European Debt Crisis Explained
Ankit Sethi
Great Lakes Institute of Management European debt crisis has been in headlines for quite some time now. But why is that we all are talking about it? Many countries take Debt but what differentiates Europe (PIIGS*) from others i.e., they don’t have money to pay back. Now that’s a problem? To deal with this problem we have IMF, ECB, EFSF and many more. But why we have this problem. Let’s have a look at this from a broader point of view. When does your debt becomes a problem? Government debt + Banking System > 5x Revenue The above equation is a white paper equation of Debt as a part of the system. What this equations tells us this – if your banking sector and debt is huge, It’s difficult to government to bail out any one them in crisis. If both fall, some serious trouble is coming your way? Some figures as per the equation- Ireland (43-45x), Greece (8-10x), Germany (8-10x) and many more. Now the question is why Greece is in crisis but Germany isn’t? Because Germany has a healthy economy with positive BOP*. As per the above graph, Current account is running in negative for PIGS* i.e., money is flowing out of the economy but in case of Germany money is flowing in. This money will end up in the banking sector. *PIIGS- Portugal, Ireland, Italy, Greece and Spain How it started? This all started with the formation of European Union (EU). In the year 1958, European Coal and Steel community was established which later became EU by the Maastricht Treaty in 1993. Euro was introduced as the single currency and countries started to join EU. So how did EU helped European countries? Before EU, countries like PIIGS* were borrowing at a much higher rate than other countries. With them coming together their borrowing rate fell. They started borrowing at rates on which Germany was borrowing.
Now can you compare German economy with Greece? No, but Greece and others dint realised until the bubble burst in 2009 after the US financial outburst. These countries than had enormous amount of funds flowing primarily debt funding. Reasons? It’s not that all the countries in European Union are going through bad phase. There are few countries that are overleveraged i.e., debt to size of economy is high. PIIGS* unfortunately are the ones who are over-leveraged. Italy’s Debt is 121%,Ireland is 109% and Greece is 168%.
February 2013
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