Greece Financial & Debt Crisis: Details, Causes & Lessons

Greece is the birthplace of Western civilization, modern democracy, the Olympic Games, new ideas in science / art / philosophy and also the birthplace of Alexander the Great. About 2,500 years ago, the Greeks created a way of life that other people admired and copied.

Now, Greece is falling apart. Greece’s economy is on the verge of financial collapse. The economy has shrunk by a quarter in five years, unemployment is above 25%, four in ten children are living in poverty, Greeks can’t withdraw their own money from Bank ATMs…. The state of affairs in Greece is pathetic.

What are the reasons for Greek Economy collapse? What is happening in Greece? What is Greek Debt Crisis? How did Greece get into this unmanageable Debt situation? What caused the Greece’s Financial Crisis? What are the lessons from Greece’s Debt crisis?

 

Greece’s Financial / Debt Crisis

Let me try to explain the whole crisis in simple terms 

Example – Let us assume there is a company called ‘Asatya’. It has been informed that XYZ bank is offering Business Loans at low interest rates on certain terms & conditions. Asatya gets the loan by falsifying its Accounts (the company is actually not eligible to get the loan and do not meet the terms & conditions laid down by the bank). The company uses the loan amount on unproductive things (not related to its business). It continues to get the loans from XYZ bank year after year. One fine day, due to downturn in world economy, XYZ bank can’t afford to provide loans and hence stopped funding Asatya. The bank asks for repayment of loan along with the interest amount. Asatya finds it difficult to repay the debt. Asatya defaults and goes bankrupt.

Like Asatya, Greece’s economy is facing a similar challenge.

Causes of Greece’s Economic collapse

• Greece joined the Euro club in 2001-02. As an European Union member, the Greek government borrowed money (loans) at very cheap interest rates to manage the country’s finances. From 2001 to 2008, it continued to get funding from EU, borrowing more than it reported publicly, meaning the country was running bigger deficits and racking up more debt. (As an EU member, it was required to limit its deficits to 3 percent of GDP and its debt to 60 percent of GDP. But Greece evaded those rules and borrowed money to enable more spending. Statisticians in Greece went terribly wrong. Each year they generated wrong data regarding the countries fiscal debt and expenditure)
• During this period, the Greek government had mostly utilized these funds on public spending only (economic reforms were ignored). During the period 2004 to 2009, the government’s primary expenditure increased by 87% against 31% increase of income from taxation causing huge fiscal imbalances. (The below image clearly shows the very high Debt to GDP ratio of Greece)

• After the 2008 global financial crisis, the Greek government found it very difficult to get the new loans. The funds started to dry up. The public debt increased to unmanageable proportions. In 2010, Greece’s credit rating (the assessment of its ability to repay its debts) has been downgraded to the lowest in the euro zone.

• Another reason for the Greek’s economic crisis is ‘Tax evasion’. A 2012 study comparing Greek bank account data with government tax data found that the true income of the average Greek person was about 92 percent higher than the income they reported to the government. Tax evasion accounted for half of Greece’s 2008 deficit and a third of its 2009 deficit. So, Greece’s budget management was bad and its tax evasion is a chronic problem.

• Another major reason for Greek’s financial crisis is ‘Single currency – The Euro’. If Greece was not part of the Eurozone (EU), it could have printed the currency notes(Drachma, the country’s pre-euro currency) and allowed its currency to depreciate, inflation to raise, make the exports competitive, try to revive the economy by creating demand and jobs…similar to the way the USA did after the 2008 global financial crisis. But the Greek Govt cannot do so, as they are part of EU.

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(The wider lesson is that the single currency experiment has been a general disaster and done nothing to help EU nations in the global race for markets.

From an economic standpoint, however, the euro has worked to the advantage of the rich and powerful nations, such as Germany, but to the detriment of poorer nations like Greece. The poor economic performance of the southern European nations drags down the value of the euro. That is great for a country exporting BMWs and Mercedes Benz cars to China. But the robust economic performance of a country like Germany makes the poor nations uncompetitive because of the euro’s relative strength. Greece, along with Italy, Spain and Portugal would be much better off with a weak currency or with their own currencies that could have spurred their home industries and made them globally competitive – Courtesy abc.net)

• The banks or financial institutions like IMF-ECB-EC (International Monetary Fund, European Central Bank & European Commission) which provided financial assistance to Greece levied terms & conditions for the bail out. These terms are known as ‘austerity measures’, to control public spending, to cut the fiscal deficit, to remove subsidies, to increase tax collections etc., These austerity measures have deepened the crisis further(incomes decreased, unemployment rate increased, banks stopped providing loans, standard of living decreased..)

• Greece’s social and political set up also needs to be blamed for the crisis. Greece has a very low productivity rate (though it has one of the longest working hours as a country). It has a very inefficient government. Corruption is very high. Greeks retire earlier compared to other countries. Too many people depend on the workforce to feed them, and there are too few people who work.

To put in a nutshell, the reasons for Greek’s political, social and financial turmoil are

..

• Reckless borrowing by the Greek Government
• Very high non-productive expenditure
• More spending than earning
• Excessive military spending
• Failing to implement financial reforms by the Greek Govt
• High corruption levels
• Tax evasion by the citizens and business houses
• Single Euro zone currency….

The Greek crisis is a COMPETITIVENESS crisis disguised as a FISCAL crisis and now being expressed as a GOVERNANCE crisis.

On 30^th June 2015, Greece failed to make a scheduled debt repayment of about 1.5 Billon euros ($1.7 Billion) to the IMF. Greeks now face a choice (Referendum on 5^th July 2015) – either stick with the bailout offered by troika (IMF-ECB-EC ) and endure the pain of austerity (or) reject the terms of the bailout which may lead to default and possibly, leaving the Euro zone entirely.

If Greece fails and defaults, will this lead to another major worldwide financial crisis? The Greek economy is very small and may not lead to a major global crisis. But, let’s remember the famous quote by Warren Buffet – “Only when the tide goes out do you discover who’s been swimming naked.”

The major learning’s from Greece’s social and economic crisis are –

• Do not over leverage (applicable to an individual or a company or an economy)
• Spending more than earning is always dangerous
• Reckless borrowing should be avoided
• Be productive
• Do not falsify any records
• Do not evade taxes &
• Live within your means