Greece Financial crisis : In & Out

Since few days I was thinking on writing about Greece crisis in sample way because I don’t understand much complex financial words( Believe me, I am trying my best!!) . I will try to explain it in Layman’s language. If you have any question put as a comment, I will definitely try to elaborate topic for your understanding.

Behind the all financial crisis only one sin is there – “Expenditure is more than earnings”. The problem with our so called capitalist – Bankers, politicians and all big money makers is they forget history. In last 3 decades we have seen this is happening in 1980’s in South America, 1997 in South East Asia and now in Dubai, Greece and other Euro zone countries.

Government runs on same way as we. It may borrow loan in terms of bonds. It may collect earnings as form of tax and government body’s revenues. It may expend on infrastructure and projects which are growth engines for a country. Now problem comes when government cannot control on their expenses and their revenue is coming down. So Beta is gradually increases, in other terms fiscal deficit is increasing and Govt will continuously borrow more money.

Government borrows money in terms of bonds. Actually sovereign bonds were considered as a risk free investment for an individual and government is serving public by providing a risk free investment instrument. An amount of between 15% – 50% is usually fine, for most countries. This actually works well, because here the fiscal situation of the government is in good order. It means govt can repay interest on debt + continue their infrastructure and project for country’s growth with their normal earnings.

Now where Greece got failed??

Now Greece is not having only one of the above problems but in fact all which caused this crisis. If you see and compare Greece GDP numbers with Euro zone then you will not find any problem between 1996 to 2006. In fact they were showing their GDP is between 2.5% to 5 % which were pretty good. But real story came in 2007 recession time when newly elected president “Karolos Papoulias “ declared that previous administrations had cooked the book and they may need to revise GDP numbers. According to the CIA, Greece had estimated GDP growth rates in the latter years of 4% in 2007, 2% in 2008 and -2% in 2009

Eurozone, an EU agency, recently put out a report that paints a damning picture of the Greece fiscal situation.

Gov. Expenditures: Gov. Revenues:

2006 = 43.2% of GDP 2006 = 39.3% of GDP

2007 = 45% 2007 = 39.7%

2008 = 46.8% 2008 = 39.1%

2009 = 50.4% 2009 = 36.9%

We can see here expenditure is increasing to and fold but revenues are continuously decreasing. This might be because of powerful labour unions, world economy slow down and mainly Political leaders who are promising to people more than country can afford in this situations. A $147B bailout package was put together by IMF to bailout Greece seems to have soothed markets fears about Greece’s problems.

Here I would love to quote which caused this crisis apart from above numbers. First is very famous line – “Speculation is mother of all EVIL” and second thing is confidence. These both the things are tightly knotted with each other, whenever confidence disappear speculation market becomes hot.

The most important factor in financial markets is confidence. Confidence in everything. The New Greek Prime Minister shattered market and public confidence by saying that several revisions have to be made on their reported numbers (i.e. they have been lying) starting with the budget deficit being double previous estimates @ 12.5% of GDP. As a result of that announcement the credit ratings agencies S&P downgraded Greece’s debt. This trigger panic in world market and created another round of speculation which played a big role in further unfolding bitter truth about Greece economy rather than healing it. Sin is everywhere in financial market from giants like US to tiny like Greece and everyone is having loophole in system. We need to identify and cure it rather than speculating because in today’s world everyone is connected in financial market. Though India will have least effect in Greece’s crisis, we can see our market falling 3 % - 4 % along with world market.

PIIGS country – Portugal, Ireland, Italy, Greece and Spain, they are very much interconnected in terms of business, industries, banks borrowing. Example: Some of the Banks in Spain, running their business in Greece also. If Greece Govt. and public are not capable to return their borrowing then definitely that will affect on Spain money lenders (depositors). So when things were being contained in Greece, S&P downgraded Portugal & Spain’s debt also. This causes panic among investors as stock markets all over the world start to decline. Now the EU leaders, IMF and the US put together a $1 Trillion bailout package for all troubled Euro nations. So ultimately crisis started with small country that first ‘needed’ a $25B bailout, turn into a large $1T bailout for the entire EU.

But for the public of these countries, real problem comes now. IMF and US will put tight austerity measures on these countries. This will include wedge cuts up to 30 – 40 %, higher interest rate to cut higher spending, depreciation of the currency to improve export competitiveness and bring in money from overseas and severe budget cuts.In 1997 crisis Indonesian people had repay their loan as much as 30 % Interest rate and it ensured that other creditors - the large international banks were paid.

Lessons to be learned from Greece crisis:

1) In today’s world no financial instrument is risk free even sovereign bonds also.

2) Smaller countries should think twice before loading on foreign debt.

What I feel in whole this story is: If each time the IMF only punishing the borrower but not the reckless lenders, it just encourages the same to be done again, and again. We need to solve fundamental problem and keep austerity measures intake in every country. If we have 5 Rs. in pocket don’t try to spend single penny more then that.