The Euro debt crisis, often called as Eurozone Sovereign Debt crisis has emerged on the international financial screen when the world was waiting for the dust of 2008 US Sub-Prime crisis to be settled. The Eurozone debt crisis owes its origin to the Greek debt crisis.
Euro Debt Crisis
It is said that when US sneezes, world economy shivers because US economy is the largest economy of the world. But Greek economy is too small to affect the world in such a manner, then why there is so much panic over the Greek debt in the Europe as well as the rest of the world.
Now lets look into the origin of Greek debt, its problem, solutions, nature of debt in Portugal, Ireland, Spain and there cumulative impact of Eurozone.
Origin and the nature of Greek debt
With accession to the Eurozone, Greece got the access to the cheap source of money, and started borrowing heavily. This helped the country to achieve one of the fastest growths in Europe. Meanwhile it also went on the irresponsible spending spree. Thus on one hand the public debt and public borrowing in Greece kept on rising, the huge black money and tax evasion kept the public revenue growth laggard. The budget deficit along with income and inequalities increased manifold. Since popular government was unable to either cut spending and start austerity measures or increase the tax rate to reduce deficit and debt service payments, government came at the brink of default.
The members of the Eurozone don’t have there own currency and therefore can’t adopt independent monetary policy to stimulate the growth. For e.g. in India, RBI can depreciate Rupee to stimulate exports but such measure are not possible for Greece. It can’t depreciate Euro on it own. Neither it can bridge its deficit by printing new currency as did U.S. The only recourse available to Greece is to borrow and this excessive borrowing without restructuring the economy had brought Greece at the brink of default.
If Greece defaults then other highly debted Eurozone countries like Spain, Portugal, Ireland can also default, snowballing the Greece crisis into a global crisis. It also poses a threat to the survivability of the oldest economic bloc E.U.
Debt of other E.U. nations
The debt of Spain, Ireland and Portugal is of different nature. In Spain due to the low rate of interest and high optimism, the asset prices, property prices rose exponentially. Speculation played its role and people started concentrating on making quick money through selling property for holiday homes for the foreigners instead of producing and selling goods to them.
Once the property bubble busted, people found themselves without jobs and the unemployment rate reached 20% in Spain and the country started seeking bail out package.
The crisis of Ireland and Portugal was somewhat similar where respective governments tried to bail out they banks engaged in mortgage deals and suffered deficit. It is very much similar to the sub-prime crises of U.S.
Since there was the risk of Greek crises being spread to the other European countries, E.U. came forward to bail out the Greece from its debt quagmire by agreeing on a bail out package but the package came with a rider where Greece had to cut expenditure and start austerity measure. It is quite possible that Greek public may not accept the austerity measure. If Greece doesn’t adopt the restructural policies suggested by E.U., then the ultimate default can be delayed by the bail out package but cant be averted.
Options available with Greece
In May 2010, European financial stability fund was established to stabilized the government bond market through credits default swaps. It was also engaged in the bank capital support to cantain the crises. The crises of Greece debt not only dangerous for the other Eurozone members who share single Euro currency but also other countries because the world financial market is very much interlinked and intertwined today.
Most economics suggest that there are two options available for the Greece-
First option as suggested by few E.U. leaders is to write off 50% of his debt and restructure its economy by increasing public revenue, reduce the share of borrowing and more importantly restructuring its public expenditure. But persuading the people of Greece to accept such measures may be bitter pill for the political leaders of Greece to swallow.
Second option suggested by economists is the secession of Greece from the Eurozone. In such a scenario, Greece will be free from strict E.U. fiscal guidelines; can have its own monetary police and interest rate regime. Once it secedes from the Euro, Greece will have its own currency and will be free to depreciate to this currency. When ever a country depreciates its currency relatively to the other currency, its export got boost while imports become expensive .
For e.g. if $ 1 = Rs.45
After depreciation, $ 1 = Rs. 50
Initially suppose cost of producing a k.g. of sugar in India is Rupees 48 and international price of sugar is 1$/k.g. Now we can see that before depreciation sugar cant be exported as international price was above the domestic cost of production but after depreciation exporter can earn Rs. 2 profit on every k.g. of sugar exported.
Thus Greece can pursue flexible exchange rate policy and let its currency devalues and thus can boost its export industry. But this road is not devoid of problems as once it switched to its own currency, the debt of Greece will be re-denominated in its own currency. Then the banks which funded the Greek debt may have to seek a bail out package for themselves, transforming a sovereign debt crisis in to a global financial crises. Further such measures will not be good for the future of E.U. as the weak economies may also follow the similar path.
So to avoid the impending cloud burst, a multipronged strategy must be adopted where tough action had to be taken by Greece and some flexibility provided by E.U. The world is not in a position to bear two crisis in the succession and therefore it is expedient for not just Europe but for non-European countries to come forward for some pragmatic solution of the problem as soon as possible.