THE EFFECT OF GLOBAL CRISIS INTO EURO REGION: A CASE STUDY OF GREEK CRISIS

ASSIGNMENT -1

SUBMITTED TO: SUBMITTED BY:

PROF SNIGDHA TRIPATHY DUTTA (12202040) PREETAM

PRITISH BARUAH (12202041) TANAY KISHORE (12202057) UJJWAL BANERJEE (12202058)

EURO CRISIS INTRODUCTION

In the 1990's the major European countries decided to have a common currency. This was being done in two steps first for business transactions in 1999, and then for all citizens, beginning January 1st, 2002. Thus the countries aside the currencies they each were using previously and instead dealt themselves with Euros. From then on the so-called euro zone had a single currency, unique money". Euro zone parliaments are in the process of ratifying a tough set of rules, which are insisted by Germany, that will limit their Government's structural borrowing( excluding any extra borrowing due to recession) to just 0.5% of their economies output each year. The impact will come onto force once 12 out of 17 euro zone members states have ratified it, it will also limit their total borrowings to 3%.This rules when incorporated are supposed to stop them accumulating too much debt and thus ensuring that there won't be another financial crisis. The process of creating Euro started in 1999 by setup of Economic and Monetary Union. The monetary policies were controlled by European Central Bank but the countries were left free for the selection of the fiscal policies. This led to problems of mismatch between the monetary and fiscal policy. Thus there was a pact called Stability and Growth Pact signed. According to this pact, the GDP and Public Debt ratio was fixed at 60 percent. Additional the ceiling limit of the consumer price index was fixed at 2 percent .The prevention

of fiscal transfer between the Euro zone countries out of exceptional circumstances to prevent irresponsible loan taking between the countries. The budget deficit rule had been violated by Greece, Italy, Portugal and Spain in the pre crisis period. There was a housing boom in countries as a result of the inflation ceiling between 2002 to 2007. Germany, France, England, Italy and Spain were slow to respond policies against the crisis. This led to the increase in unemployment in the Euro zone Countries and the high fiscal deficit led to financial crunch in the credit market. This also led to fall in the GDP of the European economies were there was negative GDP in a few countries like USA. Performance in Manufacturing Industry fell below 50 indicating less confidence in the industry. The countries planned to get financial bailout packages in order to improve the financial performance .At the end of the four weakest economies reached 2.9 trillion $ i.e. Greece, Portugal, Spain, Italy. It caused problem as most of the loan was taken from the Euro Zone countries and such loss would result as a problem to the other countries in the euro zone. The countries decided to give financial support the countries advocated loan at lower interest rates. Greece agreed to reduce its fiscal deficit as well as the public debt at an agreed level for the same. The problem faced by Greece was because of factors like mismanagement, fiscal imbalances, financial fraud, imperfect market, weak competitiveness. There was an increase in the public spending and a decrease in income of the public. The public debt was 101.5 percent of GDP in 2001 when it joined European Union. It was promised decrease it beyond 60 percent in the coming year but it increased. The country as well as the speculators had hidden the information in its interest. The Goldman's Sachs helped Greece to deceive the data from the financial markets as well as European Union. By the use of Complex derivative Bonds called "Cross Currency Derivative Bond" from the European Institutions to hide their previous debts to get more debt. The foreign debt increased to 112.6 percent of GDP crossing 300 billion Euros. As the outcome of the true data by the new government in 2009 the credit rating of Greece was reduced from (A-) to (A) in October,2009.After the declaration of Fiscal Deficit the Standard and Poor rating was reduced from A2 to BBB+. Moody reduced the rating from A2 to A1 level. Greece had to repay two debts of 21.5 Billion Euros each and had a reserve of 15 Billion Euros forcing it to look for cheap debt from the International Financial Institutions. Being it could not devalue its domestic currency or increase the inflation. It could also have asked for loan restructuring. Two of suggestions offered to Greece were: To stay in the Euro Zone but balance fiscal deficit by setting the prices of domestic goods and Service. Dual Currency system where the domestic market would use Drachma and balance it Domestic for stability.

The Countries decided to extend credit facilities and the country Greece had to achieve the following goals as per its report to get Rescue plan in April, 2013.In 2011 its budget deficit would reduce to 5.6 percent in 2011 and 2.8 percent in 2012 and 2 percent in 2013.It also planned to cut the Government consumption by having a wage limit and no increment for the labours. The committee agreed to pay the required rescue amount of 45 billion dollars to the country. Most of it had to be financed by the Euro zone countries without any obligation to give loan to Greece for the countries. There was labour strike in Greece as a result of declaration of the plans to had fiscal expenditure cuts. The problem came when there was a rise in unemployment from 10 percent to 15 percent when its plan was to reduce it to 8 percent. Moody further reduced the rating to Caa1 and changed the outlook to negative affecting the economy further. The Standard and Poor also decreased Greece rating to B which also spread the rumours of Greece not able to pay its debts.

CHANGES OF TAXES

r = lower interest rate R= higher interest rate As the tax rate was increased in Euro zone r to R, consumption declined and so did the production of goods and services. This also decreased the income. A serious austerity policy was accepted. It was declared that the budget deficit would decrease to 5.6% in 2011 and to 2.8% in 2012 and to 2% in 2013. It was believed that the structuring process aiming at cuts in spending and rise in tax revenues would provide new sources to the country. Eg-Tax increase in oil products.

INFLATION
However rocketing inflation will actually help the Greek government, by reducing the real value of its mammoth debt pile. As part of the Euro zone currency union, Greece has been subject to a very strong currency one aligned to the economic powerhouse at the centre of the bloc, namely Germany. The problem is that Greece has never been as competitive as Germany and has suffered tremendously from using an overvalued currency. This has led to Greece building up an unsustainable level of debt in a currency that it cannot devalue.

90% of Greek government debt is held under local law which allows the state to determine its own currency. This means that following a Greek exit the country should be permitted to redenominate Euro debt contracts into the new Drachma currency. Therefore Greece will be able to pay back its heavy debt pile with new currency printed by its Central Bank something which is currently impossible whilst Greece is a member of the Eurozone. Under these circumstances the inflationary consequences of printing money are digestible as a means to reduce the real value of Greeces debts.

HOW WILL THE EURO ZONE CRISIS IMPACT INDIA? The economic instability in the Euro-zone has affected the lives of millions of people in Europe and has left deep scares on the financial condition of the countries altogether. The Indian Economy is often cited by many as a very resilient economy but it also has to take into account the recent situation of the Euro-zone Crisis and the effect it might have on the economy of the country. The falls in the value of the Euro will automatically push-up the value of dollar against the Indian Rupee in a drastic way which simply means the inflow in the economy will be less as the foreign investors would be very conservative in investing their money in India. One of the biggest outcomes of this would be the rise in price of the fuels, as India primarily depends for fuels in the form of imports, and thus eventually making everything costlier. But the Euro-zone crisis was not an overnight situation. It was the result of encouraging highrisk lending and borrowing practices, international trade imbalances and slow economic growth. According to a statement which was announced by the Union Finance Minister that the Fiscal Deficit stood at 5.9% of the total GDP of the country. Also according to the statement within five years, the Fiscal Deficit has increased by more than four times though in the same period while the Government's earnings have increased by only 36%. The lack of a proper framework of the country's financial management and the lack of fiscal management has brought the whole of Europe in such a situation. If the right lessons are not taken from this India might be the epicenter of another Global economic crisis.