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What is Greece Debt crisis in laymen terms?
It starts with the government of Greece and their citizens. The government paid out generous pensions and benefits to its pensioners, as well as having an early retirement age for many government employees, as compared to other developed countries. This lead to a drop in productivity coupled with a high unemployment rate, while others believed they were too old to work and took early retirement to access the pension benefits. This lead to the government paying out more in pensions and benefits. However the government never had enough money to sustain the welfare system at this level.
If a country is spending by taking on additional debt, then it also needs to collect equal or more revenue to meet those spending figures.
Greece however has a history of and reputation for ineffective tax collection. This means that Greece had limited revenue collection while its national debt was on the rise. The country’s unemployment rate shot up along with its national debt.
So when the money was exhausted, the Greek government looked to the Eurozone to bail them out. It was originally agreed that only those countries whose budget deficit was less than 3 percent of GDP could be part of the Eurozone . It is now believed that Greece’ budget deficit was four times its prescribed limit, i.e. 12% of GDP. However Athens needed money to survive, so the government employed some creative accountancy to meet this 3% criteria. The country then adopted the euro currency in 2002 and Greece avoided a default.
As a result, Greece got more credit from its neighboring countries, but its fundamental problem never changed. People were not taking up enough jobs, while the government continued to pay high pensions and generous benefits, with paltry tax collections. The national debt shot up yet again. In 2009, Greece admitted that they altered country’s accounts and budget deficit was actually 12 percent of GDP instead of 3 percent it stated earlier.
Prominent rating agencies Fitch, Moody’s and S&P frightened the creditors and investors by downgrading the country’s credit ratings pushing bond yields to alarming levels. This aggravated the situation as lower credit ratings would also mean costlier future loans and Greece was running out of options to raise funds to repay its debt.
The European Union (EU) and International Monetary Fund (IMF) decided to bailout the country by providing much needed bailout package of 110 billion euros in 2010 followed by 100 billion euros in 2012 in return of severe austerity measures to be implemented by the Greek government. The money was only good enough to repay its interest cost and keep its centralized banks barely running. The austerity measures taken by the government further slowed down the economy as people were not ready to accept the measures. Unemployment shot up again, bond yields rose, people started leaving Greece, GDP to debt ratio was 175% and voters were looking for a new government that could put an end to austerity measures.
In June 2015, European Central Bank (ECB) stopped emergency funding to Greece. Banks in the country were shut down, capital controls were imposed. On July 2, Greece failed to repay its scheduled 1.55 billion euro payment to IMF becoming the first developed country to miss its payment. A referendum on whether to accept bailout terms or exit Eurozone (also referred to as Grexit) was scheduled for July 5. In a crucial referendum held on July 5, 61 percent of Greek voters rejected the terms of new financial help from EU which included pension cuts in Greece and demands for tax hikes. The result will further increase the probability of Greece exiting the euro zone.
What will happen if Greece defaults?
If Greece fails to accept the bailout terms then it will default on its loan leading to jitters in the equity markets across the globe. The situation in Greece will lead to similar situations in several other debt-laden European countries like Portugal, Ireland, Italy and Spain. A default by Greece will increase the probability of other countries to follow suit. France and German banks have lent huge money to all these countries. Hence, a default by several countries will shake the financial system of stable countries in EU like France and Germany.
For Greece, exit from Europe will mean they would drop the euro and adopt the Drachma as their currency. Drachma would be severely devalued post exit which will make exports more attractive and competitive compared to other countries.
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