Wednesday, June 1, 2011

Euro crisis/Greece crisis/PIIGS

The Euro crisis and its origins in the Greece crisis:
First of all, Greece is important in one is part of what is called PIIGS.

PIIGS is a term denoting the 5 European countries Portugal, Italy, Ireland, Greece and Spain. And they are in the news for the financial problems they are facing.

The reasons for the Greece crisis are: years of unrestrained spending, cheap lending and failure to implement financial reforms...which left Greece badly exposed when the global economic downturn struck:
  • Greece's national debt is 113% of its GDP (around $419 Billion)
  • Greece's deficit (how much more it spends that it takes/earns in) is 12.7% (which is of course bad news)

The quick version:
Initially, Greece was a fast-growing economy and then, it joined the Eurozone and started using the common currency of Euro. At this stage, due to its previous currency's high value when compared to Euro, Greece got a lot of cheap loans and large inflows of capital. This amounted to overspending & over-borrowing and not earning enough back. Eventually, Greece started defaulting on its debts obtained earlier. And since it was part of the Eurozone, it could not devalue its currency (this needs the agreement of all the countries in the Eurozone) to pay back the loans. And then it ran up a huge budget deficit, which in simpler words, means, the Government expenditure was greater than its tax receipts/income.

To make matters worse, the Greece Government borrowed more and more money until banks were either not ready to lend anymore or would only lend at a high interest rate.

Why Greece couldn't handle it?

  • Initially, Greece was an independent country, but it decided to join the Eurozone and started using the common currency i.e Euro
  • After becoming part of the Eurozone and using the Euro as currency, Greece could no longer print its own currency. Hence, Greece could not create money on its own like the US or the UK Government can
  • The Euro value is determined by the major economies of the Eurozone (Germany, France, etc..)... where Greece is a small part
  • A major source of the Government's income is the various taxes levied in that country
  • When the global economic crisis struck, the tax revenues shrunk. The Greece Government needed more money now
  • The Greek Government had already borrowed heavily from IMF, the German and French banks
  • The option to devalue the Euro (which can solve its problems) faced stiff opposition from the major Euro-economies,especially Germany
  • Devaluing the Euro might solve the Greek problems to some extent, but at the same time, it would also negatively affect the other Euro countries
  • The Greek Government tried to pay the loans using the borrowed money (IMF, German/French banks), but has been unable to ..and the loans are still there today

What the Greek Government can and is doing...

  • Reduced Government spending
  • Hike in taxes on fuel, tobacco and alcohol
  • Increase in retirement age by 2 years (which reduces the pension-payment problem and increases the number of working citizens)
  • New tax-evasion regulations (to check tax evasions and bring in more revenue)

It is a similar problem with the other countries from PIIGS, but the epicenter and the place where it all started was Greece.

Currency-devaluation VS. appreciation/depreciation

In a "freely" and "managed" floating currency regime, a loss in currency value is conventionally called a "depreciation", whereas an increase of currency's international value will be called "appreciation". If the dollar rises from 10,000 yen to 12,000 yen, then it has shown an appreciation of 20%. Symmetrically, the yen has undergone a 8.3% depreciation. (taken online)

But central banks can also declare a fixed exchange rate, offering to supply or buy any quantity of domestic or foreign currencies at that rate. In this case, one talks of a "fixed exchange rate".

Under the latter regime, a loss of value, usually forced by market or a purposeful policy action, is called a "devaluation", whereas an increase of international value is a "revaluation". One can call it a purposeful Governmental intervention for economic reasons.

In other words currency depreciation/appreciation is controlled by the international currency rates based on the international stock market indicators; and currency devaluation is controlled by the central banks (RBI in India's case) which forces exchange rates, that subsequently devalues the currency.