Causes of Currency Crisis
Question:
A number of currency crises have affected certain countries, which have also resulted in contagion in the sense that the crises affected neighboring countries. In a critical essay, select a country (or countries) affected by a specific currency crisis. Analyze the source of the crisis and the specific resolution of the issue. Indicate whether the International Monetary Fund (IMF) or another sovereign state or country provided intervention.
Currency crisis is a severe economic crisis that every country wants to avoid. This crisis often leads to real economic crisis such as, default crisis or a banking crisis. In this situation, countries face unexpected fluctuations in their value of the currencies for a variety of reasons, which has a wider impact on the markets. The sudden volatility of currency crisis causes speculation in the foreign exchange (forex) market. During currency crisis, the investors have serious doubt about the central bank’s reserve of foreign exchange that is required to maintain a fixed exchange rate. It usually originates from chronic deficits in the balance of payments of the country and leads to devaluation or depreciation of the currency (Candelon, Dumitrescu & Hurlin, 2014).
In the world economy, Greece is facing a long term economic crisis, which was generated from currency crisis. The country is one of the most struggling economies of the world. The United Nations data says that, Greece has been facing the longest period of recession, that is, negative GDP growth for almost 63 months, since the third quarter of 2008 to second quarter of 2014 (Featherstone, 2015). With the help of other developed countries of European Union and IMF, the country recovered slightly in the early 2014 but it again started to contract by the end of 2014. Currency crisis is often associated with the government’s debt crisis, which is still poking the Greece economy and the country cannot recover from it.
The debt crisis in Greece is also known as the Greek Depression. It is an after-effect of the global financial crisis of 2007-08. The Greek crisis was triggered by the great recession in the world economy and the structural weakness of the economy of the country (Candelon, Dumitrescu & Hurlin, 2014). It can be said that the causes of the Greek crisis is mostly endogenous in nature as it was largely originated from the mismanagement of the economy of the nation and of the government finances. Along with that, the membership of Greece in the EU has prevented the country to exercise full control on its monetary policies. Hence, the rates of interest were kept at a very lower level for a long time, while the inflationary pressures kept building up in the economy (Christodoulakis, 2013). Thus, the monetary policy were absolutely out of sync with the booming economy and easier access to credit was not there due to mismanagement in the government.
As stated by Kindreich (2015), there are two primary causes of the Greek financial crisis. Firstly, the Greek economy was facing heavy challenges due to the economic mismanagement in the governmental levels, which includes corruption, fraud, absence of public accountability. Secondly, the membership of Greece in the Eurozone has imposed an economic jacket on it, which was illfitted and very much inconsistent with the financial and political goals of the country. Greece has been suffering from the severe economic mismanagement from successive governments and that has contributed in triggering the financial crisis. There were many warning signs that the economy was going down, which the investors failed to recognize. For example, the unsustainable levels of debt, excessive amount of public spending, high growth of wage but not supported by the growth in productivity that led to a fall in the competitiveness of Greece, a flow in the credit growth and massive tax evasion (Nytimes.com, 2016).
The Impact of Currency Crisis on Greece’s Economy
Kirk (2017) highlights that apart from the global financial crisis triggered from the bank failures in the USA, there were many endogenous reasons within the Greek economy that led to the massive downfall. Firstly, the inefficient pension system of Greece utilized almost 17.5% of the GDP on the pension payments. It was the highest pension payment among the EU in 2012 (Kentikelenis et al., 2014). This system is not only highly priced, but also highly political and fragmented. Hence, when the country faced a bailout, it struggled to pay the pensioners. Secondly, the government employees in Greece received some of the best benefits. Some atypical bonuses, such as, bonus for reaching office on time were also in practice. The financial austerity measures launched by the government later on eliminated such unnecessary government spending. Thirdly, provisions for early retirement have put a pressure on the government to pay pensions to a large number of population. Fourthly, Greece suffered from high level of unemployment, which is 25.6% and there were issues in the work culture (Ehrmann & Fratzscher, 2015). As the country cannot print its own currency to increase the money supply in the economy, hence, the businesses suffered from lack of funds to pay to their workers. This has been affecting the work culture badly. Lastly, the country struggled to collect the taxes from the citizens, especially from the rich people. Massive tax evasion posed a big problem because the national debt of Greece mounted to 177% of its GDP (Nytimes.com, 2016). Greece failed to create an equitable tax system.
Buckley (2015) points out that, the Greek voters did not support the financial austerity programs that were much needed to lift up the economic condition. There has been argument that if Greece should go out of the Eurozone and print their own currency, that is, Drachma. However, the voters wanted to retain the Euro as their currency. When the country is facing a huge downfall, it is most natural for the central bank to print more currency and inject the flow of money into the economy. However, Greece could not do that, as it is a member of the Eurozone. The Greek Finance Minister admitted in 2004 that it fudged the budget figures earlier to gain an entry into the Eurozone in 2001. The actual budget deficit of Greece was 4.13% and 6.44% during that time, while it needed to be less than 3% to gain an entry into the Eurozone (Featherstone, 2015). The failure of pricing the credit risk also posed a problem. Before entering the eurozone, Greece was competitive in the global market due to floating exchange rates, but after joining the eurozone, the Greek economy lost this power of adjusting the exchange rate and the drachma devalued quite continuously over the decades. This happened due to the reason that average Greek production is much less than that of other developed countries within the eurozone (Christodoulakis, 2013).
The Greek currency crisis or debt crisis further aggravated due to the fact that, the country received much loans from the other financially strong countries and IMF but could not repay those. As the economy was a victim of mismanagement, hence, after 2010, the country was banned to borrow from the international financial markets. This resulted in further bankruptcy in Greece and set off a new set of crisis. When the country was facing issues, it was not being able to depreciate its currency, which made the situation worse. To become more competitive in the market, the wages fell almost 20% between 2010 and 2014 (Kindreich, 2015). As the situation was getting worse, the Greek government announced that the citizens who have Swiss bank accounts must pay taxes or reveal the information. However, this did not happen even by 2015 and the amount of evaded tax was almost €80 billion, which was stored in the Swiss banks. Hence, the incidence of tax evasion is still continuing. The government of Greece borrowed money from the international financial market but it failed to repay those loans.
Primary Causes of the Greek Financial Crisis
Figure 1: Level of Greek debt compared to average of Eurozone
(Source: Reddy, 2015)
To improve the economic situation, Greece sold government bonds in 2010 and through this step, Greece attracted around €16 billion worth of demand for bonds. However, the situation still remained worse. The global financial markets started to lose its faith on Greece economy and the EU ministers agreed on bailout terms for Greece. In 2010, a €30 billion rescue package was announced to help the country by EU. The country further asked for additional help from IMF and the bailout was increased to €45 billion (Donnan, 2017). However, the country failed to repay the loans and asked for further bailout from Troika.
To avoid the further downfall, the International Monetary Fund, European Commission and European Central Bank, known as Troika issued total three international bailouts for the country, which totaled up to almost €246 billion (Buckley, 2013). The bailouts came with many austerity conditions. The lenders imposed many quite harsh conditions for the Greek economy such as, deep cuts in budget and steep rise in tax. They also needed Greece to fix the economy by ending the tax evasions, streamlining the activities and management of the government and making Greece a easier and profitable place for doing business.
These bailouts partially stabilized the Greek economy but it also came with big costs, such as, generation of a chronically high level of unemployment, plummeting incomes of the people and widespread poverty (Wearden, 2012). The real GDP of Greece contracted by almost one-fourth during the period of 2009 to 2015. The more the amount of bailouts provided to the country, the more harsh are the conditions imposed by the country, which made the citizens agitated.
There is also risk of Greece being a defaulter. If Greece defaults, there will be an immediate effect on the EU economy. The consequences would be big as the Greek banks would go bankrupt as they would not get loans from ECB. The huge loss could threaten the solvency of the other banks in the eurozone, especially those in the Germany and France, as, these banks along with some private investors hold almost €34.1 billion in the debt of Greece. The eurozone governments hold €52.9 billion in addition of €131 billion of EFSF. The smaller countries, who have a bigger portion in Greece’s debt, such as, Finland with 10% of its annual budget, would be hit hard if Greece defaults. Among all, the amount of debt of IMF is the maximum. IMF owns almost €21.1 billion to Greece (Munevar, 2016).
Figure 2: Share of the countries in the debt of Greece
(Source: Ruccio, 2015)
Figure 3: Countries owing to Greece in bailouts
(Source: Ruccio, 2015)
Figure 4: Break-down of the Greek bailouts
(Source: Thompson, 2015)
Even after receiving huge amount of money in bailouts, Greece still could not recover from its situation. The bail out money was meant for buying time for Greece to stabilize the finances. The Greek economy shrank in the past five years and unemployment rose upto 25%. Greece utilizes the bailout money for paying off the international loans, rather than making internal developments (Kosmidou, Kousenidis & Negakis, 2015). Hence, the nation is not experiencing any economic growth by utilizing the bailout money and the government of Greece still has a staggering debt load, which it cannot pay back. The Greek economy now needs to develop its internal conditions to improve its production and GDP to make progress. Due to such a deep downfall, the other members of EU have their lost their faith on the Greek economy and hence, flow of investment has declined. The relation between Greece and the other countries of Europe are in a fragile condition. The Greek economy must continue to repair its endogenous factors that developed from the currency crisis under the bailout terms to improve its economic condition (Li, Sy & McMurray, 2015).
Conclusion
From above essay, it can be said that, Greece has been suffering from a severe economic crisis for the past decade. The foreign exchange reserve of the country has declined so much that it cannot repay back those loans and it is going down the line to become a defaulter. IMF, European Commission and European Central Bank have provided total three bailouts, worth of €246 billion and still Greece could not recover from its debt crisis. Economic and governmental mismanagement, fixed exchange rate, tax evasion, higher pension payments, and unable to devalue the currency were the major reasons for this currency crisis in Greece. People had lost confidence in the economy and that resulted in further downfall. The European officials had taken the decision to help Greece by providing bailouts, which the country utilized in repaying the debts. However, higher value of currency, that is, euro, has worsen the situation of the country by making its exports costlier and imports cheaper. Thus, it can be said that Greece economy still has a long way to go to recover from the currency crisis
References
Buckley, R. (2015). Real reasons behind the Greek crisis: inefficiency and a fudged budget deficit. The Sydney Morning Herald. Retrieved 21 December 2017, from https://www.smh.com.au/comment/real-reasons-behind-the-greek-crisis-inefficiency-and-a-fudged-budget-deficit-20150706-gi5xca.html
Candelon, B., Dumitrescu, E. I., & Hurlin, C. (2014). Currency crisis early warning systems: Why they should be dynamic. International Journal of Forecasting, 30(4), 1016-1029.
Christodoulakis, N. (2013). Currency crisis and collapse in interwar Greece: predicament or policy failure?. European Review of Economic History, 17(3), 272-293.
Donnan, S. (2017). IMF board split over bailout terms for Greece. FinancialTimes.com. Retrieved 21 December 2017, from https://www.ft.com/content/6756e4f6-ece6-11e6-930f-061b01e23655
Ehrmann, M., & Fratzscher, M. (2015). Euro area government bonds: Integration and fragmentation during the sovereign debt crisis.
Featherstone, K. (2015). External conditionality and the debt crisis: the ‘Troika’and public administration reform in Greece. Journal of European Public Policy, 22(3), 295-314.
Kentikelenis, A., Karanikolos, M., Reeves, A., McKee, M., & Stuckler, D. (2014). Greece’s health crisis: from austerity to denialism. The Lancet, 383(9918), 748-753.
Kindreich, A. (2015). The Greek Financial Crisis (2009–2016). Financial Scandals, Scoundrels & Crises. Retrieved 21 December 2017, from https://www.econcrises.org/2017/07/20/the-greek-financial-crisis-2009-2016/
Kirk, A. (2017). European debt crisis: It’s not just Greece that’s drowning in debt. The Telegraph. Retrieved 21 December 2017, from https://www.telegraph.co.uk/news/0/european-debt-crisis-not-just-greece-drowning-debt/
Kosmidou, K. V., Kousenidis, D. V., & Negakis, C. I. (2015). The impact of the EU/ECB/IMF bailout programs on the financial and real sectors of the ASE during the Greek sovereign crisis. Journal of Banking & Finance, 50, 440-454.
Li, L., Sy, M., & McMurray, A. (2015). Insights into the IMF bailout debate: A review and research agenda. Journal of Policy Modeling, 37(6), 891-914.
Munevar, D. (2016). How the IMF Contributed to Destabilizing the Greek Economy. Globalresearch.ca. Retrieved 21 December 2017, from https://www.globalresearch.ca/how-the-imf-contributed-to-destabilizing-the-greek-economy/5557987
Nytimes.com. (2016). Explaining Greece’s Debt Crisis. Nytimes.com. Retrieved 21 December 2017, from https://www.nytimes.com/interactive/2016/business/international/greece-debt-crisis-euro.html
Reddy, S. (2015). Greece Financial Crisis..Why Greece’s economy failed? Lessons from it… ReLakhs.com. Retrieved 26 December 2017, from https://www.relakhs.com/greece-financial-debt-crisis-reasons/
Ruccio, D. (2015). Greek debt crisis. [online] Real-World Economics Review Blog. Available at: https://rwer.wordpress.com/2015/07/03/greek-debt-crisis-by-the-numbers-7-charts/ [Accessed 26 Dec. 2017].
Thompson, M. (2015). Greece shuts banks in bid to prevent collapse. CNNMoney. Retrieved 26 December 2017, from https://money.cnn.com/2015/06/28/news/economy/greece-banks-ecb/index.html
Wearden, G. (2012). Greece debt crisis: timeline. the Guardian. Retrieved 21 December 2017, from https://www.theguardian.com/business/2012/may/05/greece-debt-crisis-timeli
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