Austerity measures & Euro Crisis

An analysis into the effectiveness of Austerity measures on European Union Sovereign Debt Crisis
The article details the EU crisis and the effectiveness of the bailout packages and the austerity measures. It also goes deep into the potential alternatives that could be adopted to resolve the crisis.

Team:
Cutting Edge Shebin John Samuel pgpm811.shebin@spjimr.org Mob: 99204 69595 TasneemVakil pgpm811.tasneem@spjimr.org Mob: 98198 10652

Euro Crisis & Austerity Measures

As you are reading this article, Greece is just above the default credit rating. Fitch cut Greece's long-term ratings this week to become the first ratings agency to make the widely expected downgrade after the country announced a bond exchange plan to ease its massive debt burden. It is just a matter of time that the other EU nations like Portugal, Spain, Ireland and Italy get downgraded to the lowest level. It makes one think what went wrong so drastically that EU in general and Eurozone in particular, have been engulfed in the crises. Digging a little deeper into the history of EU, one finds The European Union, as its currently configured, consists of 27 member states. Seventeen member states of the EU, including Germany, France, Italy and Greece, belong to the Eurozone; they share the euro currency and a common monetary policy set by the European Central Bank (ECB). The fiscal policies for Euro zone is set by the ECB while that of the member countries are regulated by independent authorities. This is one of the root causes for the economic crisis which was promoted by the nonstandard standards and of inaccurate the member accounting countries.

At the centre of concerns are the "PIIGS" nations - Portugal, Italy, Ireland Greece and Spain - heavily indebted countries in danger of default, which in turn would trigger an economic domino effect around the globe. P P
Ireland Italy G S

Ireland Italy 22 18 1 16 5 46 1 47

G 10 8 7 1

S 28 30 31 0 -

5 7 0 86

Figure: PIIGS Debt Matrix, showing the debt existing among the nations Italy: The confidence on trade and credit scenario in Italy was shaken due to the Global Financial Crisis (GFC). Spain: Dramatic fall in output driven by sharp declines in investment, exports, and private consumption Portugal: GFC worsened the volatile performance of Portugals banking system, which came with the adaption of Euro. Ireland: Over-reliance on theconstruction and financial sectors, coupled with the arrival of the GFC, hurt the households, banks, and the government. TheIrish Republic became the first Eurozone

Though the European Union was created, the policies were not kept uniform throughout. The separation of powers within the European Union allowed some member states to bypass the guidelines.

country to fall into recession in 2008. Greece: Heavy borrowing along with prolonged deficit spending, economic mismanagement, and taxevasion led to crisis in Greece.
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Euro Crisis & Austerity Measures

All these factors, coupled together, pushed the Euro economy into recession, with the services sector shrinking this month along with manufacturing, tempering a wave of optimism after a new bailout deal for Greece struck this week. The impact of this crisis was echoed in even in the fast progressing Chinese economy. Similar to China, most of the developed and

Gross Government Debt Forecast

2010 EST 2015 forecast

200
100 0

developing countries in the world have export or debt relationships with the Eurozone. All these would mean a catastrophic impact on the global economy if the double dip recession hits Europe. Considering that the western economies are still struggling to get out of the after effects of the 2008 recession, the impact- a double dip will be disastrous. IMF The Saviour? This is where the International Monetary Fund (IMF) pitched in to bailout the crisis. Following requests from the Eurozone members, IMF worked with the other EU members and ECB to chalk out plans for resolving the crisis. IMF and ECB identified that simply bailing out the debt ridden economies will be of no use, unless strict measures are implemented to bring down the debt and deficit of the associated economies. This gave rise to the austerity measures, which was to be accepted by the countries as a pre-requisite to get the fund.

Figure: PIIGS Debt Forecast *EST Emerging Security Technology Austerity Measures Cuts in health and pension funds Cuts in the public power company fund Cut in pharmaceutical spending Cut in subsidies for families with more than three children Cut to Culture and Tourism Ministry funding Cut to Agriculture and Food Ministry spending Cut to education, election & salary spending Cut to public investment budget Reduction in operating costs for ministries Reduction in Defence Ministry spending Reduction in main and supplementary pensions Austerity Measures After effect? The austerity measures have resulted in Slowdown of economy Shutdown of stores Fall in tax revenues High rate of unemployment Drop in purchasing power Increase in bankruptcy
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Euro Crisis & Austerity Measures

Fall in GDP Altogether this has led to frustrated workers who are threatening to strike back. A mixture of fear, hopelessness and anger is brewing in these societies especially, Greece. There are several riots and protests going on in many of these nationsagainst these austerity measures. Alternate Measures Apart from the official responses taken by the EU, IMFand ECB, a number of different and unique alternatives exist for the debt ridden nations to ameliorate their debt issues. Debt Restructuring This is considered as a most disastrous alternative as this would affect the banking system disastrously across Europe and create panic in the markets. While debt restructuring presents its own caveats, it remains a viable option to many European nations who continue to express fears of a possible default. Innovative Fiscal Strategy This involves the Government

support extended by China to Greece, foreign investments can cater to the recovery process. However this will be at a price of opening up the markets to foreign countries. Exit the European Monetary Union Exit from the European Monetary Union (EMU) remains a possible but extremely unlikely option. Although the forced or voluntary exit of a nation within the EMU is illegal, such an exit has been touted by some politicians and economists as a better alternative to the prevalent austerity strategy. Summary Although the austerity measures

implemented by the debt ridden countries seemed to be the most preferred option, it has not gone well with the public. A better alternative to solve this scenario will be to supplement the bailout/austerity measures with foreign investment &stimulus

packages from wealthy nations across the globe. This would mean that the austerity measures will cut the deficit on one side, while the foreign investment will bring stimulus to the economy, thereby

identifying& implementingits own set of austerity measures. This includes extensive spending cuts and significant reform of welfare programs. But this will not be a feasible solution in the current scenario. Foreign Investment &Stimulus An additional alternative to overcome the present debt crisis is to look to other stable economies for support. Similar to the

improving the market and providing an incitement for the economy. As the deficit reduces, the nations can slowly chalk out their own fiscal policies to enhance economic growth.

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