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Topic

Introduction

Topic of the week for discussion: 4th

to 10th

June 2012

Topic : Greece Debt crisis

Greece is facing a sovereign debt crisis because of the debt it accumulated since thefirst half of the first decade of the present century when the market was highlyliquid. As the crisis deepened, there was a liquidity crunch in the world economythereby making borrowings difficult as well as expensive and thereby improper debtrepayments on time. As of now, the debt-GDP ratio of Greece is a whopping 160percent.

The major factors behind the crisis were supposed to be the excessive expenditures,financial mismanagement and unregulated labour market. In 2010, almost 27 percentof the total working population of the country was part of bureaucracy. The crisiswas further aggravated by the contemporary US Sub-prime crisis when the income

and savings were facing a downward trend worldwide resulting in lower demandand thereby lower output and employment. This adversely impacted the labourmarket of Greece. Moreover, volatile capital markets due to liquidity crunch resultedin lower capital flows as a result, strict norms were made for banks to grant loansand rates were also increased thereby making borrowings costlier in Greece incomparison to the rest of the world. Overall, it adversely impacted the prime sectorslike tourism shipping etc which had a significant contribution to the GDP.

In order to accommodate its rising expenditures, it had to dwelt heavily on theexternal borrowings due higher internal interest rates. On joining the EuropeanMonetary Union, it discovered that it could borrow at lower rates equal to Germanywithout doing anything and continued to incurring expenditures and avoid reforms.

Many solutions are being tried out since long; however, the desired results don'tseem to be forthcoming.

Impact of Greek crisis on India is not a direct one but it will affect the Euro zone,accounting for one fifth of Indias foreign trade. Therefore, if the crisis is notresolved early, it will have a chain reaction. It may not only engulf the Europeancountries, but could also have a severe impact on the developing economies such asIndia. Further, 75 percent of these exports are from the manufacturing sector. Aslowdown will affect demand from Europe for domestic products.

Further, the job losses, budget cuts and other austerity measures will also impactdemand. This will also have an adverse impact on the country's industrial

production. As a slowdown will affect exports, it can lead to an increase in thealready high current account deficit. High Current Account Deficit means thatimports are much higher than the exports which will ultimately depreciate the Rupeefurther strengthening the inflationary forces in the country.

The stock markets in developing countries can witness a slowdown in funds fromEurope as the foreign institutional investors (FIIs) and European banks will needfunds to meet their own requirements of capital adequacy, current obligations and

domestic needs, and will not be able to spare much for investments in overseasmarkets.

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Because of the vulnerability to European Union from the Greece crisis, Greeceexit from the Euro zone is also not ruled out. However, even after the Greeceexit from Euro zone, European banking system will involve pouring more

money into Greece. The European Financial Stability Facility, the instrumentfor fixing the European liquidity crunch, is authorised to borrow up to 440

billion Euros, of which 250 billion Euros remained available after the Irish andPortuguese bailout. Coupled with this, Spain and Italy are facing the negligiblegrowths which are supposed to be the most developed countries of Euro zone

along with Germany and France.

In such a situation, the US Dollar will emerge as the most secure currency.With the fall of the Euro, Dollar's rise against the Indian Rupee is likely whichhas already fallen to historic lows. Theoretically, the fall of the rupee will make

exports and services cheaper. But since India depends on imports to meet itsfuel demands (generally paid for in US Dollars), fuel prices would go through

the roof, making everything costlier. This may further cause depletion in theforex reserves as a result input costs will continue to rise and margins will dropdrastically.

However, a positive for India is the fact that this is mainly a domestic

economy. It is not primarily dependent on exports. Secondly, India has adiversified export portfolio, spread across various regions. These factors willhelp mitigate the impact of adverse conditions in the Euro zone to some extent.

India needs to take another more fundamental lesson from the European debt

crisis. The European sovereign debt crisis is not an overnight development.Globalisation of finance; unregulated credit conditions during the 20022008period that encouraged high-risk lending and borrowing practices; international

trade imbalances; real estate bubbles; slow economic growth since 2008; fiscalpolicy choices related to government revenues and expenses; and approaches

used by nations to bail out troubled banking industries and private bondholdersetc have all contributed to this development.

In India, unfortunately, successive governments have sacrificed fiscalconsolidation at the altar of growth. The Union finance minister, for thefinancial year 2011-2012, announced that the fiscal deficit of the governmentof India stood at 5.9 per cent of GDP. It is fiscal mismanagement that has spelttrouble for Europe. It is imperative that we draw the right lessons from this.India can cope with such crises but if we don't improve our fiscal management,

we may be in for bigger trouble.

Read further:http://www.bbc.co.uk/news/business-13798000

http://www.bbc.co.uk/news/business-13856580

http://www.bbc.co.uk/news/business-18094883

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