Issues for IIM PI Process               




What is the “fiscal cliff”?
The fiscal cliff is the phrase that’s become associated with the combination of $500 billion in spending cuts and tax increases that are scheduled to automatically start at the start of 2013 in the United States. Tax Increases: • • • The Bush-era income-tax rates, which have been extended once already under President Barack Obama, will expire at the end of the year for all taxpayers. Also ending is a payroll-tax holiday, which means a tax increase for workers of as much as two percentage points. In addition, some 26 million additional people face the alternative minimum tax, or AMT, which would raise their taxes liability sharply unless Congress acts.

Spending Cuts: • Across-the-board cuts in domestic and, particularly, defense spending would be triggered, including a $55 billion, 9% cut in the defense budget next year and another $55 billion in cuts to domestic programs, including a 2% cut to Medicare providers.

What’s the economic impact of going over the cliff?
• If the said measures are taken, the Congressional Budget Office has projected the economy would contract 1.3% in the first six months of 2013, with the economy stabilizing in the second half and eventually achieving an annual growth rate of 0.5%. Joblessness would rise to 9.2% at the end of 2013 if Congress didn’t act. But alternately, it has been argues that the budget cutting that would automatically take place will eventually boost growth by putting the government on a firmer and more sustainable financial footing. The counter argument is that going over the cliff would cause a) investor panic and b) consumer panic and fundamentally derail what’s already a weak economic recovery. "The US fiscal cliff represents the single biggest near-term threat to a global economic recovery," the Fitch ratings agency said recently. The dramatic fiscal tightening implied by the fiscal cliff could tip the US and possibly the global economy into recession. At the very least it would be likely to halve the rate of global growth in 2013. The IMF has warned that even the uncertainty raised by the fiscal cliff has hit global investment and job creation.

• • • • •

What is the likely impact on India?   

  Issues for IIM PI Process                       
  • Reserve Bank of India cited World Bank research that predicted only a modest impact on India: Economic growth in South Asia would fall by 0.2 percentage points while the current account deficit would improve by 0.1 percentage points of gross domestic product. But the central bank seems worried enough to add: “…a sharp fiscal contraction may have a deleterious impact on global growth.” Commodity prices will ease off and oil prices will stay significantly lower than in the recent past. In fact, fear of the fiscal cliff has already drove down commodity prices, starting in October. This will mean that India’s inflation rate may come down fast enough for the central bank to cut interest rates more quickly than anticipated to stimulate growth. Lower crude oil prices could also ease some of the current pressure on the balance of payments (BoP). Trade: However, there could be potentially adverse impact on the Indian economy from reduced trade and investment. India’s merchandise exports now account for nearly 16% of Gross Domestic Product, while total exports account for approximately 24% of GDP. With India’s major trading partners in trouble, exports are expected to take a hit. Capital flows will also be affected as the global recession that may result, even if the fiscal cliff is avoided, will lead investors to safe havens. That means rising demand for gold and dollar-denominated assets and capital will move away from risky assets (both equity and currency) of emerging markets, including India. Equities: If we look at the correlation of returns of EM equities, they are positively correlated to global equities. Hence any fall in global equity markets due to a fiscal cliff could cause a fall in all emerging stock markets including India.. The fundamentals of the Indian economy are far weaker than they were at the end of 2008, which means that the ability of policymakers to intervene effectively is less than before. One indication of this is the level of foreign exchange reserves with the central bank relative to monthly imports. Such import cover has nearly halved in the past four years, from 12 months to six months.  At an International Monetary Fund meeting in Nov 2012, FM P. Chidambaram said that “the issues of fiscal cliff and the lifting of the debt ceiling in the U.S. also need to be resolved. The need is to put in place a medium-term fiscal plan while avoiding excessive fiscal correction in the short run. Should the economic situation in the U.S. worsen, its impact on emerging market economies will be much more severe than in the case of the situation in the euro area.”  

NATIONAL INCOME  • • • • • • Domestic saving rate has declined to 30.4% in 2011/12   CAD ‐4.2% of GDP; merchandise trade deficit at ~10% of GDP; capital flows: 3.7% of GDP  Fiscal deficit for the Centre was 5.89% of GDP in RE 2011/12; Consolidated: 8.2 per cent of GDP  Employment elasticity falling from 0.43(99‐04) to projected 0.25 in 2011‐16   Current: Policy ratios: repo: 8%, reverse repo: 7%, MSF: 9%; Reserve ratios: CRR‐4.25%; SLR‐23%,  USD‐INR: 54.83  WPI: Primary goods carry a weight of 20.12%, 'fuel and power' 14.91% and manufactured products  64.97%.   

  Issues for IIM PI Process                       
  INDUSTRY   • • National Manufacturing Policy Goals:‐ Increase manufacturing growth to 12‐14%; Share of manufac  to 25% of gdp by 2022; create 100m jobs by 2022  MSME: MSME segment constitutes about 26 million units, contribution of 8 % in GDP, a share of 45  % of total industrial output, over 8000 products manufactured, 40 % of export, employment of 60  million people having a potential of creating 1.3 million jobs every year further ensuring balanced  regional and inclusive growth  

AGRICULTURE  • • • • • • GDP share: 30% in 90‐91 to <15% in 2011‐12;   GDP agri – 3.9% in 2005‐11; High CV => Volatile – 6x than GDP overall  BRICS experience that 1% g agri is 2‐3x more effective than reducing povrty than non‐agri g;   ~ 52% of workforce is still employed by farm sector (NSS 66th Round);   average size of operational holdings has diminished progressively from 2.28 ha in 1970‐71 to 1.55 ha  in 1990‐91 to 1.23 ha in 2005‐06 ( Agri census 2005‐06); Marginal holdings ( less than 1 ha) – 65%  GCF agri: Reversal in trend from 9th plan ‐ increase in GCF to 13.9% in 10th  – 18.7% in 1st 3 yrs of  11th. 

TRADE  Services trade:‐ Exports grew at 20.6% cagr in 2004‐11; Size – software 42% share; Imports cagr 20.2%;  Total trade incl services 50% of gdp in 2010‐11 (25% in 97‐98)  Goods trade:     Value  CAGR  Share in global X/M  • • • • • • Exports  45b $ (2001) to 303b $ (2012)  19.5% in decade  0.7% ‐> 1.5% [2000‐2010]  Imports  50b $ (2001) to 488b $ ( 2012)  25% in decade ( 2000s)  0.8% ‐> 2.2% [2000‐2010] 

In the top 100 imports of the world in 2010, India has only 15 items with a share of 2 % and above.  [Shows low export diversification]  share of Asia and ASEAN in total trade increased from 33.3 % in 2000‐1 to 57.3 % in 1st half of 2011‐ 12,   Europe and America fell from 42.5 % to 30.8 %  India’s trade deficit as a per cent of GDP at 9.9 percent in 2012, is one of the highest.  In  the  2  yrs  2009‐10  to  2011‐12,  net  gold  imports  incr  by  28b  $  or  1.5%  of  GDP  ‐>  HAD  IT  been  constant CAD wud be a manageable 2.7% instead of the daunting 4.2%  LINKAGE:   

  Issues for IIM PI Process                       
  o o Trade openness (goods and services trade) increased substantially with the trade‐GDP ratio  doubling since 1999‐2000. [ 17.2% (90‐91) to 29.2% (01‐02) to 53.7 ( 08‐09) ]  ratio  of  total  external  transactions  (gross  current  account  flows  plus  gross  capital  account  flows) to GDP – an indicator of both trade and financial integration – was 112% in 2008‐09  up from 44% in 1998‐99. 

LEVESON INQUIRY  ‐ Important as role of media has been in limelight in India too  What was the Leveson Inquiry?  • It was a public, judge‐led inquiry set up by Prime Minister David Cameron to examine the culture,  practice and ethics of the press. It was established in the wake of the phone‐hacking scandal at the  now‐defunct News of the World tabloid. 

What did it look at?  It  looked  at  the  relationship  between  the  press  and  the  public,  including  phone‐hacking  and  other  potentially  illegal  behaviour,  and  at  the  relationships  between  the  press  and  the  police  and  the  press  and politicians.   What did Lord Justice Leveson recommend?  He made broad and complex recommendations relating to how the press is regulated:   • Newspapers should continue to be self‐regulated ‐ and the government should have no power over  what they publish.  There had to be a new press standards body created by the industry, with a new code of conduct   That  body  should  be  backed  by  legislation,  which  would  create  a  means  to  ensure  the  regulation  was independent and effective  The arrangement would provide the public with confidence that their complaints would be seriously  dealt with ‐ and ensure the press are protected from interference. 

• •

Why did he recommend reworking press regulation?  • The  current  system,  where  the  press  is  self‐regulated  voluntarily  through  the  Press  Complaints  Commission  (PCC),  is  widely  agreed  to  be  doomed  ‐  the  PCC  itself  has  agreed  to  move  into  a  "transitional phase" until a long‐term replacement can be established.   The  chairman  of  the  PCC,  Lord  Hunt,  wants  a  new  "tough,  independent  regulator  with  teeth".  He  told  the  Leveson  inquiry  there  was  a  willingness  among  publications  for  a  "fresh  start  and  a  new  body" based on legally‐enforceable contracts between publishers and the new body.   

  Issues for IIM PI Process                       
  • The Free Speech Network, which represents many editors and publishers, is vigorously opposed to  any state involvement in press regulation. It says the press exists to scrutinise those in positions of  power, and it could not do that if those it was scrutinising had authority over it. 

seeks to achieve inclusive growth of the Indian economy by implementing cohesive policy measures for  creating  state‐of‐the  art  manufacturing  facilities  aimed  at  making  India  the  next  “manufacturing  destination”.   Through various policy instruments like   a) b) c) d) e) f) creation of National Investment and Manufacturing Zones (NIMZs),   rationalization / simplification of business regulations,   provision of exit mechanisms for sick units,   creation of financial and institutional mechanisms for technology development,   implementing industrial training and skill up gradation measures,   providing incentives for Small and medium enterprises (‘SMEs’) 

NMP seeks to achieve the following broad objectives:  a) b) c) d) e) f) g) Increase the share of manufacturing in GDP to 25% by 2022;  Create 100 million additional jobs by 2022;  Creation of appropriate skill sets among the rural migrant and urban poor to make growth inclusive;  Increase domestic value addition and technological depth in manufacturing;  Enhance global competitiveness of Indian manufacturing through appropriate policy support; and  Ensure sustainability of growth, particularly with regard to the environment   NMP has also outlined certain focus industries ‐primarily comprise –   a) employment intensive industries;   b) capital goods industry;   c) industries with strategic significance (like aerospace; shipping; IT hardware and electronics;  telecommunication equipment; defence equipment; and solar energy);   d) industries where India enjoys a competitive advantage;   e) SMEs and   f) Public sector enterprises (‘PSU’). 

Need:‐   1. There are attendant socio economic manifestations in terms of over dependence of a large section  of  the  population  on  agriculture  for  its  livelihood,  disguised  unemployment  and  urban  unemployment.  India  has  a  favourable  demographic  profile  with  over  60%  of  population  in  the  working age group of 15‐59 years. For a country with the largest young population in the world, this  creates  a  challenge  of  significant  magnitude.  Over  the  next  decade,  India  has  to  create  gainful  employment  opportunities  for  a  large  section  of  its  population,  with  varying  degrees  of  skills  and   

  Issues for IIM PI Process                       
  qualifications. This will entail creation of 220 million jobs by 2025 in order to reap the demographic  dividend.  The  manufacturing  sector  would  have  to  be  the  bulwark  of  this  employment  creation  initiative.  Every  job  created  in  manufacturing  has  a  multiplier  effect  of  creating  two  to  three  additional jobs in related activities. Therefore, a thrust on manufacturing is integral to the inclusive  growth agenda of the government.    2. Besides the employment imperative, the development of the manufacturing  sector is critical from  the  point  of  view  of  ensuring  that  the  growth  model  of  India  is    sustainable  by  providing  value  addition to our natural and agricultural resources,  addressing our strategic needs, and developing  new technologies for the welfare of our citizens.  3. Finally, the growth of the manufacturing sector has to be made  sustainable,   particularly ensuring  environmental sustainability through green technologies, energy  efficiency, and optimal utilization  of natural resources and restoration of damaged / degraded eco‐systems.  In order to achieve these goals:‐  1. Foreign investments and technologies will be welcomed while leveraging  the country's expanding  market  for  manufactured  goods  to  induce  the    building  of  more    manufacturing  capabilities  and  technologies within the  country;   2. Competitiveness  of  enterprises  in  the  country  will  be  the  guiding  principle    in  the  design  and  implementation of policies and programmes;   3. Compliance burden on industry arising out of procedural and regulatory  formalities will be reduced  through rationalization of business regulations.   4. Innovation will be encouraged for augmenting productivity, quality, and  growth of enterprises; and   5. Effective  consultative  mechanism  with  all  stake  holders  will  be  instituted  to    ensure  mid‐course  corrections. 

• Over  the  years,  the  Indian  planning  system  has  moved  from  centralized  investment  planning  to  a  more  directional  planning  methodology.  Today  the  Planning  Commission  concerns  itself  with  evolving  a  long‐term  strategic  vision  of  the  economy,  decides  on  priorities  and  works  out  the  sectoral targets consistent with the strategic vision and priorities. It also indicates the initiatives the  government  needs  to  take  both  in  terms  of  investments  and  policy  changes  to  realize  these  objectives.   Integrative role in the development of a holistic approach to policy formulation in critical areas of  human and economic development, specially where both the Centre and the States have a role to  play.  In  the  social  sector,  schemes  which  require  coordination  and  synthesis,  coordinated  policy  formulation.   Emphasis on maximizing the output of the economy by using our limited resources optimally.   

  Issues for IIM PI Process                       
  • Mediatory and facilitating role: With the emergence of severe constraints on available budgetary  resources,  the  resource  allocation  system  between  the  States  and  Ministries  of  the  Central  Government  are  under  strain.  This  requires  the  Planning  Commission  to  play  a  mediatory  and  facilitating  role,  keeping  in  view  the  best  interests  of  the  country.  It  has  to  ensure  smooth  management  of  change  and  help  in  creating  a  culture  of  high  productivity  and  efficiency  in  Government, both at the Centre and in the States.   Systems change role: The key to efficient utilization of resources lies in the creation of appropriate  institutions and self‐managed organizations at all levels. In this area, Planning Commission plays a  systems change role and provides capability within the Government for developing better systems  and institutional design.   Information  dissemination  role  regarding  best  practices  obtaining  in  different  States  and  institutions 

• • Taking cognisance of cases on issue of public interest; Locus standi not required; came in 1979 after  famous cases of Hussainara Khatoon vs. Bihar case and Sunil Batra vs. Delhi Administration (1980)  Judicial activism has had manifold impact on the political system.   o o As  Justice  Bhagwati  said  in  a  speech,  the  judiciary  has  been  able  to  develop  our  Human  Rights jurisprudence and brought help and succour to the masses of people in India, thru JA.  Acc to him, law‐makin gis an inherent and inevitable part of the judicial process. The judge  infuses life and blood into the dry skeleton provided by the legislature and creates a living  organism appropriate and adequate to meet the needs of the society.  It  has  democratised  the  judicial  system  by  giving  not  just  to  individuals  but  also  groups  access to the courts.   It has forced executive accountability.   It  has  also  made  an  attempt  to  make  the  electoral  system  much  more  free  and  fair.  The  court  asked  candidates  contesting  elections  to  file  affidavits  indicating  their  assets  and  income  along  with  educational  qualifications  so  that  the  people  could  elect  their  representatives based on accurate knowledge.   the  judiciary  has  also  shown  readiness  to  take  into  consideration  rights  of  those  sections  who  cannot  easily  approach  the  courts.  For  this  purpose,  the  judiciary  allowed  public  spirited citizens, social organisations and lawyers to file petitions on behalf of the needy and  the deprived.  The  right  to  life  and  personal  liberty  and  the  procedure  established  by  law  has  been  converted de facto and de jure into a procedural due process clause contrary to the intent  of the makers of the constitution. This expanding right has encompassed, within itself, the   

o o o



  Issues for IIM PI Process                       
  right to bail, the right to a speedy trial, immunity against cruel and unusual punishment, the  right  to  dignified  treatment  in  custodial  institutions,  the  right  to  legal  aid  in  criminal  proceedings and above all the right to live with basic human dignity.  Through  the  PIL,  the  court  has  expanded  the  idea  of  rights.  Clean  air,  unpolluted  water,  decent living etc. Are rights for the entire society. Therefore, it was felt by the courts that  individuals as parts of the society must have the right to seek justice wherever such rights  were violated. 


There is however a negative side to the large number of PILs and the idea of a pro‐active judiciary.   o o In the first place it has overburdened the courts.   Secondly,  judicial  activism  has  blurred  the  line  of  distinction  between  the  executive  and  legislature on the one hand and the judiciary on the other. The court has been involved in  resolving questions which belong to the executive. Thus, for instance, reducing air or sound  pollution  or  investigating  cases  of  corruption  or  bringing  about  electoral  reform  is  not  exactly  the  duty  of  the  Judiciary.  These  are  matters  to  be  handled  by  the  administration  under the supervision of the legislatures.   Therefore, some people feel that judicial activism has made the balance among the three  organs  of  government  very  delicate.  Democratic  government  is  based  on  each  organ  of  government  respecting  the powers and jurisdiction of the others. Judicial activism may be  creating strains on this democratic principle. 


More about Judicial Activism  • Judicial  activism  is  a  philosophy  of  judicial  decision‐making  whereby  judges  allow  their  personal  views about public policy, among other factors, to guide their decisions. It can be narrowly defined  as one or more of three possible actions: overturning laws as unconstitutional, overturning judicial  precedent, and ruling against a preferred interpretation of the constitution. (For instance widening  the right to life to include right to free legal aid, right to privacy, right to healthy environment etc)  The  chief  instrument  through  which  judicial  activism  has  flourished  in  India  is  Public  Interest  Litigation  (PIL).  In  normal  course  of  law,  an  individual  can  approach  the  courts  only  if  he/she  has  been personally aggrieved. But in the case of PIL, the case is filed not by the aggrieved persons but  by others on their behalf. Many public spirited citizens and voluntary organisations (eg. Center for  PIL  ‐  CPIL  represented  by  Prashant  Bhushan  and  Shanti  Bhushan)  sought  judicial  intervention  for  protection of existing rights, betterment of life conditions of the poor, environment etc.  Detractors  of  judicial  activism  charge  that  it  usurps  the  power  of  the  elected  branches  of  government  or  appointed  agencies,  damaging  the  rule  of  law  and  democracy.  They  argue  that  an  unelected  or  elected  judicial  branch  has  no  legitimate  grounds  to  overrule  policy  choices  of  duly  elected or appointed representatives, in the absence of a real conflict with the constitution. In some  instances, government regulation by appointed officers in government agencies are overturned by  elected judges.   

  Issues for IIM PI Process                       
  • Defenders  of  judicial  prerogatives  say  that  many  cases  of  so  called  "judicial  activism"  merely  exemplify  judicial  review,  and  that  courts  must  uphold  existing  laws  and  strike  down  any  statute  that violates a superseding law.   Some recent instances of Judicial Activism can be –   o Distribution of food under Public Distribution System free to poor instead of letting it rot in  godowns  o The  SC  ordered  the  Delhi  Government  not  to  demolish  night  shelters  in  Delhi  for  the  homeless  in  the  midst  of  winters  as  it  is  against  the  right  to  life.  The  court  had  taken  suo  moto cognizance from news paper reports  o The brawl on the appointment of CVC PC Thomas  In  India,  even  as  Prime  Minister  Manmohan  Singh  frowned  upon  “judicial  overreach”,  Supreme  Court  former  chief  justice  K  G  Balakrishnan  had  welcomed  its  outcome  as  a  desirable  “tension”  between the judicial and the legislative and executive branches. The source of the tension, however,  lies in the vacuum created by the lapses of both the legislative and executive branches.   The judiciary is giving the impression of stepping in to fill the vacuum by often forcing the executive  to  take  action  (against  the  privileged  sons  of  politicians,  as  in  the  Jessica  Lal  case)  or  compelling  Parliament  to  enact  laws  (for  example,  to  curb  sexual  harassment  at  workplaces).  This  has  encouraged  the  Indian  urban  middle  class  to  repose  its  faith  in  the  new‐found  concept  of  judicial  activism,  and  to  wish  that  the  judiciary  replaces  the  corrupt  legislature  and  bureaucracy  as  the  benevolent authority. But there is a catch in this wishful belief. Barring a few recent cases of judicial  intervention, which have had some positive effect on governance, the Indian judiciary on the whole  has not displayed any spontaneous will to act on behalf of the common people.   Even though this phenomenon has been welcomed by many, it has many negatives –  o It has overburdened the courts leading to delayed justice for normal cases  o It  has  blurred  the  line  of  distinction  between  the  legislature  on  the  one  hand  and  the  judiciary on the other.   o It has made the balance among the three organs of government very delicate. Democratic  government is based on each organ of government respecting the powers and jurisdiction of  the others. Judicial activism may be creating strains on this democratic principle.   Even  though  Judicial  review  is  essential  to  maintain  the  fundamental  rights  of  citizens,  the  constitution clearly defines the legislature as the law making body. Any aberration in either of these  will  be  against  the  spirit  of  the  constitution.  The  two  parts  should  try  to  work  together  without  stepping into the jurisdiction of each other for the benefit of the nation’s common man.  

There are three important effects: 1. Some people had borrowed in dollars, and left it unhedged since they were speculating that the INR would appreciate. They get hurt in the process. But this is fine as in a market economy, many people   

  Issues for IIM PI Process                       
  place bets about future fluctuations of financial prices, and half the time the speculator loses money. (If the rupee had not depreciated sharply, these speculators would have been gained). 2. When the rupee depreciates, imports become costlier and India's exports become more competitive. So exports (X) gradually start going up and imports (M) gradually start going down. The net gain in X-M is increased demand in the local economy. Hence, INR depreciation is good for aggregate demand (and conversely INR appreciation pulls back demand). However, we have to bear in mind that these effects are small and take place with long lags. 3. Many things in India are tradeable. It is important to focus on the things that are tradeable and not just on the things that are imported. As an example, there are many transactions between a domestic producer of steel and a domestic buyer of steel. The buyer and seller are both in India. But the price at which they transact is the world price of steel (which is quoted in dollars) multiplied by the INR/USD exchange rate. This is called `import parity pricing'. Through this, the domestic prices of tradeables goes up when the rupee depreciates.

Problem: The falling rupee is worrying policymakers, not least because a steady drop in the country’s foreign exchange reserves and a worsening current account deficit make it vulnerable in a tough global environment. Why the problem arose: 1. The Euro zone crisis has triggered risk-aversion among investors and slowed capital inflows 2. pressure on the economy and the currency from a slowing economy, a widening trade deficit amid high contractual repayment obligations. 3. Dollar liquidity crunch globally in the wake of downgrades by ratings agencies of European countries and banks. Measures Taken: The government has already taken measures to boost capital inflows. These include raising the foreign institutional investment limit in government securities and corporate debt, raising borrowing limits for banks and companies and asking companies to quickly bring back home funds raised overseas. Measures which are being considered: 1. 2. 3. 4. 5. 6. Imposing restrictions on overseas investments by local companies Curbing pre-payments of foreign loans Enforcement or revision of prudential limits on currency positions Strong communication to cool markets Steps to curb speculation Ease overseas borrowings for corporates and banks

Long term measures 1. Assess preparedness to deal with any financial crisis 2. Freeze the contours of the proposed Crisis Management Group with more clarity on its role and powers   

  Issues for IIM PI Process                       

Inflation has an adverse impact on the real economy. The following points are worth noting 1. High and persistent inflation imposes significant socio-economic costs. Given that the burden of inflation is disproportionately large on the poor, high inflation by itself can lead to distributional inequality. Therefore, for a welfare-oriented public policy, low inflation becomes a critical element for ensuring balanced progress. 2. High inflation distorts economic incentives by diverting resources away from productive investment to speculative activities. 3. Inflation reduces households saving as they try to maintain the real value of their consumption. Consequent fall in overall investment in the economy reduces its potential growth. 4. As inflation rises and turns volatile, it raises the inflation risk premia in financial transactions. Hence, nominal interest rates tend to be higher than they would have been under low and stable inflation. 5. If domestic inflation remains persistently higher than those of the trading partners, it affects external competitiveness through appreciation of the real exchange rate. 6. As inflation rises beyond a threshold, it has an adverse impact on overall growth. 7. RBI's current assessment suggests that the threshold level of inflation for India is in the range of 4-6%. If inflation persists beyond this level, it could lower economic growth over the medium-term. Hence there is a need for a monetary policy response by the Central Bank to control inflation

[This is an overview of the genesis of the crisis; What is happening currently in Europe is covered separately]

Portugal, Ireland, Italy, Greece and Spain share a currency and an acronym PIIGS. Each lost cost competitiveness after 1999, seeing prices and wages rise more rapidly than the Euro area average. As members of the Euro zone, they cannot devalue their currencies, making the struggle out of recession harder. Thus they need internal devaluation which means falling wages, and falling GDP (Due to fiscal consolidation). But, as GDP falls, the tax collections will drop too and the deficit will not get reduced as much, thus a further fall in GDP is necessitated. As the trouble brewed, the symptoms varied in each country. Greece and Spain sucked in cheap imports and ran-up huge current account deficits. They at least enjoyed prosperity for a while unlike Portugal and Italy whose economies were held back by high wage costs and poor productivity. Ireland’s export-led success gave way to a bubble economy built on low interest rates.   

  Issues for IIM PI Process                       

Details: Portugal – It seemed to have exhausted the benefits of Euro even before it was launched. Its boom in the second half of 1990s was fed by a sharp decline in borrowing costs, based on the mere prospect of Euro membership. Rapid wage inflation eventually made it harder for local firms to compete with foreign rivals. By 2000, Portugal’s current account deficit had widened to a deficit of 10% of GDP. The emerging economies of Eastern Europe and Asia have further dulled Portugal’s appeal as a low-cost producer. Its poor education system keeps it trapped in low-skilled work, which can be done more cheaply by others. Ireland – Ireland had a more ruinous credit boom that even America or Britain. Bank lending was heavily tilted towards mortgages and construction. One legacy is the bad commercial-property loans that have crippled its banks. Another is the stockpile of household debt, mostly mortgages that exceeded 100% of GDP. The regulation of banks was also an issue. There was huge and wasteful investment in real estate sector, financed by banks by borrowing from non residents and capital markets. At one time, 60% of bank assets = 250% of nominal GDP = loans to real estate sector. (Infact, it had a current account surplus – so that was not part of the problem)   

  Issues for IIM PI Process                       
  The government guaranteed all liabilities of Irish banks including private sector banks against defaults. But, those banks were not facing a liquidity problem but a solvency crisis. Thus, the problem could not be solved. Finally, IMF and EU bailout became necessary. The bailout was of Eur 85 bn. Ireland seeks to return to export-led growth that was once its key to success. To do so, it must lower its wages relative to its trading partners in euro area. For many households, that means wages will fall, making debt looms larger. One salve is that mortgage rates in Ireland are linked to the European Central Bank’s main interest rate, which is set to remain low. Italy- Italy had a nasty recession but unlike others was not pulled out of shape by a big credit boom or housing boom. Between 2002 and 2007, Italy’s current account deficit averaged less than 2% of GDP compared with between 7% and 9% of Greece, Spain and Portugal. Yet Italy suffers many of the same problems. Like Spain, its productivity growth is dismal. Like Greece, it has huge public debts and trouble collecting taxes. That is in part due to the country’s vibrant North that the levies raised there help pay for the many failures of the poorer south. Spain- Spain’s economic trouble is closely tied to its housing bust. The unemployment rate is close to 20% and many of the newly idle had been construction workers. Spain’s poor productivity growth is partly the result of the housing mania.(construction booms are labour-intensive). Yet much of the fault lies with Spain’s labour market rules. Wages are set centrally and most jobs are protected, making it hard to shift skilled workers from dying to blooming industries. (Most job losers were low skilled temporary workers, who are hard to reemploy). Recession revealed how dependent public finances had been on housing-related tax revenues. House prices have further to fall. On one measure, the ratio of house prices to rent, Spanish property is more than 50% above its face value. Greece- Public finances are in a mess in most rich European countries, but Greece is in by far the worst shape. There was fiscal and financial irresponsibility resulting in ultra loose fiscal policy and a huge Current account deficit. In 2009, the government ran a budget deficit of 13.6% of GDP. Greece’s debt stood at 115% of GDP in 2009. Among OECD countries, only Japan has a higher burden. Public spending was 51% of GDP– bloated by the standards of America, but broadly in line with the average for Euro area countries. Greece’s main fiscal problem is collecting revenues. Tax evasion is endemic, contributing to Greece’s low tax/GDP ratio of 31%. Among Euro area counties, only Ireland’s figures are lower. All this necessitated a record 110 bn euro ($147 bn) bailout for debt-stricken Greece after Athens committed itself to years of painful austerity. It is a three-year package of emergency loans. In exchange for by far the largest bailout ever assembled for a country, Greece announced further spending cuts and tax increases totaling 30 billion euros over three years on top of tough measures already taken. Telling angry Greeks to choose between the painful rescue or economic collapse, the government now aims to bring its towering budget deficit back to the EU limit by 2014, two years later than originally promised.   

Sign up to vote on this title
UsefulNot useful