ECONOMIC HEALTH OF GREECE

Group 5

EUROZONE AND THE ENTRY OF GREECE

• Eurozone is an economic and monetary union (EMU) of 17 European Union(EU) member states that have adopted the euro (€) as their common currency.

• Convergence criteria for joining the Euro – Stable prices Stable exchange rate Sound government finances Low interest rates

• Greece was accepted into the Economic and Monetary Union by the European Council on 19th June 2000.

Economic Overview

Greece has a capitalist economy with the public sector accounting for about 40% of GDP and with per capita GDP about two-thirds that of the leading euro-zone economies.

The Greek economy grew by nearly 4.0% per year between 2003 and 2007.

The economy went into recession in 2009 as a result of the world financial crisis, tightening credit conditions, and Athens' failure to address a growing budget deficit.

The economy contracted by 2% in 2009, and 4.8% in 2010.

Why is Greece in Trouble?

Between 2001 and 2008, Greece’s government borrowed heavily from abroad to fund substantial government budget and current account deficits.

Greece’s reported budget deficits averaged 5% per year, compared to a Eurozone average of 2%, and current account deficits averaged 9% per year, compared to a Eurozone average of 1%.

Greece funded these twin deficits by borrowing in international capital markets, leaving it with a chronically high external debt (116% of GDP in 2009).

Why is Greece in Trouble?

Government spending increased by 87% whereas revenues increased by 31%.

Public spending soared and public sector wages practically doubled in the past decade. It has more than 340bn euros of debt - for a country of 11 million people, about 31,000 euros per person.

Whilst money has flowed out of the government's coffers, its income has been hit by widespread tax evasion.

It was given 110bn euros of bailout loans in May 2010 to help it get through the crisis - and then in July 2011

Causes of Greece Crisis

Greece is facing sovereign debt crisis since it accumulated high levels of debt during the decade before the financial crisis when the market was highly liquid.

As the crisis got deepened, there was a liquidity crunch in the world economy thereby making borrowings difficult as well as expensive and thereby improper debt repayments on time.

Reasons High Government Spending and Weak Government

Revenues Structural Policies and Declining International

Competitiveness Increased Access to Capital at Low Interest Rates

GDP of Greece

Greece has a GDP of US$ 310.365 billion (2010 estimate).

GDP growth rate

Country

1999 2000 2002 2003 2004 2005 2006 2007 2008 2009 2010

Greece 3 3.8 3.5 4.7 3.7 3.7 4.2 4 2.9 -2 -4.5

Impact of Oil Prices, Shipping and Tourism

Impact on GDP growth Impact on Consumer Price Inflation Impact on Budget revenues

Inflation based on CPI

Inflation as on November 2011- 2.93%.

Historical Inflation

Larger foreign investments during 60s and 70s

higher growth rates. In mid 70s higher labour costs and oil prices poor GDP growth rate and productivity. After joining EU, intially inflation rose

because of removal of removal of protective barriers and expansionary policies .

However, later it decreased dur to fiscal consolidation, wage restriction and strict Drachma policies .

IS-LM Analysis

Increasing government debt Increase in government spending(G) Increase in aggregate demand and shift of IS curve to the right.

Shift of IS curve to the right Increase in i* and Y*.

Increase in i* Crowding out effect if G is not accompanied by increasing tax rate (t).

Crowding out effect can be reduced if LM curve is relatively flat.

Thus IS-LM analysis shows the flaw in increase in G alone as a way to stimulate the economy.

Further rise in i Increase in 10 yr bond yield spread of Greece .

High bond spread decline in investor confidence in greek economy.

This is because higher i high perceived riskiness by investors demand for higher yields higher borrowing costs for government further fiscal strain on the economy. This forms a vicious circle.

Trade Scenario

Greece reported a current account deficit equivalent to 1097 Million EUR in September of 2011. Greece remains a net importer of industrial and capital goods, foodstuffs and petroleum. The trade with European Union countries ( Germany, Italy, U.K. ) accounts for 65% of Greek trade.

FDI Scenario

Key Features of FDI

Total (gross) inflows of foreign investment capital increased in 2010 by 4.96%.

Net inflows of foreign investment capitals during the same year decreased by 5.82%.

Inflows fell in 2009-10 but were higher than during 2003-05.

In 2010, ratio of FDI in productive categories to that in M&A improved significantly.

Analysis

This inflow in the form of loans reflects the confidence of foreign investors for investment in Greece.

There exists a difference between total and net FDI inflows in 2010 because of repayment of loans to parent companies and expansion capital. This indicates the countries role as an investment springboard.

Reforms and reduction of cost of production due to crisis created investment opportunities.

Debt Management

The debt-GDP ratio – 144% Plans to cut spending further without

imposing new taxes. Salaries and pensions have been slashed. First bailout package of $147 billion in

May 2010 prevented bankruptcy. Second deal of $174 billion in October

2011 forgives about about 50% of greece overall debt.

Austerity measures

Deep cuts in public spending. Raised VAT from 19% to 23%. Increased taxes on fuel, tobacco, liquor

and luxury goods. Structural reforms.

Impact on Greece crisis on world economy

US economy Scenario 1: Mild eurozone recession would lower US GDP growth by .1 to .2 %

point in first half of 2012. Scenario 2: Financial meltdown would lower US GDP growth by 2.05%

points in 2012 and by 2.77% points In 2013 and cause deflation and rise in unemployment figures.

Indian economy Negative impact on foreign trade Loss of revenue and jobs in export

oriented industries. If European contagion leads to global

slowdown it will impact India’s trade with other nation also.

This can translate into lower domestic demand.

Greece default?

CONS Default can expose French and German

banks to huge debt causing credit lockdown. The Eurozone partners would be reluctant to

fund the Greece debt. Further, the contagion effect can spread the

crisis to other peripheral economies. Hence the need to contain it.

Higher prices for imported goods and lower wages are likely to drive people out of the country.

PROS If Greece fails to pay its debt, it would also

impact other Eurozone economies and the whole global economy.

There is additional burden on other Eurozone nations to prevent Greek default.

For Greeks, this would save them from the severe austerity measures.

This would liberate from Eurozone fixed exchange rate allowing it to become more competitive exporter and even more attractive tourist destination.

Proposed Solutions

Fiscal Union across Eurozone. Joint issue of Euro bonds. European stability mechanism. Raise country’s level of savings.

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