Euro formation and its crisis

Financial risk management

Eurozone - Introduction
Eurozone is an Economic Monetary Union of 17 European

member states.
These states have adopted Euro as their sole trading

currency.
The Eurozone came into existence with the official launch of

the euro (alongside national currencies) on 1 January 1999.

Euro banknotes and coins were put into circulation for cash

payments on 1 January 2002.

Members of Eurozone
2011: Estonia
2009: Slovakia 2008: Cyprus, Malta 2007: Slovenia 2002: Introduction of euro

banknotes and coins

2001: Greece 1999: Belgium, Germany, Ireland,

Spain, France, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland

Eurozone formation
The Cold War made the European Union possible.
Through the Bretton Woods agreement, the United States

crafted an economic grouping that regenerated Western Europes economic fortunes under a security rubric.
The United States encouraged the economic and political

integration because it gave a political underpinning to a security alliance it imposed on Europe, i.e., NATO.

Eurozone formation (Contd..)

One of the major turning points that led to the formation of

Euro was when the United States abandoned the gold standard in 1971 .
Floating currencies raised the inevitability of currency

competition among the European states, the exact sort of competition that contributed to the Great Depression 40 years earlier.
Thus there was a need of a single currency that would be

used for the whole of the European Union.

Advantages of a single currency

The single European currency stimulates trade activities and

free movement of capital, goods and people but these effects should be subject to a profound academic research.
Obliteration of the existing exchange rate fluctuations

between a number of currencies and reduction of transaction costs.

The euro exchange rate does not offer shelter from currency

fluctuations in general but provides predictability and unifies the means of exchange in all countries in the Eurozone.

Convergence criteria
To join the eurozone, a country must abide by rigorous convergence

criteria.

The criteria include: 1. 2. 3.

A budget deficit of less than 3 percent of gross domestic product (GDP); Government debt levels of less than 60 percent of GDP; Annual inflation no higher than 1.5 percentage points above the average of the lowest three members annual inflation;

4.

A two-year trial period during which the acceding countrys national currency must float within a plus-or-minus 15 percent currency band against the euro.

European Central Bank

The European Central Bank and the national central banks

together constitute the Eurosystem, the central banking system of the euro area.
The main objective of the Eurosystem is to maintain price

stability: safeguarding the value of the euro.

Furthermore, it has the exclusive right to authorize the

issuance of euro banknotes.

Role of ECB
The Bank achieves its objectives by, among other means,

controlling the supply of money in the Eurozone and determining key interest rates.
The ECB also has the task of controlling the Eurozones foreign

currency reserves and of buying and selling individual currencies as required to keep exchange rates within reasonable limits.
Setting key interest rates is an important tool in the ECB arsenal. The ECB works closely with the central banks in all 27 EU member

countries. Collectively, the ECB and these member central banks form the European System of Central Banks (ESCB).

ROAD TO THE EURO

 On May 9,1950 France and Germany decided to pool their coal and

steel production.
This coal and steel community gradually evolved to a customs

union for free trade of goods.

After the fall of communism , democracy spread through Europe

and Greece, Spain , Portugal were brought into the union.

Soon borders were opened , freedom of personal movement was

guaranteed paving the way to full economic integration.

Hence creation of the euro was next logical step to complete the

sense of European unity.

THE (UNEASY) CASE FOR MONETARY UNION

Euro was introduced to make inter-country trades less

unpredictable. However trade among euro nations were up only 10-15% , not a transformative figure.
Assuming the euro would be as successful as the dollar was a

wrong notion from start because

Europe is not fiscally integrated. German taxpayers do not

pay for Irish bank bailouts or Greek pension funds.

Lack of a common language makes workers less

geographically mobile in times of high unemployment as compared to their American counterparts.

 Also by giving up on ones own currency, a country gives

up its economic flexibility.

In times of economic recession, effecting a wage cut is

extremely difficult.
But with ones own currency a country can simple

devalue it to effect a de-facto wage cut.

EUPHORIA EUROCRISIS
The euro officially came into existence on Jan 1, 1999.

However the final transition to European money happened after 3 years.

The creation of the euro instilled a new confidence especially

in those European countries which had historically been considered risky investments.
inflation and debt defaults.

An example of this was Greece, with a long history of high The risk premium on Greece bonds melted away because

investors thought incase of bankruptcy the European Central Bank(ECB) would bail it out.

 Country-specific fiscal woes had vanished. Greek bonds, Spanish

bonds, Irish bonds and Portuguese bonds traded as if they were as safe as German bonds.
The traditionally high interest rate countries went on a borrowing

spree which was largely financed by banks in Germany.

There was a huge real estate boom and prices rose 180%. Germany too recovered from a depression fuelled by the export

boom driven by its European neighbor's spending sprees.

Then the bubble burst.

 The financial crisis spread to Europe causing the real estate bubble to

burst and employment to crash since real estate accounted for 13% employment in Spain and Ireland.

Employment rates fell to 10% in Spain and 14% in Ireland. These governments ran into huge deficits since tax receipts that

depended on real estate transactions declined and cost of unemployment benefits soared.

Greece government ran into huge debts leading to flight of investors. Deflation is the only way to pull the European continent out of this

crisis. However apart from the obvious problem of driving down wages there is another problem.

 Collision between deflating incomes and unchanged

debt causes debtors to meet the same obligations with lower income.
This is done by further cutting down expenditure

thereby further pushing the economy into deeper recession in a vicious cycle.

FOUR WAYS OUT

Willingness to endure fiscal austerity and slashing of

wages to restore investor confidence.

Debt restructuring

Combination of default and devaluation

Revived Europeanism- convincing German taxpayers to

bear the brunt of bailouts.

Impact and Recovery Measures Of Euro Crisis

Recovery Measures
There are a wide range of recovery measures implemented

by the EU,ECB, and IMF .

1.

The ECB Attempted to Stimulate Economic Activity by Easing Collateral Requirements and Lending More Money.

2.

The ECB Began a Controversial Bond Buying Program in an Effort to Keep Borrowing Costs Down for Struggling Member States

Recovery Measures(Cont)
The ECB Offered Unlimited Dollar Loans to Further Stimulate

Economic Growth and Encourage Market Activity.

The EU, European Central Banks, and the IMF Unveiled a 750

Rescue Plan.

Formation of organisations like EFSF: (European Financial

Stability Facility),EFSM(European Financial Stabilisation Mechanism) to provide financial assistance.

Recovery Measures EFSF

EFSF: EUROEAN FINANCIAL STABILITY FACILITY:

In May 2010, the 27 EU member states agreed to create the EFSF, a legal instrument aiming at preserving financial stability in Europe by providing financial assistance to Eurozone states in difficulty through issue of bonds. It has financed the following eurozone countries

17.7 billion of the total 67.5 billion rescue package for Ireland (the rest was loaned from individual European countries, the European Commission and the IMF).
It contributed one-third of the 78 billion package for Portugal. As part of the second bailout for Greece, the loan was shifted to the EFSF, amounting to 164 billion . On 20 July 2012, European finance ministers sanctioned the first tranche of a partial bailout worth up to 100 billion for Spanish banks.[

Recovery Measures EFSM

European Financial Stabilisation Mechanism (EFSM):
On 5 January 2011, the European Union created the

EFSM, an emergency funding programme reliant upon funds raised on the financial markets and guaranteed by the European Commission using the budget of the European Union as collateral.
Under the EFSM, the EU successfully placed in the

capital markets a 5 billion issue of bonds as part of the financial support package agreed for Ireland, at a borrowing cost for the EFSM of 2.59%

Impact of Euro Crisis On

European Countries

US Economy

Indian Economy

Impact On US Economy
The Euro Crisis affected the US economy in the

following ways:

1.

Trade:
devaluation of the Euro that was triggered by the crisis made American exports more expensive.

Euro had depreciated against Euro by almost 15%. This

2. Decline in American manufacturing Sector:

Impact On US Economy (Cont)

3. Banking Sector:
The second concern related to the banking sector as the

banks across the Atlantic were highly integrated with each other, they were widely affected.

4. Unemployment was seen on a rise

Impact On Indian Economy

1.

Impact on Indian Financial markets:

The debt crisis had negatively impacted the Indian Stock Market as the Europeans had pulled out their funds from the Indian stock markets, further leading to lower foreign currency reserves.

2.

Trade: 27% of Indias trade was with European countries, (with 20% of exports and 13% of imports approx) and the euro crisis had impacted Indias exports to the region by a complete 1% decline.

Impact On IndianEconomy (Cont..)

3.Tourism:
Europe accounts for more than one-third of total tourist arrivals in

India. Travel receipts have also suffered.

4.Depreciated of the rupee:

Slow growth in Europe has coaxed the investors to invest in US

dollar. This has enabled the US dollar to appreciate as compared to other currencies in the world. Dropping exports coupled with rising crude oil prices has created immense pressure on Indian rupee, which in turn has depreciated with respect to US dollar.

Impact On Indian Economy (Cont..)

5. Slowdown in the manufacturing and the service sectors:
Due to the contraction in European and American

markets, the demand of goods and services from countries like India and China have slowed down .

6. No significant Impact on FDI flows in India

Current Scenario
The European Fiscal Compact that has come into force in 2013 is a

move towards a complete economic integration of eurozone countries, under the 3% grail this number marking the limit for national budget deficits.
To finance their expenses, states rely on their fiscal revenues and

on loans they take out on the financial markets .

Countries of Southern Europe have chosen to reach this goal

through violent cuts in public spending and a considerable raise of taxes.

Various other austerity measures are also taken to reduce spending

and cut more borrowing at various levels.

THANK YOU
-SUSHMITA BHATACHARYA -NISHIT HATHI -PRIYANKA JAIDEEP -RISHIKA PODDAR