European sovereign debt crisis

1. EUROPEAN SOVEREIGN-DEBT
CRISIS

2. INTRODUCTION
• From late 2009, fears of a sovereign debt
crisis developed among investors as a result of
the rising private and government debt levels
around the world together with a wave of
downgrading of government debt in
some European states.
• Three countries significantly
affected, Greece, Ireland and Portugal,
collectively accounted for 6% of the eurozone's
gross domestic product (GDP).

3. •In June 2012, also Spain became a matter of
concern, when rising interest rates began to
affect its ability to access capital markets,
leading to a bailout of its banks and other
measures.
•The crisis has had a major impact on EU
politics, leading to power shifts in several
European countries, most notably in Greece,
Ireland, Italy, Portugal, Spain, and France.

5. CAUSES
Rising
household
and
government
debt levels
Trade
imbalances
Structural
problem of
Eurozone
system
Monetary
policy
inflexibility
Loss of
confidence

6. Rising household and government
debt levels
• A number of economists have dismissed the
popular belief that the debt crisis was
caused by excessive social welfare spending.
• According to their analysis, increased debt
levels were mostly due to the large bailout
packages provided to the financial sector
during the late-2000s financial crisis.

7. • The average fiscal deficit in the euro area in 2007
was only 0.6% before it grew to 7% during the
financial crisis.
• The International Monetary Fund (IMF) reported
in April 2012 that in advanced economies,the
ratio of household debt to income rose by an
average of 39 percentage points, to 138 percent
in Denmark, Iceland, Ireland, the Netherlands.

8. • In the same period, the average government
debt rose from 66% to 84% of GDP.
• By the end of 2011, real house prices had fallen
from their peak by about 41% in Ireland, 29% in
Iceland, 23% in Spain and the United States,
and 21% in Denmark.

10. TRADE IMBALANCES
• A trade deficit can also be affected by changes
in relative labor costs, which made southern
nations less competitive and increased trade
imbalances.
• Since 2001, Italy's unit labor costs rose 32%
relative to Germany's.
• Greek unit labor costs rose much faster than
Germany's during the last decade.

12. STRUCTURAL PROBLEM OF
EUROZONE SYSTEM
• There is a structural contradiction within the
euro system, namely that there is a monetary
union without a fiscal union (e.g., common
taxation, pension, and treasury functions).
• In the Eurozone system, the countries are
required to follow a similar fiscal path, but they
do not have common treasury to enforce it.

13. • That is, countries with the same monetary
system have freedom in fiscal policies in
taxation and expenditure.
• Eurozone, having 17 nations as its members,
require unanimous agreement for a decision
making process.

14. • This would lead to failure in complete
prevention of contagion of other areas, as it
would be hard for the Euro zone to respond
quickly to the problem.
• That is, countries with the same monetary
system have freedom in fiscal policies in
taxation and expenditure

15. MONETARY POLICY INFLEXIBILITY
• Eurozone establishes a single monetary policy,
individual member states can no longer act
independently, preventing them from printing
money in order to pay creditors and ease their
risk of default.
• By "printing money", a country's currency
is devalued relative to its (eurozone) trading
partners, making its exports cheaper,increased
GDP and higher tax revenues in nominal terms.

16. LOSS OF CONFIDENCE
• The loss of confidence is marked by rising
sovereign CDS (credit-default swaps) prices,
indicating market expectations about
countries creditworthiness.
• Since countries that use the euro as their
currency have fewer monetary policy choices
certain solutions require multi-national
cooperation.

18. IRELAND
• The Irish sovereign debt crisis was not based on
government over-spending, but from the state
guaranteeing the six main Irish-based banks who
had financed a property bubble.
• Irish banks had lost an estimated 100 billion
euros, much of it related to defaulted loans to
property developers and homeowners made in
the midst of the property bubble, which burst
around 2007.

19. • Unemployment rose from 4% in 2006 to
14% by 2010, while the national budget
went from a surplus in 2007 to a deficit of
32% GDP in 2010, the highest in the history
of the eurozone, despite austerity
measures.

21. PORTUGAL
• Portugal requested a €78 billion IMF-EU bailout
package in a bid to stabilise its public finances.
• These measures were put in place as a direct
result of decades-long governmental
overspending and an over bureaucratised civil
service.
• On 16 May 2011, the eurozone leaders officially
approved a €78 billion bailout package for
Portugal, which became the third eurozone
country, after Ireland and Greece, to receive
emergency funds.

22. • The average interest rate on the bailout loan is
expected to be 5.1 percent. As part of the deal,
the country agreed to cut its budget deficit
from 9.8 percent of GDP in 2010 to 5.9 percent
in 2011, 4.5 percent in 2012.

23. Proposed
long-term
solution
European
fiscal union
Eurobonds
European
Monetary
Fund
Drastic debt
write-off
financed by
wealth tax
Debt defaults
and national
exits from the
Eurozone

24. EUROPEAN FISCAL UNION
• Increased European integration giving a
central body increased control over the
budgets of member states.
• Control, including requirements that taxes be
raised or budgets cut, would be exercised
only when fiscal imbalances developed.

25. EUROBONDS
• A growing number of investors and economists
say Eurobonds would be the best way of
solving a debt crisis though their introduction
matched by tight financial and budgetary
coordination may well require changes in EU
treaties.
• On 21 November 2011, the European
Commission suggested that Eurobonds issued
jointly by the 17 euro nations would be an
effective way to tackle the financial crisis.

26. EUROPEAN MONETARY FUND
• On 20 october 2011, the austrian institute of
economic research published an article that
suggests transforming the efsf into
a european monetary fund (emf), which
could provide governments with fixed
interest rate eurobonds at a rate slightly
below medium-term economic growth
• These bonds would not be tradable but could
be held by investors with the EMF and
liquidated at any time.

27. DRASTIC DEBT WRITE-OFF
FINANCED BY WEALTH TAX
• To reach sustainable levels the eurozone must
reduce its overall debt level by €6.1 trillion.
• According to BCG this could be financed by a
one-time wealth tax of between 11 and 30
percent for most countries, apart from the
crisis countries (particularly Ireland) where a
write-off would have to be substantially
higher.

29. DEBT DEFAULTS AND NATIONAL
EXITS FROM THE EUROZONE
• In mid May 2012 the financial crisis in
Greece and the impossibility of forming a new
government after elections led to strong
speculation that Greece would have to leave the
Eurozone shortly.
• This phenomenon had already become known as
"Grexit" and started to govern international
market behaviour.