Greece Debt Crises: Build up to the Bust Presented By: Aditya Aima, 140041209 In partial fulfilment of the: Full Time Master of Business Administration Submitted For: Business Mastery Project Presented To: Dr David Edelshain Faculty of Management Cass Business School City University London Date: 1 st Sep 2015 Word Count: 13,292
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Greece Debt Crises: Build up to the Bust
Presented By:
Aditya Aima, 140041209
In partial fulfilment of the:
Full Time Master of Business Administration
Submitted For:
Business Mastery Project
Presented To:
Dr David Edelshain
Faculty of Management
Cass Business School
City University London
Date: 1st Sep 2015
Word Count: 13,292
Greece Debt Crises: Build up to the Bust
2
Table of Contents
TABLE OF CONTENTS ...................................................................................................................................... 2
LIST OF FIGURES ............................................................................................................................................... 4
LIST OF TABLES ................................................................................................................................................. 4
LIST OF CHARTS ................................................................................................................................................ 4
LIST OF ABBREVIATIONS ............................................................................................................................... 5
2. EU TO EURO – 20 YEARS ............................................................................................................................ 9 2.1 1980-‐1985: MACROECONOMIC IMBALANCES AND STAGFLATIONARY TRENDS ............................................ 12 2.2 1986-‐1987 STABILIZATION PROGRAM .................................................................................................................. 14 2.3 1988 -‐ 1995 – INTERNAL AND EXTERNAL IMBALANCES .................................................................................... 15 2.4 THE MAASTRICHT TREATY ......................................................................................................................................... 16
3. EURO – 2000 TO 2008 .............................................................................................................................. 21 3.1 GREEK LOOTING – SCANDALS .................................................................................................................................... 25 3.1.1 Greek Olympics ...................................................................................................................................................... 25 3.1.2 J P Morgan Bond Scandal ................................................................................................................................. 25 3.1.3 Siemens Scandal ................................................................................................................................................... 25 3.1.4 The EOT: Greek Tourist Organization ........................................................................................................ 26 3.1.5 800,000 House without Planning Permission .......................................................................................... 26 3.1.6 Other Scandals ...................................................................................................................................................... 26
3.2 PROBLEMS OF GREEK ECONOMY ............................................................................................................................... 27 3.2.1 Enviroment for Investment and Scaling of Business ............................................................................ 27 3.2.2 Public Sector: Overinflated and Inefficient ............................................................................................... 28 3.2.3 Rigid and narrow use of Human Resources .............................................................................................. 30 3.2.4 Legal and Judicial System ................................................................................................................................. 31 3.2.5 Informality .............................................................................................................................................................. 31
4. THE BEGINNING OF THE FALL ............................................................................................................... 33 4.1 DISASTER MANAGEMENT ........................................................................................................................................... 33 4.1.1 May 2010 ................................................................................................................................................................. 33
Greece Debt Crises: Build up to the Bust
3
4.1.2 March 2012 ............................................................................................................................................................. 35 4.1.3 Current Scenario .................................................................................................................................................. 35 4.1.4 The Third Bailout Package .............................................................................................................................. 36
5. GREECE – RISK ANALYSIS ........................................................................................................................ 40 5.1 FACTORS DETERMINING SOVEREIGN DEBT RISK ................................................................................................... 45 5.1.1 Degree of Indebtness .......................................................................................................................................... 45 5.1.2 Pension/Social Commitments ......................................................................................................................... 46 5.1.3 Revenue/Inflow to Government ..................................................................................................................... 48 5.1.4 Stability of Revenues ........................................................................................................................................... 50 5.1.5 Political Risk ........................................................................................................................................................... 55 5.1.6 Implicit backing from other entities ............................................................................................................ 55
6. CONCLUSION ................................................................................................................................................ 59 6.1.1 Continue as Part of the Euro ........................................................................................................................... 63 6.1.2 Grexit : Adopt Drachma ..................................................................................................................................... 64
6.2 IMPACT OF GREECE EXIT ............................................................................................................................................. 66
CHART 1 BUDGET DEFICIT AS % OF GDP ................................................................................................................................................ 10
Greece Debt Crises: Build up to the Bust
5
List of Abbreviations
Abbreviation Full Form
GDP Gross Domestic Product
EU European Union
PASOK Panhellenic Socialist Movement
OECD Organisation for Economic Cooperation and Development
FDI Foreign Direct Investment
ECU European Currency Unit
EMU Economic and Monetary Union
ECB European Central Bank
OTE Greece National Telecom
VAT Value Added Tax
CAGR Compounded Annual Growth Rate
UK United Kingdom
IMF International Monetary Fund
SBA Stand by arrangement
ESM European Stability Mechanism
PSI Private Sector Involvement
EFSF European Financial Stability Facility
SMP Securities Market Program
CDS Credit Default Spread
ELA Emergency Liquidity Assistance
Greece Debt Crises: Build up to the Bust
6
Executive Summary
Greece is a country that has a rich history and has been an institution of pride for the Euro
Zone. This report gives a detailed account of the debt crises in Greece and the possible
solutions that could help to avoid default. The current state of the Greece is due to number of
reasons: high corruption, high tax evasion, red tapism, overinflated public sector, excessive
borrowing, high unemployment and poor business environment.
To be able to understand the current crises in detail we begin with analysing the economic
growth and political environment of Greece from the time they joined the European Union.
As a country they had witnessed high growth and low inflation till the late 1970’s and from
then on they have seen various periods of erratic growth. This period was marked by high
inflation and low growth
The next part of the report looks at the growth of Greece once they joined the Euro. During
the period of 2000-‐2008 Greece was the fastest growing country in the Eurozone, their
growth was solely fuelled by the high borrowing at extremely low interest rates. There was
also an extensive debate at the time if the Government in Greece manipulated numbers to be
able to join the Euro.
We then move forward to the actually beginning of the crises and how the Euro zone had to
step in to save Greece from defaulting due to the fear of a contagion effect. We look at the
various bailout packages that were offered to Greece and also the contingency plans that
Euro zone members put in place in order to avoid a situation where other countries namely
Portugal, Spain and Italy would also default. I have also conducted the country risk analysis to
assess the risk of default for Greece based on their current fundamentals.
The last part of the report focuses on my recommendation to avoid the default by Greece
basis my research. I have drawn parallels to the debt crises of Argentina basis which I have
drawn conclusions. I would also like to point that towards my completion of this report
Greece underwent a political turmoil as the Prime Minister of Greece has resigned and has
called for a snap elections. Given that they are undergoing one of the major financial crises in
the history of Greece it would be highly beneficial to have a strong political leader who can
Greece Debt Crises: Build up to the Bust
7
guide them to overcome the mess of the huge unsustainable debt accumulated by the leaders
before them.
Greece Debt Crises: Build up to the Bust
8
1. Project Introduction
Greece is a country situated at the far south of the Balkan peninsula, combining the towering
mountains of the peninsula with over 1400 islands, with Crete being the largest. Greece has a
rich history, with the Greek civilization spreading from Greece to Egypt and the Afghanistan at
its peak. (Wikipedia, 2015). Greece has always been a matter of pride for Europe due to its high
cultural significance.
Greece is a capitalist economy with GDP of 182 Bn Euros (2013) and a GDP per capita of
16,491 Euro. (FocusEconomics | Economic Forecasts from the World's Leading Economists,
2015)
The top 2 sectors for the Greek economy are tourism, which contributed to 18% of the GDP.
(Theodora.com, 2015).
At the time of research the Greek economy has been in the news due to the unsustainable
amount of debt and near insolvency situation with debates over Grexit i.e. Greece exit from
the Euro. Will Greece be able to pay back its debt? Is being a part of EURO the most suitable
option? What are the alternatives for Greece? I will explore all possible options as we go
further in the report. The crises in Greece have a lot of similarities to the crises of Argentina
and hence I will draw certain references from that too.
Greece as a country has very high level of corruption (Red Tapism), over inflated public sector
and very high tax evasion, which is an obstruction for growth in any country. Between 2003
and 2007, Greece witnessed an average GDP growth of 4 per cent but went into recession in
the year 2009 due to world financial crises, which resulted in tightening credit conditions and
failure of the government to address growing fiscal deficit. As a result of which by 2013 the
Greek economy had contracted by 26% compared to 2007. (Theodora.com, 2015). To
understand the full extent of the crises i will explore the economic history of Greece in order
to understand what led to the situation that Greece has found itself in.
Greece Debt Crises: Build up to the Bust
9
2. EU to Euro – 20 years
The European Union (EU) emerged from the postwar initiatives at reconciliation and
partnership in Western Europe. The founding moment for the EU was the Schuman
Declaration. In a speech on 9th May 1950, the then Foreign minister of France, Robert
Schuman gave out the objectives for the European Union:
• All the member states of the European Union will never go to war.
• Promoting World Peace
• Unify Europe through a step-‐by step, including eastern Europe-‐ much of which was under
Communist control at the time
• Creating an international anti-‐cartel agency
• Creation of a single market community within the European Union for the free flow of goods
and services
(Manolopoulos, 2011)
Greece was the 10th country to join the EU in 1981. The period from the 1973 to 1995 saw
poor economic performance with the GDP growth in Greece slowing down to only on average
about 1.5 percent. The poor performance was mainly attributed to deteriorating economic
conditions in the period starting 1973. From the mid 1970’s the Greek’s ran large budget
deficits and a loose monetary policy, which resulted in a sharp acceleration in inflation, and
the high rates of wage inflation squeezed profit margins and weakened investment incentives.
From 1953 to 1973, the Greek economy enjoyed a period of high growth and low inflation,
followed by the period from 1973-‐1993, where the economy witnessed stagnation and
persistent and high inflation. (Bosworth and Kollintzas, 2001)
Amongst various reasons cited by scholars, the most important reasons for the poor
economic performance in Greece were believed to be the lifting of industrial protection
following the EU membership and the political cycle effect of a socialist party (PASOK) taking
over from the conservative party in 1981.
Greece Debt Crises: Build up to the Bust
10
Figure 1 GDP Growth from 1981-‐2000
(Greece GDP, 2015)
The macroeconomic environment totally collapsed in the Greece during the later half of
1970’s and remained like that in the 1980’s. The Greek government budget deficits went from
an average surplus of one percent of the GDP in 1960’s to an average of 9 percent in the
1980’s and peaked at 16 percent in the 1990. (Bosworth and Kollintzas, 2001)
Chart 1 Budget Deficit as % of GDP
(Source: Bloomberg)
-‐16
-‐14
-‐12
-‐10
-‐8
-‐6
-‐4
-‐2
0
Budget DeKicit % of GDP
Budget DeOicit % of GDP
Greece Debt Crises: Build up to the Bust
11
The late 1970’s and 1980’s also saw the emergence of strong cost pressures from labor
market as their bargaining power increased, and combined with control on many prices, led
to the real wages being raised well above the productivity and depressed margins severely.
The return on equity in Greek manufacturing sector fell from an average of 6 percent during
the period 1976-‐80 to -‐6.8 percent during the period 1982-‐86. (Bosworth and Kollintzas,
2001)
The fiscal position of Greece also deteriorated significantly during this period, the budget
deficit relative to GDP reached extremely high levels for an OECD member country, with the
public deficit rising from 27 percent of GDP in 1979 to 111.6 percent of GDP in 1993. This
coincided with a weak Drachma, which lost about 83 per cent of its value during this 15-‐year
period (Bank of Greece, 2001)
Figure 2 Greece Government Debt to GDP 1990-‐2015
(Greece Debt to GDP, 2015)
In order to tackle high inflation the Bank of Greece started using exchange rate as a nominal
anchor and by 1995 the exchange rate was explicitly adopted as an intermediate target
parallel to a monitoring range for the rate of growth of broad money (M3).
Greece Debt Crises: Build up to the Bust
12
Figure 3 Inflation Rate 1981-‐2015
(Inflation Rate, 2015)
It is important to look at the economic growth and policy reform initiated during this period
to understand how Greece was placed before the entered they Euro and what structural
reforms they initiated and the road blocks to them which caused the eventual debt crises.
For this sole purpose lets breakdown 1980-‐2000 into periods to get a snapshot of the
situation.
2.1 1980-‐1985: Macroeconomic Imbalances and Stagflationary Trends
The Greek’s adopted an accommodative macroeconomic policy during this period, to fuel the
growth of GDP. Despite the accommodative macroeconomic policies, the only impact it had
was on inflation, as real GDP fell during 1981 and inflation rose by 25 per cent in both 1980
and 1981. (Bank of Greece, 2001)
From the period of 1981 to 1984 the government followed accommodative macroeconomic
policies without any policy reforms towards tackling inflation. Such high levels of inflation not
only make the money less valuable but also cause the currency to depreciate causing the
imports to be more expensive. This would mean the Greek’s would had to pay more for the
Greece Debt Crises: Build up to the Bust
13
goods that they imported and with the oil price crises along the same time reflected in a
higher cost for the economy. The period also saw the rise in general government
consumption, primarily being pension expenditures and deficits of pension funds on the rise,
coupled with inadequate funding. To compensate partially for the large financing needs of the
public sector, the Bank of Greece restrained credit expansion to private sector by
implementing complex credit allocation systems. Thus, the private sector was increasingly
crowded out of the economic activity. (Bank of Greece, 2001)
Theoretically crowding out of the private sector hurts not only the efficient allocation of the
resources and employment opportunities but also impacts GDP growth.
Several other factors also impacted the growth of GDP during this period:
• According to a 1993 study undertaken at the OECD, “lack of transparency of the bureaucracy,
coupled with a lack of clear rules, exacerbated uncertainty” leading to low FDI in Greece
during the 1980’s. FDI contribute the growth in the any economy.
• The underdeveloped state of Greece’s infrastructure raised both the cost of business
transaction as well as hindered private investment.
• Public sector was heavily subsidized and not well managed.
• Regulations were introduced which were aimed at raising the purchasing power of workers
and protecting them from dismissal leading to labor market rigidities. This explains why the
strong bargaining power of unions in Greece and the low productivity. (Bank of Greece, 2001)
Greece’s economic performance further deteriorated in 1985. The lax fiscal stance was
coupled with sharp expansion in domestic credit and the money supply. As a result the
current account deficit increased from an annual average of 4 percent of GDP in the second
half of the 1970’s to 8 percent of GDP in 1985 and the ratio of external government debt to
GDP rose from 4.5 percent in the late 1970’s to 18 percent in 1985. (Bank of Greece, 2001)
Greece Debt Crises: Build up to the Bust
14
2.2 1986-‐1987 Stabilization Program
Looking at the deteriorating condition of Greek economy the government launched the
stabilization program with following being the measure:
• Drachma was devalued by 15 percent
• Introduced the temporary advance deposit for a wide range of imports
• Wage price index mechanism was modified to reflect projected inflation as opposed to past
rate of inflation
• Public sector borrowing relative to the GDP was to be reduced by 4 percentage point
• Tighter monetary policy established through a reduction in the growth of domestic credit and
gradual establishment of positive real interest rates for all borrowers (Bank of Greece, 2001)
This was primarily to reduce the high inflation rate in the economy at the same time
making sure that the Balance of Payment account doesn’t run too much into deficit as weak
currency only increases the cost of imports.
Yet nothing could have been done about the capital inflow because according to the
Impossible Trinity, only two of three objectives i.e. exchange rate management, inflation and
capital controls can be managed. The strategy of these objectives was centered on the firms
income policy, which was aimed at reducing the labor cost per unit of output and maintain
competiveness.
The European Communities with an ECU 1.75 billion loan, phased in two years, supported
the stabilization package. (Bank of Greece, 2001)
The program was a success as it led to the following results:
• During 1986 and 1987, the real wages fell and the business profitability rose for the first time.
• Public sector borrowing relative to GDP declined from 18 percent in 1985 to 13 percent in
1987.
• The current account deficit declined to 2 percent in 1987 from 8 percent of GDP in 1985
Greece Debt Crises: Build up to the Bust
15
Given the tight fiscal and monetary conditions to reduce inflation, the inflation rate reduced
from 20 percent in 1985 to 16 percent in 1987. But as we know that there is a direct
relationship between inflation and growth, the real GDP growth was 0.5 percent in 1986 and
fell by 2.3 percent in 1987 due to restraints in domestic demand. In other words, as the
supply of money reduced in the economy by 4 percent, it had an impact on wages that in turn
impacted the consumption in the economy.
2.3 1988 -‐ 1995 – Internal and External Imbalances
Some of the benefits of the stabilization package could be seen in 1988 and 1989 with
improvement in economic conditions, falling inflation, increase in export growth, falling
current account deficit but it was all short-‐lived. Also prolonged electoral uncertainty
associated with weak coalition government eroded confidence in Greece and further easing
of macroeconomic policies lead to loss of growth momentum. Inflation was again hovering
around the 15 percent mark and the public sector borrowing exceeded 18 percent of GDP in
1989. At the same time, the government debt increased to about 70 percent of GDP, which
imposed a heavy burden on the economy. (Bank of Greece, 2001)
At the end of 1990, the Greek government announced another adjustment program from
1991-‐93, with optimistic targets, notably being reduction in inflation to 8 percent and public
sector borrowing to 3 percent of the GDP. The European Communities agreed to support this
program with a balance of payment loan of ECU 2.2 billion over the 3 years. (Bank of Greece,
2001)
During this period Greece again experienced weak economic growth, the rise in the debt ratio
for the general government from 80 percent of nominal GDP in 1990 to about 110 percent of
GDP in 1993. There was a fall in inflation but that was primarily due to a weak domestic
demand.
In 1992, the Maastricht Treaty was signed which came into effect on 1st November 1993, and
provided a list of criteria’s that needed to be fulfilled for any country to join the Euro area.
Yet, at the beginning of the Stage 2 of Economic and Monetary Union (EMU) in Jan 1994,
Greece Debt Crises: Build up to the Bust
16
Greece found itself in serious divergence from the criteria’s of the Maastricht Treaty
particularly with regard to Public finances and inflation. (Bank of Greece, 2001)
2.4 The Maastricht Treaty
The Maastricht treaty defined the conditions for entry at least formally. The economic
rationale for EMU was that, by ruling out competitive devaluations, a major source of
economic instability, forces the countries to reform their labor markets and open up the
economies to greater competition. The Maastricht treaty set 5 rules of convergence that
every member had to comply by:
• The budget deficit must be kept below 3 percent of GDP
• Total public debt has to be less than 60 percent of GDP
• Inflation rate in any country should be within 1.5 percent of the three EU countries with the
lowest inflation
• Long term interest rates in any country must be within 2 percent of the three countries with
the lowest long term interest rates
• Exchange rates of any country must be kept within the normal fluctuations margins of
As part of the recent bailout package reforms, there has been talks about higher taxes on the
Shipping revenues, which may negatively impact the growth of the sector. Also if the recent
Greece Debt Crises: Build up to the Bust
55
slowdown in China translates into a full blown crash, it might impact the revenue of the
shipping industry in Greece, as China is a major exporter.
5.1.5 Political Risk
The decision to default is as much a political decision as an economic one. Sovereign default
often exposes the political leadership to the pressure and a political backlash and hence the
probability of default is higher in case of autocracies. Incase of Greece, the current political
party won majority in the elections and came to power on the pretext of ending austerity
measures. They organised a referendum to reject the terms demanded by the creditors, but
ended up agreeing to harsher terms in order to secure the third bailout package. The final
terms of bailout package have to get voted in the parliament and there is little doubt that it
will get rejected but the risk is that it will not be voted by the current majority. This may
clearly set in a motion of political instability, that would lead, at best to a reshuffle/broader
pro-‐European coalition, and at worst to a bout of political instability, with new elections and
uncertainty at some point later in the year. Although, it is unlikely that another extremist
party might come into power, yet the political risk in Greece is high in the medium term.
(London, 2015) There is a split within the Syriza party which has resulted in a emergency
congress of the party being scheduled in September. The extreme critisim of the current
bailout program may even lead to creation of a new party led by the members of the party’s
left platform which may eventually lead to a snap elections being called in autumn. (House of
Commons, 2015) In order to successfully be on the path of recovery and avoid default, it is
very important that Greece has a stable political government at Athens, cause at this stage
they do have to take some decisions and initiate reforms that might not be populist in nature.
5.1.6 Implicit backing from other entities
When Greece entered the European Union, investors, analysts and rating agencies reduced
their default risk rating for Greece, as they assumed that the European Union countries i.e
Germany, France and the scandavnian countries will protect the weaker countries from
defaulting. However the backing is implicit and not explicit and the lenders may well find
Greece Debt Crises: Build up to the Bust
56
themselves disappointed by the lack of backing and no legal recourse. (Damodaran, 2015)
Although the stronger countries in the European Union have supported Greece till now, but
due to the lack of reforms have been imposing harsher conditions on Greece as they have
been facing backlash in their own countries as it’s the tax payers money that is supporting the
bailout packages. If Greece is not successful in implementing the reform measures, there may
be a situation where the European Union may very well as Greece to exit.
5.2 Credit Default Spread
Credit default spread market allows the investors to buy protection against default in any of
the security. The buyer of the CDS on a specific bond payment makes payments of the spread
to seller of the CDS in return for the seller buying the whole issue if the entity defaults,
restructures or goes bankrupt. CDS basically are an indicator of the weakness of a country and
their ability in paying back there loans. This help to determine the credit ratings and the loan
spreads. A higher CDS spread would mean the risk of the entity/countries defaulting is high,
and the lenders would charge a higher interest rate in order to be compensated for the risk of
lending.
Greece Debt Crises: Build up to the Bust
57
Figure 18 CDS spreads Greece 2006-‐2010
(Damodaran, 2015)
The figure above provides the movement of the CDS spread between 2006 and 2010. We can
see that as they news of the debt crisis came to the market, before the ratings were changes
the CDS spreads increased. Although CDS spreads are not most accurate in predicting
defaults, yet at the same time they are a way to signal the risk of default in a country.
Greece Debt Crises: Build up to the Bust
58
Figure 19 Greece CDS spreads August 2015
(Source: Bloomberg)
A look at the current CDS spreads above , we can see the spreads for the short term bonds (6
months, 1 Year and 2 Years) are higher than spreads on the long term bonds, which signals
that the market believes the risk of a default is high in short term.
Greece Debt Crises: Build up to the Bust
59
6. Conclusion
Table 6 Risk Analysis Snapshot
Aspect Figure Level of Risk Description
Debt to GDP ratio 177.6% High According to IMF
any of debt to GDP
above 120% is
unsustainable.
Pension/Social
Contribution
17.5% of the
GDP
High The pension
system is ineffcient
and promotes low
productivity. Has
been one of the
reforms asked by
the creditors
Government Revenue 82.05 billion
euros in 2014
Medium The revenue
consist majorly of
taxes. The tax
evasion is very high
amongst
individuals and
corporates. An
efficient tax system
will increase the
revenues by more
than half
Stability of Revenues Tourism-‐ 19.8%
of GDP
Shipping – 7.5%
of GDP
High Although the
toursim and
shipping industries
are growing
Greece Debt Crises: Build up to the Bust
60
despite the
recession but are
vulnerable to a
global recession.
An economy which
is more diversified
has less default risk
Political Risk Medium in the
short term
Due to the harsh
conditions being
imposed by the
creditors may
create political
instability in the
medium term and
will increase the
risk of a default in
the short term
CDS 3500 bps for 6
months
High The CDS spread
being high over the
short term
indicates that the
market believes
that the risk of
Greece defaulting
is high in the short
run.
Total interest
payments/exports of
goods and sevices
15.35 High It is doubtful that
Greece will be able
to service their
debt through the
foreign exchange
Greece Debt Crises: Build up to the Bust
61
generated
Reserves/Imports 48.44 days High The current level
foreign reserves
that Greece has
are only enough to
provide import of
48 days.
Cash Flow Ratio 39.95 High The cash flow ratio
determines the
ability of the
entity/country to
be able to service
short term and
medium term debt
(principal and
interest) payments,
with the foreign
exchange
generated. In case
of Greece , it is at a
critical level as the
reserves are not
enough to be able
to service the debt.
Oil imports/exports 30% High Oil imports were
30% of the total
imports for Greece,
so it makes them
extremely
vulnerable to the
oil prices. A rise in
Greece Debt Crises: Build up to the Bust
62
the price of oil will
increase the
import bill and
have a worsening
effect on the trade
balance.
All the figures above point to the fact the Greek debt is unsustainable and although the third
bailout has been approved, it will still be used to service the debt in the near future and not
much of will be left to start the growth engine, which will be required in the long run for
Greece to be able to service the debt and not default. We have come to this conclusion by
looking at the traditional macroeconomic indicators.
More recently there have been models developed that analyse the sovereign risk by analysing
the health and aggregate default risk of a nation’s private sector – bottom up analysis. We will
looking at the result of one such test Risk Metrics Z-‐Metrics system. As a data set the test
included non-‐financial sector firm data over the period of 1998-‐2008, involving more than
250,000 quaterly and firm financial statements and associated market prices and
macroeconomic data observations, and used the multivariate logistic regressions structure to
construct the model. I couldn’t conduct the same test due to the lack of data available.
Also the Greek banking sector is weak and is plagued with very high level of non-‐performing
loans and as estimated by the IMF stands at 34% of the total value of all loans provided by the
Greek Banks at the end of Q4 2014. The Greek banks also hold large quantities of Greek
government bonds. (House of Commons, 2015) Since the beginning of the year the Private
Sector deposits in Greece have fallen by 42 billion euros or 25% by the end of June 2015.
(House of Commons, 2015)
No inter bank funding and trust in the banking sector, the Greek banks had to rely on the
Emergency Liquidity Assistance program and in order to prevent the banks to go insolvent had
to put capital controls.
Greece Debt Crises: Build up to the Bust
63
6.1.1 Continue as Part of the Euro
Since Greece joined the Euro, it has lost competitive advantage as compared to Germany. For
eg the Greek real exchange rate vis-‐à-‐vis Germany is
q=eP*/P
e = the nominal exchange rate
P*= German general price index
P = Greece price index
Over time q has been falling because either P* is falling or P is increasing or both, and since
Greek adopted the euro, e is fixed at 1, so the fact that P* is falling and P is rising ultimately
reflects productivity differentials between the two countries. Hence Greece has become less
competitive internationally and a lot of these manufacturing units have shifted to countries
like Bulgaria, Turkey etc. Along with the reforms in the pension and tax system, Greece still
needs restructuring of the debt cause it cannot be repaid under any plausible assumption.
Looking at the recent performance of the Greek economy and the condition of the global
economy especially with China slowing down, it is hard to see where the investment is going
to come in from and the growth in net exports. The growth rate of gross fixed capital
formation in Greece in the first three quarters of 2014 was -‐3.3 per cent against the same
period last year. Also the improvement in net exports has been as a result of the recession
and a decrease in imports. So the continuation of the current policies with the single goal of
fiscal surpluses will lead in best-‐case scenario to stagnation in the Greek economy, with high
unemployment and a significantly higher Debt to GDP ratio. (Levy Economic Institute of Bard
College, 2015) The creditors have been adamant on the fact that they are not going to cancel
any debt although the cancellation of the German debt following the Second World War
provides a template for such arrangement. It was only because of the debt being cancelled
and the remaining being restructured is why, Germany has been able to rebuild itself into one
of the biggest economies in the world and certainly the biggest in Europe. Also being a part of
Euro Union also guarantees access to the European Financial Stability Facility (EFSF)
Greece Debt Crises: Build up to the Bust
64
6.1.2 Grexit : Adopt Drachma
As I have mentioned this several times in the paper, since Greece joined the EU, they have
lost out on the international competitiveness due to the adopting the Euro. Also more so it
has been a disadvantage for the Greeks because it helped them be more irresponsible with
their fiscal policy, spending excessively to support an inefficient and large public sector.
Abandoning the Euro, would lead to huge devaluation of the drachma improving the Greek
trade balance, stimulate exports and eradicate the need to borrow large amounts of the
money. It will boost their tourism sector as well, cause it will be cheaper for tourist to visit
Greece. Historically, we know devaluation are known to stimulate exports in an economy
thereby contributing to the trade balance as well as the GDP of the economy. But in case of
Greece, due to a weak productive base, I don’t know if devaluation will have the same impact.
Yet at same time, devaluation will lead to the Greece debt inflation more for eg if the
exchange is the original one that Greece entered the euro zone with which was 1 euro =
340.750 GRD, then the Greece debt levels would go up to 350% plus levels of GDP. (The Rimni
Centre For Economic Analysis, 2015)
Also it would followed by high inflation, high unemployment, high interest rates and a total
breakdown of the banking system which is already very weak. The banking system at present
is being supported by the Emergency Liquidity Assistance (ELA) program. If Greece were to
adopt the drachma they have the privilege of their own monetary policy, through which they
can print currency in order to service the debt as well undergo the any other expenditure. Yet
at the same time as most of the private sector, has its financing activities in euro
denominated loans from non-‐Greek banks, they will not be able to service their debt
obligations.
In any case whether Greece is part of the EURO in the medium to long term or switches back
to its own currency, it will still need restructuring on the debt. The Euro zone will have to start
with forgoing to part of the debt and interest payments and restructing the rest, so that the
bailout money received by Greece is spent on building the necessary infrastructure to be able
to stimulate growth in the economy. Following are the key things that Greece will have to
address to be able to be back on the path of growth :
Greece Debt Crises: Build up to the Bust
65
1. They would need a major overhaul in the tax structure to be able to avoid massive tax
evasion by individuals as well as corporates.
2. Introduce institutional and political reforms which will lead to reduction in corruption
and red tapism in the country.
3. Due to corruption and time lag in the administrative approvals required in setting up a
business in Greece, they do not have the most favourable business environment. They need
to introduce reforms that encourage setting up of new businesses cause not only do they help
in generating employment but also increase the government revenue in the form of taxes.
4. The public sector is over inflated with the excessive number of people. Also they are
given salary hikes every year without any measure of effciency. They need to start introducing
efficiency based compensation in the public sector to be able to make the most of the
resources.
5. Providing subsidies for setting up Industrial units in the country which can not only
help in creating employment but also help in improving the trade balance.
6. There is a need to adjust and reform in Judicial system with the new constitutional
settlement, with the judiciary having full independence and putting an end to immunity and
special treatment for politicians. There has to be a repeal of Article 62 of the constitution,
with politicians facing corruption charges in the regular courts, not special parliamentary
committees. Also the five-‐year Statute of Limitations must be withdrawn. Furthermore
penalties in a fair society for non-‐compliance need to be higher. (Manolopoulos, 2011)
In case Greece does default, there is a risk that it might have a contagion effect, which may
involve countries like Portugal and Spain which have a Debt to GDP ratio of over 130%.
Although growth is better in these countries, yet they are structurally weak. Also once one
country defaults, the financial markets become vary of lending to countries to similar weak
fundamentals which would make the cost of borrowing for these countries much more
expensive and in the end make it difficult for them to raise money in the future. Also of the
total money loaned out to Greece, private holders hold only 17 per cent. The rest 83 per cent
is held in the following proportion : Euro area governments (62 per cent), International
Monetary Fund ( 10 per cent) through its participation in the two bailouts, and the European
Greece Debt Crises: Build up to the Bust
66
Central Bank (8 per cent), which purchased bonds in 2010 through its Securities Market
Program. The remaining 3 per cent is held by the Central Bank of Greece. (Bloomberg, 2015)
Figure 20 Eurozone contribution to Greece bailouts
As you can see above, of the euro area governments, Slovenia (3.06 per cent of GDP), Malta
(3.03 per cent of GDP), Spain (2.78 per cent of GDP) and Italy (2.75 per cent of GDP), have
much greater exposure than countries like Germany and France, so in case of a Greece
default, will have much more to lose.
6.2 Impact of Greece Exit
The impact of a Greece exit from Eurozone on the financial systems will depend on the
whether it was an orderly or a disorderly exit. In case of an orderly exit, the EU institutions
will make commitments to help Greece transition to the new currency at the same time
pledging support for the other Eurozone countries and banks who might come under
pressure. In case of a disorderly exit Greece will be forced to introduce the new currency,
shortly after the collapse of the banking system and with minimum intervention by the
European authorities will lead a prolonged reaction on the financial markets. (House of
Commons, 2015)
Greece Debt Crises: Build up to the Bust
67
If Greece were to default they would not be the first country to default on their sovereign
debt, Argentina, who defaulted on nearly $ 100 billion in sovereign debt, poses a cautionary
example. Once Argentina defaulted on the debt and sharply devalued the peso, it faced a
period of social unrest and political instability. Yet the Argentinian economy stabilised in 2002
and the country was able to repay the IMF in full in 2006 and never entered the international
debt market again. In case of Argentina the economic growth was largely driven by the surge
in commodity exports driven by demand from fast growing economies like Brazil and China
and also from the fact that it has a vast shale oil and gas reserve that can make it self-‐
sufficient. In case of Greece, it’s heavily dependent on imports, with the only major home-‐
grown exports being fresh fish and cotton. The only benefit from devaluation in currency
would be increase in tourism but they have already cut prices and revenues haven’t gone up
much. (Nytimes.com, 2015)
So in order to facilitate growth and be able to generate revenues to be able to pack back the
creditors, Greece will have invest in infrastructure and adopt the necessary reforms to be able
to achieve the goal. Greece needs supply side reforms. After the debt restructuring and
implementing supply side reforms, they need to have a business plan. Greece needs to focus
on their comparative advantage. It can leverage on its natural beauty to focus on developing
on the tourism sector. Greece has numerous doctors and could use this opportunity to
develop high-‐end hospitals, also presents the opportunity to promote medical tourism. Being
the Country with the largest shipping transportation fleet, they can use the expertise to
develop a world-‐class shipping and training and management centre. Also the small
businesses and entrepreneurs should be allowed to flourish and not being strangled by red
tape and closed professionals who try to extract rent from them.
Greece Debt Crises: Build up to the Bust
68
7. Recommendations
We have carefully studied the fundamentals of the Greece economy to be able to
substantially validate the ability of the Greeks to again be on the path of growth and be able
to prevent default. We have also drawn references to defaults in other countries wherever
possible as precedents to be able to showcase better and forecast the path for Greece. Due to
unavailability of data, we were not able to conduct the Risk Metric Z Metric test, for the
sovereign default risk of a country, which is being widely used to be able to predict the
probability of default. Although one cannot predict with full confidence the risk of default of a
country, fundamental analysis do help in signalling. Also during the writing of the paper, the
talk for the Third bailout package was going on, so there been intense discussions around the
terms of the bailout, which did make it easier in the availability of research material but also
required constantly updating variables. In order to be fully complete this research I would
been better placed, if I could have conducted some first-‐hand research which in a topic like
this becomes quite necessary to get a complete view.
Greece Debt Crises: Build up to the Bust
69
Reference:
1. Allianz, (2014). 2014 Pension Sustainability Index. [online] Available at: https://www.allianz.com/v_1396002521000/media/press/document/2014_PSI_ES_final.pdf [Accessed 28 Aug. 2015].
2. Athanassiou, E. (2009). Fiscal Policy and the Recession: The Case of Greece. [online] Available at: http://link.springer.com/article/10.1007%2Fs10272-009-0318-7#page-1 [Accessed 28 Aug. 2015].
3. Bank of Greece, (2001). Greece’s Economic Performance and Prospects. [online] Available at: http://www.bankofgreece.gr/BogDocumentEn/Greece's_Economic_Performance_and_prospects.pdf [Accessed 28 Aug. 2015].
4. Banque de France, (2001). ASSESSMENT OF GREECE’S CO NVERGENCE PRIOR TO ITS PARTICIPATION IN THE EURO AREA ON 1 JANUARY 2001. [online] Available at: https://www.banque-france.fr/fileadmin/user_upload/banque_de_france/Eurosysteme_et_international/04_411EXAMEN_ENTREE_GRECE-GB.pdf [Accessed 28 Jul. 2015].
5. BBC News, (2012). How 'magic' made Greek debt disappear before it joined the euro - BBC News. [online] Available at: http://www.bbc.co.uk/news/world-europe-16834815 [Accessed 28 Aug. 2015].
6. BBC News, (2015). Greece profile - Timeline - BBC News. [online] Available at: http://www.bbc.co.uk/news/world-europe-17373216 [Accessed 28 Aug. 2015].
7. BBC News, (2015). Greek bailout deal agreed 'in principle' - BBC News. [online] Available at: http://www.bbc.co.uk/news/business-33858660 [Accessed 28 Aug. 2015].
8. Bloomberg, (2015). Who Hurts Most if Greece Defualts. [online] Available at: http://www.bloombergbriefs.com/content/uploads/sites/2/2015/01/MS_Greece_WhoHurts.pdf [Accessed 28 Aug. 2015].
9. Bosworth, B. and Kollintzas, T. (2001). Economic Growth in Greece: Past Performance and Future Prospects. [online] Available at: http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=2852 [Accessed 28 Aug. 2015].
10. British Telecom, (2015). Greek PM bids to push through new bailout deal despite Syriza dissent. [online] Available at: https://home.bt.com/news/world-news/greece-agrees-to-harsh-terms-for-new-bailout-package-as-details-finalised-11363997265613 [Accessed 28 Aug. 2015].
11. Congressional Research Service, (2011). Greece’s Debt Crisis: Overview, Policy Responses, and Implications. [online] Available at: http://fpc.state.gov/documents/organization/171382.pdf [Accessed 28 Aug. 2015].
12. Damodaran, A. (2015). Country Risk: Determinants, Measures and Implications - The 2015 Edition. [online] Available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2630871 [Accessed 28 Aug. 2015].
13. Davis, O. (2015). Greek Debt Crisis: Greece’s Pension System Was Once A Bloated Mess, Now It’s A Crucial Lifeline For Struggling Families. [online] International Business Times. Available at: http://www.ibtimes.com/greek-debt-crisis-greeces-pension-system-was-once-bloated-mess-now-its-crucial-1998708 [Accessed 28 Aug. 2015].
14. Elliott, L. and Henley, J. (2015). Greece creditors raise 'serious concerns' about spiralling debt levels. [online] The Guardian. Available at:
Greece Debt Crises: Build up to the Bust
70
http://www.theguardian.com/business/2015/aug/13/greece-surprises-with-economic-growth-in-second-quarter [Accessed 28 Aug. 2015].
15. Eurobank Research, (2014). The Greek maritime transport industry and its influence on the Greek economy.. [online] Available at: http://www.eurobank.gr/Uploads/Reports/ECONOMYMARKETS_wpMAY2014.pdf [Accessed 28 Aug. 2015].
16. European Commission, (2015). Financial assistance to Greece - European Commission. [online] Available at: http://ec.europa.eu/economy_finance/assistance_eu_ms/greek_loan_facility/index_en.htm [Accessed 28 Aug. 2015].
17. FocusEconomics | Economic Forecasts from the World's Leading Economists, (2015). Greece Economic Report | Outlook, Statistics and Forecasts. [online] Available at: http://www.focus-economics.com/countries/greece [Accessed 28 Aug. 2015].
18. Greece Debt to GDP. (2015). [image] Available at: http://www.tradingeconomics.com/greece/government-debt-to-gdp [Accessed 28 Aug. 2015].
19. Greece GDP. (2015). [image] Available at: http://www.tradingeconomics.com/greece/gdp [Accessed 28 Aug. 2015].
20. Hardouvelis, G. (2007). Macroeconomic Management and the post EMU Need for Structural Reforms in Greece. [online] Available at: http://www.hardouvelis.gr/FILES/PROFESSIONAL%20WORK/Econ%20Markets%208_2_new.pdf [Accessed 28 Aug. 2015].
21. Herz, B. and Kotios, A. (2000). Coming Home to Europe: Greece and the Euro. [online] Available at: http://link.springer.com/article/10.1007%2FBF02930258#page-1 [Accessed 28 Jul. 2015].
22. House of Commons Library, (2015). Greek debt crisis: background and developments in 2015. [online] Available at: http://researchbriefings.parliament.uk/ResearchBriefing/Summary/SN07114#fullreport [Accessed 28 Aug. 2015].
23. Inc., W. (2015). Greece Income Taxes and Tax Laws - WorldWide-Tax.com. [online] Worldwide Tax. Available at: http://www.worldwide-tax.com/greece/greece_tax.asp [Accessed 28 Aug. 2015].
24. Inflation Rate. (2015). [image] Available at: http://www.tradingeconomics.com/greece/inflation-cpi [Accessed 28 Aug. 2015].
25. Levy Economic Institute of Bard College, (2015). The Greek Public Debt Problem. [online] Available at: http://www.levyinstitute.org/pubs/pn_15_2.pdf [Accessed 28 Aug. 2015].
26. London, N. (2015). Intelligent-News.com - Political risks in Greece and Europe after the Euro Summit deal - Credit Suisse. [online] Intelligent News. Available at: http://intelligent-news.com/news-analysis/political-risks-in-greece-and-europe-after-the-euro-summit-deal-credit-suisse [Accessed 28 Aug. 2015].
27. Malkoutzis, N. (2012). How the 2004 Olympics Triggered Greece's Decline. [online] Businessweek. Available at: http://www.bloomberg.com/bw/articles/2012-08-02/how-the-2004-olympics-triggered-greeces-decline [Accessed 28 Aug. 2015].
28. Manolopoulos, J. (2011). Greece's "odious" debt. London [etc.]: Anthem Press. 29. Mckinsey & Company, (2012). Greece 10 Years Ahead. [online] Available at:
http://www.mckinsey.com/locations/athens/GreeceExecutiveSummary_new/pdfs/Executive_summary_English.pdf [Accessed 28 Aug. 2015].
30. Mētsopoulos, M. and Pelagidēs, T. (2011). Understanding the crisis in Greece. Basingstoke, Hampshire: Palgrave Macmillan.
Greece Debt Crises: Build up to the Bust
71
31. Nardelli, A. (2015). Unsustainable futures? The Greek pensions dilemma explained. [online] The Guardian. Available at: http://www.theguardian.com/business/2015/jun/15/unsustainable-futures-greece-pensions-dilemma-explained-financial-crisis-default-eurozone [Accessed 28 Aug. 2015].
32. Nytimes, (2015). If Greece Defaults, Imagine Argentina, but Much Worse. [online] Available at: http://www.nytimes.com/2015/06/26/business/an-echo-of-argentina-in-greek-debt-crisis.html [Accessed 28 Aug. 2015].
33. OECD, (2014). Revenue Statistics 2014 - Greece. [online] Available at: http://www.oecd.org/ctp/tax-policy/revenue-statistics-and-consumption-tax-trends-2014-greece.pdf [Accessed 28 Aug. 2015].
34. Shedlock, M. (2015). Tax Revenue Collapses in Greece; Government Denies Capital Controls; Citizens Pull €2bn in Three Days. [Blog] Mish's Global Economic Trend Analysis. Available at: http://globaleconomicanalysis.blogspot.co.uk/2015/06/tax-revenue-collapses-in-greece.html [Accessed 28 Aug. 2015].
35. The Independent, (2015). Greek debt crisis: Goldman Sachs could be sued for helping hide debts when it joined euro. [online] Available at: http://www.independent.co.uk/news/world/europe/greek-debt-crisis-goldman-sachs-could-be-sued-for-helping-country-hide-debts-when-it-joined-euro-10381926.html [Accessed 28 Aug. 2015].
36. The Rimni Centre For Economic Analysis, (2015). The Greek Debt Crises: Suggested Solutions and Reforms. [online] Available at: http://www.rcfea.org/RePEc/pdf/pre01_11.pdf [Accessed 28 Aug. 2015].
37. Theodora.com, (2015). Greece Economy 2015, CIA World Factbook. [online] Available at: http://www.theodora.com/wfbcurrent/greece/greece_economy.html [Accessed 28 Aug. 2015].
38. Times, T. (2015). Greece’s Debt Crisis Explained. [online] NY Times. Available at: http://www.nytimes.com/interactive/2015/business/international/greece-debt-crisis-euro.html [Accessed 28 Aug. 2015].
39. Truthdig, (2015). How Goldman Sachs Helped Create the Greek Debt Crisis: Robert Reich. [online] Available at: http://www.truthdig.com/report/item/how_goldman_sachs_profited_from_the_greek_debt_crisis_20150717 [Accessed 28 Aug. 2015].
40. Wikipedia, (2015). Greece. [online] Available at: https://en.wikipedia.org/wiki/Greece [Accessed 28 Aug. 2015].
41. Willis, A. (2009). Revised Greek deficit figures cause outrage. [online] Euobserver. Available at: https://euobserver.com/economic/28853 [Accessed 28 Aug. 2015].
42. World Travel and Tourism Council, (2015). Travel & Tourism Economic impact 2015 Greece. [online] Available at: http://www.wttc.org/-/media/files/reports/economic%20impact%20research/countries%202015/greece2015.pdf [Accessed 28 Aug. 2015].