Background on Greece’s Debt Crisis “You cannot spend more than (what) you earn…you should not borrow more than (what) you can afford. ” This, according to an editorial published by the Greek newspaper Kathimerini, may be the lesson Greeks are now learning the hard way. 1 Unrestrained spending of successive Greek governments over a long period may have driven the country’s budget and current account deficits. 2 Greece borrowed heavily from international capital markets to finance public sector jobs, pensions and other social benefits. 3 As deficits and the country’s debt burden grew, the governments just kept on borrowing. When Greece joined the eurozone in 2001, it gained monetary stability and was able to borrow at lower interest rates – thus, encouraging the country’s habit of borrowing. However, while government spending and borrowing increased over time, tax revenues on the other hand, weakened due to widespread tax evasion. 5 From 2001 to 2009, Greece reported an average budget deficit of 6. 4% per year compared to a Eurozone average of 2. 6%. Current account deficits, on the other hand, averaged 9. 4% of GDP per year. In 2009, Greece had an estimated budget deficit of 13. 6% of GDP, with an accumulated government debt of 115% of GDP.
Both Greece’s budget deficit and debt levels are well above those permitted by the EU Stability and Growth Pact (Amsterdam, 1997). Under the rules of the SGP, the ratio of government deficit to GDP should be no more than 3% and the ratio of government debt to GDP should be no more than 60%. 6 Greece’s reliance on external financing for funding budget and current account deficits left its economy highly vulnerable to shifts in investor confidence. 7 Investor confidence had declined rapidly since late 2009 when the new socialist government of Prime Minister George Papandreou revised the 2009 budget deficit from 6. 7% of GDP to 12. % of GDP. Investors became more alarmed when the Greek authorities admitted that previous figures had been misleading. 8 As a result, Greece’s credit rating suffered successive downgrades from the three major rating agencies (i. e. , Fitch, Moody’s and S). With the lowest rating in the eurozone, Greek bonds are now viewed as a highly risky investment by foreign investors. 9 Consequently, Greek bond yields increased in 2010. Greek 10-year bond yields used to be 10 to 40 basis points above German 10year bonds prior to the crisis. However, with the crisis, the spread increased to over 400 basis points in January 2010.
This high bond spread further underscores investors’ loss of confidence in the Greek economy. 10 In April 2010, Eurostat, the Statistical Office of the European Communities, estimated Greece’s budget deficit to be 13. 6% of GDP – almost a full percentage higher than the 12. 7% estimate 1 2 “Back down to earth with a bang,” http://www. ekathimerini. com/4dcgi/_w_articles_columns_1_08/03/2010_115465 For example, see “Is Greece Heading for Default? ,” Oxford Economics, January 29, 2010. “Q: Greece’s economic woes,” http://news. bbc. co. uk/2/hi/business/8508136. stm “Q&A: Greece’s financial crisis explained,” http://edition. nn. com/2010/BUSINESS/02/10/greek. debt. qanda/index. html 3 Wikipedia. “2010 European Sovereign Crisis,” http://en. wikipedia. org/wiki/2010_European_sovereign_debt_crisis 4 “Back down to earth with a bang,” http://www. ekathimerini. com/4dcgi/_w_articles_columns_1_08/03/2010_115465 5 “Q: Greece’s economic woes,” http://news. bbc. co. uk/2/hi/business/8508136. stm 6 European Commission – Eurostat. “Europe in Figures: Eurostat Yearbook 2009” 7 Congressional Research Service. “CRS Report, Greece’s Debt Crisis: Overview, Policy Responses, and Implications,” April 27, 2010. “Is Greece Heading for Default? ,” Oxford Economics, January 29, 2010. 9 “Q&A: Greece’s financial crisis explained,”http://edition. cnn. com/2010/BUSINESS/02/10/greek. debt. qanda/index. html 10 Congressional Research Service. “CRS Report, Greece’s Debt Crisis: Overview, Policy Responses, and Implications,” April 27, 2010. previously released by the Greek government in October 2009. This further increased investor nervousness and revived questions about Greece’s ability to repay its debts. 11 Greece’s debt is estimated at 300 billion euros with part of it maturing in mid-May 2010.
Despite austerity measures and sales of additional Greek bonds, fears of a possible default continued to spread along with speculations on other courses of action the Greeks may take. Greece: Current Economic State Between 2000 and 2007, the Greek economy grew as GDP increased by about 4. 0% per year. However, the growth dropped to 2% in 2008 and contracted by 2% in 2009, bringing the country into recession. This decline may be attributed to the global financial crisis and Greece’s failure to address the fiscal problems. Unemployment rose to 9. 5% in 2009 from 7. 7% of the previous year.
On the other hand, inflation went down by nearly 3 percentage points. Price levels show an uptrend since 2003, almost reaching the EU average in 2009. With Greece taking a step towards comprehensive structural reforms to address its current debt crisis and restore competitiveness, the Organisation for Economic Co-operation and Development (OECD) in its Economic Outlook No. 87, provided the following projections for Greece: Source: OECD Economic Outlook No. 87 11 Congressional Research Service, “CRS Report, Greece’s Debt Crisis: Overview, Policy Responses, and Implications,” April 27, 2010.