What is the eurozone crisis?
The European sovereign debt crisis is one that has made it nearly impossible for the economically weaker countries in the eurozone to refinance their debt without assistance. In the aftermath of the US sub-prime mortgage meltdown in 2008, European banks fled to what they saw as safe — bonds from countries in Europe’s ostensibly solid monetary union. The European sovereign debt problems’ progress into the new subprime crisis is a result of governments borrowing beyond their means, regulators permitting banks to treat the bonds as risk-free, and investors failing to make a distinction between the bonds of troubled economies like Greece, Portugal and Italy and those issued by stronger ones like Germany and France.
How did the debt pile up?
When the European economic and monetary union became operational from January 1999, all the peripheral eurozone economies experienced windfall gains from the sharp reduction in bond yields and resultant cost of borrowing. Over a four-year period from 1995, bond yields more than halved and converged around 4 per cent across most eurozone economies. Governments and corporates piled up debt, especially by way of borrowings from banks in core area economies, as they splurged on this sudden access to cheaper capital, triggering resource mis-allocation and asset bubbles. The boom also led to a rise in wages and input prices, and a decline in relative economic competitiveness.
How far is the Europen Union structure responsible?
The crisis was in some ways inevitable given the impossibility of managing a monetary union without some form of fiscal union and a fully committed central bank.
To understand the problem, a parallel can be drawn by equating the eurozone countries with the Indian states. Imagine that 28 independent states federate into a single country with a single monetary policy. They embrace a single currency, rupee, and monetary aggregates including interest rates are harmonised across all states. Trade barriers between states have been brought down. However, neither the central bank (RBI) nor the Union Government will make monetary and fiscal transfers to help any state with problems. All taxes are levied by the states with no revenue shares to the Centre; the RBI is averse to banking bailouts.
Consider that Maharashtra and Tamil Nadu are booming while West Bengal, Punjab and Kerala are in recession. The latter three have a competitiveness problem, since their wages have been driven up by a positive economic shock. All three governments have indulged in populist profligacy and run up huge debts, including from neighbouring states and their banks. Both now stand on the verge of sovereign defaults. Further, when the states formed the monetary union, their initial conditions varied; the weaker states have lower labour productivity, though wages and prices remain more or less the same. As the weaker states struggle, the competitive states prosper, partly by increasing their exports to the weaker ones, and in the process displacing local production and driving out local jobs. Maharashtra and Tamil Nadu are, at least partially, prospering at the expense of the weaker states. So if Punjab, West Bengal and Kerala were independent countries with their own currencies and interest rates, they would have responded by either devaluing their currencies or lowering interest rates or both, with the objective of lowering real wages and costs.
Now that these states are part of a monetary union, they do not have access to these traditional options. In the real world, India is a monetary and fiscal union. The only strategy to restore economic strength in these three states without compromising on the monetary union is for the Union government to provide fiscal transfers to these weak states and the RBI to open liquidity windows and ensure that the credit tap is kept open. Simultaneously, these states will have to undertake structural reforms to increase their medium- and longer-term competitiveness.
Replace West Bengal and Kerala with Greece and Italy, and Maharashtra and Tamil Nadu with Germany and France.
How have they tried to handle it?
Europe’s finance ministers in 2010 approved a rescue package worth 750 billion euros by creating the European Financial Stability Facility. In 2011 and 2012, leaders agreed on more measures to prevent the collapse of member economies. This included an agreement that banks would accept a 53.5 per cent write-off of Greek debt to private creditors, increasing the EFSF to about 1 trillion euros, and requiring European banks to achieve 9 per cent capitalisation. EU leaders also agreed to create a European Fiscal Compact including the commitment of each participant to introduce a balanced budget amendment. The countries most affected, Greece, Ireland and Portugal, account for 6 per cent of the eurozone’s GDP. But the real worry is if the crisis spreads to bigger countries such as Italy or Spain. The interconnection in the global financial system means that if one nation defaults on its sovereign debt or enters into recession putting some external private debt at risk, the banking systems of creditor nations face losses.
What has been the political fallout?
It has led to the premature end of a number of governments and impacted election results. The Greek election saw the collapse of the bipartisanship leadership that had ruled the country for over 40 years as a punishment for their support to the strict measures proposed by foreign lenders and the Troika (European Union, IMF and European Central Bank). The French presidential election marked the first time since 1981 that an incumbent failed to win a second term; Nicolas Sarkozy lost to Francois Hollande.
Is there an impact on India?
The crisis in Europe has fuelled a rush among major global investors to move to safer investment destinations such as the US. This has led to a flight of US dollars from emerging markets such as India, resulting in the rupee depreciating. Where the rupee is headed could depend on what happens in Europe, particularly Greece, because if Greece were to exit the eurozone, there is a distinct possibility that the rupee could move close to 60 to the dollar.
The European sovereign debt crisis is one that has made it nearly impossible for the economically weaker countries in the eurozone to refinance their debt without assistance. In the aftermath of the US sub-prime mortgage meltdown in 2008, European banks fled to what they saw as safe — bonds from countries in Europe’s ostensibly solid monetary union. The European sovereign debt problems’ progress into the new subprime crisis is a result of governments borrowing beyond their means, regulators permitting banks to treat the bonds as risk-free, and investors failing to make a distinction between the bonds of troubled economies like Greece, Portugal and Italy and those issued by stronger ones like Germany and France.
How did the debt pile up?
When the European economic and monetary union became operational from January 1999, all the peripheral eurozone economies experienced windfall gains from the sharp reduction in bond yields and resultant cost of borrowing. Over a four-year period from 1995, bond yields more than halved and converged around 4 per cent across most eurozone economies. Governments and corporates piled up debt, especially by way of borrowings from banks in core area economies, as they splurged on this sudden access to cheaper capital, triggering resource mis-allocation and asset bubbles. The boom also led to a rise in wages and input prices, and a decline in relative economic competitiveness.
How far is the Europen Union structure responsible?
The crisis was in some ways inevitable given the impossibility of managing a monetary union without some form of fiscal union and a fully committed central bank.
To understand the problem, a parallel can be drawn by equating the eurozone countries with the Indian states. Imagine that 28 independent states federate into a single country with a single monetary policy. They embrace a single currency, rupee, and monetary aggregates including interest rates are harmonised across all states. Trade barriers between states have been brought down. However, neither the central bank (RBI) nor the Union Government will make monetary and fiscal transfers to help any state with problems. All taxes are levied by the states with no revenue shares to the Centre; the RBI is averse to banking bailouts.
Consider that Maharashtra and Tamil Nadu are booming while West Bengal, Punjab and Kerala are in recession. The latter three have a competitiveness problem, since their wages have been driven up by a positive economic shock. All three governments have indulged in populist profligacy and run up huge debts, including from neighbouring states and their banks. Both now stand on the verge of sovereign defaults. Further, when the states formed the monetary union, their initial conditions varied; the weaker states have lower labour productivity, though wages and prices remain more or less the same. As the weaker states struggle, the competitive states prosper, partly by increasing their exports to the weaker ones, and in the process displacing local production and driving out local jobs. Maharashtra and Tamil Nadu are, at least partially, prospering at the expense of the weaker states. So if Punjab, West Bengal and Kerala were independent countries with their own currencies and interest rates, they would have responded by either devaluing their currencies or lowering interest rates or both, with the objective of lowering real wages and costs.
Now that these states are part of a monetary union, they do not have access to these traditional options. In the real world, India is a monetary and fiscal union. The only strategy to restore economic strength in these three states without compromising on the monetary union is for the Union government to provide fiscal transfers to these weak states and the RBI to open liquidity windows and ensure that the credit tap is kept open. Simultaneously, these states will have to undertake structural reforms to increase their medium- and longer-term competitiveness.
Replace West Bengal and Kerala with Greece and Italy, and Maharashtra and Tamil Nadu with Germany and France.
How have they tried to handle it?
Europe’s finance ministers in 2010 approved a rescue package worth 750 billion euros by creating the European Financial Stability Facility. In 2011 and 2012, leaders agreed on more measures to prevent the collapse of member economies. This included an agreement that banks would accept a 53.5 per cent write-off of Greek debt to private creditors, increasing the EFSF to about 1 trillion euros, and requiring European banks to achieve 9 per cent capitalisation. EU leaders also agreed to create a European Fiscal Compact including the commitment of each participant to introduce a balanced budget amendment. The countries most affected, Greece, Ireland and Portugal, account for 6 per cent of the eurozone’s GDP. But the real worry is if the crisis spreads to bigger countries such as Italy or Spain. The interconnection in the global financial system means that if one nation defaults on its sovereign debt or enters into recession putting some external private debt at risk, the banking systems of creditor nations face losses.
What has been the political fallout?
It has led to the premature end of a number of governments and impacted election results. The Greek election saw the collapse of the bipartisanship leadership that had ruled the country for over 40 years as a punishment for their support to the strict measures proposed by foreign lenders and the Troika (European Union, IMF and European Central Bank). The French presidential election marked the first time since 1981 that an incumbent failed to win a second term; Nicolas Sarkozy lost to Francois Hollande.
Is there an impact on India?
The crisis in Europe has fuelled a rush among major global investors to move to safer investment destinations such as the US. This has led to a flight of US dollars from emerging markets such as India, resulting in the rupee depreciating. Where the rupee is headed could depend on what happens in Europe, particularly Greece, because if Greece were to exit the eurozone, there is a distinct possibility that the rupee could move close to 60 to the dollar.
No comments:
Post a Comment