P a g e | 1

Chapter -1

EUROPEAN MONETARY UNION

P a g e | 2

1.1 INTRODUCTION

The European Union was formed in1951 with the goal of economic and monetary

unification of the member states of Europe. These nations preferred peace and

cooperation amongst them, in place of prolonged wars and conflicts of the past. The

union had 6 founding states initially namely- Belgium, France, Germany, Italy,

Luxembourg and the Netherlands .The European Union (EU) today is an economic

and political union of 27 member states which are located primarily in Europe. The

EU operates through a system of supranational independent institutions and

intergovernmental negotiated decisions by the member states. The EU's de facto

capital is Brussels.

The EU traces its origins from the European Coal and Steel Community (ECSC) and

the European Economic Community (EEC), formed by the Inner Six countries in

1951 and 1958 respectively. The Maastricht Treaty established the European Union

under its current name in 1993.

The EU has developed a single market through a standardized system of laws which

apply in all member states. Within the Schengen Area (which includes 22 EU and 4

non-EU states) passport controls have been abolished. EU policies aim to ensure the

free movement of people, goods, services, and capital, enact legislation in justice and

home affairs, and maintain common policies on trade, agriculture, fisheries and

regional development. Through the Common Foreign and Security Policy the EU has

developed a role in external relations and defence. Permanent diplomatic missions

have been established around the world. The EU is represented at the United Nations,

the WTO, the G8 and the G-20.

With a combined population of over 500 million inhabitants or 7.3% of the world

population, the EU, in 2011, generated the largest nominal world gross domestic

product (GDP) of 17.6 trillion US dollars, representing approximately 20% of the

global GDP when measured in terms of purchasing power parity. The EU was the

recipient of the 2012 Nobel Peace Prize.

The 27 sovereign member states of the European Union are : Austria, Belgium,

Bulgaria, Cyprus, the Czech Republic, Denmark, Estonia, Finland, France, Germany,

P a g e | 3

Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the

Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and the

United Kingdom. The Union's membership has grown to the present-day 27 by

successive enlargements as countries acceded to the treaties and by doing so, pooled

their sovereignty in exchange for representation in the institutions.

Competences

EU member states retain all powers not explicitly handed to the European Union. In

some areas the EU enjoys exclusive competence. These are areas in which member

states have renounced any capacity to enact legislation. In other areas the EU and its

member states share the competence to legislate. While both can legislate, member

states can only legislate to the extent to which the EU has not. In other policy areas

the EU can only co-ordinate, support and supplement member state action but cannot

enact legislation with the aim of harmonizing national laws.

1.2 BIRTH OF THE EURO

The euro is the second largest reserve currency as well as the second most traded

currency in the world after the dollar. As of September 2012, with more than €915

billion in circulation, the euro has the highest combined value of banknotes and coins

in circulation in the world, having surpassed the US dollar.

The euro is managed and administered by the Frankfurt-based European Central Bank

(ECB) and the Euro system (composed of the central banks of the euro zone

countries). As an independent central bank, the ECB has sole authority to set

monetary policy. The Euro system participates in the printing, minting and

distribution of notes and coins in all member states, and the operation of the euro zone

payment systems. Since 5th January 2002, the national central banks (NCBs) and the

ECB have issued euro banknotes on a joint basis. Euro banknotes do not show which

central bank issued them. Euro system NCBs are required to accept euro banknotes

put into circulation by other Euro system members and these banknotes are not

repatriated. The ECB issues 8% of the total value of banknotes issued by the Euro

system. In practice, the ECB’s banknotes are put into circulation by the NCBs,

P a g e | 4

thereby incurring matching liabilities vis-à-vis the ECB. These liabilities carry interest

at the main refinancing rate of the ECB. The other 92% of the euro banknotes are

issued by the NCBs in proportion to their respective shares in the capital key of the

ECB calculated using national share of European Union population and national share

of European Union GDP, equally weighted.

Euro has become the virtual currency since 1999 and a real currency from first

January 2002, when euro notes and coins replaced national currencies in 12 of the 15

countries of the European Union. These 12 countries are Ireland Greece, Spain,

Portugal, Australia, Finland, France, Germany, Belgium, Italy, Luxembourg, and

Netherlands. Three more nations namely UK, Denmark, and Sweden still continue

with their domestic currencies namely pound sterling, Danish Kroner and Swedish

Kroner respectively. The reason for these three nations opting out of the euro is their

inability (among other reasons) to comply with the provisions of convergence criteria.

These prescribed in the Maastricht Treaty. They stipulate that:

Budget deficit of a member nation has to be below 3% of gross Domestic

Product (GDP)

Public debt has to be less than 60% of GDP.

Inflation rate within 1.5% points of the three EU countries with the lowest

rate.

Long term interest rate within 2% points of the three lowest interest rates in

EU.

Exchange rate to be kept within normal fluctuation margins of Europe’s

exchange rate mechanism.

These covenants also form the central theme of the Stability and Growth Pact (SGP)

of the EU Nations.

The euro is designed to help build a single market so as to ease travel of citizens and

goods, eliminate exchange rate problems, provide price transparency, create a single

financial market, price stability and low interest rates, provide a currency used

internationally and protect against shocks by the large amount of internal trade within

the euro zone. It is also intended as a political symbol of integration and stimulus for

more.

P a g e | 5

Transaction Costs And Risks

The most obvious benefit of adopting a single currency is to remove the cost of

exchanging currency, theoretically allowing businesses and individuals to

consummate previously unprofitable trades. For consumers, banks in the eurozone

must charge the same for intra-member cross-border transactions as purely domestic

transactions for electronic payments (e.g. credit cards, debit cards and cash machine

withdrawals).

The absence of distinct currencies also removes exchange rate risks. The risk of

unanticipated exchange rate movement has always added an additional risk or

uncertainty for companies or individuals that invest or trade outside their own

currency zones. Companies that hedge against this risk will no longer need to

shoulder this additional cost. This is particularly important for countries whose

currencies had traditionally fluctuated a great deal, particularly the Mediterranean

nations.

Price Parity

Another effect of the common European currency is that differences in prices –

particularly in price levels – have decreased because of the law of one price.

Differences in prices can trigger arbitrage, i.e. speculative trade in a commodity

across borders purely to exploit the price differential. Therefore, prices on commonly

traded goods are likely to converge, causing inflation in some regions and deflation in

others during the transition.

1.3 THE GOVERNANCE STRUCTURE OF THE EUROPEAN

UNION

P a g e | 6

The European Union has seven institutions: the European Parliament, the Council of

the European Union, the European Commission, the European Council, the European

Central Bank, the Court of Justice of the European Union and the European Court of

Auditors. Competencies in scrutinising and amending legislation are divided between

the European Parliament and the Council of the European Union while executive

tasks are carried out by the European Commission and in a limited capacity by the

European Council.

The monetary policy of the euro zone is governed by the European Central Bank. The

interpretation and the application of EU law and the treaties are ensured by the Court

of Justice of the European Union. The EU budget is scrutinised by the European

Court of Auditors. There are also a number of ancillary bodies which advise the EU or

operate in a specific area.

1.3.1 European Commission

This is the institution of the Euro community which ensures the application of the

provision of the treaty. The commission develops community policies, proposes

community legislation and exercises powers in specific areas. The European

Commission acts as the EU's executive arm and is responsible for initiating legislation

and the day-to-day running of the EU. It operates as a cabinet government, with 27

Commissioners for different areas of policy, one from each member state, though

Commissioners are bound to represent the interests of the EU as a whole rather than

their home state.

One of the 27 is the Commission President (currently José Manuel Durão Barroso)

appointed by the European Council. After the President, the most prominent

Commissioner is the High Representative of the Union for Foreign Affairs and

Security Policy who is ex-officio Vice President of the Commission and is chosen by

the European Council too. The other 25 Commissioners are subsequently appointed

by the Council of the European Union in agreement with the nominated President.

The 27 Commissioners as a single body are subject to a vote of approval by the

European Parliament.

1.3.2 European Council

P a g e | 7

The European Council gives direction to the EU, and convenes at least four times a

year. It is actively involved in the negotiation of the treaty changes and defines the

EU's policy agenda and strategies. European council provides the EU with the

necessary impetus for its development and defines the general political guidelines

thereof. It brings together the heads of states of the member countries and the

president of the European Commission.

The European Council uses its leadership role to sort out disputes between member

states and the institutions, and to resolve political crises and disagreements over

controversial issues and policies.

1.3.3 European Parliament

The European Parliament (EP) forms one half of the EU's legislature (the other half is

the Council of the European Union)

The 736 (soon to be 751) Members of the European Parliament (MEPs) are directly

elected by EU citizens every five years on the basis of proportional representation.

Although MEPs are elected on a national basis, they sit according to political groups

rather than their nationality.

The Ordinary Legislative Procedure Of The

European Union

The parliament contributes to the legislative process, although with different

prerogatives according to the procedures through which EU law is to be enacted. In

the framework of EMU the Parliament has mainly consultative powers. However

P a g e | 8

there is accountability of the ECB to the Parliament (presentation of the Annual

report, general debate on monetary policy etc)

Finally, the Commission is accountable to Parliament, requiring its approval to take

office, having to report back to it and subject to motions of censure from it. The

President of the European Parliament carries out the role of speaker in parliament and

represents it externally. The EP President and Vice Presidents are elected by MEPs

every two and a half years.

1.4 ROLE OF EUROPEAN CENTRAL BANK

The European Central Bank (ECB) is the sixth of the seven institutions of the

European Union (EU) as listed in the Treaty on European Union (TEU). It is the

central bank for the euro and administers the monetary policy of the 17 EU member

states which constitute the Euro zone. It is thus one of the world's most important

central banks.

The bank is headquartered in Frankfurt, Germany. The current President of the ECB

is Mario Draghi, former governor of the Bank of Italy.

Objective

The primary objective of the European Central Bank is to maintain price stability

within the Euro zone, which is the same as keeping inflation low and preventing

deflation. The Governing Council aims to keep inflation below, but close to, 2% over

the medium term. Unlike other central banks the ECB has a single primary objective,

with other objectives subordinated to it.

Basic Tasks

P a g e | 9

The basic tasks of the ECB are to define and implement the monetary policy for the

Euro zone, to conduct foreign exchange operations, to take care of the foreign

reserves of the European System of Central Banks and to promote smooth operation

of the financial market infrastructure payments system and the technical platform

(currently being developed) for settlement of securities in Europe.

Furthermore, it has the exclusive right to authorise the issuance of euro banknotes.

Member states could issue euro coins, but the amount must be authorised by the ECB

beforehand.

The bank must also co-operate within the EU and internationally with third bodies

and entities. Finally it contributes to maintaining a stable financial system and

monitoring the banking sector.ECB acts as the pivot of the European System of

Central Banks(ESCB) . It ensures that the tasks conferred upon the euro system and

ESCB are implemented either through its own activities or through those of the

national central banks.

ECB's Monetary Policy

ECB prefers to promote non-inflationary growth with price stability. In U.S. style

central banking, liquidity is furnished to the economy primarily through the purchase

of Treasury bonds by the Federal Reserve System. The Euro system uses a different

method. There are about 1500 eligible banks which may bid for short term repo

contracts of two weeks to three months duration.

The banks in effect borrow cash and must pay it back; the short durations allow

interest rates to be adjusted continually. When the repo notes come due the

participating banks bid again. An increase in the quantity of notes offered at auction

allows an increase in liquidity in the economy. A decrease has the contrary effect. The

contracts are carried on the asset side of the European Central Bank's balance sheet

and the resulting deposits in member banks are carried as a liability. In lay terms, the

liability of the central bank is money, and an increase in deposits in member banks,

carried as a liability by the central bank, means that more money has been put into the

economy.

P a g e | 10

To qualify for participation in the auctions, banks must be able to offer proof of

appropriate collateral in the form of loans to other entities. These can be the public

debt of member states, but a fairly wide range of private banking securities are also

accepted. The fairly stringent membership requirements for the European Union,

especially with regard to sovereign debt as a percentage of each member state's gross

domestic product, are designed to insure that assets offered to the bank as collateral

are, at least in theory, all equally good, and all equally protected from the risk of

inflation.

The ECB conducts refinance operations both for long-term and short-term. It also

provides marginal lending facility, which counterparties may use to receive credit

from an NCB at a pre-specified interest rate against eligible assets.

Shareholders

The ECB is governed by the governing council, Executive Board and the general

Council. Although the ECB is governed by European law directly and thus not by

corporate law applying to private law companies, its set-up resembles that of a

corporation in the sense that the ECB has shareholders and stock capital. Its capital is

five billion euro which is held by the national central banks of the member states as

shareholders. The owners and shareholders of the European Central Bank are the

central banks of the 27 member states of the EU. Shares in the ECB are not

transferable and cannot be used as collateral.

P a g e | 11

Chapter- 2

CURRENT EUROPEAN SOVEREIGN

DEBT CRISIS

P a g e | 12

2.1 INTRODUCTION

One of the major factors contributing to the ongoing eurozone debt crisis was the

2007-2008 global financial and economic crises, which in itself was one of the worst

crises to hit the global economy.

The global financial crisis and economic downturn emanated from the subprime

mortgage crisis in the United States of America and spread to European markets as

well as the rest of the world. The problem has since culminated in a debt crisis as the

sovereign debt levels of some of the world’s largest economies have increased

sharply, placing them at risk of default. In Europe, the crisis started with the collapse

of the banking system in Iceland in 2008 and spread to other European countries

including Greece, Ireland and Portugal in 2009. The crisis reached its first apex in

early 2010, as a result of Greece’s large structural deficits and the increasing cost of

financing government debt. The authorities spent beyond their means and

continuously misreported figures in order to satisfy the guidelines set by the European

Economic and Monetary Union (EMU).

The significant increase in savings available for investment during the 2000–2007

period when the global pool of fixed-income securities increased from approximately

$36 trillion in 2000 to $70 trillion by 2007. This "Giant Pool of Money" increased as

savings from high-growth developing nations entered global capital markets.

Investors searching for higher yields than those offered by U.S. Treasury bonds

sought alternatives globally.

The temptation offered by such readily available savings overwhelmed the policy and

regulatory control mechanisms in country after country, as lenders and borrowers put

these savings to use, generating bubble after bubble across the globe. While these

bubbles have burst, causing asset prices (e.g., housing and commercial property) to

decline, the liabilities owed to global investors remain at full price, generating

questions regarding the solvency of governments and their banking systems.

How each European country involved in this crisis borrowed and invested the money

varies. The interconnection in the global financial system means that if one nation

defaults on its sovereign debt or enters into recession putting some of the external

private debt at risk, the banking systems of creditor nations face losses.

P a g e | 13

Thus the European sovereign debt crisis resulted from a combination of complex

factors, including the globalization of finance; easy credit conditions during the 2002–

2008 period that encouraged high-risk lending and borrowing practices; the 2007–

2012 global financial crisis; international trade imbalances; real-estate bubbles that

have since burst; the 2008–2012 global recession; fiscal policy choices related to

government revenues and expenses; and approaches used by nations to bail out

troubled banking industries and private bondholders, assuming private debt burdens

or socializing losses.

2.2 TERMS TO KNOW

1. Sovereign Default Or Debt-

It is the failure or refusal of the government of a sovereign state to pay back its debt in

full. It may be accompanied by a formal declaration of a government not to pay

(repudiation) or only partially pay its debts (due receivables), or the de facto cessation

of due payments. Thus it is the failure to abide by the terms of bonds or other debt

instruments. This may occur due to national insolvency or other factors.

2. GIIPS Or PIIGS Nations -

Following the massive financial crisis, Greece, Ireland, Italy, Portugal, and Spain

have all come under fire for a varied mix of labour inflexibility, high-spending, and

lost competitiveness.

3. Deficit Spending-

It is the amount by which a government, private company, or individual's spending

exceeds income over a particular period of time, also called “deficit” or budget

deficit". It is the opposite of budget surplus.

P a g e | 14

4. Excessive Deficit Procedure (EDP)-

In order for European economic and monetary union to function smoothly, Member

States must avoid excessive budgetary deficits. Under the provisions of the Stability

and Growth Pact, they agree to respect two criteria: a deficit-to-GDP ratio of 3% and

a debt-to-GDP ratio of 60%. If a Member State exceeds the deficit ceiling, the

excessive deficit procedure (EDP) is triggered at EU level. This entails several steps –

including the possibility of sanctions – to encourage the Member State concerned to

take measures to rectify the situation. The EDP is established in the Treaty and

specified in the Stability and Growth Pact legislation.

5. Contagion -

The "contagion effect" referred to in the eurozone crisis is the fear that one country's

financial problems will spill over to another country. This happens because the capital

markets -- where sovereign bonds are bought and sold -- can be influenced by

sentiment as well as the fundamentals of each country. Contagion can also occur

because the more countries within the bloc struggle, the higher the cost to others of

giving aid.

6. Default

Countries, or companies, default when they can no longer pay their bills on time.

Defaults can come in different forms: "Orderly" -- when investors holding the bonds

can agree to take haircuts or "disorderly," where losses are unexpected and sudden.

7. Haircut

A haircut refers to a cut in the value of investments lenders are asked to take. For

example, a 50% haircut on an investment means you'll get back only half of what you

paid. Investors in Greek bonds have been asked to take a haircut on their debt. It

would be in their interest to do so if they thought the value of the debt could drop

further in the future. Investors can also be asked to swap bonds maturing soon for

longer dated ones which would pay out at a much later date.

P a g e | 15

8. Bond Yield

Countries raise money by issuing sovereign bonds which are then purchased by

investors. The '"yield" of the bonds - which can be thought of as IOUs -- is how much

the investor wants to be paid to hold that bond. So, a higher yield indicates a higher

risk bond. For sovereign bonds a yield of more than 7% is considered unsustainable

for any extended period of time, because a country's earnings are unlikely to be able

to cover repayments.

9. Liquidity

Liquidity is the oil which greases the world of finance. It refers to the ease at which

funds -- cash, for example - can flow through the system. A market with lots of buyers

and sellers is liquid, while one without is illiquid.

10.Junk

The ratings agencies -- Moody's Investors Service, Standard & Poor's and Fitch

Ratings being the big three -- award scores based on a company or country's credit

worthiness. "Junk" refers to when that rating drops below investment grade. Once a

credit rating drops below the BBB level, it is "sub-investment" grade and is

commonly referred to as junk.

11.International Monetary Fund

The International Monetary Fund, which is based in Washington D.C., is an

organization of 187 countries. It is designed to assist countries in financial trouble.

Member countries contribute to the fund, relative to their economies, when assistance

is needed. It has been a key player in the European bailouts.

12.The Troika

A group of auditors from the International Monetary Fund, the European Union and

the European Central Bank tasked with monitoring the progress of nations that have

requested sovereign bailouts such as Greece, Portugal and Ireland.

P a g e | 16

13.Economic Bubble

An economic bubble happens when a market goes through a very fast inflation of

value. When the bubble is in the growing phase, everybody makes money but this

inflation is followed by a quick decrease in value, called a "crash" or a "bubble burst".

When a bubble is building up, the debt of individual in a country to one another is

also building up.

14.Credit Default Swap

A specific kind of counterparty agreement which allows the transfer of third party

credit risk from one party to the other. One party in the swap is a lender and faces

credit risk from a third party, and the counterparty in the credit default swap agrees to

insure this risk in exchange of regular periodic payments (essentially an insurance

premium). If the third party defaults, the party providing insurance will have to

purchase from the insured party the defaulted asset.

In turn, the insurer pays the insured the remaining interest on the debt, as well as the

principal.

P a g e | 17

2.3 THE MAJOR CRISIS IN THE EURO AREA

The euro area faces three interlocking crises that together challenge the viability of

the currency union. There is a banking crisis – where banks are undercapitalized and

have faced liquidity problems. There is a sovereign debt crisis – where a number of

countries have faced rising bond yields and challenges funding themselves. Lastly,

there is a growth crisis – with both a low overall level of growth in the euro area and

an unequal distribution across countries. Crucially, these crises connect to one

another. Bailouts of banks have contributed to the sovereign debt problems, but banks

are also at risk due to their holdings of sovereign bonds that may face default. Weak

growth contributes to the potential insolvency of the sovereigns, but also, the austerity

inspired by the debt crisis is constraining growth. Finally, a weakened banking sector

holds back growth while a weak economy undermines the banks. This paper details

the three crises, their interconnections, and possible policy solutions. Unless policy

responses take into account the interdependent nature of the problems, partial

solutions will likely be incomplete or even counterproductive.

Bank Crisis

Sovereign Debt Crisis

Macroeconomic Growth &

Competitiveness Crisis

EURO AREAS THREE CRISIS

P a g e | 18

2.4 CAUSES OF THE CURRENT CRISIS

2.4.1 Rising Government Debt Levels

In 1992, members of the European Union signed the Maastricht Treaty, under which

they pledged to limit their deficit spending and debt levels. However, a number of EU

member states, including Greece and Italy, were able to circumvent these rules,

failing to abide by their own internal guidelines, sidestepping best practice and

ignoring internationally agreed standards. This allowed the sovereigns to mask their

deficit and debt levels through a combination of techniques, including inconsistent

accounting, off-balance-sheet transactions as well as the use of complex currency and

credit derivatives structures. The complex structures were designed by prominent U.S.

investment banks, who received substantial fees in return for their services.

The adoption of the euro led to many Eurozone countries of different credit

worthiness receiving similar and very low interest rates for their bonds and private

credits during years preceding the crisis. As a result, creditors in countries with

originally weak currencies (and higher interest rates) suddenly enjoyed much more

favourable credit terms, which spurred private and government spending and lead to

an economic boom. In some countries such as Ireland and Spain low interest rates

also led to a housing bubble, which burst at the height of the financial crisis.

P a g e | 19

According to economists, increased debt levels were mostly due to the large bailout

packages provided to the financial sector during the late-2000s financial crisis, and

the global economic slowdown thereafter. The average fiscal deficit in the euro area

in 2007 was only 0.6% before it grew to 7% during the financial crisis. In the same

period, the average government debt rose from 66% to 84% of GDP.

2.4.2 Trade Imbalances

Many experts believe that the root of the crisis was growing trade imbalances. In the

run-up to the crisis, from 1999 to 2007, Germany had a considerably better public

debt and fiscal deficit relative to GDP than the most affected eurozone members. In

the same period, these countries

(Portugal, Ireland, Italy and Spain)

had far worse balance of payments

positions. Whereas German trade

surpluses increased as a percentage of

GDP after 1999, the deficits of Italy,

France and Spain all worsened.

Trade deficit by definition requires a

corresponding inflow of capital to

fund it, which can drive down interest rates and stimulate the creation of bubbles. But

bubbles always burst sooner or later, and nation’s assets have evaporated but debts

remain all too real.

A trade deficit can also be affected by changes in relative labour costs, which made

southern nations less competitive and increased trade imbalances. Since 2001, Italy's

unit labour costs rose 32% relative to Germany's. Greek unit labour costs rose much

faster than Germany's during the last decade. However, most EU nations had

increases in labour costs greater than Germany's. Those nations that allowed "wages

to grow faster than productivity" lost competitiveness.

P a g e | 20

The gap between German and Greek productivity increased resulting in a large

current account surplus financed by capital flows. The capital flows could have been

invested to increase productivity in the peripheral nations. Instead capital flows were

squandered in consumption and consumptive investments.

Further, Eurozone countries with sustained trade surpluses (i.e., Germany) do not see

their currency appreciate relative to the other Eurozone nations due to a common

currency, keeping their exports artificially cheap. Germany's trade surplus within the

Eurozone declined in 2011 as its trading partners were less able to find financing

necessary to fund their trade deficits, but Germany's trade surplus outside the

Eurozone has soared as the euro declined in value relative to the dollar and other

currencies.

2.4.3 Structural Problem Of Euro Zone System

There is a structural contradiction within the euro system, namely that there is a

monetary union (common currency) without a fiscal union (e.g., common taxation,

pension, and treasury functions). In the Eurozone system, the countries are required to

follow a similar fiscal path, but they do not have common treasury to enforce it. That

is, countries with the same monetary system have freedom in fiscal policies in

taxation and expenditure. So, even though there are some agreements on monetary

policy through European Central Bank, countries may not be able to or would simply

choose not to follow it. This feature brought fiscal free riding of peripheral

economies, especially represented by Greece, as it is hard to control and regulate

national financial institutions. Furthermore, there is also a problem that the euro zone

system has a difficult structure for quick response. Eurozone, having 17 nations as its

members, require unanimous agreement for a decision making process. This would

lead to failure in complete prevention of contagion of other areas, as it would be hard

for the Eurozone to respond quickly to the problem.

In addition, as of June 2012 there was no "banking union" meaning that there was no

Europe-wide approach to bank deposit insurance, bank oversight, or a joint means of

recapitalization or resolution (wind-down) of failing banks. In Europe, hyper

P a g e | 21

connectedness both exposed just how uncompetitive some of their economies were,

but also how interdependent they had become.

2.4.4 Monetary Policy Inflexibility

Membership in the Eurozone established a single monetary policy, preventing

individual member states from acting independently. In particular they cannot create

Euros in order to pay creditors and eliminate their risk of default. Since they share the

same currency as their (eurozone) trading partners, they cannot devalue their currency

to make their exports cheaper, which in principle would lead to an improved balance

of trade, increased GDP and higher tax revenues in nominal terms.

2.4.5 Loss Of Confidence

Prior to development of the crisis it was assumed by both regulators and banks that

sovereign debt from the eurozone was safe. Banks had substantial holdings of bonds

from weaker economies such as Greece which offered a small premium and

seemingly were equally sound. As the crisis developed it became obvious that Greek

and other peripheral countries bonds offered substantially more risk. Contributing to

lack of information about the risk of European sovereign debt was conflict of interest

by banks that were earning substantial sums underwriting the bonds.

Furthermore, investors had doubts about the possibilities of policy makers to quickly

contain the crisis. Since countries that use the euro as their currency have fewer

monetary policy choices. As of June, 2012, many European banking systems were

under significant stress, particularly Spain. A series of "capital calls" or notices that

banks required capital contributed to a freeze in funding markets and interbank

lending, as investors worried that banks might be hiding losses or were losing trust in

one another. The wealthy were moving assets out of the Eurozone and within the

Eurozone from the South to the North.

P a g e | 22

2.4.6 Vulnerable And Unsound Banking System

The banking system in the euro area is both large and global. The large size of the

banking system, relative to other parts of the financial system, highlights another

important fact: firms in the euro area relies more on the banking system for financing

than American firms (who are more likely to use capital markets directly), making the

health of the banking system particularly important in Europe. Furthermore, the

largest individual banks in the U.S. and Europe are roughly the same size, and thus

the largest euro-area banks are roughly the same share of euro area GDP as the U.S.

banks are of U.S. GDP, but this implies the largest euro area banks are a much larger

share of any individual national economy in the euro area. ING bank in the

Netherlands is smaller than a number of U.S. banks, but given that the Netherlands

economy is roughly 5% the size of the U.S. economy, it is huge relative to its home

economy. In fact, ING has more assets than the entire GDP of its host country; no

U.S. bank has more than 1/8th. It is massive relative to the economy of the

government that would be responsible to help it in times of distress.

The global and trans-European nature of the banks is part of why they can be so large

as a share of GDP, but also makes the national supervision and backing of the banks

all the more problematic. Bank deposits in the Eurozone are insured, but by agencies

of each member government. If banks fail, it is unlikely the government will be able

to fully and promptly honour their commitment, at least not in euros, and there is the

possibility that they might abandon the euro and revert to a national currency; thus,

euro deposits are safer in Dutch, German, or Austrian banks than they are in Greece

or Spain.

P a g e | 23

2.5 EVOLUTION OF THE CRISIS

The European sovereign debt crisis began over three years ago when investors began

to question how Greece would be able to finance its growing debt. These fears

eventually resulted in a European Union (EU) and International Monetary Fund (IMF)

led Greek bailout in May 2010. However, the crisis did not stop there. The first Greek

bailout was followed by bailouts in Ireland in November 2010, Portugal in May 2011,

and a second Greek bailout in July 2011 that was finalized in February 2012. Despite

the bailouts, the Eurozone is still facing difficulties.

While ballooning public debt may be the clearest manifestation of the Euro crisis, its

roots go much deeper—to

the secular loss of

competitiveness that has

been associated with euro

adoption in countries

including Greece, Ireland,

Italy, Portugal, and Spain

(GIIPS).

The sequence of events that

led to the secular loss of

competitiveness is depressingly similar among the GIIPS countries:

The adoption of the euro was accompanied by a large fall in interest rates

and a surge in confidence as institutions and incomes expected to converge

to those of Europe’s northern core economies.

Domestic demand surged, bidding up the price of non-tradables relative to

tradables and of wages relative to productivity.

Growth accelerated, driven by domestic services, construction, and an

expanding government, while exports stagnated as a share of GDP, and

imports and the current account deficit soared amid abundant foreign capital.

The result was that indebtedness—public, private, or both—surged.

2.5.1 GREECE

P a g e | 24

Prior to the establishment of the euro, Greece was among the worst economic

performers of eventual Euro area members. Annual inflation was one of the highest in

the region; the Greek government paid the highest borrowing premium; and GDP

growth was the slowest in Europe.

The adoption of the euro appeared to solve many of these deficiencies. As Greece

stabilized, it quickly became an attractive destination for foreign capital. Greece’s net

foreign asset position, which measures the assets Greece, holds abroad minus Greek

assets held by foreigners, plummeted, falling to around -100 percent of GDP in 2007.

Awash with cheap capital, domestic demand surged and the current account balance

deteriorated from -3.7 percent of GDP in 1997 to -14.4 percent in 2008. Domestic

demand growth drove up prices in Greece relative to that of the Euro area, increasing

domestic labour costs and eroding Greek competitiveness.

Competitiveness was hurt further by a shift away from

manufacturing sectors in favour of the expansion of

service and non-tradable sectors. The resulting loss of

competitiveness has been substantial: the IMF

estimates that Greece’s real effective exchange rate is

overvalued by 20–30 percent. From 1997 to 2008,

Greece increased government spending per capita by

140 percent, compared to 40 percent in the Euro area. Reflecting the economy’s rapid

growth, public sector deficits remained within what appeared to be reasonable bounds

—averaging 5 percent of GDP from 2000 to 2007. As the world economy was hit by

the global financial crisis in the late 2000s, Greece was hit especially hard because its

main industries — shipping and tourism — were especially sensitive to changes in the

business cycle. The government spent heavily to keep the economy functioning and

the country's debt increased accordingly.

The picture changed markedly with the financial crisis and when markets realized

Greece’s chronic failure to report accurate statistics. With debt ballooning from 96

percent of GDP in 2007 to 115 percent in 2009—and the IMF projecting it to reach

nearly 150 percent by 2012 even under the assumption of draconian fiscal measures—

Greece’s borrowing costs skyrocketed. On 23 April 2010, the Greek government

P a g e | 25

requested an initial loan of €45 billion from the EU and International Monetary Fund

(IMF), to cover its financial needs for the remaining part of 2010. A few days later

Standard & Poor's slashed Greece's sovereign debt rating to BB+ or "junk" status

amid fears of default, in which case investors were liable to lose 30–50% of their

money. Stock markets worldwide and the euro currency declined in response to the

downgrade.

On 1 May 2010, the Greek government announced a series of austerity measures to

secure a three year €110 billion loan. The austerity relies primarily on tax increases

which harms the private sector and economy. This was met with great anger by the

Greek public, leading to massive protests, riots and social unrest throughout Greece.

The EC, ECB and IMF, offered Greece a second bailout loan worth €130 billion in

October 2011, but with the activation being conditional on implementation of further

austerity measures and a debt restructure agreement.

All the implemented austerity measures, have so far helped Greece bring down its

primary deficit - i.e. fiscal deficit before interest payments - from €24.7bn (10.6% of

GDP) in 2009 to just €5.2bn (2.4% of GDP) in 2011, but as a side-effect they also

contributed to a worsening of the Greek recession, which began in October 2008 and

only became worse in 2010 and 2011.

2.5.2 IRELAND

Well before the euro’s introduction in the late 1990s, Ireland was prospering. From

1990 to 1995, GDP was growing significantly faster than in other GIIPS, and inflation

and borrowing costs were not only below that of the other GIIPS, they were close to

German levels.

Additionally, Ireland’s governance and business climate indicators were among the

world’s strongest. Labour markets were flexible and the education system was one of

the best in Europe. Whereas in other GIIPS, the euro added confidence where there

previously was none, in Ireland, the euro gave an unsustainable boost to an already

booming economy. This rapid growth and a European monetary policy that was far

P a g e | 26

too loose for Ireland fuelled the enormous overleveraging of the financial sector. The

supply of credit exploded, surpassing 200 percent of GDP by 2008 after averaging

around 40 percent from 1975 to 1994. In just ten years, financial and monetary

institutions expanded their balance sheets by approximately 750 percent of GDP, and

by 2007, gross financial exposure had reached nearly 1,400 percent of GDP. In the

other GIIPS, balance sheets expanded by “only” 100 percent of GDP and exposure

averaged close to 200 percent.

An extraordinary housing bubble emerged. From 1997 to 2006, housing completions

grew by 9.6 percent a year, and by IMF

calculations, Irish house prices grew by 90 percent

more than fundamentals predicted, compared to 28

percent in Spain and 20 percent in the United

States. As in other GIIPS, the economy shifted

away from manufacturing and toward services and

housing. Financial intermediation, real estate, and

business sectors sapped 10 percent of GDP away from the industrial sector from 1999

to 2006. In 2008, Ireland’s bubble burst. Over the next two years, domestic demand

fell by 16 percent, investment collapsed by over 40 percent, and housing prices

plunged 30 percent. By the end of 2010, Irish output will likely have contracted by 14

percent since the beginning of the crisis.

The financial sector was hit even harder. The government responded to the

financial crisis with extraordinary measures, issuing capital injections and guarantees

to depositors and creditors of major banks and purchasing troubled assets. The total

assets of the guaranteed banks are now valued at 440 billion euros, or 270 percent of

Irish GDP and 2700 percent of Ireland’s average yearly net debt issuance.

These measures obviously took a heavy toll on government finances. At 13.9 percent

of GDP, estimated financial sector stabilization costs through 2009 are the highest of

any advanced country. The Irish sovereign debt crisis was not based on government

over-spending, but from the state guaranteeing the six main Irish-based banks who

had financed the property bubble.

2.5.3 ITALY

P a g e | 27

Italy did a better job than Greece of managing its fiscal affairs during the crisis,

but its debt as a percentage of GDP is still higher than that of Greece and, since

adopting the euro, its competitiveness has deteriorated just as sharply. The

combination of high debt, declining competitiveness, and anaemic growth means that,

even if contagion from Greece is controlled, the Italian economy will remain

exceptionally vulnerable to adverse shocks in a highly uncertain post-crisis global

environment.

To maintain its membership in the Euro area and avoid its own disastrous sovereign

debt crisis, Italy should adopt a three-year program to raise its primary balance by at

least 4 percent of GDP and engineer a real devaluation vis-à-vis Germany of at least 6

percent through wage cuts and far-reaching structural reforms. Compared to the

programs enacted or planned in Greece, Ireland, and the Baltic countries whose crises

have already erupted, these steps are modest and should be interpreted as pre-emptive.

Italy is plagued by poor regulation, vested business

interests, an ageing population and weak investment, all

of which have conspired to limit the country's ability to

increase production - problems that Italy's new

government of unelected technocrats says it is trying to

address. The country has averaged an abysmal 0.75%

annual economic growth rate over the past 15 years. That is much lower than the rate

of interest it pays on its debts.

And this creates a risk that the government's debt load could grow more quickly than

the Italian economy's capacity to support it. By moderating expenditures, partly via

pension reform in the 1990s, and increasing revenue through temporary tax measures,

Italy has avoided a starker debt explosion so far. More recently, its conservatively

managed banks did not need a bail out, nor did Italy enact substantial fiscal stimulus.

Crucially, Italy’s lower fiscal deficits, together with higher private sector savings,

establish an external balance that is also sounder than that of Greece. Italy’s cycle of

high debt and low growth has re-enforced itself for decades, but the uncertainty of the

post-crisis world economy poses new risks. In the short term, continued failure by the

Euro area to deal with the Greek crisis and contain its spread could easily lead interest

P a g e | 28

premia to surge on both government and private borrowing, eventually stifling

European demand. This would kill Italy’s fragile recovery by forcing greater fiscal

adjustment and further depressing exports.

On the other hand, sustained global growth would come with higher interest rates and

could mean another large oil shock this year or next. This would hit Italy—a heavily

oil-reliant country that imports 93 percent of its supply and is limited in its ability to

increase exports in order to pay more—particularly hard.

2.5.4 PORTUGAL

Unlike its most vulnerable Euro area counterparts, Portugal saw its boom that

followed the adoption of the euro fade quickly. In the run up to the launch of the euro,

its GDP had grown at an average annual rate of almost 4 percent—one of the highest

rates in the Euro area and more than 1 percentage point above the Euro area average.

However, the demand boom, which was triggered by a

sharp decline in interest rates and fuelled by expansionary

fiscal policy, was not followed by a parallel increase in

potential supply and, much like its boom, Portugal’s rapid

loss of competitiveness happened early relative to the

other GIIPS. By 2001–2005, Portugal’s growth rate had

decelerated sharply to just one percent.

While Portugal is doing better than Greece in terms of controlling its budget deficit

and public debt, reliance on Spain—itself vulnerable—as a market for 25 percent of

its exports, adds to the contagion risk.

Between 1995 and 2000, private savings dropped and household and non-financial

sector debt more than doubled in percent of GDP reflecting external borrowing’s role

in financing consumption and investment. After formal adoption of the euro,

monetary policy in the Euro area, while clearly too loose for Greece, Spain, and

Ireland, who saw housing booms, was too tight for Portugal, where housing

investment as a percentage of GDP had declined over time and inflation had dropped.

As household spending stalled amid high levels of debt and prospects seemed to

deteriorate—with little actual GDP per capita convergence—the investment and

consumption boom came to an end. Though the Great Recession did not hit Portugal

P a g e | 29

as hard as the other vulnerable economies, it did lead GDP to contract by 2.7 percent

in 2009. GDP is projected to grow by 0.5 percent in 2010 and 0.7 percent in 2011,

driven by external trade as domestic demand is set to essentially stagnate. The

downturn is also having a significant impact on unemployment. In addition, the crisis

severely affected public finances, with the debt level reaching 86 percent, up from 66

percent two years ago. Risky credit, public debt creation, and European structural and

cohesion funds were mismanaged across almost four decades. In 2011, Portugal

requested a €78 billion IMF-EU bailout package in a bid to stabilise its public

finances. These measures were put in place as a direct result of decades-long

governmental overspending and an over bureaucratised civil service. As part of the

bailout programme, Portugal is required to regain complete access to financial

markets starting from September 2013.

2.5.5 SPAIN

Spain’s non-tradable sectors—housing, government, and a broad array of market

services—had grown far too big. Spain has a debt-to-GDP ratio that is half that of

Greece and thus has more time and resources to fix its problems. However, its large

deficits and the collapse of its post-euro growth model imply that its public debt could

—if remedial measures are not taken—follow an exploding path. The housing sector’s

boom and bust has undeniably defined Spain’s crisis. Spain had a comparatively low

debt level among advanced economies prior to the

crisis. It's public debt relative to GDP in 2010 was

only 60%, which was less than Germany, France

or the US. Debt was largely avoided by the

ballooning tax revenue from the housing bubble,

which helped accommodate a decade of increased

government spending without debt accumulation.

At its peak, construction value-added reached 17 percent of GDP. In just ten years,

Spain’s housing prices more than doubled, and, at the peak in 2006, Spain started

more homes than the UK, Germany, France, and Italy combined, a significant share of

which were sold to foreigners. Amid this demand boom, the price of all non-tradable

P a g e | 30

activities rose relative to that of tradables (whose price is set in world markets);

investment and labour were pulled into these non-tradable sheltered sectors; and

wages were bid up higher than in other Euro area members and in excess of

productivity. Spain’s manufacturing sector, already small at the start of the process,

shrank its share of GDP by 4 percent. Amid this boom, Spain’s tax receipts swelled

temporarily, generating more revenue than expected.

When the bubble burst, Spain spent large amounts of money on bank bailouts. In May

2012, Bankia received a 19 billion euro bailout, on top of the previous 4.5 billion

euros to prop up Bankia. Questionable accounting methods disguised bank losses.

During September 2012, regulators indicated that Spanish banks required €59 billion

(USD $77 billion) in additional capital to offset losses from real estate investments.

The bank bailouts and the economic downturn increased the country's deficit and debt

levels and led to a substantial downgrading of its credit rating. To build up trust in the

financial markets, the government began to introduce austerity measures. Following

the crisis The massive rise in unemployment—which crossed the 20 percent threshold

in April—should be interpreted as part of the unwinding of the structural

misallocation, as it reflects not only the effects of global trade’s collapse on

manufacturing (which is now recovering) but also the collapse of demand for housing

and non-tradable activities generally.

As one of the largest eurozone economies (larger than Greece, Portugal and Ireland

combined) the condition of Spain's economy is of particular concern to international

observers. Under pressure from the United States, the IMF, other European countries

and the European Commission the Spanish governments eventually succeeded in

trimming the deficit from 11.2% of GDP in 2009 to an expected 5.4% in 2012.

P a g e | 31

2.7 SIZE AND COMPOSITION OF GOVT. DEBT IN THE EURO

AREA

The composition of government debt in terms of maturity, indexation, currency and

investor base influences both a government’s costs and the risks related to the rollover

of outstanding government debt. A government, or its appointed agency, typically

known as the debt management office, tries to minimise the costs in view of the risks

related to the issuance of government debt. In this respect, it is guided by the debt

management strategy, which explicitly sets out the government’s medium-term

objectives for managing its debt. There are several macroeconomic reasons for

attaching importance to the composition of government debt. First, particularly in

developed economies, the government bond yield curve serves as a benchmark for

pricing private sector bonds. The maturity composition of government debt affects the

yield curve and hence the financing conditions of the private sector, with possible

effects on overall economic activity. Higher government borrowing under certain

conditions crowds out possible private sector borrowings that are crucial for long-

term economic growth.

Second, with a high share of short-term debt the government may be vulnerable to

increases in monetary policy rates. If a government has to take fiscal measures to

counteract the effect of higher interest expenditure on the overall budget balance, this

may have a negative impact on economic activity. The government may then have an

incentive to put pressure on the central bank to maintain low policy rates. Third,

domestic currency denomination protects euro area governments against exchange

rate movement risks related to currency mismatches between a government’s interest

expenditure and tax revenue. Finally, the share of the domestic versus the foreign

investor base could have consequences in situations of sudden foreign capital stops or

bigger exchange rate movements. The domestic investor base, given its access to a

wider range of information on domestic developments and policies, may be relatively

smaller depending on rating agencies’ assessments and less prone to a herd mentality

compared to the foreign investor base.

P a g e | 32

The composition of government debt in the euro area can be broken down by-

1. Type Of Financing Instrument

2. The Level Of Government Issuing The Instrument

3. Residual Maturity

4. Debt Holders/Creditors

Long-term securities, i.e. securities with initial maturity of over one year, represented

70% of Government debt in the euro area in 2010, while short-term securities

accounted for 9% and loans from financial institutions, which are typically used at the

municipal level, corresponded to 18% of EDP (Excessive Deficit Procedure) debt.

Around 83% of EDP debt comprised debt issued by central government, while the

remaining 17% was issued by local (municipal) government, state governments or

social security funds.

P a g e | 33

The non-residents in a given euro area country, which include non-residents both

inside and outside the euro area, held some 52% of EDP debt, while residents held the

remaining 48%, out of which 38% of the total was held by monetary and financial

institutions, under 2%by the central bank and some 8% of the total by other residents,

e.g. individuals and non-financial corporations. Regarding the currency

decomposition, roughly 99% of the euro area government debt securities are

denominated in euro; this makes the euro area governments virtually insensitive to

exchange rate movements. In addition, the denomination of government debt in the

domestic currency, which is also the currency in which the euro area governments

collect taxes, reduces problems with possible currency mismatches. Under normal

circumstances, governments tend to prioritise reducing the debt-servicing costs given

a certain level of risk. In special circumstances, especially when financial markets do

not work smoothly, more attention needs to be paid to minimising the refinancing

risk. In particular, in an environment of very low short-term interest rates issuance

activity may shift towards short-term instruments in order to minimise the

government’s costs (interest payments). However, as this would increase the

refinancing risk, the government could face a situation in which a huge amount of

outstanding government debt needs to be rolled over in a short period of time and

market conditions deteriorate in such a way that investors either demand substantially

higher yields on their investments or are unwilling to buy certain government bills or

bonds at all.

The composition of government debt is determined by the interactions between the

government as issuer and investors who buy the debt instruments on offer. Both the

government and investors have their own preferences which may not always fully

match. The government needs to finance its deficit and roll over the maturing debt.

The investors may have heterogeneous preferences, depending on their investment

strategy. For example, long-term investors such as pension funds may demand fairly

long-term maturities which would match the maturity profile of their liabilities, while

commercial banks or non-financial corporations may prefer short-term instruments for

their liquidity management.

Past memories also play an important role. For example, investors in countries with a

track record of relatively high inflation or frequent changes in market conditions may

demand instruments with variable interest rates which would compensate them if

economic or financial market conditions were to change from the time of issuance. In

P a g e | 34

this respect, inflation indexed bonds are being considered as a way in which

institutional investors can match their inflation-sensitive liabilities or diversify long-

term investment portfolios. The sovereign inflation-linked bond markets in the euro

area developed around 2003 and currently centre on three countries, namely France,

Germany and Italy.

The intensification of financial turbulence was a major obstacle for the inflation-

linked bond market in 2009-10. The change in macroeconomic conditions, in

particular the sharp declines in oil prices, lowered worldwide demand for inflation

protection in that period. Moreover, the increasingly tough liquidity conditions in

financial markets triggered a major sell-off of inflation-linked bonds, whose prices, in

the light of low demand, plummeted not only in the euro area but also in global

markets. Faced with such adverse demand conditions, primary issuance was

somewhat limited in 2009 and 2010.

Debt Holders/Creditors-

Non-residents are the major government debt holders in Belgium, Greece, the

Netherlands, Austria, Portugal, Slovenia and Finland, while residents are the

dominant holders in Germany, Estonia, Spain, Italy, Cyprus, Malta and Slovakia.

Monetary and financial institutions (MFIs) (i.e. credit institutions such as banks,

excluding central banks, and money market funds) together with other financial

corporation’s (i.e. insurance corporations, pension funds, financial auxiliaries, mutual

funds, securities and derivatives dealers and financial corporations engaged in

lending) are the main resident holders of government debt in all euro area countries

except Finland, where a significant proportion of government debt is held by other

residents. The domestic central banks generally hold only very limited volumes of

government debt in the euro area, with the exception in (to some extent) Italy, Spain

and Greece, where the central banks hold roughly 3% to 4% of existing government

debt. Individual resident investors in government bonds play an important role in

particular in Malta, Spain, Finland and Germany, and also to some degree in Italy,

Portugal and Cyprus. The government debt of euro area governments is denominated

mostly in euro.

P a g e | 35

However, limited amounts of government debt denominated in other currencies were

recorded in the Netherlands (around 8% of government debt is denominated in non-

euro currencies) and Austria (less than 3% of total government debt), Greece,

Portugal and Germany (where 1% to 2% of total debt is in other currencies)

Residual Maturity Of Government Debt

The highest proportion is typically represented by debt with maturity at over five

years. For example, by the end of 2010 Estonia, Slovenia and Austria held more than

50% of their government debt in instruments with residual maturity at over five years,

while for Greece, Italy, Cyprus, Slovakia, Spain, Portugal, Malta, Finland and

Belgium the share of instruments with residual maturity at over five years was

between 40 and 50%. Residual maturity at up to one year was particularly high in

France, Germany and the Netherlands, in addition to Portugal which is subject to

EU/IMF support. A high share of debt maturing in the short term and/or a high share

of debt with a variable interest rate will sensitise countries to nominal interest rate

developments. The need to maintain price stability is thus crucial for maintaining

favourable market conditions and allowing governments to refinance at low cost.

Likewise, debt instruments with variable interest rates may also be a preferred option

for those investors having to pay variable interest on their liabilities.

The maturity profile (or average residual maturity) and currency denomination is an

important factor which affects the refinancing risk. Initial maturity is the lifetime of a

financial instrument at issuance, while residual maturity is the time from the reference

date until the contractual redemption date of the given instrument. Countries with

developed domestic financial markets prefer to issue liabilities in the domestic

currency under domestic jurisdiction. The advantage of domestic liabilities

denominated in the domestic currency is full control of the conditions under which the

debt is repaid. In principle, a country can always service such a debt by increasing

P a g e | 36

existing taxes, imposing new taxes or lowering government discretionary expenditure

(each of these three options is denominated mainly in domestic currency).

On the other hand, when government debt is denominated in a foreign currency or

under foreign jurisdiction, the government has little or no control over the repayment

conditions. Changes in monetary policy and perceptions of governments’ solvency

altered the risks and opportunities for debt managers, which led in some cases to the

implementation of short-term interest cost minimisation strategies during the crisis.

2.7 SPECULATION OVER EU BREAKDOWN

The prospect of a breakup of the euro is increasingly viewed as possible. The online

betting market in trade currently suggests the probability that a country currently

using the euro will leave the euro area by the end of 2013, is roughly 40% and these

odds peaked at over 65% in 2011. Recently, the head of the European Central Bank

(ECB) has acknowledged the possibility of some country ceasing to use the euro. He

did so critically, arguing leaving the euro would have serious negative consequences,

but this is a shift in rhetoric from simply calling a break-up an absurd notion.

Economists, mostly from outside Europe, condemned the design of the euro currency

system from the beginning because it ceded national monetary and economic

sovereignty but lacked a central fiscal authority. When faced with economic

problems, they maintained, "Without such an institution, EMU would prevent

effective action by individual countries and put nothing in its place. As the debt crisis

expanded beyond Greece, these economists continued to advocate, albeit more

forcefully, the disbandment of the eurozone. If this was not immediately feasible, 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.

Iceland, not part of the EU, is regarded as one of Europe's recovery success stories. It

defaulted on its debt and drastically devalued its currency, which has effectively

reduced wages by 50% making exports more competitive. The Wall Street Journal

conjectured that Germany could return to the Deutsche Mark, or create another

P a g e | 37

currency union with the Netherlands, Austria, Finland, Luxembourg and other

European countries such as Denmark, Norway, Sweden, Switzerland and the Baltic’s.

A monetary union of these countries with current account surpluses would create the

world's largest creditor bloc, bigger than China or Japan. The Wall Street Journal

added that without the German-led bloc, a residual euro would have the flexibility to

keep interest rates low and engage in quantitative easing or fiscal stimulus in support

of a job-targeting economic policy instead of inflation targeting in the current

configuration.

Breakup vs. deeper integration

However, there is opposition in this view. The national exits are expected to be an

expensive proposition. The breakdown of the currency would lead to insolvency of

several euro zone countries, a breakdown in

intra-zone payments. Having instability and

the public debt issue still not solved, the

contagion effects and instability would spread

into the system. Having that the exit of Greece

would trigger the breakdown of the eurozone,

this is not welcomed by many politicians,

economists and journalists. Likewise, the two

big leaders of the Euro zone, German

Chancellor Angela Merkel and former French President Nicolas Sarkozy have said on

numerous occasions that they would not allow the eurozone to disintegrate and have

linked the survival of the Euro with that of the entire European Union.

To save the Euro long-term structural changes are essential in addition to the

immediate steps needed to arrest the crisis. Recommendations include even greater

economic integration of the European Union. Solutions which involve greater

integration of European banking and fiscal management and supervision of national

decisions by European umbrella institutions can be criticized as Germanic domination

of European political and economic life.

P a g e | 38

Chapter- 3

RESPONSE

P a g e | 39

3.1 INTERNAL POLICY RESPONSE AND REFORMS BY

COUNTRIES

3.1.1 Austerity Measures

The colossal debts and rock-bottom growth of eurozone "periphery" nations -

especially Greece, Italy and Spain - have hammered market confidence. The interest

rates (yields) on their sovereign bonds have soared, making it hard or even impossible

for them to borrow in international markets.

i. GREECE

Greece, the Republic of Ireland and Portugal have all received massive bailouts from

the EU and International Monetary Fund (IMF).

The 27 EU member states aim to cut deficits to a maximum of 3% of GDP by the

financial year 2014-15. Greece is the biggest worry for the EU, after recent elections

produced a surge in support for parties opposed to the tough austerity conditions

attached to the country's bailout. There is now great uncertainty about Greece's ability

to fulfil its austerity pledges and much speculation about a possible Greek exit from

the eurozone. In the largest restructuring of government debt in history, lenders and

banks wiped 105bn euro’s ($138bn, £88bn) off Greece's debt burden.

But in order to receive the new bailout, the government committed Greece to far-

reaching spending cuts. Greece has now been in recession for five years. The cuts

proved deeply unpopular with the Greek people, leading to a wave of protests and

crippling strikes. To make the economy more competitive Greece pledged to cut the

minimum wage and make labour markets more flexible, weakening job security.

The aim is to cut the Greek government's debt from 160% of GDP to a little over

120% of GDP by 2020.The more unpopular austerity measures include a new

property tax and the suspension of 30,000 civil servants on partial pay. Many Greeks

feel the credit terms are intolerable, condemning the country to years of painful cuts

and job losses. The unemployment rate has risen to 22%.Greece remains frozen out of

international credit markets because its sovereign debt has junk status.

P a g e | 40

ii. ITALY

Italy has slid further into recession - its steepest economic contraction for three years.

The markets are still jittery about Italy's public debt, which rose to around 1.9 trillion

euros (approximately 120% of GDP) at the end of 2011.

The government had already adopted an austerity package in July 2011, featuring

savings worth 70bn euros. It included increases in healthcare fees, and cuts to regional

subsidies, family tax benefits and the pensions of high earners. Further austerity

measures which have been implemented include higher taxes for the wealthy, a rise in

pension ages and a major drive to tackle tax evasion. The government aims to cut

public spending by 4.2bn euros by 2012. Italy has been cutting public sector pay and

freezing new recruitment. Only one employee will be replaced for every five who

leave. The government is currently locked in a dispute with unions over labour market

reforms. The changes - supported by the EU - would make it easier to sack staff.

iii. IRELAND

The IMF signed off on a 3.9bn euros tranche of loans to Ireland in December 2011,

following on from a EU/IMF bailout worth 85bn euros a year earlier.

In July 2011 the interest rate was lowered from around 6% to between 3.5% and

4%.The length of time to pay back the loan was also extended from seven-and-a-half

years to 15 years. The toughest budget in the nation's history included a pledge to trim

the deficit by 6bn euros in 2011. Government spending has been slashed by 4bn

euros, with all public servants' pay cut by at least 5% and social welfare reduced.

VAT rose to 23% as child benefit was cut and police stations were closed. The

government aims to cut public service pay by 400m euros in 2012. Ireland's economy

shrank by almost 2% in the third quarter of 2011, compared with growth of 1.4% in

the previous quarter.

P a g e | 41

iv. PORTUGAL

In 2011 Portugal became the third eurozone country to receive a huge EU/IMF bailout

- 78bn euros. The government adopted a range of austerity measures, including a 5%

pay cut for top earners in the public sector, a VAT rise of 1% and income tax hikes

for high-earners. The military budget was slashed and two high-speed rail projects

have been postponed.There has also been widespread privatisation, and

unemployment rose to 14.8% in January 2012.

v. SPAIN

Unemployment in Spain has soared to nearly 25% - the highest rate in the EU - and

for young people under 25 the rate is above 50%.The government plans to cut 27bn

euros from the state budget this year - one of the toughest austerity drives in modern

Spain's history. Spain has seen widespread protests against austerity, with makeshift

tent cities organised by young people who fear a bleak, jobless future.

Changes will include freezing public sector workers' salaries and reducing

departmental budgets by 16.9%. Health and education are among the areas hit. The

cuts are aimed at meeting the new deficit target agreed with the EU Commission:

5.3% of output (GDP) this year. Spain had already passed an austerity budget in 2011

which included tax rises for the rich, a 28% increase in the tax on tobacco and 8%

spending cuts.

vi. UNITED KINGDOM

Savings estimated at about £83bn are to be made over four years. The plan is to cut

490,000 public sector jobs. The retirement age is to rise from 65 to 66 by 2020. In the

2012 budget, several measures were announced to ease taxes - including a 5% cut to

the top rate of tax and a rise in the personal income tax allowance threshold.

However, there were also cuts made in the personal income tax allowance pensioners

receive, reduced child benefit and raised taxes on tobacco and other items.

P a g e | 42

vii. GERMANY

Germany's economy is doing better than most in Europe. It grew by 3% in 2011 and

its growth of 0.5% in the first three months of 2012 was stronger than expected. The

German performance - largely a result of strong exports - meant the eurozone as a

whole narrowly avoided returning to recession. German unemployment in April was

7% - the lowest rate in more than 20 years. The government plans to cut the budget

deficit by a record 80bn euro by 2014. The plans include a cut in subsidies to parents,

10,000 government job cuts over four years, and higher taxes on nuclear power

3.2 EXTERNAL RESPONSES AND AIDES

3.2.1 EU Emergency Measures

These emergency measures were taken by the European union member nations so as

to immediately counter the initial crisis situation after the financial crises erupted in

September 2008.

a) European Financial Stability Facility (EFSF)

The European Financial Stability Facility (EFSF) is Europe's temporary bailout fund.

It was hurriedly set up after Greece needed its first bailout in May 2010, and has since

become a key tool to combat the debt crisis. European leaders have increased its

lending capacity from around €250 billion to €440 billion, and are investigating ways

to boost its clout. A permanent bailout fund, the European Stability Mechanism, or

ESM, has become operational since mid 2012. a legal instrument aiming at preserving

financial stability in Europe by providing financial assistance to eurozone states in

difficulty. The EFSF can issue bonds or other debt instruments on the market with the

support of the German Debt Management Office to raise the funds needed to provide

loans to eurozone countries in financial troubles recapitalize banks or buy sovereign

debt.

Emissions of bonds are backed by guarantees given by the euro area member states in

proportion to their share in the paid-up capital of the European Central Bank. The

€440 billion lending capacity of the facility is jointly and severally guaranteed by the

eurozone countries' governments and may be combined with loans up to €60 billion

P a g e | 43

from the European Financial Stabilisation Mechanism (reliant on funds raised by the

European Commission using the EU budget as collateral) and up to €250 billion from

the International Monetary Fund (IMF) to obtain a financial safety net up to €750

billion.

Reception By Financial Markets

The EFSF issued €5 billion of five-year bonds in its inaugural benchmark issue 25

January 2011, attracting an order book of €44.5 billion. This amount is a record for

any sovereign bond in Europe.

Stocks surged worldwide after the EU announced the EFSF's creation. The facility

eased fears that the Greek debt crisis would spread, and this led to some stocks rising

to the highest level in a year or more. The EFSF only raises funds after an aid request

is made by a country. The EFSF is set to expire in 2013, running some months

parallel to the permanent €500 billion rescue funding program called the European

Stability Mechanism (ESM), which will start operating as soon as member states

representing 90% of the capital commitments have ratified it.

b) European Financial Stabilisation Mechanism (EFSM)

The European Commission also agreed on the creation of a permanent crisis

mechanism: the European Financial Stability Mechanism (EFSM) which is an

emergency funding programme reliant upon funds raised on the financial markets and

guaranteed by the European Commission using the budget of the European Union as

collateral. It runs under the supervision of the Commission and aims at preserving

financial stability in Europe by providing financial assistance to EU member states in

economic difficulty. The Commission fund, backed by all 27 European Union

members, has the authority to raise up to €60 billion and is rated AAA by Fitch,

Moody's and Standard & Poor's.

Under the EFSM, the EU successfully placed in the capital markets a €5 billion issue

of bonds as part of the financial support package agreed for Ireland, at a borrowing

cost for the EFSM of 2.59%. ESM will become operational when the EFSF expires

and it will build on the existing EFSF. The aim of EFSM will be to support countries

P a g e | 44

of the euro zone which may find themselves in financial distress. ESM loans will

enjoy preferred creditor status and they will be junior only to IMF loans. The EFSM

has been operational since 10 May 2010.

c) Brussels Agreement And Aftermath

On 26 October 2011, leaders of the 17 eurozone countries met in Brussels and agreed

on a 50% write-off of Greek sovereign debt held by banks, a fourfold increase (to

about €1 trillion) in bail-out funds held under the European Financial Stability

Facility, an increased mandatory level of 9% for bank capitalisation within the EU

and a set of commitments from Italy to take measures to reduce its national debt. Also

pledged was €35 billion in "credit enhancement" to mitigate losses likely to be

suffered by European banks.

In February 2012 the Euro group agreed with the IMF and the Institute of

International Finance on the final conditions of the second bailout package worth

€130 billion. The lenders agreed to increase the nominal haircut from 50% to 53.5%.

EU Member States agreed to an additional retroactive lowering of the interest rates of

the Greek Loan Facility. Furthermore, governments of Member States where central

banks currently hold Greek government bonds in their investment portfolio commit to

pass on to Greece an amount equal to any future income until 2020.

d) European Stability Mechanism (ESM)

The European Stability Mechanism (ESM) is a permanent rescue funding programme

to succeed the temporary European Financial Stability Facility and European

Financial Stabilisation Mechanism but it had to be postponed until after the Federal

Constitutional Court of Germany had confirmed the legality of the measures.

On 16 December 2010 the European Council agreed a two line amendment to the EU

Lisbon Treaty to allow for a permanent bail-out mechanism to be established

including stronger sanctions. In March 2011, the European Parliament approved the

treaty amendment after receiving assurances that the European Commission, rather

than EU states, would play 'a central role' in running the ESM. According to this

treaty, the ESM will be an intergovernmental organisation under public international

P a g e | 45

law. Such a mechanism serves as a "financial firewall." Instead of a default by one

country rippling through the entire interconnected financial system, the firewall

mechanism can ensure that downstream nations and banking systems are protected by

guaranteeing some or all of their obligations. Then the single default can be managed

while limiting financial contagion.

e) European Fiscal Compact

In March 2011 a new reform of the Stability and Growth Pact was initiated, aiming at

straightening the rules by adopting an automatic procedure for imposing of penalties

in case of breaches of either the 3% deficit or the 60% debt rules. By the end of the

year, Germany, France and some other smaller EU countries went a step further and

vowed to create a fiscal union across the eurozone with strict and enforceable fiscal

rules and automatic penalties embedded in the EU treaties. At the European Council

meeting, all 17 members of the eurozone and six countries that aspire to join agreed

on a new intergovernmental treaty to put strict caps on government spending and

borrowing, with penalties for those countries that violate the limits. All other non-

eurozone countries apart from the UK are also prepared to join in, subject to

parliamentary vote. The treaty will enter into force on 1 January 2013, if by that time

12 members of the euro area have ratified it.

f) European Central Bank

The European Central Bank (ECB) has taken a series of measures aimed at reducing

volatility in the financial markets and at improving liquidity. It took the following

actions:

It began open market operations buying government and private debt

securities, reaching €219.5 billion in February 2012, though it simultaneously

absorbed the same amount of liquidity to prevent a rise in inflation.

It reactivated the dollar swap lines with Federal Reserve support.

It changed its policy regarding the necessary credit rating for loan deposits,

accepting as collateral all outstanding and new debt instruments issued or

guaranteed by the Greek government, regardless of the nation's credit rating.

P a g e | 46

The move took some pressure off governments bonds, which had just been

downgraded to junk status, making it difficult for the governments to raise money on

capital markets.

Bond Purchase

The ECB normally does not buy bonds outright.The normal procedure used by the

ECB for manipulating the money supply has been via the so-called refinancing

facilities. In these facilities, bonds are not purchased but used in reverse transactions:

repos or collateralized loans. These two transactions are similar, i.e. bonds are used as

collaterals for loans, the difference being of legal nature. In the repos the ownership of

the collateral changes to the ECB until the loan is repaid.

This changed with the recent sovereign-debt crisis. The ECB purchased bonds issued

by the weaker states even though it assumes, in doing so, the risk of a deteriorating

balance sheet. ECB buying focused primarily on Spanish and Italian debt. The

assumption is that speculative activity will decrease over time and the value of the

assets increase. Such a move is similar to what the U.S. federal reserve did in buying

subprime mortgages in the crisis of 2008, except in the European crisis, the purchases

are of member state debt. The risk of such a move is that it could diminish the value

of the currency.

When the ECB buys bonds from other creditors such as European banks, the ECB

does not disclose the transaction prices. Creditor’s profit of bargains with bonds sold

at prices that exceed market's quotes.

Long Term Refinancing Operation

Though the ECB's main refinancing operations (MRO) are from repo auctions with a

(bi)weekly maturity and monthly maturation, the ECB now conducts Long Term

Refinancing Operations (LTROs), maturing after three months, six months, 12

months and 36 months.

In 2003, refinancing via LTROs amounted to 45bn Euro which is about 20% of

overall liquidity provided by the ECB. In December 2011 the bank instituted a

P a g e | 47

programme of making low-interest loans with a term of 3 years (36 months) and 1%

interest to European banks accepting loans from the portfolio of the banks as

collateral. Loans totalling €489.2 billion ($640 billion) were announced. The loans

were not offered to European states, but government securities issued by European

states would be acceptable collateral as would mortgage securities and other

commercial paper that can be demonstrated to be secure. The by far biggest amount of

€325 billion was tapped by banks in Greece, Ireland, Italy and Spain. This way the

ECB tried to make sure that banks have enough cash to pay off €200 billion of their

own maturing debts in the first three months of 2012, and at the same time keep

operating and loaning to businesses so that a credit crunch does not choke off

economic growth. It also hoped that banks would use some of the money to buy

government bonds, effectively easing the debt crisis.

3.2.2 IMF HELP TO EU CORE AND PERIPHERAL

COUNTRIES

The IMF is actively engaged in Europe as a provider of policy advice, financing, and

technical assistance. It works both independently and, in European Union (EU)

countries, in cooperation with European institutions, such as the European

Commission (EC) and the European Central Bank (ECB). The IMF’s work in Europe

has intensified since the start of the global financial crisis in 2008, and has been

further stepped up since mid-2010 as a result of the euro area crisis.

During the global financial crisis, a number of emerging European countries requested

financial support from the IMF to help them overcome their fiscal and external

imbalances. In 2010-12, three members of the euro area―Greece, Portugal, and

Ireland―accessed IMF resources.

Access to IMF resources for Europe is being provided through Stand-By

Arrangements (SBA), the Flexible Credit Line (FCL), the Precautionary and Liquidity

Line (PLL), and the Extended Fund Facility (EFF).

As of August, 2012, the IMF had arrangements with 10 countries in Europe with

commitments totalling about €124.06 billion or $186.97 billion. This means that, of

the IMF’s total disbursing and precautionary commitments, about 62 percent are

currently to Europe as a whole.

P a g e | 48

Most of the first wave of IMF-supported programs in 2008-09 was for countries in

emerging Europe. The IMF provided front-loaded, flexible, and high levels of

financing for many emerging European countries. The IMF Cooperation through the

Troika is aimed at ensuring maximum coherence and efficiency in staff-level program

discussions with governments on the policies that are needed to put their economies

back on the path of sustainable economic growth and job creation.

While the IMF coordinates closely with the other members of the Troika, Fund

decisions on financing and policy advice are ultimately taken independently of the

Troika process by the IMF’s 24-member Executive Board.

The IMF does not require collateral from countries for loans but rather requires the

government seeking assistance to correct its macroeconomic imbalances in the form

of policy reform. If the conditions are not met, the funds are withheld. Thus IMF

conditionality is a set of policies or “conditions” that the IMF requires in exchange for

financial resources.

P a g e | 49

Chapter- 4

IMPLICATIONS AND EFFECTS

P a g e | 50

4.1 WITHIN THE EUROPEAN COUNTRIES

In addition to the initial liquidity crunch many banks faced solvency problems, and

national governments across the euro area stepped in to provide funds or guarantees

for their banks. Unlike the liquidity concerns which have been a supranational issue,

countered by the ECB at times in coordination with the other global central banks,

solvency concerns have been treated as a local matter. The European Commission and

the ECB helped play a coordinating role as various EU nations grappled with banking

solvency issues, but the plans – and most importantly their funding – came from the

member states.

The implications of a crisis can be numerous and they can refer to the financial sector,

the real economy, regulations etc. The rapid growth of hedge funds and private equity

firms has stopped abruptly, but they are still expected to recover in the future.

There is a big divergence between the core countries (Germany, France) and the

crisis-hit peripheral countries (Greece, Ireland, Portugal and Spain): while the core

countries have been enjoying an economic recovery since 2010, the peripheral

countries are still struggling with recession. Being part of the same monetary union

(i.e. the eurozone), they are governed by the same monetary policy. While all

eurozone countries were at the height of a financial and economic crisis, there was no

debate regarding the appropriateness of the monetary policy. However, following the

recent divergence, such debates have increased, showing a difficult task ahead of the

European Central Bank regarding the rising of the interest rate for the euro. The four

main peripheral countries mentioned above do represent a significant 18% of euro

area GDP. However, Germany and France together represent 50% of euro area

GDP. One of the consequences of the financial crisis in Europe was the creation of the

European Financial Stability Facility (EFSF) in June 2010 by the 16 euro area

member states. The EFSF has been fully operational since August 2010 and its

purpose is to finance loans for euro area member states which are experiencing

difficulty in obtaining financing at sustainable rates (EFSF (2011)). EFSF will be able

to borrow up to EUR 440bn by issuing bonds guaranteed by the euro area member

states, and it has received the best possible credit rating (AAA) from all three credit

rating agencies (Fitch, Moody’s and Standard & Poor’s). The money borrowed

through such bonds will then be lent to struggling euro zone countries.

P a g e | 51

EFSF issued its first bond on the 24th of January 2011 and met spectacular demand

on this occasion, bankers not being able to recall such a large order book for any

bond, government or corporate. This first bond has been seen as a “landmark deal”

and some investors said it could be “a precursor to the first common eurozone bond”.

The recent crisis also brought changes in the government debt issuance practices in

the 16 euro zone countries. Before the crisis, these practices had converged to a

common standard which involved placement of long-term, fixed rate debt

denominated in national currency via competitive auctions. This standard could not be

followed anymore, because of the increase in sovereign funding needs and the fall in

investor risk appetite, which made risk premium rise. Therefore, the impact of the

crisis was that it has forced governments to assume additional risk. This negative

effect was especially pronounced in countries with high deficit and high debt. Thus

change in the standard for government debt issuance allowed governments to deal

with the reduced risk appetite of investors and to limit the impact of high deficits and

debt on interest payments, but at the same time exposed them to significantly higher

risks of refinancing and reprising, and sometimes to exchange rate risk as well.

One other implication of the crisis was that the use of complex financial instruments

has been more and more questioned, and so were the financial regulations that are

concerned with them. During the crisis, the Greek governments used derivatives to

conceal the true level of Greece’s debt. For example, they traded currency swaps

through which they were receiving upfront payments which under EU accounting

rules could not be recorded as loans, even if in essence they were. Some do believe

that derivatives played an important role in creating Greece’s debt crisis and as a

result, an urgent need to tighten financial regulation for derivatives has been

identified.

The implications of the crisis have also been very complex: lower availability of

credit, the decoupling of the core European countries from the peripheral ones, the

creation of the European Financial Stability Facility (EFSF), debates on complex

derivatives and their regulation, implications for the government debt issuance,

criticism of the credit rating agencies for failing to predict the crisis, and others. There

have also been multiple protests and demonstrations in affected EU countries against

the austerity measures. This has led to political instability in Greece and government

P a g e | 52

changes in countries such as Italy, France, Greece etc. There is increased bitterness

between the EU nations and the people of these member states about the measures

taken to resolve or ratify the crisis and the bailout given to the problem states. The

countries are facing a Crisis and the domino effect where Fall of one lead to the fall

of another. The domino effect is a chain reaction that occurs when a small change

causes a similar change nearby, which then will cause another similar change

It has created a low confidence of the European economy. Weak banks within the

eurozone have started to fall ill as their investors, trading partners and clients pull

short-term funding. The market has hammered French banks into the ground first, but

banks in Italy, Spain, Germany and the United Kingdom face serious funding issues

as well. Swift action is needed on the part of eurozone members to shore up

confidence in its crippled banking sector.

The big fear is that the banks are extremely undercapitalized (Undercapitalization is a

condition that involves an inability to fund a business ventures sufficiently.

Essentially, the amount of generated revenue and other resources in the control of the

business are not enough to cover the ongoing operating costs associated with the

venture. When a corporation lacks capital to sustain production at a profitable level,

the business is in immediate danger of bankruptcy and possibly dissolution.) and

could therefore collapse at any moment. In Europe, especially in France, a large

chunk of funding comes in the form of short-term loans from prime money funds,

money market accounts and other banks. This short-term funding is rolled over

nightly in some cases, making it an extremely unreliable and volatile source of

funding.

P a g e | 53

4.2 ON OTHER ADVANCED ECONOMIES

Although the most jarring effects of the European sovereign debt crisis have been

largely contained to Europe, the continent’s problems have affected the world’s other

advanced economies, including the U.S. and Japan. There have been changes in

investor buying behaviour in these countries.

4.2.1 United States (USA)

Investors Have Bought U.S. Currency and Bonds in the Wake of the Crisis, but U.S.–

Europe Trade and Investment Have Weakened. Before the major events of the

European sovereign debt crisis, the U.S. was recovering from the global financial

crisis. Although the U.S. economy contracted during the first two quarters of 2009, it

was on its way to recovery in the last two quarters with 1.7% economic growth in the

third quarter and 3.8% economic growth in the fourth quarter. Throughout the

European sovereign debt crisis, investors have retained confidence in the U.S.

economy. Two related measures, the exchange rate and U.S. bond yields, reveal that

investors continue to view the country as a relative safe haven. The U.S. dollar has

risen in value against the euro since the start of the European sovereign debt crisis.

The stronger dollar, however, has had some negative effects on the U.S. economy. A

stronger dollar in comparison to the euro makes goods priced in dollars less

competitive on the global market. This change has the effect of reducing U.S. exports

and slowing economic growth. In January 2012, the U.S. saw its overall trade deficit

(meaning that it imports more than it exports) widen to a three-year high of $52.7

billion. Specifically, exports to the Eurozone, which account for 15% of U.S. exports,

were down 11% ($1.32 billion) from the previous 3 months. Although the stronger

dollar relative to the euro has accounted for some of the decline in U.S. exports to the

Eurozone, exports have also decreased because of generally lower demand in the

Eurozone as its economies have slowed due to the European sovereign debt crisis.

U.S. bond yields also reveal that investors have retained confidence in the U.S.

economy since the beginning of the European sovereign debt crisis. Bond yields are

inversely related to bond prices, so when investors are more confident in the U.S.

economy and the ability of the U.S. government to repay its debt, the price of bonds

goes up and the yield goes down.

P a g e | 54

The confidence investors have shown in the U.S. economy is surprising given what

has occurred in the U.S. during the crisis. The U.S. was still recovering from its own

financial crisis when the European crisis began, and in January 2011 the Republican

Party took over the House of Representatives, which produced a divided government.

Throughout the summer of 2011, the divided government engaged in a prolonged

political stalemate about whether the U.S. should raise its debt ceiling (the limit on the

amount of debt the U.S. can issue), which would allow it to issue more bonds to

borrow more money and prevent a default on its outstanding loans. Eventually, the

Congress agreed to raise the debt ceiling on August 1, 2011. The agreement increased

investors’ demand for U.S. bonds in the days following the agreement, which lowered

their yields. Despite this agreement, however, the credit rating agency Standard &

Poor’s downgraded the U.S.’ credit rating one notch from the highest possible rating,

AAA, to AA+ due to the ineffectiveness and unpredictability of the U.S. government

during a critical time.

Aside from decreased exports due to lower demand in Europe and a more expensive

dollar, the crisis has also adversely affected European investment in the U.S. In 2010,

from EU 4 companies invested $131.9 billion in the U.S, bringing the cumulative total

of EU investment in the U.S. to $1,484 billion (accounting for 63.3% of all EU

foreign direct investment). However, in 2011, EU companies only invested $105.07

billion in the U.S. Foreign investment aids economic growth because it provides jobs,

new technology, and increases competition.

Despite declining exports to the EU and lower foreign direct investment from the EU,

the U.S. economy grew by 3% in 2010 and 1.7% in 2011. Although growth slowed in

2011 due, in part, to the effects of the European sovereign debt crisis, it far exceeded

the 3.5% economic contraction in 2009.

In terms of the U.S.’ response to the ongoing crisis in Europe, the Obama

administration has stressed that Europe needs to increase the funding of its bailout

mechanism—the European Financial Stability Facility (EFSF)—to convince investors

that Europe can contain the crisis. European countries created this fund in May 2010

to provide assistance to European countries during financial difficulties. The Obama

administration favours increased funding for the EFSF (which Europe alone is

responsible for funding) instead of increasing the IMF’s funding, of which 17% (the

P a g e | 55

most of any country) comes from the U.S. In March 2012, U.S. Treasury Secretary

Timothy Geithner stated that Europe must increase the funding of its bailout

mechanisms before the U.S. would be willing to support additional funding for the

IMF.

In addition to these political statements, the U.S. has acted to ease the pressure on

Europe as well. In mid-September 2011, European banks began experiencing a

shortage of U.S. dollars as U.S.-based money-market funds (investment funds that

seek to achieve modest growth with minimal risk) began to pull out of European

banks because they were worried that the banks held too much risky European

sovereign debt. If Greece defaulted, for example, Greek bonds would be practically

worthless and, depending on how much Greek debt a bank held, the solvency of that

bank itself might be threatened. If the money-market fund was partially invested in

one of these banks, the value of the money-market fund would be adversely affected

as well.

After U.S. money-market funds pulled out of European banks, the banks had a

shortage of U.S. dollars. These banks needed U.S. dollars because they financed

investment throughout the world in U.S. dollars, which is a widely-accepted global

currency. However, to lend U.S. dollars these banks sometimes need to borrow U.S.

dollars themselves if they do not have enough U.S. dollar deposits. With the U.S.

money-market funds pulling out of European banks, these banks did not have enough

U.S. dollars to pay back their dollar-denominated loans, and, therefore, risked

defaulting on their debt. If the banks defaulted, their creditors would face losses and

would have to find alternative sources to finance their own loans. The lack of dollars

in European banks on account of the money-market funds pulling out would

potentially increase the costs of borrowing and would exacerbate the crisis as banks,

companies, and individuals all over the world would find it more difficult to obtain

affordable loans.

In September 2011, the Federal Reserve, ECB, Bank of England, Bank of Japan, and

Swiss National Bank attempted to prevent the tightening of credit by coordinating to

provide U.S. dollar loans to these troubled banks. In essence, the Federal Reserve

loaned foreign central banks U.S. dollars in exchange for foreign currency in what is

referred to as a ―swap line. When the foreign central bank receives U.S. dollars, the

P a g e | 56

supply of U.S. dollars in that country increases, which has the effect of lowering the

rates banks charge each other for access to U.S. dollars. When the rates that banks

charge each other for U.S. dollars decrease, banks can provide cheaper credit to

companies, which promotes spending to that produces economic growth. The

announcement of the swap line led to four straight days of global stock gains and

eased tensions in the Eurozone.

In December 2011, the Federal Reserve again took action to help the Eurozone. The

Federal Reserve began to charge foreign central banks a lower interest rate for access

to U.S. dollars. This policy made it cheaper for foreign central banks to loan dollars to

commercial banks and likewise made it cheaper for banks to lend to businesses and

individuals. Again, stocks across the globe rose on the day of the announcement.

In summary, the U.S. has managed to continue its economic recovery from the global

financial crisis, but the European crisis has prevented that recovery from being more

robust. Concerns about the rising dollar (which makes U.S. exports more expensive)

and decreased European investment are warranted. Furthermore, an anticipated

recession in the EU is likely to lower European demand for U.S. goods further and

may also decrease profits for U.S. multinational companies operating in Europe.

Another concern is that if banks fail in Europe due to overexposure to European

sovereign debt, those banks will not be able to repay what they owe to U.S. banks,

which could tighten credit to U.S. businesses and consumers and slow economic

growth. However, U.S. banks have very limited direct exposure to the most

vulnerable countries in Europe. Moreover, the concern that European banks will

default has declined in recent months as European banks have recapitalized (acquired

more cash), in part, thanks to a return of U.S. money-market funds.

4.2.2 JAPAN

During the European sovereign debt crisis, investors have also been attracted to

Japan’s currency (the yen) and government bonds. Indeed, the yen has risen in value

against the euro since the beginning of the European sovereign debt crisis. On January

1, 2010, the euro was valued at ¥133.256, but on April 2, 2012, the euro was only

valued at ¥110.78. Similarly, the yields on Japanese ten-year bonds have decreased

(as bond prices have increased) since January 2010 from 1.33% to 0.98% on April 2,

P a g e | 57

2012 as investors have sought a safe haven for their money. It is important to note,

however, that investors may be losing faith in Japan’s ability to meet its future debts

as indicated by the rising costs of insuring against a default on Japanese debt through

credit default swaps (a form or insurance to protect against a drop in the value of

bonds). In July 2011, it cost $90,000 to insure $10 million in Japanese debt for five

years, but by January 2012 the cost had increased to $155,000, indicating that

investors are beginning to worry about the heavily-indebted country.

Investors have turned to Japan despite the fact that Japan, like the U.S., is dealing

with its own economic problems. Japan has a massive debt—its gross debt ($12.19

trillion) is over two times larger than its 2011 GDP ($5.86 trillion). Furthermore, the

Japanese economy contracted by 0.9% in 2011. Japan’s economy struggled, in part,

due to an earthquake, tsunami, and nuclear disaster that hit Japan’s coast in March

2011. Nevertheless, investors have valued the

Japanese yen because it is a liquid currency (widely available and used in world

markets) and much of Japan’s debt is held by its own citizens and Japanese

government agencies, which makes it less likely to be sold off because they have a

vested interest in the currency’s value remaining stable. Moreover, the U.S. Federal

Reserve’s actions to supply dollars to the world economy have decreased the value of

the dollar relative to the yen.

Like the U.S., the high value of Japan’s currency has negatively affected Japan’s

exports and, therefore, its economic growth. In 2011, Japan posted its first trade

deficit (meaning it imported more than it exported) in thirty-one years, with exports

falling 2.7% from 2010. Given the poor performance of exports and the 0.9%

economic contraction in 2011, Japanese consumers and businesses alike have called

for the Bank of Japan (BOJ) to intervene in the currency market to lower the value of

the yen. The BOJ did intervene in October 2011 by buying ¥9 trillion ($110 billion)

worth of Japanese bonds from investors, which injected ¥9 trillion into the economy

and lowered the value of the yen by increasing its supply. Furthermore, in February

2012, the BOJ announced it would again attempt to decrease the value of the yen by

increasing its scheduled purchases of yen-denominated assets during 2012 from ¥55

trillion to ¥65 trillion ($798 billion). By purchasing yen-denominated assets (such as

P a g e | 58

Japanese government bonds), the BOJ injects yens into the global economy which

increases its supply and lowers its value.

Unlike the U.S., however, Japan has played a more active role in assisting Europe

during the sovereign debt crisis. Not only has Japan participated in the collaborative

central bank action with the Federal Reserve, but it has also directly participated in

assisting the Eurozone by buying EFSF bonds, which gives the EFSF more money

with which to combat the crisis.

One of the reasons Japan may be more willing than the U.S. to help the Eurozone is

that it has a greater capacity to do so. Japan held nearly $1.3 trillion in foreign

reserves as of April 2012 (second only to China), which it can use to buy European

bonds. Knowing this reality, Eurozone leaders urged Japan to buy more EFSF bonds

in October 2011 in an effort to quadruple the size of the EFSF. However, neither

Japan nor any other non-European country was willing to contribute enough to meet

the Eurozone leaders’ goals. Although Japan did not buy bonds in October, it bought

13.2% of the bonds that the EFSF issued in December 2011 despite signs that credit

rating agencies may downgrade EFSF bonds. In fact, Japan has bought EFSF bonds at

every auction, even after Standard and Poor’s downgraded EFSF bonds from an AAA

rating to an AA+ rating. As of January 2012, Japan holds €3.76 billion-worth of EFSF

bonds—15% of all EFSF bonds issued. Still, Japan’s investment represents only a tiny

fraction of what the EFSF needs to serve as a sufficient safety net to quell investors’

fears of further financial crisis.

In summary, investors have flocked to the yen and Japanese bonds in an effort to find

a safe haven in a tumultuous market. Higher currency values have, however, made

Japanese exports less attractive, thereby hurting the country’s economy. Furthermore,

despite the contracting economy and large debt, the Japanese cabinet approved a

record-high budget of ¥90 trillion ($1.15 trillion) in December 2011, which has led

some investors to question whether Japan will remain economically stable. Unlike the

U.S., Japan has been more active in assisting the Eurozone by purchasing EFSF

bonds, but the amount purchased is miniscule in comparison to what the Eurozone

needs to ensure investors that it is secure.

P a g e | 59

4.3 ON EMERGING ECONOMIES (BRIC NATIONS)

The European sovereign debt crisis has had relatively little effect on emerging

economies. Indeed, many emerging economies experienced high economic growth in

2010 and throughout most of 2011. In recent years, slow growth in advanced

economies—European countries, the U.S., and Japan—has led investors seeking

higher returns to invest in these faster-growing emerging countries, which has

propelled their economic growth. However, toward the end of 2011, emerging

markets began to feel the effects of the European sovereign debt crisis as banks in

Europe and the U.S. tightened credit in anticipation of a prolonged economic

slowdown in Europe. Here we examine the economies of China, Brazil, India, and

Russia—four important emerging economies.

However should the pessimisms come true, it can substantially impact the economies

of the developing countries. While many developing countries are likely to avoid

contractions in output seen in advanced economies, they are considerably more

vulnerable to an economic slowdown. Major conduits for a renewed financial crisis to

impact the developing countries in the short‐run are:

a) Fall of commodities and minerals exports

b) Fall of Diaspora remittances

c) Fall of Market Capitalization

a) Fall Of Commodities And Minerals Exports

A reaction of the developed countries to a global scale economic and financial crisis is

to reduce their imports of commodities and Minerals in the international markets,

causing drastic reductions in the price of such goods and consequently revenues of the

developing countries (e.g., crude oil dropped from $147 in 2007 to $47 in 2009). This

is essentially dangerous for low income countries given the pre‐crisis increases in the

share of such export revenues in their gross domestic produce (GDP).

According to the European Commission, in 2010 the European Union ranked second

in terms of share in total imports from the Least Developed Countries (LDCs) with a

share of about 18.3%, in which Primary Products formed 56.7% of the EU imports

from the LDCs. With the developing countries, EU ranked second in terms of share in

total imports from the developing countries with a share of about 16.6%, in which

P a g e | 60

Primary Products formed 35.4% of the EU imports from the developing countries.

Hence, a deepening of the debt crisis in Europe could have immediate direct impacts

on the prices of commodities in the world market and substantial subsequent negative

impacts as the crisis spreads to other major trade partners with the developing

countries.

b) Fall Of Diaspora Remittances

Rising unemployment in the developed countries in the aftermath of economic and

financial crises is affecting employment prospects of existing migrants and hardening

political attitudes toward new immigration, making remittances to dry up as migrant

workers lose their jobs or are no more able to afford to send as much money back

home. According to the World Bank , even though the officially recorded remittance

flows to developing countries are estimated to have reached $351 billion in 2011, its

growth remains slow for the years to come. In the event of a new global crisis sourced

by the European debt crisis, the growth rates may become negative once again,

especially for flows to countries in Eastern Europe and Central Asia (e.g. Romania,

Bulgaria, Moldova) and North African and Middle‐Eastern countries that have a large

share of their emigrants in Europe.

c) Fall Of Market Capitalization

In the event of a global scale economic and financial crisis, foreign investors

massively withdraw their investments, including from the developing countries

fearing that contagion could spread to these countries as well.

Long Term Effects

In the long run, with the slowdown of the EU economies there will be less room,

appetite, and public support for importing manufacturing goods from developing

countries. This will adversely impact the manufacturing sector in the developing

countries and further exacerbate their already high unemployment and poverty rates.

Unavoidable fall of exports to and foreign investment in the developing countries, due

to the slow‐down of economies in the high income countries, would also endanger the

transfer of know-how and technology necessary for their medium and longer term

P a g e | 61

growth and development, further impairing and complicating the process of socio‐economic development.

According to the European Commission, during 2006‐2009, European Union (EU)

had an average share of about 18.3% in total imports from developing countries. In

2010 this figure dropped to 16.6%. With “Machinery and Transport Equipment,”

“Miscellaneous Manufactured Articles,” and “Manufactured Goods, Classified

Chiefly by Material” forming about 63.7% of EU’s imports by value from the

developing counties, a financial crisis in Europe translates into loss of the precious

manufacturing jobs and considerable rises in unemployment rates across the

developing countries.

4.3.1 BRAZIL

Brazil’s Economy Has Slowed during the European Sovereign Debt Crisis, but the

Slowdown is Mainly Due to Tighter Monetary Policy. Although Brazil’s economic

growth declined from 7.5% in 2010 to 2.7% in 2011, this decline was not due to a

lower demand for Brazil’s exports, which one might assume given the economic

slowdown in Europe. In fact, Brazil posted a record $256 billion in exports in 2011,

including a 43% increase to China for a total of $44.3 billion.

Throughout 2010 and early 2011, Brazilian leaders feared that the U.S. and,

eventually, Japanese policies of pumping their own currencies into the global

economy by buying their own bonds would depreciate their currencies and cause an

increase in the value of the Brazilian real, which would decrease Brazilian exports.

The U.S. and Japan claimed they were engaging in quantitative easing because they

wanted to speed up their economic growth by making credit cheaper. Normally,

countries attempt to spur economic growth by lowering their interest rates to make it

cheaper for businesses and consumers to borrow money to spend and spur economic

growth, but with U.S. and Japanese interest rates already at extremely low levels, this

was not an option. However, by engaging in quantitative easing, these countries could

inject additional money into banks which the countries’ central banks hoped would

entice banks to extend credit.

P a g e | 62

In fact, Brazilian leaders’ fears that their currency would appreciate if the U.S. and

Japan engaged in quantitative easing were confirmed during 2010 and the first six

months of 2011. However, following a steep decline in the latter half of 2011, the real

actually traded lower at the end of 2011 than it had at the beginning of 2010 relative

to the dollar and yen, as investors left Brazil due to increased inflation and low

economic growth. The economy slowed due to Brazil’s Central Bank’s decision to

increase interest rates and other government actions meant to stem the flow of foreign

capital entering Brazil in the hopes of lowering inflation. These actions essentially

limited Brazilian companies’ access to funding to expand their operations.

Although Brazilian exports did not suffer in 2011, a prolonged crisis in Europe would

continue to lower demand for Chinese goods and, therefore, Chinese demand for

Brazilian commodities. This outcome would be problematic for Brazil since 17% of

its exports (mostly raw materials) go to China. Already China has lowered its

economic growth target to 7.5% in 2012, down from 8% during the previous seven

years, which means that Brazil may not be able to depend as much on the Chinese

market in the future.

So far, Brazil has done little to aid Europe during the sovereign debt crisis. Leaders

from Brazil, India, China, Russia, and South Africa met in September 2011 to discuss

using their large quantities of foreign reserves to buy European government bonds

(Brazil alone has $350 billion in reserves), but the countries did not take any action

and Brazil has since said that Europe must ―save itself‖ before Brazil will help. The

government has stated that Brazil primarily invests in safe, high-grade bonds and only

has 3% invested in more risky AA-rated bonds—a level which many troubled

European countries are at or below. Brazil has even avoided buying safer EFSF bonds

due to its preference to contribute through the IMF if it will contribute at all to saving

the euro.

P a g e | 63

4.3.2 RUSSIA

Russian Growth has Remained Strong due to High Oil Prices, but Decreased Global

Demand for Oil Could Slow Its Economy.

Russia’s economy grew 4% in 2010 and 4.1% in 2011. Foreign investment in Russia

fell during the summer of 2011, as it did in other emerging economies, as banks

decreased lending to potential investors to recapitalize (which builds a cash barrier

against potential losses) during the height of the European sovereign debt crisis.

Although the reduction in foreign investment on account of the crisis decreased the

value of the Russian currency and stock market, the economy continued to grow

because of high oil prices in 2011. Overall, oil prices increased from $61.80 to $104

dollars per barrel from 2009 to 2011, partially due to shocks in supply throughout the

Middle East. However, Russia’s economy may slow in the coming years due to a

continued economic slowdown in Europe, which may decrease global demand and

reduce oil prices.

Russia has been hesitant to give any loans to European countries or the EFSF, and

would prefer to make loans through the IMF, much like China, Brazil, and India. If

these countries loaned money to the European countries through the IMF rather than

to European countries or the EFSF directly, the IMF’s executive board, which these

countries could influence,

would be able to hold back some funds if the country receiving aid was not following

the austerity plan the IMF would require as a condition to receiving the loan.

P a g e | 64

4.3.3 INDIA

Although Decreased Foreign Investment on Account of the European Sovereign Debt

Crisis has Hurt India’s Economy, Most of its Economic Slowdown is Due to

Decreased Domestic Spending.

In India, the economic growth rate has slowed since the European sovereign debt

crisis began, declining from 9.9% in 2010 to 7.4% in 2011. In fact, India’s economy

contracted for seven consecutive quarters from April 2010 to December 2011. Part of

the reason India’s economic growth rate has slowed is due to declining foreign

investment into India, though the EU still has more foreign investment in India than in

any other country, which is a general consequence of investors fleeing to safety in the

time of crisis. This decline in investment has, in turn, led to a depreciation of the

Indian rupee, particularly in the latter half of 2011 (like Brazil). However, the

depreciation of the rupee has boosted Indian exports, which rose by 21% in the eleven

months beginning in April 2011 compared to the eleven months beginning in April

2010.

Although decreased foreign investment in India’s economy partially contributed to its

slowdown, lower domestic demand has been a much larger cause. Domestic demand

in India has fallen due to high interest rates that give Indian businesses and consumers

an incentive to save their money rather than spend or invest it. Despite slower

economic growth, the Reserve Bank of India raised interest rates thirteen times

between March 2010 and November 2011 to reduce high inflation (which had been

over 10% throughout 2010). In addition to foreign investors’ flight to safety in the

latter half of 2011, India’s inability to reduce inflation has also discouraged foreign

investment. In some ways, India is in a uniquely precarious position because it

imports nearly 80% of its oil needs. Therefore, while a recovery in Europe will boost

India’s exports and foreign investment in India, it will also increase the global

demand and, therefore, the price for oil, potentially increasing India’s deficit and

causing prolonged inflation as the government pumps money into the economy in the

form of subsidies.

Like China and Brazil, India has said that it would prefer to assist Europe through the

IMF rather than make direct loans to troubled countries or purchase EFSF bonds.

P a g e | 65

Interestingly, as European leaders were soliciting funds throughout Asia in late

October 2011, they did not approach India, perhaps because it lacks the foreign

reserves that countries like China, Japan, and Brazil have.

After the IMF contributed to the European bailouts, India expressed what it perceives

as a double-standard under which European countries can more easily obtain

assistance from the IMF than developing countries. As a result of this dissatisfaction,

India has led a proposal for the BRICS (Brazil, Russia, India, China, and South

Africa) to set up an alternative to the World Bank (which is usually led by an

American) and the IMF (which is usually led by a European) to better finance the

developing world. The BRICS officially proposed this bank on March 27, 2012, and

the outgoing World Bank president, Robert Zoellick, supported the plan.

4.3.4 CHINA

The European Sovereign Debt Crisis has Reduced Chinese Exports and Has Led

China to Re-evaluate the Structure of its Economy

China’s economy, monetary policy, and fiscal policy have all been affected by the

crisis in Europe. After growing 9.2% in 2009 and 10.4% in 2010, China began

implementing measures to tighten its monetary policy in 2011 due to worries about

high inflation that often accompanies such high growth. To lower inflation, China

raised interest rates and increased the amount of money banks must keep on hand as

protection against potential losses, both of which lower the supply of money in the

economy and, thus, increase its value. However, this monetary tightening was only

temporary as China began to feel the effects of the European sovereign debt crisis.

China has much at stake in Europe. It sends 20% of its exports to the EU, but demand

from Europe has fallen as European economies have entered recessions. Indeed,

during the last quarter of 2011, Chinese quarterly growth dipped below 9% for the

first time since mid-2009 due, in part, to reduced exports to Europe. China’s exports

have continued to fall in 2012, with February 2012 exports down an estimated 15.2%

from the previous year. In response to this slowdown, China began to ease lending

conditions by lowering the reserve requirement in the hope of spurring economic

growth through increased spending by businesses and individuals.

P a g e | 66

Realizing its vulnerability to changes in foreign demand, which was made evident by

the onset of the European sovereign debt crisis, China has recently announced plans to

make its economy more domestically-driven. To do this, China plans to increase its

minimum wage, government support for consumer credit, and pension and healthcare

assistance in an attempt to encourage Chinese citizens to spend more money. China

may also attempt to make its economy more domestically-driven by allowing its

currency to appreciate, which would give Chinese citizens more purchasing power

and thereby increase domestic demand for Chinese products. However, an increase in

the value of its currency would also raise the cost of Chinese exports for foreigners,

which would lower global demand for Chinese exports and counteract some of the

increased domestic demand. If overall demand for Chinese products were to fall,

Chinese manufacturers would import fewer raw materials necessary to produce its

exports, which may negatively affect the economies of countries such as Brazil,

Australia, and many countries in Africa that depend largely on raw material exports to

China.

Throughout the latter months of 2011, China hinted that it may be able to assist

Europe in its crisis, but it has yet to commit any major resources. In November 2011,

Eurozone leaders requested that China buy the bonds of troubled countries to help

lower those countries’ borrowing costs, but China has been unwilling to spend much

of its $3.2 trillion in foreign currency reserves to do so. China has told Europe that it

must take care of itself before China would offer any help.

China has also been reluctant to help because it sees the crisis as an opportunity to

advance some of its long-standing grievances against Europe. China has long opposed

Europe’s treatment of the Chinese economy because Europe places high tariffs on

many Chinese goods because it does not consider China a market economy. These

barriers hurt China’s exports and are the basis for China’s demand that Europe grant it

market economy status (which would prevent Europe from placing higher tariffs on

Chinese goods) before it assists Europe. China is also tired of the EU’s continued

pressure for China to relax currency-controls that artificially keep the Yuan’s value

low so that Chinese exports are cheaper compared to European exports. However,

Europe does not appear willing to make any of these concessions. For its part, the EU

complains that the tariffs are necessary to allow its manufacturers to compete fairly

with Chinese manufacturers that receive generous subsidies from the government and

P a g e | 67

benefit from the undervalued Yuan. EU officials believe that if the EU allowed

Chinese exports to enter freely, many of the EU’s industries would be put out of

business.

If it were to help the Eurozone, China would prefer to lend to the Eurozone through

the IMF rather than lending to it directly. For China, contributions to the global

organization to help ease the crisis may give it the political leverage to demand a

larger role in the IMF. Regardless of whether China were to help the Eurozone

directly or through the IMF, one motivation for assisting is that contributions to the

Eurozone would allow China to eventually receive euro back in the form of interest

and principal on European bonds (either backed by the IMF, the EFSF, or European

countries directly), which would provide an alternative to the U.S. dollar in their

foreign reserves. On February 14th, China’s Central Bank pledged that it would

increase its holdings of euro-denominated assets (such as European government

bonds) in an effort to diversify its investments away from the U.S. dollar, but

maintained that its interest was in less-risky European assets, such as EFSF bonds.

China also announced it would be willing to help struggling European countries such

as Greece, Portugal, and Spain, but would prefer to lend to these countries through the

IMF, which has a preferred-creditor status that ensures China’s (or any other country

who lends to the IMF) loan would be repaid before that of any other creditor who

lends to Europe directly.

P a g e | 68

4.4 ON DEVELOPING NATIONS

Like the advanced (e.g., U.S. and Japan) and emerging (e.g., China, Brazil, India, and

Russia) economies, the European sovereign debt crisis has also affected the

developing countries of Africa and the Middle East, especially through changes in

commodity prices.

4.4.1 Middle East and North Africa

The Change in Oil Prices on Account of the European Sovereign Debt Crisis Has Led

to Divergent Outlooks for Countries in the Middle East and North Africa

There is a sharp dichotomy in the growth outlook of the countries in North Africa and

the Middle East, with oil exporters (e.g., Qatar, Iraq, and Saudi Arabia) expected to

grow at rate of 4.9% in 2011, and oil importers (e.g., Egypt, Syria, Tunisia) only

expected to grow 1.4% in 2011. This, of course, is due to high oil prices, which

increased 31.6% in 2011. Although the crisis slowed economic growth and lowered

global demand for oil, prices remained high in 2011 because social unrest throughout

the Middle East and North Africa limited supply. However, global demand for oil will

fall if the European crisis continues, lowering oil prices and, therefore, the oil-

exporting countries’ economic growth. For oil-importing countries that export many

of their manufactured goods to Europe, including Tunisia (80%), Morocco (65%), and

Egypt (40%), an ongoing economic downturn in Europe could likewise slow their

economic growth as there may not be a sufficient market for their goods.

One thing oil exporters and importers have in common is that they will feel the effects

of the European sovereign debt crisis more through trade than the financial sector, in

which their integration is relatively weak. Furthermore, both oil exporters and

importers will feel the future effects of the European crisis more severely than in the

2008–2009 crisis, because rather than merely growing at a slower pace, they may

actually stagnate or contract in future years, which could increase unemployment and

poverty.

4.4.2 Sub-Saharan Africa

Sub-Saharan Africa Has Been Relatively Insulated from the Crisis Since it is Less

Integrated into the Global Manufacturing and Financial Markets

P a g e | 69

Many countries in sub-Saharan Africa experienced strong growth in 2010 and 2011.

As a whole, low-income country such as Ethiopia, Kenya, and Ghana have been

relatively immune from the impacts of the European sovereign debt crisis due to their

limited integration into the global manufacturing and financial markets. The average

growth for these countries was 5.8% in 2010 and is projected to be 5.9% in 2011. The

middle-income countries, such as South Africa, Swaziland, and Botswana, are more

integrated into the global economy, so the European sovereign debt crisis has hit them

harder with the average growth rate in these countries falling from 3.5% in 2010 to

3.1% in 2011. High commodity prices, particularly for oil, spurred most of the growth

in sub-Saharan African countries. However, high commodity prices have also created

inflationary pressures in many of these countries, particularly in Ethiopia, Kenya, and

Botswana. Foreign direct investment from around the globe, which had stalled during

2011 as banks recapitalized during the height the European crisis, has returned to pre-

crisis levels in only a few countries, including Ghana, Mauritius, and South Africa.

Overall, foreign investment in sub-Saharan Africa increased by 25% in 2011

following decreases the previous two years.

Sub-Saharan Africa will likely feel the effects of the European sovereign debt crisis in

a number of ways. Lower global demand could reduce commodity prices, which

would decrease export revenue for those countries dependent on commodity exports

(e.g., Equatorial Guinea, Republic of the Congo, Gabon, Angola, Nigeria, Zambia,

Benin, and Mali). However, the effect of the crisis on these countries is less than it

would have been ten years ago, as the share of these countries’ exports which go to

Europe has decreased from 40% in 2002 to less than 25% at the end of 2010.

Furthermore, a significant downturn in the global economy on account of the crisis

may limit the ability of struggling advanced economies to provide foreign assistance

to countries that depend on it, such as Burundi and Rwanda.

P a g e | 70

Chapter- 5

PROPOSED REFORMS AND

SOLUTIONS FOR RECOVERY

P a g e | 71

5.1 PROPOSED REFORMS

5.1.1 Increase Investment

There has been substantial criticism over the austerity measures implemented by most

European nations to counter this debt crisis. Nobel laureate Paul Krugman predicts

that deflationary policies now being imposed on countries such as Greece and Spain

will prolong and deepen their recessions. In a 2003 study that analyzed 133 IMF

austerity programmes, the IMF's independent evaluation office found that policy

makers consistently underestimated the disastrous effects of rigid spending cuts on

economic growth. In early 2012 an IMF official, who negotiated Greek austerity

measures, admitted that spending cuts were harming Greece. In October 2012, the

IMF said that its forecasts for countries which implemented austerity programs have

been consistently overoptimistic, suggesting that tax hikes and spending cuts have

been doing more damage than expected, and countries which implemented fiscal

stimulus, such as Germany and Austria, did better than expected.

According to Keynesian economists "growth-friendly austerity" relies on the false

argument that public cuts would be compensated for by more spending from

consumers and businesses, a theoretical claim that has not materialized. The case of

Greece shows that excessive levels of private indebtedness and a collapse of public

confidence (over 90% of Greeks fear unemployment, poverty and the closure of

businesses) led the private sector to decrease spending in an attempt to save up for

rainy days ahead. This led to even lower demand for both products and labour, which

further deepened the recession and made it ever more difficult to generate tax

revenues and fight public indebtedness. Austerity is bound to fail if it relies largely on

tax increases instead of cuts in government expenditures coupled with encouraging

private investment and risk-taking, labour mobility and flexibility, an end to price

controls, tax rates that encouraged capital formation etc as Germany has done in the

decade before the crisis.

Instead of public austerity, a "growth compact" centring on tax increases and deficit

spending is proposed. Since struggling European countries lack the funds to engage in

deficit spending, economists suggest providing €40 billion in additional funds to the

European Investment Bank (EIB), which could then lend ten times that amount to the

P a g e | 72

employment-intensive smaller business sector. Over 23 million EU workers have

become unemployed as a consequence of the global economic crisis of 2007–2010,

and this has led many to call for additional regulation of the banking sector across not

only Europe, but the entire world.

5.1.2 Increase Competitiveness

Crisis countries must significantly increase their international competitiveness to

generate economic growth and improve their terms of trade. No debt restructuring

will work without growth, even more so as European countries face pressures from

three fronts: demography (an aging population), technology (which has allowed

companies to do much more with fewer people) and globalization (which has allowed

manufacturing and services to locate across the world).

In case of economic shocks, policy makers typically try to improve competitiveness

by depreciating the currency, as in the case of Iceland, which suffered the largest

financial crisis in 2008–2011 in economic history but has since vastly improved its

position. However, eurozone countries cannot devalue their currency.

Internal devaluation

Internal devaluation is a process where a country aims to reduce its unit labour costs.

Some economists argue that no matter how much Greece and Portugal drive down

their wages, they could never compete with low-cost developing countries such as

China or India. Instead weak European countries must shift their economies to higher

quality products and services, though this is a long-term process and may not bring

immediate relief.

Fiscal devaluation

Another option would be to implement fiscal devaluation, where policy makers can

increase the competitiveness of an economy by lowering corporate tax burden such as

employer's social security contributions, while offsetting the loss of government

revenues through higher taxes on consumption (VAT) and pollution, i.e. by pursuing

an ecological tax reform.

P a g e | 73

EURO PLUS PACT

The Euro-Plus Pact is a 2011 plan in which some member states of the European

Union made concrete commitments to a list of political reforms which are intended to

improve the fiscal strength and competitiveness of each country. The Euro-Plus Pact

came with four broad strategic goals along with more specific strategies for

addressing these goals. The four goals are:

Fostering competitiveness

Fostering employment

Contributing to the sustainability of public finances

Reinforcing financial stability.

An additional fifth issue is:

tax policy coordination

These goals are intended to be addressed by all member countries of the pact, unless a

Member State can show that action is not needed in a particular area. While the pact

comes with specific strategies these are not seen as compulsory.

EUROZONE ECONOMIC HEALTH AND ADJUSTMENT PROGRESS 2011

(Source: Euro plus Monitor)

Adjustment Progress

OverallHealth

P a g e | 74

5.1.3 Address Current Account Imbalances

Regardless of the corrective measures chosen to solve the current predicament, as

long as cross border capital flows remain unregulated in the euro area, current account

imbalances are likely to continue. A country that runs a large current account or trade

deficit (i.e., importing more than it exports) must ultimately be a net importer of

capital; this is a mathematical identity called the balance of payments. In other words,

a country that imports more than it exports must either decrease its savings reserves or

borrow to pay for those imports. Conversely, Germany's large trade surplus (net

export position) means that it must either increase its savings reserves or be a net

exporter of capital, lending money to other countries to allow them to buy German

goods.

A country with a large trade surplus would generally see the value of its currency

appreciate relative to other currencies, which would reduce the imbalance as the

relative price of its exports increases. This currency appreciation occurs as the

importing country sells its currency to buy the exporting country's currency used to

purchase the goods. Alternatively, trade imbalances can be reduced if a country

encouraged domestic saving by restricting or penalizing the flow of capital across

borders, or by raising interest rates, although this benefit is likely offset by slowing

down the economy and increasing government interest payments.

Either way, many of the countries involved in the crisis are on the euro, so

devaluation, individual interest rates and capital controls are not available. The only

solution left to raise a country's level of saving is to reduce budget deficits and to

change consumption and savings habits. For example, if a country's citizens saved

more instead of consuming imports, this would reduce its trade deficit. It has therefore

been suggested that countries with large trade deficits (e.g. Greece) consume less and

improve their exporting industries. On the other hand, export driven countries with a

large trade surplus, such as Germany, Austria and the Netherlands would need to shift

their economies more towards domestic services and increase wages to support

domestic consumption.

P a g e | 75

5.2 PROPOSED LONG-TERM SOLUTIONS

5.2.1 European Fiscal Union

European union till now has been a monetary union where the fiscal decisions are

internal matters of the member states and they decide their fiscal budget, government

expenditure, tax rates etc. However this system is being questioned since the onset of

the crisis and with the stronger EU nations paying for the bailout of the weaker and

ill-managed countries. Increased European integration giving a central body increased

control over the budgets of member states was proposed on June 14. Control,

including requirements that taxes be raised or budgets cut, would be exercised only

when fiscal imbalances develop. This proposal is similar to calls by Angela Merkel

for increased political and fiscal union which would "allow Europe oversight

possibilities."

5.2.2 Eurobonds

Eurobonds are being suggested as a way to tie the finances of the eurozone's 17

countries more closely. A eurobond would be a bond -- or debt which investors buy in

return for yield -- backed by all the countries of the bloc. The idea remains under

discussion, although it has rejected by the euro zone’s two most powerful leaders,

German Chancellor Angela Merkel and ex-French President Nicolas Sarkozy.

A growing number of investors and economists say Eurobonds would be the best way

of solving a debt crisis, though their introduction matched by tight financial and

budgetary coordination may require changes in EU treaties. Germany remains largely

opposed at least in the short term to a collective takeover of the debt of states that

have run excessive budget deficits and borrowed excessively over the past years,

saying this could substantially raise the country's liabilities. Here the indebted states

could borrow new funds at better conditions as they are supported by the rating of the

non-crisis states.

P a g e | 76

5.2.3 European Monetary Fund

Experts have suggested transforming the EFSF into a European Monetary Fund

(EMF), which could provide governments with fixed interest rate Eurobonds at a rate

slightly below medium-term economic growth (in nominal terms). These bonds would

not be tradable but could be held by investors with the EMF and liquidated at any

time. To ensure fiscal discipline despite lack of market pressure, the EMF would have

to operate according to strict rules, providing funds only to countries that meet fiscal

and macroeconomic criteria. Governments lacking sound financial policies would be

forced to rely on traditional (national) governmental bonds with less favorable market

rates. The econometric analysis suggests that if the short-term and long- term interest

rates in the euro area were stabilized at 1.5% and 3%, respectively, aggregate output

(GDP) in the euro area would be 5 percentage points above baseline in 2015.

Furthermore, banks would no longer be able to unduly benefit from intermediary

profits by borrowing from the ECB at low rates and investing in government bonds at

high rates.

5.2.4 Drastic Debt Write-Off Financed By Wealth Tax

A Bank for International Settlements study released in June 2012 warns that budgets

of most advanced economies, excluding interest payments, "would need 20

consecutive years of surpluses exceeding 2 per cent of gross domestic product just to

bring the debt-to-GDP ratio back to its pre-crisis level". The study also found that

increased financial burden imposed by aging populations and lower growth makes it

unlikely that indebted economies can grow out of their debt problem if only one of the

following three conditions is met:

Government debt is more than 80 to 100 percent of GDP;

Non-financial corporate debt is more than 90 percent;

Private household debt is more than 85 percent of GDP.

To reach sustainable levels the Eurozone must reduce its overall debt level by €6.1

trillion. According to Boston Consulting Group (BCG) this could be financed by a

P a g e | 77

one-time wealth tax of between 11 and 30 percent for most countries, apart from the

crisis countries (particularly Ireland) where a write-off would have to be substantially

higher. The authors admit that such programs would be "drastic", "unpopular" and

"require broad political coordination and leadership" but they maintain that the longer

politicians and central bankers wait, the more necessary such a step will be.

Some economists have called for a 30 year debt-reduction plan, similar to the one

Germany used after World War II to share the burden of reconstruction and

development.

5.2.5 Debt Defaults And National Exits From The Eurozone

Exit from the European Monetary Union (EMU) remains to be a possible but

extremely unlikely option. Germany at one point threatened to kick-out fiscally

irresponsible countries that were failing to follow EMU guidelines. Although the

forced or voluntary exit of a nation within the EMU is illegal, such exit has been

touted by some politicians and economists as a better alternative to the prevalent

austerity strategy. Because PIIGS nations could potentially drag down the entire

Eurozone, exit from the EMU may be welcomed by other member states as means to

halt further damage to the union. Exit from the EMU would require departing nations

to issue their own national currency at great expense and economic uncertainty. On

the other hand, exit from the EMU would allow highly indebted nations to exercise

P a g e | 78

their own monetary policy. Through currency devaluation these nations could assuage

fiscal austerity measures and stimulate the economy through more price competitive

exports.

Greece is highly likely to default on its debt and exit the eurozone. Greece is stuck in

a vicious cycle of insolvency, lost competitiveness, external deficits, and ever-

deepening depression. The only way to stop it is to begin an orderly default and exit,

coordinated and financed by the “Troika” that minimizes collateral damage to Greece

and the rest of the eurozone.

Without a return to growth, its debt burden will remain unsustainable. But all of the

options that might restore competitiveness require real currency depreciation. The

first option, a sharp weakening of the euro, is unlikely, as Germany is strong and the

ECB is not aggressively easing monetary policy. A return to a national currency and a

sharp depreciation would quickly restore competitiveness and growth.

The most significant problem would be capital losses for core eurozone financial

institutions. Overnight, the foreign euro liabilities of Greece’s government, banks, and

companies would surge. Yet these problems can be overcome. Argentina did so in

2001, when it “pesofied” its dollar debts. Losses that eurozone banks would suffer

would be manageable if the banks were properly and aggressively recapitalized.

Avoiding a post-exit implosion of the Greek banking system, however, might require

temporary measures, such as bank holidays and capital controls, to prevent a

disorderly run on deposits. The European Financial Stability Facility/European

Stability Mechanism (EFSF/ESM) should carry out the necessary recapitalization of

the Greek banks via direct capital injections.

P a g e | 79

Chapter- 6

RECOMMENDATIONS AND

CONCLUSION

P a g e | 80

6.1 RECCOMENDATIONS

A. GREECE, IRELAND, ITALY, PORTUGAL, AND SPAIN

• Implement fiscal consolidation to stabilize the debt-to-GDP ratio.

• Structural reforms designed to rebalance the economy toward the tradable sectors

and increase competitiveness are essential. To facilitate this, reducing unit labor costs

and instituting structural reforms to raise productivity, starting with public sector

wages.

• Explain the severity of the situation to citizens in order to build the public will

necessary for these adjustments. Distribute the adjustments in a transparent and fair

way to ensure that specific groups do not feel unjustly hit, and that the most

vulnerable are protected.

a) GREECE

• Seriously consider restructuring the debt, allowing time for creditors to prepare to

facilitate progress on an agreed solution.

• Prepare for a severe contraction in employment and income regardless of how the

crisis is resolved.

• Rely increasingly on exports and undertake measures, including encouraging wage

reduction in the private as well as the public sector, to restore competitiveness, in

spite of political challenges.

• If progress on restoring competitiveness is not achieved within a reasonable time

frame, consider leaving the Euro area—this will imply restructuring the debt.

b) IRELAND

• Maintain reforms to lower the deficit, including expanding the tax base, increasing

the minimum pension age, reducing social welfare benefits, and cutting public wages.

• Promote rebalancing of the economy away from services and the financial sector

toward exports.

P a g e | 81

• Encourage flexible management of financial sector support programs as they

respond to continuing trouble.

c) ITALY

• Reduce the primary deficit by 4 percent of GDP over three years.

• Attack rigidities that create a dual labour market.

• Increase the efficiency of backbone services.

d) PORTUGAL

• Increase flexibility in labour markets.

• Increase competition in relatively sheltered backbone services.

• Improve the human capital base. This will improve productivity and help the

country regain attractiveness with foreign investors.

• Implement a systematic approach to correct deficiencies in the business climate,

especially in starting a business, paying taxes, and getting credit.

e) SPAIN

• Reduce the primary deficit by 8 percent of GDP within three years.

• Increase competition and decrease barriers to entry so as to help lower the price of

non-tradables.

• Lower the severance costs that employers must pay to terminated employees that

create labour market inflexibility.

B. EURO AREA

• Maintain an expansionary monetary policy for an extended period.

• Explicitly promote a weak euro.

• Require countries to cede some fiscal autonomy. Give member states the right to

review other members’ annual budgets and main economic indicators, such as GDP

growth, productivity growth, and the balance of payments.

P a g e | 82

• Allow European governments—not just the European Commission and the IMF—to

discuss, propose, and monitor action taken by the GIIPS, as well as agree on

appropriate sanctions.

• Tighten the criteria for admission to the Euro area. Require newcomers to run large

fiscal surpluses to offset the demand boom that typically accompanies euro adoption.

Do not require one size to fit all, however; consider cyclical as well as structural

indicators.

• Implement requirements that existing members and members-to-be release timely,

reliable, and comparable data on macroeconomic indicators.

C. GERMANY AND OTHER SURPLUS COUNTRIES

• Expand domestic demand by about 1 percent of the Euro area’s GDP over three

years in order to offset the deflationary impact of fiscal adjustments in the GIIPS.

• Accept slightly higher inflation to keep the aggregate European rate in the 2 percent

range.

D. DEVELOPED COUNTRIES

• Maintain stimulus efforts in the short term. Strong economic growth is the best long

term debt reduction strategy and the global recovery is still dependent on government

support.

• Restrain spending and/or increase taxes as soon as a robust recovery is established.

• Accept a lower euro.

• Expand the resources available to the IMF.

E. DEVELOPING COUNTRIES

• Rely less on exports to the industrial countries and more on South-South trade.

• Match the currencies of foreign liabilities with those of export proceeds and reserve

holdings.

P a g e | 83

• Moderate the inflow of portfolio capital and encourage the more stable form of

foreign direct investment instead.

• Allow the currency to appreciate if the external surplus is large and capital inflows

are significant.

• Closely monitor and tightly regulate the operation of foreign banks and their links

with domestic banks.

• Either allow the exchange rate to float, or institute tight capital controls if the

exchange rate is pegged.

P a g e | 84

6.2 CONCLUSION

The European sovereign debt crisis has affected countries throughout the world.

Although Europe’s ties to some countries (e.g., China and the U.S.) are stronger than

others, in the age of globalization no country has escaped Europe’s problems.

Already, the World Bank has revised its estimates for global economic growth down

from 3.6% in 2012 and 2013 to 2.5% and 3.1%, respectively. In a worst-case scenario

for the Eurozone, the World Bank estimates global GDP could contract 1.5% in 2012

and 0.9% in 2013. The European Union accounts for around 28% share of the world

GDP and 20% share of global trade. The euro is the second largest reserve currency as

well as the second most traded currency in the world after the United States dollar.

Uncertainty and frequent fluctuation in their exchange rate has led to market panic

and pessimism. This has encouraged growing fears of recession in the euro zone

economies as well as the global economy. No one knows exactly when and how the

European sovereign debt crisis will be resolved, but the entire global community has

plenty at stake.

A renewed global financial crisis stemming from the current sovereign debt problems

in Europe can have major repercussions for the developing countries, and especially

for the lower income countries in this group. The collapse of the European Union

financial systems is capable of severe direct impacts on the process of development in

the Least Developed Countries. Further contagions around the world would further

amplify the development crisis in the poor countries.

Investment flows to the economies most in‐need will evaporate and will be replaced

by strong outflows of investments instead. Export revenues from the commodities and

minerals, which in many developing countries are among the major sources of

revenue for the countries, will evaporate as the prices of these goods fall in the event

of a global financial crisis. Remittances, also a major source of revenue especially in

the poorest countries, will sharply fall and opportunities for emigration will cease to

exist. Economic growth will eventually severely decline and unemployment and

poverty rates will soar high, undermining the progress made in the past decade. There

have been significant job losses in manufacturing, mining, and construction sectors.

P a g e | 85

These all could well endanger the institutional capacities that were built during the

growth years.

The recent global crisis had multiple causes: The general cause appears to be a rapid

growth of the level of debt (especially in the case of households), accompanied by

sharp increases in real estate prices. There have been individual causes for each

country: In USA –the increased use of hybrid capital instruments and the adoption of

the “originate and distribute” model by the banks, which involved the creation of

diversified portfolios of credit instruments and their resale as a redesigned product; in

Iceland – the huge growth of the debt to GDP ratio to 1200%, which led to the fall of

local banks; in Ireland –the burst of the real estate bubble in the context of a debt to

GDP ratio of 900% generated huge costs for recapitalizing the Irish banking system;

In Greece – unsustainable budget deficits, lack of competitiveness of its economy due

to overhiring and overpayment in the public sector, inappropriate use of complex

financial instruments; in Portugal – large public debt and high budget deficit; in Spain

– the housing bust and its negative impact on the Spanish banking system, and the

highest unemployment rate among all developed economies. Several countries have

already received external help from the IMF and other organizations: Greece, Iceland,

Ireland etc.

The implications of the crisis have also been very complex: lower availability of

credit, the decoupling of the core European countries from the peripheral ones, the

creation of the European Financial Stability Facility (EFSF), debates on complex

derivatives and their regulation, implications for the government debt issuance,

criticism of the credit rating agencies for failing to predict the crisis, and others.

The financial resources devoted by high‐income countries to support development

processes in the least developed countries quickly evaporate in the event of such

financial crises at the global scale. Furthermore, the frequency of such events at the

global scale appears to be increasing. Perhaps it is time for developing countries to

form stronger cooperation, financial alliances, and economic ties among themselves

that help them survive when financial resources from high‐income countries cease to

P a g e | 86

be available. This would make economic development financially more sustainable at

the time of global financial crises.

P a g e | 87

WEBLIOGRAPHY

http://www.brookings.edu/~/media/Files/Programs/ES/BPEA/

2012_spring_bpea_papers/2012_spring_BPEA_shambaugh.pdf

http://www.voxeu.org/article/economic-crisis-europe-cause-consequences-and-

responses

http://carnegieendowment.org/publications/special/misc/EuroCrisis/

http://www.imf.org/external/pubs/ft/wp/2011/wp1121.pdf

http://en.wikipedia.org/wiki/Euro

http://www.tradingeconomics.com/euro-area/gdp-growth

http://ablog.typepad.com/keytrendsinglobalisation/eurozone/

http://bonds.about.com/od/advancedbonds/a/What-Is-The-European-Debt-

Crisis.html

http://ec.europa.eu/trade/creating-opportunities/bilateral-relations/countries-and-

regions/

http://finance.townhall.com

http://data.worldbank.org/data-catalog/africa-development-indicators

http://blogs.cfainstitute.org/investor/2011/11/21/european-sovereign-debt-crisis-

overview-analysis-and-timeline-of-major-events/

http://forexnewsnow.com/uncategorized/debt-crisis-similarities-and-differences-

between-the-crises-of-2008-and-2011/

http://news-basics.com/2011/europes-debt-crisis/

http://en.wikipedia.org/wiki/European_Central_Bank#Causes

http://www.bbc.co.uk/news/business-15429057

http://edition.cnn.com/2011/12/07/business/europe-explainer-jargon-glossary/

index.html

http://www.investorwords.com/5876/

http://www.project-syndicate.org/commentary/greece-must-exit

http://ec.europa.eu/europe2020/making-it-happen/country-specific-

recommendations/2011/index_en.html

http://ec.europa.eu/economy_finance/publications/publication15887_en.pdf

http://www.imf.org/external/np/exr/facts/pdf/europe.pdf

http://www.greekcrisis.net/2011/12/he-eurozone-crisis-explained-in-5.html

P a g e | 88

Bibliography

The books referred were-

1. “Banking in European union”

Edited by Katuri Nageswara Rao and Yash Paul Pahuja

The ICFAI University Press

2. “Banking Crises In Europe – Country Experiences”

Edited By N. Rajshekar And V. Subbulakshmi

The ICFAI University Press