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Midterm: Greece Debt Crisis Getting Nashty 1 I. Introduction Greece’s debt crisis of 2010 was triggered by high budget deficits that reached 13.6% of GDP – 4 times the amount allowed by the EU – and high national debt levels reaching €300bn, representing 124% of GDP. This high spending, mainly funded by other European counterparts, was done to heighten the luxurious life of Greeks, causing a furor throughout the region when the Greeks debt crisis threatened to collapse the entire Eurozone. The decisions by both Greece and the EU would have a substantial impact on the survival of Greece, the fate of the other the “PIIGS” (Portugal, Ireland, Italy, Greece and Spain - all of whom are running unsustainable debts and/or deficits and who either have at present, or are likely to, demand bailouts from the EU as well), and the entire European Monetary System (EMS). To better understand the situation, we have restated the key events in the following timeline. II. Understanding the Situation – Timeline of Events1 Date Event 20 01 Greece joins Euro, but fudged budget deficits 2009 Beginning of financial crisis • Greek economy contracted by 0.3% • National debt rose to €262bn, from €168bn in 2004and was projected to rise to 124% of GDP in 2010. • Its deficit reached 12.7% of GDP – more than four times the stipulated EU amount. • Fitch cut Greece's long-term debt to BBB+, from A- Jan 2010 Greece to clean its own house • "We need no bilateral loans, we have never asked for bilateral loans," says Greek prime minister. • Jean-Claude Trichet, president of ECB, ruled out help for Greece, "Each country has its own problems. It is a problem that has to be solved at home. It is your own responsibility." Feb 2010 Announcement of austerity package, riots begin, EU leaders consider rescue package but some opposition • Greece announces a wider austerity package, including a freeze on public sector pay and higher taxes for low and middle-income households. • Debt ballooned to €300bn while the spread between the interest charged on Greek and German debt widens to 4% as investors fret that Greece may default. • European leaders consider a rescue package for Greece at an economic summit. 11 Feb 2010 Germany opposes a quick bailout of Greece • “Greece must tackle its debt problems itself.” Mar 2010 First bond issue oversubscribed, but 2nd issue received weak response • Greece’s €5bn 10-year bond issued on March 4, was well-received • However, the second €5bn 7-year bond issue on March 29 met with weaker response, as financial markets start to lose faith in Greece's ability to service its debts. 11 Apr EU ministers agree terms to bailouts, though Greece reluctant to activate 1 http://www.guardian.co.uk/business/2010/may/05/greece-debt-crisis-timelineMidterm: Greece Debt Crisis Getting Nashty 2 2010 • Finally, Eurozone agrees to a €30bn rescue package. • The interest rate expected to be pegged at about 5%, well below the market rates 16 Apr 2010 Greece may need help from the IMF, pushing its bailout up to €45bn. • The intervention of IMF would expose Eurozone’s internal weakness and inability to solve a debt crisis. 23 Apr 2010 Greece activates €45bn EU/IMF loans • With €16bn of debt maturing in May, Papandreou officially requests a bailout. 27 Apr 2010 Standard & Poor's downgrade Greek credit rating to BB+, junk status. • Analysts warn that €45bn simply won't be enough to sort out the Greek crisis, with prediction that the country may need a €150bn rescue package. • Cost of servicing its short-term debt has increased to 14%. 28 Apr 2010 EU and IMF officials hold crunch talks with German leaders • Rumors of a €120bn package being planned. • The yield on Greek two-year bonds has skyrocketed to 38%. Austerity measures under discussion include: • Hiking VAT to between 23% and 25% (it's 21% at present) • Cuts in the bonuses and wage supplements on offer to state workers • A 10% (or greater) hike in taxes on petrol, tobacco products and alcohol • Slashing the budget deficit by 6.5% in 2010 2 May 2010 Greece granted €110bn aid to avert meltdown • A three-year package to rescue Greece. Of the €110bn over three years, the other 15 Euro countries are to supply €80bn in bilateral loans, while the IMF puts up the remaining €30bn. • In return for the lifeline, Papandreou will implement spending cuts amounting to more than €36bn, or 11% of national GDP, over the next three years. Wages, pensions, and benefits in Greece's bloated public sector will be cut, and large VAT and other tax rises will be imposed. The retirement age is to be raised. III. Understanding the Options for EU and Greece Options for EU Before we analyze ‘game’ dynamics, it is important to understand the pros and cons of each option, in order to understand the rationale behind each decision. 1) Let Greece default Pros Cons • Sets an example for other EMU countries to emphasize self-discipline. Each country will need to conduct structural reforms, increase competitiveness, and pursue sound public finances. • Prevents the moral hazard problem within EMU members. This emphasizes the “no • Letting Greece default could lead to a contagion effect, which will result in lower confidence and higher borrowing costs for other high debt countries, in particular, the PIIGS. • Destabilizes the banking sector as over €200bn are held by European banks, includingMidterm: Greece Debt Crisis Getting Nashty 3 bailout” clause of the Maastricht treaty, which states that there will be no bilateral assistance for other economies. • Satisfies the public of other EU countries as tax money will not need to be spent on the bailout of Greece. €30bn and €55bn held by German and France banks, respectively. • The massive political and financial turmoil in Greece could force Greece to leave the Euro. • Harmful to EU’s image in its ability to handle internal problems Assessment: Letting Greece default is the most costly option for the EU. The contagion effect of the default could lead to debt crisis among the other PIIGSs, especially Spain, which has a much larger economy, and its crisis will have a much larger impact than that of Greece. 2) Let Greece call the IMF for


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