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The Greek Debt Crisis

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The recent worldwide financial crisis (often called the Global Financial Crisis) is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s. It has resulted in the collapse of several US and European financial institutions, the bailout of banks and major corporations by national governments and severe falls in equity markets across the world. In the US and UK the housing markets also suffered, resulting in thousands of evictions, foreclosures and vacancies. It contributed to the failure of key corporations, declines in personal wealth estimated in the trillions of dollars and a severe decline in economic activity, leading to a significant global economic recession in 2008/9.

It has now given way to an emerging sovereign debt crisis, currently centered in Europe. This report focuses on Greece, the current epicentre of distressed sovereign debt. This report reviews the factors giving rise to the crisis and determines that the world has not yet successfully recovered and that further trouble is likely to lie ahead.

3 The European Sovereign Debt Crisis

From late 2009, fears of a sovereign debt crisis developed among conservative investors concerning some European states, with the situation initially coming to a climax in early 2010. This included EU members including Greece, Ireland, Spain and Portugal and also some other EU countries. Iceland, the country which experienced the most significant crisis in 2008 when its entire international banking system collapsed has emerged less affected by the sovereign debt crisis as the government was unable to bail its banks out. In the EU, especially in countries where sovereign debts have increased sharply due to the bailout of banks, a crisis of confidence has developed with the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other EU countries, most notably Germany.

While the sovereign debt increases have been most pronounced in only a few EU countries they have developed into a serious problem for the entire region. In May 2011, the crisis resurfaced, concerning mostly the refinancing of Greek public debts. The Greek people have generally rejected the austerity measures and have expressed their dissatisfaction through angry street protests. In late June 2011, the crisis situation was again temporarily brought under control with the Greek government managing to pass a package of new austerity measures and EU leaders pledging funds to support the country.

Concern about rising government deficits and debt levels across the globe together with a wave of downgrading of European government debt created alarm in financial markets in early 2010. On 9 May 2010, Europe's Finance Ministers approved a comprehensive rescue package worth €750 billion aimed at ensuring financial stability across Europe by creating the European Financial Stability Facility (EFSF).

In 2010 the debt crisis was mostly centered on events in Greece, where the cost of financing government debt was rising. On 2 May 2010, the EU countries and the International Monetary Fund agreed to a €110 billion loan for Greece, conditional on the implementation of harsh austerity measures. The Greek bail-out was followed by a €85 billion rescue package for Ireland in November, and a €78 billion bail-out for Portugal in May 2011.

This was the first EU crisis since its creation in 1999. Niall Ferguson, the prominent academic and author, wrote in 2010 that "the sovereign debt crisis that is a fiscal crisis of the western world".

4 Causes of the Greek Crisis

Figure One: Greek debt as a percentage of GDP in comparison to EU average

From 2000 to 2007, the Greek economy was one of the fastest growing in the EU. During that period, it grew at an annual rate of over 4% as foreign capital flooded the country. A growing economy and falling bond yields allowed the Greek government to run large budget deficits. Large budget deficits are one of the features that have marked the Greek economic model since the restoration of democracy in 1974. Following a period of military rule, the new democratic government wanted to bring disenfranchised portions of the population into the economic mainstream. In order to do so, successive governments have run large budget deficits to finance a large public sector workforce and other social benefits. Since 1993, the debt to GDP ratio has been above100%.

Currency devaluation of the drachma initially helped finance the borrowing. Upon the introduction of the euro in early 2001, Greece was able to borrow due to the lower interest rates government bonds could attract. The late-2000s financial crisis that began in 2007 had a large effect on Greece. Greece's largest industries are shipping and tourism, and both were heavily affected by the downturn with revenues falling approximately 15% in 2009.

To keep within EU guidelines, the government of Greece had misrepresented the country's official economic statistics. In early 2010, it was discovered that Greece had paid investment bank Goldman Sachs and others hundreds of millions of dollars over several years for engineering transactions that hid the true level of borrowing. The purpose of these transactions made by several subsequent Greek governments was to enable them to continue spending while hiding the actual level of deficit from authorities.

In 2009, the Papandreou government revised its budget deficit from an estimated 6% to 13%. In May 2010, the Greek government deficit was 14% which is one of the highest in the world relative to GDP. Greek government debt was estimated at €220 billion in early 2010. Total government debt was forecast to be 120% of GDP in 2010. The Greek government bond market depends heavily on foreign investors, up to 70% of Greek government bonds are held by external sources.

Estimated tax evasion costs the Greek government in excess of $US20 billion per year. Despite the crisis, Greek government bond auctions were all over-subscribed up until early 2010.

5 Downgrading of Debt

Figure Two: Interest rate of Greek Two Year Government Bonds

On 27 April 2010, the Greek debt rating was decreased to the upper levels of 'junk' status by Standard & Poor's amidst hints of default by the Greek government. Yields on Greek government two-year bonds rose to 15.3% following the downgrading. Some analysts continue to question Greece's ability to refinance its debt. Standard & Poor's estimates that in the event of default investors



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