek parliament passed the Economy Protection Bill, expected to save 4.8 billion through a number of measures including public sector wage reductions. On 23 April 2010, the Greek government requested that the EU/IMF bailout package be activated. The IMF had said it was "prepared

to move expeditiously on this request". Greece needed money before 19 May, or it would face a debt rollover of $11.3bn. On 2 May 2010, a loan agreement was reached between Greece, the other Eurozone countries, and the International Monetary Fund. The deal consisted of an immediate 45 billion in loans to be provided in 2010, with more funds available later. A total of 110 billion has been agreed as rescue package for Greece to prevent a default and stop the worst crisis in the currencys 11-year history from spreading through the rest of the bloc. The 16-nation bloc will pay 80 billion Euros at a rate of around 5 percent and the International Monetary Fund contributes the rest. The government of Greece agreed to impose a fourth and final round of austerity measures. These include: Public sector limit of 1,000 introduced to bi-annual bonus, abolished entirely for those earning over 3,000 a month. An 8% cut on public sector allowances and a 3% pay cut for DEKO (public sector utilities) employees. Limit of 800 per month to 13th and 14th month pension installments; abolished for pensioners receiving over 2,500 a month. Return of a special tax on high pensions. Changes were planned to the laws governing lay-offs and overtime pay. Extraordinary taxes imposed on company profits. Increases in VAT to 23%, 11% and 5.5%. 10% rise in luxury taxes and taxes on alcohol, cigarettes, and fuel. Equalization of men's and women's pension age limits. General pension age has not changed, but a mechanism has been introduced to scale them to life expectancy changes. A financial stability fund has been created.

Average retirement age for public sector workers has increased from 61 to 65. Public-owned companies to be reduced from 6,000 to 2,000

Long-term solutions
EU finance ministers have agreed for the need to be tougher on member states' budgets in the wake of the Greek debt crisis. And following criticism that Europe did too little, too late to defend the euro, they pledged to react quicker and more efficiently in future. European Union leaders have made two major proposals for ensuring fiscal stability in the long term. 1: The first proposal is the creation of the European Financial Stability Facility. The EFSF is set up by the 16 countries whose currency is the euro to provide a funding backstop should a euro area Member State finds itself in financial difficulties. 2: The second is a single authority responsible for tax policy oversight and government spending coordination of EU member countries, temporarily called the European Treasury. The stability facility is financially backed by the EU and the IMF. The European Parliament, the European Council, and especially the European Commission, can all provide some support for the treasury while it is still being built. However, strong European Commission oversight in the fields of

taxation and budgetary policy and the enforcement mechanisms that go with it have been described as infringements on the sovereignty of euro zone member state and are opposed by key EU nations such as France and Italy, which could jeopardize the establishment of a European Treasury Some senior German policy makers went as far as to say that emergency bailouts should bring harsh penalties to EU aid recipients such as Greece. The Economist has suggested that ultimately the Greek "social contract," which involves "buying" social peace through public sector jobs, pensions, and other social benefits, will have to be changed to one predicated more on price stability and government restraint if the euro is to survive. As Greece can no longer devalue its way out of economic difficulties it will have to more tightly control spending

A Uneasy Calm
A whole raft of measures, which include huge cuts to Greece's public sector, have been announced since December last year, when the Greek government acknowledged the need to tackle Greece's dire public finances.The plans hope to achieve budget cuts of 30bn euros over three years - with the goal of cutting Greece's public deficit to less than 3% of GDP by 2014. It currently stands at 13.6%. These Austerity measures planned by the Greek government have been met with violent protests in Athens. However The Prime Minister of Greece George Papandreou called on Greeks to brace for more painful spending cuts to deal with an unprecedented financial crisis, saying their sacrifices were essential to national survival.These measure are already showing moderate results. the beleaguered country managed to raise 1.6 billion ($2 billion) at a yield of 4.65% in its first venture into the markets since a 110 billion rescue package from the European Union and the IMF was secured in May. Greece has also been getting pats on the back from its EU and IMF lenders for its progress on fiscal consolidation. George Papaconstantinou, the finance minister, this week announced that the countrys first-half budget deficit had been cut by 46%

compared with last year, beating targets. On July 8th the Greek parliament passed a pension-reform bill which, if properly implemented, will radically change the countrys lavish socialsecurity system. Credit-default-swap spreads on Greek debt have fallen to a one-month low.However such harsh measure have let to serious repercussions. Trade Unions, which have already held a series of strikes, have said abolishing the holiday bonus of public servants would be taken as "an act of war."apart from these problems a larger question is being asked-about the demise of the euro. Could the Greek crisis be the beginning of the end for the common currency, just eight years after its first notes and coins were issued? The monetary union was never followed up by political union to coordinate budget and taxation practices and create euro-zone institutions and capacities to help member economies adapt to changes and turmoil. The result is member governments are left very few ways to deal with the current attack on Greek debt and the severe pressure that it's putting on the euro. However the two biggest economies of the eurozone frace and germany have pledged to do all that is possible to to see Greece through its deficit crisis and defend the common currency. the euro zone will be forced to further integrate their economies, coordinate budgets and tax structures as well as cede budgetary and oversight powers to a central body tasked with preventing further collective calamities

Meaning for other countries

The crisis in Greece is being felt in financial markets around the world.Countries that have a big budget deficit, compared with how much money their economy generates. Portugal and Spain are reckoned to be two that could face problems next. The EU hopes that its bailout will reassure the money markets that their cash is safe. However, that depends on Greece getting control of the situation and proving it can make the cuts needed. The UK does not use the Euro currency, but could still be affected. Its budget deficit is also large, and we could start to appear unattractive to lenders. If they were to go bankrupt, it would mean more problems for Britain's banks. However as far as India is concerned it dosent have much to fear. Finance secretary Ashok Chawla recently stated that he expected the crisis to have a minimal impact on India, while one of the deputy governors at Reserve Bank of India Subir Gokarn said, there may not be any impact in the long term. However In the short run, the impact is likely to be direct. If the debt crisis spreads to other nations in Europe and their banking systems, a possibility is that European

entities could start withdrawing funds from Indian stock markets. This will negatively impact the Indian stock market and lead to lower reserves as well as depreciation of the Indian rupee denting the growth prospects. Then again, the long run outlook remains positive. From an investment perspective, if the Eurozone becomes unattractive given debt servicing and currency concerns, India stands to gain. Investors may shift their attention to emerging markets such as India and China.

BIBLIOGRAPHY

1: Economic Times 2: Newsweek 3:www.wikipedia.com 4:www.bbc.co.uk