European Debt Crisis 2009 - 2011

The PIIGS…and…The Rest From Maastricht to Papandreou

Group VIII: Ankur Salunke (A047), Shamik Bose (A012), Partho Choudhury (A016), Aditya Mishra (A037), Manas Ranjan Kar (A030), Abhishek Shrivastav (A053), Darpan Thakkar (A060)

Put simply…


10-year Bunds – How much more interest do they need to pay than Germany? .10-year Government bond yield – How much interest do they pay annually to borrow money?? Bond yields spreads vs.

How much do they need to pay regularly to insure against a sovereign default? .

General Government Surplus/Deficit as a %age of GDP 2006 .

General Government Surplus/Deficit as a %age of GDP 2007 .

General Government Surplus/Deficit as a %age of GDP 2008 .

General Government Surplus/Deficit as a %age of GDP 2009 .

General Government Surplus/Deficit as a %age of GDP 2010 .

Government Debt as a %age of GDP 2006 .

Government Debt as a %age of GDP 2007 .

Government Debt as a %age of GDP 2008 .

Government Debt as a %age of GDP 2009 .

Government Debt as a %age of GDP 2010 .

% 2006 .Seasonally adjusted unemployment rate.

% 2007 .Seasonally adjusted unemployment rate.

% 2008 .Seasonally adjusted unemployment rate.

% 2009 .Seasonally adjusted unemployment rate.

% 2010 .Seasonally adjusted unemployment rate.

Seasonally adjusted unemployment rate. % 2011 .

Foundation of the crisis… 7th Feb. 2003: Germany and France override the EU budget rule not to let their respective national budget deficits to exceed 3% of their annual budgets 20th March. 2001: Greece enters Euro region 24-25th Nov.1998: Greece enters the European Exchange Rate Mechanism (ERM) 1st Jan. 1992: An “irrevocable” monetary union set up under the Maastricht Treaty. No central finance ministry or mechanism to leave the Euro 14th Dec. 1999: The Euro established 1st Jan. 1996: EU leaders consent to a German inspired “Stability Pact” designed to impose stiff penalties on countries that overstep deficit limits 14th March. 2005: EU finance ministers bow to German pressure to relax budget rules to suit Germany .

Process of nationalization has begun • Jan 2009: Sovereign ratings of Greece and Spain pared down • Oct 2009: The Greek Socialist Pasok Party wins a landslide victory in general elections. 2009: Massive austerity measures announced by the new Greek government . announces doubling of the deficit from 6% to 12. It is alleged that previous administrations hid the extent of debts • 8th Dec.Precursor… • 2007: Greece has one of the Eurozone’s fastest growing economies (@ 4. but also has one of highest debt-to-GDP ratios in the region (113%) • 15th Sept. 2008: Lehman Brothers file for bankruptcy in NY • 30th Sept. 2008: Ireland steps in to guarantee all commercial bank deposits.2% YoY).5%. 2009: Sovereign ratings of Greece cut down to BBB+ (Fitch) • 14th Dec.

Greek financial instability creeps into its private banks.1/10 – 3/10 The Greek and Spanish budgets show a deficit of 13% and 9. Germany and France enter into a pact with the IMF to help Greece and other distressed economies through bailout packages. . Both countries launch austerity measures to bring the deficit in line with EU norms (~ 3% of GDP). Widespread riots in Athens to protest the raise in taxes and freeze in salaries.8% respectively.

ramped up privatization plan. thereby increasing their borrowing costs in the short to medium term. caps on public sector wages and higher taxes on HNWI. Spain. Ireland. including spending cuts. Greece and Portugal face sovereign ratings downgrades. The ECB assures support by agreeing to buy the downgraded bonds.1/10 – 3/10 Portugal joins Greece and Spain in austerity measures and attempts to control its deficit. .

There is across-the-board ratings downgrades of several EU nations. and a spike in bond yields (to 7.1%).6%) than what the Greek government had initially estimated. leading to further downgrades by ratings agencies.4/10 – 6/10 It is suspected that the budget deficit is higher (at 13. which makes government borrowing more expensive. The IMF and EU jump in with an assistance package of 23 Billion Euros .

Greece becomes the first EU country to enter into a bailout agreement with the IMF and EU (for 100 Billion Euros over 3 years). . Plans are made to include more distressed economies into a larger 750 Billion Euro bailout plan. Spain and Portugal chip in with spending cuts and higher taxes for services and HNWI.4/10 – 6/10 Across the board sovereign ratings downgrades trigger massive selling pressure on the Euro.

Growth rates across the distressed economies crawl at < 2% YoY.7/10 – 9/10 Ireland is the latest country to suffer from rising borrowing costs and lowering of sovereign ratings. Budget cuts (including spending cuts on government programs) are announced by countries such as Ireland. . Bank stress tests reveal that 91 banks across Europe will need capital infusion or raise new capital on their own to survive. but borrowing costs continue to rise.

Ireland receives a 67. and infighting between individual nations.5 Billion Euro bailout package. while borrowing costs continue to soar. growth stalls in the PIIGS region.10/10 – 12/10 Political support for budget cuts weaken in countries such as Ireland and Greece. . EU talks about a permanent bailout fund to instill some confidence in the capital markets.1% in 2011. Because of indecisiveness and inaction by the ECB. and announces budget cuts to reduce its deficit to 9.

thereby increasing borrowing costs by a factor of 3. besides a “Euro Plus Pact” to kick off structural reforms beginning 2012-13. . Ratings agencies continue to cut the ratings of all PIIGS economies to “near junk” status.1/11 – 4/11 France and Germany propose a EU-wide “pact for competitiveness” to initiate economic reforms. A permanent 500 Billion Euro fund is agreed upon.

despite street protests. Greece receives a second bailout of 109 Billion Euros. .6%.5/11 – Present Portugal gets a first bailout package of 78 Billion Euros. But Greece’s 10-year bond yields continue to rise to reach a record 23. Italy begins the first of its 2 rounds of budget cuts. but a second bailout might be needed. and the ECB continues to buy distressed government securities of the PIIGS economies.

10 year bond yields since the last crisis .

tax breaks for the rich Economic Weakness Political Weakness Irrational exuberance • Refusal to learn from history . Debt-revenue or Debt-exports ratio Excessive debt servicing • Debt service-GDP or Debt service-tax revenue ratio Excessive reliance on foreign capital • Debt-export ratio • Low growth • Low returns on private sector investments • Excessive expenditure on non-productive/populist measures.What causes these crises? Excessive Debt • Debt-GDP.


In theory. A higher rate of growth A lower interest rate on the public debt A bailout A current transfer payment Fiscal pain Increasing recourse to seigniorage by the central bank Default Increase in taxes Cut in public spending A capital transfer from abroad Revenues from monetary issuance Debt repudiation Debt standstill Debt moratorium Debt restructuring/resch eduling . there are 6 ways out….

there are only 3 ways out… A higher rate of growth A lower interest rate on the public debt A bailout A current transfer payment Fiscal pain Increasing recourse to seigniorage by the central bank Default Increase in taxes Cut in public spending A capital transfer from abroad Revenues from monetary issuance Debt repudiation Debt standstill Debt moratorium Debt restructuring/resch eduling .Usually.

Cut. and Japan to a certain extent Defaulters • States with limited monetary sovereignty • States with foreign currency debt . Print or Default Cutters are few and far in between • Only Great Britain has been able to aggressively reduce its debt burden through budget surpluses. lower interest rates and higher growth • And Great Britain had the advantage of the Industrial Revolution Printers • States with monetary sovereignty • None of the Eurozone countries has that luxury • States with own-currency debt • US.

Lessons of history…. conflicts with creditors can arise • In case of currency depreciation. reserve currency status may be lost to a rising rival . discretionary military spending is usually the first casualty • In case of default on external debt. What do Governments NOT do with huge debts • Slash expenditures or entitlements • Reduce marginal tax rates on income and corporate profits to stimulate growth • Raise taxes on consumption to reduce deficits • Grow their way out without defaulting or depreciating their currencies What do Governments USUALLY do with huge debts • Oblige central banks and commercial banks to hold government debt • Restrict overseas investment by firms and citizens • Default on commitments to politically weak groups and foreign creditors • Condemn bond investors to negative real interest rates What are the geopolitical consequences of a crises of public finance? • In fiscal stabilizations.

Worst case scenario – growth dips to 7% YoY WPI inflation to lower to 7% YoY Interest rates expected to be cut by RBI Capital infusion by RBI Sharp fall in bond yields • Borrowing costs fall. setting the stage for another round of debt-fuelled growth in the medium term USD-INR exchange rates expected to rise • Exports hit in the near term .Impact on India….

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