POST 8: 
EURO CRISIS

The entire global attention is currently focused towards the ongoing crisis in the Euro zone. The present article seeks to simplify and logically explain the crisis which has engulfed PIIGS.

Q1) What does the term PIIGS stand for?

Ans. PIIGS stands for Portugal, Ireland, Italy, Greece and Spain. The current Euro crisis started in Greece and has now finally spread to Italy. In fact, there is a worry that ultimately it will slowly engulf the entire Euro zone and that there will be sovereign defaults.

Q2) What is a sovereign default?

Ans. Sovereign default occurs when a country defaults on the loans it has taken and is unable to repay them as per the originally decided terms. Sovereign default is considered catastrophic as the lenders normally have to make huge sacrifices.

Q3) How did the crisis originate in Greece?

Ans. Greece had a very liberal social security program for its citizens. Govt aided healthcare, education, pensions etc. which were heavily subsidised as the Greek Govt was bearing the major part of the expenditure. The Greek Govt went on a borrowing spree to finance its expenditure leading to the current debt position which looks unsustainable. It is feared that there will soon be a contagion effect.

Q4) What is the contagion effect?

Ans. Contagion is derived from the word “contagious” which means to spread. The worry is that this alarming situation would spread to soon other Euro regions leading to many sovereign defaults. Already pain is being felt in Italy and Spain as of late their borrowing costs have substantially increased.

Q5) Why is any crisis by Italy and Spain particularly worrying?

Ans. Any crisis in Italy and Spain is expected to have serious global effects as they are comparatively bigger economies. Also any defaults by Italy & Spain would have disastrous effects as a large number of French, German, British banks & investors have lent money to them. There is worry that finally there would be defaults in the bigger economies. Actually the current predicament is due to the basic problem in the structure of the Euro zone.

Q6) What is the basic problem in the Euro zone structure?

Ans. The Euro zone has a single monetary policy by which the interest rates are same for the region. However each individual country decides their fiscal policy. In short the problem of the Euro zone is a common monetary policy but different fiscal policies. This fundamentally flawed structure worked during the good economic times. But this arrangement has now come under stress due to the response of the lenders in the current weak economic conditions.

Q 7) What is the response of lenders in weak global conditions?

Ans. It is said that funds becomes scarce when they are needed the most. Often lenders refuse to lend in times of crisis when the threat of default looms. In any case during such times the lenders always increase the interest rate charged on loans, due to the higher risk perceived. In the current case of Greece, Portugal and Ireland, their borrowing costs have increased substantially in the last seven months. Of late this worrying increasing trend is visible in case of the borrowing rates of Italy and Spain also. This increasingly alarming situation has led to many analysts fearing the worst.

Q8) What is the worst case scenario?

Ans. Currently one can identify three types of regions within the Euro zone. Germany has been least affected. Countries like Italy and France however are experiencing a slowdown i.e. they are growing but at a slower rate than normal. However countries such as Greece , Portugal etc are facing recessionary conditions i.e. negative economic growth. Thus the whole Euro zone is witnessing differential growth rates causing strain. In a worst case scenario, this severe strain would cause Euro in its current form to eventually break down. However there are high costs of this breakdown as it will have some serious economic ramifications globally and especially for the countries in the Euro zone. Many analysts hope that all Euro countries will make unitedly make serious efforts to retrieve the situation.

Q9) How can the situation be retrieved?

Ans. It is felt that the stronger countries in the Euro zone would completely bail out the weaker ones. The European Union has already come with a safety net where the stronger countries like Germany would contribute to bail out the weaker countries. Also these countries are expected to tap the lender of last resort, the International Monetary Fund (IMF). However though this arrangement looks good on paper it is easier said than done. The tax payer citizens of the stronger economies (particularly Germany) are not particularly happy to see their money being used to bail out the weaker economies. Unfortunately even the citizens of the weaker economies are also not currently comfortable with this arrangement.

Q10) Why are the citizens of the economically weaker countries not currently happy?

Ans. Often good economics often is bad politics. During bailouts several conditions are imposed on the borrowing countries. For example one of the conditions is that the weaker economies should adopt austerity measures in order to reduce their debt levels. Consequently taxes are increased and a number of social benefits reduced.  These stiff conditions attached to bail-out are leading to a lot of social unrest in weaker economic countries like Greece etc.

This crisis can have two outcomes, the extremes of which are as under. On a positive note this crisis can lead to better unification on fiscal terms, of the entire Euro zone. On a negative side, the Euro itself can collapse. This situation needs to be keenly watched as it would have serious global repercussions

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