Friday, December 23, 2011

The Greek Economic Problem and the difficult choices.

Sarfaraz A.K. (2011)
When the Euro was first introduced in 1999, Greece was left out as it failed to meet the economic benchmarks. To join the Eurozone, Greece had to introduce tough austerity measures which included massive decline in the public spending. Joining the Eurozone, according to the polls, was supported by two-thirds of the population therefore the public accepted the budget-cuts wholeheartedly. Greece was finally admitted to the EMU (European Monetary Union) in 2001 while the European currency was introduced in 2002. The Greek Finance Minister Ioannis Papandoniou described 1st January, 2001 as a ‘historic day’ for Greece

Fast forward to 2011; ten years later, Greece has witnessed another historic day on 2ndNovember, 2011. Prime Minister George Papandreou has decided to hold a referendum over EU and IMF’s decision to bailout the Greek Economy as Greece witnesses its “worst crisis of the modern times”. His decision stunned IMF, EU and other stakeholders of Greece as global markets saw a huge decline fearing an economic crisis. Reactions came from around the world as French President Nicolas Sarkozy sharply criticized Mr. Papandreou's decision as it surprised “all of Europe”. Unlike 1999, the current polls (October, 2011) show that 60% of the Greeks are opposed to the bailout package. A ‘No’ vote could lead to an immediate economic chaos for Greece as it would directly go towards default with prospects of it leaving the Euro Zone or at least cause a redefinition of its membership terms.

The political turmoil in Greece continues as the Prime Minister decided to step down. The politicians are hoping to find a new candidate who could steer the country out of the crisis.

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In a decade, Greece has gone from being the host of Summer Olympics, 2004 to being a country on the brink of bankruptcy. The main problem with Greece is its inability to live within its means. The European currency came into Greece in 2002 which made it easier for Greece to borrow money. Greece started borrowing heavily from other European countries, US and Japan. Two years later it hosted the extraordinarily expensive summer Olympics. The public sector expenditure, particularly the public sector wages saw an increase of 100% in the past decade. Tax evasions, on the other hand, increased causing a decrease in tax income. Furthermore, the poor financial condition meant that lenders now started charging higher interest rates for their money.

Greece was therefore not prepared for the global financial crisis of 2010. Its poor economic condition meant it could no longer borrow money commercially. The only reasonable solution for Greece was to receive bailout money from lenders. To receive the bailout, Greece had to decrease its public expenditure and increase its tax income. The implementation of this decision caused a public uproar causing massive riots and strikes. However, Greece was able to secure $150 billion as first bailout in May, 2010 from EU and IMF. It was originally thought that during one year, Greece would sort out its public expenditure, increase its taxation income and therefore will be able to borrow money commercially. As the rest of the world slowly pulled itself out from the recession, Greece was never able to do so. In 2010, Greece’s deficit was at 10.5% of its GDP with S&P declaring it the ‘least credit worthy country it monitors’.
Greece was in need of another bailout. The EU and IMF agreed to lend $148 billion, mainly from the European Financial Stability Facility (EFSF). The bailout package also includes private lenders writing-off half of what Greece owes. Greece initially agreed to further tougher austerity measures as demanded by Eurozone partners. The austerity measures included

· Decrease in public sector wages, pensions and bonuses.
· Increase in taxation by $2.32 billion and improving the tax collection system.
· Introducing a new pay and promotions system for all the public sector employees.
· Temporary suspension leading towards layoff of 30,000 public sector employees.
· Shutting down of public organizations facing recurring losses.
· Raising $68 billion dollars through privatization by 2015.
· Reduction in defense spending of $272 million.
· Reduction in health spending of $2.9 billion by 2015.

The Eurozone leaders have agreed to write off their debt to Greece by 50%, an increase from initially agreed amount of 20%. Many economists believe that Greece will not be able to pay back its debts and is in fact heading towards an ‘orderly default’. What the markets fear is the disorderly default and the domino effect it creates. An orderly default will cause the returns to be ‘deferred over decades’. In a disorderly default, the lender will not receive any payment in the future.

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Other European nations, such as Portugal and Irish Republic, were in line to receive bailout money from EU. The experiment with Greece has failed miserably. This calls into question whether EU should repeat the same experiment with Portugal and Irish Republic?

If Greece had not joined the Eurozone then, according to some critics, it would not have faced this crisis in the first place. Even if Greece had gone into recession in spite of it not being a part of Eurozone then Greece could have devalued its currency to steer out of the crisis. Many Economists believe that leaving the Eurozone is probably the best solution for Greece right now.

The economist, Peter Dixon thinks that if Greece goes for the ‘nuclear option’ i.e. introduces the new drachma, then in the short term, inflation would rise rapidly and living standards would fall dramatically leaving Greece bankrupt. On the other hand, if the austerity measures are implemented in their entirety, then this would lead to a short term but massive rise in unemployment levels and reduction in living standards. Nobel Prize winning economist, Paul Krugman sums it up “there aren’t any non-terrible answers” for Greece.

Comments and feedback are highly appreciated
Sarfaraz A.K.