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European Financial Crisis. Sai Kumar Swamy Course Director, T.I.M.E. PGPM IIM Bangalore. Agenda. Genesis Sub-Prime Crisis Contagion Effect European Financial Crisis Iceland Principal Actors PIIGS Portugal Ireland Italy Greece Spain Current Status Future Scenario. Genesis. EU
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European Financial Crisis Sai Kumar Swamy Course Director, T.I.M.E. PGPM IIM Bangalore
Agenda • Genesis • Sub-Prime Crisis • Contagion Effect • European Financial Crisis • Iceland • Principal Actors • PIIGS • Portugal • Ireland • Italy • Greece • Spain • Current Status • Future Scenario
Genesis • EU • Economic & Political Union of 27 member states • 500 Mn citizens • GDP - $16Tn and 30% of total world output • Free movement of people, goods, services & capital • Schengen – Free movement – Abolition of passport controls • Treaty of Maastricht – 1st Nov 1993 • Salient Features • Common Currency - Euro • EMU • SGP - Stability & Growth Pact • Convergence Criteria – Article 121 • Inflation; Deficit & Debt; Interest rates • Fiscal Monitoring of members • Article 122 • EC can take measures to help an ailing country
Sub-Prime Crisis • Sub-Prime loans • Housing Bubble • Fuelled by Low interest rates • Supply Glut • Foreclosures • MBS • CDS • Failure of Banks • Credit Crunch • Reduced Output – Unemployment • Government Bail-outs • Stimulus Packages • Fannie Mae and Freddie Mac • Keynesian model adopted – Deficit Spending • Contagion effect – Global linkages
Principal Actors - Iceland • Pre 1990s • Natural resources • Tourism – Fiords, Glaciers and Geysers • Fishing – Salted Cod • David Oddsson • Mayor of Reykjavik • Prime Minister in 1991 • Promised to end the boom and bust cycles based on Fish catch • Privatization - $2Bn • Privatized banking industry • Thrust on • Biotechnology • Software
Principal Actors - Iceland • Banking • Tapped Overseas markets • Landbanski – ‘Icesave’ Scheme • High interest rates • Banking accounted for 75% of stock market • KaupthingBank • Assets – 208Bn Krn in 2000 6600Bn Krn in 2008 • Loans & Assets were 10 times Iceland GDP • High inflows Strong kronor • Consumption led economy • Global Financial Crisis – large scale outflow of funds • Haarde in US for assistance • Central bank had €2Bn – Loans were €70Bn • Defaults by Glitner bank – €600Mn • Govt. bailout for Glitner – Landsbanski - Kaupthing
Principal Actors - Ireland • Economic Transformation in the 90’s • Low Taxes – Educated workforce – Entry of MNCs • Bridge between US and Europe • GDP Growth rate of 6.5% • Celtic Tiger • Housing Boom • Cheap Loans – Tax Incentives • House prices increased 3 fold in a decade • 40% of houses built in 1996-2006 • Housing Bubble • Over Supply • Speculative nature of demand • ‘Sub-prime echoes of the US • Multi unit loans to property developers with ‘sub-prime’ characteristics
Principal Actors - Greece • Cause • Economic downturn post 2008 • Tourism & Shipping badly hit • Govt. revenues decreased significantly • Govt. expenditure increased – worsened debt situation • Huge spending – Deficit Budgets • Cheap lending • Lack of financial reform • Government cooking the accounts • Effect • €300 billion Debt • Budget Deficit – 12.7% • Violation of Growth & Stability Pact • Accumulated debt– Estd. at 160% in 2011 • Credit Rating downgraded • Bond Yield – 34%
Principal Actors - Greece • Steps Taken/To be taken • Cut in spending • Austerity measures • Increase in Taxes • Better Tax collection • Public Sector Pay cuts • Increase in retirement age by 2 yrs – Later by 4 yrs • Denationalization to raise money • Fears • Civil Unrest • Sovereign Debt default • Orderly Default – Debt write off - 50% • Euro under pressure
Principal Actors - Spain • GDP contracted in 2008 • Construction Sector – 10% of GDP • Housing Bubble • Price increases of more than 200% • Bubble started in 1995 and sustained till 2007 • 28% of houses vacant • Fuelled by tax incentives similar to India • High indebtedness • High Inflation • High Oil prices • High Interest Rates pricks the bubble • Large scale unemployment ~ 25-30% • Severe pressure on Banking system • Bond Yield – 5%
Principal Actors - Portugal • GDP – $220Bn • Tourism, Cork, Fishing, Wine • High Debt to GDP Ratio – 113% • Mostly external debt • Socialist Govt. with excess spending • Very low GDP growth rates • Debt Servicing Issues • Unable to generate new loans • Required a bailout from EU • Bond Yield – 12-15% • Severe unemployment – 12.4% in 2011 • Emigration • Austerity measures • Social Unrest
Italy • 7th largest economy • GDP - $2 Tn • Manufacturing & Services led economy • Big brands – Quality products • Current Issue • Huge Debt to GDP ratio – roughly 120% in 2010 • Similar to Greece • Key difference is that most of it is internal • Recession • Contraction of almost 7% in GDP • Political Weakness • High Govt. Spending – Profligacy • Black market economy • Organized crime – 7% of GDP • Protection money • Bond Yield – 5-6%
Current Status • Greece • Austerity measures • Looking for a bail-out • Germany against such a bailout – France in favour • Portugal • Govt. trying to raise money to prop up banking system • Failed Bond Auction to raise €500Mn • Spain & Ireland • Reduce fiscal deficit • Rollback Keynesian debt fuelled monetary policies
Future Scenario • Sovereign Debt Crisis looms • Euro under threat • The concept of ‘United States of Europe’ in grave danger • Political Union of Europe unlikely • Issues of Solidarity & Responsibility • Return to ‘Non-Keynesian’ policies can further deflate the economies • Double Dip recession possible • Common Fiscal Policy for the EU • Two Solutions • EMF – Fund for Bailouts - EFSF • European Treasury – Single authority for • Tax policy • Govt. Spending
