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Stimulus Package: An Empirical Analysis of

Dillip Khuntia
Prafulla Kumar Sahu
Master of Finance & Control
Utkal University

Reviving Greece; Is the Greek crisis the beginning of a deeper sovereign debt crisis that

could destabilise the Euro zone?

This article argues the Euro zone is no closer to a debt crisis than the US, but some

members are getting close. EU governments could bailout Greece and, to avoid having

to do so, they should clarify their stance on the matter.

The Greek crisis has led to fears that this is only the beginning of a deeper

sovereign debt crisis that could ultimately destabilise the Euro zone. Are these fears

exaggerated? How to deal with these problems?

Financial markets now ask the question of whether the addition of government

debt is sustainable. Clearly the rate of increase of the last two years is unsustainable. But

with Euro-zone government debt standing at 85% of GDP at the end of 2009, the Euro-

zone is miles away from a possible debt crisis.

Things are different in some individual countries, in Greece in particular, a

country with a weak political system that has been adding government debt at a much

higher rate than the rest of the Euro-zone and that in addition has a debt level exceeding

100% of GDP. So, while the Euro-zone as a whole is no closer to a debt crisis than is the

US, some of its member states have been moving closer to such a crisis.

Is it conceivable that a debt crisis in one member country of the Euro-zone

triggers a more general crisis involving other Euro-zone countries? My answer is that

yes, it is conceivable, but that it can easily be avoided. The main concern lays at the

point that bailout can be done when the banks fail and the euro countries can follow UK

model to lend rentlessly to markets and to resort to fiscal and monetary measures to the

scope of a potential second global financial crisis so soon after the credit crisis of 2008-

09 goes far beyond the euro zone, the 16 nations sharing a common currency, the euro.

Last week's dramatics could have been far worse. And they may yet manifest

themselves in an ugly fashion in weeks to come if the euro-zone countries don't rescue

what Greek Prime Minister George Papandreou described last week as "the weakest link

in the euro zone."

Greece accounts for just 3 per cent of the euro-zone economy. The crisis in the

cradle of Western civilization serves merely as proxy for government over-indebtedness

Only a few months ago, a Dubai on the edge of default had to be bailed out by oil-

rich neighbour Abu Dhabi. A debt-strapped Argentina recently tried and failed to pay

debts by raiding its central-bank treasury.

Greece's debt-to-GDP ratio is an eye-popping 95 per cent. But then, the U.S. isn't

far behind at 84 per cent. (The Canadian ratio is estimated at 35.5 per cent in the

current fiscal year.) Greece's deficit-to-GDP ratio is an alarming 13 per cent. But then,

Britain isn't far behind at 12.6 per cent.

A debt crisis is conceivable

Let’s start with the first part of the answer: It is conceivable. Financial markets

are nervous and the most nervous actors in the financial markets are the rating agencies.

One thing one can say about these institutions is that they systematically fail to see

crises come. And after the crisis erupts, they systematically overreact thereby

intensifying it.

This was the case two years ago when the rating agencies were completely caught

off guard by the credit crisis. It was again the case during the last few weeks. Only after

Dubai postponed the repayment of its bonds and we had all read about it in the FT, did

the rating agencies realise there was a crisis and did they downgrade Dubai’s bonds.

The Greek crisis represents a crucial test for the European Union since a default,

or a bailout that prevents one, would be a serious blow to the credibility of the euro.

Membership in the shared currency demands that governments keep their budgets

under control.

Financial markets, it is feared, would respond to a default by selling off the bonds

of other struggling euro governments. That would make it more costly for them to

borrow money, deepening their predicament.

The world is awash in potentially unsustainable debt.

The U.S. looms largest. President Barack Obama just tabled a budget that

projects a doubling in America's national debt, to $28 trillion (U.S.), by decade's end.

That's twice the size of the U.S. economy.

Few nations emulated Canada's example of 11 consecutive budget surpluses

heading into the Great Recession. And so the necessary stimulus spending to inject life

into paralyzed economies worldwide has inflated already burdensome debt loads

accumulated by less prudent jurisdictions than Canada, Australasia and a handful of


To cover their stimulus-related and other debt obligations, national governments

are expected to borrow a staggering $4.5 trillion (U.S.) this year. That's almost triple the

average for advanced economies over the previous five years.

Any hint that certain issuers of those government bonds and other borrowings

are flirting with deadbeat status will jack up the interest rates bond-buyers will demand.

That could easily lift the general level of interest rates worldwide. Which in turn would

raise the cost of capital for businesses and individuals. And that would be a major

impediment to economic recovery at a time when central banks are trying to keep their

key lending rates at or near zero to encourage investment and job creation.

In order not to set off this "global debt bomb," as Forbes describes the plight on

its latest cover, the EU and the better-off EU nations haven't much choice but to rescue
Greece. Recalling how the failure of just one New York brokerage, in September 2008,

turned a local banking problem into a full-blown global crisis, EU officials now regard

Greece as "Europe's Lehman Brothers."

A coordinated EU bailout of Greece, spearheaded by Germany, would defend the

value of the euro. It would bolster an EU whose reputation would otherwise suffer from

having abandoned one of its members. And it could stave off a currency and debt crisis

that would likely be a worldwide spectre.

In Athens last week for a conference, Nobel laureate Joseph Stiglitz, a liberal

economist, counselled against the austerity measures the Greek government has just

imposed – including wage freezes, pension cutbacks and budget slashing across

government departments. He cavilled against the "deficit fetish" for which the

International Monetary Fund and the World Bank are notorious.

The compelling counter-argument is that global markets aren't as rational as

Nobel laureates. They need assurance now that Greece will not become an insolvent

Iceland. And that the EU will backstop Spain, Portugal, Ireland and any other EU

member that has obligations outstanding to world banks, already undermined by losses

on U.S. subprime, or junk, mortgages and other "toxic assets."

Even Stiglitz's fellow liberals on the Continent are insisting Greece "be helped with all

the fiscal brutality" of which the EU is capable, as Germany's centre-left Suddeutsche

Zeitung editorialized late last week. The EU "has taken the first step to putting the

country under its control, and virtually deprives it of its sovereignty. This is the worst

imaginable punishment for a nation."


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