Definition of the Greek Debt Crisis

Definition of the Greek Debt Crisis

Images of money being exchanged in hands, the Greek flag, and money bags are displayed together with a chronology from 2008 to 2018. “The Greek debt problem is the risky amount of sovereign debt Greece owes to the EU between 2008 and 2018.” Greece warned in 2010 that if it didn’t pay its debts, the eurozone’s continued existence would be in jeopardy. The EU gave Greece enough money to keep paying in order to prevent this. The largest lenders, Germany and its bankers, supported austerity measures, which included overhauling Greece’s pension system as well as changing how Greece managed its public finances. In 2017, Greece had a 0.8 percent budget surplus, 1.4 percent economic growth, a 22 percent unemployment rate, one-third of the population living in poverty, and a debt-to-GDP ratio of 182 percent.

The risky amount of sovereign debt Greece owes to the European Union between 2008 and 2018 is what is causing the Greek debt crisis. Greece threatened the viability of the eurozone in 2010 by threatening to default on its debt. 

The EU granted Greece enough money to keep up payments in order to prevent a default.

Greece has received almost 320 billion euros in loans from various European governments and private investors since the economic crisis started in 2010.

The largest financial rescue of a bankrupt nation ever took place.

 Greece had only returned 41.6 billion euros as of January 2019. Beyond 2060, debt repayments are planned.

The EU required Greece to enact austerity measures in exchange for the loan. The goal of these changes was to make Greece’s financial and governmental systems stronger. In doing so, however, they also caused Greece to enter a recession that lasted until 2017 

Fears that the crisis would lead to a global financial disaster were raised when the eurozone debt crisis was brought on by it. It foreshadowed what would happen to other highly indebted EU nations. The nation of China, whose economic output is little larger than the state of Connecticut in the United States, was the catalyst for this severe disaster. 

Why the Crisis in Greece?

Greece had a fiscal deficit that was higher than 15% of its GDP in 2009.

Fear of a default increased the 10-year bond spread, which finally caused Greece’s bond market to collapse. This would prevent Greece from funding additional debt repayments. A large debt restructuring compelled private bondholders to accept investment losses in exchange for less debt, which is highlighted in red in the chart below during the time when the yield on 10-year government bonds exceeded 35%.

EU leaders had a difficult time coming to a consensus. Greece requested that the EU forgive a portion of the debt, but the EU refused to give Greece a pass.

Germany and its bankers were the largest lenders. They supported austerity policies. They thought the actions would strengthen Greece’s competitive advantage in the international market. Greece had to manage its public finances more effectively in order to comply with the austerity requirements. It had to update its financial reporting and data. It reduced trade restrictions, boosting exports.

The most significant requirement of the measures was that Greece restructure its pension system. Pension payments have consumed 17.5 percent of GDP.Public pension underfunding was 9 percent, compared to 3 percent in other countries. Greece was compelled by austerity measures to reduce pensions by 1% of GDP. Additionally, it restricted early retirement and demanded increased employee pension contributions. 

Half of all households relied on pension income because one in every five Greeks was 65 or older.

 Paying payments in order for seniors to earn bigger pensions didn’t make the workforce happy. 

The government was compelled to reduce spending and raise taxes as a result of the austerity measures. They were expensive—72 billion euros, or 40% of GDP. The outcome was a 25% decline in the Greek economy. This decreased the tax income required to pay off the loan. Youth unemployment reached 50% as the jobless rate increased to 25%. There was rioting in the streets. The political system was in disarray as voters flocked to anyone offering a simple solution.

There are various outcomes. In 2017, Greece had a 0.8 percent budget surplus7. Although its GDP expanded by 1.4%, unemployment remained at 22.0%. 8. The poverty rate was one third of the total population. Its debt to GDP ratio in 2017 was 182%.

Timeline

Greece declared in 2009 that its budget deficit would be 12.9% of its GDP. That exceeds the EU’s 3 percent cap by more than four times. Credit rating companies Fitch, Moody’s, and Standard & Poor’s downgraded Greece. This increased the cost of future loans and drove away investors.

Greece unveiled a strategy in 2010 to reduce its deficit to 3% of GDP in two years. The EU lenders were reassured by Greece that it was fiscally prudent. Four months later, Greece issued a default warning. 

In exchange for austerity measures, the EU and the IMF contributed 240 billion euros in emergency assistance. Greece only received enough funding from the loans to cover the interest on its existing debt and maintain bank capitalization. The only option left to the EU was to support one of its members by providing a bailout. Otherwise, it would be subject to the negative effects of either Greece defaulting or quitting the Eurozone.

 As a result of austerity measures, Greece has to raise the corporation tax rate and the VAT tax. It was necessary to close tax gaps. It formed an independent tax collector to combat tax evasion. Early retirement incentives were lowered. It increased worker pension system contributions. In order to minimize the cost of goods and increase exports, it also reduced wages. Greece was forced by the measures to privatize a large number of state-owned enterprises, including energy transmission. As a result, socialist unions and parties had less influence.

What made the EU so strict? Greek officials were warned against using the new loan to settle the old debt by EU leaders and bond rating companies. Germany, Poland, the Czech Republic, Portugal, Ireland, and Spain have previously strengthened their respective economies with austerity measures. They wanted Greece to imitate their success since they were funding the bailouts. Slovakia and Lithuania, two EU nations, refused to demand money from their taxpayers to release Greece from its obligations. 10. Without assistance from the EU, many nations have just undergone their own austerity measures to stay afloat.

The European Financial Stability Facility increased the bailout by 190 billion euros in 2011. That money came from EU nations, notwithstanding the name change.

By 2012, bondholders had ultimately consented to a haircut, exchanging 77 billion euros worth of bonds for debt that was worth only 75% as much.

Greece’s GDP expanded by 0.7 percent in 2014, giving the impression that it was improving. Bond sales were successful, and the budget was balanced.

Voters chose the Syriza party in January 2015 to oppose the despised austerity policies. Greek Prime Minister Alexis Tsipras called a vote on the reforms for June 27. He made the misleading claim that a “no” vote would give Greece more negotiating power to secure a 30% debt reduction from the EU. Greece failed to make its 1.55 billion euro payment on June 30th, 2015. 11. Both parties described it as a delay rather than a formal default. The IMF issued a warning two days later that Greece required 60 billion euros in fresh funding. It instructed lenders to continue taking losses on the more than 300 billion euros that Greece owed them.

Greek voters rejected austerity measures on July 5.

12 banks were attacked as a result of the unrest. Greece suffered significant economic losses in the two weeks prior to the election. ATM withdrawals were limited to 60 euros per day, and banks were closed. At the height of the season, when 14 million people were traveling throughout the nation, it posed a threat to the tourism sector. Greek banks will be able to reopen after receiving recapitalization from the European Central Bank ranging from 10 to 25 billion euros. 

A weekly withdrawal cap of 420 euros was set by the banks. This stopped depositors from emptying their accounts and making the situation worse. Additionally, it lessened tax avoidance. Consumer debit and credit cards were used by consumers to make purchases. The consequence was an annual boost in federal revenue of 1 billion euros.

Despite the vote, the Greek parliament approved the austerity measures on July 15.

 It would not be granted the 86 billion euro loan from the EU. Greece’s debt reduction was agreed upon by the ECB and IMF. It increased the terms’ length, which decreased net present value. Greece’s debt would remain unchanged. Simply pay it over a longer period of time.

Greece paid the ECB on July 20 thanks to a 7 billion euro loan from the EU emergency fund. The UK insisted that the other EU countries guarantee its bailout contribution.

A quick election was won by Tsipras and the Syriza party on September 20.

They were given the green light to keep pushing for debt relief in talks with the EU. They also had to keep up with the unpopular measures that they had pledged to the EU.

As mandated by the ECB, Greece’s four largest banks raised 14.4 billion euros privately in November.

 The money paid off problematic debts and allowed the banks to operate normally once more. On their books, over half of the loans that banks held were at risk of default. This sum was provided by bank investors in exchange for the 86 billion euro rescue loans. Economic activity fell by 0.2%. 

The Bank of Greece forecast that the economy would resume recovery by the summer of March 2016. Despite a 0.2 percent decrease in 2015, Greek banks continued to lose money.They were hesitant to write off bad debt because they thought their debtors would pay back once the economy picked up. That consumed money they could have lent to start-up businesses.

Greece received 7.5 billion euros from the EU’s European Stability Mechanism on June 17.

  1. It intended to utilize the money to pay the debt’s interest. Greece kept on with its austerity policies. It adopted measures to update the income tax and pension systems. It is committed to selling off nonperforming loans and privatizing more businesses.

Tsipras agreed to reduce pension benefits and widen the tax base in May 2017. In return, Greece received a further 86 billion euro loan from the EU. Greece utilized it to pay down more of its debt. Tsipras anticipated that his accommodative demeanor would enable him to pay off the 293.2 billion euros in unpaid debt. However, the German government would not make many concessions before the September presidential elections.

For the first time since 2014, Greece was able to issue bonds in July. To win back the confidence of investors, it intended to exchange the notes issued during the restructuring with the new notes.

In order to be eligible for the upcoming bailout round, the Greek parliament approved new austerity measures on January 15, 2018. The finance ministers of the eurozone authorized 6–7 billion euros on January 22. 13. The new regulations make it more difficult for union strikes to bring about a national shutdown. They adjusted child benefits, opened up the energy and pharmacy markets, and assisted banks in reducing bad debt.

The bailout program came to an end on August 20, 2018.

The EU emergency funding bodies are owing the majority of the unpaid debt. The majority of these are financed by German banks.

168 billion euros in total for the European Financial Stability Mechanism and the European Stability Mechanism

Governments in the eurozone have 53 billion euros.

34 billion euros in private investors.

Investors in Greek government bonds total 15 billion euros.

13 billion euros at the European Central Bank.

IMF: 12 billion euros.

European creditors will legally monitor adherence to current austerity measures up until the loan is repaid. The agreement forbids the creation of any new laws.

Causes

How did Greece and the EU initially get into this mess? Greece’s adoption of the euro as its official currency back in 2001 was the sowing of the seeds. Greece has been a member of the EU since 1981, but it has been unable to join the eurozone. For the Maastricht Criteria of the eurozone, its budget deficit has been too high. 

For the first few years, everything went smoothly. Greece benefited from the power of the euro, just like other nations in the eurozone. It decreased interest rates and attracted loans and investment money.

Greece admitted in 2004 that it had been misled to avoid the Maastricht Criteria.

There were none imposed by the EU. Why not? Three explanations were given.

At the time, Germany and France were also going over budget. Sanctioning Greece before enacting their own austerity measures would be hypocritical. 

The precise sanctions to be imposed were a matter of debate. Greece may be expelled, but that would cause chaos and damage the euro.

The EU seeks to increase the influence of the euro on global currency markets. Other EU nations like the United Kingdom, Denmark, and Sweden would be persuaded to accept the euro if it were strong.

Up until the crisis broke out in 2008, Greek debt grew as a result.

Greece’s Reasons for Refusing to Leave the Eurozone

Greece had the option to leave the euro and bring back the drachma. The Greek government could have added new employees if the austerity measures hadn’t been implemented. It would have boosted economic growth and reduced the 25% unemployment rate.Greece could have produced additional money, decreased its exchange rate for the euro, and changed its euro-based debt to drachmas. That would have decreased its debt, lowered the price of exports, and drawn travelers to a less expensive vacation spot.

At first glance, that would appear to be perfect for Greece, but international holders of Greek debt would have experienced crippling losses as the value of the drachma fell. The value of payments made in their own currency would decrease as a result. Several banks would fail. Governments in Europe control the majority of the debt, and their citizens would be responsible for paying it.

Hyperinflation would have resulted from falling drachma values as import prices soared. Greece imports 40% of its food, 40% of its medicine, and 80% of its energy. 

Many businesses balked at sending these goods to a nation that might default on its debts. In such a volatile environment, the nation was unable to entice additional foreign direct investment. Only Russia and China would have provided loans to Greece. Greece would eventually find itself back where it started, unable to pay off its debt.

Other debt-ridden nations would have seen an increase in interest rates. Rating agencies would worry that they would also abandon the euro. Due to currency dealers’ decision to bet against the euro due to the crisis, the value of the currency itself would have decreased.

Greece avoided default for several reasons.

More quickly felt effects would result from a broad Greek default. First, without financing from the European Central Bank, Greek banks would have failed. Losses would have put other European banks’ viability in danger, especially those in Germany and France. The total amount of Greek debt held by them and other private investors was 34.1 billion euros. 

52.9 billion euros were controlled by eurozone governments. Additionally, the EFSF, which is effectively the eurozone governments, owns 131 billion euros. Germany had the largest debt, although it only represented a small portion of its GDP. A large portion of the debt wasn’t due until 2020 or later. The situation was more acute for smaller nations. 10% of Finland’s annual budget was allocated to its share of the debt. The Greek debt was owned by the ECB for 26.9 billion euros.

The ECB would have been fine if Greece had gone into default. Other debt-ridden nations were not expected to go into default.

Due to these factors, the 1998 Long-Term Capital Management debt crisis wouldn’t have been worse as a result of a Greek default. At the same time, other emerging market nations saw a tsunami of defaults as a result of Russia’s default. The IMF helped many countries avoid defaults by supplying capital until their economies had stabilized. The amount of Greek debt held by the IMF, 21.1 billion euros, is insufficient to pay it off.

The magnitude of the defaults and the fact that they are in developed markets would be a contrast. It would have an impact on where the IMF gets a lot of its funding. There would be no assistance from the United States. Despite being a strong supporter of IMF assistance, it is currently heavily indebted. A political appetite would not exist for an American bailout of European sovereign debt.

Outlook

Numerous elements of Greece’s economy continue to be problematic despite austerity measures. While EU bailouts account for about 3% of GDP, government spending accounts for 48% of it. 22. In 2017, 20% of Greece’s GDP was derived from tourism. Commercial investments are frequently delayed by bureaucracy for decades. Despite being smaller, the government is nonetheless ineffective. The level of political patronage is too high. The centralization of government decision-making significantly slows reaction times.

Greece has been unable to sell state-owned assets worth 50 billion euros due to bureaucracy, murky property rights, and court roadblocks. Since 2011, only 6 billion euros’ worth of real estate has been sold.

As more people participate in the underground economy, tax avoidance has become widespread. It now accounts for 21.5% of GDP. People are paying higher taxes as a result, and they are receiving less from the government than they were before the crisis.

Many of the open positions pay less than they did prior to the crisis and are part-time. As a result, tens of thousands of the most talented individuals have departed the nation. Banks are hesitant to provide fresh loans to firms since they haven’t fully recovered. It will take time for things to get better.

Questions and Answers (FAQs)

When did the Greek debt crisis begin?

The debt crisis in Greece erupted in 2009. The nation disclosed that the budget deficit had risen above 15% of GDP. Due to this borrowing boom in comparison to production, Greek debt was downgraded by credit rating agencies. 

What impact did the Greek debt crisis have on the US economy?

Hence, Greece’s debt crisis did not immediately affect the United States, and hence there was no immediate effect. Since Europe and the United States are important trading partners, the severe effects on Europe’s economy did represent a threat to the stability of the American economy, but the Greek debt crisis wasn’t a direct threat in and of itself. 

Leave a Reply