Question

question 2 and 3 only please

The Greek Crisis: Tragedy or Opportunity Case Objectives Greece suffered from the highest debt to GDP ratio in Europe and chronic budget deficit. A new Government was formed following a general election in October 2009, revealed that previous deficit estimates for the year had been optimistic, and announced that they were over 15% of GDP, more than twice previously claimed. The interest rate on newly issued Greek sovereign bonds increased dramatically over concerns by market participants that the country might not be able to repay its debt in full. By May of 2010, as the interest on the two year notes reached 19%. Greece had effectively lost access to the capital market and the ability to refinance its debt. With over 20 billion euro coming due within a few weeks, it faced the very real possibility of having to default by a country of the European Monetary Union since the introduction of the euro in 1999. And there were profound motives to avoid Surrested Questions 1. How did Greece get into this difficult situation? a. Was the fiscal crisis unequivocally Greece's fault? Was it irresponsible, dishonest? Were the cause's structural/political/cultural? b. Was Greece assuming It would be bailed out? c. Could you have seen this crisis coming from the data? Was it inevitable? d. Was the crisis fault of the euro? e. Was it wise to allow Greece to borrow at such cheap rates after joining the euro? f. Why did the German and the French banks lend so much? Why did it take so long on a rescue of an economy that is only 2.6% of the Eurozone? h. Was it the fault of the markets? Were they overoptimistic in marking the spreads down so much so fast? Are they over pessimistic now? 2. Exactly one year after the package was announced, the 10 year GGB could be bought for 50% of par, yielding 15.3% in euros. That is a yield to maturity of over 30% in euros would you have invested in it knowing what you knew at that point in time? 3. Does the Greek crisis spell doom for the future of the euro and the euro area

Answer 1

Answer:-

1) (A) The historical factors that contributed to greece’s financial crisis:-

a) Corrupt Political System-Part of ottoman Empire for 300 years, Turkish Rule unstable political scenario, tax evasion and losing 8% of GDP to bribery and unauthenticated means.

b) Weak Economy- Grece is very less in production , during 19th century its income was majorly based on shipping and agriculture, high administrative burden because of corruption, german occupancy drained significant resources.

c) Pubic sector expansion in 1980’s-Inefficient and unnecessary expansion in public sector by paying high wages and pensions, Nationalization of industry, Public spending increased from 29% to 48% of GDP.

d) Excessive Debt Burden-Credit facility initiated when Greece adopted Euro, Borrowings were done to sustain the highly paid public sector, Bailouts delaying the inevitable when behaviour does not change.

(B) The Greek financial crisis was a result of several problems within Greece. These problems can be divided into two aspects: structural and political.

a. Structural problems

The first problem lies in Greece’s GDP composition- During 2000-2010 the average GDP consumption accounted for roughly 90% of GDP, whereas Gross fixed capital formation made up around 20%. This means Greek growth was mainly from Consumption. Also, Greece’s agricultural and industrial outputs declined from 6.6% to 4% for agriculture and 21% to 16.9% for the industry. This helps explain the constant trade deficits, negative current account, and increasing government debt of Greece from 2000 – 2010.

In addition, Greece’s economy based heavily on the service sector (roughly 80% of GDP in 2010). During 2008 – 2009, the global financial crisis caused Greece’s services balance to drop 26% (from 17.1 to 12.6 billion EUR) and the result was the slowdown of the whole economy. While Greece has potential comparative advantages in textiles, clothing, and refined petroleum products, low spending R&D might explain why industry only accounted for 16.9% of GDP and why Greece’s economy relied heavily on services.

Greece also had another problem with productivity. While Greece’s labor productivity was among the lowest (18.2 EUR per hour (2007) only higher than Portugal’s 13.8 EUR per hour), it had the highest nominal cost index (124.5) as compared to other nations like Germany (99.3), France (114.3), and United Kingdom (119.7). From 2000 – 2010, although Labor productivity growth slowed down (4.1 to -1.6), nominal labor unit cost index increased significantly (100 to 140) (Exhibit 2). This means Greece raised wages while there was no significant improvement in output per worker. As productivity is considered a major factor to economic growth, Greece’s productivity situation, together with the increasing debt and an inhospitable business climate, were clear signals to an inefficient economy and a financial crisis ahead.

b. Political problems

Greece also suffered from political problems that led to the crisis. These problems were caused by two governing parties: ND and PASOK. While both parties tried to win elections at all cost, Greece’s economy suffered. For example, during the populist years, PASOK won the election by calling social protection and income redistribution. This resulted in the increase of public spending from 29% to 48% of GDP, averaged deficits of 10% of GDP, and public debt tripled from 28% (1980) to 89% (1990). Another example was the 2009 election, efforts to win the election resulted in a relaxation of tax collection (revenue loss) and overstaffing issue (expenditure increase).

(C )Since Greece did not control the Euro devaluation the most likely action for Greece to resolve this crisis was either to bailout(get help from abroad) or to default. Greece was thinking that it would be bailed out due to following reasons:-

a) Europian Union and Euro Area- If Greece would have defaulted the other small countries like Portugal, spain etc would also been in danger as they share the same high public debts and current account deficits, if all these countries defaulted the exchange rate of Euro would have declined which was already the case because of Greece (i.e. within 8 months (oct 2009-june 2010) the value declined from 1.50% to 1.20%) and this would have resulted in global economy slowdown. Also France and Germany would also have been impacted as these countries hold Greece’s government bonds , hence EU decided to bailout Greece.

b) IMF- Managing director of the IMF, was interested in bailing out Greece considering the facts that he was a possible contender for the French presidency in 2012 and two-thirds of the French public agreed to support Greece. Therefore, generously helping Greece would also help Dominique Strauss-Kahn gain French public support in the 2012 election.

(D) No it was not a fault of the Euro , Once when Greece accepted the Euro If Greece would have defaulted the other small countries like Portugal, spain etc would also been in danger as they share the same high public debts and current account deficits, if all these countries defaulted the exchange rate of Euro would have declined which was already the case because of Greece (i.e. within 8 months (oct 2009-june 2010) the value declined from 1.50% to 1.20%) and this would have resulted in global economy slowdown. Also France and Germany would also have been impacted as these countries hold Greece’s government bonds , hence EU decided to bailout Greece.

(E ) *Europian Union and Euro Area- If Greece would have defaulted the other small countries like Portugal, spain etc would also been in danger as they share the same high public debts and current account deficits, if all these countries defaulted the exchange rate of Euro would have declined which was already the case because of Greece (i.e. within 8 months (oct 2009-june 2010) the value declined from 1.50% to 1.20%) and this would have resulted in global economy slowdown. Also France and Germany would also have been impacted as these countries hold Greece’s government bonds , hence EU decided to bailout Greece.

*IMF- Managing director of the IMF, was interested in bailing out Greece considering the facts that he was a possible contender for the French presidency in 2012 and two-thirds of the French public agreed to support Greece. Therefore, generously helping Greece would also help Dominique Strauss-Kahn gain French public support in the 2012 election.

(F) France and Germany would also have been impacted as these countries banks hold Greece’s government bonds (60 to 120 billion EUR) , hence EU decided to bailout Greece.

(G)Although it was 2.6% of the Eurozone but it had huge impact on the economics of other countries which fall under Euro Zone, by making all deliberations and bailing out and correcting the system it took long to correct the financial crisis faced by Greece.

(H) No it was not fault of the market , market is run by the sentiments hence when the Greece’s bonds and economy was showing a declining trend market became overoptimistic and hence acted accordingly . Right now also market is pessimistic that Greece has evolved from the crisis and would show a rising trend.

2) As the yield to maturity ratio after 1 years comes to over 30% in euros , Yes we would have invested in it as Yeild to maturity ratio itself explains the bond is expected to generate yield if it is held till its maturity given its coupon rate , maturity and current market price.

3) Yes The Greece crisis has already put The Euro Zone and the IMF in question as the countries are also getting affected by this and its impact is shown on the economy of other countries as well with a question on IMF regulatory committee which is helping Greece to recover from its financial crisis.