Once upon a time in Greece

Battered Greece witnessed  its budget deficit fall to 9.1% of GDP in 2011. When George Papandreou took charge of office in 2006, the budget deficit was around 13% of GDP, way higher than the falsified figure of 5% stated by Karamanlis's government. The country currently has a debt of around USD 485 bn. There is immense pressure on the government to raise finance to pay off the debt which seems never-lasting (looking at the figure! but hope lives).

To continue to remain a member of the Euro Zone, members are required to maintain a budget deficit of no more than 3% of GDP and the debt to GDP must not exceed 60%. The current budget deficit is more than 9% of GDP and the debt is more than 120% of GDP!!! Greece is an unusual member of the Euro Zone which in the past had a two digit budget deficit and continues to have a three digit debt to GDP%.

The new coalition government, under Lucas Papademos, like the previous government plans to cut deficits, but we need to analyze how realistic these plans are fiscally and politically. The government is bound to raise taxes and cut spending on pensions, healthcare and welfare of the public. This comes at the expense of the turmoils in the form of protests and strikes campaigned by the strong labor unions in Greece. Any government in Greece is closely linked to the trade unions for political reasons and hence these unions are in a strong position to force governments to satisfy their expectations and demands. Any changes in the austerity measures will have both economic and political repercussions.

So what is the way out ? What options do we have ? Will Greece be forced out of the Euro Zone or will Greece be bailed out by the fellow EU members (mainly Germany and France). Let's analyze both the scenarios.

In the first case, we need to understand that there was no exit clause at the time of setting/joining the Euro Zone. Greece might approach the IMF like Hungary, but additional austerity measures will be required. The costs involved in switching back to the drachma from the Euro will be excessively high. The drachma would depreciate and the debt would surge as it is denominated in Euros. Hence, this is not a feasible option. Now, we are left with the second option, i.e. Plan: Bailout Greece!. It can be depicted from the chart above that France and Germany (the two leading Euro Zone countries) are most exposed to the Greek debt, hence if Greece falls, it will definitely have a knock-on effect and these countries will use all their muscles to save it. We have observed the significance of the Greek debt issue in the politics of France and Germany. The French and German banks have held significant amounts of the Greek debt and hence are a big support to its survival. 

Conclusively, I believe that the Greeks will be bailed out by their fellow EU members. We have to wait for the elections to get over in France and see the approach of the newly elected government towards this highly critical issue.

The blind eye

Back in 2004, the biggest wall street banks had created the instrument for the self-destruction. The credit default swap enabled investors to bet against the price of any given bond. In simple terms, it was an insurance policy, but with a crack: the buyer did not need to own the insured asset (i.e. the risks incidental to the ownership were never transferred in actual). Consider the credit swaps the titanic and the recession the ice berg. The collision being caused by the so called sane people residents of the insane world.

We all observed the the false boom in the first world developed economies, post 2002. The economic growth was super heated and fueled by borrowing. The US national debt, alone is more than USD 15.5 trillions, and the average debt per citizen is more than USD 50,000. For a moment, imagine the global debt and the consequences that will follow up in the coming times (hope it does not). Human kind has never, for sure, witnessed this kind of accumulation of debt in world history.

Private enterprises, majorly banks, were bailed out by the local and federal governments, after all the financial institutions were big credit lenders to the governments and local bodies. The governments plunged themselves into debt and any increase in interest rates means a greater proportion of the budget being consumed to meet the interest payments on debts.

In my coming blogs, I will be analyzing the blunders in Greece and Iceland in particular.