International Finance

Presentation on:

Debt Crisis in Eurozone

Prepared for: Syeda Mahrufa Bashar Lecturer

International Finance
Submitted by: Group 3
Laura Amin Hisham Haider Dewan Ummey Rehnuma Zaman Ridwan Rahman Ehsan Malek Chowdhury Mujahidun Nabi Lamia Bashar RQ 08 ZR 13 RQ 14 ZR 31 ZR 34 ZR 35 RQ 51
BBA 16 Institute of Business Administration, University of Dhaka

September 14, 2011

Definitions

Monetary Policy
Setting of money supply by policymakers in the

central bank

Includes decisions regarding increase or decrease

of money supply

Budget Deficit
Shortfall of tax revenue from government spending Governments finance budget deficit by borrowing in the bond market Results in lower national savings

Government Debt
Accumulation of past government borrowing Also known as Public Debt, National Debt, Sovereign Debt Can be categorized as:
Internal debt: owed to lenders within the country External debt: owed to foreign lenders

Background

Euro
Introduced on January, 1999 Official currency of the Euro zone 17 member countries of EU 5 other European countries Second most traded currency of the world after US Dollar

Euro Zone
Consists of Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain

Criteria to Use Euro as a Trading Currency

Budget deficit of less than 3% of the countrys GDP A debt ratio of less than 60% of GDP Low inflation Interest rates close to the EU average
Has been widely flouted after the introduction of Euro

 Video

Benefits of Euro
No transaction cost among the member countries Price transparency Eliminating Exchange Rate uncertainty Inward investment

Benefit of the financial sector

Problems of Euro
Cost of replacing currency Loss of autonomy over economic policy Loss of independence over Fiscal Policy Asymmetric Shocks Different effects of Monetary Policy in different countries Instability of Euro against Dollars

What Went Wrong?

Europe's PIGS
PIGS: Acronym for economically troubled and heavily-indebted countries of Europe. Consists of four countries:
P: Portugal I: Ireland G: Greece S: Spain

Video

Portugal
GDP Growth: 0.9% Gross Debt in 2010: 84.6% of GDP Factors leading to Debt Crisis
Affect of the financial crisis of 2008 Over-expenditure and investment bubbles through unclear public-private partnerships Funding of numerous unnecessary external consultancy firms Risky credit, public debt creation Mismanaged European structural and cohesion funds

Portugal
Bailout package of 78 billion approved by the Eurozone leaders in 2011
In return for the deal private bondholders have been instructed to maintain their exposure to Portuguese debt, rather than sell it off. Portugal, has also agreed to reform its health care system and pursue an "Ambitious Privatization Program ". Moody's downgraded Portugal bonds to junk status

Ireland
GDP growth : 0.3% Gross debt in 2010: 82.9% of GDP Factors leading to Debt Crisis
Stemmed from the financial crisis of 2008 Exposure of six main Irish-based banks to the property bubble State guarantee for those banks Hidden Loans Controversy within Anglo Irish Bank

Ireland
These factors resulted in
Rise in government help for the banks (32% of GDP) drop of share price of the banks Increased government deficit

ECB & IMF, proceeded the 85 billion Bailout agreement in 2010

Moody's downgraded the Irish banks' debt to junk status

Spain
GDP growth : -0.1% Gross debt in 2010: 36.2% of GDP
Factors leading to Debt Crisis
long term loans building market crash including bankruptcy of major companies huge trade deficit

Spain
The government announced a 50bn-euro austerity package, including a civil service hiring freeze

IMF expecting Spain to contract by 0.6%

Many investors feel it will be the next country to need bailout.

Greece

Greece Economy
27th largest economy Very high HDI, ranking 22nd in the world One of the fastest growing in Eurozone in 2000-07 Annual growth rate 4.2% Revenue depends on Tourism and shipping industry

What Led to Another Greek Tragedy?

VIDEO

After-effect of Recession
High budget deficit Less FDI
Collapse of tourism and shipping industry Revenue down 15%

Greek Government Conspiracy

Issues of creative accounting and manipulation of statistics Paid Goldman Sachs and other banks hundreds of millions of dollars in fees since 2001 Hide the actual borrowing from EU
Cope with the Monetary union guidelines

Overspending & Tax Evasion

Government continued overspending Tax evasion costs over $20 billion per year
Budget deficit peaked to 153% of GDP by mid 2011

Bailout Loan Package

Bailout Loan Package

On 23 April 2010, the Greek government requested that the EU/IMF bailout package be activated A total of 110 billion has been agreed. The first installment covered 8.5 billion of Greek bonds that became due for repayment

Internal Impact

Decrease in Credit Rating

Just after 4 days of Bailout announcement On 27 April 2010, the Greek debt rating was decreased to BB+ (a 'junk' status) by S&P Following downgrading by Fitch and Moody's

Increase in Bond Yield

S&P lowered the debt rating to CCC, the LOWEST in the world

Decrease in Euro Value & Share Price

Euro was traded lower against US Dollar Standard & Poor's estimated that in the event of default, investors would lose 30 50% of their money.

Stock markets declined

Share price of Greek Banks went down

Protest Against Austerity Packages

Conditions to be fulfilled in order to get the loan Included:
- reduction in salary, pension and benefits - increase in retirement age - cut in public sector allowances - indirect tax and special tax etc.

Nationwide general strike was held where three were killed, dozens injured, and 107 arrested

Negativity Towards Government

A survey on 18 May 2011 resulted that, 62% of the people felt that the IMF memorandum that Greece signed in 2010 was a bad decision 65% felt that IMF is hurting Greece's economy 64% felt that the possibility of bankruptcy is likely

What Factors Made the Greek Debt Crisis Severe?

Credibility Problem
Greece struggled to convince international creditors This is due to their low growth rate, high deficit, low FDI Market responded to crisis before downgrades

No Control Over Monetary Policy

Cannot print money or inject it into system

Crisis in Industry
Industry did not boom after recession Negative growth GDP Strikes People refused to pay tax

Effect of Greek debt on other countries

France, Germany, UK, US

Wont be able to raise revenue

Wont be able to meet their obligations

Governments fear if one country moves away from the Euro, others might follow

Impact on US
EU and US two-way transatlantic flow amounts to 1.25 Trillion European Crisis has temporary benefit on the US dollar CDO Lose 40,000 jobs London Fewer American tourist

Macro Factors of Debt Crisis in Eurozone

Macro Factors
Odious Debt
Greeces national debt Does not serve nations best interests Considered personal debts of the regime Not debts of state; should not be enforceable

Credit Rating Agencies

Moody's, S&P and Fitch Conflicts of interest Give generous ratings Tend to act conservatively Take time adjusting when a firm/country is in trouble

Macro Factors
Media
Attempt to draw international capital away from euro UK and USA continue funding large external deficits matched by large government deficits Only "bad" news propagated by media; never "good" news

Role of Speculators
Accused by Spanish and Greek Prime Ministers of worsening crisis Role of Goldman Sachs in Greek bond yield increases under scrutiny Some markets banned naked short selling for few months

Macro Factors
Finland Collateral
August 18 - requested by Finnish parliament Condition for any further bailouts Receive collateral from Greece Other European nations agitated Demanded equal treatment/similar deal with Greece To avoid increased risk level over their participation in bailout Main point of contention collateral aimed as cash deposit

Long Term Solution

Orderly Default And Reintroducing Domestic Currency

Expert opinion: major troubled country like Greece should engineer an Orderly Default on public debt
This will result in
withdrawal of Greece from the Eurozone and reintroduce a national currency, such as Drachma, at a debased rate

Delay in organizing an orderly default might hurt EU lenders and neighboring European countries even more

Measures taken by ECB

Open market operations buying government and private debt securities Two 3-month and one 6-month full allotment of Long Term Refinancing Operations (LTRO's) Reactivation the dollar swap lines with Federal Reserve support

EFSF And European Treasury

European Financial Stability Facility (EFSF)
Legal instrument jointly & severally guaranteed by Eurozone countries' governments

European treasury
single authority for the EU member countries responsible for :
o tax policy oversight o government spending coordination

Common fiscal policy

How does Eurozone Crisis Affect Asia?

Effect on Asia Good News

Little immediate risk in the Eurozone crisis
banks in the region have less exposure to Greek debt. Strong international financing position

Effect on Asia Bad News

Descent in Stock markets across the continent
Japanese Nikkei Index - 2.6% Hong Kongs Hang Seng Index - 1.5% Chinas Shanghai Stock Exchange - 0.3%

Fears in China and the rest of Asia of a significant economic downturn

Credit markets seizing Growth hampered

Effect on Asia Bad News

Appreciation of the Yuan:
During august 9-15 2011, Yuan appreciated 1.2%. Inflation Lower magnitude of the trade balance in Chinas favor

Depreciation of the Euro

Exports from Asia more expensive Markets shrinking further Huge loss might result in economic downturn

Impact on Bangladesh

Impact on Bangladesh
Weakened Balance of Payments (BoP) due to
reduced remittance flows rising import bills

Dip in export earnings growth

Reduced EU and US demand

Increased the exchange rates of the Swiss Franc Impact of debt was low because of low exposure to European debt

Takeaways

Background of Euro and Eurozone Introduction to European Debt Crisis Europes PIGS Details on Greece debt crisis Effect of Greece Debt crisis on other countries Macro factors of debt crisis in the Eurozone Long-term solution Impact on Asia and Bangladesh

Thank You

Sources
http://en.wikipedia.org/wiki/European_sovereign_debt_crisis

http://www.bbc.co.uk/news/
http://www.economist.com/ http://www.cnbc.com/id/43440375/Wall_Street_Economist_Greece_Ripple_Effects_Could_Create_An other_US_Financial_Crisis http://curiouscapitalist.blogs.time.com/ http://www.reuters.com/ http://www.seigniorage.de/financial_crisis.php

http://www.csmonitor.com/World/Europe/2010/0428/Will-the-Greek-debt-crisis-affect-Asia
http://www.wsws.org/articles/2010/may2010/shar-m21.shtml http://www.moneyweek.com/news-and-charts/economics/moneyweek-asia-why-the-eurozone-crisiswont-rattle-asia-01806