After the 2008 global meltdown, when financial markets were in distress, the Greek financial crisis came as a double whammy to all the economies of the world. The sovereign crisis of Greece has a bearing not only on Europe but also on countries such as India. Find out more in the story
The land of wisdom, ideas and scholarship is a mere shadow of its former glory and greatness. The nation from which the world learnt an awful lot in the ancient days failed to memorize its own lessons. The nation that taught the world many concepts failed to remember the concept of sound financial governance and, as a result, left its economy floundering in the end. The state of Greece faltered and committed mistakes. As a result, its economy has been in disarray, its banks have been running out of money and its people have been out of work for years. And, at the end of July 2015, when there seems to be no end to Greece’s misery, one wonders where those famous wisdom and scholarship went!
When the global meltdown hit the world in 2008, it brought economic hardship to the economies world over. Some countries were better positioned to weather the storm. For instance, India withstood the crisis because its banks were flush with money, because of huge savings, and there was a massive internal demand as well. And the government of India at that time took more measures to boost their internal demand.
But, Greece was badly prepared for this global financial crisis. In early 2009, a new government was elected and in October 2009 it revealed, much to the horror of the entire world, that its predecessor had been cooking the fiscal books. The new government announced that the Greek government had been understating its deficit figures for years and the budget deficit of 6.8% of GDP for 2009 was actually 12.7%, which was, however, later revised to 15.7%. For the world reeling already under the global meltdown, the Greece’s admission of gross financial misconduct came as a double whammy.
The decade of overspending had weakened Greece’s economy and public finance. It was immediately shut out from the borrowing in the financial market. And in the year 2010 Greece sent a distress signal, and since then there has been a constant struggle for the Greece to bring its nation’s economy back on the rails.
A country accumulates external debt when its government or private sector borrows from foreigners. We know that if the expenditure of the government is higher than the revenue, the government has a deficit. Then the government borrows which leads to debt. A good government has to control its fiscal deficit. In India we have a policy which makes it mandatory for the government to check the fiscal deficit. In the Greece’s case, it was utter fiscal profligacy with net public debt close to 100% of GDP even before the crisis hit the headlines in 2009. Its external public debt, defined as the part of external debt accumulated by the government, in 2009 was 89% of GDP and, according to IMF forecasts, it will be close to 120% of GDP in 2020.
According to experts, the Greek government accumulated debt with continuous borrowing over a decade. Because the country was in deficit, regular borrowing year after year raised the debt. The experts point out that the relationship between debt and deficit goes in both directions: not only a deficit in a given year raises debt accumulated over previous years, but also debt accumulated over previous years raises the deficit in the current year. This is because interest payments on debt that has accumulated over previous years are the expenditure during the current year, and add to that year’s deficit.
The Maastricht Treaty had established European Union (EU) in 1993 and eurozone came into existence with the official launch of the euro (alongside national currencies) on 1 January 1999. Greece joined eurozone in 2001.The EU developed a single market through a standardised system of laws that apply to all member states. EU is currently composed of 19 member states that use the euro as their legal tender. As of 2014, the EU has the largest economy in the world, generating a GDP bigger than any other economic union or country. In 2012, the EU was awarded the Nobel Peace Prize. After joining eurozone, it had become easy for the Greece to access capital from the international market. The Greek government raised funds in international market by issuing bonds at lower rate of interest, as the euro helped keep the borrowing cost down.
However, EU decreased funding Greece as it wanted to support the new nations in the east of Europe and other Baltic nations that had entered the EU and wanted to join eurozone. Meanwhile Greece continued with its fiscal profligacy and failed to balance the budget related spending. The major spending of the government was related to defence, service, education, housing amenities etc. In the 10 years before the financial crash, public sector wages doubled and departmental spending soared. Greece’s defence expenditure also continued to soar. According to some reports, even in 2011, three years after the crash, the country was still spending 4.6 bn Euro on defence, representing 2.1% of GDP against an EU NATO average of 1.6%. The reckless lending by French and German banks had allowed the Greeks to finance widening budget and current account deficits for six years, but private capital flows dried up sharply after the 2008 global meltdown.
As we know banks lend out some of their depositors’ money, along with financing raised in markets, to finance economic activity. The Economist points out that a bank can run into trouble in a number of ways. A rash of bad loans can push a bank into bankruptcy: where the value of its assets is too small to cover its liabilities.
In 2009, as the Greek debt was downgraded to junk bond status, its banking system came under stress. Its interest rates began to rise and by 2010 it was on the brink of bankruptcy. The Greece bonds’ rating was downgraded at BB+ and A2 by Standard & Poor’s rating services and Moody’s standard respectively. The crisis forced Greece to seek help from eurozone governments and the International Monetary Fund in 2010. To avert calamity, the so-called troika — the International Monetary Fund, the European Central Bank and the European Commission — issued a rescue package of 110 billion euros in 2010 and an additional 140 billion euros in 2012 for the period up to the end of 2014.
The bailouts came with conditions, which included deep budget cuts and steep tax increases. It required overhauling its economy by streamlining the government, ending tax evasion and making Greece an easier place to do business.
The result of all this lending led to improvement in the fiscal deficit and a fall in current account deficit. But, as the reports point out, the real economy deteriorated with unemployment, which was projected to rise to 19.4% in 2013 and then fall to 18.5% in 2014, actually increased to 24.6% in 2013 and further to 27.5% in 2014 and the youth unemployment to 50%. According to economists, this happened because of excessive fiscal control. Leading economists of the day say that fiscal contraction is bound to be counterproductive in a situation where global demand is depressed.
We have already talked that the excessive emphasis on fiscal austerity did not get the desired result, as was expected. The budgetary austerity drove Greece into a vicious spiral and its economy contracted by 25% between 2010 and 2014, fatally weakening Greece’s ability ever to repay its debts.
Much of the previous bail out funds went into paying off Greek bonds held by private investors and the other eurozone governments. They were not used for stoking up growth. It was not used by banks to lend money and revive growth.
Interestingly, an important reason for the Greece’s persistent misery is the fact it is a Eurozone member, which does not allow devaluation of its currency by allowing them to print more money. If Greece had not been a eurozone member, it might have gone for devaluation of its currency and restructuring of its debt.
It has been pointed out by economists that the key to understanding the sovereign debt crisis in the Eurozone has to do with an essential feature of a monetary union. Members of a monetary union issue debt in a currency over which they have no control. As a result the governments of these countries cannot give a guarantee that the cash will always be available to pay out bondholders at maturity. It is literally possible that these governments find out that the liquidity is lacking to pay out bondholders. Where as in the case of countries that issue debt in their own currency, they can give a guarantee to the bondholders that the cash will always be available to pay them out. The reason is that if the government were to experience a shortage of liquidity it would call upon the central bank to provide the liquidity. So, Greece is missing crucial options for adjustment because she is an eurozone member.
Today, the Greece owes foreign creditors such as the International Monetary Fund, the European Commission and European Central Bank about 280 billion euros. It doesn’t have the cash to make the interest payment and has defaulted paying back its lenders.
The Greek Prime Minister, Alexis Tsipras, who was elected in 2014 as a direct result of backlash from the Greeks on austerity programme, is trying hard to negotiate another package of bail out from the troika, which is about 82-86 billion euros. The country held a referendum on Grexit, which meant exiting eurozone. But Greeks rejected the referendum. However, Tsipras has been quoted as saying that Grexit will be on the table until debt relief comes, for which he is bargaining hard with his lenders. The government meanwhile imposed capital control and has been making a pitch for further reforms to be able to secure funds from the lenders. There are party hardliner within his party, Syriza, who are against the reforms. But the reforms such as labour, pension and in taxes are important to make. Greece’s tax machinery is accepted as being riddled with corruption and evasion. It is about high time the Greece tried to undo some of the damage done due to their country’s 50-year record of failed reforms.
Worried that the Greek crisis may trigger capital outflows, Finance Secretary Rajiv Mehrishi assured in June this year that the government was in touch with the Reserve Bank which will take necessary steps to deal with the issue. “Obviously we are in touch with the RBI but they will do what they have to do,” he told reporters as uncertainty over Greece pulled down the BSE index, Sensex, by over 500 points in June this year.
Experts say that Indian can withstand the Greece crisis because of its huge foreign reserves and strong economic fundamentals. India’s foreign reserves have reached a record high of $355.46 billion as of June 19 this year. Recently, Dr Raghuram Rajan, RBI Governor, said while talking to the media, “Because the direct impact from Greece is limited, our sense is after the initial burst of volatility, which undoubtedly there might be if developments turn adverse, investors will start differentiating and when they start doing that they will see that the India story continues to be a good one. We not only have good macro-policies in place but growth prospects are quite healthy as compared to the rest of the world.”
Whereas other experts say, as reported in the media, that the Greek financial crisis has created uncertainty in the investing community the world over, including those in India. Pointing to fiscal balances, they say that the main long term lesson of the Greek crisis for India is to eliminate its revenue and fiscal deficit and thus eliminate the major policy driver of the increase in net external indebtedness. As a note of caution, they advise adjusting cyclically adjusted revenue deficit to zero by 2020 and cyclically adjusted fiscal deficit to zero by 2025. They also warn, as reported by the BBC, that the crisis, if it were to spread quickly from the Mediterranean coast, could upset India’s ambitions of regaining its lost position as an engine for global growth. It says that India also cannot drop the guard on the currency front to avoid a repeat of 2013 when a rush of dollar outflow weakened the currency to record lows; fresh and urgent reform measures will, at the very least, help soothe the frayed nerves of investors. However, according to Assocham, with over USD 355 billion foreign exchange reserves and the country promising to grow at the fastest rate in the world, India can withstand any pressure from Greek crisis.
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