(Wrote this article for an event... posting it here...)
Rising debts
and a loss of competitiveness are the main challenges facing Greece Economy.
Presently, it does not have any options which can be proved to be good for all.
Problems of Greece increased with the adoption of Euro. In February
1992, European leaders signed the Maastricht Treaty, laying the foundation for
monetary union and adoption of the euro. Greece qualified in 2000 and was admitted on 1 January 2001. Prior to the adoption of euro, Annual inflation in
Greece was one of the highest in the region and GDP growth was the slowest in
Europe.
Adoption of the Euro led to a drop in inflation from an average of 18
percent from 1980–1995 to just above 3 percent from 2000–2007. After averaging
annual GDP growth of 1.1 percent from 1980 through 1997, Greece’s economy
expanded at an average rate of 4.1 percent over the next ten years, the fourth
fastest rate in the Euro area. Per capita GDP rose from 39 percent of that of
Germany in 1995 to 71 percent in 2008. It quickly became an attractive
destination for foreign capital.
But, this fuelled the domestic demand. Domestic demand growth drove up
prices in Greece increasing domestic labor costs and eroding Greek
competitiveness. If we have a look at numbers, since 1997, consumer prices have
risen by 47 percent and since 2000, per capita employee compensation has grown
by over 80 percent. Competitiveness was hurt further by a shift away from
manufacturing sectors in favor of the expansion of service and non-tradable
sectors. Increase in Revenues increased government spending especially in
social transfers and public sector wages.
Reflecting the economy’s rapid growth, public sector deficits averaged 5
percent of GDP from 2000 to 2007. The scenario changed markedly with the
financial crisis and when markets realized Greece’s chronic failure to report
accurate statistics. GDP expanded by only 2 percent in 2008 and contracted by 2
percent in 2009, pushing down tax revenues and driving up the restated deficit
to 7.7 percent in 2008 and 13.6 in 2009.
With debt levels rising and the IMF projecting it to reach nearly 150
percent by 2012, borrowing costs of Greece skyrocketed. Attempts are being made
by EU and IMF to restore the economy of Greece and other EU nations(PIIGS)
Bailing out Greece
There are different views and solutions to restore the economy of Greece
and other EU nations in danger. There are three different viable options possible
in the existing situation
1.
Greece voluntarily leaving Eurozone
2.
Other EU nations forcing the Greece out
of the EMU
3.
Greece undergoing a massive debt
restructuring plan and with the aid of IMF and other EU nations, it stabilizes
itself
Let us analyze each of these cases in detail in order to understand the
best possible option available for Greece.
Default of Greece would mean breaking away from Euro. Presently, there
is no provision in Maastricht Treaty for a country to exit the Euro. Neither is
there a provision to expel a country from Euro. This is an irrevocable aspect
of the union and any mistake in the membership is permanent. Founders of Euro
chose not to include the opting out mechanism because of different reasons like
existence of opt out mechanism would have been seen as a lack of commitment
from member states, it would have raised the possibility of a country exiting
and this would have completely shattered their goal of a common currency. This
clause was put under scrutiny and the Lisbon treaty makes explicit reference to
a withdrawal option for EU member.
According to this treaty, the withdrawal should come from the individual
member state’s initiative and willingness but this does not provide the
information about what should the actual mechanism be for exiting from the EU.
This treaty says nothing about leaving EMU.
The only way for a country to leave EMU is to negotiate with the member
nations and exercise it’s newly granted right. Rationally, an economy would
choose to leave monetary union if the costs of staying in exceed the costs of
departure.
Now, if Greece decides to leave Euro, it will have to choose a new
currency for itself. In this case, the sovereign debt which it has raised over
the years will be in foreign currency and the only way for Greece to earn Euros
and repay the debt would be by doing trade, which is likely to be significantly
disrupted and so default on the Euro denominated national debt is almost
certain.
Default on sovereign debt would generate lasting economic costs as the
long term cost of capital for the government would increase. In addition to the
sovereign default, because of high cost of capital, there is also likely to be
a corporate default. With the government changing the currency of the country,
it will force the change on the corporate sector, they will have to suffer
problems in meeting their obligations with the new and “devalued” currency.
Also, once the Greece decides to exit from the Eurozone, it is very much likely
that the entire banking system may collapse. Anyone with savings in euros in
bank will take them out in the fear of getting devalued new currency in place
of euros. People will hold on to their euros as long as possible. No one will
spend money more than what is required and in this case, a complete collapse of
the banking system is inevitable. In the event of these issues, Greece may not
opt out of the Euro unless it is forced to do so.
Forced Default
Legal Provisions do not provide any right to the member nations to expel
any country from the European union. However, EU nations can force Greece out
of the Union by not extending their support to Greece. Expelling a Member state
would need an amendment of the existing treaties and which would take away a
large time in negotiating with all the member states.
Present economic conditions give us hints that Germany is trying to play
a game with Greece and trying to force it out of the Union while not accepting
it officially. Recent attempt to delay the bailout plan worth 130bn euros by
proposing that they want Greeks to agree to another 325m euros in cuts, setting
a budget deficit target of 7.5% of GDP in 2011, when it actually missed the
9.6% target of 2010, give us clear cut hints in this direction. It’s an attempt
to put more pressure on Greeks in order to make them walk out of the Union
Voluntarily.
The other issue with the forced default is that other EU Nations in
danger may also be forced to leave the Union. Without control over interest
rates, EU nations are limited in their ability to deal with bubbles. And as a
result, a complete collapse of Euro can occur. In addition, Forced default will
also have the issues listed under voluntary default.
But the benefit with the default is that the devalued currency might
encourage capital into the economy, will also stop the austerity measures, and
Greece can start with the growth process and the so called austerity amount can
be used to bail out “Bailable” countries instead of Greece which is almost
certain to default sometime in future.
Debt restructuring and Austerity
measures
If Greece has to survive without defaulting, then EU Nations and IMF
will have to lend their massive support to Greece. Present Fiscal policy
adjustments aim to begin reducing the debt-to-GDP ratio by 2013 and bring the
government deficit below 3 percent of GDP by 2014. The total adjustment, 11
percent of GDP, is composed of reductions in spending of 5.3 percent of GDP,
tax increases of 4 percent, and structural reforms that are expected to add 1.8
percent of GDP. However these cuts will accentuate the deep recession in the
private sector and result in wage and price deflation, which in turn will take
a major toll on output growth and on tax revenues and may further decrease the
competitiveness of Greece and the growth may be stagnated for years.
Conclusion
Whatever Option Greece may choose to opt, the scale of effects is going
to be huge. However, if we consider the cases of Argentina(2002) and
Latvia(2008), Argentina was forced to devalue Peso and Latvia adjusted itself
with the help of the massive support and the economists estimated that the total
cost of default and the output losses was lower in devaluation and default, the
primary reason for which was the fact that Argentina started on the growth
process sooner instead of waiting for the austerity measures and imposing huge
cuts thereby contributing to the decline or stagnation of the economy. Though we
cannot compare Argentina with Greece, However, these cases suggest that it is
better for Greece to default and since, most probably, Greece would not go on
Voluntary default, a Forced default, in a matter of time, is most likely to
happen.
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