GREECE FINANCIAL CRISIS AND MORE
Greece unable to repay its public debt; Around $ 1 trillion rescue fund announced by the European Union for Euro countries in debt crisis and unable to borrow from financial markets; Markets volatile. We see these flashes of financial news making headlines these days. Because of sub prime crisis, many banks and financial institutions world over have gone bankrupt and Governments pumped trillions of dollars to revive them and restore financial normalcy. Now, a Government has gone bankrupt! And the news circulating is that many euro countries are almost there, though not yet openly known especially Spain, Portugal, Italy and even to some extent even France.
WHAT’S WRONG WITH GREECE?
Greece recently openly admitted that it is in a financial crunch. The whole world raised its eye brows when S&P downgraded Greek Govt Bonds to Junk status in April 2010. Markets all over started falling when this news popped up. Spain and Portugal are in a dire condition with some malice also hiding in Italy, Ireland and even France.
That means, many Euro Countries are in a debt trap, running high fiscal deficits and public debts. Greece has a fiscal deficit of 13.6% of 2009 GDP and Debt to GDP ratio of around 120%. After sub prime melt down, its major industries tourism and shipping have gone for a toss. Corruption, reckless Govt spending, large public unproductive work force and black money (nearly 30%) over the years are cited as the reasons for the downfall.
Foreign investment has almost stopped and hence debt is available only for heavy unviable rates of interest.
OK, now you may ask: why can’t Greece print currency or devalue its currency and slowly turnaround? It cannot because it is part of Euro Zone where such authority is centralized and it doesn’t have the two rights independently like we have.
70% of Greek Sovereign Bonds are subscribed by Foreign funds and institutions like global pension funds (US,UK etc), mutual funds since Govt debt is the least risky one ( Alas! Not any more!!). S&P came up with an estimate that only 50-70% of the principal may be recoverable.
HOW IS GREECE BEING BAILED OUT?
IMF and the European Central Bank have announced a $ 1 trillion rescue fund for the Euro Countries in financial distress unable to repay debts and when not able to borrow from financial markets. IMF’s contribution is around 1/3rd of the fund amount. Countries who seek help from this fund have to bend to severe austerity measures like cutting Govt spending, not increasing wages, bringing fiscal deficits under control etc. Greece will be given more than $100 billion over a period of three years. This has been announced on 1st May 2010 and world markets have bounced back with nearly 5 % gains on a single trading day. They cheered that the crisis has been averted but from the next day, they again had doubts!
NOW, WHAT’S THE PROBLEM THEN?
Will the public of every Euro zone country agree to lend their hard earned tax money to a reckless neighbour when his or her own country is yet to totally recover after the financial melt down? We have enough evidence in the news that politicians and diplomats of EU are having heated verbal exchanges.
Greece is bailed out. But what if Spain follows? Spain is 4 times bigger than Greek economy. So it becomes harder and impossible.
Even in the $ 1 trillion package announced, the major chunk is by printing money i.e., new Euros. Many economists feel this is dangerous.
With all these doubts, how far the bailout is going to be successful is a big question mark.
Also, the bailouts come with a big list of austerity measures that force the borrowed countries to trim down their costs and reduce fiscal deficits.
So Europe is going for a financial consolidation cutting down spending which means growth taking the second place below financial prudence. So markets will fall to factor in these new changes. The latest news is that Europe may slip into recession and euro at a 4 year low against US dollar.
WHY SHOULD THE WORLD WORRY?
If Greece goes bankrupt, Greeks should worry, at the most the Euro Zone, since Euro is the common currency in 16 out of 27 European countries and Greece is one of them. The truth is far from that. (Few more countries have euro has their currency though they are not part of EU).
The truth is European banks have a huge stake in European Sovereign Debt and if things go wrong in some European countries, these banks are also at risk.
Two, countries having prominent European exports will be hit. Europe boasts largest volume of world’s trade.
Three, Euro falling so drastically against major currencies will re write all the International trade equations.
So, the world financial situation will change and will give rise to a new financial uncertainty.
WILL INDIA BE AFFECTED?
Just because of Greece crisis, no. But if the malice gets bigger, sure it will like any other part of the world.
As of now, India is benefiting. Global Funds are investing in India esp in Govt Bonds (the limit of $5 billion for Foreign Investors has been fully subscribed) and Infrastructure space since India looks safer and Europe very uncertain. Lot of capital investments is flowing into India but too much of it is not good for India either.
And the latest news is that, investors are going back to gold and US treasuries since they find the emerging markets too risky now!
JIST OF THE STORY:
Governments world around are borrowing like corporates. When the going is good, they generate huge returns but when going goes wrong, debt traps and even bankruptcy like we are seeing now. Do such things suit a socially responsible Government? How can the whole population be put to risk to bail out reckless institutions, banks and Governments?
Are people elected leaders are ruling the countries or rich capitalists and financial markets? We sure have to ponder over.
People welfare is most important than anything else. Bailouts and borrowings happen to please the markets. But looking at it precisely, this mantra postpones the damage; it does not cure the actual problem.
Hence it is time for the World to get back to financial discipline, cut down on unnecessary costs, invest in productive areas and bring fiscal deficits to reasonable and manageable levels.
Meanings of some terms used:
Sovereign Debt: Debt the repayment of which is secured by the Government.
Government Bonds (Public Debt): These bonds are issued through the Central Bank of the country by the Govt to borrow money from public when there is a fiscal deficit.
Fiscal deficit: Simply put, this is excess of total Budgeted Expenditure over Budgeted Income in the Govt Budget. Govt borrows what ever is the excess either domestically or from outside the country.
Printing money: Only the Central Banks of every country have this exclusive right. Printing with out corresponding growth results in Inflation.
For suggestions and further clarifications, you can reach me at email@example.com
CA. SivaPriya V L Tenneti,