By Group 6 :

The Greek Debt Crisis 2010 Anmol Chopra

Chu Qionghua Katherine
Kuah Boon Lee Kelly
Toshiya Suzawa
Wong Kim Fatt
I. Crisis

• Run-up to the crisis

• Indicator Assessment
• Sign of bubble and future crisis examination
 I. Crisis

1981-82 1993 1999 2003-07 2007 End 2009 Early 2010 2012 2015 2020
Political Maastricht Euro Credit GFC: Revised Greek Debt Financial Failure to Partial
shift Treaty; Creation creation & Froze budget Crisis Starts Distress repay IMF recovery
resulting in Stability & Mismatches liquidity deficit: loan
a structural Growth Shut out of Major IMF- COVID-19
break in Pact Euphoria 6% -> bond EU bailout 2nd Minsky
productivit 12.1% market package moment
y& 2nd
spending Fundament Credit to Sudden Austerity
al GDP: 180% trigger for measures
1st Exogenous reappraisal
Fundament Shock
al 1st Minsky
Exogenous moment
Shock
 Major Political Shift – 1st Fundamental Exogenous Shock
• In Oct. 1981, the Panhellenic Socialist Movement (PASOK), came into power on a
populist platform

• In a continuing bid to keep Greek voters happy, both parties lavished liberal welfare
policies
GDP Size
• 1982-1985: Debt
accumulation; however
GDP did not grow

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Major Political Shift – 1st Fundamental Exogenous Shock

• Labor productivity and TFP declined since

the political shift

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Formation of European Union – 2nd Fundamental Exogenous Shock

• A monetary union; not a banking union or a fiscal union

o national responsibility for financial regulation and fiscal policy

• Stability and Growth Pact set limits

o annual budget deficits at 3 percent of GDP
o stock of public debt of 60 percent of GDP
o a “no bailout” clause; a sovereign default would occur if a national
government failed to meet its debt obligations

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Pre-crisis build up – Credit creation & Mismatches

• Aggregate European data on debt/GDP ratio masked considerable variation

at the individual country level Phase I: pre-Maastricht
treaty; debt already
more than 90% of GDP
III
II Phase II: formation of
EU; limits under treaty;
I period of growth (or
bubble build up?)

Phase III: Bubble burst;

full blown crisis; EU-
IMF joint bailout

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Pre-crisis build up – Credit creation & Mismatches
• Domestic credit boom – key predictor of a banking crisis

• Lower interest rates and easier availability of credit stimulated consumption-

related and property-related borrowing

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Pre-crisis build up – Credit creation & Mismatches

• An alarmingly high CAD masked by Euro area balance ~0 (primarily due to

Germany’s high surplus)

Short Term impact Medium Term impact

Capital flow reversals lead to output Can be harmful if increased expenditure
contractions, rising unemployment, and bids up wages, drawing resources away
asset price decline; with a greater risk of from industries that have more scope for
a banking crisis, if capital flows productivity growth
intermediated through banking system

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Pre-crisis build up – Credit creation & Mismatches

• Elimination of national currencies meant that

national fiscal policies took on additional
Fiscal deficit as % of GDP
importance as a tool for countercyclical
macroeconomic policy

• However, government failed to tighten fiscal policy

during the 2003 –2007 boom period

• Fiscal policy became less countercyclical after the

creation of Euro

• International banking standards (Basel et al) were

not very stringent during this period

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Pre-crisis build up – Euphoria

Government Spending (€ mn)

Confidence in Greece, as
evidenced by the successful
2004 Olympic Games, had
contributed to Greek
government bonds viewed
as risk-free as German
bunds

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 The Crisis

2008 GFC tightened credit conditions Flight to safety during GFC led to
leading to domestic recession & higher liquidity squeeze in funding markets
loan losses for banks

Twin problem for banking industry

• While the impact on countries with macro imbalances was disproportionately
higher within the EU (such as Greece), focus was on ECB to:
o Slash interest rates;
o Provide Euro-denominated liquidity; and
o Enter into currency swap arrangements to facilitate Dollar denominated
liquidity
Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 The Crisis

• In late 2009 though, the sovereign crisis entered a new phase

• Fiscal revenues declined sharply due to subdued economic activity

o revised 2009 budget deficit forecast of 12.7% of GDP; more than double
the previous estimate of 6.0% Sudden trigger for reappraisal;
1st Minsky moment
• Resulted in spike in yield spreads
o annual spread on ten-year sovereign bond yields between Germany and
Greece was close to zero before the crisis

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 The Crisis
1. Greek yield began to diverge from the
group in early 2010

2. Required official assistance in May 2010

• joint EU-IMF program established
for fiscal austerity & structural
reforms
• however, scale of macro imbalance
meant a longer than standard 3
year term of such deals 2
• fiscal austerity could not be
1
counterbalanced with currency
devaluation

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 The Crisis
Problems with the 1st bailout package:

o Longer term required

o Currency devaluation not possible

o Declining disposable household income – fiscal & political narrative

o Global/wider European headwinds impacting recovery making fiscal targets unobtainable

o Standard IMF penalty premium of 300 bps

− Debt servicing even harder
− Lending nations benefitting at the expense of borrowing nations

o Pressure to provide fiscal funding to banks; who in turn held domestic sovereign bonds

o No haircut on private sector debt

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 The Crisis

3. Discussion of need for 2nd bailout 4

package – Financial panic

4. Second bail-out package

• Bring debt/GDP ratio to 120% 3
by 2020
• About 50% haircut on private
sector debt (~47% of GDP)
2
1

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
II. Policy Response
• Assessment of policy responses &
• Financial market implications
 Response & Post Crisis recovery

Challenges in reducing debt levels (vis-à-vis GDP)

• Low expected nominal GDP growth
o real growth of 2% may be optimistic
o prolonged unemployment
o reduced public spending & austerity

• Challenging political environment

o Imposing spending cuts & tax increases

• Strict regulations on domestic financial institutions

• Non-trivial risk premia

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Response & Post Crisis recovery
Reforms
• Fiscal Compact Treaty (EU) ; came into effect on 01/01/2013
o fiscal balance should be close to zero “over the cycle”
o reducing public debt in excess above 60% at an average rate of “one twentieth” each year

• External surveillance and the threat of external sanctions remain as a “second line of defense” against
fiscal misbehavior

• European Stability Mechanism (erstwhile European Financial Stability Facility) lent €13 bn to
Government in Aug-15; €5.4 bn to two banks in Dec-15. A permanent firewall for the eurozone, to
safeguard and provide instant access to financial assistance programmes for member states of the
eurozone in financial difficulty.

• Proposals which did not materialise:

o Eurobonds: issued by Euro bloc; proceeds passed to weaker nations
o Integrated fiscal union mooted but as at Oct 2019 remains as a proposal.

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Response & Post Crisis recovery
GDP growth (%) Sovereign Bond Yield
45 3500
40
3000
35
2500
30
25 2000

20 1500
15 2 3 1000
10
500
5
0 0
-
b u c y c g n n v
1
10 l-10 -10 -11 t-11 r-12 -12 -13 -13 -13 r-14 -14 -15 l-15 -15 -16 t-16 r-17 -17 -18 -18 -18 r-19 -19 -20 l-20 -20
p b u c y c g n n v p b u c
Fe J De Ma O Ma Au Ja Ju No Ap Se Fe J De Ma O Ma Au Ja Ju No Ap Se Fe J De

Greece 10 yr bond yield (%) Spread over Germany yield (bps)

Source: World Bank data Source: Bloomberg

• 1 (Apr-14): First sovereign issue after 4 years
• Partial V-shaped recovery • 2 (Jun-15): Fails to repay IMF loan – A second Minsky moment
• Sustained positive growth • 3 (Aug to Dec-15): ESM programme
• 10 yr yield: ~0.7%
• Spread over Germany: ~120 bps

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Response & Post Crisis recovery

Debt/GDP Ratio (%) Fiscal Deficit/GDP Ratio (%)

Source: CEIC Source: CEIC

• Debt levels have remained elevated • Fiscal budget almost balanced
• SGP threshold: 60% × • SGP threshold: 3% 
• 2nd bailout package threshold: 120% ×

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Response & Post Crisis recovery

Inflation rate (%)

• Expected to remain in 0-2%

range
• Help in achieving growth
without overheating the
economy

Source: Statista

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Response & Post Crisis recovery
Unemployment rate (%)

• Peaked at 27.47% (2013)

• Improved to 15.47% (2019)
• Partially recovered

Source: Statista

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Financial Markets Implications

Contagion effect on the Financial Markets

• Greece Crisis triggered the European Debt crisis (2010 to 2012)

• Oct 2009 Greece’s announcement on public debt led to considerable doubts as to whether
Greece could still pay their debt
• Led to reversal of capital flows and the increasing interest rates demanded by creditors
• Loss of confidence in international financial markets
• Interest rate premium on long-term government bonds > 5% above IR German government
bonds
• Tense market atmosphere influenced by downgrades of rating agencies leading to Funds
force selling bonds, which increased the price pressure and worsened the rating position

Run-up to Crisis Indicator Assessment Signs of Bubbles & Policy Response Financial Market
Future Crisis Assessment Assessment Implications
 Conclusion
• Pre 2007 period served multiple warnings of bubble build up
o High debt/GDP ratio, CAD/GDP & fiscal balance/GDP

• Govt failed to tighten fiscal policy; less counter cyclical after creation of Euro; non-existant
macroprudential policies

• Multiple assistance programs have resulted in balanced fiscal budget & softening of yields

• Concerns still remain:

o Very high debt/GDP ratio (IMF 2028 forecast: 135%)
o Rating still below investment grade; BB- (S&P), Ba3 (Moody’s), BB (Fitch)
o GDP size still well below pre-crisis level
o Unemployment ~15% (NAIRU: ~10%)
o “banking system remains highly vulnerable” (IMF): high NPLs, weak capital, high
corporate leverage
o “Austerity fatigue”: jump in minimum wages; reversal to collective bargaining
agreements; cancellation of pension reforms
o “When anyone would sneeze, Greece will catch a cold”
References
Lane, Philip, The European Sovereign Debt Crisis, 2012, Journal of
Economic Perspectives.
Available at: https://www.aeaweb.org/articles?id=10.1257/jep.26.3.49
• https://www.statista.com/statistics/263698/unemployment-rate-in-gr
eece/
• https://tradingeconomics.com/greece/gdp-per-capita#:~:text=GDP%2
0per%20capita%20in%20Greece%20is%20expected%20to%20reach%
2022500.00,according%20to%20our%20econometric%20models
• https://www.statista.com/statistics/276351/inflation-rate-in-greece/