Credit: EuroCrisisExplained, a site that follows the Euro debt crisis.
by Shivani Shikha
July 1st, 2015
Mired in heated discussions about the ominously pending euro-zone crisis, Greece’s economy has been at the forefront of widespread financial tension. After adopting the Euro currency, Greece was running a budget deficit that was four times of what the Euro-zone rules allow. The accruing deficit had comprised of massive and irrecoverable government expenditures in public services, such as early retirement benefits, higher pensions and wages for public employees. Though these expenditures were highly well-intentioned, Greece had severely limited revenue coming in through taxes partly due to the infamous tax evasion in the country. As a result of the Greek government’s inability to finance itself, it was recently locked out of the external capital market and, consequently, turned to European banks and the IMF for fiscal assistance. This precipitated the outset of the euro-zone crisis, as the Greek government began to finance its activities by massively borrowing from other nation’s banks. Soon, the government was borrowing billions of euros and those debts, like subprime mortgages in the United States, were often repackaged and sold off around the Continent. This allowed for almost all banks, especially banks in France and Germany, to invest heavily in Greece’s debt. The ECB, European Central Bank, which has been the largest holder of Greece’s debt, has been buying an enormous quantity of bonds in the open market as a means to alleviate the interest rate that Greece must pay. As part of the bail out package, Greece had received a large sum of 240 billion euros in EU and IMF funds to stay afloat, in addition to the 100 billion euros of privately held bonds from private creditors. Under the leadership of Antonis Samaras, Greece had started implementing stringent fiscal policies to reform its economic structure. Towards the end of 2013, the country had achieved a budget surplus before interest payments, and in doing so, complied with one of the conditions set by the IMF and the EU in exchange for the large stimulus packages and bailout assistance they had offered to Greece. However, this remained very temporary, as the debt grew to more than 170% of the GDP, since the country borrowed more and the economy shrank with an overall unemployment exceeding 30%.
The depression has only intensified since then, with the election of the present Greek Prime Minister, Alexis Tsipras, who came to political power in January on the promise to rectify the economic downfall haunting Greece. Tsipras’s relationship with the rest of Eurozone that is demanding inherent changes in the economic structure has been acrimonious at its best. Since Tsipara hasn’t been adhering with the existing bailout deals mandated by the Eurozone and the IMF, and no concessions have yet been made, Greece’s economic position remains tepid. Tsipara has been persistent with his own economic agenda that he wishes to implement, causing a massive rancor in Europe as all Greece’s Eurozone partners have rejected the prime minister’s proposal. Officials are under the impression that if no deal is finalized by next week regarding the conclusion of the second bail-out, Greece and other eurozone partners will not have sufficient time to pass a legislation to help Greece before two huge bills become due: a €1.5 billion loan repayment to the IMF on June 30, and a € 3.5 billion bond redemption on July 20. Under such pressure and the ineptitude of Tsipiras leadership, it’s speculated that Greece may simply make a “grexit” by pulling out of the euro and reverting to it’s own currency, drachma.</p> <p>In light of the most recent news, Greece has instituted a six-day shut down of the banking system in which all the lenders in the country have been ordered to stay closed. Furthermore, the central bank too, has complied with the government order and has imposed controls to restrict any monetary outflow to foreign countries. Such untimely and unwarned decision was a sole result of European Central Bank’s refusal to expand a lifeline of emergency funds to Greece. With the entire Eurozone being cast into uncertainty after this step, Alexis Tsipiras announced a need for a referendum, which would essentially allow the Greek citizens to vocalize their opinions on the set of bailout terms that had been arranged for Greece. As the country entangles itself in the political referendum and protests amid the financial insolvency and ambiguity, one thing remains certain. If Greece can’t convince the ECB to resume the emergency lending, the only pragmatic solution is for Greece to declare bankruptcy and begin printing it’s own currency, drachma, so the banks can be revived and safely carry out their day-to-day functions.
Failure to avert this imminent default will have terrifyingly drastic effects on Greece and it’s peripheral countries that are part of the Eurozone union. Pulling out of the euro standard would launch Greece into a short-term recession as it would have to re-negotiate the terms, such as a fair exchange rate, for it’s new currency. Furthermore, with stifling liquidity that Greece is already subject to, a “grexit” would require the country to impose capital controls and sharply devalue it’s currency. This would entail a period of high inflation and steep decline in GDP along with employment. The massive dip in consumer confidence due to the rapid bank runs in Greece will severely impact all the foreign lenders, public and private, who were hoping to get their principal investment back. Moreover, the entire political dynamic within the Eurozone would change due to the prevailing danger that other instable neighboring countries to exit the euro as well. Given the weakening market in Eurozone members such as Spain and Portugal, the IMF and the other Eurozone partners, there would always be a seed of irrational doubt in willingly investing or extending credit to subpar nations. The damage to the euro’s credibility as a stable currency would be incorrigible. Another huge concern is the bond market, which could trigger increasing interest rates across Europe, making consumer spending and lending very difficult. In this case, there could be huge capital outflows in form of investments and hence, a salient contraction in the European economy. The current Greek crisis could have unimaginably perilous ripples across the world if the ambiguity surrounding the bailout’s conclusion isn’t brought to control in a few days.
References
The Economics Review 