Financial markets worldwide are still on a decline and are being dragged supposedly because of the Eurozone debt crisis. Foremost among these problems is Greece — a country of 11.3 million people with external debt reaching more than $500 billion — currently at the brink of debt default.
What exactly happened? What led Greece to reach this unenviable position? Why are Greek people protesting?
Here’s a simple explanation of the Greek debt crisis.
Like most countries, Greece had to rely on debt to finance its spending. However, low government revenues due to rampant tax evasion, generous social security and pension payments, and unrestrained spending finally took their toll when the global financial crisis erupted in 2007-2008. The problem-laden Greek economy was further hit when tourism and shipping, the country’s primary industries, suffered severely due to the economic downturn.
Blame it on the debt
Greece’s debt has remained above 100% of its Gross Domestic Product (GDP) since the 1990s but by June 2010, the country’s external debt — the combined foreign currency-denominated loans of the government and the private sector — had reached a massive $532.9 billion, equivalent to around 174% of Greece’s GDP.
The country’s deficit, meanwhile, had grown to become one of the highest in the world. Deficit refers to the excess of spending to total revenues collected. The Greek government in 2009 revised its deficit estimate from 6% to 12.7%. In 2010, it was revealed that Goldman Sachs and other banks were paid by the Greek government to arrange transactions to hide the actual level of the country’s debt. This was supposedly made to enable Greece to remain in the European Union (EU) which requires member-nations to subscribe to stringent monetary and fiscal policies in order to retain membership.
Downgrade to Junk status
This confluence of events eventually led credit rating agency Standard & Poor’s (S&P) to downgrade the Greek sovereign bonds to junk status. On April 27, 2010, S&P reduced Greece’s long-term sovereign debt rating from BBB+ to BB+, the first notch in the junk category.
Other credit rating firms such as Moody’s and Fitch Ratings followed and, as a result, yields from government bonds rose. The yield of Greece’s 2-year government bond, for example, jumped from 10% in November 2010 to a whopping 110% one year later (see Bloomberg screenshot below).
The premiums on Greek debt had risen to an alarming level that necessitated restructuring; otherwise, Greece would have to default.
In response, the government requested a multi-billion dollar bailout from the EU and the International Monetary Fund (IMF). On May 2010, the EU and IMF approved a €110 billion loan ($146 billion) for Greece.
The bailout came with what some critics regarded as tough concessions. The loans, for example, were charged 5%, a relatively high interest rate for a bailout loan. At the same time, the release was conditional on the implementation of strict austerity measures.
Austerity measures and violent protests
To comply with the conditions of the EU/IMF bailout, the first round of austerity measures were approved by the government in 2010. These included a freeze in the salary of all government employees, a 10% reduction in their bonuses, a cut in their overtime work pay, and a decrease in work-related travels.
To generate additional income and savings, the Greek government approved another set of belt-tightening measures that included (on top of the earlier austerity actions) a 7% cut in the salaries of public and private employees, an increased tax on oil and petroleum products, and higher Value Added Tax (VAT) in various industries (e.g. VAT increase from 4% to 5.5%; from 9% to 11%; and from 19% to 23%).
In addition, the Greek government would privatize several government-owned companies, increase the retirement age of public sector workers from 61 to 65, and further reduce employee bonuses and pension payments while raising tax rates.
Unsurprisingly, the austerity measures were met by strong and sometimes violent reactions from its citizens. Various demonstrations were held and workers staged strikes closing schools, airports, and government offices. In May 2010, three employees were killed in a firebomb attack on a bank during a nationwide protest.
On October 2, 2011, the government approved the draft 2012 budget with an estimated 8.5% deficit, still below the target of 7.6%. In addition, amid widespread protests, the Cabinet approved a “labor reserve” measure which would reduce to 60% the salaries of 30,000 public workers and move for their dismissal after one year.
On October 27, 2011, Eurozone leaders were able to convince creditors to accept a 50% loss on their Greek debt holdings. The write-off would reduce Greece’s sovereign debt by 100 billion euros ($132 billion) and enable Greece to receive an additional bailout money of 100 billion euros ($132 billion) by early 2012.
New unity government
However, in a surprise move, Prime Minister George Papandreou announced he is putting the latest Greek bailout plan up for a vote in a national referendum. Critics believe the public would shoot down the plan, sending financial markets around the world again in turmoil.
EU leaders angrily reacted to Papandreou’s announcement and threatened to discontinue the bailout if the referendum would push through. A few days later, Papandreou declared he is withdrawing the referendum plan after discussing with the EU leaders. He also announced his intention to step down to give way for a new Greek unity government.
On November 10, 2011, banker Lucas Papademos was named as Prime Minister of the new interim government of Greece. Papademos is now faced with the challenge of keeping Greece out of bankruptcy and retaining the country in the 17-nation European Union.
Sources: Yahoo News, Reuters, Bloomberg, BBC News
Read more here: FAQ on Greece’s Debt Crisis