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Greece Crisis

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  1. 1. Greece-an Economic Impasse? EC3102 Assignment Ankit Kanoria A0074661A Naman Shah A0074727X 4/2/2012Submitted in partial fulfillment of module requirement.
  2. 2. ‘Greece- An Economic Impasse?’The start of the new millennium saw a historic event which revolutionized the worldeconomy; Euro-a formalized common currency for 12 European nations went into circulationin 2002. Adoption of the Euro by Greece made easy credit available for the country at lowinterest rates (refer to figure1). This primarily steered the economy which grew at an averagerate of 4.3% from 2001-2008 with an increase in private consumption. The government wasalso able to finance the high current (9% average) and budget (5% average) deficits throughborrowing in international capital markets due to easy availability of credit (IMF, WorldEconomic Outlook , 2009).During this period, the Greek government faced such high deficits as it indulged in highgovernment expenditures especially in pension benefits and health benefits (11.6 % and 5.7%of GDP on average over 2001-2007) (OECD Factbook Statistics., 2012). Economists aroundthe world feel that tax evasion and Greece‟s informal economy which is estimated to be 25-30% of GDP (Country Report: Greece, March 2010) has lead to weak revenue collection onlyleading to higher debt borrowings which was 119% of GDP in 2009 and 144.9% in 2010(Eurostat, Updated: 29.03.2012)On the other hand, wages grew at an average of 5% during 2001-2008 which was double theaverage rate in the Eurozone (“Is Greece Headed for Default?”, January 29, 2010.). Over thesame period, Greek exports to its major trading partners grew at 3.8% per year, only half therate of those countries‟ imports from other trading partners. This, coupled up with lowproductivity spiraled Greece into declining international competitiveness.It was all too long before the investors realized that Greece might not be in a position to repayits debt obligations evident from the increase in interest spread for the Greek bond to 400basis points when in October 2009, Prime Minister Papandreou revised the governmentbudget deficit estimate from 6.7% to 12.7% of GDP. This is when the "Greece crisis" seemsto have set in motion.Thus, some economists in Eurozone regard Greeks "fiscal irresponsibility" while someoutside regard the introduction of Euro and a common monetary policy as the primary reasonbehind the crisis. It was however, a culmination of weak and inefficient fiscal policies andother domestic factors such as decreasing competitiveness and also the extreme sensitivity ofGreece to international investor confidence that unfolded into what seemed an economicimpasse as not only did the economys GDP shrink , but also inflation rose from below 1% to
  3. 3. around 2.5% at the end of 2009(refer to figure 3) unemployment rate increased coupled upwith the high debt levels and fiscal deficits(refer to figure 2).Hence, Greece had to deal with the debt obligations and also the recessionary trends. Ittherefore, had the option of leaving Euro by defaulting on its debt obligations andreintroducing drachma as its currency. However, „Drachmatisation‟ would leave the countryinto a state of bank run, and a limit on withdrawals would further exacerbate the liquiditycrunch and vulnerability in the investment scenarioGreece therefore had to resort to external assistance to recover from this sovereign debtcrisis. This came in the form of Troika (European Central Bank, European Commission andIMF) and other Eurozone members as they came forward with various bailout packages.However, austerity measures were as a precondition to receive the bailout. These includedimplementation of contractionary fiscal measures including pension and defence cuts;privatization ; labour reforms- reducing wage rates and structural reforms -opening differentprofessions to competition among others .These bailout packages, however, came at the costof social unrest and protests. Therefore, the road ahead for Greece is tumultuous and wouldrequire a strong reforms package.A major policy change would be to promote foreign investment and trade. The austeritymeasures have left the country with reduced consumption and government expenditureleading to the shrinking of GDP. The growth path can become reality by promotinginvestment from neighbouring countries like Turkey. Turkish Deputy Ali Babacan feelsGreece has “reached improved levels of well being when it is closer to Turkey”. In 2011Turkey imported more than $2.5 billion worth of goods from Greece, more than double thelevel in 2009. The negative balance of trade needs to be corrected by increasing exportsrather than reducing imports. There could be a shift in ownership with Greeks privatisation inenergy, infrastructure, tourism and real estate sectors being brought over foreign investors. As the graph shows exports have not increased but imports have decreased to correct the trade deficit.
  4. 4. The recovery calls for education and competitiveness enhancing reforms. Greece had spent42.4% of GDP on social protection in 2006 compared to only 5.5% on education in the sameyear (refer to figure 4). This calls for reducing expenditure on social protection and shiftingresources to education. An increase in human capital accumulation and education willeventually lead to higher economic growth rate. Although in 2010, the “New School” policyfor primary and secondary education introduced flexible curricula and streamlined teachingmodules (Economic Policy Reforms 2012,OECD- Country Notes), Greece should alsoimprove the education levels through better teaching quality and collaboration with thepremier universities.These measures will solve the issue of unemployment, reduced growth rates and thus, willsteer the economy out of recession. However, to fuel resources towards education at such avolatile juncture might not be very welcome by the EU foreign ministers. Also, trade andinvestment from Turkey might not be sustainable in the long run as Turkey itself faces astaggering 10% current account deficit.On the other hand, to meet its debt issues-Greece was successful in reaching an agreementwith the private sector lenders on a "voluntarily debt swap" which reduced the governmentsdebt burden by 100 billion euros by investors accepting losses in net present terms of 74 %.This gave the green signal for Greece to receive its second bailout package of 130 billioneuros .Thus, Greece might be able to solve its temporary economic hurdle by being the recipient ofthese bailouts. However, to survive in the long run - it must adopt structural reforms toincrease competitiveness, focus on trade and foreign investment and education in order tomeets its target of 2.5%-3% growth in 2013 and 2014and grow sustainably thereafter.(WORDS 999 (excluding in text sources))
  5. 5. APPENDIXThe following graphs and table support the point made in the article.
  6. 6. Figure 4Bibliography 1. IMF World Economic Outlook,2009 2. Oxford Economics 3. Export figures: Greece‟s Debt Crisis: Overview, Policy Responses and Implications, Congressional Research Service, May 2010 4. OECD Statistics and Reports. 5. Eurostat 6. Wall Street Journal (Mar,2012) 7. The Economist ( Various articles were read to garner a clear opinion) 8. ELSTAT 9. European Central Bank Reports