Greek Default of Sovereign Debt - Essay Example

Greek Default of Sovereign debt Introduction It is no doubt that the global economy is interlinked. The national economies of each country are influenced by each other. Evidence of this comprises of past incidents of economic crises that have affected many countries and regions in the world. For example, the 2008/2009 financial crisis affected many parts of the world, although it emanated from the US. This shows that the global economy is actually interconnected such that a major shock in one region could trigger ripple effects in other regions. Due to the interconnection of the global economy, countries within the same geographic regions or with similar economic conditions have formed regional bodies for various purposes. For some, such as the NAFTA (North American Free Trade Area), regional integration is based on establishing free trade zones. For others, such as the AU (African Union) and the EU (European Union), regional integration is based on political and economic cooperation (Sore, 2010). With the trend of regional and global integration, one of the emerging concepts is sovereign debt borrowing. Under this concept, a country can borrow a loan from another country or institutions. For example, a country that is experiencing financial problems such as growing budget deficits has the option of sovereign debt to address the problem. Some of these institutions include the World Bank, EU, and IMF (International Monetary Fund). Foreign debts are supposed to be paid as per the agreement. However, there have been cases of defaults in repayment. Usually, a country that is unable to repay its foreign debts on the agreed date can renegotiate the deal for an extension. The renegotiation option is not always a guarantee. A foreign debt default can cause adverse implications for the affected countries. In the past, such defaults have resulted in military invasions such as when the US occupied Haiti in 1915 (Huang, 2014). There have various foreign debt defaults since 2000. Some of these include: i. Argentina default of $82 billion in 2001. ii. Ecuador default of $3.2 billion in 2008. iii. Jamaica default of $7.9 billion in 2010 (Huang, 2014). Apart from these cases, one of the largest and most recent foreign debt default occurred in 2012. Greece defaulted on its $138 billion foreign debt, which became the all-time biggest foreign debt default (Huang, 2014). The purpose of this paper is to present an in-depth analysis of the Greece sovereign default. The paper will present a detailed discussion of how the default came to be, what factors and actors contributed to it, the reactions of different stakeholders, the lessons drawn, and the way forward. The paper will present a background of the Greek debt crisis, its structure, the government’s policies to address the crisis, the role of the EU in the crisis, the lessons drawn, and the future outlook of the economy of Greece. Apparently, the Greek debt crisis is attributable to the improper financial and structural policies of the government as well as the laxity of the EU in enforcing fiscal discipline. 2. Background of Crisis Like most other cases of foreign debt defaults, the Greece sovereign default did not occur abruptly. However, the issue only came out when the government came out about Greece’s financial problems in 2012. The government announced that Greece had a public debt amounting to $410 billion. Prior to this, there had been indications that the country would default on its foreign debt obligations. Some of the main indicators included: Poor economic and financial policies – one of the main indicators of the Greek debt default was the poor economic and financial policies adopted by the government. Apparently, the government engaged in high spending, especially in private consumption. Between 2003 and 2010, the general government spending as a percentage of the Gross Domestic Product grew from 44.7 percent to 49.5 percent (Rady, 2012, p. 90). This was a worrying trend because there was no matching increase in government revenues as would be expected. Within the same period of 2003 to 2010, government revenue as percentage of GDP grew slightly from 39 percent to 39.1 percent, which led to a major budget deficit. By 2010, the budget deficit had hit -10.4 percent of Greece’s GDP (p. 90). The declining government revenue was due to poor tax collection due to a widespread problem of tax evasion in the country. The culture of tax evasion is attributed to various factors, including public sector inefficiencies, corruption, high taxation, and excessive regulation (Katsios, 2006). Poor trade policies – prior to the 2008 financial crisis, Greece’s current account balance declined from 2000 to 2008. This led to an increase in imbalances in the country’s current account. The country’s external debt obligations grew to 149 percent of the GDP by 2008. The private sector debt also grew significantly within the same period, mainly due to a credit expansion strategy to private entities (Athanassiou, 2009). The increased debt obligations led to a decline in net savings, which fell to negative percentages of GDP by 2005. By 2007, the net savings were -2.7 of the GDP (Rady, 2012, p. 92). Decline in Greece’s international competitiveness –Greece’ competitiveness in the international arena also dropped significantly in the period preceding the debt default. According to Rady (2012, p. 92), the main causes of this decline in competitiveness were the declining productivity and high wages compared to other countries. The average wage in Greece between 2001 and 2010 grew at a faster rate compared to the Eurozone. In terms of productivity, educational achievement, which is a major factor of productivity, in Greece was actually lower than the average in the OECD. Therefore, it was clear that Greece was loosing in terms of international competitiveness before the debt default. 2009 government declaration – in 2009, the new government in Greece announced that the national budget deficit had been understated by the previous government. Rather than the stated budget deficit of six to eight percent, the new government declared that the budget deficit was actually higher in the range of 12 to 13 percent (Ardagna & Caselli, 2014, p. 293). This announcement was a major pointer to the imminent debt default because it showed that there was more to the Greek financial situation than met the eye. From the above points, it is clear that the Greek foreign debt default was predictable. There were multiple factors that showed the country’s ability to settle the foreign debt obligation was declining. Yet, the Greek government continued to spend unrealistically while not being keen on collecting taxes to offset the growing expenditures. As a result, the country suffered a major budget deficit. 3. Structure and Trend of Yield of Greek Sovereign Debt The Greek foreign debt default had a unique structure. It followed a systematic process involving three main phases. These include the buildup phase, the outbreak phase, and the external assistance. This structure is discussed in detail below. Buildup phase–from the previous section, it has emerged that the Greek foreign default was predictable. This means that there was a buildup phase prior to the outbreak. The buildup phase can be traced to a decade prior to the outbreak, which mainly covers the period between 2001 and 2011. During this 10 year period, the Greek government adopted an extravagant behavior by borrowing heavily from foreign markets to fund the local budget. However, the government had weak administrative structures that led to poor management of government budget. Apparently, the government focused so much on foreign borrowing and less on raising revenues locally. This led a growing imbalance between the government expenditure and revenues (Nelson, Belkin, & Mix, 2010). Outbreak phase –the debt crisis facing Greece started coming out after a new government came to power in 2009. The revision of the country’s budget deficit upwards by the new government raised concerns among investors. Investor confidence in Greece started dropping. The new government attempted to restore the declining investor confidence by adopting several austerity measures (this will be discussed in detail in the next section). However, the government austerity measures were not effective because Greek bonds were downgraded after a few months (Nelson, Belkin, & Mix, 2010). External assistance – ultimately, the Greek government requested for financial assistance to address its debt crisis. The government made a formal request for assistance from the IMF and Eurozone. This formal request was accepted and in May 2010, the IMF and Eurozone announced a $145 billion (€110 billion) to assist Greece in settling its debt obligations. The assistance was also aimed at protecting other countries in the EU region from being affected by the Greek crisis (Nelson, Belkin & Mix, 2010). The EU assistance to Greece was met with divergent views. While some supported the decision to bail out Greece, others opposed it on several grounds (see Kulish, 2010). For those supporting EU bailout of Greece, the Greek crisis could spread to other EU countries leading to a wider and more severe regional crisis. Therefore, it was important to support Greece to avert such a situation from happening. On the other hand, opponents of EU involvement in the Greek crisis felt that Greece had engaged in budget indiscipline. By bailing Greece out, these opponents felt that the EU would be rubber stamping such behaviors. Moreover, Greece was not the only country in the Eurozone that was experiencing financial challenges. Therefore, supporting Greece alone was seen by some as being selective and unfair (Nelson, Belkin, & Mix, 2010). The involvement of the IMF was also controversial. At first, most members of the EU opposed the involvement of IMF because it was perceived as an outsider. Many felt that the Greek crisis was a problem of the EU and that the EU should take full ownership and responsibility over the problem. By involving IMF, some felt that this would be undermining the authority and capability of the EU, which wanted to be seen as a strong entity capable of handling its internal issues. However, this position changed later and IMF was involved. The involvement of the IMF was partly because of the tough policy reforms that the IMF attaches to its loans, which many perceived as a necessary boost to the proposed reforms and austerity measures on Greece (Nelson, Belkin, & Mix, 2010). 4. Main Areas of Reform The IMF and EU placed some conditionalities on the rescue loans to bailout Greece. The conditionalities focused on several main areas for macroeconomic reforms in Greece. First, they focused on public spending in Greece. The IMF and EU required the Greek government to reduce its public spending to reduce the budget deficit. This was to be realized by cutting government jobs, adjusting the minimum wage downwards, and applying salary and employment freezes (Kyriakopoulos, 2014). Additionally, the IMF and EU required that Greece undertakes a reformation of its pension system, raise the retirement age, impose a new business levy, increase VAT and other taxes (Forelle, 2010). 5. Greek Economic and Public Debt Structure According to Economy Watch (2010), Greece is a capitalist economy. The public sector contributes approximately 40 percent to the country’s economy. However, the private sector is also a major sector in the country’s economy. In terms of specific sectors that form the Greek economy, the services sector is the largest, followed by industry and then agriculture. Table 1 below shows the main economic sectors in Greece based on their contribution to the country’s GDP for the period between 2008 and 2013. Since the Greek economy is heavily reliant on the service sector with tourism as one of the leading sectors, the 2007/2008 affected the economy significantly. In an effort to save these service sectors from the effects of the financial crisis, the government resorted to pumping more money into the economy, which led to structural deficits, which led the government to borrow more sovereign debts (The Competition Master, 2010).By the end of 2010, the Greek sovereign debt comprised of a public debt of €340 billion, an external debt of €149 billion, and an institutional debt of €40 billion (Tsafos, 2011). Table 1: Greece Economic Sectors and GDP 2008-2013 Percentage Contribution to GDP Sector 2008 2009 2010 2011 2012 2013 Services 78.77 79.1 79.8 80.81 80.2 79.83 Industry 18.09 17.75 16.98 15.82 16.43 16.46 Agriculture 3.14 3.15 3.23 3.37 3.37 3.71 Source: Statista (2014). 6. Government Policies Towards Crisis The Greek government’s response towards the debt crisis was mixed. At first, the government seemed to ignore the looming problem. The government that was in office prior to 2009 did nothing much to address the problem although. Rather than try to stop the extravagant spending and borrowing habits, the government continued with the same trend. For over a decade, the Greek government managed to conceal the real budget deficits, it was experiencing (see Ardagna & Caselli, 2014). In fact, as the previous government was leaving office, it understated the budget deficit at six to eight percent when actually it was double this percentage (p. 193). With a new government coming into office in 2009, the first reaction of the new government was to rectify the understatement of the country’s budget deficit by the previous government. The new prime minister announced that the budget deficit was actually higher in the range of 12 to 13 percent. This was a major step that the government had taken because it attracted reactions from multiple stakeholders. The announcement led to a decline in investor confidence, which may have caused some investors to reconsider their intentions of extending foreign loans to the country in the face of a major foreign debt crisis (Nelson, Belkin, & Mix, 2010). This was evident shortly after when the Greece credit rating was downgraded, which meant that Greece was locked out of the financial market despite the previous decade where the government had been borrowing at the same rates as Germany (Ardagna & Caselli, 2014, p. 293). One of the major reactions of the Greek government to the debt crisis was adoption of several austerity measures with the aim of reducing the growing budget deficit (Ardagna & Caselli, 2014, p. 293). One of the austerity measures adopted by the Greek government was cutting government expenditure. Based on a three-year plan, the new government led by Prime Minister Papandreou implemented major cuts in public spending. This was an aggressive approach that primarily affected civil servants. The government either reduced or froze wages, pensions, and bonus for civil servants. Additionally, the government implemented a major free on hiring of new civil servants (Nelson, Belkin, & Mix, 2010, p. 8). Apart from reducing government expenditure, the government also raised taxes and adopted more stringent measures to avert tax evasion. The government increased the VAT from the initial 19 percent to 23 percent. The government also implemented tax increases on other items including luxury products, tobacco, fuel, and liquor. With the increased taxation strategy, the government hoped to achieve a revenue increase of 1.8 percent (Nelson, Belkin, & Mix, 2010, p. 8). Apart from the fiscal austerities, the government also implemented some structural reforms. The government targeted the pension system as well as the healthcare system in these reforms. Prior to the reforms, the Greek pension scheme was notable for its generosity, which exceeded other countries’ in Europe. The government raised the retirement age to 63 from the initial 61. Moreover, the government adopted more stringent measures to reduce evasion of social security contribution that had plagued the country for many years. The structural reforms also targeted the healthcare and public administration systems to seal the loopholes that had led to poor revenue collection and spending. For example, the government reduced the municipalities, administrative authorities, and legal public entities associated with the local authorities (Nelson, Belkin, & Mix, 2010, p. 9). The fiscal and structural measures taken by the government did not do much to address the budget deficit problem. Therefore, the government started looking externally for bail out in a final attempt to avoid a debt default. In 2010, the government managed to secure bailout from the EU and the IMF. The EU agreed to provide bilateral loans amounting to £80 billion in a three-year period. This was to be topped up by the IMF, which provided £30 billion more covering the same three-year period (Ardagna & Caselli, 2014, p. 293; Seitz & Jost, 2012, p. 3). In total, the bailout amounted to £110 billion package, which was based on strict conditions that Greece had to implement. In signing the bailout package, Greece was required to implement drastic measures in its fiscal and structural policies to reduce expenditures and increase revenue (IMF, 2010). According to Alogoskoufis (2012), the Greek government was given a three-year period to reduce its budget deficit from the 13 percent level in 2011 to less than three percent by 2014. 7. EU Role in Encouraging the Crisis The Greek debt crisis was largely blamed on the improper internal structures and policies of the government. However, external factors also contributed to or escalated the problem. The EU is partly to blame for the debt crisis. Greece attained EU membership in 2001 after an initial application to join the single currency block was rejected because the country had not met any of the criteria set by the EU (Greece joins euro, 2001; James, 2000). Some top ranking members of the criticized the decision to admit Greece into the EU. Angela Merkel, the German Chancellor, admitted in 2013 that the admission of Greece into the Eurozone may have been a mistake (Zeller, 2013; Thompson, 2013). The EU was specifically culpable in the Greek debt crisis in two ways including failing to ensure fiscal discipline in Greece and provision of lower lending rates (Frankel, 2011). a. Failure to Ensure Fiscal Responsibility The EU has been blamed for failing to ensure fiscal responsibility among EU member states including Greece. The EU came up with the Stability and Growth Pact in 1997, which intension was to give the EU greater mandate in scrutinizing and enforcing public financial rules as set out in the convergence criteria of the Maastricht Treaty of 1992 (Ngai, 2012). Under the public finance rules, EU member states are required to ensure that budget deficits do not surpass a threshold of three percent of GDP while public debt is capped at 60 percent of GDP. EU member states that contravened these thresholds could be subjected to fines (Nelson, Belkin & Mix, 2010, p. 6). However, the EU commission and council have been lax at implementing this rule. Over 30 cases of excessive deficit procedures have been witnessed since 2003 without any tangible action by the EU. This laxity in enforcing fiscal responsibility among member states also played out in the case of Greece. Although the EU commission noted that Greece had violated the deficit rules, it went ahead declare that it was satisfied with the measures undertaken by Greece to address the excess deficit (Nelson, Belkin& Mix, 2010, p. 7). It is clear that the EU was not keen on enforcing the Stability and Growth Pact, which could have helped in checking the extravagant behavior of the Greek government leading to the debt crisis. b. Overconfidence in the EU Member States The EU includes members such as Germany and France, which are viewed as economic heavyweights. The inclusion of other states such as Greece, which is considered as the poorest among the EU member states, was overshadowed by the presence of strong economies such as Germany and France. This created overconfidence in the member countries, including those that has weak economies such as Greece. This overconfidence led to the EU lending member states at dramatically lower interest rates. These low interest rates encouraged countries such as Greece to borrow excessively (Rady, 2012, p. 93). On its part, the EU did not see anything wrong with Greece’s over-borrowing behavior. It took over a decade for the EU to realize the extravagant borrowing by Greece, which was too late to avert the imminent debt default. Had the EU discouraged this bad borrowing behavior by Greece, the default could have been avoided because Greece would have been compelled to adopt austerity measures early enough (Nelson, Belkin & Mix, 2010, p. 6; Rady, 2012, p. 93). 8. Lessons Learnt From Crisis and Economic Reforms Several lessons can be drawn from the Greek debt default. First, the crisis emphasizes the importance of in-depth scrutiny of countries before admitting them into regional bodies. The case of Greece joining the Eurozone highlights this factor. Apparently, Greece produced inaccurate reports of its public debt and budget deficits, which formed the basis for its admission into the Eurozone (Woods, 2012, p. 15). Had the EU taken more keen interest in analyzing and scrutinizing the reports provided by Greece, perhaps it would have decided against admitting the 12th member of the regional body. From the perspective of Greece, had the country avoiding the hurried move to gain admission into the Eurozone, the debt crisis could have been averted because the Greek government could not have been able to access the low-rate loans that is accessible to EU members. According to Nicolas Sarkozy, Greece was not ready to join the EU (Elliot, Treanor, & Smith, 2011). Second, the Greek debt default and specifically the IMF and EU imposed austerity measures have shown that there is greater need for considering the role of political dynamic in regional integration (see United Nations, 2012). Apparently, the EU member states are divided into two categories including the economic giants such as France and Germany and the other members whose economies are not so strong or stable such as Greece. In this system, the political dynamics are seen to play. For example, after Greece requested for a bailout, Germany and France were among the leading EU member states to require Greece to comply with stringent austerity measures. Essentially, Germany and other well-off northern EU member states used the Greek debt crisis to implement greater control and oversight over their counterparts in the south including Greece (Karger, 2012, p. 35). Therefore, it is important for states to consider the political dynamics when seeking to join regional integrations. Third, the Greek crisis highlights the necessity of bailouts that are linked to austerity measures. Although Greek received a bailout from the EU and the IMF, the country was required to implement severe austerity measures that had adverse implications on the Greek economy and citizens. The high taxation and labor freeze was a major blow to the citizens who had to shoulder a heavier tax burden, wage freeze, and loss of jobs (Casert, 2013). According to Dabalis (2013), the conditions attached to the Greek bailout may have had more devastating impacts on the society compared to the positive impact on Greek budget deficit. Fourth, the Greek crisis has emphasized the importance of more stringent scrutiny and enforcement of discipline in government fiscal policies and structures (Ngai, 2012).The Greek government’s poor fiscal and structural systems led to the budget deficit, which culminated in the foreign debt default. This shows that there is a need for heightened internal and external measures to check the behavior of governments and enforce rules and measures that will prevent improper behavior (Williams, 2014). Finally, Greek’s failure in negotiation with employee unions was a major mistake. Instead of negotiation with workers unions for a fair burden-sharing, the government focused on the austerity and structural measures imposed by the EU and IMF after they bailed out the country (Eichengreen, 2013). This was a miscalculated move because it creates more internal pressure with workers protesting against the austerity measures. The protests and strikes had far reaching implications of the Greek economy, which needed to sustain and boost productivity to increase revenues. 9. Future Outlook of the Greek Economy The future outlook for the Greek economy is positive (Economides, 2014). The economy of the country has emerged from a period of recession. The GDP of the country grew by 1.7 percent in 2014 (Bensasson& Chrysoloras, 2014).This was the first time in the last seven years that the country’s GDP has recorded a positive growth. The implication of this positive growth of to the future of the Greek economy is that the country will emerge from the debt crisis in the short term. The adverse impact and reforms implemented after the crisis will provide a strong basis for more positive economic growth. The lessons from the crisis period will lead to the development of stronger structures and fiscal policies to reduce the gaps that led to the crisis. Apart from the GDP growth, the Greek economy is also showing signs of improvement based on an eight percent decline in government borrowing (Joy, 2013). This trend is projected to continue into the next several years, which shows a positive outlook for the economy. The primary budget deficit has also improved. According to Granitsas and Stevis (2014), Greece realized a primary budget deficit of €1.5 billion in the financial year 2013. This improvement was appreciated by the EU, which noted that the Greek economy was progressing well since the 2010 bailout (Granitsas & Stevis, 2014). Table 2 below presents recent statistics on Greek GDP on four different economic indicators. Table 2: Recent GDP Statistics for Greece (2013/2014) Economic Indicators Statistics GDP growth rate 1.7% Trade balance -1761 Deficit 12.70% Inflation Rate -1.2% Source: Trading Economics (2014). 10. Conclusion The Greek debt crisis represents that largest sovereign debt crisis in history. The crisis was caused by internal and external factors that acted together. Internally, the Greek government engaged in unreasonable borrowing while government revenue declined, leading to a growing budget deficit. Externally, the EU failed in its role to ensure fiscal discipline in Greek government borrowing and spending. 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Angela Merkel: Greece ‘should not have been admitted’ into the Euro Zone. Huffington Post. Retrieved from http://www.huffingtonpost.com/2013/08/28/angela-merkel-greece_n_3828423.html Read More