Macro Final Presentation

8/8/2019 Macro Final Presentation

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PRAVEEN


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European Union

An economic and political union of 27 countries

Generates 21% of world gross product 200916 members form Eurozone - economic and monetary union

(EMU)

European Central Bank determines the monetary policy for

these 16 countries union

Common policies in trade, agriculture, fisheries, customs and

migration

Diverse national fiscal policies

Incomplete political union

Economic differences between Northern and Southern

countries(Pareshs slide)

Close relation between European banking system andsovereign credit systems


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Criteria Member states

Allowed limit of 3% of budget deficit

Debt should be below 60 % of GDP

Inflation rate should be no more than 1.5% points higher

than the average of the three best performing countries Long term interest rate be no more than 2% points higher

than the average of the three best performing countries

Of the 27 countries, 20 already crossed these limits

Greece becomes 12

th

country to adopt Euro currency in2001 (through manipulating figures)


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Why EU?

Member states are small to compete in world trade

Meet the challenges of globalisation

To provide a Europe-wide free market to build

competency Single currency and monetary policies to simplify trade

economic, social, technological, commercial andpolitical clout than if its member states had to actindividually

Security Stability and disaster control

Sustainable development- Earth Summit


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EU problems

Milton Friedman was critical of the eurozone when it wascreated skeptical of an economic crisis putting groups

against one another Krugman: didnt think the continent was ready for the

euro experiment, not unified politically Countries were entering the eurozone without having met

the requirements (i.e. Greeces manipulated numbers) Because political unity was never mandated, countries such

as Greece arent held as accountable for high levels of debt,and the Union isnt obligated to prevent fiscal failure


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Background of Greek economy

Greek economic miracle (1950-1975)- average

growth of 7%

25th

largest economy in the world Member of OECD,WTO, Black sea economic

cooperation and EU

High HDI- ranking 22nd

in the world Was facing inefficient bureaucracy, tax evasion

and corruption


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GDP

Maritime industry(4.5 % of GDP)

Tourism (15% of GDP)

High GDP growth in last decade

Public sector- 50% of GDP

Mediocre growth in the 1980s (oil crisis)

Recession (1981-1983)


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Politics

PASOK- socialist party (ruled from 1981 till now, except for abrief spell from 2004-2009)

PASOK was characterized by highly populist policies(excessive capital expenditure and benefits to public sector

employees)

This caused high deficits and inflation

Change of national debt during PASOK reign

1981 1991 1993-2010

25 71%

>100%


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Statistics (2008-2009)

GDP $343 billion (nominal, 2008

est.) 339.2 billion (PPP, 2008

est.)

GDP growth 2.0% (2009)

GDP per capita $29,060 (nominal 2010

estimate); $29,420(PPP 2010

estimate)

GDP by sector agriculture: 3.4%; industry:

20.8%; services: 75.8% (2009

est.)

Inflation (CPI) 5% (2009 est.)

Population

below poverty line

< 2.0% (2009)


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Exports $18.64 billion (2009 est.)

Export goods food and beverages,

manufactured goods,

petroleum products,

chemicals, textiles

Main export partners Italy 11.5%, Germany 10.5%,

Bulgaria 7.1%, Cyprus 6.2%,US 5%, UK 4.7%, Romania

4.4% (2008)

Imports $61.47 billion (2009 est.)

Import goods machinery, transport

equipment, fuels, chemicals

Main import partners Germany 12.1%, Italy 11.7%,

Russia 7.4%, China 5.6%,

France 5.1%, Netherlands

4.7% (2008)


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Major players


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SHRUTI


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A Classic Sovereign Debt Crisis Greece had shifted to the Euro in 2001. October 2009, the newly elected Greek

government revised the estimate of thegovernment budget deficit for 2009 from6.7% of gross domestic product (GDP) to12.7% of GDP

Reliance on financing from internationalcapital markets left Greece highlyvulnerable to shifts in investor confidence

Maturing debt obligations estimated at54 billion for 2010

National debt exceeded 300 billion Euros

Maturing debt obligations, estimated at54 billion ($72.1 billion) for 2010

On April 23, 2010, the Greek governmentrequested financial assistance from otherEuropean countries and the IMF

Fitch ratings called Greece as Euro zone'sweakest member

Greeces debt was 113% of its GDP.


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W

hat caused the Crisis?


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Domestic Factors Budget Deficit stood at 12.7% of GDP in 2009 well above the EUs

agreed-upon 3% of GDP threshold

In the last 6 years, government expenditures increased by 87%,revenues grew by only 31%

High Government Spending

In 2009, Greek government expenditures accounted for 50% of GDP An overstaffed and inefficient public administration in Greece

Costly pension and healthcare systems an aging population,entitlement to a full pension requires only 35 years of contributionand not 40 years

Weak Government Revenues

Informal economy in Greece estimated to represent between 25%-30% of GDP

Tax evasion owing to high levels of taxation and a complex tax code,excessive regulation and inefficiency in the public sector


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Domestic Factors cont.

Declining international competitiveness

High relative wages - have increased at a 5%annual rate since the country adopted the euro,

about double the average rate in the Euro zone asa whole

low productivity - Greek exports to its majortrading partners grew at 3.8% per year, only half

the rate of those countries imports from othertrading partners

Low savings rate


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International Causes

Increased access to capital at low interest rates owing toGreeces adoption of the euro as its national currency in2001 Currency bloc anchored by economic heavyweights Germany

and France

a common monetary policy conservatively managed by theEuropean Central Bank (ECB)

The perceptions of stability conferred by euro membershipallowed Greece to borrow at a more favorable interest rate than

would likely have been the case outside the EU access to artificially cheap credit allowed Greece to accumulate

high levels of debt


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International Causes Cont.

Issues with EU Rules Enforcement The lack of enforcement of the Stability and Growth Pact

(adopted in 1997 by EU members), an agreement to enhancethe surveillance and enforcement of the public finance rules setout in the 1992 Maastricht Treatys convergence criteria forEMU

calls for budget deficits not to exceed 3% of GDP and debt notto exceed 60% of GDP

excessive deficit procedure to be applied to member states thatsurpassed the deficit limit

more than 30 excessive deficit procedures have beenundertaken but EU has never imposed a financial sanctionagainst any member state for violating the deficit limit

Less incentive for EU countries to cut down on debt


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International Causes Cont.

Unsatisfactory quality of public data EUs statistical office, Eurostat, had not certified or had unilaterally

amended data provided by the National Statistical Service of Greecesince 2000

Through creative accounting Goldman Sachs helped Greece meet

the required 3% deficit ratio by using collateralized debt obligationsrendering SGP criteria meaningless

Between 2004 and 2007 revealed that Greece had violated the 3%limit in every year since 2000, with its deficit topping out at 7.9% ofGDP in 2004

Greeces debt had been above 100% of GDP since before Greece

joined the euro Lack of investor confidence and not the level of absolute debt

Slashing prices of Government-backed bonds and credit defaultswaps


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A viewpoint

George Soros new Instituteof New Economic Thinking

Markets are irrational

Global monetary system notfully explained throughmathematical models butpsychology of people

Questions a system where aprivate credit rating agencyhas so much control on anentire nations economy


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SUSHANTH


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Actions Taken

1 Sold Government Bonds

2

Reduced Government expenditure-austerity measures

3 Received financial assistance


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If measures taken are insufficient, either

Default

Restructure Debt


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Restructuring Debt

Companies use debt restructuring to avoid default onexisting debt or to take advantage of a lower interestrate.

A company will often issue callable bonds to allowthem to readily restructure debt in the future. Theexisting debt is called and then replaced with new debtat a lower interest rate.

Companies can also restructure their debt by alteringthe terms and provisions of the existing debt issue.


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SUSHANTH


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Why is EU scared?

Financial contagion refers to

the transmission of a financial

shock in one entity to other

interdependent entities.

Reasons:

inancial links wherebytwo entities are connected

through the international

financial system

real links such as

competitive trade

political links in whichexchange rates are closely

tied

the propensity of a herd

mentality to develop

among investors

EU has a common monetary

but diverse fiscal policies


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Sovereign Debt Crisis

Sovereign default: is a failure by thegovernment of a sovereign state to pay back itsdebt in full.

If potential lenders or bond purchasers begin tosuspect that a government may fail to pay backits debt, they may demand a high interest rate

in compensation for the risk of default. Adramatic rise in the interest rate faced by agovernment due to fear that it will fail to honorits debt is sometimes called a sovereign debtcrisis.

Governments may be especially vulnerable toa sovereign debt crisis when they rely onfinancing through short-term bonds, since thiscreates a situation ofmaturity mismatchbetween their short-term bond financing andthe long-term asset value of their tax base.


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Sovereign Debt Crisis cont.

Since a sovereign government, by definition, controlsits own affairs, it cannot be obliged to pay back itsdebt. Nonetheless, a government which defaults maybe excluded from further credit; some of its overseas

assets may be seized; and it may face political pressurefrom its own domestic bondholders to pay back itsdebt. Therefore governments rarely default on theentire value of their debt.

Instead, they often enter into negotiations with their

bondholders to agree on a delay or partial reduction oftheir debt payments, which is often called a debtrestructuring. The International Monetary Fund oftenassists in sovereign debt restructurings.


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Greek situation vis--vis other European

countries

Yield Spread of Bonds Concept

Market assessment for Default Risk.

Spreads for PIIGS reached record levels since Inception(Euro zone 1999, Greece 2001)

Switch to German bonds Most liquid n safe

Sovereign Credit Rating

Competition from government-backed bank bonds

E.g. UK government-backed bank bonds have higher

ratings than Greece


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countries


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countries


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countries

Contagion : Ring of Fire Concept : Transmission of shocks across countries


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PARESH


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countries

Credit Default Swap(CDS) Concept

Launched a decade ago


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countries

CDS Market Insurance-like contracts that promise to cover losses on certain

securities in the event of a default

Were seen as easy money for banks

The economy was booming and corporate defaults were few

back then, making the swaps a low-risk way to collect premiums

and earn extra cash

CDS market exploded to $45 trillion in mid-2007, twice the size

of the U.S. stock market (which is valued at about $22 trillion andfalling) and far exceeds the $7.1 trillion mortgage market and

$4.4 trillion U.S. treasuries market

Banks and insurance companies are regulated; the credit swaps

market is not


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countries

Credit Default Swap(CDS)


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countries

Credit Default Swap(CDS)


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countries

Less Exposure for US Banks Direct Losses from Lending / Derivatives: limited, especially

compared to European banks The U.S. banking system relies very little on overseas earnings (< 20%)

Tier 1 capital is well in excess of direct exposures

However, indirect impact of an escalating crisis could be

significant: Bank spreads are particularly vulnerable to exogenous shocks in the global

financial system

Negative impact on lending and bank facilities

Contagion through increased systemic risk

Heightens focus on financial regulation (with upward pressure on capital, and

downward pressure on earnings)


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countries

Less Exposure for US Banks


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countries

Current Situation Bailout packages for Greece and Ireland (85-billion ($115-

billion)

Permanent mechanism for Debt Swamped Economies

Each bill, note and bond issued by a euro zone member willinclude legal language laying out what happens in the event

of default.

The 2009 trade deficits for Spain, Greece, and Portugal were

estimated to be $69.5 billion, $34.4B and $18.6B, respectively($122.5B total), while Germany's trade surplus was $109.7B


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countries

European Central Bank Institution of the European Union(EU) and administers the

monetary policy.

Prolong measures to provide ready cash to banks

Bond Buying Program of financially troubled euro zonecountries

Bonds of both Ireland and Portugal rose (Relief)

The bank, the European Union and the 16 governments that

share the euro are struggling to contain a crisis caused by toomuch state debt in some countries. They are trying to reassure

bond investors that countries will not default and keep the

interest rates on their debt loads from rising


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countries

European Imbalance Single Monetary Policy but 16 different Fiscal Policies and single

currency.

Northern European

1) Rely on exports for

economic growth

2)Wage moderation to keep

production costs low

3) Conservative fiscal policiesresulting into high credit

surpluses

4) Pursue policies to

promote export led growth.

Southern European

1) High levels of wage

growth

2) Expansionary fiscal

policies leading to less

competitive exports.

3) Lower savings due to

spending on luxuries.

4) Led to large current

account deficits and hence

borrowing.


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Smitesh


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Bail Out by IMF and EU

On April 23, 2010, Papandreou announced

that Greece would draw on 45 billion as Bail

Out

Total Size: EUR 110 billion

EUR 80 billion from Euro nations

EUR 30 billion from IMF

Cost: Approximately 5%

Duration: 3 years


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Other Options considered

Raise debt in capital markets: too little demandfor Greek debt; pricing too high

EU Debt guarantees : violation of EU treaties

EU Bond issuance : reconciliation with EUtreaties challenging

Bilateral arrangements: moral hazard

issues; little German domestic support

Infrastructure advances: not sufficient

size


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Austerity Measures: Aim


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MEASURES TAKEN

1: Revenue Raising Initiatives

Increase value added tax from 19% to 21%

Excise tax on petrol, alcohol, cigarettesand luxury goods

Sale of selected state assets

Taxing illegal construction 2: Expenditure Reductions

Reduce public sector wages and pensions

Reduce size of public investmentprograms

Reduce education expenditures

Banning increases in public sector salaries

and pensions for at least three years Capping annual holiday bonuses and axing

them for higher earners


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The role of IMF and EU

EU has embarked on a path of not justintensely monitoring Greek policy, but actuallysteering it

Greek interest rate policy: to be determinedby the European Central Bank

Greek currency policy: to be determined by

the EMU Greek fiscal policy: monitored by the EU &

IMF


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Sivaharsh


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countries

Long term Solutions

1)

Creation of European Financial Stability Facility

European Treasury

2)

Cross Border capital flows remain unregulated

Balance of Payments to be satisfied

3)

If large current account or trade deficit then country must borrow to pay forthe imports

Conversely, if large trade surplus, i.e., net exporter should lend money to bycapital to buy their goods


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countries

Long term Solutions

4)

The 2009 trade deficits for Spain, Greece, and Portugal wereestimated to be $69.5 billion, $34.4B and $18.6B, respectively($122.5B total

Germany's trade surplus was $109.7B.

5)

A country with a large trade surplus would generally see thevalue of its currency appreciate relative to other currencies

However, many of the countries involved in the crisis are on theEuro, so this is not an available solution at present

6)

Alternatively, trade imbalances might be addressed bychanging consumption and savings habits.

For example, if a country's citizens saved more instead ofconsuming imports, this would reduce its trade deficit.


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countries

Long term Solutions

7)

Likewise, reducing budget deficits is another method of raising a country's levelof saving.

Capital controls that restrict or penalize the flow of capital across borders isanother method that can reduce trade imbalances

8)

High Interest rates to encourage domestic saving, although this benefit is offsetby slowing down an economy

The suggestion has been made that long term stability in the euro zone requiresa common fiscal policy

9)

Unjust crisis management & call for additional regulation of banking sector.

Over 23 million EU workers have become unemployed as a consequence of theglobal economic crisis of 2007-2010, whilst thousands of bankers across the EUhave become millionaires despite collapse or nationalisation .


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How Greek Concealed the Debt

Simple!!! Accounting Techniques.

Paid Goldman Sachs and

Swaps- Over the Counter (OTC) Derivatives based onexchange of cash flows

swap agreement defines the dates when the cash flowsare to be paid and the way they are calculated

Usually at the time when the contract is initiated atleast one of these series of cash flows is determined by

a random or uncertain variable such as an interest rate,foreign exchange rate, equity price or commodity price.

swaps can be in cash or collateral


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Currency Swaps

Government debt issued in dollars and yen wasswapped for euro debt for a certain period -- to beexchanged back into the original currencies at a laterdate.

For example, suppose a U.S.-based company needs toacquire Swiss francs and a Swiss-based company needsto acquire U.S. dollars. These two companies couldarrange to swap currencies by establishing an interestrate, an agreed upon amount and a common maturity

date for the exchange. Currency swap maturities arenegotiable for at least 10 years, making them a veryflexible method of foreign exchange.


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Fictional Exchange Rates

US bankers devised a special kind of swap withfictional exchange rates.

Helped Greece receive a far higher sum than

the actual euro market value. In that way Goldman Sachs secretly arranged

additional credit worth billions for the Greeks

The Maastricht rules can be circumventedquite legally through swaps

Standards modified in 2007 to prevent this


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European Integration

Single Monetary Policy

16 Separate fiscal Policies

Combined with conservative fiscal policies that promotehigh levels of savings, a northern countries have run large

current account surpluses. Southern European countries, like Greece, have had higher

levels of wage growth and more expansionary fiscalpolicies, leading to less competitive exports and lowerlevels of savings.

These countries have run large current account deficits andborrowed to finance these deficits.

To Bridge the imbalance a fiscal policy integration to someextent is required


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Thank you


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Questions


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Impact of Crisis

Greece is already in major breach of Euro-zone rules ondeficit management and with the financial marketsbetting the country will default on its debts, thisreflects badly on the credibility of the euro.

Impact on private individuals:

The most obvious way would be through tax bills, asEurope agrees to ride to the rescue and help Greecedeal with its mounting public and foreign debts.

Any assistance to Greece will come at a cost that willultimately have to be borne by taxpayers in the nationsthat contribute.


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Contagion Effect

Greek crisis has made investors nervous about

lending money to governments through buyinggovernment bonds. Everybody's interest rates areheading higher as governments are having to paya greater risk premium to borrow money.

Reduced wealth:Take-home pay is likely to fall as it is eroded by

rising taxes and everyone will have to work longerbefore they retire - by which time they are likelyto find that their pensions have shrunk

Slower recovery

The crisis is also set to slow down the embryoniceconomic recovery.


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Strikes and demonstrations have long been a way

of life in Greece

Greece's adjustments to its new economic reality

won't be fair. For instance, if you turned 60 in2009, you're comfortably retired. If you turned 60

in 2010, you'll need to work seven more years

Greek VAT (Value Added Tax, a national sales tax)will incrementally rise from 19 percent to 25

percent


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Result of the measures taken

central government revenues coming in

closely as expected

firm expenditure control in the state budget

Progress in the structural reforms in areas

such as local administration, privatization,

labour market, and tax administration


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Conclusion

Greeces Debt Crisis has put the EU under thescope, & it has shifted the attention to theefficiency & the success of the Euro-zone. Itsconsidered as probably the biggest test the EU (&

the EMU-in particular) has gone through. Howthe EU & Greece are handling the crisis with thewhole bail-out plan will reflect to what extent theEU is able to function on its own as a powerful

economic entity. Its too early yet to measure the effectiveness of

the bail out plan.


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Thank you


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Background to Greek economy

Greece had shifted to the Euro in 2001.

European integration helped an otherwiseweaker economy to raise billions of dollars in

capital. It further lowered its interest rates onthe German model.

This money was principally used to finance

larger government spendings.

High government spending and crowding out

effects


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Background to Greek economy

Greece had shifted to the Euro in 2001.

European integration helped an otherwiseweaker economy to raise billions of dollars in

capital. It further lowered its interest rates onthe German model.

This money was principally used to finance

larger government spendings.

High government spending and crowding out

effects


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Greek situation vis vis other European


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countries

Long term Solutions Unjust crisis management

Over 23 million EU workers have become unemployed as a

consequence of the global economic crisis of 2007-2010, whilst

thousands of bankers across the EU have become millionairesdespite collapse or nationalisation (ultimately paid for by

taxpayers) of institutions they worked for during the crisis, a fact

that has lead many to call for additional regulation of the banking

sector across not only Europe, but the entire world



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countries

Long term Solutions Creation of European Financial Stability Facility & European

Treasury

Cross Border capital flows remain unregulated.

Country that runs a large current account or trade deficit (i.e., itimports more than it exports) must also be a net importer of

capital; this is a mathematical identity called the balance of

payments. In other words, a country that imports more than it

exports must also borrow to pay for those imports. Conversely,

Germany's large trade surplus (net export position) means that it

must also be a net exporter of capital, lending money to other

countries to allow them to buy German goods.



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countries

Long term SolutionsThe 2009 trade deficits for Spain, Greece, and Portugal were

estimated to be $69.5 billion, $34.4B and $18.6B, respectively

($122.5B total), while Germany's trade surplus was $109.7B.

A country with a large trade surplus would generally see thevalue of its currency appreciate relative to other currencies,

which would reduce the imbalance as the relative price of its

exports increases. This currency appreciation occurs as the

importing country sells its currency to buy the exporting

country's currency used to purchase the goods. However, many

of the countries involved in the crisis are on the Euro, so this is

not an available solution at present.



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countries

Long term SolutionsAlternatively, trade imbalances might be addressed by changing

consumption and savings habits. For example, if a country's

citizens saved more instead of consuming imports, this would

reduce its trade deficit. Likewise, reducing budget deficits isanother method of raising a country's level of saving. Capital

controls that restrict or penalize the flow of capital across

borders is another method that can reduce trade imbalances.

Interest rates can also be raised to encourage domestic saving,

although this benefit is offset by slowing down an economy andincreasing government interest payments

The suggestion has been made that long term stability in the

euro zone requires a common fiscal policy

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