european sovereign debt crisis
TRANSCRIPT
• Japan 2012 Debt/GDP – 200%• Mexico default 1980s – Debt/GDP - 50% • Ability to Repay? Or Willingness to Repay?• Willingness is a cultural problem.• Fiscal Austerity Measures– Higher Taxes– Cutting
European Sovereign Government Debt Crisis
Social Services
Public Spending
Civil Servant Jobs
More Fundamental Problem
Common Scenario among PIIGS
Pre Euro Scenario – Risk Factors• Process of Convergence – key macroeconomic variables inflation, interest
rates should be same.Stability and the growth pact *Limits Budget Deficits – 3% (GDP),*Public Debts – 60%(GDP)*No Bailout Clause – Sovereign Default
Due to common currency, Financial MarketsLooked at countries like Greece, Ireland with same risk of default as Germany.
Free rider problems: Easy Credit
Pre Euro Scenario – Risk Factors
Evolution of Debt/GDP Post 1999-2000
Public Debt Swells – 2000 to 2010
Financial Imbalances
2003-2007 - Housing Bubbles booms In Ireland & Spain
Euro Zone Meant Banks could raise from International sources in their own currency (euro) - Lower interest rates & easy credit consumption related & property related borrowings
Easy credit: ↑Private Sector Borrowings
External Imbalances
Current Account Balance in Euro Area is close to zero due to sheer size of German Economy
* Capital inflows fueled property bubbles which have little effect on future productivity growth. • Delayed Structural Shocks – Competition from Eastern Europe & emerging Asian markets in
the production of low margin goods Significant Macroeconomic Risks• CAD is harmful if increased expenditure on nontradables squeezes tradable sector by bidding
up wages and drawing resources away from high productivity growth.• Sudden shocks external capital flow reversals output contractions, asset price declines,
rising unemployment
Failure to Tighten Fiscal Policy
Private Sector taking risks* Increased Tax revenues * Capital gains taxes* Asset transaction taxes
* Instead of reducing external debt Governments cut taxes & increased Public spending* Just contained regular fiscal deficits.
Global Financial Crisis • High Exposure of European banks to US market in asset – backed
securities.• Investors reassessed their international exposure levels and withdrew
funds to home markets.
ECB Actions• Slashed short term interest rates• Provided euro-denominated liquidity • Currency swap arrangements • Facilitated access by European banks to dollar-denominated liquidity
• Cross Border financial flows dried up in late 2008.
Implications of Drying up of Cross Border Financial Flows
• Asymmetric effects across Euro Area • High Dependency on external
funding; reliance of banking system on international short term funding
• Squeeze on External funding --> End of Credit boom, property bubble bursts
• Falling asset prices, abandoned projects.
• Huge losses to banks that made property-backed loans.
• Banking Crisis
Euro Area Sovereign Debt Markets (bonds) remained stable – danger lurking in the dark!
Asymmetric Effects on Ireland, Portugal & GreeceWithin Euro Area.
Lets get back to Greece!
*Change in Government in 2009*New Government Revised Budget deficit forecast from 6% to 12.7%*Shocks
* No more rollover debt* Imminent bailout talks
*Social unrest ,High Unemployment
No more Rollover Debt Why bother?
*Monetary Union lead to highly intertwined European economies.*Cross border project financing
Wakeup call, rollover problem hit larger economies like Italy and Spain
What happens when Greece Defaults?
Rising bond Yields
Self-fulfilling – Speculations! ↑ Perception of default risk ↑ Rate of borrowing & investors demand higher yields Perception of default risk turns a reality.
Rising bond yields indicates higher risks
Reforms to Address Sovereign debt Concerns
• Stability and growth pact: pre-crisis focused on containing budget deficit to 3% of GDP, but left out Debt/GDP levels. New systems focuses on structural budget balance. Governments bank on cyclical revenue gains in exchange for a greater slippage during recessions.
• Banking Union: diabolic loop between national banking systems and national governments was central to fiscal crisis.
• Introduction of “euro bonds” to counter the self fulfilling speculative attacks – European Financial Stability Facility
• Problem: Weaker states might over borrow using euro bonds.• Solution: limit these bonds to short maturities, thereby denying access to
ill-disciplined countries.
Response to Sovereign Debt Crisis
• Joint bailouts in 2010-2011 by EU & IMF• Fiscal Austerity packages & structural reforms to boost growth.• Repayment period in general was 3 years.Problems • Macroeconomic adjustments were longer in high income countries (Debt/GDP
ratios are stickier).• Very difficult for real growth rates to exceed long term growth rates of 2% in
advanced economies.• Adding to that – erosion in human capital due to prolonged unemployment.• So repayment period was increased to 15-30 years. • IMF principle : if sovereign debt level is not sustainable, private sector creditors
take a beating by reduced PV of debt owed to them.• March 2012, Second bailout package of Greece required 50% cut in PV.
Need for Fiscal Union
Surrendering National Sovereignty?
Fiscal rules written into domestic legislation
giving greater political legitimacy
External Sanctions, remain as
“second line of defense”
- United States of Europe?
Or Euro Break up?
Recent Phenomena• S&P Downgrades Greece’s credit rating from B to B- (Feb 6,2015)