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Eurozone Debt Crisis


How the crisis unfolded?

Euro was born when European Union became a single

economic zone. EU comprised of strong (Germany, France) as well as weak (Greece, Portugal) economies. Euro being the single currency in the union, there was no fear of local inflation, so banks lent indiscriminately. World economy was in good shape, so direct correlation between economic and repayment strength was not evident. Weaker economies of EU (PIIGS) overspent using borrowed money. Now they are unable to pay back their debt.

What did the PIIGS do?

Ireland underwent a massive real estate bubble, and its banks

sustained giant losses. The Irish government wound up rescuing its banks, and now the country is burdened under a huge debt load. Spain also experienced a huge housing bubble. The country didn't indulge in excessive borrowing, rather, it ended up with high deficits because it couldn't collect enough tax revenue to cover its expenses. Greece not only borrowed beyond its means, but exacerbated the problem with lots of overspending, little economic production to make up the difference, and some creative bookkeeping to prevent euro zone authorities from realizing the true extent of the situation. Italy and Portugal have huge debt to GDP ratios, high unemployment and are struggling with a weak economy.

And now
Given the huge size of the PIIGS debt, investors are

reluctant to buy bonds from European countries, since many are in huge debts and others may have to assume responsibility for the black sheep. We could be looking at depression for Europe and recession for rest of the world. Uncertainty prevails as

EU may break up Some countries may pull out of the EU Leading to a rash of ban failures

Timeline of the crisis

1999-2008 Euro is introduced, more countries join in. In Dec 08 EU leaders agree on a 200bn-euro stimulus plan to help boost European growth following the global financial crisis.

2009 Slovakia joins EU, Estonia, Denmark and others make preparations to join. In April, the EU orders France, Spain, the Irish Republic and Greece to reduce their budget deficits In December, Greece admits that its debts have reached 300bn Euros; 113% of GDP, nearly double the EU limit of 60%.

Timeline of the crisis (contd)

2010 Severe irregularities are found in Greeces accounting procedures. Talks start over austerity measures, sparking riots and protests Euro continues to fall against Dollar and Pound. In May, EU members and IMF agree on a 110 bn Euro bail-out package for Greece. Ireland, Portugal, Spain, Italy come under review. In November, the EU and IMF agree to a bailout package to the Irish Republic totaling 85bn Euros. The Irish Republic soon passes the toughest budget in the country's history.

Timeline of the crisis (contd)

2011 In February, eurozone finance ministers set up a permanent bailout fund, called the European Stability Mechanism, worth about 500bn euros. In April, Portugal admits it cannot deal with its finances itself, leading to a 78bn-euro bailout. Greece approves fresh round of austerity measures, the EU approves the latest tranche of the Greek loan, worth 12bn euros. A second bailout of Greece is agreed upon, at 109 bn Euros.

Timeline of the crisis (contd)

2012 S&P downgrades France and eight other euro zone countries, blaming the failure of euro zone leaders to deal with the debt crisis. Euro zone service sector shrinks, unemployment rates hit all time high and European Commission predicts that the euro zone economy will contract by 0.3% in 2012. Attention shifts to Spain and Italy, as they struggle to avoid going the Greece way.

Extent of the Crisis: Debt as a % of GDP

Extent of the Crisis: Unemployment Rate

Extent of the Crisis: Projected GDP

Whose fault is it?

Irresponsible" countries who borrowed too much, taking advantage

of the low interest rates available to all euro member nations. The euro as a single currency cant meet the needs of 17 different economies.

Typically, a country's central bank can adjust a nation's money supply to encourage or inhibit growth as a way of dealing with economic turmoil. However, the nations yoked together under the euro frequently haven't had that option. If Spain and Germany hadn't both spent the last several years on the euro, for example, then they wouldn't have been able to borrow at the same low interest rates. If the PIIGS all still had their own individual currencies, they might be able to export their way out of the mess they're in -- selling goods on the international market until their respective situations were a little less dire

The interconnectedness of the modern financial industry. Default by

Italy or a departure of the eurozone by a fed-up Germany , could reverberate around the world.

What s being done to avoid the crisis?

Stronger economies are pushing for stringent

spending control guidelines, where a countrys spending will be directly proportional to its economic strength. Several options are being discussed, such as, issuance of Euro Bonds, backed by the entire EU. Restructuring of debt, with strict austerity measures placed on countries at risk of default. Troubled eurozone countries are pledging to cut back government spending to show they can be trusted

How does it affect us?

Stock market volatility.

Financial institutions exposed to the debt will write it

down, affecting their bottom line. Borrowing will get costlier as interest rate will remain high. As a result, spending will be less leading to a longer recession. Weak consumption and spending in Europe spells trouble for the rest of the world economy, that is struggling to get out of the downturn.