Group 2 has members from various departments including international, financial management, and management. The document then discusses the Eurozone crisis that affected countries like Greece, Portugal, Spain, Ireland, and Italy. It analyzes the causes of the crises in these countries, including loose monetary policy, rising debt levels, and housing bubbles. The document also discusses theories around optimum currency areas and debates if Europe formed an optimum currency area for the euro.

1. GROUP 2
HASAN NAYYAR 16C INTERNATIONAL
JASMIT SINGH CHAWLA 19C
KAPISH KAUSHAL 20C FINANCIAL
KUMAR VIVEK 22C MANAGEMENT
NISHANT SHEKHAR 27C
SHASHWAT SINHA 41C
SHREYASH AGARWAL 42C
SURJODEB SARKAR 44C
VAIBHAV GUPTA 47C

2. LAYOUT
GREECE, PORTUGAL, SPAIN, IRELAND
AND ITALY: DETAILED REVIEW
CAUSES OF THE CRISES IN GENERAL
OPTIMUM CURRENCY AREA THEORY
FROM EMS TO EURO

3. GENESIS OF “THE IDEA OF A COMMON CURRENCY”
After the end of WW II in 1945, many EU leaders agreed that economic cooperation
and integration among the former belligerents would be the best guarantee against
a repetition of the 20th century’s two devastating wars.
The result was a gradual ceding of national economic policy powers to centralized
EU governing bodies such as European Commission in Brussels and European
System of Central Banks, headquartered in Frankfurt, Germany.
The first significant step was the European Monetary System

4. EUROPEAN MONETARY SYSTEM
Germany Italy
(2.7% inflation) (12.1% inflation)
In 1979, with a wide divergence in inflation rates, the prospects for a
successful fixed rate area looked bleak
However, through a mix of policy cooperation and
realignment, the EMS fixed exchange rate club survived

5. MEASURES TAKEN TO MAKE EMS SUSTAINABLE

6. FROM EMS TO EURO
Greater degree of
European market Eliminating
integration. costs to traders
of converting
one EMS
currency into
another
ECB would be
more
considerate of
other countries
problems
A SINGLE EU CURRENCY WAS INTENDED AS A POTENT SYMBOL
OF EUROPE’S DESIRE TO PLACE COOPERATION AHEAD OF THE
NATIONAL RIVALRIES, AND ACTING AS ONE TO COMPETE
AGAINST THE DOLLAR

8. THE THEORY OF OPTIMUM CURRENCY AREAS
This theory predicts that fixed
exchange rates are most
appropriate for areas closely
integrated through international
trade and factor movements.
THE MORE EXTENSIVE ARE CROSS BORDER TRADE AND FACTOR
MOVEMENTS, THE GREATER IS THE GAIN FROM A CROSS BORDER
EXCHANGE RATE

9. GG SCHEDULE LL SCHEDULE
GG
Monetary
Efficiency Economic
gain Stability
Loss
LL
Degree of economic integration between the
joining country and the exchange rate area
GG Schedule shows how the potential gain to a particular The cost of joining the Euro is that the country will have to
country from joining the Euro Zone depends on the give up its ability to use the exchange rate and monetary
country’s trading links with that region. policy for the purpose of stabilizing output and employment.
This economic stability loss from joining is related to the
country’s economic integration with exchange rate partners
and graphically shown by LL schedule

10. Gains and GG Schedule
losses for the
joining
country
Gains exceed losses
Losses exceed gains
LL Schedule
Q1
Degree of economic integration between the joining
country and the exchange rate area
The country should only join the single currency, if its degree of economic integration
is greater than Q 1

11. IS EUROPE AN OPTIMUM CURRENCY AREA?
The overall degree of economic integration can be judged by looking at the integration
of product markets, that is, the extent of trade between the joining country and the
currency area, and at the integration of factor markets, that is , the ease with which
labor and capital can migrate between the joining country and the currency area.
People changing region of residence in the 1990s(% of total pop)
Britain Germany Italy USA
1.7 1.1 0.5 3.1
Source: Peter Huber
There is evidence that national financial markets have become better integrated with
each other as a result of the Euro, and this has promoted intra-EU trade. But while
capital moves with little interference, labor mobility is nowhere near the high level
countries would need to adjust smoothly to product market disturbances through
labor migration.

12. CAUSES OF THE EURO CRISIS
2008 crisis made
Exports from
tax revenues
prosperous
Domestic demand Tax revenues collapse. Govt.
Euro Introduced The prices of Eurozone Demand spurred Pan-European
and consumption increased in PIIGS, spending
=> Interest rates domestic activities countries increased wage monetary policy
in PIIGS increased govts. increased unfeasible &
decline in PIIGS rose=> Investment increased costs. Emergence , loose on PIIGS &
=> increased spending.Blatant competitiveness
countries to those in non-tradable following the of China =>lower tight on
spending led to fiscal decreased, so
of Europe’s stable sectors increased growing demands competence of Germany=> loss of
higher foreign mismanagement foreign demand
countries vis-à-vis ExIm in PIIGS. PIIGS competitiveness
debts in Greece couldn’t be
Deutschemark
tapped
higher than Euro

13. Greece

14. GDP
agriculture: 3.6%
industry: 18%
services: 78.3% (2011 est.)
Unemployment rate

15. INVESTMENT
DEBT

16. Inflation

17. EXPORTS
IMPORTS

18. Exchange Rates
Country--Old Currency Rate
GREECE
Belgium--Belgian franc 44.3399
0.7715 (2010) Greece--Greek drachma 340.750
0.7179 (2009) France--French frank 6.55957
0.6827 (2008) Italy--Italian lira 1936.27
Netherlands--Dutch guilder 2.20371
0.7345 (2007) Portugal--Portuguese escudo 200.482
0.7964 (2006) Germany--Deutsche Mark 1.95583
Spain--Spanish peseta 166.386
Ireland--Irish pound 0.787564
Luxembourg--Luxembourg franc 40.3399
Austria--Austrian schilling 13.7603
Finland--Finnish markka 5.94573

19. Debt repayment
 With any debtor, there is a chance they will not be able to repay
their debts. These figures in the above graph express the likelihood
as a percentage called the Cumulative Probability of Default (CPD)
 The figures express the probability of a country defaulting
sometime over the next five years

20. Greece : Economic Woes
• Its government owes about 300bn euros ($400bn; £260bn)
• spread over three years - but on condition that Greece slashes
public spending and boosts tax revenue.
• Ratings agency S&P has already downgraded Greek debt to
"junk", which means it views Greece as a highly risky place to
invest.
• As the money flowed out of the government's coffers, tax
income was hit because of widespread tax evasion.

21. Options for Greece
 Europe/IMF continues to bail out Greece
• Bail out are most effective for temporary and short term mismatches
• Greece lacks any credible fiscal control program
• Spending cuts have met with widespread resentment
• Large current account deficit means a pressure to raise foreign savings
 Exit the EURO
• Could default and devalue its currency, thereby providing scope for improving
competitiveness
• Would shift some of the debt burden to foreign creditors and avoid further debt build-
up
• Could trigger an even greater financial crisis
• Reintroducing Drachma would lead to re-pricing of all contracts with no clear idea of
how to achieve this
• It will also antagonize other Euro members and have huge political risks
• Will affect trade with Euro zone which accounts for 2/3 of its total trade
• There is no provision in Euro treaty for a country exiting the same and thus it will affect
all contracts and other legalities

22. Greece Defaults and Restructures its debt
• Most viable option available
• Will affect the banking system but that is a price for ignoring associated risks for
such a long time
• There are fears that this might lead to a Lehman king of moment due to huge
interlinks in the banking system
Soft Restructuring involving private sector
• Plans to share the debt burden with private sector akin to soft restructuring of
government debt
• Would involve creditors exchanging their soon to mature bonds with debt for
longer maturity
• Would however lead to large losses for banks and recapitalizing them would
require further borrowing

23. The way out !!
• Restructuring its debt while at the same committing to strong fiscal
measures
• Cut its budget deficit, or the amount its public spending exceeds
taxation, to 8.7% of its GDP in 2010, and to less than 3% by 2012.
• Just before the massive bail-out package was announced the Greek
government pledged to make further spending cuts and tax
increases totalling 30bn euros over three years - on top of austerity
measures already taken.
• Greece plans to freeze public sector workers' pay, make further cuts
in civil servants' benefits, hike VAT (sales tax) and fuel duty, raise
the retirement age and reduce pensions.
• Greece's Socialist government says the nation faces "sacrifices" in a
"choice between collapse or salvation".

24. PORTUGAL

25. • Unlike its most vulnerable Euro area counterparts, Portugal saw its boom that followed the
adoption of the euro fade quickly.
• In the run up to the launch of the euro, its GDP had grown at an average annual rate of
almost 4 percent —one of the highest rates in the Euro
• However, the demand boom, which was triggered by a sharp decline in interest rates and
fueled by expansionary fiscal policy, was not followed by a parallel increase in potential
supply
• Between 1995 and 2000, private savings dropped by about 7 percentage points of GDP, while
average gross fixed capital formation had accelerated. Household and non-financial sector
debt more than doubled in percent of GDP terms between the mid-1990s and 2002.
• Reflecting external borrowing’s role in financing consumption and investment, the current
account deficit soared to 9.0 percent in 2000, up from near-zero in 1995.

26. After formal adoption of the euro, monetary policy in the Euro area, while clearly too loose for
Greece, Spain, and Ireland, who saw housing booms, was too tight for Portugal, where housing
investment as a percentage of GDP had declined over time and inflation had dropped.
The euro’s adoption led interest rates to fall sharply in Portugal—from an average of 12.3
percent in 1991–1995 to about 6 percent in 1996–2000—setting the stage for a consumption
boom.

27. Significant labor market
tightening and rapid wage
increases had characterized
the boom.
The consequence was an
Effects of the appreciation in the real
euro boom effective exchange rate
(REER)—about 12 percent
from 1994 to 2000.
This appreciation led to a
build-up of macroeconomic
imbalance & was reflected in
current a/c deficits.

28. At the same time, labour productivity slowed & was well below EU average—32 percent in
agriculture, for example—in all sectors of the economy.
Reasons for it:
• The country’s relatively low human capital formation
• Limited use of information technology
Causes of end of Euro boom.
• Portugal’s export structure at the launch of the euro was too weighted towards traditional
slow-growing sectors where comparative advantage was shifting toward the emerging
economies in Asia. The share of production in low-tech manufacturing sectors, for
example, was 80 percent in 1995 and 73 percent in 2001.
• Another important factor was the inflexibility of portugal’s labor markets.
• Rapid deterioration of competitiveness
As household spending stalled amid high levels of debt—the investment and consumption
boom came to an end.

29. Current scenario
The downturn also had a significant impact on unemployment, which reached 10.7 percent in
2010, up three percentage points from two years ago—a relatively modest increase by the
standards of Spain and Ireland.
• There has been
Effect of crisis an increase in
on unemployment
unemployment after 2002
• Portugal’s spending on R&D as a percentage of GDP is half of the average in the Euro area.
• Furthermore, its governance and business climate indicators are today among the lowest in
the euro area.

30. Increase flexibility in labour Increase competition in relatively
markets. sheltered backbone services.
Policy
Recommendations
Improve the human capital base Implement a systematic approach
so that productivity is improved to correct deficiencies in the
and country regains business climate, especially in
attractiveness with foreign starting a business, paying
investors. taxes, and getting credit.

31. SPAINSjfjfjkjSPAIN

32. Euro timeline of Spain Problems After Euro adoption
2002
1999 • Huge misallocation of resources
Issuance
of euro
1986 Adopted banknotes
euro as and coins
• Loss of competitiveness
the official after a 3
Joined EU currency year
transition • Large Deficits and rising public debt
period
Public Debt(% of GDP) Unemployment rate(%)

33. Causes of the Crisis
Housing sector boom and bust: At Interest rates plummeted
its peak, construction value-added
reached 17 percent of GDP. In just
and confidence Labor cost and the unit
ten years, Spain’s housing prices soared, leading domestic labor cost increased by
more than doubled, and, at the demand and inflation to nearly 200% between
peak in 2006, Spain started more rise more than 1.5 times 2000-2010 which was not
homes than the
UK, Germany, France, and Italy faster than the Euro area in line with productivity
combined. average.
ULC(%)
8
7
ULC(%)
6
5
4
3
2
1
0
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
-1
-2

34. Remedies
Start with Encourage
government reallocation across
spending sectors
Remedies
Demand a
Reduce the unit
coordinated effort
cost of labor
across Europe

35. IRELAND- The Celtic Tiger
The collapse of the Irish economy has come as a particular shock to many
people, at home and abroad, because of its seemingly remarkable success in the
preceding years
THE GOOD OLD DAYS
• Growth was largely based on the attraction of (mainly US) multinationals taking
advantage of Ireland’s low corporate profits tax rate
• using the country as a base from which to export to the EU
• ‘Transfer pricing‘ mechanisms used
• After 2001, economic growth was based largely on a property price bubble

36. THE PROBLEM
The Main Reasons for the country specific problem
After 2001, economic growth was based largely on a property price bubble
Investment in buildings accounted for 5% of output in 1995 but for over 14% in 2008
Fuelling the property price bubble was a massive rise in household debt, which shot upwards from €57 billion in
2003 to €157 billion in 2008
Lending for mortgages rose from €44 billion in 2003 to €128 billion in 2008
Irish banks were themselves borrowing in order to lend on to their customers: the 6 main Irish banks borrowed €15
billion from abroad in 2003 but this figure had risen to €100 billion by 2007.
The European Dimension Bailing out the banks
•This reckless splurge was facilitated by liberalised lending • When the global financial crisis hit, access to credit declined
practices across the EU and by lax cross-border regulation of drastically worldwide and asset values tumbled
the financial sector • The Irish government chose to respond to the plight of the
• The very design of Economic and Monetary Union (EMU) banks in an extraordinary manner: on 30th September 2008 all
helped cause the crisis by establishing exchange rates that left depositors and senior bondholders (creditors to the Irish
peripheral EU countries uncompetitive relative to Germany banks) were guaranteed by the state
and encouraged the peripherals to rely on the accumulation of • An example of a contingent liability arises from the Irish state
debt to ‘compensate’ for this creating a National Assets Management Agency (NAMA) to
• The Irish authorities also contributed to the property bubble buy up some of the worst property loans in the hope of selling
with a range of tax incentives to property development. them on later

37. THE PROBLEM
Austerity for ordinary How Ireland is linked
people
• Despite all the upheaval surrounding bank funding and debt
problems in Greece and Italy, investors are betting that one
country is seeing better days: Ireland
• Its economy expanded 1.6% in the second quarter after
Corrective actions growing 1.9% during the previous quarter
• Irish 10-year yields slipped below 10% for the first time since
taken Portugal's rescue, according to Bloomberg
• To be immune a cautious measure which helps increase
further exports and spending
A loan of €58 billion from • In spite of this there can be further problems as there are
the IMF and EU was higher risks of the contagion
contracted in December
2010 - at an interest rate of
5.8%
SOME OPTIONS

38. CAN EURO SURVIVE
• In June 2010, banks in Austria, France, Germany and the Netherlands had
nearly one-quarter of their overall loans tied up in those weaker economies.
Should the countries drop the euro and default on those loans, worth an
estimated €1.9 trillion, the impact would be catastrophic for both the banks
and their home countries
• The countries that desert the euro and attempt to reinstate their old
currencies inevitably would face rapid, severe devaluation
• Greeks, fearing the disastrous consequences of a return to the drachma on
their personal accounts, they would naturally transfer their assets to Germany
or another euro zone state
• European fiscal union
• Eurobonds
• The heads of state are confused and more of self interests are put forth.

40. What is Italy’s Crisis???

41. Why is Italy in Crisis???
 One of the largest economies of the world
(6 times that of Greece itself)
 Problematic Sovereign Debt & Fiscal Deficit
 Fragile European Banks (holding the debt)
 Secular Loss of Competitiveness due to Euro adoption (too
loose monetary policy)
 Political Instability, doubtful future
 Non-tradable investments increasing, hence exportables
not keeping pace with boom
 Specializes in low-skill goods, has lost the most market
share in its traditional geographic markets
 Heavily oil-reliant country that imports 93% of its supply

42. Numbers say it better…
Italy - Current Account Balance
Source: T,C&S & World Fact book

43. Numbers say it better…
Italy - Unemployment Figures
Source: Google Public Data

44. Numbers say it better…
Household savings rate drop 5.7 % points from 1997 to 2007
% increase in unit labour cost in Euros (Q1 2001 to Q3 2009)
Italy: 32%
Germany: 6%
Source- Carnegie Endowment For International Peace
From 1996 to 2004, Total Factor Productivity declined at an
average annual rate of almost 1 %
Source- Carnegie Endowment For International Peace

45. What can/has to be done???
POLICY RECOMMENDATIONS
 Bring down debt-to-GDP ratio by increasing its primary
balance by 4 percent of GDP at least
 Must cut its unit labour costs in order to regain its lost
competitiveness
 Enact critical structural reforms that would include
removing rules that create a dual labour market and
increase the efficiency of backbone services

46. IS THERE LIGHT AT THE END OF THE TUNNEL?
The first step to the solution of protecting the Euro is a political support of all the
governments because its not about saving one country or region. It is about saving the
world from a downward economic spiral.
ECB can soothe markets by buying bonds, but only to a certain point.
If the 17 member states of the single currency area would be able to borrow in bonds
issued by a European debt agency. These would be jointly guaranteed by all euro area
countries and underwritten by the most creditworthy of them i.e. Germany.
Advantages:
1. A common euro bond would create a large new government bond with lot of
liquidity. This would attract a lot of investors particularly China, which is keen to
diversify its dollar holdings.
2. An underlying rationale for Eurobonds is that the public finances of the euro area
as a whole look quite respectable…The IMF envisages that general government
debt will reach 88% of the single currency zone's GDP this year. This is lower than
America's 98% and not much higher than Britain’s 83%. The euro area's projected
budget deficit will be a bit above 4% of GDP, rather better than America's 10% and
Britain's 8.5%