Greece’s, debt crisis was built up by a long history of problems with its public debt. Many years of unrestrained spending, cheap lending and failure to implement financial reforms make the Greek government badly exposed when the global economic downturn struck. The recession made it difficult to sustain their borrowings since the tax revenues were declining as welfare payments increases.
As investors were losing confidences in the Greek government, they started demanding very high interest rate as they were afraid that the risk of default was also high. This implied the higher the borrowing costs was, the harder it became for Greece to be out of this mess.
Things went out of control when the Greek government’s credit rating was downgraded and the cost of borrowing went even higher causing its international overdraft facility to be cancelled overnight. In fear of being bankruptcy, Greece turned to the European Union and the International Monetary Fund (IMF) for financial assistance. The central banks also played the role of providing liquidity in the region.
The fear was that the Greek default would spread into the Eurozone, so the European leaders, Greek government, central banks and the IFM responded with policies from 2010 to avoid the Greek default. They provided loans to Greece at market-based interest rates. The payment of funds was conditional on the implementation of economic reforms.
The Greek government undertook ambitious fiscal consolidation measures and economic reforms. In order to reduce the government deficit a program was outlined in May 2010 aiming to cut the deficit below 3% of GDP by 2014. The objectives of this program were to cut public spending and enhance revenue growth through tax increases and a crack-down on tax evasion. In 2011 as the crisis became worse, the government approved an additional round of austerity measures and structural reforms.
The policy responses had some consequences. Policy responses were successful in avoiding the Greek default but were less successful in putting Greece in path in terms of crisis recovery up to now. The debt even accumulated between 2010 and 2011 and is also expected to increase in 2012. Most of the analysts argued that the path towards debt was hindered by lack of growth in the Greek economy and the policy responses did not provide enough assurance to bond markets to prevent the spread of debt crisis to other Euro zone countries.
Besides Greece being a small economy accounting for around 2.4% of the total Euro zone GDP, the implications of the debt crisis were far reaching. The policy response to the Greece debt crisis has set precedents for how the debt crises in other Euro zone countries have been handled. This also raised concerns about the health of the fragile European financial sector. Greece debt crisis created new financial liabilities of the European countries. The policy constraints in the Euro zone were highlighted arguing that if Greece was not a member of EU the currency could have been used to reduce the impact of the crisis. The Greek crisis has sparked a broader re-examination of EU economic governance, in order to improve the long-term functioning and stability of the currency union. Greece debt crisis has posed challenges to and opportunities for deeper EU integration.
Author: Fortue Murambadoro