European Sovereign Debt Crisis
A financial turmoil that affected Eurozone countries, was marked by high government debts, budget deficits, and macroeconomic instability, leading to bailouts and austerity measures.
What Was Europe's Sovereign Debt Crisis?
Europe's Sovereign Debt Crisis (2009 to mid-to-late 2010s) was a financial turmoil that affected Eurozone countries. It was marked by high government debts, budget deficits, and macroeconomic instability, leading to bailouts and austerity measures.
Europe is a beautiful continent with many eye-pleasing places. Still, amidst the beauty, chaos was brewing for a long time, and it erupted first in Greece in 2008 and then covered the entire Eurozone in its flame, later known as the European Sovereign Debt Crisis.
The crisis occurred because Greece's debt levels reached unsustainable levels, economic failures occurred, and restrictive fiscal policies were followed by all countries with the Euro as their national currency.
Another primary reason behind the crisis was that governments, especially those of weak economic status, were heedless regarding public spending.
One key reason for the debt crisis was the lack of appropriate mechanisms to handle a crisis within the Eurozone. The debt crisis exposed structural issues within the Eurozone, where the countries shared the same currencies but had their own fiscal policies.
Regardless of the fiscal policies adopted by the Eurozone countries, they accumulated substantial levels of debt compared to their GDP. When it first started with Greece, the financial catastrophe spread to Portugal, Spain, Ireland, and Cyprus.
This flawed economic system resulted in governments facing severe public debt. At one point, Greece's sovereign debt peaked at 113% of its GDP, leaps and bounds ahead of the limit (60%) set by the Eurozone.
Apart from the foundational and structural limitations of the Eurozone countries, the 2008-09 financial crisis acted as a catalyst for the whole European sovereign debt crisis.
Key Takeaways
- Europe's Sovereign Debt Crisis (2009 to mid-to-late 2010s) refers to a period of financial turmoil affecting Eurozone countries. It was characterized by high government debts, budget deficits, and macroeconomic instability, which led to bailouts and austerity measures.
- The crisis began with Greece's unsustainable debt levels and economic failures, exacerbated by restrictive fiscal policies across Eurozone countries.
- The crisis started in economically weaker Eurozone countries like Greece, Iceland, and Portugal in 2008, with Greece being the first to experience the global recession's impact.
- The formation of the Eurozone initially seemed advantageous, but differing economic conditions among member countries revealed underlying weaknesses.
History Of The Crisis
The European Sovereign Debt Crisis initially started as a shockwave in the economically weaker countries of the Eurozone, like Greece, Iceland, Portugal, etc., in 2008; Greece was the first country to be shaken by the onset of the global recession.
All the countries comprising the Eurozone have the same currency and monetary policy, yet each country can individually control its fiscal policy.
When the Eurozone was formed, the idea seemed lucrative. However, they soon realized that countries vary greatly in other criteria.
The path might not be as easy as they predicted. This worked as a loophole for all the economically weaker countries under the Eurozone. Due to this, they could borrow and overspend, even more than what they could repay.
Therefore, Greece soon was under huge sovereign debt, and to bail out, it had to be assisted by other countries and financial institutions like the World Bank and the International Monetary Fund (IMF). This was the onset of one of the biggest economic blunders the world has ever witnessed.
Bubbles under the Surface: Subprime Crisis
The world only realized the blunder once the volcano had started erupting in mid-2007 and had started wrapping financial institutions in its lava. The bubbles underneath the surface began forming in 2001 after the terrorist attack shook the US economy and broke its back.
The US Government, in an attempt to manage the situation, reduced its interest rates which stimulated economic success in the country.
As people started growing strong economically, the number of homeowners grew massively. It reached an extent where banking institutions faced complications in finding new homebuyers.
So, they increased the number of subprime loans being sanctioned. Everything seemed perfectly alright until the recession hit, and people with poor credit scores lost their jobs and failed to repay their mortgages.
It all started in the US, but the values of assets like houses had to be written down worldwide in every bank's accounts, which resulted in a significant liquidity crisis. (Subprime loans)
Chaos Reaches Europe
In 1998, 11 European countries adopted the Euro as their national currency and formed a Eurozone group.
There were many benefits for underdeveloped countries and countries that needed financial assistance. The stronger countries could protect them in the group in many ways. This also became the reason for their downfall.
No country under the group ever came under a magnifying glass individually until 2007 because, from a distance, their debt-to-GDP ratio would look decent.
Only after a closer glance could it be seen that the weaker countries in the group are actually in serious trouble, but it stays hidden as the ratio among all the countries averages out and looks decent as a unit.
Once the recession hit Europe, it was evident that their journey to become an economically supergiant unit was not as smooth sailing as one could expect.
Tale of Troika
How Was The Bailout For The Debt-Ridden Countries Carried Out?
An association between the European Commission, European Central Bank, and the International Monetary Fund (IMF) was formed so that countries like Greece, Cyprus, Portugal, Ireland, and Spain could be bailed out during the European Sovereign Debt Crisis.
The austerity measures required to be implemented after the loans were sanctioned, the determination of loan amount.
This association, later termed Troika, supervised every technicality that was supposed to be considered during the execution of these bailout plans.
Debt Crisis Contributing Causes
Although there are a number of reasons why the debt crisis occurred, structural issues and a combination of foundational issues could be among the major contributors.
Some of the factors include
- Balance Of Payments Crisis
- Macroeconomic Instability
- Comparative Political Economies
- Unstable Capital Flows
- Euro as a Currency
- Increased Public Debt, and
- Decelerated Economic Growth, to name a few.
Let us discuss these factors below.
Balance Of Payments
There are a number of reasons for the sovereign European debt crisis, but one factor that is agreed upon is the existence of the balance-of-payments crisis. This crisis particularly worsened the event because eurozone countries weren't authorized to devalue the currency.
Balance of Payment refers to the condition where there is a sudden stop to the foreign capital in the countries that were dependent upon the foreign funds.
And, devaluation refers to diminishing the value of the currency to make more exports in the foreign markets.
Macroeconomic Instability
The instability and divergence in the Eurozone nations also contributed to the crisis. A range of diverse interests of the eurozone nations led to the imbalances between the capital flows and member states.
Although macroeconomic conditions were changing, the European Central Bank could accept only one interest rate. This interest rate had different effects on different countries. For example, in Germany, the real interest rate was high compared to inflation, and the same rate was lower in Southern European countries.
This incentivized lending from Southern European countries to Northern European countries because of the lower interest rates, which, in turn, led to the accumulation of debt across Europe.
Comparative Political Economies
Comparative political economies explain many of the root causes of the debt crisis. Differences between institutional structures, fundamental fiscal policies, and lending mechanisms also contributed to the crisis.
Apart from this, the differences between the Nothern and Southern Europeans made the union susceptible to external factors.
Euro, The Currency
Countries like Portugal, Spain, and especially Greece followed the footsteps of Ireland and were the next few economies to collapse. So it was a big decision to have the Euro as a national currency for the entire Eurozone, which finally backfired.
The countries under the Eurozone had more differences than similarities. For example, they were supposed to follow the same monetary policy but could create fiscal properties independently.
Countries like Greece were nothing in terms of financial status compared to some of their counterparts, so similar workings from all the governments in the group were just not practical.
Neither did Greece get the option to print more Euros to pay back their creditors, as it would undervalue the Currency for every nation. So the synergy just was not possible to this extent at this point.
Increased Public Debt
Usually, countries devalue their Currency to pay off debt, but in this scenario, the change in the exchange rates would just increase the dollar debt.
Moreover, countries like Greece managed to dig deeper holes for themselves each year from 2007-to 2010; therefore, governments that already had lost the confidence of their citizens were also bound to lose the interest of their investors.
This resulted in increased interest rates, which only worsened the matter.
Decelerated Economic Growth
The Sovereign debt of a few countries had increased to such an extent that they needed help from third parties like the World Bank, IMF, and European Central Bank (ECB—a bank that fundamentally pools money from all the countries that are part of the European Union).
Since the recession had hit all the countries, only France and Germany were practically in a condition to loan money to other countries under the Eurozone. Germans did not want their government to lend money to other countries just because those particular countries mishandled their finances.
Therefore, loans were still sanctioned, but austerity measures were implemented. The economically weaker government got those loans by increasing taxes and cutting the financial benefits provided to its citizens.
These measures caused unemployment, new businesses failed, and since there was no independent economic growth in these countries, the situation more or less remained stagnant.
Greek Example of European Crisis
When the banking and housing industry ultimately collapsed, it had exponential effects on the world.
The stock market crashed worldwide, and recession struck, and along with that, countries like Greece, Ireland, Spain, Portugal, and Cyprus tumbled down and fell under massive sovereign debt.
When the European Sovereign Debt Crisis struck and reached its peak, all of these countries had to be bailed out by their ally in the Eurozone and other third parties.
Massive amounts were borrowed with the promise of accepting a few conditions (Austerity Measures). Different countries, according to their financial position, were subject to similar measures.
Here is what happened in Greece:
- Record Levels of Unemployment: The government had to cut spending and increase taxes per the conditions, but since the government could not comfortably help its private industries grow, the GDP shrank.
- The unemployment level reached 25% (youth unemployment was 50%). The tax revenue generated afterward was not even sufficient to repay the country's debt.
- Income Inequality: In times of crisis, people at the bottom of the food chart suffer the most. Similarly, in Greece, the elites still found a way not to get affected, but people who heavily relied on the government suffered severely, and the gap between the rich and poor widened over time.
- Rising Poverty: Since the government's financial assistance suddenly stopped, it put economic progress on a regressive track, and people lost jobs and businesses, increasing poverty.
- Loss of People's Confidence in the Government: The austerity measures placed repaying debt at the top of the government's priority list, which did not go down well with the citizens. Earlier, Greece allotted 17% of its GDP to the pensions given to 20% of its population. However, the debt and the austerity measures reduced this to 1% of the total GDP.
- This affected almost half of the households. In addition, many other limitations, like lowering minimum wages, increased property, and luxury taxes with the scrapping of many tax exemptions, frustrated the citizens greatly.
GREXIT
Grexit refers to the potential Greece's exit from the association of the Eurozone. They would change their national and official Currency to Drachma from the Euro. The concept of Grexit had polarizing views.
There were two schools of thought: Some believed it would elevate Greece's debt crisis, while others believed this disassociation could solve Greece's problems after a brief period of struggle and adjustment.
This term was coined frequently after 2012 due to the debt crisis.
Most citizens and economists believed that, due to the Austerity measures, external financial assistance provided by third parties was not being used to uplift people's lifestyles but only to repay their debts.
However, if Greece left the Eurozone, it would enable the country to use Drachma. Moreover, having their own national Currency would provide them with the autonomy the government needed to control monetary policy.
Under the Eurozone, they could not devalue the Euro currency by printing more of it due to its implications for other countries. Therefore, since deficit financing was not practical, they had to ask third parties to assist them in repaying their debt.
The rest of the people believed that the struggle caused by lowered living standards resulting from not adopting austerity measures would not be bearable. On the contrary, it would cause social unrest.
Moreover, the recovery through this method was not inevitable, and the repercussions could put Greece in an even worse situation. Therefore, most people thought that in this plan, the odds didn't favor them, and in hopes of a miraculous recovery, they were putting too much at risk.
The party campaigning and advocating against adopting austerity measures and leaving the Eurozone did come into power. However, they kept assisting third parties and upheld the austerity measures.
This is an alternative used by the Government to reduce its budget deficits. These measures are used when Deficit Financing is insufficient to handle the situation.
These economic policies usually impose rules like increased taxes, cuts in government spending, or sometimes both.
Covid-19 Strikes
Covid-19 shook the world way beyond one's imagination. What started as a virus in China metamorphosed into a global pandemic within a couple of months. It led to permanent lives, fear, and depression worldwide.
The whole concept of living, running a business, or running a country changed drastically. Of course, not all countries were blossoming before COVID-19; for such countries, the situation deteriorated.
The European Sovereign Debt Crisis is a long-standing issue in Europe. Unfortunately, Italy became one of the first countries to experience the full wrath of destruction caused by the Coronavirus.
Italy already had a huge public debt burden before the pandemic. During the pandemic, the conditions only got worse.
The Government had no choice but to spend more on public health facilities to protect its citizens. This ultimately led to their debt-to-GDP ratio increasing drastically. As a result, the obligation to GDP, which had already crossed the limit way before the pandemic, soared even higher.
The entire Euro-area's debt-to-GDP ratio reached a staggering 98%. Among the countries, the worst debt-to-GDP ratio was held by Greece (205.6%) and Italy (155.8%).
Countries with severe sovereign debt could not possibly manage the situation themselves; luckily, the European Central Bank(ECB) stepped in.
ECB Intervenes
The euro-zone is being protected by the European Central Bank in this coronavirus era. It created the Pandemic Emergency Purchase Program(PEPP) with an envelope of 1850 billion euros. It lets the countries finance the debt at record-breaking low levels of interest.
Although it is getting the much-needed help it requires, the Eurozone has put itself in a tricky dilemma.
Under the PEPP, countries can end up putting a lot of burden on their respective central banks. Moreover, the more the ECB tolerates the country's debt burden, the more it will participate in the country's monetary policy.
Countries can also adopt a callous attitude towards the monetary and fiscal policy as governments would know that the ECB will have to intervene in their sovereign debt-related problems as their situation and circumstances affect other countries under the Eurozone.
Is the Crisis over?
The path to a complete recovery from the European Sovereign Debt Crisis still seems to be long. The sovereign debt issues of the European countries will still be the main focus of every country's ECB, EU, and governments.
The Austerity measures, in a way, reduced the burden of debt in many countries from 2010 to 2016.
However, income generation was still minimal in such states due to the cut in government spending. Therefore, countries will have to generate more income and reduce their debt-to-GDP ratio in the coming years to see light, prosperity, and growth.
Covid was a significant bump on the road to recovery or development for all the countries. It hit the Eurozone a little more complicated than most of their counterparts. Whatever progress was made in the past years seems insufficient suddenly.
Tourism was a primary revenue-earning business for significant countries that was completely shut down for almost two years. In addition, the austerity measures slowed the development of essential human life resources, making it difficult for countries to fight the pandemic.
Hopefully, the Eurozone has learned from its mistakes in the past two decades. They desperately need to reorganize the degree of control over the monetary and fiscal policies between the countries and the ECB.
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