After saying, “I do…!”
View(s):
File photo - A woman holds a plastic bag with goods after exiting a Jumbo store in Athens, Greece, November 23, 2015. REUTERS/Alkis Konstantinidis.
In December 2009, rating agencies – Fitch, Moody’s, and Standard and Poor’s, all downgraded the Greece sovereign bonds. These bonds so far had “A” ratings and the sudden downgrading shocked the investors in Greece bonds or, to say it in plain language, the lenders to the Greece government holding its bonds.
With further downgrading in 2010, the Greece bonds fell into “junk” status which carries “high risk” for the investors. Until 2017, a series of further downgrading continued with lower ratings carrying higher risks; thereafter, however, there could be seen some improvements over the past three years, 2018-2020 until the economy was hit by Europe and also by the COVID-19 pandemic issue.
What went wrong for Greece? What were the economic consequences? How did Greece avert a potential “Grexit” – a near possibility of leaving the European Union? How did Greece pull the economy back on track? As part of our ongoing discussion on European integration and disintegration, today I thought of providing brief answers to these questions.
The big deal
As one of the important milestones of European integration – the longest and the deepest regional integration in the world, the European Union (EU) was established under the Maastricht Treaty of 1993. The EU is an “Economic Union” which is a higher level of integration than a mere Free Trade Area (FTA), as we discussed last week. Within an Economic Union, the member countries should have established free movement of goods, services, money and people as well as a harmonization and coordination of fiscal and monetary policies.
Maastricht Treaty provides “convergence criteria” – conditions required for entering its “single currency union” – the so-called eurozone: These conditions relate to the maintenance of the inflation rate, interest rate, government budget, and government debt. Inflation must not exceed more than 1.5 percentage points to that of the three best performing member states. Long-term interest rate must not be more than 2 per cent higher than that of the three best performing member states. The budget deficit must not be more than 3 per cent of GDP and, public debt must not be more than 60 per cent of GDP. In addition, prior to joining the single currency, countries should have a proven record of maintaining a flexible and stable exchange rate as well.
In 1999, 11 countries of the EU satisfied the convergence criteria and formed the Euro zone, introducing a single currency and single monetary policy for the zone. Greece was qualified to join it in 2001 raising the Eurozone membership to 12. However, there were allegations against Greece for misrepresenting its finances to join the Eurozone, whereas Greece had a budget deficit over 3 per cent and a debt level above 100 per cent of GDP.
Then one could ask the question, “What’s the big deal about all these conditions?” Well, it is the “big deal” for everybody before they say, “I do…!”
Debt crisis
For instance, take the case where money is freely moving across the countries which are integrated to an “economic and monetary union” such as the Eurozone. If free movement is allowed, then money is moving to the countries where it has better returns and lower risks. When the investors who have put their money in bonds of a particular country find that the returns to bonds are not as good as expected or the risks of holding such bonds are greater, then they will all rush to leave that market. This would exert pressure on the interest rates to rise and the value of the currency to fall.
If inflation is running at higher rates than that of other countries in a single currency union, obviously the interest rate should rise too, in compensating for real interest rate losses to the investors. If the government is spending too much, it would lead to higher budget deficits as well as higher borrowings. While higher government spending leads to higher aggregate demand causing pressure on inflation, higher government borrowings would increase the investor risks. All these issues eventually point to one thing: The member states of a single currency union must agree to policy harmony and they must remain faithful to what they have agreed on.
This is where Greece went wrong. As the US financial crisis in 2009 was sweeping across Europe, Greece had reported its budget deficit over at 15 per cent of GDP, and government debt at over 125 per cent of GDP. As the rating agencies downgraded the creditworthiness, Greece had to face a spike in its borrowing costs. Investors panicked and started seeking a way out, resulting in “bonds for sale”, which nobody wants to buy. The outcome was the increase in long-term interest rates from 5 per cent in 2009 to over 35 per cent by 2012.
Bailout packages
Together with the interest rate spike, Greece declared its inability to pay off government debt in 2010. In order to avoid default, the EU and the IMF agreed to provide Greece with their first bailout package – Euro 110 billion. Since then, the IMF, the EU, and the European Central Bank (ECB) – all three organisations have provided a Euro 320 billion bailout package to Greece to pay off the maturing debt.
In addition, the ECB also launched an unprecedented programme worth Euro 750 billion to buy bonds of Greece and other troubled countries, held by worried investors, in order to mitigate the loss of investor confidence. In spite of all the support, Greece became the first rich country in the world to default its loan repayment to the IMF in 2015, which was then interpreted as “delays”.
In exchange for bailout packages, Greece agreed to cut down government spending, including its spending on welfare programmes, wages and salaries as well as pensions payments, and tax hikes. These “austerity measures” were harsh on the people from an economic point of view and on the government from a political point of view. As a result, there were many violent riots in Greece against the austerity measures.
Leaving Eurozone?
Although there was speculation that Greece would decide to leave the single currency union, neither Greece nor the EU countries wanted it. Why? In answering this question, let’s look at what is meant by leaving the Eurozone.
It means that Greece would abandon Euro and return to its national currency – Drachma, convert all its Euro-based sovereign bonds to Drachma-based sovereign bonds, do away with all convergence criteria, and regain its own monetary policy autonomy. Consequently, Drachma would have depreciated against Euro making the investor returns even worse. This would be a big loss to the EU governments and EU banks which had invested in Greece bonds and this is what the EU didn’t want to happen. Neither Greece wanted it which would have spiked interest rates as well as inflation – even hyperinflation too. Greece would have the ability to print money, which would have added more problems to the above. After all, the recovery path would be even more difficult, and the country would have been left on its own without the support of 18 more countries in the Eurozone.
More integration
It is the austerity measures and the external support from the IMF, the EU and the ECB, which helped Greece to breathe and recover. Government debt to GDP is about 177 per cent compared to the Eurozone average of 78 per cent. Unemployment rate which was closer to 26 per cent in 2013 has declined to 16 per cent by 2020. Credit rating has improved to one of the “B” grades. However, the economy has not returned to its pre-crisis levels, as the government had to deal with more fundamental structural issues such as poverty, inequality, black economy, brain drain, and other similar issues.
In conclusion, there are two important points to consider. Greece had organisations and EU member countries to help in its recovery from the crisis, including at times when the country was about to default its debt repayment. Integration is beneficial, but it requires higher degree of policy harmony particularly when countries move beyond free trade stages. The future depends even more on integration at policy levels.
(The writer is a Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk and follow on Twitter @SirimalAshoka).