Topic of the week for discussion: 4th to 10th June 2012

Topic : Greece Debt crisis

Greece is facing a sovereign debt crisis because of the debt it accumulated since the first half of the first decade of the present century when the market was highly liquid. As the crisis deepened, there was a liquidity crunch in the world economy thereby making borrowings difficult as well as expensive and thereby improper debt repayments on time. As of now, the debt-GDP ratio of Greece is a whopping 160 percent. The major factors behind the crisis were supposed to be the excessive expenditures, financial mismanagement and unregulated labour market. In 2010, almost 27 percent of the total working population of the country was part of bureaucracy. The crisis was further aggravated by the contemporary US Sub-prime crisis when the income and savings were facing a downward trend worldwide resulting in lower demand and thereby lower output and employment. This adversely impacted the labour market of Greece. Moreover, volatile capital markets due to liquidity crunch resulted in lower capital flows as a result, strict norms were made for banks to grant loans and rates were also increased thereby making borrowings costlier in Greece in comparison to the rest of the world. Overall, it adversely impacted the prime sectors like tourism shipping etc which had a significant contribution to the GDP.

Topic Introduction

In order to accommodate its rising expenditures, it had to dwelt heavily on the external borrowings due higher internal interest rates. On joining the European Monetary Union, it discovered that it could borrow at lower rates equal to Germany without doing anything and continued to incurring expenditures and avoid reforms. Many solutions are being tried out since long; however, the desired results don't seem to be forthcoming. Impact of Greek crisis on India is not a direct one but it will affect the Euro zone, accounting for one fifth of Indias foreign trade. Therefore, if the crisis is not resolved early, it will have a chain reaction. It may not only engulf the European countries, but could also have a severe impact on the developing economies such as India. Further, 75 percent of these exports are from the manufacturing sector. A slowdown will affect demand from Europe for domestic products. Further, the job losses, budget cuts and other austerity measures will also impact demand. This will also have an adverse impact on the country's industrial production. As a slowdown will affect exports, it can lead to an increase in the already high current account deficit. High Current Account Deficit means that imports are much higher than the exports which will ultimately depreciate the Rupee further strengthening the inflationary forces in the country. The stock markets in developing countries can witness a slowdown in funds from Europe as the foreign institutional investors (FIIs) and European banks will need funds to meet their own requirements of capital adequacy, current obligations and domestic needs, and will not be able to spare much for investments in overseas markets.

Because of the vulnerability to European Union from the Greece crisis, Greece exit from the Euro zone is also not ruled out. However, even after the Greece exit from Euro zone, European banking system will involve pouring more money into Greece. The European Financial Stability Facility, the instrument for fixing the European liquidity crunch, is authorised to borrow up to 440 billion Euros, of which 250 billion Euros remained available after the Irish and Portuguese bailout. Coupled with this, Spain and Italy are facing the negligible growths which are supposed to be the most developed countries of Euro zone along with Germany and France. In such a situation, the US Dollar will emerge as the most secure currency. With the fall of the Euro, Dollar's rise against the Indian Rupee is likely which has already fallen to historic lows. Theoretically, the fall of the rupee will make exports and services cheaper. But since India depends on imports to meet its fuel demands (generally paid for in US Dollars), fuel prices would go through the roof, making everything costlier. This may further cause depletion in the forex reserves as a result input costs will continue to rise and margins will drop drastically. However, a positive for India is the fact that this is mainly a domestic economy. It is not primarily dependent on exports. Secondly, India has a diversified export portfolio, spread across various regions. These factors will help mitigate the impact of adverse conditions in the Euro zone to some extent. India needs to take another more fundamental lesson from the European debt crisis. The European sovereign debt crisis is not an overnight development. Globalisation of finance; unregulated credit conditions during the 20022008 period that encouraged high-risk lending and borrowing practices; international trade imbalances; real estate bubbles; slow economic growth since 2008; fiscal policy choices related to government revenues and expenses; and approaches used by nations to bail out troubled banking industries and private bondholders etc have all contributed to this development. In India, unfortunately, successive governments have sacrificed fiscal consolidation at the altar of growth. The Union finance minister, for the financial year 2011-2012, announced that the fiscal deficit of the government of India stood at 5.9 per cent of GDP. It is fiscal mismanagement that has spelt trouble for Europe. It is imperative that we draw the right lessons from this. India can cope with such crises but if we don't improve our fiscal management, we may be in for bigger trouble.

Read further: http://www.bbc.co.uk/news/business-13798000 http://www.bbc.co.uk/news/business-13856580 http://www.bbc.co.uk/news/business-18094883