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Greek
Government Debt Crisis

 

Greece is a developed country whose economy is
mainly dependent on the Service
sector (amounting to 85%) followed by Industries (12%) where tourism and merchant shipping are the most crucial and then agriculture sector that’s at 3%.

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1.         
ORIGIN AND BACKGROUND

 

Greek government’s fiscal
profligacy (“profligacy” is defined as wasteful and excessive
expenditure) is the origin of the debt crisis. The Greek economy and its
finances were in good shape when it became the 10th member of the
European Community (1981). Its  debt-to-GDP ratio was 28% and budget deficit was below 3% of GDP. But the condition
deteriorated dramatically over the next 30 years.

Over the next 3 decades, either of the
2 political parties (namely, the Panhellenic Socialist Movement and the New Democracy Party) were in power. So as to keep their voters
happy, both parties lavished liberal
welfare policies on their electorates, creating a bloated, inefficient, and protectionist economy.

For example, salaries
for public sector workers rose automatically every year, instead of being based on factors like
performance and productivity. Pensions were also generous. Workers were entitled to an additional month’s pay in
December to help with holiday expenses and also received one-half month’s pay
at Easter and one-half when they took their vacation.

This resulted in low
productivity, eroding
competitiveness, and rampant
tax evasion. Hence to keep the party going, the government had to resort
to a huge debt.

Greece’s admission in the Eurozone (2001) and its adoption of the Euro
made it much easier for it to borrow. This was because Greek bond yields and interest rates declined sharply as they converged with
those of strong EU members like Germany.
Greece became one of the fastest growing economies in the Eurozone with an
average 3.9 % increase in GDP per year between 2001-08.

But that boom in the economy came at a steep price, as certain measures for
Greece had already exceeded
the limits mandated by
the EU’s Stability and
Growth Pact when it was admitted into the Eurozone. For instance, Greece’s
debt-to-GDP ratio was at 103% in 2000, way above the Eurozone’s maximum
permitted level of 60%. Greece’s fiscal deficit as a proportion of GDP was 3.7%
in 2000, also above the Eurozone’s limit of 3%.

The Greek government debt crisis happened shortly after the crisis of 2008-09. This
is as the investors and creditors focused on the colossal sovereign debt loads
of the US and Europe. The investors began demanding much higher yields from
Greece for the sovereign debts, due to added higher risk. Until the Global
Financial Crisis, sovereign debt risk had been camouflaged by Greece’s
wealthy neighbours in the north, such as Germany.

Greece’s economy contracted in the aftermath of
the crisis, the debt-to-GDP
ratio increased, peaking at 180% in 2011. Also, the new government in 2009 revealed that the
fiscal deficit was 12.7%, more than twice
the previously disclosed figure, sending the debt crisis into higher gear.

 

 

2.         
CAUSES

The Greek financial crisis was a chain
of debt crisis starting in 2008. The main reasons for crisis were basically
endogenous factors that are mal-administration
of Greek economy and government expenses rather than exogenous factor which is
international factors.

 

# MAJOR CAUSES FOR FINANCIAL CRISIS ARE:

a)    Mismanagement of Greek economy

b)   Lack of data credibility (Greek fiscal data)

c)     Tax evasion

d)   Unregulated Labor market

e)   
excessive public spending

f)     
surge in credit growth

g)   
unsustainable debt levels

h)   high wage growth not
supported by productivity growth, which led to a decline in Greece’s
competitiveness

 

·      
Greece’s Membership in the Eurozone Contributes to the
Crisis

Despite Greece’s gross government debt and budget deficit, Greece was allowed to join the Eurozone. This was some
obvious rule bending which undermined the credibility of the European project.

If Greece had not adopted the Euro, it could have devalued its currency to stimulate exports and its economy and inflate its
way out of the crisis. Currency devaluation would have taken the pressure off interest rates.
Greece could not set its own interest rates, as interest rates are set by ECB
for the members of the Eurozone.

 

3.         
IMPACT

 

a.    Income and savings had a downward trend

b.    Norms for granting loans became strict

c.     Interest rates were increased

d.    Liquidity crunch resulted in lower capital
flows

 

v   Impact on Greek Tourism

The economic downturn greatly affected
the Greek Tourism and hotel industry especially after other countries worldwide
were facing serious economic problems and the unemployment rose rapidly. The
government later decides to reduce
prices to encourage travelers to come to Greece yet there is an increase in protests and strikes
disrupting and hampering the flow of revenue into the economy.

 

4.         
POLICIES
FOR RECOVERY BY THE GOVERNMENT

 

A Fight
against corruption and tax evasion

 

a. Methods to
reduce tax evasion

The OECD estimated the size of the
Greek black market
to be approx. 25% of the GDP leading to 20 billion euros worth of unpaid taxes
each year (2009).  A more effective tax collecting
system has been recommended to rapidly increase the revenues of the
government although several successive Greek govts have been unsuccessful in
doing so.

A tax reform was implemented by the Greek government
in 2010. All the people who owed the state more than 1,50,000 euros were called
upon by the finance minister of Greece to pay their taxes that were outstanding
by November 24, 2011 or otherwise their names would be published on a black list on the
internet.

In the year 2011, the Greeks having accounts in the Swiss
bank were told by the finance ministry that they would have to give the
identity of the bank account holder or pay a certain amount of tax to the Greek
internal revenue services. To battle tax evasion more effectively a new tax transparency law
was finally ratified by Switzerland (2016). Both Greece and Switzerland would
exchange their country’s citizens bank information with the other country for minimizing any
possibilities of hiding
untaxed incomes, from the year 2018.

The Greece government, in 2016 and
2017 encouraged the use of
credit or debit cards to reduce the transactions involving payment by
cash for goods and services. By January of 2017, only when the transactions
made by the people were done electronically along with a “paper trail” making
the task of auditing easier for the government were people granted tax
deductions or allowances. To avoid payment of sales tax (VAT) and income tax,
many companies used the tactics of not issuing an invoice. This was introduced
to solve this issue.  

By July 28, 2017, a lot of businesses
by law were required to install a point of sale for acceptance of payment by
debit or credit cards.

b.
Anticorruption
measures

It was estimated that to avoid
bureaucratic rules and other benefits, companies paid approximately 1 billion euros to public institutions as bribe.
The newly elected government had in its agenda to make the fight against fakelaki
(bribe in envelopes full of cash) (2009). An online census of civil servants
was started by the inspector general of public administration. A number of criminal offences were uncovered with the help
of this census.

 

B Austerity packages and reforms

 A total fiscal tightening of 41 billion euros was included in the
first three austerity packages that had been negotiated and agreed upon from
February 2010 till May. Out of this 28 billion euros were related to 2010-11
and the leftover 13 billion euros were scheduled for 2012-14.

The Greek government felt the
austerity measures were a cause for the recession while the creditors
attributed the Greek government’s inability to implement the necessary economic
structural reforms for the increased need for fiscal tightening.

This package had been implemented to
save an approx. of 0.8 billion euros; on 9 February 2010; it also involved a 10% cut in bonuses, freezing of salaries of
government employees as well as cuts in public employees, overtime workers and
work- related travels.

 The 14th austerity package had more of tax changes as well as pension cuts.

 

 

 

vTIMELINE

November 2004

The Greek budget deficit and
government debt have been misreported on no less than 11 occasions since 2000.

2005–2009

Issues and concerns about the quality
of Greek data on five separate occasions are raised.

September 2008

Lehman Brothers, a global financial
service firm collapsed, which led to start of the global financial crisis.

October 2009

Greek government forecast for the 2009
budget deficit to a startling 12.5% of GDP, up from an earlier estimate of 3.7%
of GDP.

December 2009

Three renowned credit-rating agencies
downgrade Greece’s credit ratings, Greek debt to below A for the first time in
a decade.

Early 2010

Greek government took austerity
measures for the very first time to yield their rapidly increasing debt.

April 2010

Credit-rating agencies further
downgrade Greek debt.

May 2010

Greece receives its first bailout from
Troika consisting of the European Commission, the European Central Bank and the
International Monetary Fund. The bailout amounted to a total of EUR 110
billion.

2011

Greece’s creditors agree to take a cut
on their debt of 53.5% of face value.

February 2012

second Greek bailout, EUR 130 billion.

January 2014

Greece announces it attained a primary
budget surplus

April 2014

Greece returns to the capital markets
for paying for the first time in four years.

May 2014

Fitch upgrades Greece’s credit rating
to B from B market.

January 2015

general election leads to winning of
Syriza Political Party, an anti-austerity party hostile to bailouts and
international creditors. Also, Syriza brought a financial package to reduce
poverty and the consequences of before taken austerity measures.

June 2015

Greece failed to USD1.7 billion IMF,
but making it the first developed country to ever default on an IMF loan after
Zimbabwe in 2001.

5 July 2015

In a referendum held on Greece’s third
bailout package, the Greek people reject its terms by 61.3% to 38.7%. However,
the government pushed further with the austerity measures required by the
bailout.

 

5.         
CURRENT SCENARIO

 

·       France and Germany are trying to help Greece, yet they stand the chance to
go bankrupt themselves if there was a sudden default.

·       US is trying to persuade the EU to aid Greece
without which there stands a chance that the economy may head for a double dip
recession.

·       There is a high rate of unemployment along with
years of austerity
weighing of the household consumption.

·       Exports have shown signs of growth which bring much needed respite.

·       The labor market is improving along with positive business sentiment should
facilitate stronger growth in 2018

·       It might be difficult for Greece to reach the
target 1.6% of growth with the slow pace of expansion.

·       High
taxation has dampened the competitiveness of
the export goods, though the revenue generated by the tourism industry remains strong.

·       Imports in the 3rd quarter have
slowed down which show a weak state of domestic demand.

 

6. CONCEPTS INVOLVED

 

v Borrowings
-Borrowing can be done in two ways by the government :-
Domestic Borrowing Or International Borrowing
If a government decides to borrow within the country i.e. in the same currency
and when the government is defaulting in payment of the loans then they can
even print more currency whereas in International borrowings if suppose a
country X borrows from Country Y which has a different currency, then in this
case the country X can’t pay them in their home currency and they can’t print
more to pay Country Y.

 

v Budgeting
Budgeting is simply
balancing your expenses with your income.
How much income is to be generated and how much expenditure is to be incurred.

There are three components involved in
it and are Income, Expenditure and debt.

How budgeting is
done in the real scenario?
-The people in a particular country produce goods and services and they are
one’s who are adding value to the economy by this process, out of which the
government takes some part of the revenue earned by the people of the country
known as tax which is basically income for the government.

-The budget is approved in the
parliament (Hellenic Parliament) in case of Greece.

-Normally after a budget season the
parliament to a decision regarding where to spend? how much to spend? and how
to spend? which is known as the Fiscal Policy.

 

 

v   Bond market

In finance, a bond is an instrument of
indebtedness of the bond issuer to the holders. The government raises
money through the bond market and the debt accumulated through the bond market
by the government is called Sovereign
Debt.

Let’s assume
The Greek government has an expenditure of 200 crore but it doesn’t the amount
right now to proceed with the payment’s and henceforth the Greek government
decides to go to the bond market to raise money by issuing bond whose face
value will be 220 crores at a price of 200 crore which will state that the
government promise to pay the sum within the next 10 years with 20% interest.
The interest rates are determined by the forces of demand and supply of funds
which can be lent.

 

Let’s again
assume but now two scenarios
One when money supply is more
When money supply is more in the market then the amount to be lent would be
more and interest rates will eventually fall as the money available in the
market is more and lot of people are ready to give money.

When money supply is less
When money supply is less in the market then the amount to be lent would be
less and interest rates will eventually increase.

The supply of the loanable funds
depends upon the confidence shown in the government. The strong economies would
find it easy to raise money through the bond market whereas the weaker
economies would face difficulties in getting money as investors see instability
in their growth.

What happened in
the case of the Greek-Government crisis?
As we know the Greek is a part of
European Union from 1981 and which acted as a major advantage for the Greek
government in getting loans easily as people relied on the European Union and
exhibited great confidence
which lead to the Greek government to borrow more and more.

 

 

 

v  
Devaluation

It refers to reduction in value of domestic currency by the government.
It is deliberately done by the government to increase exports and reduce trade
deficit. It takes place under fixed exchange rate system.

 

v     
Government Budget

ü  
 Budget Expenditure

a.  Revenue Expenditure

It is expenditure incurred on normal running of the government
departments and provision of various services. It does not lead to creation of
physical or financial assets.

It includes –

1.   
Salaries and pensions

2.   
Subsidies and grants given to state government

3.   
Interest charges on debt incurred by the government

4.   
Defence expenditure

 

b.   Capital
Expenditure

It leads to creation of physical or financial assets.

Ex. Buildings, roads, dams, social welfare programs, purchase of shares,
repayment of loans

 

v     
 Fiscal Deficit

= total expenditure – revenue receipts – capital receipts (excluding borrowings)

It indicates the total borrowing requirements of the government from all
sources. It shows the extent of dependence of the government on borrowings to
meet its budget expenditure. The growing fiscal deficit creates many problems
for the economy as it leads to large internal debt.

 

The solution for this can be –

a.    Reducing public expenditure

b.   
Increasing revenue receipts by mobilising resources
through Taxation

We saw these steps being taken by the Greek government to reduce their
Fiscal Deficit.

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