We all have surely heard of a person being bankrupt, a company being bankrupt but have you ever wondered how a country can get bankrupt. This is one of the most fascinating incidents that has caught my eye and I would like to share that with all the CCI’s
What is the real problem in Greece?
Greece was a very fancy country in the 1980’s and with the emergence of the European Union it now started to have a fancy currency in the form of Euro. Everyone wanted to invest in Greece for the obvious reasons that it had a very good economic growth and had a very fancy currency in the form of Euro. Greece issued a number of government bonds to take in more and more money into the nation. This is the easiest way to get money.
Did I mention bonds? Isn’t debt bad to a country?
Yes you heard it right it is bonds (it is a form of debt).
As students of finance we all know that debt is not a bad thing to have. It gives us leverage and it enables us to earn more.
“Debt is not bad, but not repaying the debt is very bad”
Greece had one more thing to its advantage inflation rate was much higher than the interest rate. Really!
But how does this help a country when it borrows?
Today Greece takes a loan of Rs.10,000/- @ 3% interest rate p.a. & the inflation rate is hovering at say 5% p.a.
Greece makes investment in say oil @ Rs.100 per barrel, it gets 100 barrels of oil. (nothing Latin here )
One year later,
Interest on the loan becomes due i.e. at Rs.300.
Due to inflation the oil rates have hiked from Rs.100 to Rs.104 – i.e. an increase of Rs.4 per barrel. Greece is holding 100 barrels so in turn the profit from holding oil is Rs.400.
So Greece was being paid to borrow.
“If you are rich you must be stupid enough not to continue to be rich and if you are poor you have work hard to be rich”
This formula works for sometime but after sometime it doesn’t. Backed by the recent subprime mortgage crisis, recession etc there was a financial crunch everywhere. People who had invested in Greece started pull back their money (it happened not only with Greece but also with India). It was time that Greece was in a problem. It had used a lot of money received by way of loan for public expenditure (huge amount of money was spent on pension payments, unemployment benefits, subsidies etc) & It had used up a lot of money to improve shipping industry, infrastructure and other capital items.
It is like using short term money to buy long term assets.
Thus the crisis evolved.