– V.Srinivas IAS  –

The year 2010, the European crisis unfolded. The euro area economy was in a terrible mess. The euro currency area had become too large and diverse – with the anti-inflation mandate of the European Central Bank too restrictive. There were no fiscal mechanisms to transfer resources across regions.  A group of European Emerging Market Countries required financial support in 2008-09. The group included Georgia, Hungary, Iceland, Latvia, Ukraine, Armenia, Bosnia and Herzegovina, Romania and Serbia. The euro area crisis countries of Greece (2010, 2012), Ireland (2010), Portugal (2011) and Cyprus (2013) faced problems of problems of public and private balance sheet vulnerabilities with large current account imbalances within the Euro Area.

In Greece, the homeless lined up at soup kitchens, pensioners committed suicide, the sick could not get prescription medicines, shops were shuttered and scavengers picked through dustbins – conditions almost reminiscent of the post war Europe. Every person under 25 was unemployed. Greece economy was teetering due to heavy public debt and loss of market access. High fiscal deficits and dependency on foreign borrowing fuelled demand. Entry to Euro Area had enabled Greece to access low cost credit, boost domestic demand with an average growth rate of 4 percent. Greece also ran pro-cyclical fiscal policies with tax cuts, increasing spending on wages and ran fiscal deficits of 7 percent for the period 2000-2008. Health care and pension costs were very high at 4.5 percent and 12.5 percent of GDP respectively. Further, Greece had a poor business environment, high inflation well above the Eurozone average and low productivity. The governance systems were poor, hardly any inward FDI and public sector was highly inefficient.

The Greece authorities made feeble attempts initially to address vulnerabilities like reducing the fiscal deficit. The efforts were not convincing and concerns about fiscal sustainability deepened with a further weakening of the market sentiment. Foreign funding dried up and there was a loss of confidence in the banking system. There were sovereign downgrades by rating agencies, sharp increases in non-performing loans, and decline in viability of banks. Greece was misreporting its fiscal data for access to foreign borrowing. The fiscal deficit was 2008 was revised from 5 percent of GDP to 7.7 percent of GDP and the fiscal deficit for 2008 was revised from 3.7 percent of GDP to 13.6 percent of GDP. The 2009 public debt data was revised from 99.6 percent of GDP to 115.1 percent of GDP. Greece needed a strong and sustained adjustment program to lower fiscal deficits, to decline its debt ratio and improve its competitiveness. The IMF stand-by arrangement in 2010 for Greece was Euro 28 billion and bilateral program assistance was provided by Greece’s 15 partner Eurozone countries, in ratio of their shares in the European Central Bank capital. Greece required an additional program with the IMF in 2012 amounting Euro 30 billion. The Greece program aimed at restoring confidence and fiscal sustainability to regain market access, restore competitiveness and safeguard financial sector stability.

The unprecedented crisis in the Euro Area also affected Ireland and Portugal. In Ireland the global crisis had major repercussions on the Irish Banking sector. This was coupled with the bursting of the real market bubble resulting in a 41 percent collapse of investment and a severe economic downturn, resulting in rising bank losses and growing difficulties for banks to secure wholesale financing. The lack of market funding access and large outflows of wholesale deposits by corporates, banks increasingly relied on Central Bank funding to replace maturing liabilities. Ireland’s exposure was Euro 90 billion through European Central Bank and at Euro 150 billion through the Central Bank of Ireland. The initial crisis response from the Irish authorities was insufficient to stabilize the economy and Ireland required an IMF program of Euro 22.5 billion.

Against the backdrop of crisis in Greece and Ireland and fear of euro area contagion, Portugal also faced a sudden drop in financing in 2011. Portugal had the lowest per capita income of founding member countries when it joined the euro area. Easy financing with euro accession sparked a spending boom and build-up of debt. Portugal failed to adhere to the fiscal rules of EU’s stability and growth pact. By 2010, when financing began to dry up, Portugal had twin deficits – current account and fiscal, of 10 percent of GDP, and public and private debt, which were amongst the highest in the euro area. Portugal required an IMF financing program of Euro 26 billion.

The crisis in the Euro Area was unprecedented, coming against the backdrop of global financial crisis, the risks of contagion were very high. The key challenges included abrupt loss of market access, need for orderly adjustments in countries with deep imbalances and no recourse to exchange rate policies, and absence of euro area firewalls. The stabilization programs were successful in giving time to build firewalls, preventing the crisis from spreading and restoring growth and market access. That the Euro Area remains together represents a collective success story for the IMF, the International Partners and the Program Countries.

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About the author

V.Srinivas IAS

Senior Bureaucrats and Author

V.Srinivas is an IAS officer of 1989 batch, presently posted as Chairman Board of Revenue for Rajasthan

He had previously served in the Ministry of Finance and as Advisor to Executive Director (India) IMF, Washington DC. Also worked as Planning and Finance Secretary of Rajasthan.

Disclaimer : The views expressed by the author in this feature are entirely his  own and do not necessarily reflect the views of INVC NEWS.


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