Project Objectives and Scope

OBJECTIVE:
The objective behind taking a project on euro crisis is to study and analyze European
zone as major partner of india
SCOPE:
Project will be useful to common man who dont know reasons behind euro crisis and
consequences of euro crisis on india.

EXECUTIVE SUMMARY
The European economy is in the midst of the deepest recession since the 1930s, with
real GDP projected to shrink by some 4% in 2009, the sharpest contraction in the
history of the European Union. Although signs of improvement have appeared
recently, recovery remains uncertain and fragile. The EUs response to the downturn
has been swift and decisive. Aside from intervention to stabilise, restore and reform
the banking sector, the European Economic Recovery Plan (EERP) was launched in
December 2008. The objective of the EERP is to restore confidence and bolster
demand through a coordinated injection of purchasing power into the economy
complemented by strategic investments and measures to shore up business and labour
markets. The overall fiscal stimulus, including the effects of automatic stabilisers,
amounts to 5% of GDP in the EU.
According to the Commission's analysis, unless policies take up the new challenges,
potential GDP in the EU could fall to a permanently lower trajectory, due to several
factors. First, protracted spells of unemployment in the workforce tend to lead to a
permanent loss of skills. Second, the stock of equipment and infrastructure will
decrease and become obsolete due to lower investment. Third, innovation may be
hampered as spending on research and development is one of the first outlays that
businesses cut back on during a recession. Member States have implemented a range
of measures to provide temporary support to labour markets, boost investment in
public infrastructure and support companies. To ensure that the recovery takes hold
and to maintain the EUs growth potential in the long-run, the focus must increasingly
shift from short-term demand management to supply-side structural measures. Failing
to do so could impede the restructuring process or create harmful distortions to the
Internal Market. Moreover, while clearly necessary, the bold fiscal stimulus comes at
a cost. On the current course, public debt in the euro area is projected to reach 100%
of GDP by 2014. The Stability and Growth Pact provides the flexibility for the
necessary fiscal stimulus in this severe downturn, but consolidation is inevitable once
the recovery takes hold and the risk of an economic relapse has diminished
sufficiently. While respecting obligations under the Treaty and the Stability and
Growth Pact, a differentiated approach across countries is appropriate, taking into
2

account the pace of recovery, fiscal positions and debt levels, as well as the projected
costs of ageing, external imbalances and risks in the financial sector. Preparing exit
strategies now, not only for fiscal stimulus, but also for government support for the
financial sector and hard-hit industries, will enhance the effectiveness of these
measures in the short term, as this depends upon clarity regarding the pace with which
such measures will be withdrawn. Since financial markets, businesses and consumers
are forward-looking, expectations are factored into decision making today. The
precise timing of exit strategies will depend on the strength of the recovery, the
exposure of Member States to the crisis and prevailing internal and external
imbalances. Part of the fiscal stimulus stemming from the EERP will taper off in
2011, but needs to be followed up by sizeable fiscal consolidation in following years
to reverse the unsustainable debt build-up. In the financial sector, government
guarantees and holdings in financial institutions will need to be gradually unwound as
the private sector gains strength, while carefully balancing financial stability with
competitivenessconsiderations. Close coordination will be important. Vertical
coordination between the various strands of economic policy (fiscal, structural,
financial) will ensure that the withdrawal of government measures is properly
sequenced -- an important consideration as turning points may differ across policy
areas. Horizontal coordination between Member States will help them to avoid or
manage cross-border economic spillover effects, to benefit from shared learning and
to leverage relationships with the outside world. Moreover, within the euro area, close
coordination will ensure that Member States growthtrajectories do not diverge as the
economy recovers. Addressing the underlying causes of diverging competitiveness
must be an integral part of any exit strategy. The exit strategy should also ensure that
Europe maintains its place at the frontier of the low-carbon revolution by investing in
renewable energies, low carbon technologies and "green" infrastructure. The aim of
this study is to provide the analytical underpinning of such a coordinated exit strategy.

INDEX
Topic

Particulars

No

Page
No.

Introduction & History

Causes of euro crisis

Evaluation of crisis

11

Policy reaction

27

Economic Reforms and Recovery Proposal

37

Proposed long term solution

49

Controversies

53

Political impact

64

Euro crises-its impact on indian economy

67

10

Economic consequences of euro crises

73

-impact on actual & potential growth

-impact on labour,market& employee
-impact on budgetary policy
-impact on global inbalance
11

Conclusion

76

12

Bibliography

77

CHAPTER 1
INTRODUCTION

The euro zone crisis often referred to as the euro crisis or the sovereign debt crisisis
an ongoing crisis that has been affecting the countries of the eurozone since early
2009, when a group of 10 central and eastern European banks asked for a bailout.At
the time, the European Commission released a forecast of a 1.8 per cent decline in EU
economic output for 2009.The crisis made it difficult or impossible for some countries
in the eurozone to repay or refinance their government debt without the assistance of
third parties like the ECB or IMF Banks in the eurozone were undercapitalisedand
have faced liquidity and debt problems. Additionally, economic growth was slow in
the whole of the eurozone and was unequally distributed across the member
states.Governments of thestatesmost severely affected by the crisis have co-ordinated
their responses with a committee dubbed "the Troika" formed by three international
organisations:

the European

Commission,

the European

Central

Bank and

the International Monetary Fund.

In 1992, members of the European Union signed the Maastricht Treaty, under which
they pledged to limit their deficit spendingand debt levels. In the early 2000s, some
EU member states were failing to stay within the confines of the Maastricht criteria
and turned to securitizing future government revenues to reduce their debts and/or
deficits, sidestepping best practice and ignoring international standards. This allowed
the sovereigns to mask their deficit and debt levels through a combination of
techniques, including inconsistent accounting, off-balance-sheet transactions as well
as the use of complex currency and credit derivatives structures

From late 2009, fears of a sovereign default developed among investors as a result of
the rising private and government debt levels around the world together with a wave
of downgrading of government debt in some European states. Causes of the crisis
varied

by country.

In

several

countries,

private

debts

arising

from

property bubble were transferred to sovereign debt as a result of banking

5

system bailouts and government responses to slowing economies post-bubble. In

Greece, high public sector wage and pension commitments were connected to the debt
increase.The structure of the eurozone as a currency union (i.e., one currency)
without fiscal union (e.g., different tax and public pension rules) contributed to the
crisis and harmed the ability of European leaders to respond. European banks own a
significant amount of sovereign debt, such that concerns regarding the solvency of
banking systems or sovereigns are negatively reinforcing.
Concerns intensified in early 2010 and thereafter,leading European nations to
implement a series of financial support measures such as the European Financial
Stability Facility (EFSF) and European Stability Mechanism (ESM).
As well as the political measures and bailout programmes being implemented to
combat the eurozone crisis, the European Central Bank (ECB) has also done its part
by loweringinterest rates and providing cheap loans of more than one trillion euro to
maintain money flows between European banks. On 6 September 2012, the ECB also
calmed financial markets by announcing free unlimited support for all eurozone
countries involved in a sovereign state bailout/precautionaryprogrammes from
EFSF/ESM, through some yield loweringoutright Monetary Transactions (OMT).
The crisis had adverse economic effects for the worst hit countries, with
unemployment rates in Greece and Spain hitting 27%, and also had a major political
impact on the ruling governments in 8 out of 17 eurozone countries, contributing to
power shifts in Greece, Ireland, Italy, Portugal, Spain, Slovenia, Slovakia, and the
Netherlands.

CHAPTER 2
CAUSES OF EURO CRISIS
The reasons for the eurozone crisis are many and varied, with some general causes
and some country-specific factors. A summary of the key issues are provided in this
short note. The list is not exhaustive.
Over the past few years a number of countries in the eurozone Greece in May 2010
and February 2012, Ireland in November 2010, Portugal in May 2011, Spain in July
2012 for its banks and Cyprus in May 2013 have been forced into taking emergency
loans from other eurozone and EU governments and the IMF. These countries
governments asked for these loans when they became unable to fund their budget
deficits at sustainable interest rates on the financial markets and faced the prospect of
defaulting on their debt.
In return for the loans, these countries signed up to implement economic reforms and
public sector austerity intended to reduce their budget deficits and make their
economies more competitive. So, inability to borrow money on the markets to fund
deficits was the short-term factor behind the crisis, but what were the underlying
reasons behind it?

Causes of the crisis

2.1 One-size-fits-all monetary policy
The single currency began in 1999 with 11 member countries (there are now 18). As a
result, euro members gave control of monetary policy to the European Central Bank
(ECB) which sets interest rates for the whole of the eurozone. Some large countries,
notably Germany, had weak growth and this led to the ECB setting a relatively low
interest rate. However, this rate was too low for some booming economies like Ireland
and Spain and helped create large housing market bubbles there.
Also, by giving up an independent monetary policy and currency, countries with high
debt burdens were not able to use certain measures to respond to the crisis that
countries outside the euro (like the UK) could use. These include allowing higher
inflation (to reduce the debt burden), directly/indirectly depreciating your currency (to
7

promote exports) and buying up your own debt to avoid default (like in quantitative
easing programmes).

2.2 Misplaced confidence and assessment of risks

Debt in Greece and Portugal, as well as private sector debt in Portugal, Ireland and
Spain. The implication was that Borrowing costs for all euro zone governments
converged upon the euros creation, meaning countries, like Greece, that previously
had to offer a higher interest rate than, say, Germany to attract investment were now
able to borrow more cheaply. Likewise, private sector borrowing costs in these
countries also fell toward German levels. This fuelled a buildup of government
financial markets perceived every country in the eurozone to have virtually the same
risk of defaulting on their loans (perhaps assuming all eurozone countries were in it
together). Once the global financial crisis began in 2008, investors thought again.
Countries with high debt burdens and weak economies, such as Greece, soon saw
their borrowing costs rise.

2.3 Economic divergence and trade imbalances

As mentioned above, different economies in the eurozone were growing at different
speeds in the 2000s. Many of the countries that ultimately needed bailouts also saw
their economys productivity levels and competitiveness decline (due to higher
labourcosts) relative to the eurozone average (and especially Germany) during this
period. So, countries like Greece, Ireland and Spain, who were growing strongly and
buying lots of imports, were also becoming less competitive internationally. The
result was that a large trade deficit had to be funded by high levels of public and
private borrowing (which had become cheaper).
Once the financial crisis hit and borrowing costs starting rising for these countries,
confidence in their ability to repay this debt was called into question, making
financing it more difficult and expensive. The single currency also meant that the easy
way to regain competitiveness (at least in the short-term) of devaluing your currency
was not an option for these countries. Meanwhile, Germany had accumulated large
trade surpluses during this time, partly as a result of lowering its labour costs (through
restraint in wage growth).

2.4 Response to the crisis

When the euro was created, no mechanism was set up to deal with debt crises such as
those seen since 2010. As a result, emergency rescue plans had to be drawn up and
8

agreed on the hoof. The long drawn-out affairs that became synonymous with these
bailouts were viewed unfavourably by many. It also created the impression that the
larger eurozone countries that were providing the bulk of the loans were split as to
how best to resolve the crisis. This lack of decisive action weakened confidence in
international markets, prolonging the crisis.

2.5 Country-specific factors

The reasons leading up to the crisis were different for each country. Some of these
factors are summarised very briefly below:
Greece (loans totalling 240bn) high public sector debt, generous public sector
benefits, chronic tax evasion and weak competitiveness.
Ireland (loans totalling 85 billion, including 17.5 billion from Irish Treasury and
National Pension Reserve Fund) declining competitiveness and property bubble
funded by banks which went bust and were taken over and underwritten by the state,
causing government debt crisis.
Portugal (loans totalling 78bn) moderately high private and public sector debt,
weak competitiveness, and anaemic growth.
Spain (loans totalling 41bn) an ailing banking sector had lent heavily to
construction sector before the housing bubble burst.
Cyprus (loans totalling 10bn) collapse of the banking sector (massive relative to
size of economy), partly due to links to Greece.

The majority of the loans provided to the countries were funded by other eurozone
countries, with the IMF also contributing.
The eurozone crisis resulted from a combination of complex factors, including
the gloablisationof finance; easy credit conditions during the 20022008 period that
encouraged high-risk lending and borrowing practices; the financial crisis of 200708;
international trade imbalances; real estate bubbles that have since burst; the Great
Recession of 20082012; fiscal policy choices related to government revenues and
expenses; and approaches used by states to bail out troubled banking industries and
private bondholders, assuming private debt burdens or socialising losses.

A research report completed in 2012 for the United States Congress explains, "The
current eurozone crisis has been unfolding since 2009, when a new Greek government
revealed that previous Greek governments had been under-reporting the budget
deficit. The crisis subsequently spread to Ireland and Portugal, while raising concerns
about Italy, Spain and the European banking system, and more fundamental
imbalances within the eurozone"
The under-reporting was exposed through a revision of the forecast for the 2009
budget deficit from "68%" of GDP (no greater than 3% of GDP was a rule of
the Maastricht Treaty) to 12.7%, almost immediately after Pasok won the October
2009 national elections. Large upwards revision of budget deficit forecasts due to the
international financial crisis were not limited to Greece: for example, in the United
States forecast for the 2009 budget deficit was raised from $407 billion projected in
the 2009 fiscal year budget, to $1.4 trillion, while in the United Kingdom there was a
final forecast more than 4 times higher than the original. In Greece the low ("68%")
forecast was reported until very late in the year (September 2009), clearly not
corresponding to the actual situation.
The fact that the Greek debt exceeded $400 billion (over 120% of GDP) and France
owned 10% of that debt, struck terror into investors at the word "default". Although
market reaction was rather slow Greek 10-year government bond yield only
exceeded 7% in April 2010 they coincided with a large number of negative
articles, leading to arguments about the role of international news media and
other actors fuelling the crisis.
Contagion was considered possible. Greece was bailed out in 2010 with a 110 billion
euro direct loan by the European Union and the International Monetary Fund. After 2
years of fiscal austerity and Greek riots, another 130 billion euro loan was made.
Greek austerity programs greatly reduced public pensions and public wages.

10

CHAPTER 3
EVOLUTION OF EURO CRISIS

The 2009 annual budget deficit and public debt both relative to GDP, for selected
European countries. In the eurozone, the following number of countries were: SGPlimit compliant (3), Unhealthy (1), Critical (12), and Unsustainable (1).

The 2012 annual budget deficit and public debt both relative to GDP, for all eurozone
countries and UK. In the eurozone, the following number of countries were: SGPlimit compliant (3) Unhealthy (5), Critical (8), and Unsustainable (1).

11

In the first few weeks of 2010, there was renewed anxiety about excessive national
debt, with lenders demanding ever higher interest rates from several countries with
higher debt levels, deficits and current account deficits. This in turn made it difficult
for some governments to finance further budget deficits and service existing debt,
particularly when economic growth rates were low, and when a high percentage of
debt was in the hands of foreign creditors, as in the case of Greece and Portugal.
To fight the crisis some governments have focused on raising taxes and lowering
expenditures, which contributed to social unrest and significant debate among
economists, many of whom advocate greater deficits when economies are struggling.
Especially in countries where budget deficits and sovereign debts have increased
sharply, a crisis of confidence has emerged with the widening of bond yield
spreads and risk insurance on CDS between these countries and other EU member
states, most importantly Germany. By the end of 2011, Germany was estimated to
have made more than 9 billion out of the crisis as investors flocked to safer but near
zero interest rate German federal government bonds (bunds). By July 2012 also the
Netherlands, Austria and Finland benefited from zero or negative interest rates.
Looking at short-term government bonds with a maturity of less than one year the list
of beneficiaries also includes Belgium and France. While Switzerland (and
Denmark)equally benefited from lower interest rates, the crisis also harmed its export
sector due to a substantial influx of foreign capital and the resulting rise of the Swiss
franc. In September 2011 the Swiss National Bank surprised currency traders by
12

pledging that "it will no longer tolerate a euro-franc exchange rate below the
minimum rate of 1.20 francs", effectively weakening the Swiss franc. This is the
biggest Swiss intervention since 1978.
Despite sovereign debt having risen substantially in only a few eurozone countries,
with the three most affected countries Greece, Ireland and Portugal collectively only
accounting for 6% of the eurozone's gross domestic product (GDP),it has become a
perceived problem for the area as a whole, leading to speculation of further contagion
of other European countriesand a possible break-up of the eurozone. In total, the debt
crisis forced five out of 17 eurozone countries to seek help from other nations by the
end of 2012.
In mid-2012, due to successful fiscal consolidation and implementation of structural
reforms in the countries being most at risk and various policy measures taken by EU
leaders and the ECB (see below), financial stability in the eurozone has improved
significantly and interest rates have steadily fallen. This has also greatly diminished
contagion risk for other eurozone countries. As of October 2012 only 3 out of 17
eurozone countries, namely Greece, Portugal and Cyprus still battled with long term
interest rates above 6%.By early January 2013, successful sovereign debt auctions
across the eurozone but most importantly in Ireland, Spain, and Portugal, shows
investors believe the ECB-backstop has worked.In November 2013 ECB lowered
its bank rate to only 0.25% to aid recovery in the eurozone. As of May 2014 only two
countries (Greece and Cyprus) still need help from third parties.

13

In the early mid-2000s, Greece's economy was one of the fastest growing in the
eurozone and was associated with a largestructural deficit.As the world economy was
hit by the financial crisis of 200708, Greece was hit especially hard because its main
industriesshipping and tourismwere especially sensitive to changes in the
business cycle. The government spent heavily to keep the economy functioning and
the country's debt increased accordingly.
Despite the drastic upwards revision of the forecast for the 2009 budget deficit in
October 2009, Greek borrowing rates initially rose rather slowly. By April 2010 it
was apparent that the country was becoming unable to borrow from the markets; on
23 April 2010, the Greek government requested an initial loan of 45 billion from the
EU and International Monetary Fund (IMF), to cover its financial needs for the
remaining part of 2010.A few days later Standard & Poor's slashed Greece's sovereign
debt rating to BB+ or "junk" status amid fears of default, in which case investors were
liable to lose 3050% of their money. Stock markets worldwide and the euro currency
declined in response to the downgrade.

14

On 1 May 2010, the Greek government announced a series of austerity measures to

secure a three-year 110 billion loan.This was met with great anger by some Greeks,
leading to massive protests, riots and social unrest throughout Greece.The Troika, a
tripartite committee formed by the European Commission, the European Central
Bank and the International Monetary Fund (EC, ECB and IMF), offered Greece a
second bailout loan worth 130 billion in October 2011, but with the activation being
conditional on implementation of further austerity measures and a debt restructure
agreement. A bit surprisingly, the Greek prime minister George Papandreou first
answered that call by announcing a December 2011 referendum on the new bailout
plan,but had to back down amidst strong pressure from EU partners, who threatened
to withhold an overdue 6 billionloan payment that Greece needed by midDecember.On 10 November 2011 Papandreou resigned following an agreement with
thenew Democracy party and the Popular Orthodox Rally to appoint non-MP
technocrat Lucas Papademos as new prime minister of an interimnational union
government, with responsibility for implementing the needed austerity measures to
pave the way for the second bailout loan.
All the implemented austerity measures have helped Greece bring down its primary
deficiti.e., fiscal deficit before interest paymentsfrom 24.7bn (10.6% of GDP)
in 2009 to just 5.2bn (2.4% of GDP) in 2011, but as a side-effect they also
contributed to a worsening of the Greek recession, which began in October 2008 and
only became worse in 2010 and 2011. The Greek GDP had its worst decline in 2011
with 6.9%,a year where the seasonal adjusted industrial output ended 28.4% lower
than in 2005,and with 111,000 Greek companies going bankrupt (27% higher than in
2010).As a result, Greeks have lost about 40% of their purchasing power since the
start of the crisis[48] and the seasonal adjusted unemployment rate grew from 7.5% in
September 2008 to a record high of 27.9% in June 2013, while the youth
unemployment rate rose from 22.0% to as high as 62%.Youth unemployment ratio hit
16.1 per cent in 2012.
Overall the share of the population living at "risk of poverty or social exclusion" did
not increase noteworthily during the first 2 years of the crisis. The figure was
measured to 27.6% in 2009 and 27.7% in 2010 (only being slightly worse than the
EU27-average at 23.4%), but for 2011 the figure was now estimated to have risen

15

sharply above 33%.In February 2012, an IMF official negotiating Greek austerity
measures admitted that excessive spending cuts were harming Greece.
Some economic experts argue that the best option for Greece and the rest of the EU,
would be to engineer an "orderly ", allowing Athens to withdraw simultaneously from
the eurozone and reintroduce its national currency the drachma at a debased rate. If
Greece were to leave the euro, the economic and political consequences would be
devastating. According to Japanese financial company Nomuraan exit would lead to a
60% devaluation of the new drachma. Analysts at French bank BNP Paribas added
that the fallout from a Greek exit would wipe 20% off Greece's GDP, increase
Greece's debt-to-GDP ratio to over 200%, and send inflation soaring to 40%
50%. Also ubswarned of hyperinflation, a bank run and even "military coups and
possible civil war that could afflict a departing country". Eurozone National Central
Banks (ncbs) may lose up to 100bn in debt claims against the Greek national
bank through the ECB's TARGET2 system. The Deutsche Bundesbank alone may
have to write off 27bn.
To prevent this from happening, the Troika (EC, IMF and ECB) eventually agreed in
February 2012 to provide a second bailout package worth 130 billion,conditional on
the implementation of another harsh austerity package, reducing the Greek spendings
with 3.3bn in 2012 and another 10bn in 2013 and 2014. Then in March 2012, the
Greek government did finally default on its debt, which was the largest default in
history by a government, about twice as big as Russia's 1918 default. This counted as
a "credit event" and holders of credit default swaps were paid accordingly. This
included a new law passed by the government so that private holders of Greek
government bonds (banks, insurers and investment funds) would "voluntarily" accept
a bond swap with a 53.5% nominal write-off, partly in short-term EFSF notes, partly
in new Greek bonds with lower interest rates and the maturity prolonged to 1130
years (independently of the previous maturity).It is the world's biggest debt
restructuring deal ever done, affecting some 206 billion of Greek government
bonds. The debt write-off had a size of 107 billion, and caused the Greek debt level
to fall from roughly 350bn to 240bn in March 2012, with the predicted debt burden
now showing a more sustainable size equal to 117% of GDP by 2020, somewhat
lower than the target of 120.5% initially outlined in the signed Memorandum with the
Troika.
16

Critics such as the director of LSE's Hellenic Observatory argue that the billions of
taxpayer euros are not saving Greece but financial institutions,as "more than 80 % of
the rescue package is going to creditorsthat is to say, to banks outside of Greece
and to the ECB."The shift in liabilities from European banks to European taxpayers
has been staggering. One study found that the public debt of Greece to foreign
governments, including debt to the EU/IMF loan facility and debt through the
eurosystem, increased from 47.8bn to 180.5bn (+132,7bn) between January 2010
and September 2011,while the combined exposure of foreign banks to (public and
private) Greek entities was reduced from well over 200bn in 2009 to around 80bn
(120bn) by mid-February 2012.
Mid May 2012 the crisis and impossibility to form a new government after elections
and the possible victory by the anti-austerity axis led to new speculations Greece
would have toleave the eurozone shortly due.This phenomenon became known as
"Grexit" and started to govern international market behaviour. The centre-right's
narrow victory in the 17 June election gave hope that Greece would honour its
obligations and stay in the Euro-zone.
Due to a delayed reform schedule and a worsened economic recession, the new
government immediately asked the Troika to be granted an extended deadline from
2015 to 2017 before being required to restore the budget into a self-financed situation;
which in effect was equal to a request of a third bailout package for 201516 worth
32.6bn of extra loans. On 11 November 2012, facing a default by the end of
November, the Greek parliament passed a new austerity package worth
18.8bn,including a "labour market reform" and "midterm fiscal plan 201316". In
return, the Eurogroup agreed on the following day to lower interest rates and prolong
debt maturities and to provide Greece with additional funds of around 10bn for
a debt-buy-back programme. The latter allowed Greece to retire about half of the 62
billion in debt that Athens owes private creditors, thereby shaving roughly 20
billion off that debt. This should bring Greece's debt-to-GDP ratio down to 124% by
2020 and well below 110% two years later, Without agreement the debt-to-GDP ratio
would have risen to 188% in 2013.
The Financial Times special report on the future of the European Union argues that
the liberalization of labour markets has allowed Greece to narrow the cost17

competitiveness gap with other southern eurozone countries by approximately 50%

over the past two years.This has been achieved primary through wage reductions,
though businesses have reacted positively.The opening of product and service markets
is proving tough because interest groups are slowing reforms. The biggest challenge
for Greece is to overhaul the tax administration with significant part of annually
assessed taxes not paid.Poul Thomsen, the IMF official who heads the bailout mission
in Greece, stated that "in structural terms, Greece is more than halfway there."
In June 2013 Equity index provider MSCI Inc. Reclassified Greece as an emerging
market, citing failure to qualify on several criteria for market accessibility.
On 10 April 2014, Greece returned to international capital markets, issuing bonds
worth 3 billion.

3.1 IRELAND

The Irish sovereign debt crisis was not based on government over-spending, but from
the state guaranteeing the six main Irish-based banks who had financed a property
bubble. On 29 September 2008, Finance Minister Brian Lenihan, Jnr issued a twoyear guarantee to the banks' depositors and bond-holders. The guarantees were
subsequently renewed for new deposits and bonds in a slightly different manner. In
2009, an National Asset Management Agency (NAMA), was created to acquire large
property-related loans from the six banks at a market-related "long-term economic
value".
18

Irish banks had lost an estimated 100 billion euros, much of it related to defaulted
loans to property developers and homeowners made in the midst of the property
bubble, which burst around 2007. The economy collapsed during 2008.
Unemployment rose from 4% in 2006 to 14% by 2010, while the national budget
went from a surplus in 2007 to a deficit of 32% GDP in 2010, the highest in the
history of the eurozone, despite austerity measures.
With Ireland's credit rating falling rapidly in the face of mounting estimates of the
banking losses, guaranteed depositors and bondholders cashed in during 200910, and
especially after August 2010. (The necessary funds were borrowed from the central
bank.) With yields on Irish Government debt rising rapidly it was clear that the
Government would have to seek assistance from Together with additional 17.5
billioncoming from Ireland's own reserves and pensions, the government received 85
billion, of which up to 34 billion was to be used to support the country's failing
financial sector (only about half of this was used in that way following stress tests
conducted in 2011).In return the government agreed to reduce its budget deficit to
below three per cent by 2015.

In April 2011, despite all the measures

taken, Moody's downgraded the banks' debt to junk status.

In July 2011 European leaders agreed to cut the interest rate that Ireland was paying
on its EU/IMF bailout loan from around 6% to between 3.5% and 4% and to double
the loan time to 15 years. The move was expected to save the country between 600
700 million euros per year. On 14 September 2011, in a move to further ease Ireland's
difficult financial situation, the European Commission announced it would cut the
interest rate on its 22.5 billion loan coming from the European Financial Stability
Mechanism, down to 2.59 per centwhich is the interest rate the EU itself pays to
borrow from financial markets.
The Euro Plus Monitor report from November 2011 attests to Ireland's vast progress
in dealing with its financial crisis, expecting the country to stand on its own feet again
and finance itself without any external support from the second half of 2012
onwards. According to the Centre for Economics and Business Research Ireland's
export-led recovery "will gradually pull its economy out of its trough". As a result of
the improved economic outlook, the cost of 10-year government bonds has fallen

19

from its record high at 12% in mid July 2011 to below 4% in 2013 (see the graph
"Long-term Interest Rates").
On 26 July 2012, for the first time since September 2010, Ireland was able to return to
the financial markets selling over 5 billion in long-term government debt, with an
interest rate of 5.9% for the 5-year bonds and 6.1% for the 8-year bonds at salein
December 2013, after three years on financial life support, Ireland finally left the
EU/IMF bailout programme, although it retained a debt of 22.5 billion to the IMF,
which in August 2014 early repayment of 15 billion was being considered, which
would save the country 375 million in surcharges. Despite the end of the bailout the
country's unemployment rate remains high and public sector wages are still around
20% lower than at the beginning of the crisis. Government debt reached 123.7% of
GDP in 2013.
On 13 March 2013, Ireland managed to regain complete lending access on financial
markets, when it successfully issued 5bn of 10-year maturity bonds at a yield of
4.3%. Ireland ended its bailout programme as scheduled in December 2013, without
any need for additional financial support.
3.2 PORTUGAL
According

to

report

by the Dirio

de

Notcias Portugal

had

allowed

considerable slippage in state-managed public worksand inflated top management and

head officer bonuses and wages in the period between the Carnation Revolution in
1974 and 2010. Persistent and lasting recruitment policies boosted the number of
redundant public servants. Risky credit, public debtcreation, and European structural
and cohesion funds were mismanaged across almost four decades. When the global
crisis disrupted the markets and the world economy, together with the US credit
crunch and the eurozone crisis, Portugal was one of the first and most affected
economies to succumb.
In the summer of 2010, Moody's Investors Service cut Portugal's sovereign
bond rating, which led to an increased pressure on Portuguese government bonds.In
the first half of 2011, Portugal requested a 78 billion IMF-EU bailout package in a
bid to stabilise its public finances.These measures were put in place as a direct result
of decades-long governmental overspending and an over bureaucratised civil service.
20

After the bailout was announced, the Portuguese government headed by Pedro Passos
Coelho managed to implement measures to improve the State's financial situation and
the country started to be seen as moving on the right track. This also led to a strong
increase of the unemployment rate to over 15 per cent in the second quarter 2012 and
it is expected to rise even further in the near future.
Portugal's debt was in September 2012 forecast by the Troika to peak at around 124%
of GDP in 2014, followed by a firm downward trajectory after 2014. Previously the
Troika had predicted it would peak at 118.5% of GDP in 2013, so the developments
proved to be a bit worse than first anticipated, but the situation was described as fully
sustainable and progressing well. As a result from the slightly worse economic
circumstances, the country has been given one more year to reduce the budget deficit
to a level below 3% of GDP, moving the target year from 2013 to 2014. The budget
deficit for 2012 has been forecast to end at 5%. The recession in the economy is now
also projected to last until 2013, with GDP declining 3% in 2012 and 1% in 2013;
followed by a return to positive real growth in 2014.
As part of the bailout programme, Portugal was required to regain complete access to
financial markets by September 2013. The first step towards this target was
successfully taken on 3 October 2012, when the country managed to regain partial
market access by selling a bond series with 3-year maturity. Once Portugal regains
complete market access, measured as the moment it successfully manage to sell a
bond series with a full 10-year maturity, it is expected to benefit from interventions by
the ECB, which announced readiness to implement extended support in the form of
some yield-lowering bond purchases (omts),aiming to bring governmental interest
rates down to sustainable levels. A peak for the Portuguese 10-year governmental
interest rates happened on 30 January 2012, where it reached 17.3% after the rating
agencies had cut the governments credit rating to "non-investment grade" (also
referred to as "junk").As of December 2012, it has been more than halved to only
7%.A successful return to the long-term lending market was made by the issuing of a
5-year maturity bond series in January 2013,and the state regained complete lending
access when it successfully issued a 10-year maturity bond series on 7 May 2013.
According to the Financial Times special report on the future of the European Union,
the Portuguese government has "made progress in reforming labour legislation,
21

cutting previously generous redundancy payments by more than half and freeing
smaller employers from collective bargaining obligations, all components of
Portugal's 78 billion bailout program." Additionally, unit labour costs have fallen
since 2009, working practices are liberalizing, and industrial licensing is being
streamlined.
On 18 May 2014 Portugal left the EU bailout mechanism without additional need for
support, as it had already regained a complete access to lending markets back in May
2013,and with its latest issuing of a 10-year government bond being successfully
completed with a rate as low as 3.59%. Portugal still has many tough years ahead.
During the crisis Portugal's government debt increased from 93 to 139 percent of
GDP. It may take until 2040 that the country will have paid off EU loans and
eventually reach a sustainable debt level of 60 percent.On 3 August 2014, Banco de
Portugal announced the country's second biggest bank bancoespirito Santo would be
split in two after losing the equivalent of $4.8 billion in the first 6 months of 2014,
sending its shares down by 89 percent.

3.3SPAIN

Spain had a comparatively low debt level among advanced economies prior to the
crisis.Its public debt relative to GDP in 2010 was only 60%, more than 20 points less
22

than Germany, France or the US, and more than 60 points less than Italy, Ireland or
Greece.Debt was largely avoided by the ballooning tax revenue from the housing
bubble, which helped accommodate a decade of increased government spending
without debt accumulation.When the bubble burst, Spain spent large amounts of
money on bank bailouts. In May 2012, Bankia received a 19 billion euro bailout,on
top of the previous 4.5 billion euros to prop up Bankia. Questionable accounting
methods disguised bank losses.During September 2012, regulators indicated that
Spanish banks required 59 billion (USD $77 billion) in additional capital to offset
losses from real estate investments.
The bank bailouts and the economic downturn increased the country's deficit and debt
levels and led to a substantial downgrading of its credit rating. To build up trust in the
financial markets, the government began to introduce austerity measures and in 2011
it passed a law in congress to approve an amendment to the Spanish Constitution to
require a balanced budget at both the national and regional level by 2020.The
amendment states that public debt cannot exceed 60% of GDP, though exceptions
would be made in case of a natural catastrophe, economic recession or other
emergencies.As one of the largest eurozone economies (larger than Greece, Portugal
and Ireland combined) the condition of Spain's economy is of particular concern to
international observers. Under pressure from the United States, the IMF, other
European countries and the European Commissionthe Spanish governments
eventually succeeded in trimming the deficit from 11.2% of GDP in 2009 to an 7.1%
in 2013.
Nevertheless, in June 2012, Spain became a prime concern for the Euro-zone when
interest on Spain's 10-year bonds reached the 7% level and it faced difficulty in
accessing bond markets. This led the Eurogroup on 9 June 2012 to grant Spain a
financial support package of up to 100 billion.The funds will not go directly to
Spanish banks, but be transferred to a government-owned Spanish fund responsible to
conduct the needed bank recapitalisations (FROB), and thus it will be counted for as
additional sovereign debt in Spain's national account. An economic forecast in June
2012 highlighted the need for the arranged bank recapitalisation support package, as
the outlook promised a negative growth rate of 1.7%, unemployment rising to 25%,
and a continued declining trend for housing prices. In September 2012 the ECB
removed some of the pressure from Spain on financial markets, when it announced its
23

"unlimited bond-buying plan", to be initiated if Spain would sign a new sovereign

bailout package with EFSF/ESM.
According to the latest debt sustainability analysis published by the European
Commission in October 2012, the fiscal outlook for Spain, if assuming the country
will stick to the fiscal consolidation path and targets outlined by the country's current
EDP programme, will result in a debt-to-GDP ratio reaching its maximum at 110% in
2018followed by a declining trend in subsequent years. In regards of the structural
deficit the same outlook has promised, that it will gradually decline to comply with
the maximum 0.5% level required by thefiscal Compact in 2022/2027.
Though Spain is suffering with 27% unemployment and an economy set to shrink by
1.4% in 2013, Mariano Rajoy's conservative government has pledged to speed up
reforms, according to the Financial Times special report on the future of the European
Union. "Madrid is reviewing its labour market and pension reforms and has promised
by the end of this year to liberalize its heavily regulated professions."But Spain is
benefiting from improved labour cost competitiveness.[90] "They have not lost export
market share," says Eric Chaney, chief economist at Axa."If credit starts flowing
again, Spain could surprise us."
On 23 January, as foreign investor confidence in the country has been restored, Spain
formally exited the EU/IMF bailout mechanism.
3.4 CYPRUS

24

Cyprus's debt percentage compared to eurozone average since 1999

The economy of the small island of Cyprus with 840,000 people was hit by several
huge blows in and around 2012 including, amongst other things, the 22 billion
exposure of Cypriot banks to the Greek debt haircut, the downgrading of the Cypriot
economy into junk status by international rating agencies and the inability of the
government to refund its state expenses.
On 25 June 2012, the Cypriot Government requested a bailout from the European
Financial Stability Facility or the European Stability Mechanism, citing difficulties in
supporting its banking sector from the exposure to the Greek debt haircut.
On 30 November the Troika (the European Commission, the International Monetary
Fund, and the European Central Bank) and the Cypriot Government had agreed on the
bailout terms with only the amount of money required for the bailout remaining to be
agreed upon. Bailout terms include strong austerity measures, including cuts in civil
service salaries, social benefits, allowances and pensions and increases in VAT,
tobacco, alcohol and fuel taxes, taxes on lottery winnings, property, and higher public
health care charges. At the insistence of the EU negotiators, at first the proposal also
included an unprecedented one-off levy of 6.7% for deposits up to 100.000 and 9.9%
for higher deposits on all domestic bank accounts.Following public outcry, the
eurozone finance ministers were forced to change the levy, excluding deposits of less
than 100,000, and introducing a higher 15.6% levy on deposits of above 100,000
25

($129,600); in line with the EU minimum deposit guarantee. This revised deal was
also rejected by the Cypriot parliament on 19 March 2013 with 36 votes against, 19
abstentions and one not present for the vote.
The final agreement was settled on 25 March 2013, with the proposal to close the
most troubled Laiki Bank, which helped significantly to reduce the needed loan
amount for the overall bailout package, so that 10bn was sufficient without need for
imposing a general levy on bank deposits. The final conditions for activation of the
bailout package was outlined by the Troika's mou agreement, which was endorsed in
full by the Cypriot House of Representatives on 30 April 2013. It includes:
1. Recapitalisation of the entire financial sector while accepting a closure of the
Laiki bank,
2. Implementation of the anti-money laundering framework in Cypriot financial
institutions,
3. Fiscal consolidation to help bring down the Cypriot governmental budget
deficit,
4. Structural reforms to restore competitiveness and macroeconomic imbalances,
5. Privatization programme.
The Cypriot debt-to-GDP ratio is on this background now forecasted only to peak at
126% in 2015 and subsequently decline to 105% in 2020, and thus considered to
remain within sustainable territory.

26

CHAPTER 4
POLICY REACTION

4.1 EU emergency measures

The table below provides an overview of the financial composition of all bailout
programs being initiated for EU member states, since the Global Financial
Crisis erupted in September 2008. EU member states outside the eurozone (marked
with yellow in the table) have no access to the funds provided by EFSF/ESM, but can
be covered with rescue loans from EU's Balance of Payments programme (bop), IMF
and bilateral loans (with an extra possible assistance from the Worldbank/EIB/EBRD
if classified as a development country). Since October 2012, the ESM as a permanent
new financial stability fund to cover any future potential bailout packages within the
eurozone, has effectively replaced the now defunct GLF + EFSM + EFSF funds.
Whenever pledged funds in a scheduled bailout program were not transferred in full,
the table has noted this by writing "Y out of X".

4.2 European Financial Stability Facility (EFSF)

On 9 May 2010, the 27 EU member states agreed to create the European Financial
Stability Facility, a legal instrumentaiming at preserving financial stability in Europe
by providing financial assistance to eurozone states in difficulty. The EFSF can issue
bonds or other debt instruments on the market with the support of the German Debt
Management Office to raise the funds needed to provide loans to eurozone countries
in financial troubles,recapitalise banks or buy sovereign debt.
Emissions of bonds are backed by guarantees given by the euro area member states in
proportion to their share in the paid-up capital of the European Central Bank. The
440 billion lending capacity of the facility is jointly and severally guaranteed by the
eurozone countries' governments and may be combined with loans up to 60 billion
from the European Financial Stabilisation Mechanism (reliant on funds raised by
the European Commission using the EU budget as collateral) and up to 250 billion

27

from the International Monetary Fund (IMF) to obtain a financial safety net up to
750 billion.
The EFSF issued 5 billion of five-year bonds in its inaugural benchmark issue 25
January 2011, attracting an order book of 44.5 billion. This amount is a record for
any sovereign bond in Europe, and 24.5 billion more than the European Financial
Stabilisation Mechanism (EFSM), a separate European Union funding vehicle, with a
5 billion issue in the first week of January 2011.
On 29 November 2011, the member state finance ministers agreed to expand the
EFSF by creating certificates that could guarantee up to 30% of new issues from
troubled euro-area governments, and to create investment vehicles that would boost
the EFSF's firepower to intervene in primary and secondary bond markets.

4.3 Reception by financial markets

Stocks surged worldwide after the EU announced the EFSF's creation. The facility
eased fears that the Greek debt crisis would spread, and this led to some stocks rising
to the highest level in a year or more.The euro made its biggest gain in 18
months, before falling to a new four-year low a week later.Shortly after the euro rose
again as hedge funds and other short-term tradersunwound short positions and carry
trades in the currency.Commodity prices also rose following the announcement.The
dollar Libor held at a nine-month high. Default swaps also fell.The VIX closed down
a record almost 30%, after a record weekly rise the preceding week that prompted the
bailout. The agreement is interpreted as allowing the ECB to start buying government
debt from the secondary market which is expected to reduce bond yields. As a result
Greek bond yields fell sharply from over 10% to just over 5%.Asian bonds yields also
fell with the EU bailout.

4.4 Usage of EFSF funds

The EFSF only raises funds after an aid request is made by a country. As of the end of
July 2012, it has been activated various times. In November 2010, it financed 17.7
billionof the total 67.5 billion rescue package for Ireland (the rest was loaned from
individual European countries, the European Commission and the IMF). In May 2011
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
28

billion (130bn new package plus 34.4bn remaining from Greek Loan Facility)
throughout 2014. On 20 July 2012, European finance ministers sanctioned the first
tranche of a partial bail-out worth up to 100 billion for Spanish banks. This leaves
the EFSF with 148 billionor an equivalent of 444 billion in leveraged firepower.
The EFSF is set to expire in 2013, running some months parallel to the
permanent 500 billion rescue funding program called the European Stability
Mechanism (ESM), which will start operating as soon as member states representing
90% of the capital commitments have ratified it. (see section: ESM)
On 13 January 2012, Standard & Poor's downgraded France and Austria from AAA
rating, lowered Spain, Italy (and five other) euro members further, and maintained the
top credit rating for Finland, Germany, Luxembourg, and the Netherlands; shortly
after, S&P also downgraded the EFSF from AAA to AA+.

4.5 European Financial Stabilisation Mechanism (EFSM)

On 5 January 2011, the European Union created the European Financial Stabilisation
Mechanism (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. It runs under the supervision of the
Commission and aims at preserving financial stability in Europe by providing
financial assistance to EU member states in economic difficulty. The Commission
fund, backed by all 27 European Union members, has the authority to raise up to 60
billionand is rated AAA by Fitch, Moody's and Standard & Poor's.
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%.
Like the EFSF, the EFSM was replaced by the permanent rescue funding programme
ESM, which was launched in September 2012.

4.6 Brussels agreement and aftermath

On 26 October 2011, leaders of the 17 eurozone countries met in Brussels and agreed
on a 50% write-off of Greek sovereign debt held by banks, a fourfold increase (to
about 1 trillion) in bail-out funds held under the European Financial Stability
29

Facility, an increased mandatory level of 9% for bank capitalisation within the EU

and a set of commitments from Italy to take measures to reduce its national debt. Also
pledged was 35 billion in "credit enhancement" to mitigate losses likely to be
suffered by European banks. Jos Manuel Barrosocharacterised the package as a set
of "exceptional measures for exceptional times".
The package's acceptance was put into doubt on 31 October when Greek Prime
Minister George Papandreou announced that a referendum would be held so that the
Greek people would have the final say on the bailout, upsetting financial markets.On
3 November 2011 the promised Greek referendum on the bailout package was
withdrawn by Prime Minister Papandreou.
In late 2011, Landon Thomas in the New York Times noted that some, at least,
European banks were maintaining high dividend payout rates and none were getting
capital injections from their governments even while being required to improve
capital ratios. Thomas quoted Richard Koo, an economist based in Japan, an expert on
that country's banking crisis, and specialist in balance sheet recessions, as saying:
I do not think Europeans understand the implications of a systemic banking crisis.
When all banks are forced to raise capital at the same time, the result is going to be
even weaker banks and an even longer recession if not depression Government
intervention should be the first resort, not the last resort.
Beyond equity issuance and debt-to-equity conversion, then, one analyst "said that as
banks find it more difficult to raise funds, they will move faster to cut down on loans
and unload lagging assets" as they work to improve capital ratios. This latter
contraction of balance sheets "could lead to a depression", the analyst said.Reduced
lending was a circumstance already at the time being seen in a "deependingcrisis"
in commodities trade finance in western Europe.

4.7 Final agreement on the second bailout package

In a marathon meeting on 20/21 February 2012 the Eurogroup agreed with the IMF
and the Institute of International Finance on the final conditions of the second bailout
package worth 130 billion. The lenders agreed to increase the nominal haircut from
50% to 53.5%. EU Member States agreed to an additional retroactive lowering of the
interest rates of the Greek Loan Facility to a level of just 150 basis points above
30

the Euribor. Furthermore, governments of Member States where central banks

currently hold Greek government bonds in their investment portfolio commit to pass
on to Greece an amount equal to any future income until 2020. Altogether this should
bring down Greece's debt to between 117%and 120.5% of GDP by 2020.

4.8 European Central Bank

ECB Securities Markets Program (SMP) covering bond purchases since May 2010
The European Central Bank (ECB) has taken a series of measures aimed at reducing
volatility in the financial markets and at improving liquidity.
In May 2010 it took the following actions:
It

began open

market

operations buying

government

and

securities,reaching 219.5 billion in February 2012, though it

private

debt

simultaneously

absorbed the same amount of liquidity to prevent a rise in inflation. According

torabobank economist Elwin de Groot, there is a "natural limit" of 300 billion the
ECB can sterilise
It reactivated the dollar swap lineswith Federal Reserve support.
It changed its policy regarding the necessary credit rating for loan deposits, accepting
as collateral all outstanding and new debt instruments issued or guaranteed by the
Greek government, regardless of the nation's credit rating.
31

The move took some pressure off Greek government bonds, which had just been
downgraded to junk status, making it difficult for the government to raise money on
capital markets.
On 30 November 2011, the ECB, the US Federal Reserve, the central banks of
Canada, Japan, Britain and the Swiss National Bank provided global financial markets
with additional liquidity to ward off the debt crisis and to support the real economy.
The central banks agreed to lower the cost of dollar currency swaps by 50 basis points
to come into effect on 5 December 2011. They also agreed to provide each other with
abundant liquidity to make sure that commercial banks stay liquid in other currencies.
With the aim of boosting the recovery in the eurozone economy by lowering interest
rates for businesses, the ECB cut its bank rates in multiple steps in 20122013,
reaching an historic low of 0.25% in November 2013. The lowered borrowing rates
have also caused the euro to fall in relation to other currencies, which is hoped will
boost exports from the eurozone and further aid the recovery.
With inflation falling to 0.5% in May 2014, the ECB again took measures to stimulate
the eurozone economy which grew at just 0.2% during the first quarter of
2014. (Deflation or very low inflation encourages holding cash, causing a decrease in
purchases.) On 5 June, the central bank cut the prime interest rate to 0.15%, and set
the deposit rate at -0.10%.The latter move in particular was seen as "a bold and
unusual move", as a negative interest rate had never been tried on a wide-scale
before.Additionally, the ECB announced it would offer long-term four-year loans at
the cheap rate (normally the rate is primarily for overnight lending), but only if the
borrowing banks met strict conditions designed to ensure the funds ended up in the
hands of businesses instead of, for example, being used to buy low risk government
bonds.Collectively, the moves are aimed at avoiding deflation, devaluing the euro to
make exportation more viable, and at increasing "real world" lending.
Stock markets reacted strongly to the ECB rate cuts. The German DAX index, for
example, set a record high the day the new rates were announced. Meanwhile, the
euro briefly fell to a four month low against the dollar.However, due to the
unprecedented nature of the negative interest rate, the long term effects of the
stimulus measures are hard to predict.Bank president Mario Draghi signaled the
central bank was willing to do whatever it takes to turn around the eurozone
32

economies, remarking "Are we finished? The answer is no." He laid the groundwork
for large scale bond repurchasing, a controversial idea known as quantitative easing

4.9 Resignations
In September 2011, Jrgen Stark became the second German after Axel A. Weber to
resign from the ECB Governing Council in 2011. Weber, the former Deutsche
Bundesbankpresident, was once thought to be a likely successor to Jean-Claude
Trichet as bank president. He and Stark were both thought to have resigned due to
"unhappiness with the ECB's bond purchases, which critics say erode the bank's
independence". Stark was "probably the most hawkish" member of the council when
he resigned. Weber was replaced by his Bundesbank successor Jens Weidmann, while
Belgium's Peter Praet took Stark's original position, heading the ECB's economics
department.

4.10 Long Term Refinancing Operation (LTRO)

On 22 December 2011, the ecbstarted the biggest infusion of credit into the European
banking system in the euro's 13-year history. Under its Long Term Refinancing
Operations (ltros) it loaned 489 billion to 523 banks for an exceptionally long period
of three years at a rate of just one per cent. Previous refinancing operations matured
after three, six and twelve months.The by far biggest amount of 325 billion was
tapped by banks in Greece, Ireland, Italy and Spain
This way the ECB tried to make sure that banks have enough cash to pay off 200
billion of their own maturing debts in the first three months of 2012, and at the same
time keep operating and loaning to businesses so that a credit crunch does not choke
off economic growth. It also hoped that banks would use some of the money to buy
government bonds, effectively easing the debt crisis. On 29 February 2012, the ECB
held a second auction, LTRO2, providing 800 eurozone banks with further 529.5
billion in cheap loans. Net new borrowing under the 529.5 billion February auction
was around 313 billion; out of a total of 256 billion existing ECB lending (MRO +
3m&6m ltros), 215 billion was rolled into LTRO2.
ECB lending has largely replaced inter-bank lending. Spain has 365 billion and Italy
has 281 billion of borrowings from the ECB (June 2012 data). Germany has 275
billion on deposit.
33

4.11 Reorganization of the European banking system

On 16 June 2012 the European Central Bank together with other European leaders
hammered out plans for the ECB to become a bank regulator and to form a deposit
insurance program to augment national programs. Other economic reforms promoting
European growth and employment were also proposed.

4.12 Outright Monetary Transactions (omts)

Lowering bond purchases (OMT), for all eurozone countries involved in a sovereign
state bailout program from EFSF/ESM.A eurozone country can benefit from the
program if -and for as long as- it is found to suffer from stressed bond yields at
excessive levels; but only at the point of time where the country possesses/regains a
complete market access -and only if the country still comply with all terms in the
signedmemorandum of Understanding (mou) agreement.Countries receiving a
precautionary programme rather than a On 6 September 2012, the ECB announced to
offer additional financial support in the form of some yield-sovereign bailout, will per
definition have complete market access and thus qualify for OMT support if also
suffering from stressed interest rates on its government bonds. In regards of countries
receiving a sovereign bailout (Ireland, Portugal and Greece), they will on the other
hand not qualify for OMT support before they have regained complete market access,
which will normally only happen after having received the last scheduled bailout
disbursement. Despite

none

OMT

programmes

were

ready

to

start

in

September/October, the financial markets straight away took notice of the additionally
planned OMT packages from ECB, and started slowly to price-in a decline of both
short term and long term interest rates in all European countries previously suffering
from stressed and elevated interest levels (as omts were regarded as an extra potential
back-stop to counter the frozen liquidity and highly stressed rates; and just the
knowledge about their potential existence in the very near future helped to calm the
markets).

4.13 European Stability Mechanism (ESM)

The European Stability Mechanism (ESM) is a permanent rescue funding programme
to succeed the temporary European Financial Stability Facility and European
Financial Stabilisation Mechanism in July 2012[233] but it had to be postponed until
34

after the Federal Constitutional Court of Germany had confirmed the legality of the
measures on 12 September 2012.[261][262] The permanent bailout fund entered into
force for 16 signatories on 27 September 2012. It became effective in Estonia on 4
October 2012 after the completion of their ratification process.
On 16 December 2010 the European Council agreed a two line amendment to the
EU Lisbon Treaty to allow for a permanent bail-out mechanism to be established
including stronger sanctions. In March 2011, the European Parliament approved the
treaty amendment after receiving assurances that the European Commission, rather
than EU states, would play 'a central role' in running the ESM.The ESM is
an intergovernmental organisation under public international law. It is located in
Luxembourg.
Such a mechanism serves as a "financial firewall." Instead of a default by one country
rippling through the entire interconnected financial system, the firewall mechanism
can ensure that downstream nations and banking systems are protected by
guaranteeing some or all of their obligations. Then the single default can be managed
while limiting financial contagion.

4.14 European Fiscal Compact

Public debt to GDP ratio for selected eurozone countries and the UK2008 to 2011.
Source Data: Eurostat. In March 2011 a new reform of the Stability and Growth
Pact was initiated, aiming at straightening the rules by adopting an automatic
procedure for imposing of penalties in case of breaches of either the 3% deficit or the
60% debt rules. By the end of the year, Germany, France and some other smaller EU
countries went a step further and vowed to create a fiscal unionacross the eurozone
35

with strict and enforceable fiscal rules and automatic penalties embedded in the EU
treaties. On 9 December 2011 at the European Council meeting, all 17 members of the
eurozone and six countries that aspire to join agreed on a new intergovernmental
treaty to put strict caps on government spending and borrowing, with penalties for
those countries who violate the limits.All other non-eurozone countries apart from the
UK are also prepared to join in, subject to parliamentary vote.The treaty will enter
into force on 1 January 2013, if by that time 12 members of the euro area have ratified
it.
Originally EU leaders planned to change existing EU treaties but this was blocked by
British prime minister David Cameron, who demanded that the City of London be
excluded from future financial regulations, including the proposed EU financial
transaction tax. By the end of the day, 26 countries had agreed to the plan, leaving the
United Kingdom as the only country not willing to join.Cameron subsequently
conceded that his action had failed to secure any safeguards for the UK.Britain's
refusal to be part of the fiscal compact to safeguard the eurozone constituted a de
facto refusal (PM David Cameron vetoed the project) to engage in any radical
revision of the Lisbon Treaty. John Rentoul of The Independent concluded that "Any
Prime Minister would have done as Cameron did".

36

CHAPTER 5
ECONOMIC REFORMS AND RECOVERY PROPOSAL

5.1 Direct loans to banks and banking regulation

On 28 June 2012 eurozone leaders agreed to permit loans by the European Stability
Mechanism to be made directly to stressed banks rather than through eurozone states,
to avoid adding to sovereign debt. The reform was linked to plans for banking
regulation by the European Central Bank. The reform was immediately reflected by a
reduction in yield of long-term bonds issued by member states such as Italy and Spain
and a rise in value of the Euro.

5.2 Less austerity, more investment

There has been substantial criticism over the austerity measures implemented by most
European nations to counter this debt crisis. US economist and Nobel laureate Paul
Krugmanargues that an abrupt return to "'non-Keynesian' financial policies" is not a
viable solution Pointing at historical evidence, he predicts that deflationary
policies now being imposed on countries such as Greece and Spain will prolong and
deepen their recessions.Together with over 9,000 signatories of "A Manifesto for
Economic Sense"Krugman also dismissed the belief of austerity focusing policy
makers such as EU economic commissioner Olli Rehn and most European finance
ministers that "budget consolidation" revives confidence in financial markets over the
longer haul.In a 2003 study that analysed 133 IMF austerity programmes, the IMF's
independent evaluation office found that policy makers consistently underestimated
the disastrous effects of rigid spending cuts on economic growth. In early 2012 an
IMF official, who negotiated Greek austerity measures, admitted that spending cuts
were harming Greece. In October 2012, the IMF said that its forecasts for countries
which implemented austerity programmes have been consistently overoptimistic,
suggesting that tax hikes and spending cuts have been doing more damage than
expected, and countries which implemented fiscal stimulus, such as Germany and
Austria, did better than expected.

37

Despite years of draconian austerity measures Greece has failed to reach a balanced
budget as public revenues remain low.
According to Keynesian economists "growth-friendly austerity" relies on the false
argument that public cuts would be compensated for by more spending from
consumers and businesses, a theoretical claim that has not materialised.The case of
Greece shows that excessive levels of private indebtedness and a collapse of public
confidence (over 90% of Greeks fear unemployment, poverty and the closure of
businesses)led the private sector to decrease spending in an attempt to save upfor
rainy days ahead. This led to even lower demand for both products and labour, which
further deepened the recession and made it ever more difficult to generate tax
revenues and fight public indebtedness. According to Financial Times chief
economics commentator Martin Wolf, "structural tightening does deliver actual
tightening. But its impact is much less than one to one. A one percentage point
reduction in the structural deficit delivers a 0.67 percentage point improvement in the
actual fiscal deficit." This means that Ireland e.g. Would require structural fiscal
tightening of more than 12% to eliminate its 2012 actual fiscal deficit. A task that is
difficult to achieve without an exogenous eurozone-wide economic boom.According
to the Europlus Monitor Report 2012, no country should tighten its fiscal reins by
more than 2% of GDP in one year, to avoid recession.Austerity is bound to fail if it
relies largely on tax increasesinstead of cuts in government expenditures coupled with
encouraging "private investment and risk-taking, labour mobility and flexibility, an
end to price controls, tax rates that encouraged capital formation" as Germany has
done in the decade before the crisis. Italy, for example, has essentially no cuts in
spending (i.e. Government austerity) when taken into account the shifting of spending
from national to local levels. Instead, Italy has relied on tax increases which is an
imposed austerity on the private sector, thereby reducing economic activity.

38

Instead of public austerity, a "growth compact" centring on tax increases and deficit
spending is proposed. Since struggling European countries lack the funds to engage
in deficit spending, German economist and member of the German Council of
Economic Experts Peter Bofinger and Sony Kapoor of the global think tank ReDefine suggest providing40 billion in additional funds to the European Investment
Bank (EIB), which could then lend ten times that amount to the employment-intensive
smaller business sector.The EU is currently planning a possible 10 billion increase in
the EIB's capital base. Furthermore the two suggest financing additional public
investments by growth-friendly taxes on "property, land, wealth, carbon emissions
and the under-taxed financial sector". They also called on EU countries to renegotiate
the EU savings tax directive and to sign an agreement to help each other crack down
on tax evasion and avoidance. Currently authorities capture less than 1% in annual tax
revenue on untaxed wealth transferred between EU members.According to the Tax
Justice Network, worldwide, a global super-rich elite had between $21 and $32
trillion (up to 26,000bn Euros) hidden in secret tax havens by the end of 2010,
resulting in a tax deficit of up to $280bn Apart from arguments over whether or not
austerity, rather than increased or frozen spending, is a macroeconomic
solution, union leaders have also argued that the working population is being unjustly
held responsible for the economic mismanagement errors of economists, investors,
and bankers. Over 23 million EU workers have become unemployed as a consequence
of the global economic crisis of 20072010, and this has led many to call for
additional regulation of the banking sector across not only Europe, but the entire
world.
In the turmoil of the Global Financial Crisis, the focus across all EU member
states has been gradually to implement austerity measures, with the purpose of
lowering the budget deficits to levels below 3% of GDP, so that the debt level would
either stay below -or start decline towards- the 60% limit defined by the Stability and
Growth Pact. To further restore the confidence in Europe, 23 out of 27 EU countries
also agreed on adopting the Euro Plus Pact, consisting of political reforms to improve
fiscal strength and competitiveness; and 25 out of 27 EU countries also decided to
implement the Fiscal Compact which include the commitment of each participating
country to introduce a balanced budget amendment as part of their national
law/constitution. The Fiscal Compact is a direct successor of the previous Stability
39

and Growth Pact, but it is more strict, not only because criteria compliance will be
secured through its integration into national law/constitution, but also because it
starting from 2014 will require all ratifying countries not involved in ongoing bailout
programmes, to comply with the new strict criteria of only having a structural
deficit of either maximum 0.5% or 1% (depending on the debt level).Each of the
eurozone countries being involved in a bailout programme (Greece, Portugal and
Ireland) was asked both to follow a programme with fiscal consolidation/austerity,
and to restore competitiveness through implementation of structural reforms
and internal devaluation, i.e. Lowering their relative production costs.[303] The
measures implemented to restore competitiveness in the weakest countries are needed,
not only to build the foundation for GDP growth, but also in order to decrease the
current account imbalances among eurozone member states.
It has been a long known belief that austerity measures will always reduce the GDP
growth in the short term. The reason why Europe nevertheless chose the path of
austerity measures, is because they on the medium and long term have been found to
benefit and prosper GDP growth, as countries with healthy debt levels in return will
be rewarded by the financial markets with higher confidence and lower interest rates.
Some economists believing in Keynesian policies criticised the timing and amount of
austerity measures being called for in the bailout programmes, as they argued such
extensive measures should not be implemented during the crisis years with an
ongoing recession, but if possible delayed until the years after some positive real GDP
growth had returned. In October 2012, a report published by International Monetary
Fund (IMF) also found, that tax hikes and spending cuts during the most recent
decade had indeed damaged the GDP growth more severely, compared to what had
been expected and forecasted in advance (based on the "GDP damage ratios"
previously

recorded

in

earlier

decades

and

under

different

economic

scenarios).Already a half-year earlier, several European countries as a response to the

problem with subdued GDP growth in the eurozone, likewise had called for the
implementation of a new reinforced growth strategy based on additional public
investments, to be financed by growth-friendly taxes on property, land, wealth, and
financial institutions. In June 2012, EU leaders agreed as a first step to moderately
increase the funds of theeuropean Investment Bank, in order to kick-start
infrastructure projects and increase loans to the private sector. A few months later 11
40

out of 17 eurozone countries also agreed to introduce a new EU financial transaction

tax to be collected from 1 January 2014.

5.2.1 Progress
In April 2012, Olli Rehn, the European commissioner for economic and monetary
affairs in Brussels, "enthusiastically announced to EU parliamentarians in mid-April
that 'there was a breakthrough before Easter'. He said the European heads of state had
given the green light to pilot projects worth billions, such as building highways in
Greece." Other growth initiatives include "project bonds" wherein the EIB would
"provide guarantees that safeguard private investors. In the pilot phase until 2013, EU
funds amounting to 230 million are expected to mobilise investments of up to 4.6
billion." Der Spiegel also said: "According to sources inside the German government,
instead of funding new highways, Berlin is interested in supporting innovation and
programmes to promote small and medium-sized businesses. To ensure that this is
done as professionally as possible, the Germans would like to see the southern
European countries receive their own state-owned development banks, modeled after
Germany's [Marshall Plan-era-origin] kreditanstaltfrwiederaufbau(kfw) banking
group. It's hoped that this will get the economy moving in Greece and Portugal."In
multiple steps during 20122013, the ECB lowered its bank rate to historical lows,
reaching 0.25% in November 2013. Soon after the rates were shaved to 0.15%, then
on 4 September 2014 the central bank shocked financial markets by cutting the razorthin rates by a further two thirds from 0.15% to 0.05%, the lowest on record.The
moves were designed to make it cheaper for banks to borrow from the ECB, with the
aim that lower cost of money would be passed on to businesses taking out loans,
boosting investment in the economy. The lowered borrowing rates caused the euro to
fall in relation to other currencies, which it was hoped would boost exports from the
eurozone.

5.3 Increase competitiveness

Crisis countries must significantly increase their international competitiveness to
generate economic growth and improve their terms of trade. Indian-American
journalist fareedzakaria notes in November 2011 that no debt restructuring will work
without growth, even more so as European countries "face pressures from three
41

fronts: demography (an aging population), technology (which has allowed companies
to do much more with fewer people) and globalisation (which has allowed
manufacturing and services to locate across the world)."
In case of economic shocks, policy makers typically try to improve competitiveness
by depreciating the currency, as in the case of Iceland, which suffered the
largest financial crisis in 20082011 in economic history but has since vastly
improved its position. Eurozone countries cannot devalue their currency.

5.4 Internal devaluation

Relative change in unit labour costs, 20002012

As a workaround many policy makers try to restore competitiveness through internal
devaluation, a painful economic adjustment process, where a country aims to reduce
its unit labour costs. German economist Hans-Werner Sinn noted in 2012 that Ireland
was the only country that had implemented relative wage moderation in the last five
years, which helped decrease its relative price/wage levels by 16%. Greece would
need to bring this figure down by 31%, effectively reaching the level of Turkey.By
2012, wages in Greece have been cut to a level last seen in the late 1990s. Purchasing
power dropped even more to the level of 1986. Similarly, wages in Italy have hit a 25year low and consumption has fallen to the level of 1950.
Other economists argue that no matter how much Greece and Portugal drive down
their wages, they could never compete with low-cost developing countries such as
China or India. Instead weak European countries must shift their economies to higher
42

quality products and services, though this is a long-term process and may not bring
immediate relief.

5.5 Fiscal devaluation

Another option would be to implement fiscal devaluation, based on an idea originally
developed by John Maynard Keynes in 1931. According to this neo-Keynesian logic,
policy makers can increase the competitiveness of an economy by lowering corporate
tax burden such as employer's social security contributions, while offsetting the loss
of government revenues through higher taxes on consumption (VAT) and pollution,
i.e. By pursuing an ecological tax reform.
Germany has successfully pushed its economic competitiveness by increasing
the value added tax (VAT) by three percentage points in 2007, and using part of the
additional revenues to lower employer's unemployment insurance contribution.
Portugal has taken a similar stanceand also France appears to follow this suit. In
November 2012 French president Franois Hollande announced plans to reduce tax
burden of the corporate sector by 20 billion within three years, while increasing the
standard VAT from 19.6% to 20% and introducing additional eco-taxes in 2016. To
minimise negative effects of such policies on purchasing power and economic activity
the French government will partly offset the tax hikes by decreasing employees' social
security contributions by 10 billion and by reducing the lower VAT for convenience
goods (necessities) from 5.5% to 5%.

43

5.5.1 Progress

Eurozone economic health and adjustment progress 20112012 (Source: Euro Plus
Monitor)
On 15 November 2011, the Lisbon Council published the Euro Plus Monitor 2011.
According to the report most critical eurozone member countries are in the process of
rapid reforms. The authors note that "Many of those countries most in need to adjust
are now making the greatest progress towards restoring their fiscal balance and
external competitiveness". Greece, Ireland and Spain are among the top five reformers
and Portugal is ranked seventh among 17 countries included in the report
In its Euro Plus Monitor Report 2012, published in November 2012, the Lisbon
Council finds that the eurozone has slightly improved its overall health. With the
exception of Greece, all eurozone crisis countries are either close to the point where
they have achieved the major adjustment or are likely to get there over the course of
2013. Portugal and Italy are expected to progress to the turnaround stage in spring
2013, possibly followed by Spain in autumn, while the fate of Greece continues to
hang in the balance. Overall, the authors suggest that if the eurozone gets through the

44

current acute crisis and stays on the reform path "it could eventually emerge from the
crisis as the most dynamic of the major Western economies".
The Euro Plus Monitor update from Spring 2013 notes that the eurozone remains on
the right track. According to the authors, almost all vulnerable countries in need of
adjustment "are slashing their underlying fiscal deficits and improving their external
competitiveness at an impressive speed", for which they expected the eurozone crisis
to be over by the end of 2013.

5.6 Address current account imbalances

Current account imbalances (19972014)

Regardless of the corrective measures chosen to solve the current predicament, as

long as cross border capital flows remain unregulated in the euro area, current
account imbalances are likely to continue. A country that runs a large current account
45

or trade deficit (i.e., importing more than it exports) must ultimately be a net importer
of capital; this is a mathematical identitycalled the balance of payments. In other
words, a country that imports more than it exports must either decrease its savings
reserves or borrow to pay for those imports. Conversely, Germany's large trade
surplus (net export position) means that it must either increase its savings reserves or
be a net exporter of capital, lending money to other countries to allow them to buy
German goods.
The 2009 trade deficits for Italy, Spain, Greece, and Portugal were estimated to
be $42.96 billion, $75.31bn and $35.97bn, and $25.6bn respectively, while Germany's
trade surplus was $188.6bn. A similar imbalance exists in the US, which runs a large
trade deficit (net import position) and therefore is a net borrower of capital from
abroad. Ben Bernanke warned of the risks of such imbalances in 2005, arguing that a
"savings glut" in one country with a trade surplus can drive capital into other
countries with trade deficits, artificially lowering interest rates and creating asset
bubbles.
A country with a large trade surplus would generally see the value of its currency
appreciate relative to other currencies, which would reduce the imbalance as the
relative price of its exports increases. This currency appreciation occurs as the
importing country sells its currency to buy the exporting country's currency used to
purchase the goods. Alternatively, trade imbalances can be reduced if a country
encouraged domestic saving by restricting or penalising the flow of capital across
borders, or by raising interest rates, although this benefit is likely offset by slowing
down the economy and increasing government interest payments.
Either way, many of the countries involved in the crisis are on the euro, so
devaluation, individual interest rates and capital controls are not available. The only
solution left to raise a country's level of saving is to reduce budget deficits and to
change consumption and savings habits. For example, if a country's citizens saved
more instead of consuming imports, this would reduce its trade deficit. It has therefore
been suggested that countries with large trade deficits (e.g., Greece) consume less and
improve their exporting industries. On the other hand, export driven countries with a
large trade surplus, such as Germany, Austria and the Netherlands would need to shift
their economies more towards domestic services and increase wages to support
46

domestic consumption.Economic evidence indicates the crisis may have more to do

with trade deficits (which require private borrowing to fund) than public debt levels.
Economist Paul Krugman wrote in March 2013: "... The really strong relationship
within the [eurozone countries] is between interest spreads and current account
deficits, which is in line with the conclusion many of us have reached, that the euro
area crisis is really a balance of payments crisis, not a debt crisis." A February 2013
paper from four economists concluded that, "Countries with debt above 80% of GDP
and persistent current-account [trade] deficits are vulnerable to a rapid fiscal
deterioration

5.6.1 Progress
In its spring 2012 economic forecast, the European Commission finds "some evidence
that the current-account rebalancing is underpinned by changes in relative prices and
competitiveness positions as well as gains in export market shares and expenditure
switching in deficit countries." In May 2012 German finance minister Wolfgang
Schuble has signalled support for a significant increase in German wages to help
decrease current account imbalances within the eurozone.According to the Euro Plus
Monitor Report 2013, the collective current account of Greece, Ireland, Italy, Portugal
and Spain is improving rapidly and is expected to balance by mid 2013. Thereafter
these countries as a group would no longer need to import capital. In 2014, the current
account surplus of the eurozone as a whole almost doubled compared to the previous
year, reaching a new record high of 227.9bn Euros Mobilisation of creditseveral
proposals were made in mid-2012 to purchase the debt of distressed European
countries such as Spain and Italy. Markus Brunnermeier, the economist Graham
Bishop, and danielgros were among those advancing proposals. Finding a formula
which was not simply backed by Germany is central in crafting an acceptable and
effective remedy.

5.7 Commentary
US President Barack Obama stated in June 2012: "Right now, [Europe's] focus has to
be on strengthening their overall banking system making a series of decisive actions
that give people confidence that the banking system is solid...In addition, they're
going to have to look at how do they achieve growth at the same time as they're
carrying out structural reforms that may take two or three or five years to fully
47

accomplish. So countries like Spain and Italy, for example, have embarked on some
smart structural reforms that everybody thinks are necessaryeverything from tax
collection to labour markets to a whole host of different issues. But they've got to
have the time and the space for those steps to succeed. And if they are just cutting and
cutting and cutting, and their unemployment rate is going up and up and up, and
people are pulling back further from spending money because they're feeling a lot of
pressureironically, that can actually make it harder for them to carry out some of
these reforms over the long term addition to sensible ways to deal with debt and
government finances, there's a parallel discussion that's taking place among European
leaders to figure out how do we also encourage growth and show some flexibility to
allow some of these reforms to really take root."The Economist wrote in June 2012:
"Outside Germany, a consensus has developed on what Mrs. Merkel must do to
preserve the single currency. It includes shifting from austerity to a far greater focus
on economic growth; complementing the single currency with a banking union (with
euro-wide deposit insurance, bank oversight and joint means for the recapitalisation or
resolution of failing banks); and embracing a limited form of debt mutualisation to
create a joint safe asset and allow peripheral economies the room gradually to reduce
their debt burdens. This is the refrain from Washington, Beijing, London and indeed
most of the capitals of the euro zone. Why hasn't the continent's canniest politician
sprung into action?"[

48

CHAPTER 6
PROPOSED LONG TERM SOLUTION

6.1 European fiscal union

Increased European integration giving a central body increased control over the
budgets of member states was proposed on 14 June 2012 by Jens Weidmann President
of the Deutsche Bundesbank, expanding on ideas first proposed by Jean-Claude
Trichet, former president of the European Central Bank. Control, including
requirements that taxes be raised or budgets cut, would be exercised only when fiscal
imbalances developed. This proposal is similar to contemporary calls by Angela
Merkel for increased political and fiscal union which would "allow Europe oversight
possibilities."

6.2 European bank recovery and resolution authority

European banks are estimated to have incurred losses approaching 1 trillion between
the outbreak of the financial crisis in 2007 and 2010. The European Commission
approved some 4.5 trillion in state aid for banks between October 2008 and October
2011, a sum which includes the value of taxpayer-funded recapitalisations and public
guarantees on banking debts. This has prompted some economists such as Joseph
Stiglitz and Paul Krugman to note that Europe is not suffering from a sovereign debt
crisis but rather from abanking crisis.
On 6 June 2012, the European Commission adopted a legislative proposal for a
harmonised bank recovery and resolution mechanism. The proposed framework sets
out the necessary steps and powers to ensure that bank failures across the EU are
managed in a way which avoids financial instability. The new legislation would give
member states the power to impose losses, resulting from a bank failure, on the
bondholders to minimise costs for taxpayers. The proposal is part of a new scheme in
which banks will be compelled to "bail-in" their creditors whenever they fail, the
basic aim being to prevent taxpayer-funded bailouts in the future.The public
authorities would also be given powers to replace the management teams in banks
49

even before the lender fails. Each institution would also be obliged to set aside at least
one per cent of the deposits covered by their national guarantees for a special fund to
finance the resolution of banking crisis starting in 2018.

6.3 Eurobonds
A growing number of investors and economists say Eurobonds would be the best way
of solving a debt crisis, though their introduction matched by tight financial and
budgetary co-ordination may well require changes in EU treaties.[350] On 21
November 2011, the European Commission suggested that eurobonds issued jointly
by the 17 euro nations would be an effective way to tackle the financial crisis. Using
the term "stability bonds", Jose Manuel Barroso insisted that any such plan would
have to be matched by tight fiscal surveillance and economic policy coordination as
an essential counterpart so as to avoid moral hazard and ensure sustainable public
finances.Germany remains largely opposed at least in the short term to a collective
takeover of the debt of states that have run excessive budget deficits and borrowed
excessively over the past years, saying this could substantially raise the country's
liabilities.

6.4 European Monetary Fund

On 20 October 2011, the Austrian Institute of Economic Research published an article
that suggests transforming the EFSF into a European Monetary Fund (EMF), which
could provide governments with fixed interest rate Eurobonds at a rate slightly below
medium-term economic growth (in nominal terms). These bonds would not be
tradable but could be held by investors with the EMF and liquidated at any time.
Given the backing of all eurozone countries and the ECB "the EMU would achieve a
similarly strong position vis-a-vis financial investors as the US where the Fed backs
government bonds to an unlimited extent." To ensure fiscal discipline despite lack of
market pressure, the EMF would operate according to strict rules, providing funds
only to countries that meet fiscal and macroeconomic criteria. Governments lacking
sound financial policies would be forced to rely on traditional (national) governmental
bonds with less favourable market rates.
The econometric analysis suggests that "If the short-term and long- term interest rates
in the euro area were stabilised at 1.5% and 3%, respectively, aggregate output (GDP)
50

in the euro area would be 5 percentage points above baseline in 2015". At the same
time sovereign debt levels would be significantly lower with, e.g., Greece's debt level
falling below 110% of GDP, more than 40 percentage points below the baseline
scenario with market based interest levels. Furthermore, banks would no longer be
able to unduly benefit from intermediary profits by borrowing from the ECB at low
rates and investing in government bonds at high rates.

6.5 Drastic debt write-off financed by wealth tax

Overall debt levels in 2009 and write-offs necessary in the eurozone, UK and US to
reach sustainable grounds.
According to the Bank for International Settlements, the combined private and public
debt of 18 OECD countries nearly quadrupled between 1980 and 2010, and will likely
continue to grow, reaching between 250% (for Italy) and about 600% (for Japan) by
2040. A BIS study released in June 2012 warns that budgets of most advanced
economies, excluding interest payments, "would need 20 consecutive years of
surpluses exceeding 2 per cent of gross domestic productstarting nowjust to
bring the debt-to-GDP ratio back to its pre-crisis level" The same authors found in a
previous study that increased financial burden imposed by ageing populations and
lower growth makes it unlikely that indebted economies can grow out of their debt
problem if only one of the following three conditions is met

Government debt is more than 80 to 100% of GDP;

Non-financial corporate debt is more than 90 percent;

Private household debt is more than 85% of GDP.

51

The first condition, suggested by an influential paper written by Kenneth

Rogoff & Carmen Reinhart has been disputed due to major calculation errors. In fact,
the average GDP growth at public debt/GDP ratios over 90% is not dramatically
different from when debt/GDP ratios are lower.
The Boston Consulting Group (BCG) adds that if the overall debt load continues to
grow faster than the economy, then large-scale debt restructuring becomes inevitable.
To prevent a vicious upward debt spiral from gaining momentum the authors urge
policy makers to "act quickly and decisively" and aim for an overall debt level well
below 180% for the private and government sector. This number is based on the
assumption that governments, nonfinancial corporations, and private households can
each sustain a debt load of 60% of GDP, at an interest rate of 5 per cent and a nominal
economic growth rate of 3 per cent per year. Lower interest rates and/or higher
growth would help reduce the debt burden further.
To reach sustainable levels the eurozone must reduce its overall debt level by 6.1
trillion. According to BCG this could be financed by a one-time wealth tax of
between 11 and 30% for most countries, apart from the crisis countries (particularly
Ireland) where a write-off would have to be substantially higher. The authors admit
that such programmes would be "drastic", "unpopular" and "require broad political
coordination and leadership" but they maintain that the longer politicians and central
bankers wait, the more necessary such a step will be.
Instead of a one-time write-off, German economist haraldspehl has called for a 30year debt-reduction plan, similar to the one Germany used after World War II to share
the burden of reconstruction and development.Similar calls have been made by
political parties in Germany including the Greens and The Left.

52

CHAPTER 7
CONTROVERSIES
The European bailouts are largely about shifting exposure from banks and others, who
otherwise are lined up for losses on the sovereign debt they have piled up, onto
European taxpayers.

7.1 EU treaty violations

Wikisource has
original text related
to this article:
Consolidated
version

of

the

Treaty

on

the

Functioning of the
European Union

7.1.1 No bail-out clause

The EU's Maastricht Treaty contains juridical language which appears to
rule out intra-EU bailouts. First, the "no bail-out" clause (Article 125
TFEU) ensures that the responsibility for repaying public debt remains
national and prevents risk premiums caused by unsound fiscal policies
from spilling over to partner countries. The clause thus encourages
prudent fiscal policies at the national level.
The European Central Bank's purchase of distressed country bonds can be
viewed as violating the prohibition of monetary financing of budget
deficits (Article 123 TFEU). The creation of further leverage in EFSF
with access to ECB lending would also appear to violate the terms of this
article.
53

Articles 125 and 123 were meant to create disincentives for EU member
states to run excessive deficits and state debt, and prevent the moral
hazard of over-spending and lending in good times. They were also meant
to protect the taxpayers of the other more prudent member states. By
issuing bail-out aid guaranteed by prudent eurozone taxpayers to rulebreaking eurozone countries such as Greece, the EU and eurozone
countries also encourage moral hazard in the future.While the no bail-out
clause remains in place, the "no bail-out doctrine" seems to be a thing of
the past.
7.2 Convergence criteria
The EU treaties contain so called convergence criteria, specified in the protocols of
the Treaties of the European Union. Concerning government finance the states have
agreed that the annual government budget deficit should not exceed 3% of the gross
domestic product (GDP) and that the gross government debt to GDP should not
exceed 60% of the GDP (see protocol 12 and 13). For eurozone members there is
the Stability and Growth Pact which contains the same requirements for budget deficit
and debt limitation but with a much stricter regime. In the past, many European
countries including Greece and Italy have substantially exceeded these criteria over a
long period of time.Around 2005 most eurozone members violated the pact, resulting
in no action taken against violators.
7.3 Credit rating agencies

Standard & Poor's Headquarters in Lower Manhattan, New York City

54

The

international

US-based credit

rating

agenciesMoody's, Standard

&

Poor's and Fitchwhich have already been under fire during thehousing bubbleand
the Icelandic crisishave also played a central and controversial role in the current
European bond market crisis. On one hand, the agencies have been accused of giving
overly generous ratings due to conflicts of interest. On the other hand, ratings
agencies have a tendency to act conservatively, and to take some time to adjust when
a firm or country is in trouble. In the case of Greece, the market responded to the
crisis before the downgrades, with Greek bonds trading at junk levels several weeks
before the ratings agencies began to describe them as such.
According to a study by economists at St. Gallen University credit rating agencies
have fuelled rising euro zone indebtedness by issuing more severe downgrades since
the sovereign debt crisis unfolded in 2009. The authors concluded that rating agencies
were not consistent in their judgments, on average rating Portugal, Ireland and Greece
2.3 notches lower than under pre-crisis standards, eventually forcing them to seek
international aid. On a side note: as of end of November 2013 only three countries in
the eurozone retain AAA ratings fromstandard & Poor, i.e. Germany, Finland and
Luxembourg.
European policy makers have criticised ratings agencies for acting politically,
accusing

the Big

Three of

bias

towards

European

assets

and

fuelling

speculation. Particularlymoody's decision to downgrade Portugal's foreign debt to the

category Ba2 "junk" has infuriated officials from the EU and Portugal
alike.[379] State owned utility and infrastructure companies like ANA Aeroportos
de Portugal, Energias de Portugal, redesenergticasnacionais, and Brisa Autoestradas de Portugal were also downgraded despite claims to having solid financial
profiles and significant foreign revenuefrance too has shown its anger at its
downgrade. French central bank chief Christian Noyer criticised the decision of
Standard & Poor's to lower the rating of France but not that of the United Kingdom,
which "has more deficits, as much debt, more inflation, less growth than us". Similar
comments were made by high-ranking politicians in Germany. Michael Fuchs, deputy
leader of the leading Christian Democrats, said: "Standard and Poor's must stop
playing politics. Why doesn't it act on the highly indebted United States or highly
indebted Britain?", adding that the latter's collective private and public sector debts

55

are the largest in Europe. He further added: "If the agency downgrades France, it
should also downgrade Britain in order to be consistent."
Credit rating agencies were also accused of bullying politicians by systematically
downgrading eurozone countries just before important European Council meetings.
As one EU source put it: "It is interesting to look at the downgradings and the timings
of the down grading. It is strange that we have so many downgrades in the weeks of
summits."

7.4 Regulatory reliance on credit ratings

Think-tanks such as the World Pensions Council (WPC) have criticised European
powers such as France and Germany for pushing for the adoption of the Basel
II recommendations, adopted in 2005 and transposed in European Union law through
the Capital Requirements Directive (CRD), effective since 2008. In essence, this
forced European banks and more importantly the European Central Bank, e.g. When
gauging the solvency of EU-based financial institutions, to rely heavily on the
standardised assessments of credit risk marketed by only two private US firmsMoody's and S&P.

7.5 Counter measures

Due to the failures of the ratings agencies, European regulators obtained new powers
to supervise ratings agencies. With the creation of the European Supervisory
Authority in January 2011 the EU set up a whole range of new financial regulatory
institutions, including the European Securities and Markets Authority (ESMA), which
became the EU's single credit-ratings firm regulator. Credit-ratings companies have to
comply with the new standards or will be denied operation on EU territory, says
ESMA Chief Steven Maijoor.Germany's foreign minister Guido Westerwelle has
called for an "independent" European ratings agency, which could avoid the conflicts
of interest that he claimed US-based agencies faced. European leaders are reportedly
studying the possibility of setting up a European ratings agency in order that the
private US-based ratings agencies have less influence on developments in European
financial markets in the future. According to German consultant company Roland
56

Berger, setting up a new ratings agency would cost 300 million. On 30 January
2012, the company said it was already collecting funds from financial institutions and
business intelligence agencies to set up an independent non-profit ratings agency by
mid-2012, which could provide its first country ratings by the end of the year. In April
2012, in a similar attempt, the Bertelsmann Stiftung presented a blueprint for
establishing an international non-profit credit rating agency (INCRA) for sovereign
debt, structured in way that management and rating decisions are independent from its
financiers.
But attempts to regulate more strictly credit rating agencies in the wake of the
eurozone

crisis

have

been

rather

unsuccessful. World

Pensions

Council

(WPC) financial law and regulation experts have argued that the hastily drafted,
unevenly transposed in national law, and poorly enforced EU rule on ratings agencies
has had little effect on the way financial analysts and economists interpret data or on
the potential for conflicts of interests created by the complex contractual
arrangements between credit rating agencies and their clients"

7.5 Media
There has been considerable controversy about the role of the English-language
press in regard to the bond market crisis.
Greek Prime Minister Papandreou is quoted as saying that there was no question of
Greece leaving the euro and suggested that the crisis was politically as well as
financially motivated. "This is an attack on the eurozone by certain other interests,
political or financial". The Spanish Prime Minister Jos Luis Rodrguez Zapatero has
also suggested that the recent financial market crisis in Europe is an attempt to
undermine the euro. He ordered the Centro Nacional de Inteligencia intelligence
service (National Intelligence Centre, CNI in Spanish) to investigate the role of the
"Anglo-Saxon media" in fomenting the crisis.So far no results have been reported
from this investigation.
Other commentators believe that the euro is under attack so that countries, such as the
UK and the US, can continue to fund their large external deficits and government
deficits,and to avoid the collapse of the US$. The US and UK do not have large
domestic savings pools to draw on and therefore are dependent on external savings
57

e.g. From China.[413][414] This is not the case in the eurozone, which is selffunding.

7.6 Speculators
Both

the

Spanish

and

Greek

Prime

Ministers

have

accused financial

speculators and hedge funds of worsening the crisis by short selling euros.German
chancellor Merkel has stated that "institutions bailed out with public funds are
exploiting the budget crisis in Greece and elsewhere."
The role of Goldman Sachs in Greek bond yield increases is also under scrutiny.It is
not yet clear to what extent this bank has been involved in the unfolding of the crisis
or if they have made a profit as a result of the sell-off on the Greek government debt
market.
In response to accusations that speculators were worsening the problem, some
markets banned naked short selling for a few months.

7.7 Speculation about the break-up of the eurozone

Economists, mostly from outside Europe and associated with Modern Monetary
Theory and other post-Keynesian schools, condemned the design of the euro currency
system from the beginning because it ceded national monetary and economic
sovereignty but lacked a central fiscal authority. When faced with economic
problems, they maintained, "Without such an institution, EMU would prevent
effective action by individual countries and put nothing in its place."US
economist Martin Feldstein went so far to call the euro "an experiment that
failed". Some non-Keynesian economists, such as Luca A. Ricci of the IMF, contend
that the eurozone does not fulfil the necessary criteria for an optimum currency area,
though it is moving in that direction.
As the debt crisis expanded beyond Greece, these economists continued to advocate,
albeit more forcefully, the disbandment of the eurozone. If this was not immediately
feasible, they recommended that Greece and the other debtor nations unilaterally
leave the eurozone, default on their debts, regain their fiscal sovereignty, and re-adopt
national currencies.Bloomberg suggested in June 2011 that, if the Greek and Irish
bailouts should fail, an alternative would be for Germany to leave the eurozone to
58

save the currency through depreciationinstead of austerity. The likely substantial fall
in the euro against a newly reconstituted Deutsche Mark wouldgive a "huge boost" to
its members' competitiveness.
Iceland, not part of the EU, is regarded as one of Europe's recovery success stories. It
defaulted on its debt and drastically devalued its currency, which has effectively
reduced wages by 50% making exports more competitive. Lee Harris argues that
floating exchange rates allows wage reductions by currency devaluations, a politically
easier option than the economically equivalent but politically impossible method of
lowering wages by political enactment. Sweden's floating rate currency gives it a
short term advantage, structural reforms and constraints account for longer-term
prosperity. Labour concessions, a minimal reliance on public debt, and tax reform
helped to further a pro-growth policy.
The Wall Street Journal conjectured as well that Germany could return to the
Deutsche Mark, or create another currency union with the Netherlands, Austria,
Finland, Luxembourg and other European countries such as Denmark, Norway,
Sweden, Switzerland and the Baltics. A monetary union of these countries with
current account surpluses would create the world's largest creditor bloc, bigger than
China or Japan. The Wall Street Journal added that without the German-led bloc, a
residual euro would have the flexibility to keep interest rates low and engage
in quantitative easing or fiscal stimulus in support of a job-targeting economic
policy instead of inflation targeting in the current configuration.

7.8 Breakup vs. Deeper integration

There is opposition in this view. The national exits are expected to be an expensive
proposition. The breakdown of the currency would lead to insolvency of several euro
zone countries, a breakdown in intrazone payments. Having instability and the public
debt issue still not solved, the contagion effects and instability would spread into the
system.Having that the exit of Greece would trigger the breakdown of the eurozone,
this is not welcomed by many politicians, economists and journalists. According to
Steven Erlanger from The New York Times, a "Greek departure is likely to be seen as
the beginning of the end for the whole euro zone project, a major accomplishment,
whatever its faults, in the postwar construction of a Europe "whole and at

59

peace."Likewise, the two big leaders of the Euro zone, German Chancellor Angela
Merkel and former French president Nicolas Sarkozyhave said on numerous
occasions that they would not allow the eurozone to disintegrate and have linked the
survival of the Euro with that of the entire European Union. In September 2011, EU
commissioner joaqunalmunia shared this view, saying that expelling weaker
countries from the euro was not an option: "Those who think that this hypothesis is
possible just do not understand our process of integration". The former ECB
president Jean-Claude Trichet also denounced the possibility of a return of the
Deutsche Mark.
The challenges to the speculation about the break-up or salvage of the eurozone is
rooted in its innate nature that the break-up or salvage of eurozone is not only an
economic decision but also a critical political decision followed by complicated
ramifications that "If Berlin pays the bills and tells the rest of Europe how to behave,
it risks fostering destructive nationalist resentment against Germany and ....it would
strengthen the camp in Britain arguing for an exita problem not just for Britons but
for all economically liberal Europeans.Solutions which involve greater integration of
European banking and fiscal management and supervision of national decisions by
European umbrella institutions can be criticised as Germanic domination of European
political and economic life. According to US author Ross Douthat "This would
effectively turn the European Union into a kind of postmodern version of the
old Austro-Hungarian Empire, with a Germanic elite presiding uneasily over a
polyglot imperium and its restive local populations".
The Economist provides a somewhat modified approach to saving the euro in that "a
limited version of federalisation could be less miserable solution than break-up of the
euro."The recipe to this tricky combination of the limited federalisation, greatly lies
on mutualisation for limiting the fiscal integration. In order for overindebted countries
to stabilise the dwindling euro and economy, the overindebted countries require
"access to money and for banks to have a "safe" euro-wide class of assets that is not
tied

to

the

fortunes

of

one

country"

which

could

be

obtained

by

"narrower Eurobond that mutualises a limited amount of debt for a limited amount of
time."The proposition made by German Council of Economic Experts provides
detailed blue print to mutualise the current debts of all euro-zone economies above
60% of their GDP. Instead of the break-up and issuing new national governments
60

bonds by individual euro-zone governments, "everybody, from Germany (debt: 81%

of GDP) to Italy (120%) would issue only these joint bonds until their national debts
fell to the 60% threshold. The new mutualised-bond market, worth some 2.3 trillion,
would be paid off over the next 25 years. Each country would pledge a specified tax
(such as a VAT surcharge) to provide the cash." So far German Chancellor Angela
Merkel has opposed to all forms of mutualisation.
The Hungarian-American business magnate George Soros warns in "Does the Euro
have a Future?" that there is no escape from the "gloomy scenario" of a prolonged
European recession and the consequent threat to the eurozone's political cohesion so
long as "the authorities persist in their current course." He argues that to save the Euro
long-term structural changes are essential in addition to the immediate steps needed to
arrest the crisis. The changes he recommends include even greater economic
integration of the European Union. Soros writes that a treaty is needed to transform
the European Financial Stability Fund into a full-fledged European Treasury.
Following the formation of the Treasury, the European Council could then authorise
the ECB to "step into the breach", with risks to the ECB's solvency being indemnified.
Soros acknowledges that converting the EFSF into a European Treasury will
necessitate "a radical change of heart." In particular, he cautions, Germans will be
wary of any such move, not least because many continue to believe that they have a
choice between saving the Euro and abandoning it. Soros writes that a collapse of the
European Union would precipitate an uncontrollable financial meltdown and thus "the
only way" to avert "another Great Depression" is the formation of a European
Treasury.
The British betting company Ladbrokes stopped taking bets on Greece exiting the
eurozone in May 2012 after odds fell to 1/3, and reported "plenty of support" for 33/1
odds for a complete disbanding of the eurozone during 2012.

7.9 Odious debt

Some protesters, commentators such as Libration correspondent Jean Quatremer and
the Lige based

NGO Committee

for

the

Abolition

of

the

Third

World

Debt (CADTM) allege that the debt should be characterised as odious debt. The
Greek documentary Debtocracy,and a book of the same title and content examine

61

whether the recent Siemens scandal and uncommercial ECB loans which were
conditional on the purchase of military aircraft and submarines are evidence that the
loans amount to odious debt and that an audit would result in invalidation of a large
amount of the debt.

7.10 Manipulated debt and deficit statistics

In 1992, members of the European Union signed an agreement known as
the Maastricht Treaty, under which they pledged to limit their deficit spending and
debt levels. Some EU member states, including Greece and Italy, were able to
circumvent these rules and mask their deficit and debt levels through the use of
complex currency and credit derivatives structures. The structures were designed by
prominent US investment banks, who received substantial fees in return for their
services and who took on little credit risk themselves thanks to special legal
protections for derivatives counterparties.Financial reforms within the U.S. since the
financial crisis have only served to reinforce special protections for derivatives
including greater access to government guarantees while minimising disclosure to
broader financial markets.
The revision of Greece's 2009 budget deficit from a forecast of "68% of GDP" to
12.7% by the new Pasok Government in late 2009 (a number which, after
reclassification of expenses under IMF/EU supervision was further raised to 15.4% in
2010) has been cited as one of the issues that ignited the Greek debt crisis.
This added a new dimension in the world financial turmoil, as the issues of "creative
accounting" and manipulation of statistics by several nations came into focus,
potentially undermining investor confidence.
The focus has naturally remained on Greece due to its debt crisis. There have been
reports about manipulated statistics by EU and other nations aiming, as was the case
for Greece, to mask the sizes of public debts and deficits. These have included
analyses of examples in several countries or have focused on Italy, the United
Kingdom, Spain,the United States, and even Germany.

62

7.11 Collateral for Finland

On 18 August 2011, as requested by the Finnish parliament as a condition for any
further bailouts, it became apparent that Finland would receive collateral from
Greece, enabling it to participate in the potential new 109 billion support package for
the Greek economy.Austria, the Netherlands, Slovenia, and Slovakia responded with
irritation over this special guarantee for Finland and demanded equal treatment across
the eurozone, or a similar deal with Greece, so as not to increase the risk level over
their participation in the bailout.The main point of contention was that the collateral is
aimed to be a cash deposit, a collateral the Greeks can only give by recycling part of
the funds loaned by Finland for the bailout, which means Finland and the other
eurozone countries guarantee the Finnish loans in the event of a Greek default.
After extensive negotiations to implement a collateral structure open to all eurozone
countries, on 4 October 2011, a modified escrow collateral agreement was reached.
The expectation is that only Finland will utilise it, due to requirement to contribute
initial capital to European Stability Mechanism in one instalment instead of five
instalments over time. Finland, as one of the strongest AAA countries, can raise the
required capital with relative ease.
At the beginning of October, Slovakia and Netherlands were the last countries to vote
on the EFSF expansion, which was the immediate issue behind the collateral
discussion, with a mid-October vote.On 13 October 2011 Slovakia approved euro
bailout expansion, but the government has been forced to call new elections in
exchange.
In February 2012, the four largest Greek banks agreed to provide the 880 million in
collateral to Finland to secure the second bailout programme.
Finland's recommendation to the crisis countries is to issue asset-backed securities to
cover the immediate need, a tactic successfully used in Finland's early 1990s
recession, in addition to spending cuts and bad banking.

63

CHAPTER 8

POLITICAL IMPACT

Handling of the ongoing crisis has led to the premature end of several European
national governments and influenced the outcome of many elections:

Ireland February 2011 After a high deficit in the governments budget in

2010 and the uncertainty surrounding the

proposed bailout

from

the International Monetary Fund, the 30th Dil (parliament) collapsed the
following year, which led to a subsequent general election, collapse of the
preceding government parties, fiannafil and the Green Party, the resignation
of the Taoiseach Brian Cowen and the rise of the Fine Gael party, which
formed a government alongside the Labour Party in the 31st Dil, which led to
a change of government and the appointment of Enda Kenny as Taoiseach.

Portugal March 2011 Following the failure of parliament to adopt the

government austerity measures, PM Jos Scratesand his government
resigned, bringing about early elections in June 2011.

64

Finland April 2011 The approach to the Portuguese bailout and the EFSF
dominated the April 2011 election debate and formation of the subsequent
government.

Spain July 2011 Following the failure of the Spanish government to handle
the economic situation, PM Jos Luis Rodrguez Zapatero announced early
elections in November. "It is convenient to hold elections this fall so a new
government can take charge of the economy in 2012, fresh from the balloting"
he said. Following the elections, Mariano Rajoy became PM.

Slovenia September 2011 Following the failure of June referendums on

measures to combat the economic crisis and the departure of coalition
partners,

the borutpahor government

confidence and December

2011

early

lost
electionswere

a motion
set,

of

following

which janezjana became PM. After a year of rigorous saving measures, and
also due to continuous opening of ideological question, the centre-right
government of janezjana was ousted on 27 February 2013 by nomination
of alenkabratuek as the PM-designated of a new centre-left coalition
government.

Slovakia October 2011 In return for the approval of the EFSF by her
coalition partners, PM ivetaradiov had to concede early elections in March
2012, following whichrobert Fico became PM.

Italy November 2011 Following market pressure on government bond

prices in response to concerns about levels of debt, the right-wing cabinet, of
the long-time Prime Minister Silvio Berlusconi, lost its majority: Berlusconi
resigned on 12 November and four days later was replaced by the
technocratic government of Mario Monti.

Greece November 2011 After intense criticism from within his own party,
the opposition and other EU governments, for his proposal to hold
a referendum on the austerity and bailout measures, PM George Papandreou of
the PASOK party announced his resignation in favour of a national unity
government between three parties, of which only two currently remain in the
coalition. Following the vote in the Greek parliament on the austerity and
65

bailout measures, which both leading parties supported but many mps of these
two parties voted against, Papandreou and Antonis Samaras expelled a total of
44 mps from their respective parliamentary groups, leading to PASOK losing
its parliamentary majority.The early Greek legislative election, 2012 were the
first time in the history of the country, at which the bipartisanship (consisted
of PASOK and New Democracy parties), which ruled the country for over 40
years, collapsed in votes as a punishment for their support to the strict
measures proposed by the country's foreign lenders and the Troika (consisted
of the European Commission, the IMF and the European Central Bank). The
popularity of PASOK dropped from 42.5% in 2010 to as low as 7% in some
polls in 2012. The extreme right-wing, radical left-wing, communist and
populist political parties that have opposed the policy of strict measures, won
the majority of the votes.

Netherlands April 2012 After talks between the VVD, CDA and PVV over
a new austerity package of about 14 billion euros failed, the Rutte
cabinet collapsed. Early elections were called for 12 September 2012. To
prevent fines from the EU a new budget was demanded by 30 April five
different parties called the kunduz coalition forged together an emergency
budget for 2013 in just two days.

66

CHAPTER 10
EURO CRISIS-ITS IMPACT ON INDIAN ECONOMY
All economies are interdependent, so there will be positive and negative
repercussions, when countries are involved in trade. This fact is very much apparent
when there was a global recession in the year 1933. History has again proved that
economic crisis has affected all world economies, the American recession in 2008 and
now the Euro crisis. But what concerns is the stability of the world economies. This
applies to the Indian Economy as well. The Euro was the outcome of the Maastricht
treaty and is a powerful traded currency amongst developed and emerging economies.
The Euro as the single currency of the European Union and equally powerful as US
dollar is now facing a weakening due to debt in its member countries and this crisis
has affected Indian capital markets with a decline due to large sales by fiis resulting in
a bearish outcome of the stock market. The present paper is an attempt to study the
causes for downtrend of Euro and its impact on India.

10.1.

Introduction

Today it is a world of uncertainty in the economic environment of business. The

current Euro crisis has affected the financial health of the economy of India. As we all
know the Euro is the second largest currency in the world and presently has 27
member states. The Euro area consists of 17 member states that accounts for over
75% of the European Unions GDP. It all started in 2009 when Greece one of the
prominent members revealed fiscal debts that shook the entire economy. Gradually,
Ireland, Portugal, Spain and Italy also witnessed a severe debt that led to rise in
borrowing costs.
The current global financial crisis is due to trade cycles which affects levels of
employment, prices, output and overall economic growth as J M Keynes rightly says,
a trade cycle is composed of periods of good trade characterized by rising prices and
low unemployment percentages, shifting with periods of bad trade characterized by
falling prices and high unemployment percentages. It has been said that the
European sovereign debt crisis is due to 2
67

Factors such as globalization of finance, trade imbalances, fiscal debts, high spending,
trying to bail out sick industries resulting in slow pace of economic progress affecting
employment, trade adversely. But according to Martin Wolf a Financial Times
journalist, the root cause was Germany which experienced public debt and fiscal
deficit compared to GDP than the affected member economies from 1999 till 2007.
India which has a close economic linkage with the Euro zone is also affected by its
crisis, mainly the financial or the capital market has been hit hard due to the Euro
crisis and a deficit in current account balance. Nevertheless, measures are undertaken
both at the fiscal and monetary levels to reduce the adverse effect of Euro crisis on its
economy. The present paper studies the causes that resulted in Euro crisis and its
impact on India.

10.2 FORMATION OF EURO CURRENCY

The Euro is the currency used by the Institutions of the European Union and is the
official currency of the Euro zone which consists of 17 members of the European
Union namely Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece,
Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and
Spain. But Denmark, Sweden and the United Kingdom chose not to join the Euro
zone.
It is the second most traded currency in the world. According to International
Monetary Fund (IMF) estimates of 2008 GDP and purchasing power parity among the
various currencies, the Euro is the second largest economy in the world. The name
Euro was officially adopted on 16th December 1995. It was introduced to the world
financial markets on 1st January 1999. Euro coins and bank notes were circulated in
the year 2002 on 1st January. It has been equally powerful traded currency but off
late, it has weakened due to crisis in Greece, Italy, Spain and Germany.
The Euro is administered by the European Central Bank (ECB) and consists of Euro
system which comprises of the central banks of the Euro zone members. The Euro
was the outcome of the 1992 Maastricht treaty. The name Euro was officially
adopted in Madrid on 16th December 1995.
Maastricht Treaty : The Maastricht Treaty formally known as the Treaty on
European Union was signed on 7th February 1992 by the members of the European
68

Community in Maastricht, Netherlands. The European Council drafted the treaty

which came into force on 1st November, 1993 that created the European Union and
the outcome was the introduction of the currency Euro. This treaty has been amended
by the treaties of Amsterdam, Nice and Lisbon. This Maastricht established the three
pillars of the European Union known as the European Community (EC), Common
Foreign and Security Policy (CFSP) and the Justice and Home Affairs (JHA). This
treaty enabled the European Union to function as a single market that would ensure
the free movement of capital, goods and services.

10.3 FACTORS THAT LED TO EURO CRISIS

The European sovereign debt crisis can be attributed to factors such as globalization
of finance, trade imbalances, fiscal debts, slow economic growth, high spending and
trying to bail out sick industries. Germanys trade balance improved later but its
counterparts Portugal, Ireland, Italy , France and Spain had trade deficits.
The economy of Greece was one of the fastest growing in the Euro zone community
in which the Government took advantage that resulted in deficit that has been
observed mainly due to high spending and not so good relations with Turkey. The
prime industries of Greece namely shipping and tourism were adversely affected due
to fluctuations in trade cycles. The Euro debt crisis began in 2009, when the new
Greek Government announced that its predecessors had wrongly reported the data on
Government budget which eventually had deficit at high levels and its extravagance
spending during 2004 Olympic Games.
As a result, the countrys debt began to increase rapidly. Consequently, this created a
panic amongst the Euro countries On 23 April 2010, the Greek Government requested
an initial loan of 45 billion from the EU and International Monetary Fund (IMF) and
in May 2010, Greece received a financial assistance package (loans) from other Euro
zone Governments and the IMF.
Though the Government expenditure increased by 87%, its revenue grew by only
31%.
Euro being second foreign exchange reserve currency, there were hedge funds against
Greece, that the crisis spread to countries like Portugal, Ireland, Italy and Spain.
69

Starting from Greece, Ireland, Italy, Portugal and Spain (GIIPS), these Euro zone
economies have witnessed a severe downgrade in the rating of their sovereign debt,
fears of default, and a sudden rise in borrowing costs. Greece, Ireland and Portugal
have lost access to international capital markets and are now getting bail-outs by the
IMF, European Financial Stability Facility
Some causes for Euro debt crisis also include large pension obligations and poor
demographics/ageing population, high safety net and social services, cyclically weak
tax receipts resulting from higher unemployment, lower property values and lower
business activity, high business tax rates and uncompetitive minimum wage levels.
The Euro zone banks have failed to adjust their balance sheets to the new post-global
financial crisis environment. These banks continue to have weak capital ratios.
Therefore, the fragility of European banks has been magnified in the current
environment.

Due to this crisis, unemployment rates have increased since 2009 in Spain and
Ireland. In Spain, unemployment increased, from 8% to 18%, and in Ireland, from 5%
to 12%. In Germany also unemployment increased to 9.5% and similar increases in
Portugal, Greece and France.

10.4 EURO CRISIS- IMPACT ON INDIA

Just as India could adjust its economy with the American crisis, another crisis in the
form of Euro crisis surfaced the economy , making it difficult to return to normalcy
that held to deficit in its current account balance.
The crisis in Greece has been viewed as the tip of an ice burg which will lead to a
slowdown in growth in Europe that would impact India, with financial crisis in USA
and Europe can hamper business for India.
The Maplecroft study states that India ranks 85th in a list of 169 countries outside of
the Euro zone that have close economic linkages with the Euro zone economies.
This crisis resulted in falls in exports, deficit in balance of payments, decline in
capital inflows and fall in the economic growth rate.
70

Indias economy is currently facing inflationary pressures, trade deficits and public
debt. These internal weaknesses, together with an adverse international environment,
have prompted the IMF to revise Indias growth prospects downwards in 2013 to
around 4.9% and 6% respectively.
The EU countries have a share of 18.6 percent in Indias exports and it is the second
largest destination for our exports. The Euro areas instability has been negatively
reflected in Indias exports. Indias total exports has declined from 20.2 percent in
2009-10 to 18.6 percent in 2010-11. The impact is negatively felt in textile and
apparel exports as both Europe and US are major importers. Europe accounts for
nearly 50 per cent of India's total apparel exports and hence it is no surprise that its
debt crisis has adversely hit apparel exports from India.
The Euro crisis has also affected Indias stock market. Due to crisis in USA in 200809 foreign institutional investors (fiis) had pulled out money from India for most part
of the year because the many of these investors were facing difficulties in their home
markets. The reduced savings and lack of confidence among investors has resulted in
lower investment flows.
In order to combat the crisis, the finance minister stated that liberalization in external
commercial borrowings (ECB) policy and portfolio investment norms and also it
improve access to corporate bond market through Infrastructure Debt funds. The
Reserve Bank of India (RBI) has tried to control speculation in the forex market by
raising of NRI deposit interest rates, easing availability of export credit and
stipulation that 50 per cent of balances in the Exchange Earner's Foreign Currency
Account be converted into rupees balances

10.5 FINDINGS OF THE STUDY

On 1 May 2010, the Greek government announced a series of security measures to
secure a three year 110 billion loan.
The EU, ECB and IMF offered Greece a second bailout loan worth 130 billion in
October 2011.but with the activation being conditional on implementation of further
austerity measures and a debt restructure agreement.

71

Due to an alarming current account deficit, the finance ministry in India has
announced a hike in import duty on gold thereby discouraging the purchase of
physical gold and platinum also turned costlier.
India is also the world's largest producer of organic cotton, with annual production
exceeding 75,000 tons.
India in its capacity as the Co-Chair of the Working Group on the 'Framework for
Strong, Sustainable and Balanced Growth trying to attain the objective of
sustainability of economic growth.
The EU is Indias largest trading partner and observed a compound annual growth
rate (CAGR) of over 15% during the last decade from $21 billion in 2000-01 to over
$91 billion in 2010-11.
India-EU trade relations are of great importance as the EU receives over 18% of
Indias global exports and is also the source of over 12% of Indias imports.

72

CHAPTER 11
ECONOMIC CONCEQUENCES OF EURO CRISIS

11.1 IMPACT ON ACTUAL AND POTENTIAL GROWTH

The financial crisis has had a pervasive impact on the real economy of the EU, and
this in turn led to adverse feedback effects on loan books, asset valuations and credit
supply. But some EU countries have been more vulnerable than others, reflecting
inter alia differences in current account positions, exposure to real estate bubbles or
the presence of a large financial centre. Not only actual economic activity has been
affected by the crisis, also potential output (the level of output consistent with full
utilisation of the available production factors labour, capital and technology) is likely
to have been affected, and this has major implications for the longer-term growth
outlook and the fiscal situation. Against this backdrop this chapter first takes stock of
the transmission channels of the financial crisis onto actual economic activity (and
back) and subsequently examines the impact on potential output.

11.2 IMPACT ON LABOUR, MARKET, AND EMPLOYEE

Labour markets in the EU started to weaken considerably in the second half of 2008,
deteriorating further in the course of 2009. Increased internal flexibility (flexible
working time arrangements, temporary closures etc.), coupled with nominal wage
concessions in return for employment stability in some firms and industries appears to
have prevented, though perhaps only delayed, more significant labour shedding so far.
Even so, the EU unemployment rate has soared by more than 2 percentage points, and
a further sharp increase is likely in the quarters ahead. The employment adjustment to
the decline in economicactivity is as yet far from complete, and more pronounced
labour-shedding will occur as labour hoarding gradually unwinds. Accordingly, the
Commission's latest spring forecast (European Commission 2009a) indicates that, on
current policies, employment would contract by 2 % this year and a further 1 % in
2010. The unemployment rate is forecast to increase to close to 11% in the EU by
2010 (and 11 % in the euro area). The present chapter takes stock of labour market
73

developments since the onset of the and examines the evidence on further job losses
possibly being in the pipeline. 2007 the EU labour markets had performed relatively
well. The employment rate, at about68% of the workforce, was approaching the
Lisbon target of 70%, owing largely to significant increases in the employment rates
of women and older workers. Unemployment had declined to a rate of about 7%,
despite a very substantial increase in the labour force, especially of non-EU nationals
and women. Importantly, the decline in the unemployment rate had not led to a
notable acceleration in inflation, implying that the level of unemployment at which
labour shortages start to produce wage pressures (i.e. Structural unemployment) had
declined. These improvements had been spurred by reforms to enhance the flexibility
of the labour market andraise the potential labour supply.

The reforms usually

included a combination of cuts in income taxes targeted at low-incomes and a

redirection ofactive labour market policies towards moreeffective job search and early
activation. Measuresto stimulate the supply side of the labour marketand improve the
matching of job seekers with vacancies were at the centre of policies in a majority of
countries. Importantly, however, in many countries the increase in flexibility of the
labour market was achieved by easing the access to non-standard forms of work.

11.4 IMPACT ON BUDGETORY POLICY

The fiscal costs of the financial crisis will be enormous. A sharp deterioration in
public finances is now taking place. The decline in potential growth due to the crisis
may add further pressure on public finances, and contingent liabilities related to
financial rescues and interventions in other areas add further sustainability risk. Part
of the improvement of fiscal positions in recent years was associated inter alia with
growth of tax rich activity in housing and construction markets. The unwinding of
these windfalls in the wake of the crisis, along with the fiscal stimulus adopted by EU
governments as part of the EU strategy for coordinated action, is likely to weigh
heavily on the fiscal challenges even before the budgetary cost of ageing kicks in
(which will act as a source of fiscal stress in its own right). Against this backdrop, this
stock of the short-run fiscal developments and analyses the forces that have shaped
them. It also looks at the implications for interest rate differentials.

74

11.5 IMPACT ON GLOBAL IMBALANCE

Persistent 'global imbalances' are seen as one of the culprits of the financial and
economic crisis. The persistent and large current account surpluses in the emerging
Asian and oil producing economies have served to finance the US current account
deficit at favourable terms, which, coupled with quasi-fixed exchange rate against the
dollar, further added to lax financial conditions. The emerging economies in Asia in
particular China and oil exporters are disposed to assume their role as US creditor
owing to their large national saving surpluses with the open and deep financial
markets in the United States attracting large capital inflows. These easy financial
conditions have spilled over to the EU economy via arbitrage-driven capital flows. An
important issue is if the financial and economic crisis in turn has helped to ease the
global imbalances. This is important because, if global imbalances do not correct
even if partially in response to the crisis, the Damocles sword of a disorderly
unwinding of these imbalances remains. A major concern is that a sharp drop in the
US dollar exchange rate would take down the currencies in emerging Asia China in
particular in its wake since these are pegged to the US dollar. This would leave the
euro area with an overvalued single currency and an associated loss in its
competitiveness. Another concern is that a possible increase in US interest rates spills
over to the EU economy. Monetary conditions could thus end up being very tight and
a relapse into recession could ensue. But even disregarding these disorderly
unwinding scenarios, a more gradual unwinding of global imbalances may also have
detrimental effects on Europe if a reduction in the US current account deficit is not
matched by a concomitant reduction in the Chinese trade surplus. Against this
backdrop, the links between the implications of the global financial crisis and the
global imbalances, including the implications if the crisis for the unwinding, and
raises a number of associated policy issues for the European Union in the medium
term.

75

CONCLUSION

So, finally we have reached to the end of our euro crisis journey. The trip was bit long
but it was exiting & to some extent pleasant as well. In this project we made fair
attempt to understand very concept of euro crisis. We saw causes, evaluation,
consequences, reasons of euro crisis. Out of this some topics like meaning,
introduction, evaluation are easy to understand where as topics like policy reaction,
reforms and recovery, impact are bit technical. But all were aiming at the same goal,
i.e. To increase the knowledge and understanding of what is really going on in the
Indian Economy Market.
In a recent news report by the Guardian Newspaper, Latvia was said to be still keen
to join the euro area despite the financial crisis. In fact, Latvia plans to apply for euro
membership in 2014. This enthusiasm for euro area membership, even in the face of
financial crisis, bodes well for Europe.
If euro area membership is still seen as an attribute, confidence in the euro areas
ability to stage a financial recovery must be high. In particular, the recent discussion
around euro bonds (shared euro area debts) does not seem to be putting-off applicants;
if anything were to serve as a disincentive, euro bonds would be it. If confidence in
the euro zone as an institution is high, then one might also logically expect that
investor and buyer confidence may soon follow.
There are other positives on the horizon: The European Central Bank (ECB) has just
announced its new bond-purchasing program, a move which it is hoped will change
the face of EU finances. Essentially, the new program will cheapen borrowing costs
for troubled euro zone countries, allowing them to grow their economies without
simultaneously heaping even more debt onto the ever-growing euro zone pile.
It couldnt come at a better time; unemployment figures for Northern Ireland currently
stand at 8.2%, and the Italian economy shrunk by 0.75 in the second quarter of the
year. Europe needs to see light at the end of the tunnel, and the bond-purchasing
program is a move in the right direction.

76

Bibliography

Books
The euro crisis and its aftermath / Jean Pisani-Ferry ; translated by Christophe
Gouardo

Websites
Www.eurocrisis.com
Www.expatforum.com
Www.eurofound.europa.eu.com
Www.topics.nytimes.com
Www.economist.com

77