Sovereign CDSprices of selected European countries (2010-2011). The left axis is in basis points; a level of 1,000 means it costs $1 million to protect $10 million of debt for five years.
Euro debt crisis div a
Flow of Presentation Introduction Making of the Crisis PIIGS Solutions Possible Future Scenarios
Introduction: In 1958, an organization called European Coal and Steel Community was formed. This evolved in European Union (EU) which was established by the Maastricht Treaty in 1993. The EU introduced Euro in 1st January, 1993. From that day 11 countries started using Euro. There are 27 counties are in the European Union Currently 17 countries have the EURO currency.
Late 2009,Investors started loosing confidence.Problems rose in early 2010,for PIGS to refinance it’s debts.The onus of the bail out falls on Germany , the strongest country in the Euro Zone.The current euro crisis threatens to shake the financial world.
Making Of The Crisis• Rising In Government Debt Levels• Trade Imbalances• Monetary Policy Inflexibility• Loss Of Confidence
Rising Government Debt Level Violation of Maastricht Treaty Average fiscal deficit in the euro area in 2007 was only 0.6% before it grew to 7% during the financial crisis. average fiscal deficit in the euro area in 2007 was only 0.6% before it grew to 7% during the financial crisis
Trade Imbalance: Imbalance in BoPMonetary policy inflexibility: Week Euro Countries do not have option of currency devaluation.Loss of Confidence: As the crisis developed it became obvious that Greek, and possibly other countries, bonds offered substantially more risk.
Greece Government ran a huge deficit To finance public sector jobs, pensions, and other social benefits Initially currency devaluation and then introduction of Euro gave borrowing power Misreported financial statistics with help of Goldman Sachs After the 2008 recession – Greece economy took a hit as it’s main industries (shipping and tourism) were affected
Revised its deficit from an estimated 6% to 12.7%. In May 2010, the Greek government deficit was estimated to be 13.6% Debt is reported to be 120% of the GDP Downgrading of the debt Austerity measures
Ireland The Irish economy expanded rapidly during the Celtic Tiger years (1997–2007). This led to an expansion of credit and included a property bubble which petered out in 2007. State guaranteed the six main Irish-based banks that financed the property bubble Irish banks lost an estimated 100 billion euros Shifted the loss to taxpayers GDP contracted by 14% & unemployment rose by 14%
Italy The debt of Italy has increased to almost 120 percent of GDP Longer maturity and is held domestically Deficit is 4.6%
Portugal Government encouraged over expenditure and investment bubbles through unuclear public private partnerships Funding of numerous ineffective and unnecessary external consultancy and advisory of committees and firms Increase in redundant public servants
Spain One of the largest Eurozone economies The country’s public debt relative to GDP was 60 percent in 2010 Most of it controlled internally
European Financial StabilityFacility (EFSF) Established on 9th May,2010 this facility aims at providing financial assistance to countries in need. They can issue bonds or debt instruments in the market. Emissions of bonds are backed by guarantees given by the euro area member states. It has a lending capacity of 440 Billion Euros.
European Financial StabilizationMechanism (EFSM) It is an emergency funding program reliant upon funds raised on the financial markets. It is guaranteed by the European Commission. It has the authority to raise up to €60 billion. It runs parallel to the EFSF.
Breakup of the Eurozone Economists always criticize Euro currency system because of lacked a central fiscal authority They recommended that Greece and the other debtor nations unilaterally leave the Eurozone, default on their debts, regain their fiscal sovereignty, and re- adopt national currencies Bloomberg suggested in June 2011 that, if the Greek and Irish bailouts would fail, an alternative would be for Germany to leave the eurozone in order to save the currency through depreciation
Eurobonds European Commission suggested that Eurobond issued jointly by the 17 euro nations would be an effective way to tackle the financial crisis. Using the term "stability bonds
ECB interventions It began open market operation buying government and private debt securities in May 2010, reaching €211.5 billion by end of 2011 It loaned €489 billion to 523 banks for an exceptionally long period of three years at a rate of just one percent.
Scenarios: Next potential flashpoints foreuro zone debt crisis Rating AgenciesStandard & Poors -It could downgrade 15 euro zone members, includingAAA-rated Germany and France, if EU summit failed to providemeasures to tackle the debt crisis.Moodys Investors Service- It intends to review the ratings of all 27members of the European Union in the first quarter of 2012 Rescue FundsThe European Financial Stability Facility (EFSF)-250 billion euros.The European Stability Mechanism (ESM)- 500 billion euros in mid-2012
But The ESM is still 6 or 7 months away and Germany has refused tolet it have a banking license which would allow it to draw upon ECB fundswhile the US and others appear reluctant to give the IMF more resources Italy, Spain and France together have to raise an average 17 billion euros of government debt every week in 2012, leaving plenty of scope for a funding accident. Italy-Pushing through a harsh austerity program, including pension reform, tax hikes and spending cuts, which is vital to avoid Italy becoming insolvent. Spain -Tough amendments to a labour reform to help untie wages from inflation and to raise competitiveness partly through cutting business tax rates and wants to finish off a restructuring of the financial system.
Four Possible Scenarios Successful Resolution of Crisis Orderly Greek Default Disorderly Default-Banking Crisis in EU Collapse of Europe
Successful Resolution of CrisisEnvironment Effectiveness of ESFS, EFSM European countries experience slow recovery at 1.6% in2012(ECB Central Forecast)Best policy Responses(FP Tight MP Tight) Tight Fiscal policy supported by IMF programmes Tight monetary policy to defend exchange rate Growth policy should focus on improving productivity and innovation
Orderly Greek DefaultEnvironment Expanded ESFS buys bonds of indebted countries Export demand leading to job lossesBest Policy Responses Expand – Expand government expenditure to support demand in countries with lower external debt; cut taxes (flat taxes) and widen the tax base Maintain tight monetary policies to support exchange rates Countries should press for faster EU entry to access ESFS/EFSM and structural funds to support long term growth
Disorderly Default-Banking Crisis inEUEnvironmentEuropes banks must find of 115 billion euros extra capital to make them strong enough towithstand the euro zone debt crisis Disorderly Greek default triggers banking crisis Contagion to other indebted Eurozone countries EU banks pull out reducing staff and branches, consolidating to smaller sizeBest policy response (FP loose, MP loose) Central banks should expand liquidity to offset foreign bank withdrawal Collapse of export demand requires slower fiscal consolidation Begin to diversify exports to emerging markets Temporary capital controls to prevent capital flight Industrial policies plus temporary job creation
Euro zone Break UpEnvironment Greece leaves euro triggering others to exit EU GDP contracts by 5%; GDP falls by 6% in 2012 Unemployment rises above 25% in all countries Migrants return from EU countries; remittances collapsePolicies (FP tight, MP loose) To allow currency depreciation – austerity with changed long run growth strategy) Expand CEFTA to take in Turkey, North Africa Rethink speed of EU accession Place greater reliance on regional cooperation
Sources of Information Long-term interest rate "Long-term interest rate statistics for EU Member States“ "EU debt crisis: Italy hit with rating downgrade“ "Peripheral euro zone government bond spreads widen“ "Acropolis now“ "EU ministers offer 750bn-euro plan to support currency“
"Leaders agree eurozone debt deal after late-night talks“ "Angela Merkel vows to create fiscal union across eurozone“ "PIIGS Definition“ "WRAPUP 5-Europe moves ahead with fiscal union, UK isolated“ http://www.cnbc.com/id/45653146/Scenarios_Next_p otential_flashpoints_for_euro_zone_debt_crisis http://www.oecd.org/dataoecd/53/58/48789363.pdf
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