The

European
Crisis
A project in
Economics

Hiral Patel 111

Sirjan Gupta 113
Swati Prabhu 115
Rupal Dixit 117
Sumit Jaiswal 119
Table of Contents
About Eurozone.....................................................................................................................................4
Economic and Monetary Union (EMU)..................................................................................................4
Fiscal policies.........................................................................................................................................4
Eurozone before the crisis hit................................................................................................................5
The crisis initiated..................................................................................................................................6
Spread of Crisis......................................................................................................................................7
Greek Crisis........................................................................................................................................7
Effect of global crisis on shipping and tourism..............................................................................7
Large public deficits and large debts.............................................................................................7
Lack of transparency......................................................................................................................7
Downgrading of debt.....................................................................................................................7
Austerity and Loan Agreement......................................................................................................8
Danger of default...........................................................................................................................8
Objections to proposed policies....................................................................................................8
Euro as a cause of Economic Crisis........................................................................................................9
1.Currency Devaluation.....................................................................................................................9
2.Monetary policy was too loose.......................................................................................................9
3.Tourism Affected............................................................................................................................9
Impact of European Crisis :....................................................................................................................9
Stock and Debt market reactions......................................................................................................9
Fiscal Austerity..................................................................................................................................9
Moral Hazard...................................................................................................................................10
Polarized Community......................................................................................................................10
World Trade Disrupted....................................................................................................................10
Credit Shortage................................................................................................................................10
Inflation, Hyperinflation and Social Security....................................................................................10
Disruptive Consequences................................................................................................................11
Impact on Euro....................................................................................................................................11
Contagion effect..............................................................................................................................11
Criticism of euro-model...................................................................................................................11
Degradation of euro........................................................................................................................12
Monetary Deflation.........................................................................................................................12
 Pressure building on the currency...................................................................................................12
Monetary Policy Response by European Central Bank (ECB)...............................................................13
ECB injected liquidity into European banks.....................................................................................13
Federal Reserve used Euro-dollar swaps to make dollars available to ECB to lend to banks...........13
ECB did not lower interest rates until October 2008 because of its focus on inflation....................13
Assistance provided to crisis struck countries.....................................................................................14
Japan...............................................................................................................................................14
Germany..........................................................................................................................................14
Impact of crisis on India.......................................................................................................................14
1.Trade Channels :...........................................................................................................................14
2. Currency Channel........................................................................................................................15
3. Banking Channels.........................................................................................................................15
4.Commodity price Channels...........................................................................................................15
Present Situation.................................................................................................................................15
About Eurozone

The Eurozoneofficially the euro area, is an economic and monetary union (EMU) of 17
European Union (EU) member states that have adopted the eurocurrency as their sole legal
tender. It currently consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany,
Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and
Spain..

Monetary policy of the zone is the responsibility of the European Central Bank, though there
is no common representation, governance or fiscal policy for the currency union. Some co-
operation does however take place through the euro group, which makes political decisions
regarding the eurozone and the euro.

Economic and Monetary Union (EMU)

All EU Member States form part of Economic and Monetary Union (EMU), which can be
described as an advanced stage of economic integration based on a single market. It
involves close co-ordination of economic and fiscal policies and, for those countries fulfilling
certain conditions, a single monetary policy and a single currency – the euro. When the EU
was founded in 1957, the Member States concentrated on building a 'common market'.. But
the goal of achieving full EMU and a single currency was not enshrined until the 1992
Maastricht Treaty (Treaty on European Union), which set out the ground rules for its
introduction. These say what the objectives of EMU are, who is responsible for what, and
what conditions Member States must meet in order to adopt the euro.

Fiscal policies
The primary means for fiscal coordination within the EU lies in the Broad Economic Policy
Guidelines which are written for every member state, but with particular reference to the 17
current members of the eurozone. These guidelines are not binding, but are intended to
represent policy coordination among the EU member states, so as to take into account the
linked structures of their economies. For their mutual assurance and stability of the
currency, members of the eurozone have to respect the Stability and Growth Pact, which
sets agreed limits on deficits and national debt, with associated sanctions for deviation. The
Pact originally set a limit of 3% of GDP for the yearly deficit of all eurozone member states;
with fines for any state which exceeded this amount.
Eurozone before the crisis hit

1. Confidence in the prospects for growth and stability of the economies of Greece,
Ireland, Italy, Portugal, and Spain (GIIPS) surged when the euro was introduced, causing
their interest rates to decline to those of Europe’s more stable members.

2. Improved confidence and lower interest rates drove up domestic demand in the
GIIPS and investors and consumers were emboldened to increase spending and run up
debts, often owed abroad as foreign capital flowed in.

3. Growth accelerated and the prices of domestic activities (i.e., those least exposed to
international competition, such as housing) rose relative to the price of exportable or
importable products, attracting investment into the less productive non-tradable
sectors and away from exports and industries competing with imports.

4. Meanwhile, exports rose sharply as a share of GDP in Germany, the Netherlands, and
other historically stable countries in the European core. Growing demand in the GIIPS
enabled these core countries to increase exports. The adoption of a common currency
whose value was based on broader European competitiveness trends that made it
lower than the deutschmark or guilder might have been, made their exported goods
more affordable.

5. The domestic demand boom in the GIIPS induced rapid wage growth that outpaced
productivity, increasing unit labour costs and eroding external competitiveness further.
This trend was reinforced by especially rigid labour markets in most of the GIIPS that
make wage adjustments difficult. The emergence of China, as well as currency
depreciation and rapid labour productivity growth in the export sectors of the United
States and Japan, added to the competitiveness problems of the GIIPS.

6. The single European monetary policy was too loose for the rapidly growing GIIPS
(Spain, Greece, and Ireland) and too tight for Germany, whose domestic demand and
wages grew very slowly compared to the European average. This reinforced the loss of
competitiveness in the GIIPS.

7. Lower borrowing costs and the expansion of domestic demand boosted tax
revenues. Instead of recognizing this as temporary revenue and saving the windfall
gains for when growth slowed, GIIPS governments significantly increased spending.
Blatant fiscal mismanagement added to the problems in Greece.
The crisis initiated

The crisis was initiated by the deflating of the US housing bubble (and later the equity
bubble), which set off a vicious chain reaction, with a number of negative feedback
mechanisms. This had a direct effect on consumer demand as rising house prices had been
the cash cow of stretched US consumers (equity withdrawal, mortgage refinancing).
Defaults and foreclosures increased. Worse, the securitisation of the underlying assets
swiftly led to the implosion of the US financial sector, as losses emerged and confidence in
the solvency of counterparties evaporated. The resulting credit crunch then impacted
consumers and nonfinancial businesses that could no longer roll over loans, causing
consumers to retrench and firms to lay off workers.

There
were four
main

transmissions to the
European economy from
across the US economy:

• US consumer retrenchment (and also stalling business investment) directly affected

the sales opportunities of European exporters, already squeezed by past currency
appreciation.
 • The European financial sector had been a major purchaser of ‘toxic’ assets from US
banks. Their collapse in value of or the cessation of trading in these assets led to a
knock-on implosion of the European banking sector, which then hit European
companies (and to a lesser extent consumers, especially homeowners).
• The massive rate cuts by the US Federal Reserve in response to the crisis (initially
unmatched in Europe) led to a sharp further fall in the USD against the euro,
exacerbating the competitive pressure on European producers.
• Finally, and after a lag, the crisis also hit emerging economies (not least, China,
where recent reports suggest a major increase in unemployment is likely), which led
them to cut their import demand.

Spread of Crisis
Greek Crisis
Effect of global crisis on shipping and tourism
The global financial crisis that began in 2008 had a particularly large effect on Greece. Two
of the country's largest industries are tourism and shipping, and both were badly affected by
the downturn with revenues falling 15% in 2009.

Large public deficits and large debts

Initially currency devaluation helped finance the borrowing. After the introduction of the
euro in Jan 2001, Greece was initially able to borrow due to the lower interest rates
government bonds could command. In the beginning of 2010, it was discovered that Greece
had paid Goldman Sachs and other banks hundreds of millions of dollars in fees since 2001
for arranging transactions that hid the actual level of borrowing. Greek government debt
was estimated at €216 billion in January 2010. Accumulated government debt is forecast,
according to some estimates, to hit 120% of GDP in 2010.

Lack of transparency
To keep within the monetary union guidelines, the government of Greece has been found to
have consistently and deliberately misreported the country's official economic statistics.

Downgrading of debt
On 27 April 2010, the Greek debt rating was decreased to the first levels of ' junk' status by
Standard & Poor's amidst fears of default by the Greek government. Yields on Greek
government two-year bonds rose to 15.3% following the downgrading. Some analysts
question Greece's ability to refinance its debt. Standard & Poor's estimates that in the event
of default investors would lose 30–50% of their money. Stock markets worldwide declined
in response to this announcement. On 3 May 2010, the European Central Bank suspended
its minimum threshold for Greek debt "until further notice", meaning the bonds will remain
eligible as collateral even with junk status.
Austerity and Loan Agreement
On 5 March 2010, the Greek parliament passed the Economy Protection Bill, expected to
save €4.8 billion through a number of measures including public sector wage reductions. On
23 April 2010, the Greek government requested that the EU/IMF bailout package be
activated. The IMF had said it was "prepared to move expeditiously on this request".Greece
needed money before 19 May, or it would face a debt roll over of $11.3bn.

On 2 May 2010, a loan agreement was reached between Greece, the other Eurozone
countries, and the International Monetary Fund. The deal consisted of an immediate €45
billion in loans to be provided in 2010, with more funds available later. A total of €110
billion has been agreed.

Danger of default
Without a bailout agreement, there was a possibility that Greece would have been forced to
default on some of its debt. The premiums on Greek debt had risen to a level that reflected
a high chance of a default or restructuring. Analysts gave a 25% to 90% chance of a default
or restructuring. A default would most likely have taken the form of a restructuring where
Greece would pay creditors only a portion of what they were owed, perhaps 50 or 25
percent. This would effectively remove Greece from the euro, as it would no longer have
collateral with the European Central Bank. It would also destabilise the Euro Interbank
Offered Rate, which is backed by government securities.

Because Greece is a member of the eurozone, it cannot unilaterally stimulate its economy
with monetary policy. For example, the U.S. Federal Reserve expanded its balance sheet by
over $1.3 trillion USD since the global financial crisis began, essentially printing new money
and injecting it into the system by purchasing outstanding debt.

Objections to proposed policies

The crisis is seen as a justification for imposing fiscal austerity on Greece in exchange for
European funding which would lower borrowing costs for the Greek government. The
negative impact of tighter fiscal policy could offset the positive impact of lower borrowing
costs and social disruption could have a significantly negative impact on investment and
growth in the longer term. Joseph Stiglitz has also criticised the EU for being too slow to
help Greece, insufficiently supportive of the new government, lacking the will power to set
up sufficient "solidarity and stabilisation framework" to support countries experiencing
economic difficulty, and too deferential to bond rating agencies.

Effect on other Eurozone Countries

• Ireland,Italy,Portugal and Spain • The UK

• Iceland • Latvia,Lithuania and Estonia

• Slovania • Belgium
Euro as a cause of Economic Crisis
1.Currency Devaluation
One of the core ideas of the euro is that the member nations will no longer be able to
devalue their currencies. Devaluation is a trick that constitutes a semi-default by a country.
Officially, no default is set into place, all loans are paid out in full – but in money worth
significantly less than when the loans were originally made.
Devaluations not only makes the national debt lose value, it also renders imports more
expensive and exports cheaper, creating at once austerity measures and improved
conditions for exports, both good for reversing problematic deficits. This is exactly what
Greece could use these days.

2.Monetary policy was too loose

In essence, for the past decade, Greece took advantage of a strong euro and rock-bottom
interest rates to fuel a debt binge by the country’s consumers and government.  The EU
treaty limits each nation’s deficits to about 3% of their gross domestic product.  So, when
Greece recently announced that its government deficit would be 12.7% (not the 3.7%
previously forecast), investors were stunned

3.Tourism Affected
Because the currency was of the economy was valued at a high rate ,tourism had become
very expensive for other countries like US.

Impact of European Crisis :

On November 30, 2010 Standard & Poor's announced rating the proposed EU treaty
changes regarding the seniority of private-sector creditors following the Ireland bailout.
They also downgraded Portugal by placing Portugal 'A-1' long-term and 'A-2' short-term
ratings on CreditWatch with negative implications. Next in stop light is Spain and Italy and
the European insurance companies.

Stock and Debt market reactions

The immediate consequences were the stock and debt market reactions. If these are
controlled or stalled than confidence will rebuild in the non-downgraded countries. The risk
of contagion to the financial markets and debt markets of other European continent nations
is the major consequence. This is very relevant as consumer confidence or sentiment is a
key component for economic activity. Debt markets affect borrowings like mortgages or
small business loans.

Fiscal Austerity
 If borrowing costs rise than the cost of doing business rises, for a government there is less
money to spend. This is why austerity is critical for servicing and reducing that debt.
Moral Hazard 
Moral Hazard is another consequence of bailouts. How does that the common man you ask,
look at the U.S. and the money that has been given to banks and the car companies, hardly
productive parts of the economy. With the EU/IMF bailout moral hazard is created by their
status as the lender of last resort. 

This is a pattern that the major nations have got into, and there are plenty of theories why,
Basically if a bank goes broke, then it should go bust, not bailed out by taxpayers through a
central bank as we have seen by multiple quantitative easing liquidity programs.

Polarized Community 
Another consequence of the Greek, Spain and Portugal downgrades is the common man’s
reactions. There are usually two disparate views, let them go broke or help them out. We
have seen this in the U.S. where it has become highly polarized this is classic socialist versus
free market ideology. Simply I want the Government to bail me out or I don’t want the
government to interfere anymore and waste my money.

You could argue politically going forward the Republicans will veto all tax increases and the
Democrats will veto all public spending cuts.

World Trade Disrupted 

Another consequence of the Greek, Spain and Portugal downgrades is, temporary or more
lasting if protectionism kicks in is a disruption to world trade.  There is always the potential
of a currency crisis when you are playing with such massive amounts of money, currency
and interest rate swaps and spreads. What we are seeing with these downgrades is more
money going towards debt financing and therefore more debt.

If our dollar weakens, than imports get more expensive. Protectionist policies also make
imports more expensive. Political influence in trade can cause exports to be too expensive
for importing countries and effect the economy as less money comes in.

Credit Shortage 
When credit is tight any disruption to the credit market can causes more exaggerated
tightening. Downgrades of sovereign debt flow put a further strain to the related debt. In
Greece for example we saw the Greek banks downgraded and banks or countries lending
are also affected.

Further countries that are suspect to contagion like Italy also reverberate with higher costs. 
If this leads to inflation credit can become unavailable or is prohibitively expensive.

Inflation, Hyperinflation and Social Security 

The danger as the consequences unfold of printing money as recklessly as we have in the US
is we are monetizing our debt which is likely to lead to higher inflation. Indeed we already
have as essentials such as food and energy rise.  This tends to negatively affect more the
poor and middle class than the rich. Thus the division between the rich and poor becomes
an ever widening chasm.
As countries unemployment or other social benefits grow there is an ever growing strain on
financés, the answer has been bailouts and monetization. One thing to note is that many
major benefit programs in like social security are linked to inflation. If it gets to the point
where we have high enough inflation social programs may be scaled back by governments.

We may see a massive reduction in what are deemed the unproductive areas of our society.
This would include government, finance and the military. This would see a defactor return of
control to local governments.  The flip side to this is the police state argument where the
government strives to centralize more control following an economic collapse to boost the
military and police, government, and finance or debt collection at the expense of local
government and the individual. 

Disruptive Consequences
These are some of the consequences of the Greek, Spain and Portugal downgrades. Focused
on the consequences that can be most disruptive you can be prepared for the worst & it
should develop this into the Global Financial crisis double dip. It is important to be prepared
for the next down leg in the world economy if there is one. When the underlying facts to the
global crisis hit the mainstream you should already be prepared before fear and loathing
penetrates the public consciousness.  

Impact on Euro

Even more alarming is the exposure of other EU banks to Greek debt, which totals
$193 billion, according to the Bank for International Settlements. Factor in the risk of
copycat crises in Portugal and Spain, and you begin to see the outlines of a disastrous
Europewide banking crisis. The only way out of that will be further compromises by the ECB
about the paper it accepts as collateral. When the euro was launched back in January 1999,
it was worth less than $1.20, and for most of its first three years it was down below parity
with the dollar. So its recent slide from close to $1.60 before the global financial crisis to
$1.27 last week is far from unprecedented. But the way this crisis is unfolding, further
declines seem likely. It will surely be at least a year before investors wake up to the fact that
the fiscal predicament of the United States is actually worse than that of the euro zone.

Contagion effect
Greece’s debt crisis and the contagion fears that come along with it are putting the future
of the euro currency into question, experts say. Greece is a relatively minor eurozone
economy, representing about 3 per cent of the region’s gross domestic product. Its
problems have hurt the euro partly because of fears over contagion – because other
eurozone countries such as Spain and Portugal also have large budget deficits and high
labour costs.

Criticism of euro-model
Some experts have suggested the euro model itself is flawed and lacks an overarching fiscal
policy. There’s no mechanism to adjust fundamentals when economies don’t grow in
tandem. The absence of real labour mobility and adherence to sovereign debt rules
threaten the currency's survival. Just the thought of Greece’s problems infecting debt-
ridden countries including Spain, Italy, Portugal and Ireland has left investors spooked and
challenged the euro’s robustness.

Degradation of euro
The cause of the European debt crisis, in its simplest form, was overspending by European
governments during the last decade, and especially after the 2008 financial crisis. The
recognition that overspending had occurred was brought about by reduced economic
growth and the subsequent reduced tax revenues, which were less than the amount needed
for both expenditures and dept payments.

One of the first concerns voiced at the start of the debt crisis — a concern that was acted
upon by foreign-exchange traders — was that if PIIGS governments defaulted on their
debts, the euro would decline in value.

First, it must be understood that, in the case of default, the possible monetary scenarios is
the monetary deflation due to a decrease in the money supply, in the case that no
government intervention takes place.

Monetary Deflation
1. If one or more governments defaulted, northern European banks, which were
large-scale investors in government debt, would have massive loan and
capital losses. The result of these losses would be banks going out of
business, calling in outstanding loans, or both, thereby reversing the money
multiplier process and causing a decline in the money supply. The falling
money supply — deflation — would make the euro more, not less, valuable.
2. However, a more realistic threat to the euro is that some governments might
shed it and return to their own domestic currency. Fed up with the (prudent)
restraint of money creation imposed upon them by the ECB, indebted
governments might want to be able to print their way out of their trouble.
But even if one or more countries walked away from the euro in favor of their
own currencies, the euro could still be protected by the ECB.

Pressure building on the currency

Since concerns began to heighten over the ability of Greece to service its debt at the turn of
the year, the single currency has been under relentless selling pressure.
Monetary Policy Response by European Central Bank (ECB)
ECB injected liquidity into European banks
Since the financial turbulence erupted in summer 2007, financial and economic
developments as well as central bank policy responses can be usefully examined and
assessed over two time periods. On July 2008, it raised its key policy rates by 25 basis points
to counter increasing inflationary pressures and medium-term inflation risks. But from the
onset of the crisis in August 2007, the ECB took swift and decisive action to provide liquidity
in the interbank money market to alleviate the stresses and ensure, to the maximum extent
possible, that liquidity problems would not turn into solvency problems, and that systemic
risk would be effectively contained.

During this period the Eurosystem engaged in active liquidity management adjusting the
intertemporal distribution of liquidity provision within the reserve maintenance period, but
without changing the total supply of bank reserves over the entire maintenance period (of,
in most cases, 28 days). At the same time, the maturity profile of the refinancing operations
was altered, with more central bank liquidity provided to banks for periods up to 3 months
(and as of March 2008, also up to 6 months), and correspondingly less in the weekly main
refinancing operations, so that the overall supply of central money was kept broadly
unchanged. As a result, between the end of June 2007 and the end of September 2008, the
balance sheet of the Eurosystem increased only moderately by about 100 billion euro. 

Federal Reserve used Euro-dollar swaps to make dollars available to ECB to

lend to banks.
Following the Lehman Brothers bankruptcy last September, banks became ever more
reluctant to lend to each other as a result of a sharp increase in the perceived risks of
counterparty default and a continued lack of transparency about the health of banks’
balance sheets. To reduce banks severe funding problems, the ECB took unprecedented
steps and increased its intermediation activity. Since last October, the ECB has provided
unlimited funding in euro at fixed interest rates over periods up to six months against an
expanded list of eligible assets for use as collateral in Eurosystem refinancing operations. In
addition, the ECB has supplied liquidity in other currencies, notably US dollars, on a basis of
a swap agreement with the Federal Reserve. This extraordinary expansion of liquidity
provided to euro area banks is reflected in the growth of the Eurosystem’s balance sheet.

ECB did not lower interest rates until October 2008 because of its focus on
inflation.
The transmission of the policy rates to money market interest rates is an important step but
it is also an intermediate one. The structure of the euro area financial system, with the
dominant role played by the banking system in the financing of the economy, implies that
the transmission of the ECB’s policy rates to the euro area bank lending rates is of utmost
relevance for economic activity. Until October 2008, the borrowing costs of households and
firms seemed to have increased compared to the policy rate, as bank lending standards
tightened and bank interest rates followed the path of the Euribor rate. But the substantial
reduction in policy rates and the unlimited provision of liquidity to the banking system over
the past seven months have resulted in a decline in bank lending rates, particularly as
regards short-term credit.

Assistance provided to crisis struck countries

On 9 May 2010 the 27 member states of the European Union agree to create the European
Financial Stability Facility (EFSF), a legal instrument aiming at preserving financial stability in
Europe by providing financial assistance to eurozone states in difficulty.
In order to reach these goals the Facility is devised in the form of a special purpose
vehicle (SPV) that will sell bonds and use the money it raises to make loans up to a
maximum of € 440 billion to eurozone nations in need. The bonds will be backed by
guarantees given by the European Commission representing the whole EU, the eurozone
member states, and the IMF. The new entity will sell debt only after an aid request is made
by a country.
The EFSF will be combined to a € 60 billion loan coming from the European financial
stabilization mechanism (reliant on guarantees given by the European Commission using the
EU budget as collateral) and to a € 250 billion loan backed by the IMF in order to obtain a
financial safety net up to € 750 billions. The agreement allows the European Central Bank to
start buying government debt which is expected to reduce bond yields.(Greek bond yields
fell from over 10% to just over 5%; Asian bonds yields also fell with the EU bailout.

Japan
Japanese Finance Minister Yoshihiko Noda said Tuesday that the government would
purchase eurozone bonds to help the region as it struggles with a debt crisis among some of
its members.
Noda said Japan would use its foreign-currency reserves to buy more than 20 per cent of the
bonds to be issued this month by the European Financial Stability Facility, the eurozone's
sovereign rescue fund, which aims to help debt-ridden European states

Germany
This would represent a transfer of resources from Germany and the other members of the
EU core to the crisis countries.  It would be the first step toward a fiscal union in which there
were ongoing payments from rich to poor European countries.  Again, this is not something
that will appeal to decision makers in Germany and the other members of core Europe.  The
cost, approximately 3 per cent of the combined GDP of Germany and France, would be
equivalent to the cost of recapitalizing those two countries’ bank

Impact of crisis on India

There Are Five Principle Channels Through Which The Developments In Europe Can
Percolate too the Indian Economy. Those Channels Are :

1.Trade Channels :
 Merchandise goods & commercial services.
  Major Exports To Germany, France, & UK.

 India Contributes Around 25% Of Commercial Services To European Countries.

 This Channel Did Not Affect Indian Economy Much.

2. Currency Channel
 Depreciation Of Euro Against Currencies Including Rupee.

 Profit Margin Negatively Impacted for Indian Exporters.

 Imports Relatively Cheaper; Benefits Imports of Machinery & equipments.

 Appreciation Of Rupee Could Also Undermine India’s Export Competitiveness.

3. Banking Channels
 Merchandise goods & commercial services.

 Major Exports To Germany, France, & UK.

 India Contributes Around 25% Of Commercial Services To European Countries.

 This Channel Did Not Affect Indian Economy Much.

4.Commodity price Channels

 Global Commodity PricesDirectly Affects Price Of Imports and Cost Of Products

 Oil Is One Of The Major Commodity Imported.

 Oil Imports In India Are Relatively Price Inelastic.

 Crude Oil Prices Were Raised To US$ 147/Barrel In July 2008

 The Demand For Crude Oil & Primary Commodities Was& Was Soaring Higher,
Whereas The Price Became The Supply Constraint.

Present Situation

1. Greece’s situation is simply unsustainable. This year, Greece needs to find at least
€53 billion just to avoid increasing its already massive debt. Even in a best case
scenario and with the help of foreign taxpayers, Greece is set to fall short of these
targets. The numbers simply do not add up and some sort of restructuring – or
additional help – therefore seems inevitable.

2. EU leaders are right to consider a Greek restructuring. However, the plan on the
table, which will see Greece buy back its own debt using even more money from the
EU/IMF bail-out funds, is unlikely to be sufficient and throws up a number of
problems:
 a. o Since it hinges on new loans, debt is not so much removed as transformed.
The plan will only reduce Greece’s debt by between 2.4% and 4.2%, meaning
that Greece’s debt to GDP will still top around 146-147% this year

b. The new loans offered at lower interest rates along with the rescheduling of
previous bailout funds effectively mean that the EU offers a country that has
mismanaged its finances even more cheap money – this raises huge moral
hazard concerns.

3. However, Greece’s problems ultimately stem from its lack of economic

competitiveness which a restructuring will not in itself solve. To address this
problem, Greece effectively has three options: completely reform the economy, rely
on permanent subsidies from stronger economies, or seek monetary independence,
allowing for currency devaluation.

4. The Greek debt to GDP ratio is forecast to reach 152% in 2011, around €341 billion,
and its total deficit will be running at around 9.3% (€20.85 billion).
This year, Greece needs to find at least another
Greek Funding gap 2011
€53.35 billion just to remain at its current levels of
€ bn
debt.The bail-out fund agreed by EU leaders last
Primary Budget Deficit 4.95
year is expected to pay out €46.5 billion, meaning
Debt Repayments 32.5
that even with the bail-out money, Greece is still Interest payments on
€6.85 billion short. Realistically, it cannot borrow debt 15.9
this money on the markets, as it would be forced to Total 53.35
pay an interest rate of around 11%, which is wholly unaffordable for the country. The
money simply has to come from somewhere else.

At the same time, the Greek economy is expected to shrink by 4% in 2011. The tax uptake in
the country remains small and patchy with tax evasion estimated to cost the government
around €20 billion a year.

5. Similarly, with inflation in the euro zone at its highest point for many years, hitting
2.4% in January,there is likely to be increasing pressure on the ECB from Germany to
increase interest rates. Such a move, while understandable from a German point of
view, would be detrimental to the Greek economy due to the high levels of private
sector debt and the lack of funding available in the economy. At a time when Greece
needs time to recover, increasing interest rates is the exact opposite policy to what
is needed. This shows the massive tensions at work within the euro zone.