European Debt Crisis 2009 - 2011

The PIIGSandThe Rest From Maastricht to Papandreou

Group VIII: Ankur Salunke (A047), Shamik Bose (A012), Partho Choudhury (A016), Aditya Mishra (A037), Manas Ranjan Kar (A030), Abhishek Shrivastav (A053), Darpan Thakkar (A060)

Put simply

A BIG MESS!!!

10-year Government bond yield How much interest do they pay annually to borrow money??

Bond yields spreads vs. 10-year Bunds How much more interest do they need to pay than Germany?

How much do they need to pay regularly to insure against a sovereign default?

General Government Surplus/Deficit as a %age of GDP

2006

General Government Surplus/Deficit as a %age of GDP

2007

General Government Surplus/Deficit as a %age of GDP

2008

General Government Surplus/Deficit as a %age of GDP

2009

General Government Surplus/Deficit as a %age of GDP

2010

Government Debt as a %age of GDP

2006

Government Debt as a %age of GDP

2007

Government Debt as a %age of GDP

2008

Government Debt as a %age of GDP

2009

Government Debt as a %age of GDP

2010

Seasonally adjusted unemployment rate, %

2006

Seasonally adjusted unemployment rate, %

2007

Seasonally adjusted unemployment rate, %

2008

Seasonally adjusted unemployment rate, %

2009

Seasonally adjusted unemployment rate, %

2010

Seasonally adjusted unemployment rate, %

2011

Foundation of the crisis

7th Feb, 1992: An irrevocable monetary union set up under the Maastricht Treaty; No central finance ministry or mechanism to leave the Euro 14th Dec, 1996: EU leaders consent to a German inspired Stability Pact designed to impose stiff penalties on countries that overstep deficit limits 14th March,1998: Greece enters the European Exchange Rate Mechanism (ERM)

1st Jan, 1999: The Euro established

1st Jan, 2001: Greece enters Euro region 24-25th Nov, 2003: Germany and France override the EU budget rule not to let their respective national budget deficits to exceed 3% of their annual budgets

20th March, 2005: EU finance ministers bow to German pressure to relax budget rules to suit Germany

Precursor
2007: Greece has one of the Eurozones fastest growing economies (@ 4.2% YoY), but also has one of highest debt-to-GDP ratios in the region (113%)

15th Sept, 2008: Lehman Brothers file for bankruptcy in NY

30th Sept, 2008: Ireland steps in to guarantee all commercial bank deposits; Process of nationalization has begun
Jan 2009: Sovereign ratings of Greece and Spain pared down
Oct 2009: The Greek Socialist Pasok Party wins a landslide victory in general elections; announces doubling of the deficit from 6% to 12.5%; It is alleged that previous administrations hid the extent of debts

8th Dec, 2009: Sovereign ratings of Greece cut down to BBB+ (Fitch)
14th Dec, 2009: Massive austerity measures announced by the new Greek government

1/10 3/10
The Greek and Spanish budgets show a deficit of 13% and 9.8% respectively. Both countries launch austerity measures to bring the deficit in line with EU norms (~ 3% of GDP). Germany and France enter into a pact with the IMF to help Greece and other distressed economies through bailout packages. Greek financial instability creeps into its private banks. Widespread riots in Athens to protest the raise in taxes and freeze in salaries.

1/10 3/10
Portugal joins Greece and Spain in austerity measures and attempts to control its deficit, including spending cuts, ramped up privatization plan, caps on public sector wages and higher taxes on HNWI. Ireland, Spain, Greece and Portugal face sovereign ratings downgrades, thereby increasing their borrowing costs in the short to medium term. The ECB assures support by agreeing to buy the downgraded bonds.

4/10 6/10
It is suspected that the budget deficit is higher (at 13.6%) than what the Greek government had initially estimated, leading to further downgrades by ratings agencies, and a spike in bond yields (to 7.1%), which makes government borrowing more expensive. There is across-the-board ratings downgrades of several EU nations. The IMF and EU jump in with an assistance package of 23 Billion Euros

4/10 6/10
Across the board sovereign ratings downgrades trigger massive selling pressure on the Euro. Greece becomes the first EU country to enter into a bailout agreement with the IMF and EU (for 100 Billion Euros over 3 years). Plans are made to include more distressed economies into a larger 750 Billion Euro bailout plan. Spain and Portugal chip in with spending cuts and higher taxes for services and HNWI.

7/10 9/10
Ireland is the latest country to suffer from rising borrowing costs and lowering of sovereign ratings. Bank stress tests reveal that 91 banks across Europe will need capital infusion or raise new capital on their own to survive. Growth rates across the distressed economies crawl at < 2% YoY. Budget cuts (including spending cuts on government programs) are announced by countries such as Ireland, but borrowing costs continue to rise.

10/10 12/10
Political support for budget cuts weaken in countries such as Ireland and Greece. Because of indecisiveness and inaction by the ECB, and infighting between individual nations, growth stalls in the PIIGS region, while borrowing costs continue to soar. EU talks about a permanent bailout fund to instill some confidence in the capital markets. Ireland receives a 67.5 Billion Euro bailout package, and announces budget cuts to reduce its deficit to 9.1% in 2011.

1/11 4/11
France and Germany propose a EU-wide pact for competitiveness to initiate economic reforms. A permanent 500 Billion Euro fund is agreed upon, besides a Euro Plus Pact to kick off structural reforms beginning 2012-13. Ratings agencies continue to cut the ratings of all PIIGS economies to near junk status, thereby increasing borrowing costs by a factor of 3.

5/11 Present
Portugal gets a first bailout package of 78 Billion Euros, but a second bailout might be needed. Greece receives a second bailout of 109 Billion Euros, and the ECB continues to buy distressed government securities of the PIIGS economies. But Greeces 10-year bond yields continue to rise to reach a record 23.6%. Italy begins the first of its 2 rounds of budget cuts, despite street protests.

10 year bond yields since the last crisis

What causes these crises?

Excessive Debt

Debt-GDP, Debt-revenue or Debt-exports ratio

Excessive debt servicing

Debt service-GDP or Debt service-tax revenue ratio

Excessive reliance on foreign capital

Debt-export ratio Low growth Low returns on private sector investments Excessive expenditure on non-productive/populist measures, tax breaks for the rich

Economic Weakness

Political Weakness

Irrational exuberance

Refusal to learn from history

In theory, there are 6 ways out.

A higher rate of growth

A lower interest rate on the public debt

A bailout
A current transfer payment

Fiscal pain

Increasing recourse to seigniorage by the central bank

Default

Increase in taxes Cut in public spending

A capital transfer from abroad

Revenues from monetary issuance

Debt repudiation

Debt standstill

Debt moratorium

Debt restructuring/resch eduling

Usually, there are only 3 ways out

A higher rate of growth

A lower interest rate on the public debt

A bailout
A current transfer payment

Fiscal pain

Increasing recourse to seigniorage by the central bank

Default

Increase in taxes Cut in public spending

A capital transfer from abroad

Revenues from monetary issuance

Debt repudiation

Debt standstill

Debt moratorium

Debt restructuring/resch eduling

Cut, Print or Default

Cutters are few and far in between

Only Great Britain has been able to aggressively reduce its debt burden through budget surpluses, lower interest rates and higher growth And Great Britain had the advantage of the Industrial Revolution

Printers

States with monetary sovereignty None of the Eurozone countries has that luxury States with own-currency debt US, and Japan to a certain extent

Defaulters

States with limited monetary sovereignty States with foreign currency debt

Lessons of history.

What do Governments NOT do with huge debts

Slash expenditures or entitlements Reduce marginal tax rates on income and corporate profits to stimulate growth Raise taxes on consumption to reduce deficits Grow their way out without defaulting or depreciating their currencies

What do Governments USUALLY do with huge debts

Oblige central banks and commercial banks to hold government debt Restrict overseas investment by firms and citizens Default on commitments to politically weak groups and foreign creditors Condemn bond investors to negative real interest rates

What are the geopolitical consequences of a crises of public finance?

In fiscal stabilizations, discretionary military spending is usually the first casualty In case of default on external debt, conflicts with creditors can arise In case of currency depreciation, reserve currency status may be lost to a rising rival

Impact on India.

Worst case scenario growth dips to 7% YoY

WPI inflation to lower to 7% YoY

Interest rates expected to be cut by RBI Capital infusion by RBI

Sharp fall in bond yields

Borrowing costs fall, setting the stage for another round of debt-fuelled growth in the medium term

USD-INR exchange rates expected to rise

Exports hit in the near term