GROUP ASSIGNMENT

AFE425 – INTERNATIONAL FINANCE

CRISIS OF THE WORLD REPORT
European Sovereign Debt Crisis 2008-2012

Prepared by:
Bella Scholastica (16111006)
Bunga Ludmilla (16111007)
Fariz Aufarifqi (16111010)
Karina Maharani (16111014)
Rizshad Abdillah Ericska (16111023)

Facilitated by:
Prof. Ir. Roy Sembel, MBA, PH.D, CSA

Statement of Originality:

The content of this report is of our own work and responsibility

IPMI International Business School

Bachelor of Business Administration 2016
 Table of Content

Executive Summary
European Sovereign Debt Crisis
Cause Analysis
- History of Euro
- Monetary policy VS Fiscal policy
- Austerity Measures
- Crisis in 2008
- Timeline
Impact and Aftermath
- Impact on Greece
- Impact on the Economic Abroad
Lesson Learned
 Executive Summary
European Debt Crisis its the failure of Euro; the currency that ties together 17
european countries in an intimate but flawed manner. Over the past three years
Greece, Portugal, Ireland, Italy and Spain have all teetered on the brink of the
financial collapse. Threatening to bring down the economy of the entire continent
and the rest of the world.
 I. European Sovereign Debt Crisis
According to Organization for Economic Cooperation and Development, European
Sovereign Debt Crisis is a phenomena that served as the biggest global threat in 2011. As a result,
Europe experienced a collapse in financial institutions, high government debt, and rise of bond
yield spread in government securities. This crisis began to develop since 2008 following after some
other global crisis such as U.S. Financial Crisis of 2008-2009, the Great Recession of 2007-2009,
the Real Estate Market Crisis, and property bubbles of several countries, that has been slowing
down the economic growth globally. Doubling the effect of all these crisis, the collapse of
Iceland’s banking system in 2008 quickly impacted the economic of the other Eurozone members
in 2009 namely Portugal, Italy, Ireland, Greece, and Spain, causing an inability for these countries
to generate a sufficient economic growth that could payback government debt or to bail out the
indebted bank under the national supervision (without third-party assistance).
As the result to the sovereign debt crisis, the society lose their confidence in Europe
economy causing the investors to react by demanding a higher bond yields to some Eurozone
members in 2010 as a way to anticipate similar problem. This demand has add up to the struggles
of Eurozone states to finance their budget deficits while having to keep up with the overall
economic recession. In response towards the situation, the government of the affected countries
deducted the expenditures and raised the taxes of the country, which leads to social upset and
confidence crisis towards their leadership, especially in Greece. In addition, to worsen up the
investor’s fear, some of the affected countries such as Greece, Portugal, and Ireland was
downgraded into junk status by international credit rating agencies during the crisis.

II. Cause Analysis

II.A History of Euro

In most of the European history, there has been several

wars between the European states. Thus, result to the tendency
for them to do less business together. Therefore, Europe was
always been a continent of trade barriers, tariffs and different
currencies, which causes doing business across the borders so
difficult. People who wanted to trade needed a fee to exchange
currencies and then they needed to pay a tariff fee to buy and
sell goods to companies in other countries.
The condition in Europe causes its entire economy to be prone towards uncertainties. One
of the threat that has severely affected their economy was the World War II. As the after effect
was getting dire, the continent decided to rebuild Europe by removing these economic barrier. One
of the improvement shown was that the steel and coal tariffs decreasing, which the European
leaders see as a strategy to enable the steel mills of one country to be sold in another countries.
This gave the people the idea of “A Unified Europe”; a union across the continent that would end
all future wars.
The European States began to move together toward one goal; “decreasing trade barrier,
lowering the cost of doing business, reducing complexity of a big market, and establishing a
freedom of the movement of people, goods, and service in order to create an economical value on
a much greater scale”. Twenty-seven countries signed the Maastricht Treaty and created the
European Union. This made doing business across borders easier, but there was still one major
obstacle, which was the difference in currencies among the union countries. Therefore, Euro was
launched on January 1st 1999. Countries adopting the Euro currency was called the Euro Area. To
adopt the new currency, these countries discontinued their initial monetary policy and gave control
to the newly formed European Central Bank (ECB). However, although the Euro Area have a
unified monetary policy, their fiscal policies still differ between each states. This difference was
said to be the key reason towards the European Sovereign Debt Crisis.

II.B Monetary policy VS Fiscal policy

Monetary policy refers to a policy which controls the money supply, such as the amount
of money in the economy and the interest rates for the country. Whereas, fiscal policy is a policy
which controls the amount which the government collects and spends.
Before Euro currency was established, countries like Greece had to pay high interest rates
and was not allowed to borrow beyond the small portion of limitation. So, lenders were not
comfortable lending them too much money. However, now
that they are part of the Euro area's new united monetary
policy, the amount they could borrow skyrocketed. Similarly,
smaller countries also had access to credit like never before.
Like Greece and other countries, which previously could
only borrow at rates around 18 %, could now borrow for the
same low rates as Germany. This is because, joining the Euro
area is a lot like sharing a credit card.
Lenders now believed that if Greece was unable to
repay its loans, Germany and the other big economies of
Europe would step in and repay them because they were now
bound by a common currency. With a new abundance of
cheap credit, Greece and other EU countries were able to
adjust their fiscal policies and increase spending to
previously impossible levels. Some countries embarked on Figure I: Illustration of greek
huge deficit spending programs, primarily for politicians to economy -
get elected. They made promises such as more jobs and https://ritholtz.com/2010/02/the-
generous pensions all of it paid for with the new money they could now borrow. The government
of Greece, Portugal and Italy accumulated huge debt. However, they were able to repay the debt
 with more borrowed money. As long as the borrowing continued, so did the spending and the
unbalanced fiscal policies. Commented [1]: picture credit:
https://ritholtz.com/2010/02/the-crumbling-greek-
In Ireland and Spain, cheap credit fueled enormous housing bubbles. just as it did in the economy/
United States. Credit flowed, debt accumulated and the Economies of Europe became tightly
intertwined. Companies began opening factories and offices across Europe. German banks lending
to French companies, French banks lending to Spanish companies and vice-versa. This made doing
business incredibly efficient, while at the same time tying together the collective fate of the Euro
area. Things continue this way as long as credit was available and credit was available until 2008.
Spurred by a collapse in the US housing market, a credit swept the globe. bringing borrowing to a
halt everywhere. Suddenly the Greek economy couldn't function. It couldn't borrow money to pay
for all the new jobs and benefits it created. What’s more important, it couldn't borrow the new
money it needed to pay its old debts. This was a problem for Greece, but because of the unified
monetary policy it was also a problem for all of Europe. Much of Europe had been on a spending
spree and borrowed more money that it could ever repay.

II.C Austerity Measures

As the biggest and the strongest economy in the Europe,

Germany reluctantly agree to help bailout the debt of other
countries. In other words, Germany agreed to repay the bill but
only if the debtor countries agreed to implement strict austerity
measures to ensure that it never happen again. Austerity Measure
means sucking it up, cutting spending, borrowing less and paying
back more debt. This sounds like a simple solution, but its not.
Figure II: Illustration - First of all, nobody wants austerity. Austerity means cutting
https://www.debatingeurope.eu/20 government spending and since the government is by far the
13/10/10/have-austerity-measures- bigger spender in any economy. When the government cut
finally-started-working/
spending, it cuts the earnings of many of its citizen. People lose
jobs, they get angry and they riot in the street. An austerity also doesn’t automatically balance a
country’s budget. The government collect taxes based on people’s earnings. So, when earning are
reduced the government collect less taxes. They still can’t pay down the debt. The pain is so bad
that it’s almost politically impossible to accomplish. On top of that, there are huge cultural
differences within the Europe area. Commented [2]: picture:
https://www.debatingeurope.eu/2013/10/10/have-
austerity-measures-finally-started-working/
II.D Crisis in 2008 Commented [3]: Reference:
The European Sovereign debt crisis was triggered in 2008 with the Iceland’s banking https://www.thebalance.com/iceland-financial-crisis-
bankruptcy-and-economy-3306347
system collapse, this is started from the three largest Iceland nationalized which are Kaupthing https://www.investopedia.com/terms/e/european-
Bank, Landsbanki, and Glitnir Bank had defaulted on $62 billion of foreign debt which lead almost sovereign-debt-crisis.asp
https://www.bbc.com/news/business-13856580
every businesses in Iceland went bankrupt and housing pricing fell while the mortgage double.
This became worse as Iceland’s economy almost went bankrupt in January 2009, the failure
occurred because Iceland Prime Minister Haarde resigned due to cancer.
During the European Debt Crisis, several countries in the Eurozone were faced with high
structural deficits, a slowing economy and expensive bailouts that led to increase in interest rate,
which exacerbated these governments' tenuous positions. In response, the (EU), European Central
Bank and (IMF) embarked on a series of bailouts in exchange for reforms that were eventually
successful in decreasing interest rates. There are some
contributing factor that impacted the European Financial Debt
Crisis are the Financial crisis of 2007 to 2008, and the Great
Recession of 2008 through 2012 Commented [4]: picture: http://www.being-
here.net/page/6647/sovereign-debt-crisis

Figure III: Illustration -

http://www.being-
here.net/page/6647/sovereign-debt-

The debt crisis that started in Iceland

will spread into various European country
that is primarily to Portugal, Italy, Ireland,
Greece and Spain in 2009, that cause a loss of
confidence in european businesses and
economies. In which the EU order France,
Spain, Irish Republic and Greece to reduce
their budget deficit in April, which later on in
Figure IV: EU Debt as A Percentage of GDP -
https://www.huffpost.com/entry/european-debt- December same year Greece revealed that its
crisis_n_1147173 debt have reach 300 billion Euros which is the
highest in the modern history, this burden
amounting to 113% of GDP which is nearly double of the eurozone limit of 60%, since Greece
revealed that the previous government had grossly underreported its budget deficit, signifying a
violation of EU policy and spurring fear of a Euro collapse via political and financial contagion. Commented [5]: Picture:
https://www.huffpost.com/entry/european-debt-
crisis_n_1147173
During early 2010, The European Central Bank dismisses the speculation that Greece will
have to leave the EU and concern start to build up on all the heavily indebted countries in Europe
such as Portugal, Ireland, Spain and Greece. Due to Greece in debt, EU promises to act over the
Debt and tells Greece to make further spending cuts, and the prime minister of Greece
Mr.Papandreou continue to insist that no bailout is needed and the Euro continues to fall against
the dollar and the pound. Eurozone and International Monetary Fund (IMF) agree a safety net of
22 billion Euros to help Greece without loans, however it wasn't enough with the following worse
financial markets and increase of protests, Eurozone countries agree to provide up to 30 billion
euros in emergency loans. On may same year, the eurozone members and the International
Monetary Funds (IMF) agree to a bailout package to rescue Greece for 110 billion euros and later
on November EU and IMF agree to a bailout package to Irish Republic totaling 85 billion euros
which the Irish Republic record as the toughest budget in the country history, while the growing
speculation, the EU denies that portugal will be next for a bailout.
In the year 2011 won't be much better,
due to in April Portugal admits it cannot
deal with its finance and asks the EU for
help in May the eurozone and the IMF
approve a 78 billion bailout for Portugal.
In June eurozone minister said Greece
need new austerity before Greece next
stage of its loan which in July the Greek
parliament votes in favour of a fresh
round of drastic austerity measures in
which EU approves the latest stage of the
Greece loan. The second bailout for
Greece had been approves the eurozone
had agrees a comprehensive 109 billion
euros which had design to solve Greek
Figure V: Illustration -
http://www.europeandebtcrisis.mamorllc.com/latest-
crisis and prevent spreading to other
european-debt-crisis-timeline-news-2/ European economies. The yield of
government bonds from Germany falls to
record lows on the other hand
government bonds from Spain and Italy rise sharply, in August the European Central Bank buy
Italian and Spanish government bonds as to bring down their borrowing cost, from the concern
grows that the debt crisis may spread to larger economies of Italy and Spain, in September Italy
passes a 50 billion euro austerity budget to balance the budget after weeks of negotiating in
parliament and during October eurozone finance minister agree the next 8 billion euro stage of
Greek bailout loans that is potentially saving the country from default. Commented [6]: picture:
http://www.europeandebtcrisis.mamorllc.com/latest-
european-debt-crisis-timeline-news-2/
During the early 2012, meeting between Greece and its private creditors over a debt write
off deal went stall, the deal is necessary if Greece is to receive the bailout funds it needs to repay
billions of euros of debt. On March eurozone finally back a second Greek bailout that is worth 130
billion euros that later IMF had backed, in may Spain fourth largest bank had asked the government
for a bailout that is worth 19 billion euros which after emergency talk Spain Economy Minister
would make formal request for up to 100 billion euros in loans from eurozone funds to help shore
up its banks.
Figure VI: Greek Bailouts - https://www.bbc.com/news/business-33537445
II.E Timeline
 Figure VII: European Sovereign Debt Crisis Timeline

III. Impact and Aftermath

III.I Impact on Greece

The European Debt Crisis is giving a bad effect for

these several country; Greece, Spain, Italy, Portugal,
Cyprus, Slovenia, and the Netherlands. All these
countries, Greece is the one that needs help the most. The
reason why this crisis has been so confounding is that
Greece’s monetary policy is how much money they can
print is controlled by the European Central Bank.
However, Greece fiscal policy is how much money they
can spend and where they spend it is mostly controlled by
the Greek government. The fact that Greece and other
Eurozone countries are supposed to follow some basic
fiscal rules like no more than three percent annual budget
Figure VIII: Greece’s Great Depression
deficits, for instance, many Eurozone countries, including
Source
https://www.visualcapitalist.com/greeces Greece, have broken those rules. Since 1990s, the Greek
-debt-and-whos-on-the-hook-in-a- government had been reporting deficits and debts that
default-chart/
were much lower than the actual deficits and debts in
2009. No new government want to spill the truth about the
actual deficits. Then in 2009, a newly elected government announced that the budget deficit that
year was 13,9% of total economic output and that the numbers had been fudged for some previous
year.
 Figure IX: Greece’s Debt Breakdown -
https://www.visualcapitalist.com/greeces-debt-and-whos-on-the-hook-in-a-default-chart/

Some people point out that Greece’s labor cots got much higher after joining the Eurozone.
They probably had too much debt to start, there was also a huge problem with tax evasion in
Greece. In the 2008, US recession become global. Greece was disproportionately affected because
two of its biggest industries were shipping and tourism, neither of which fare particularly well in
recessions.
So far, they had been able to borrow money at low interest rates ever since joining the Euro
because people figured they were a safe bet. Many people thought that Euro is save. However,
with these revelations in 2009 that Greece’s deficits were so high, investors started to get nervous,
and they started to ask for higher interest rates in exchange for loans. The fact that Greece needed
that money, Greece accepted the higher interest rates, which made its deficits problem worse.
Means that the interest rate go up again and that is a vicious cycle. In the 2010, the problem
had become so bad that the European Commission and the International Monetary Fund came to
Greece’s aid with a 110 billion euro bailout. The European Central Bank also helped out by buying
some Greek debt, and giving Greek bank access to capital, and these three institutions came to be
known as the troika. However, when European trying to help Greek on the same time the interest
rates were also starting to creep up in Portugal and Ireland and Spain. This was a real fear that the
whole Eurozone might fall apart. That would be disastrous for trade and would also lead to a big
worldwide recession.
Furthermore, most of Greece’s debt was owed to German and French banks. So in a way,
the governments of the biggest countries in the Eurozone were lending money to Greece so that
Greece could pay back the banks of the biggest countries in the Eurozone. So in exchange for these
loans, Greece agreed to austerity measure. Basically they raised taxes and cut pensions and other
benefits. Somehow, this action is worked, it indeed decrease Greece budget deficits from 25 billion
euro in 2009 to just 5.2 billion euro in 2011. Yet, it also caused the Greek economy to contract
dramatically. People had less money to spend as their pensions shrank and their taxes rose, and
that in turn led to the failure of businesses and fewer jobs.

Figure X: Greece’s G.D.P. and Unemployment Rates in Europe

(Source: Eurostat)

As the economy shrank, so did tax revenues because the economy is the thing that
governments tax, and in the end, nothing really got better. Greece still did not have a sustainable
economy. In 2012, the troika loaned them another 130 billion euro. Over the last couple years there
were some real signs of life in the Greek economy, and its looked like things were starting to
bottom out. However, the unemployment is still over 25 percent. Due to this problem, 30 percent
of people in Greece is live in poverty and almost one in five does not have enough money to buy
food that will meet their daily nutritional needs.
The Greek depression has been as deep as the United States’ Great Depression. From a
wider European economic perspective, things have gotten a lot better in the last five year. Private
European banks own much less Greek debt than they did in 2010, the economies of Ireland and
Portugal are much healthier, and so it’s much less likely that the Greek economy collapsing, or
even Greece exiting the euro would be catastrophic for the rest of Europe
Flash forward to the end of 2014, a new leftist government is elected in Greece and state
that they do not want to have more austerity. Then, the troika stopped sending loan payments and
did many negotiations with Greek. In July 5th 2014 the Greek people voted to not continuing troika
helps.
However, so far, without troika helps Greece was predicted to face a serious liquidity in
Greek’ bank. Basically, Greek banks may have only 500 million euro left, which is very little.
Many ATMs were out of cash. If this continues, Greek will forced to print some form of alternate
currency to make payment to retirees and government employees. That would be the so-called
Grexit - a Greek exit from the Eurozone.
 III.II Impact on the Economic Abroad
Not only giving a bad effect for these several country; Greece, Spain, Italy, Portugal,
Cyprus, Slovenia, and the Netherlands, The European Debt Crisis also has a great influence on the
economies abroad. Since it mention before that many bank in the Eurozone is looking for lots of
loans, many local banks look for opportunities in the US and Latin American markets.

Figure XI: Total Debt and Public Debt by Region

Source https://www.stlouisfed.org/publications/regional-economist/january-2015/sovereign-debt-crisis

This action is actually not a their best move. The reason is because increased borrowing
will result in higher interest rates due to higher risks. In addition, as a result of investing and
borrowing from abroad, the stock indexes for the US and Latin America have risen significantly.
However, even though borrowing from abroad allows the European companies to raise enough
money to pay down its debt in the short run, it sounds like they are just swapping one debt for
another rather than paying down the debt. The fact that borrowing money is not giving any solution
for this crisis, European country has also tried to cut their government spending. Well, it might
help the situation in the short term. However, the negative effects can be offset by structural
overhauls in the long run. Second impact happen in the trade goods. The drop in trade finance has
resulted in a reduction in the flow of critical goods into and out of emerging markets amid warnings
that gaps in the agriculture and energy sectors in particular would hurt poor countries. The fact
that many developing countries rely on international banks to provide them with credit, this crisis
scared the banks to provide such credit. The total global trade finance volume fell to $26.8bn in
the first quarter of this year, down 18% year-on-year to become the lowest quarterly volume since
the third quarter of 2009 ($24.4bn). In terms of global financial flows, the IFC says gross capital
flows to developing countries fell sharply in the second half of 2011, to $170bn just over half the
amount received during the same period in 2010. The slowdown is hurting efforts to reduce
unemployment, which remains high from the 2009 global recession. According to the International
Labour Organisation, more than 200 million people were unemployed in 2010. While the impact
of the eurozone crisis is felt throughout the global economy, the poorest are often those who are
most affected by a reduction of economic growth, income, liquidity and critical goods.

IV. Lesson Learned

Based on the analysis of European Sovereign Debt
Crisis, we come up with few lesson learned, as follows:
1. History Always Repeats, People Never Learns
Despite the excuses that crisis is a crisis because it is
unforeseeable, there are actually few similar crisis that
happens before European Sovereign Debt Crisis, which the
European government could have learn from. These similar
crisis includes the crisis of Latin America and East Asia.
Therefore, it is important to learn from previous history and
Figure XII: Real (Inflation Adjusted) make a prevention steps beforehand because ‘This time
International Lending Rate WILL NOT be different’ unless we make a difference.
Source
https://www.stlouisfed.org/publication
s/regional-economist/january- 2. Monetary Union Needs Extra Coordination
2015/sovereign-debt-crisis One of the biggest factor that almost lead to the
collapse of Eurozone is actually the single currency policy
or monetary union. From the crisis, it was seen that the Eurozone applied a single currency to
countries who does not even have a similar macroeconomic conditions. In addition, there is even
lack of fiscal policy coordination among the Euro member states and fragmented financial
regulation. Hence, we learn that when having a single monetary policy in a lot of countries or even
in companies, it is important to have a detailed and thorough regulation that will support all the
parties in times of crisis. It is even more important to make a coordination on the policies that has
been established.

3. Transparency is Important
Especially that single currency is being applied for Eurozone countries, the risk are spread
out among the country members. Hence, if one country is experiencing a crisis, it will affect the
entire Eurozone members since they are tied down by single currency. The dishonesty and
intransparency of Greek government, where they failed to report their actual deficit has made a
major contribution to the crisis. When the truth is finally been revealed, the market lose their
confidence in Greece causing the country interest rate to go higher, which makes the country to be
a less attractive investment option and suffer from a bigger debt. Not only that, this intransparency
further causes the weakening of Euro currency.

4. Financial Market is Always Risky

The crisis might actually prove to us that financial market is and will always be risky. As
scary as it may sounds, it is undeniably true that high risk will lead to a high return. One of the
reason why investors are offered with a high long-term return in the international security market
is because they will always be exposed with a risk of domestic or international crisis. However,
turns out, investors tend to trade their low risk - low interest rate security for a high risk - high
return one, which risk they did not really understand. This search of higher yield has often lead
these investors to substitute their high-quality fixed income with the high-yield fixed income,
which has a higher risk as well.
One thing that most of investors did wrong is that, most of them tend to fail to weigh down
between their greed and fear when it comes to making an investment decision. Therefore, when
the crisis happens or when they realize that their security was underperforming, they immediately
do the “buy high, sell low” strategy. This behavior is what tends to cause bubble and many crisis
to happen. To avoid worsening the existing crisis and cause any bubble burst, it is wise for
investors to make an investment decision that meets their ability, willingness, and need to take risk
and sticking with it despite the situation they are in.

5. Public Debt and Political Instability Makes a Country Less Attractive

This crisis furthermore proves the International Finance theory about public debt. As the
public debt of a nation grow bigger, it will trigger a high inflation in the country. As the result,
there are 2 major effect that will happen to the country, which are: the decreasing purchasing power
and weakening currency strength.
When the country is experiencing a high inflation due to their big amount of debt, it will
result into a lower purchasing power. The lower purchasing power will further impact the
consumption of the country and its citizen, resulting into a lower GDP. The low purchasing power
and GDP will make the country less attractive in the eye of investors. Therefore, country currency
will have a lower value.
Similarly, political instability and weak economic performance also causes the foreign
investors to lose their confidence. Therefore, will seek out other stable countries with a good
political performance to invest in. This will cause the country who are suffering from debt and
crisis to lose their source of capital.
 V. Reference List

Anil Kashyap's Primer on the Greek Crisis: http://faculty.chicagobooth.edu/anil....

The New York Times' introduction: http://www.nytimes.com/interactive/20...

History of the European Debt Crisis: https://en.wikipedia.org/wiki/Europea...

The Economist's excellent coverage of Greece, bailouts, debt woes, and how the banking system works now:
http://www.economist.com/topics/greece and especially http://www.economist.com/blogs/freeex…

https://www.thebalance.com/what-is-the-european-debt-crisis-416918
https://www.thebalance.com/eurozone-debt-crisis-causes-cures-and-
consequences-3305524
https://en.wikipedia.org/wiki/European_debt_crisis
https://www.investopedia.com/terms/e/european-sovereign-debt-crisis.asp
https://edition.cnn.com/2013/07/27/world/europe/european-debt-crisis-fast-facts/index.html
https://www.thebalance.com/iceland-financial-crisis-bankruptcy-and-economy-3306347
https://www.investopedia.com/terms/e/european-sovereign-debt-crisis.asp
https://www.bbc.com/news/business-13856580
https://www.theguardian.com/global-development/2012/jun/19/eurozone-debt-crisis-emerging-
markets