Euro-zone and the European
Debt crises
A study on impact of European Debt crisis on the European economy
The History of European Union
History of European union
• European Coal and Steel Community (ECSC)
• European Communities
• Schengen Agreement
• Fall of Iron Curtain
• Maastricht Treaty
• Lisbon Treaty - EU
The European union
European union
• 27 member states, 5 candidate states
• Formed by the Maastricht treaty in 1993.
• Conditions for joining EU as per the Copenhagen
treaty
– Stable democracy which respects Human rights and has a
rule of law
– A functioning market economy
– the acceptance of the obligations of membership,
including EU law.
Key statistics
• Surface Area – 4,215,000 sq.km (4th largest)
• Population – 501 million (3rd largest)
– 0-14 years: 15.44%
– 15-64 years: 67.23%
– 65 years and over: 17.33%
• Population rate
– Growth rate: 0.098%
– Birth: 9.83/1000 pop.
– Death: 10.33/1000 pop.
Statistics courtesy - CIA Factbook and EuroStat
Key statistics
• GDP - $15.95 trillion (2010 est.)
– Growing at 1.8%
• GDP by sectors
– agriculture: 1.8%
– industry: 25%
– services: 73.2%
• Trade
– Imports: 6.95 trillion euros
– Exports: 6.75 trillion euros
Statistics courtesy - CIA Factbook and EuroStat
Key statistics
• Industrial production rate: 4.1% (2010 est.)
• Unemployment rate : 9.5%
• Per capita GDP - $32,900 (2010 est.)
• Labor Force 225.4 million (2010 est.)
– agriculture: 5.6%
– industry: 27.7%
– services: 66.7% (2007 est.)
• GINI Index: 30
Statistics courtesy - CIA Factbook and EuroStat
The European Union
• Main decision bodies
– European parliament (EP)
– Council of European Union
– European Commission
• Other bodies include
– European Central Bank
– European Court of Justice
Euro and the Eurozone
• Eurozone is an economic and monetary union (EMU) of 17
European Union (EU) member states that have adopted the
euro (€) as their common currency
• 17 member states with 329 million people in the eurozone
• The monetary policy of all countries in the eurozone is
managed by the European Central Bank (ECB)
• EU member states are legally bound to adopt euro when all
criteria ERM-II are met. However a few countries have
avoided the euro
The Eurozone
Exchange rate mechanism (ERM-II)
• A group of policies aimed at converging the economies of EU
member states to adopt Euro currency.
• Criteria to join Eurozone
– Inflation rate: 1.5% max.
– Govt. deficit to GDP: 3% max
– Gross Govt. Debt to GDP: 60%
– Accepted Exchange rate mechanism (ERM-II)
– Long term interest rate: 2% max
• The purpose of setting the criteria is to maintain the price
stability within the Eurozone even with the inclusion of new
member states.
Euro and the Eurozone
• Why Euro??
– easing travel of citizens and goods,
– eliminating exchange rate problems,
– providing price transparency,
– creating a single financial market,
– price stability and low interest rates,
– providing a currency used internationally and protected
against shocks by the large amount of internal trade within
the Eurozone
Initial successes of Euro
• Emerged as an alternate reserve currency
• Since it was pared closed to the dollar, this allowed countries
to finance their debts at a lower cost.
• Eliminated transaction costs and exchange rate risk
• Increase of trade within Eurozone (5-10%)
• Increase in investment
• Low interest rate
• Price convergence
• Tourism
The Bad times start….
American Financial crises of 2007
• The financial crisis of 2007was triggered by a liquidity shortfall
in the United States banking system, and had resulted in the
collapse of large financial institutions, the bailout of banks by
national governments, and some downturns in stock markets
around the world.
• The main reason for shortfall were
– Collapse of Housing bubble
– Sub-prime Lending
– Easy credit conditions
– Increase in debt by US companies
– Deregulation
– Shadow banking
Effect of Financial crisis on Europe
• Real Economy shrinks by about 4%
• High unemployment - 9%
• Increase in public debt to about 80% of GDP
• Fall in consumption and investment
• Run on the banks:
– Northern Rock and 3 Icelandic banks
• Fall in International trade
• Stock market crash
• And all this gave rise to the European Debt crisis..
So what is this European Debt crisis all about?
• The crisis is mainly about a group of countries (viz. PIGS) and
other eurozone countries who are finding it difficult to repay
their public debt.
• The concern is more about the solvency (the ability to repay
the debt) rather than the liquidity (having the money to pay
the interest payments)
• The crisis started in Greece in 2010 when it was found that
the Greek Govt.’s finances were in serious trouble and it
expressed its inability to sustain interest payments.
• The crisis then slowly spread to other surrounding countries
and raised questions about these countries ability to service
debt.
What is a public debt?
• It is a term for all of the money owed at any given time by any
branch of the government.
• 2 classifications
– Internal Debt and External Debt
– Long term (10 yrs +) and Short term debt (90 days)
• Bond ‘yields’
• Bonds are rated by external agencies S&P and Moody’s.
Ranges from AAA rating (US) to ‘junk’
• Rating depends on factors such as economic conditions, risks
associated with that country, etc,
Total debt issuance in the world’s
economies
How rich countries finance their debt?
The PIGS countries
PIGS
• Stands for Portugal, Ireland, Greece and Spain
• PIGS is an acronym for the group of countries who are directly
affected by the debt crisis.
• These are a group of countries with similar economic
conditions and are most likely ‘expected’ to pay back the
money loaned to them.
• All these countries have a very similar economic conditions
and problems, which led the markets to believe that all these
countries will have a problem of paying their debtors.
PIGS before the crisis
• Well developed economies with high standard of living
• Following are 2009 indicators of PIGS economic and social
standing.
Countries GDP per capita ranking * GINI rating
Portugal 30 38.5
Ireland 7 34.3
Greece 26 34.3
Spain 25 34.7
* World bank stats (2009)
But the alarm bells started ringing..
• Falling IIP and GDP numbers, ageing population and high
unemployment .
Country Net external IIP Government Unemployment
debt (as a % growth deficit rate
GDP)
Portugal 75.1 -9% 9.4% 9.6%
Ireland 82.6 N.A. 14.3% 11.9%
Greece 88.6 -9% 13.6% 9.5%
Spain 80.7 -16% 11.2% 18%
PIGS Government deficit
PIGS balance sheet
Govt. debt as a share of GDP
In a nutshell…..
• All these countries exhibited
– Huge government deficit
– Highly leveraged economies
– Owed a lot of money to foreigners
– Shrinking and Uncompetitive economies
– Aging labor force
In short cannot pay their liabilities in the long
run……..
The Greek tragedy
The crisis triggers …
• Corruption scandal – under reporting of debt to maintain the
debt limits under control.
• Bloated public sector, welfare state
• Had one of the highest government deficits in the world
• High external debt
• Falling GDP numbers due to recession affecting Shipping and
Tourism
• Downgrade of Greek debt to ‘Junk’ status.
• Riots in Greece due to spending cuts
How the debt cycle is broken
And the contagions spreads
All happy families resemble one another, every
unhappy family is unhappy in its own way
-Leo Tolstoy
The contagion spreads
• Ireland
– A severe banking crisis, property bubble and excessive dependence on
Financial sector
• Portugal
– Slow growth, large deficit and uncompetitive in economy
• Spain
– High unemployment, low productivity and exposure to European
sovereign debt
• Italy
– Healthy economy but exposure to European sovereign debt
• Belgium
– Government crisis and large public debt
• Iceland
– Failure of 3 of its biggest banks
But the superpowers were in denial mode
• Germany and other countries were initially hesitant on
providing financial assistance due to political compulsions.
• The EU\ECB treated the crisis as a temporary liquidity
problem when in reality it was a problem of solvency.
• Speculators and Hedge funds placed their bets on default by
Greece.
• This denial mode forced lending rates of public debt of PIGS
countries to be increased to record levels
10 yr Euro zone bond yields
But then they finally woke up
• Portugal, Ireland, Greece and Belgium have in common,
– small, narrowly based economies
– very high and potentially unsustainable debt levels
– common a reliance on foreign investors to purchase their debt
• Exposure of European banks to sovereign debts
• Increase in risks for Investors in sovereign debt
• Speculators and hedge funds betting against the sovereign
debts
Similar problems across Europe
Country Net external IIP Government Unemployment
debt (as a % growth deficit rate
GDP)
Portugal 75.1 -9% 9.4% 9.6%
Ireland 82.6 N.A. 14.3% 11.9%
Greece 88.6 -9% 13.6% 9.5%
Spain 80.7 -16% 11.2% 18%
Belgium 29.6 -14% 6% 7.9%
Italy 37.3 -18% 5% 7.8%
Exposure to sovereign debt
Creation of EFSF
• European Financial Stability Facility
• A financial safety net of about 750 billion euros which can be
utilized to provide support to a euro economy in case of
another crisis.
• Was aimed as confidence building measure in the markets
Possible solutions
Future looks bleak for Greece
• Unsustainable debt position
– Increase in Government Debt = Budget Deficit + [(Interest Rate – GDP
Growth) X Debt]
• Therefore the only option that remains is to default on debt
– This is not acceptable for Investors as well as other EU members who
have invested in Greek debt
• Get out of euro
– It would allow for devaluation which will support its economy but will
be a messy affair
• So the only option remains is to sustain the debt and the IMF
conditions, and endure a long period of recession
Options before Eurozone
• Greater economic integration by means of common fiscal
policy
– Unacceptable since means giving up on economic freedom
• Increase support to troubled countries as and when needed
• Print money
• Allow for an orderly default or debt restructuring mechanism
Lessons from the crisis
• Its all about ‘Perceptions’.
• Keep an eye on rising debt.
• Do not ignore thy neighbor’s problems
• Allow for fiscal consolidation in good times
Thank You
