Economics
Akshay Iyer SIBM - Pune Demystifying the Euro Zone Crisis
of being limited, got doubled in these years with only 5 countries had their debt below 60% of GDP. Government deficit was not capped with only 4 countries falling below 3%. Also, a clause in the Treaty which restricted countries from being bailed out in case of economic problems got broken when a bailout package got designed for Greece, Portugal & Ireland.
The idea of creating a common currency for countries belonging to the European Union was formed so that there is better integration among EU countries & also there exists a possibility of creation of an alternate reserve currency vis-àvis the US dollar. The countries which wanted to use this common currency had to sign the Maastricht Treaty comprising the following clauses: 1. Inflation rate of the participating country should not be higher than 1.5% of the average inflation rate of the 3 best performing countries in Eurozone. 2. The ratio of Government deficit to GDP for a year should not exceed 3%. 3. The ratio of Government debt to GDP should not exceed 60%. 4. The long-term interest rate for a country should not be higher than 2% than the 3 lowest inflation states. Any country that satisfied the above conditions would be allowed to use the common currency. By adopting Euro as their currency & being part of monetary union, countries received a higher credit rating which helped them borrow at lower rates. As a result, countries such as Greece, Portugal & Italy borrowed more money at lower interest rates with longer maturities. Also, there was irresponsible spending by many of these countries in areas of public welfare, wage hikes & no formalised structure which would help them earn the amount of revenue that they were spending each year. It was also reported that some of the clauses of Maastricht Treaty were breached by these countries & they used creative accounting techniques to hide these discrepancies. The clauses mentioned in Maastricht treaty were broken by few member nations. Government, debt instead All these were concealed in the years prior to 2008, where the governments were able to pay timely interest on their borrowings due to a well-functioning global economy. Problems surfaced in 2008 when there was the economic downturn & countries were not able to make timely interest payments. It was on January 14th 2009 that for the first time, Standard & Poor downgraded Greek government bonds to A-, the lowest rating among Eurozone member states. It also strangely presented the start of a big crisis that was about to unravel. As the Greek bonds were downgraded, investors started demanding a higher premium for lending to Greece which led to an increase in their borrowing costs. This leads to a vicious cycle where a country has to pay a higher cost for borrowing which further leads to more fiscal strain and increases borrowing cost. S&P predicted in October 2009 that Greek debt would increase to 125% of its GDP by
9
iNM - Magazine