EuroZone Crisis

EUROZONE CRISIS

SHUBHAM, SUMAN, TANYA, VANSHIKA, VIKRANT

Agenda• What is Euro-Zone Crisis?

• Reasons behind Euro-Zone Crisis

• Short-term remedies

• Long-term proposals

• Impact on/of other Economies

• Case Studies

WHAT IS EURO-ZONE CRISIS ?

What is Euro-zone ?Countries having their official currency as EURO.

http://en.wikipedia.org/wiki/File:En-us-Eurozone.ogg

The eurozone officially called the euro area is a monetary union of 19 European Union (EU) member states that have adopted the euro (€) as their common currency and sole legal tender.

The eurozone consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

Other EU states (except for Denmark and the United Kingdom) are obliged to join once they meet the criteria to do so. No state has left, and there are no provisions to do so or to be expelled. Andorra, Monaco, San Marino, and Vatican City have formal agreements with the EU to use the euro as their official currency and issue their own coins

Other states, like Kosovo and Montenegro, have adopted the euro unilaterally but these countries do not officially form part of the eurozone and do not have representation in the ECB or the Eurogroup.

Monetary policy of the zone is the responsibility of the European Central Bank (ECB) which is governed by a president and a board of the heads of national central banks. The principal task of the ECB is to keep inflation under control.

Though there is no common representation, governance or fiscal policy for the currency union, some co-operation does take place through the Eurogroup, which makes political decisions regarding the eurozone and the euro.

The Eurogroup is composed of the finance ministers of eurozone states, but in emergencies, national leaders also form the Eurogroup.

To Execute this , the prospective members nations were to sign “Maastricht treaty” which would lead to formation of a single currency Euro and contained the convergence criteria for the nations.

MAASTRICHT TREATY

The treaty was signed on February 1992 in Maastricht , Netherlands which lead to formation of Euro by the members of European Community.

THE MAASTRICHT CRITERIA:

1. Inflation Rates

2. Government Finance :

- Debt

- Deficit

3.Exchange Rate

4. Long term interest rates.

A Brief History : Why EUROZONE was formed ?

But one main obstacle was the different currencies , therefore the member nations discontinued their own currency and gave rise to the uniform currency “EURO” and lead to the formation of Eurozone in 1999.

They also discontinued their monetary policy giving rise to European Central Bank but had separate fiscal policies.

This was one of the main reasons for the crisis since they failed to realise the need for fiscal integration along with the monetary.

THE CRISIS

Euozone crisis , also known as European debt crisis is the failure of Euro , the currency that ties together 19 European nations in an intimate but flawed manner.

PIIGS-(Portugal , Ireland , Italy , Greece , Spain) economies has teetered down on the brink of financial collapse threating the bring down the entire European Economy and the rest of the world.

The European debt crisis (often also referred to as the Eurozone crisis or the European sovereign debt crisis) is an ongoing multi-year long debt crisis taking place in a handful of Eurozone member states since the end of 2009. These states were unable to repay or refinance their government debt or to bail-out over-indebted banks under their national supervision without the assistance of third parties like the ECB, or the IMF.

The European debt crisis erupted in the wake of the Great Recession around late 2009, and was characterized by an environment of overly high government structural deficits and accelerating debt levels. The states getting adversely hit by the crisis, faced a strong rise of interest rate spreads for government bonds, as a result of investor concerns about their future debt sustainability, to the extent that four eurozone states needed to be rescued by sovereign bailout programs, delivered jointly by the International Monetary Fund and European Commission - with additional support at the technical level by theEuropean Central Bank. Together these three international organisations representing the bailout creditors, became nicknamed "the Troika".

CRISIS!!

Agenda

• What is Euro-Zone Crisis?


• Remedies: Short-term and Long-term


• Case Studies

MONETARY POLICY VS. FISCAL POLICY

The countries which signed the Maastricht treaty had common monetary policies, set by the EUROPEAN CENTRAL BANK.

Due to united monetary policy the amount countries like Greece could borrow skyrocketed – at cheaper interest rates.

Each country in the Euro zone followed their own fiscal policy.

INCREASE ACCESS TO LOAN for smaller countries - Deficit spending increased.

GERMANY’S CREDIT CARD

Lenders believed that if Greece was unable to repay the loans, Germany and other big economies would step in as they were now bound by a common currency.

Governments of PIIGS accumulated huge debts, however they were able to repay these debts with more borrowed money.

As a result- With the new abundance of cheap credit Greece and other such weak countries were able to increase spending to previously impossible levels.

POLITICAL REASONS Some countries embarked on huge deficit programs primarily for politicians to get elected.

They made promises as to more jobs and generous pension from the new money they could borrow.

POLITICAL REASONS The government of Greece, Portugal and Italy accumulated huge debts however they were able to repay these debts from new borrowed money.

As long as the borrowing continued so did the spending and the UNBALANCED FISCAL POLICY.

Credit flowed debt accumulated and the economy of Europe became tightly intertwined.

Companies started building offices and factories across Europe.

German Bank lending to French companies- French banks lending to Spanish companies…

This made doing business across the countries very convenient.

COLLAPSE OF THE US HOUSING MARKET

Things continued this way as long as the credit was available until- 2008.

Spurred by the collapse of the US housing market a credit crisis swept the Globe bringing borrowing to a hault everywhere.

Suddenly, the Greek economy couldn’t function. It couldn’t borrow money to pay for all the new jobs and benefits created.

It couldn’t borrow the new money and needed to pay its old debts.

This was a problem of Greece but because of the unified monetary policy it was also a problem of all Europe.

Germany Since the countries who ran up the bill couldn’t repay everyone looked to Germany.

As the biggest and the strongest economy in Europe Germany reluctantly agreed to help bail out the debtor countries but only if the debtor countries agreed to strict austerity measures to ensure that it would never happen again.

THIS MEANT- going away with the extra benefits and jobs promised to the citizens.

But the government collects taxes based on people’s earnings.So if earnings reduced so did the taxes, the government could still not pay the debts

EXTREME CULTURAL DIFFERENCES

Germany is very financially responsible, extremely risk inflation averse and incredibly careful about spending and borrowing.

Unlike Greeks who enjoy generous state benefits and don’t pay taxes

Greek- has never collected the majority of the taxes imposed on the citizens and it has always been this way.

Joining the EURO just amplified it.

INTERTWINED ECONOMY

Debtor countries borrow from bank, investors and other government throughout Europe.

As the debtor country gets closer to default everyone who lends them money becomes weaker

And everyone who lends them money also becomes weaker and so on and so forth…

As the debtor countries headed towards default the whole continent of Europe was in danger.

Even though the economies of the debtor countries are relatively small they pose huge threat because of the European financial system is so interconnected precisely because of the Euro.

THE PROBLEM is one country could reverberate throughout the continent configuring a chain reaction of default.






• Case Studies

Economic reforms and recovery proposals

Address current account imbalances :–

Case-1 Country with Trade Surplus-This currency appreciation occurs as the importing country sells its currency to buy the exporting country's currency used to purchase the goods. Alternatively, trade imbalances can be reduced if a country encouraged domestic saving by restricting or penalizing the flow of capital across borders, or by raising interest rates, although this benefit is likely offset by slowing down the economy and increasing government interest payments.

Case-2 Country with Trade Deficit - The only solution left to raise a country's level of saving is to reduce budget deficits and to change consumption and savings habits. For example, if a country's citizens saved more instead of consuming imports, this would reduce its trade deficit.

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Economic reforms and recovery proposals

Progress - European heads of state had given the green light to pilot projects worth billions.

Provide guarantees that safeguard private investors and Historic decrease in Bank Charges

"Many of those countries most in need to adjust are now making the greatest progress towards restoring their fiscal balance and external competitiveness"

Increase competitiveness- Crisis countries must significantly increase their international competitiveness to generate economic growth and improve their terms of trade. Indian-American journalist notes in November 2011 that no debt restructuring will work without growth.

Facing problem on 3 fronts-Demography, Technology and Globalization

Internal devaluation - Where a country aims to reduce its unit labor costs

Fiscal devaluation - Shifting Corporate burdens on Consmers

Austerity Measures:






• Case Studies

Long-term Proposals to deal with the Eurozone Crises

European fiscal union: creation of a fiscal union to match its monetary union, fiscal union must have authority to set fiscal policy in every euro country.

Eurobonds: bonds issued jointly by the 17 euro nations would be an effective way to tackle the financial crisis. Also, any such plan

would have to be matched by tight fiscal surveillance and economic policy coordination to ensure sustainable public finances

European bank recovery and resolution authority: to avoid banking failure. Powers over bank management. Each institution would also be obliged to set aside at least one per cent of the deposits covered by their national guarantees for a special fund to

finance the resolution of banking crisis

Gexit


European Monetary Fund: creation of European Monetary Fund, which could provide governments with fixed interest rate (non- tradable) Eurobonds at a slightly lower rate compared to other financial institutions.

Debt write-off based on international agreement: In 1953, private sector lenders as well as governments agreed to write off about half of West Germany’s outstanding debt, eventually leading to the beginning of Germany's “economic miracle”. West Germany only had to make repayments when it was running a trade surplus.

Drastic debt write-off financed by wealth tax: most economies would need 20 consecutive years of surpluses exceeding 2 per cent of gross domestic product just to bring the debt-to-GDP ratio back to its pre-crisis level.

To reach sustainable levels the Eurozone must reduce its overall debt level, financed by a one-time wealth tax of between 11 and 30% for most countries, apart from the crisis countries.







• Case Studies

Impact on South AsiaThe euro area has traditionally been an important economic partner for South Asia. Between 2011 and 2012, share of SAARC’s export to euro area has contracted significantly.

Another way in which euro area crisis has impacted the South Asian economies is through the finance channel. European banks have been an important source of credit to South Asia.

Impact on Indian EconomyIndia was reeling under the American Subprime Crisis in 2008. Then it was hit by Eurozone Crisis in 2009.

Falls in exports

Fall in FDI from Europe.

Deficit in balance of payments

Decline in capital inflows thus affecting stock market speculations.

Fall in the economic growth rate

Impact in NumbersIndia’s economy is currently facing inflationary pressures, trade deficits and public debt. These internal weaknesses, together with an adverse international environment, have prompted the IMF to revise India’s growth prospects downwards in 2013 to around 4.9% and 6% respectively.

The EU countries have a share of 18.6 percent in India’s exports and it is the second largest destination for our exports. The Euro area’s instability has been negatively reflected in India’s exports. India’s total exports has declined from 20.2 percent in 2009-10 to 18.6 percent in 201011.

The impact is negatively felt in textile and apparel exports as both Europe and US are major importers. Europe accounts for nearly 50 per cent of India's total apparel exports and hence it is no surprise that its debt crisis has adversely hit apparel exports from India.

The Euro crisis has also affected India’s stock market. Due to crisis in USA in 2008-09 foreign institutional investors (FIIs) had pulled out money from India for most part of the year because the many of these investors were facing difficulties in their home markets. The reduced savings and lack of confidence among investors has resulted in lower investment flows.

Steps taken by India Oil and gold are the two major items of our imports. With regard to oil, the domestic pricing has increasingly been made market determined. It is expected that this will help economizing the domestic oil consumption. Recently import duty on gold has been raised and bank finance against pledge of gold has been restricted.

India has also introduced inflation indexed bonds which should help contain gold demand to the extent these bonds are used as an investment hedge against inflation.

The policy measures taken to encourage capital inflows include liberalisation of the interest rates on non-resident deposits and external commercial borrowings,

Rationalisation of norms related to foreign institutional investment (FII) in infrastructure debt and allowing foreign direct investment (FDI) in multi-brand retail.

The sectoral limit for FII investment in government securities and corporate bonds has been hiked.






• Case Studies

Economic Calculus of Euro Optimal currency area

EU a logical step

1. Many currency bothersome and costly

2. The associated risk impedes the flow of goods and capital across borders

3. Currency unification produces substantial benefits, in particular by encouraging trade and financial integration

If EU what do economies loose

1. Flexible exchange rate allows governments to adjust policy to changes in economic conditions

2.Compromise on exchange rate or shock absorber

Example:-CASE-! FLEXIBLE EXCHANGE RATE

If demand for American cars decreases, a weakening of the dollar, which makes American cars cheaper for foreigners, can help offset the negative impact on the economy. Fixing one’s exchange rate to a certain value or, at the extreme, giving up one’s currency, eliminates that shock absorber.

Assumption-Trade Currency is same

CASE-!! RANGE OF EXCHANGE RATE

If demand for Wisconsin cars fell, the Wisconsin dollar could lose value so that some of that demand could be made up by selling the cheese at a lower price (in U.S. dollars). But those sales would incur the cost of converting currency for each transaction, and indeed for every cross-border transaction, including those for banking and finance, as well as other goods and services.

Assumption- Trade Currency Different

Wisconsin- U.S. a case

Reasons for Survival of Wisconsin :-

1. The first is that Wisconsin is part of a “fiscal union” that the federal government manages. Members of the U.S. fiscal union share the risks.

2. The second reason that monetary union works well for Wisconsin is that labor mobility is fairly high in the United States

3. A long-established U.S. policy is that the federal government will not “bail out” states that run into financial difficulties

Thank You!

Economy & Finance

EuroZone Crisis