Greece announced that the 2011 deficit is projected to be 8.5% of GDP - down from 10.5% in 2010. This figure is still short of the 7.6% of GDP target set by the EU and IMF. Debt levels currently stand at 180% of GDP.
Once Greece dropped its drachma currency in favour of the Euro in 2002, the government borrowed heavily and went on something of a spending spree, including funding very costly projects such as the 2004 Athens Olympics. Government spending mounted and public sector wages practically doubled. In October 2009, hope was placed on the newly elected government under Prime Minister George Papandreou to efficiently handle the financial crisis of the state. However, this seemed to be an implausible expectation.
Eurozone states united: How did/do they help?
Although Athens issues bonds in euros, the price of Greek bonds has become higher than for other eurozone countries, reflecting a real concern about the possibility of a default. After months of bargaining and delays, eurozone countries have finally agreed on a multi-billion bailout aid to Greece to help fund its crippling debt. Also, the European Commission and the European Central Bank (ECB) have been in Athens reviewing the deficit reduction scheme.
The bailout package summed up to a prodigious €110 billion ($ 145 billion) which will be funded by two bodies; 30 billion of which will be provided by loans from the International Monetary Fund (IMF) and the remainder to be paid out by the EU states over the next 3 years (till 2014). ). Eurozone leaders have recently agreed on a further €109 billion package and a 50% write-off of its debts to be handed over to Greece.
Why EU states were/are so concerned?
The primary motive of the bailout measures is to fuel the Greek economy, stabilise the financial markets and prevent a contamination of such a financial malaise to other debt-laden Eurozone states. EU financial markets are still quivering and questions are now posed on the attractiveness of EU investment. The spiralling Greek debt is threatening the economic stability of the entire Euro currency.
The hope for Greece is that the injection of emergency funding into the economy should close the debt gap so much so that Greece may have access to commercial finance (ability to borrow commercially). The same is expected of Portugal, Northern Ireland, Spain and Italy.
The bailout packages - Why Greece was in dire need
In February 2010, EU leaders pledged to take harmonised procedures to secure the stability of the Euro currency by preventing a Greek default on the agreed financial aid. Until March 2010, EU finance ministers did not reach an agreement on the main outline of an emergency aid. Many EU countries such as Italy, Portugal and Spain are experiencing rises in borrowing costs thus higher economy pressure.
Greece received its original bailout in May 2010 because the cost of borrowing commercially outgrew the benefits. The outstanding debt was enormous so much so that it couldn't afford to borrow from financial markets. As expected, issuing government bonds was not an option either because of the poor credit rating and high indebtedness. The rating agency S&P recently mentioned that Greece was the least credible country it monitors. The initial idea by the EU and IMF was to set some time out for Greece to sort out its economy so that the cost of borrowing commercially would fall. Apparently the timing fell short of expectations as Greece issued a statement requesting further aid on April 23 2011 which was approved by EU leaders. Eurozone leaders warned that the further €109 billion to be granted to Greece was not up for renegotiation.
What were/are the terms and conditions of the aid package?
Athens will
receive €110 billion euros ($146 billion) in the form of unsecured loans over
the next three years; 30 billion of which was handed out in 2010. Athens is set to make an
€8.5 billion debt repayment to its major creditors. Eurozone states and the IMF
will effectively cover the credit requirements leaving Greece with an annual interest rate
of 5% per year which is far lower
than the market base rate. Greece
has been given until 2014(the end of the duration of the bailout package) to
reduce its deficit to under 3% of GDP. Once this happens, Greece would meet the criteria of
the EU stability contract. To prevent defaults, the IMF has been tasked to
ensure that Greece
meets the quarterly targets set in the bailout plan
How does Greece manage the package? What austerity measures are set?
Greek Prime Minister George Papandreou announced two sets of austerity measures namely; an increment in the legal retirement age by two years, public sector pay freezes, a restraint on tax evasion and some 30000 civil servants being suspended. Retirement pensions have fallen by 14% and government spending is set to be cut by €1 billion before early 2012. A hike in VAT rates from 21% to 23% followed by tax rises on tobacco, fuel, alcohol and property fall on the list of measures set up by the Greek government.
The measures are also extended to private sector where there are job cuts after the announcement permitting private firms from laying off more than 2% of staff in a month. It is feared that yearly bonuses will be cancelled in the private sector as a result. These measures sound harsh but they are a ‘take it or leave it' plan to revamp the damaged economy.
Government Referendum
In a bid to cut down on the public and internal cabinet rioting, Greek PM George Papandreou shocked the whole world by proposing a referendum on the bailout package and on whether Greece is better off staying in the Eurozone or not. This referendum, if it happens would be scheduled for December 4 and will be the first in Greece since the country voted against the monarchy in 1974. Many of Mr. Papandreou's MP's, including Finance Minister Evangelos Venizelos (whom he appointed in June) have failed to back the referendum plan. Eurozone leaders and the IMF now threaten Greece to drop the plan or risk not receiving the second bailout package. The Greek PM is facing calls from senior members of his Pasok party to resign which is prompting the New Democracy opposition party to call for a caretaker government to handle the crisis. 151 parliamentary seats are needed for an agreement to be made on the referendum. If a referendum is held and rejects the bailout package, it could mean instant bankruptcy for Greece. However, the Greek PM dropped the referendum plans and agreed to stand down as PM with elections rumoured to be scheduled for February 2012. An interim coalition government is to be chosen.
What could happen if Greece defaulted?
Europe's major banks are major holders of Greek debt, with say $50-60 billion of outstanding debt. A default by Greece leaves the banks in a crisis where they have to reschedule repayments to a much later date, possibly in decades. This would mean even higher interest rates which may not be repaid at all.
Greek default could affect the national banks by exposing them to independent debts of the economy. Retail banks cease to have access to funds from the central bank (Bank of Greece) which causes massive holes in the coffers of such banks. However, Greek banks would need emergency capital and some face being nationalised to the damaged economy. Individuals like you and I would withdraw monies from such banks and save elsewhere making the problem even worse.
On a macro level, a default might cause a repeat of the credit crunch that hit the EU and the US into recession. The lack of credibility could prevent foreign banks from lending.
What could a default mean to the Eurozone?
Most certainly, Greece could be axed out of the Eurozone and will still have to repay all of its bills. As an economic union, the EU would be highly affected. Bailout packages were also handed to Portugal and Northern Ireland earlier on in the year and they would automatically face the consequences of the Greek betrayal - If Greece can default why not them. France (56.7%), Germany (33.9) and the UK (14.6%) would be directly affected as they as the most exposed to the burden of the Greek debt. The political and economic structures that have bound the 17-nation bloc together could begin to unravel.
Sema Fongod from Touch Financial [1], the Factoring [2] specialists.