WHAT IS GREECE DEBT CRISIS?
Greece is in a sovereign debt crisis. It is unable to repay debt owed to other countries. Greece has been in crisis since the year 2009 and now its debt is over 170% of GDP.
WHAT IS THE ROOT CAUSE OF THE CRISIS?
The root cause of the crisis can be traced back to the creation of Eurozone in the year 1999. The Eurozone is a group of 17 European countries (inc. Greece) that had agreed to adopt a common currency Euro.
To be a part of euro-zone, a country has to maintain its fiscal deficit within 3% of GDP. (Fiscal deficit is excess of Government expenditure over its revenues). But, Greece has always been a fiscally irresponsible country. It was spending far beyond its means even before 1999. To get entry into the euro-zone, it manipulated its accounts books to show that its deficit is in control.
Entry into the euro-zone further exacerbated the situation. Greece became more indisciplined as it could now borrow at cheaper rates. Creditors believed that if anything were to go wrong, other European countries like Germany would step in to repay the debts.
Greece went on an expenditure spree. It had uncollected tax receipts of 89.5% while it gave away huge sums of money as salaries and pensions.
Till 2008, Greece always managed to repay its debt as it had high GDP growth rate. Also, it could take new loans to refinance its debt without any difficulty. (Refinancing is taking new loans to repay existing ones.)
But, after the financial crisis of 2008, liquidity dried up. Greece could no longer borrow at cheaper interest rates to refinance its debt. The GDP growth rate of the country also slowed down.
The situation became grave. In the year 2009, Greece had to confess that it had always underreported its deficit and its debt was well above the limit of 3% imposed by the Eurozone (it was 12.9% of GDP in 2009).
Greece was on the verge of bankruptcy. Its spill-over effect would have been felt on other European countries (mainly France and Germany) that had given loans to it. Therefore, Eurozone and IMF had to step in.
What did the other euro members do to contain the crisis?
The troika extended two bailouts funds totalling 240 billion euros to Greece. It was given in tranches/ instalments over a five year period from 2010 to 2014. [Troika comprises of IMF, European Central Bank (ECB) and European Commission (EC).]
In exchange of the bailout funds, austerity conditions were imposed on Greece. It had to overhaul its economy by increasing taxes and reducing expenditure.
But, Why IS THE CRISIS STILL IN NEWS?
Because Greece’s economy never recovered. Most of the bail-out funds went towards paying interests to the creditors and Greece could not reduce its debt burden. Its situation worsened. It went further into recession with the unemployment rate around 25% and debt to GDP ratio of more than 170%.
On 30th June 2015, Greece became the first developed country to default on loan repayment to IMF.
To save Greece from bankruptcy, on 13th July 2015, the troika agreed to extend a third bail-out package of 86 billion euros. It will be given over 3 years and strict austerity conditions have been imposed on Greece.
What Are the conditions imposed on Greece by the Troika?
Basically, Greece has to take steps to increase revenues and reduce expenditure.
- Rationalise and increase its Value-added tax (VAT).
- Raise the corporate tax rate.
- Reduce rampant tax evasion in the country to increase its tax receipts
- Privatise state-owned businesses
- Cut its pension expenditure
LASTLY, Would the situation be any different if Greece were not a part of Eurozone?
If Greece were not a part of Euro and were still using its old currency Drachma, it could have devalued its currency to encourage investment in the economy (as investment becomes cheaper for foreign investors) and convert its debt into cheaper Drachma. However, devaluation is not necessarily the solution as it could have led to inflation because of more expensive imports. [You can read more about inflation here.]
The biggest drawback of the eurozone is that it has a unified monetary policy but different fiscal policies. It allowed Greece to be fiscally irresponsible.
To summarise, Greece has been in crisis since the year 2009. Though, the immediate cause of the crisis was the financial recession of 2008, the seeds were sown back in 1999 when a fiscally irresponsible country like Greece was admitted into Eurozone.
Recently, Greece was extended a bailout fund in July 2015 and more austerity measures were imposed on it, to help it strengthen its economy.
You can also check out our articles on the financial crisis of 2008: