Significance of the study
The European debt crisis, which began in Greece in 2010 and quickly affected other nations, has garnered significant attention from economic researchers and policymakers worldwide This crisis is viewed as a subsequent phase and a direct consequence of the global financial crisis.
In 2008, governments faced severe debt challenges, resulting in credit rating downgrades and a deteriorating economy characterized by increasing unemployment and political instability This crisis not only impacted many nations but also cast a shadow over the global market, with Vietnam experiencing similar adverse effects.
Vietnam faces challenges with a high budget deficit, elevated public debt ratio, and decreasing investment efficiency, making it somewhat vulnerable to the European sovereign debt crisis While currently within a safe zone, experts, including those from the International Monetary Fund, warn that Vietnam could approach a debt crisis within the next decade if conditions do not improve This situation underscores the urgent need for enhanced public debt management and crisis prevention strategies The European debt crisis has provided valuable lessons for Vietnam to address its economic issues more effectively.
Realizing the significance of this issue, this graduation thesis is conducted under the topic “The European Sovereign Debt Crisis and Lessons for Vietnam”
Research purposes
This graduation thesis provides a comprehensive analysis of the European sovereign debt crisis, detailing its evolution, causes, impacts, and policy responses It also examines the crisis's effects on the Vietnamese economy and offers recommendations to enhance the country's public debt management.
Research questions
To achieve the purposes, the following questions are raised in this working paper:
1 How did the European sovereign debt crisis spread in Europe?
2 What are the causes and its effects on European countries?
3 How did Europe react to this contagious issue?
4 To what extent has it influenced the Vietnamese economy and what can Vietnam learn from the crisis in sovereign debt crisis prevention?
Research methods
This thesis utilizes credible secondary data, including statistics, reports, working papers, and research studies from reputable institutions and economic experts, to draw conclusions on the topic The research employs qualitative data analysis methods, encompassing the entire process from data collection to interpretation.
Research structure
Sovereign Debt
Sovereign debt, often referred to as public, government, or national debt, encompasses the total liabilities of a government, including debts guaranteed by the government According to the World Bank, this type of debt reflects the overall financial obligations of a nation, while the International Monetary Fund defines it as the responsibility to settle debts incurred by both the public financial sector and the public non-financial sector.
Sovereign debt is influenced by a country's economic and political conditions In Vietnam, it is specifically categorized into three types: government debt, government-guaranteed debt, and debt incurred by local authorities.
It is often measured compared to Gross Domestic Product (GDP) (Mankiw, 2010)
There are certain criteria in classification of sovereign debt, and each criterion has a different meaning in the management and ultilization
Domestic debt consists of obligations owed by debtors, including individuals and institutions, within a country, while external debt involves liabilities to foreign governments, international financial institutions, and foreign entities Both types of debt serve as crucial indicators for assessing a country's balance of international payments.
Short-term debt refers to obligations that must be repaid within one year, while long-term debt extends beyond that timeframe Governments often utilize short-term debt to finance developmental projects such as hydroelectric initiatives, infrastructure, and national defense To maximize profits, commercial banks and insurance companies must strategically balance their investments between short-term and long-term debts.
Productive debt refers to loans that generate income sufficient to cover both the principal and interest, effectively making them self-liquidating within the asset's lifespan In contrast, unproductive debt is incurred for financing assets or expenditures that do not enhance economic productivity, requiring repayment from alternative revenue sources, such as taxation.
Redeemable debt refers to terminable obligations where both the principal and interest must be repaid upon maturity, while irredeemable debt has an infinite maturity period, with the government required to make regular interest payments.
Sovereign debt typically arises from voluntary investments by individuals and institutions looking to invest surplus funds However, in times of emergencies or inflationary periods, governments may need to exercise their authority to secure loans, leading to the issuance of compulsory debt This type of debt is created when the government mandates subscriptions to its bonds, ensuring necessary funding during critical times.
Debt can be classified into various categories, including funded and unfunded debt based on maturity, as well as marketable and non-marketable debt depending on the exchangeability of government loans Additionally, distinctions can be made between gross and net government debt, highlighting the different aspects of a government's financial obligations.
According to Law on Public Debt Management of Vietnam, public debt is divided by different criteria compared to general standard These criteria are listed as follows:
- By Geographical Origins of Capital: Domestic debt and Foreign debt
- By Capital Mobilization Modality: Public debt from direct deals and Public debt from debt instruments
- By Preferential Nature of Loans Incurring Public Debt: Public debt from
ODA loans, Public debt from concessional loans and Conventional commercial debt
- By Liability for Creditors: Public debt in need of payment and Public debt with government guarantee
- By Debt Management Levels: Public debt of Central government and Public debt of local authorities
1.1.3 The Impacts of Sovereign Debt a Impact of Sovereign Debt on GDP
The long-term effects of changes in sovereign debt can significantly impact economic activity, with increases potentially leading to negative outcomes and reductions fostering positive effects Key transmission channels illustrate these dynamics, highlighting the intricate relationship between sovereign debt levels and economic performance.
The diagram illustrates how increased government debt can result in lower GDP over the long term, while reducing government debt can lead to the opposite effect.
An increase in sovereign debt typically leads to a decrease in positive savings, which reduces net national savings and drives up interest rates This situation results in diminished private investment and slower growth of capital stock, exemplifying the "crowding-out effect" where private savings are substituted by government bonds Consequently, the lack of capital accumulation in the private sector stifles innovations that enhance productivity, ultimately resulting in lower labor productivity and potentially higher unemployment rates However, the extent of these impacts from rising interest rates is influenced by the scale of the region experiencing the increase in sovereign debt.
The rise in government debt leads to increased interest charges, which can displace productive spending like public infrastructure investment or necessitate higher taxes Depending on the fiscal strategies implemented, this can adversely affect consumer behavior through VAT and excise duties, hinder private investment due to capital taxes, and reduce labor supply as a result of wage taxes.
The rise in government debt contributes to sovereign risk, resulting in elevated risk premiums As these premiums increase, financing costs soar, jeopardizing the stability of public finances Consequently, individuals and private firms face higher interest rates.
L Van Meensel) b Impact of Sovereign Debt on Inflation
The increase of sovereign debt may heighten the risk of inflation in the following situations:
Governments may reduce the value of debt through inflation by monetizing it, which involves issuing debt purchased by the central bank, leading to an expanded money supply and inflationary pressure However, this practice is restricted in jurisdictions where laws prohibit monetary financing of government spending or deficits, such as in the European Union.
External debts create repayment pressures that increase the demand for foreign currencies, leading to the devaluation of the domestic currency This devaluation results in higher costs for importing machinery and raw materials, which poses a significant risk of inflation.
Apart from the transmission channels mentioned above, this would be an additional negative impact on economic activity c Other Impacts of Sovereign Debt
Sovereign Debt Crisis
A sovereign debt crisis arises when a government's budget deficit exceeds manageable levels, leading to potential failure in repaying principal and interest on time or violating contractual agreements This definition, however, does not account for scenarios where a government hints at default, prompting creditors to voluntarily renegotiate the terms of the contract.
Credit rating agencies, such as Standard and Poor's (S&P), identify a sovereign debt crisis as occurring when a government fails to meet the contractual obligations of its debt or when it proposes an exchange offer for new debt that comes with less favorable terms than the original agreement (Beers and Chambers, 2006).
The European sovereign debt crisis began in 2008, triggered by the collapse of Iceland's banking system, and quickly spread to Greece, Ireland, and Portugal in 2009 This period was marked by the failure of financial institutions, soaring government debt, and increasing bond yield spreads in government securities As a result, the crisis eroded confidence in European businesses and economies, leading to widespread economic instability.
The Evolution of the European Sovereign Debt Crisis
Figure 2.1: Timeline of the European Sovereign Debt Crisis
The Euro was introduced in 1999 following the establishment of the European Economic Community (EEC) and the signing of the Maastricht Treaty, initially adopted by 11 countries: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain By 2002, the Euro fully replaced national currencies, becoming the exclusive legal tender in these twelve Euro area nations.
2007, five other countries have joined the Euro area, including Slovenia, Cyprus, Malta, Slovakia, and Estonia
In response to the freezing of European interbank markets following the collapse of Lehman Brothers, the European Commission adopted the €200 billion "European Recovery Plan" in November 2008, representing 1.5% of the EU's GDP This plan included €170 billion from budgetary expansions by Member States and €30 billion from EU funding through the European Investment Bank The plan received endorsement from EU Member States during the December Council meeting.
In November, following the Dubai sovereign debt crisis, worries about the debts of certain EU Member States began to escalate By December, Greece acknowledged its total debt of €300 billion, which represented about 113% of its GDP, nearly double the Eurozone limit, despite earlier claims of payment capability Consequently, the three major rating agencies—Fitch, Moody's, and Standard and Poor's—downgraded Greece's sovereign credit rating.
In February, Greece introduced austerity measures to address its deficit, while Spain implemented salary cuts and reduced pension and government spending in May Additionally, Portugal enacted an austerity budget in both March and November, as reported by the BBC.
In April, Greece experienced an increase in borrowing costs, reaching 8.7% Eurostat's report revealed a significant upward revision of Greece's 2009 budget deficit to 13.6%, exceeding the Maastricht Treaty's maximum limit by over four times On April 23, 2010, Greek Prime Minister George Papandreou sought the activation of a financial assistance package.
On May 2 nd , the European Central Bank (ECB), the EC and IMF (thenceforth called
In response to Greece's financial crisis, the "Troika" announced a €110 billion bailout package, leading to the creation of the European Financial Stability Facility (EFSF) to offer loans to struggling nations Concurrently, the European Central Bank (ECB) introduced the Securities Markets Program (SMP) aimed at purchasing sovereign debt in secondary markets, with an initial emphasis on Greek government bonds.
In November, Ireland accepted an €85 billion bailout from the IMF, the EC, and the EFSF after incurring a staggering budget deficit of 32% of GDP and bailing out Anglo Irish Bank at a cost of €34.3 billion.
In April 2011, Portugal sought a €78 billion bailout, finalizing the deal by mid-May, which was structured over three years Following this request, Moody's downgraded the country's sovereign rating to junk status in June.
In July 2011, the European Stability Mechanism (ESM) was established with plans for a permanent rescue fund, enabling lending of up to €500 billion funded by Euro-area countries To alleviate market tensions, the European Central Bank (ECB) resumed secondary market purchases on August 4th, targeting Italian and Spanish bonds.
In response to the Greek crisis, Euro-area leaders implemented a new set of measures aimed at preventing contagion, which included a second bailout for Greece during the July Summit and a 50-percent haircut on Greek debt held by the private sector at the October Summit Additionally, on December 8th, the European Central Bank (ECB) lowered interest rates and initiated two long-term refinancing operations (LTROs) to bolster the banking system.
On January 13th, Standard & Poor's downgraded nine Euro-area sovereigns and, three days later, the EU bailout fund EFSF, highlighting the failure of European leaders to effectively address the Euro-area crisis.
On March 2nd, EU member states ratified the Treaty on Stability, Convergence, and Governance in the Economic and Monetary Union, known as the "fiscal compact." Additionally, a significant debt agreement was achieved in Greece, with 85.8% of creditors consenting to a 53.5% loss on their investments.
In June, Spain became the first country to request financial assistance to recapitalize its banking sector, followed by a bailout request by Cyprus
Due to continuous regional austerity measures, on November 14 th , unions went on strike in Spain, Portugal, Greece and Italy to protest, recorded about 50 trade unions in
28 countries participated by striking or protesting
Since January 2013, successful sovereign debt auctions in the Eurozone, particularly in Ireland, Spain, and Portugal, helped restore investor confidence, allowing these countries to regain access to financial markets through bond issuance throughout the year In contrast, Cyprus faced challenges in securing a bailout agreement until March 25, which included a proposal to close the troubled Laiki Bank To support economic recovery, the European Central Bank implemented two additional interest rate cuts to 0.25% Ultimately, in December 2013, Ireland successfully exited the EU/IMF bailout program.
In 2014, Spain officially exited the bailout mechanism on January 23rd, signaling restored foreign investor confidence, while Portugal followed suit on May 18th, demonstrating a strong position in lending markets without requiring additional support Despite these advancements, both nations continued to grapple with high debt-to-GDP ratios and unemployment Meanwhile, Greece and Cyprus recorded positive growth but remained reliant on financing measures; Greece engaged in negotiations with the Troika for its final Eurozone bailout tranche in December, while Cyprus gradually re-entered private lending markets.
On January 22, 2015, the European Central Bank (ECB) unveiled an expanded asset purchase program that includes existing initiatives for asset-backed securities and covered bonds This program aims for total monthly purchases of €60 billion in public and private sector securities, set to continue until the program's conclusion.
September, 2016 Predictions for the debt-to-GDP ratios in the European countries in the year 2015 are illustrated as follows (updated on April 9 th , 2015)
Figure 2.2: Debt-to-GDP Ratio, 2015 Forecast
Causes of the European Sovereign Debt Crisis
There are number of factors that led to the European sovereign debt crisis These can be categorized into root causes and direct causes
2.2.1 Root Causes a Economic Model Management
The inefficiencies of an economic model reliant on banking and financial services, coupled with shortcomings in the EU and Eurozone's management, lead to significant issues Economic recessions and elections often trigger surges in government debt, as policymakers prioritize short-term fixes over long-term strategies This approach typically involves borrowing new funds to pay off existing debts and propping up insolvent banks Ultimately, this mismanagement results in an inability to control government debt levels effectively.
The Euro system faces internal contradictions, as Eurozone countries share a monetary union through the European Central Bank (ECB) while maintaining decentralized fiscal policies without a common treasury This fragmentation has hindered the enforcement of uniform fiscal practices among member nations, leaving fiscal policy decisions in their hands Although the Maastricht Treaty established limits on budget deficits and government debt for member countries, lax management and oversight have facilitated borrowing, complicating the EU's ability to regulate these financial activities effectively.
The complexity of the decision-making structure among member nations hinders quick responses during crises, as unanimous agreement is required This challenge is exacerbated by conflicting national interests, making the mechanism increasingly complicated and counterproductive (Batasin, 2012).
The introduction of the Euro (€) resulted in many Eurozone nations enjoying similar and low interest rates, comparable to Germany's This enhanced credibility and favorable conditions for countries with weaker currencies, enabling them to attract significant foreign investment However, this influx of investment also led to increased budget deficits, rising debt, and higher inflation rates, which fueled both private and government spending, creating a cyclical pattern that continued until the onset of the crisis.
Eurozone countries face challenges in managing long-term current account budget deficits due to their reliance on external capital flows and the constraints of a common currency Any alterations to monetary policy in one nation could negatively impact the entire region, highlighting the complexities of coordinated economic governance within the Eurozone.
2.2.2 Direct Causes a Failure to Tighten Fiscal Policy
Many governments facing debt crises exhibit lax fiscal discipline, consistently overspending their budget targets at year-end Crucially, they failed to implement significant fiscal policy tightening between 2003 and 2007, a time when the private sector was increasingly assuming risks This oversight can be attributed to ineffective analytical frameworks for evaluating fiscal sustainability (Lane, 2012).
There was an increase in the dispersion and persistence of current account balances across the Euro area, as demonstrated in the following table:
Table 2.1: Current Account Balances (unit: percentage of GDP)
(Source: IMF’s World Economic Outlook database)
Prior to the crisis, Germany maintained a significantly lower government debt and fiscal deficit relative to GDP compared to other Eurozone countries Between 2003 and 2007, Portugal, Greece, and Spain faced substantial external deficits of -9.2%, -9.1%, and -7.0%, respectively, while Germany enjoyed a trade surplus of 5.1% of GDP Cultural differences played a key role in this disparity; for instance, the Greek government often prioritized political objectives in capital distribution, leading to a societal tendency to rely on generous state benefits and tax evasion In contrast, Germans exhibited financial responsibility and had more modest expectations for retirement.
The disparities in current account balances among member states have intensified the flow of resources from capital-abundant to capital-scarce countries (Blanchard & Giavazzi, 2002) Nevertheless, Paul Krugman (2009) warns that the influx of capital can lead to reduced interest rates and potentially foster the development of economic bubbles.
Several Eurozone countries, notably Greece and Italy, struggled to address their debt issues over a prolonged period of up to ten years They failed to meet international standards through various methods, including inconsistent accounting practices, off-balance-sheet transactions, and the use of complex currency and credit derivatives This lack of transparency resulted in significant challenges for timely adjustments, culminating in Greece's alarming debt-to-GDP ratio disclosure in 2009, which eroded confidence in their financial stability.
Before the crisis, banks held significant amounts of bonds from weaker economies like Greece, bolstered by the Eurozone's reputation As the crisis unfolded, these bonds became much riskier Warning signs regarding European sovereign debt were obscured by banks' conflicts of interest in underwriting the bonds The loss of confidence is reflected in the rising prices of sovereign bonds and credit default swaps (CDS), signaling market concerns about the creditworthiness of these countries.
As of June 2012, European banking systems, especially in Spain, faced considerable stress due to a wave of "capital calls" from banks needing additional funds This situation led to a freeze in funding markets and interbank lending, as investors became concerned that banks might be concealing losses and losing trust in each other.
The recent downgrades of sovereign credit ratings for Eurozone countries by major credit rating agencies, including Fitch, Moody’s, and Standard & Poor’s, have significantly contributed to market instability and the ongoing crisis This continuous reduction in ratings has eroded investor confidence and raised concerns about policymakers' ability to effectively manage the situation Consequently, there has been a noticeable shift of assets away from the Eurozone.
The Impacts of the European Sovereign Debt Crisis on European countries 17 1 Financial Impacts
This section examines the financial, economic, and political repercussions of the current challenges facing the government and citizens of Europe, highlighting how these issues have intensified since the onset of the debt crisis.
2.3.1 Financial Impacts a Banking System Crisis
The transmission of sovereign stress to the banking sector primarily occurs through banks' substantial holdings of sovereign debt Prior to and during the crisis, European banks accumulated significant amounts of sovereign debt, particularly from countries with weak economic fundamentals, such as the PIIGS nations These governments, obligated to support their banks, faced challenges that directly impacted the banks' balance sheets and profitability due to losses on sovereign debt.
The increased riskiness of banks due to higher sovereign debt can negatively impact their funding costs and availability As banks often use sovereign debt as collateral for securing wholesale funding, elevated sovereign risk may diminish the eligibility of this collateral, thereby limiting banks' funding capacity Additionally, the decline in the value of sovereign collateral has affected banks holding distressed foreign government debt, leading to a regional funding shock This deterioration in sovereign creditworthiness also tarnishes the reputation of local banks, making it more challenging for them to access necessary funding.
Since mid-2010, European banks have faced persistent deposit outflows due to a loss of confidence, leading to a significant decline in bank lending and credit availability across the region Additionally, the depreciation of the Euro has further exacerbated these financial challenges.
During the Eurozone crisis, the common currency experienced inevitable devaluation due to market risks Between 2007 and 2015, the EUR to USD exchange rate showed significant fluctuations, marked by sharp declines.
Figure 2.3: The Exchange Rate of EUR/USD (2007-2015)
2.3.2 Economic Impacts a Slowdown in Economic Growth
Since its onset in 2009, the economic crisis has significantly hindered growth across the EU, with all member countries experiencing negative GDP growth that year Greece faced the most severe decline, plummeting to -8.9% in 2011 Over time, many European nations have seen their growth rates stabilize around zero; however, Cyprus and Italy remained below zero by the end of 2004.
Figure 2.4: Real GDP Growth Rates of European countries (2008-2014)
(Source: Eurostat) b Fluctuations in Trade Balance
The volatility of the Euro significantly impacts trade activities within the region While a depreciating Euro might enhance price competitiveness for exports, data reveals a contrasting reality Between 2010 and 2013, the Eurozone's trade balance faced considerable challenges, resulting in substantial declines below zero.
Figure 2.5: Eurozone Balance of Trade (2009-2015)
(Source: Eurostat) c Rise in Unemployment Rates
Austerity measures implemented in many countries have resulted in rising unemployment due to cuts in government spending, particularly affecting public sector jobs This has negatively impacted social lives, prompting widespread protests and strikes against these austerity plans Consequently, the situation has exacerbated political instability in Eurozone countries since the onset of the crisis.
Figure 2.6: Unemployment Rates of European countries (2009-2014)
The unemployment rate in the Euro area followed roughly the same trend as in the
By the end of 2014, the unemployment rate in the EU remained high at approximately 10% In contrast, Germany saw a steady decline, achieving a rate of 5% However, Greece and Spain faced significant challenges, with unemployment rates soaring to around 25% in 2014, marking them as the countries with the highest rates in the region.
Youth unemployment rates in the EU and Euro area are alarmingly high, often exceeding double the overall unemployment rates As of December 2014, Germany (7.2%), Austria (9.0%), and the Netherlands (9.6%) reported the lowest youth unemployment rates, all under 10% In stark contrast, Spain (51.4%), Greece (50.6%), Croatia (44.8%), and Italy (42.0%) faced the highest rates, highlighting a significant disparity across member states (Eurostat, 2015).
Figure 2.7: Youth Unemployment Rates in EU and Euro area (2000-2015)
European politicians face three interconnected challenges: ensuring stability in the sovereign debt market and providing financial access for weaker states, reinforcing the banking system to restore public confidence, and establishing preventive measures to avert future crises swiftly The management of the ongoing crisis has resulted in the premature downfall of several national governments, including those of Ireland, Portugal, Finland, Spain, Slovenia, Slovakia, Italy, Greece (2011), the Netherlands, and Germany (2012), significantly impacting election outcomes across the region.
Policy Reactions to the European Sovereign Debt Crisis
2.4.1 EU Emergency Measures: EFSF and EFSM
Established on May 9, 2010, the European Financial Stability Facility (EFSF) aims to ensure financial stability in Europe by offering assistance to struggling Eurozone countries In 2011, the European Financial Stabilization Mechanism (EFSM) was introduced, providing an additional €60 billion in balance-of-payments support Together, the EFSF and EFSM created a combined financial support package of €500 billion, funded through market-raised amounts and guarantees from Eurozone nations.
€250bn on behalf of the IMF, a total amount of €750bn was available to support troubled countries within the monetary union
Since the fund's inception, three rescue packages have been issued (excluding Greece's 2010 package), which mandated strict fiscal austerity measures These measures included budget cuts, tax hikes, salary freezes, and extensive reforms designed to enhance the country's competitiveness The primary objective of these requirements was to restore economic growth and mitigate moral hazard.
By July 2012, various financial assistance programs had been activated, beginning with an €85 billion package issued in December 2010 to support Ireland's banking system following its real estate market collapse Portugal sought help next in May 2011 due to recession, weak competitiveness, and unsustainable fiscal deficits, resulting in a €78 billion package from the EFSF, EFSM, and IMF to stabilize capital markets Greece's second bailout involved a loan from the EFSF, with conditions differing from previous packages, including a 50% write-off on Greek bonds to reduce debt levels In July 2012, European finance ministers approved a €100 billion partial bailout for Spanish banks.
The EFSF and the EFSM were later replaced by a permanent rescue funding
The European Stability Mechanism (ESM) was established to protect and offer financial assistance to member states facing economic challenges, succeeding the temporary funding programs EFSF and EFSM With a maximum lending capacity of €500 billion, the ESM has been responsible for all new bailouts since October 2012, while previous bailout loans remain under the oversight of the EFSF and EFSM.
When seeking ESM support, a country's financial stability is assessed by the Troika, which determines whether one or more of the five available support programs should be provided.
In terms of lending activities, so far the ESM has financed €9bn out of €10bn to support Cyprus (May, 2013)
2.4.3 The ECB a Monetary Policies Decision
The European Central Bank (ECB) lowered interest rates on main refinancing operations, marginal lending facilities, and deposit facilities to support recovery rates and ensure liquidity among European banks These rate adjustments, effective until December 2014, are detailed in Table 2.3.
Table 2.3: Interest Rates Policies by ECB
Launched on May 10, 2010, the Securities Markets Program (SMP) aimed to enhance liquidity in the Euro area's public and private debt securities markets, addressing dysfunction until February 2012 Its primary goal was to restore effective monetary policy transmission for medium-term price stability The intervention's impact was neutralized through specific operations that reabsorbed the injected liquidity, ensuring the monetary policy stance remained unchanged By February 2012, the total value of bonds purchased under the program reached €219.5 billion.
Figure 2.8: SMP Covering Bond Purchases (May 2010 – February 2012)
On December 8, 2011, the Governing Council announced two longer-term refinancing operations (LTROs) with a three-year maturity to complement the main refinancing operations (MROs) These non-standard monetary policy measures aimed to ensure effective transmission of monetary policy to the real economy, thereby supporting banks in maintaining and expanding lending to Euro area households and non-financial corporations Conducted as fixed rate tender procedures with full allotment, these operations provided banks with stable funding over longer maturities, mitigating the adverse effects of challenging funding market conditions Furthermore, after one year, banks were given the option to repay outstanding amounts, enhancing their flexibility in liability management (ECB, 2012).
On December 21, 2011, the European Central Bank (ECB) provided €489 billion to 523 credit institutions at a low rate of 1%, aiming to ensure banks had sufficient liquidity to cover €200 billion in maturing debts in early 2012 This initiative sought to prevent a credit crunch that could hinder economic growth while encouraging banks to lend to businesses Additionally, the ECB hoped that some of the funds would be used to purchase government bonds, thereby alleviating the debt crisis Subsequently, on March 1, 2012, a second package of €529.5 billion was injected into 800 Eurozone banks.
On November 30, 2011, major central banks, including the ECB, Bank of Canada, Bank of England, Bank of Japan, Federal Reserve, and Swiss National Bank, announced coordinated efforts to bolster liquidity support for the global financial system They agreed to reduce the pricing on existing temporary US dollar liquidity swap arrangements by 50 basis points, effective from December 5, 2011, and established temporary bilateral liquidity swap arrangements for providing liquidity in various currencies These measures significantly enhanced the Eurozone banking system's ability to conduct adequate liquidity operations, including Outright Monetary Transactions (OMTs).
On September 6, 2012, the European Central Bank (ECB) announced its commitment to provide additional financial support through outright transactions in secondary sovereign bond markets, aimed at ensuring effective monetary policy transmission and maintaining the integrity of monetary policy The Outright Monetary Transactions (OMT) program can be activated for Eurozone members that have received financial assistance from the European Financial Stability Facility (EFSF) or the European Stability Mechanism (ESM), whether through direct macroeconomic support or precautionary credit lines A member state can participate in the program as long as it is experiencing distressed bond yields, but must regain full market access and adhere to the terms outlined in the Memorandum of Understanding to continue benefiting from the program.
The Fiscal Compact, signed in March 2012, aims to ensure that government budgets do not jeopardize the financial stability of others Key sections III, IV, and V outline regulations on fiscal discipline, economic coordination, and governance Although the treaty is applicable to all ratifying Eurozone countries, only specific provisions are enforced among them.
V, covering Euro summit participation, automatically applies for ratifying non-Eurozone member states However, these states can attach a declaration to their instrument of ratification stating their desire to also be bound by the treaty's fiscal provisions (Title III) and/or enhanced economic coordination provisions (Title IV)
Member states subject to Title III of the Fiscal Compact may incur annual fines of up to 0.1% of their GDP if they do not implement a self-correcting mechanism within one year of the treaty's enforcement, ensuring their government budget is balanced or in surplus The treaty stipulates that a balanced budget is defined as a general budget deficit not exceeding 3.0% of GDP, along with a structural deficit that must remain within a country-specific Medium-Term Budgetary Objective of 0.5% to 1.0%.
As of April 1, 2014, the Fiscal Compact was ratified and came into effect for 25 EU member states that signed the treaty, excluding the UK, Croatia, and the Czech Republic.
CHAPTER THREE LESSONS FOR VIETNAM IN SOVEREIGN DEBT
The Vietnamese Economy under the Impact of the European Sovereign Debt
3.1 The Vietnamese Economy under the Impact of the European Sovereign Debt Crisis
3.1.1 Trade in Goods with European countries
Contrary to the impacts of the global financial crisis and economic recession in
2008, Vietnam – EU trade flows have undergone positive developments under the European debt crisis period, as illustrated in Figure 3.1
Figure 3.1: Vietnam – EU Trade Flows (2008-2014)
After experiencing a 9% decline in 2009 due to the global financial crisis, Vietnam's export flow demonstrated significant growth, reaching approximately €22 billion by 2014 During this seven-year span, Vietnam's share of goods in the total imports of the EU notably increased, as reported by Eurostat In contrast, import activities mirrored this upward trend, although the values were marginally lower, with the import value recorded at €22 billion in 2014.
€6bn – 82% higher than that of 2008
Table 3.1 provides a detailed overview of trade flows from 2010 to 2014, highlighting key export categories to the EU, including Food and Live Animals, Material-Classified Manufactured Goods, Machinery and Transport Equipment, and Miscellaneous Manufactured Articles Notably, the Machinery and Transport Equipment sector saw a remarkable increase from €1.5 billion in 2010 to €10.3 billion by 2014, making up nearly half of the total export structure Conversely, significant growth in imports during this period was driven by Food and Live Animals (up 71.5%), Chemicals (up 61%), and Material-Classified Manufactured Goods (up 50.54%).
Table 3.1: Vietnam – EU Trade Flows by SITC Section (2010 – 2014)
The European sovereign debt crisis significantly impacted investment capital flows to Vietnam, primarily through three channels: Foreign Direct Investment (FDI), Official Development Assistance (ODA), and Remittances As foreign investors grew wary of the risky Vietnamese business climate and shifted their focus to government debt concerns, notable changes occurred in these three indicators.
Europe stands out as a major source and destination for foreign direct investment (FDI), significantly impacting global investment flows For developing nations like Vietnam, Europe serves as a crucial contributor to FDI Notably, European countries represent 24% of the total investors in Vietnam, with 10% of these investors coming from the European Union, highlighting the region's importance in Vietnam's economic landscape.
2010) Conclusion can be made that any changes in the Europe’s economic situation may
Figure 3.2: FDI in Vietnam by Countries and Territories (1988-2010)
The European share of foreign direct investment (FDI) in Vietnam decreased significantly from 18% in 2009 to 11% in 2011, resulting in a loss of over $2 billion, as reported by the Foreign Investment Agency of the Ministry of Planning and Investment This decline contributed to a reduction in overall FDI inflows into Vietnam.
After reaching the peaks in 2008, at $71.7bn of the total registered capital and
In 2009, Vietnam experienced a significant decline in foreign direct investment (FDI) inflows, with registered FDI value dropping to $23.1 billion, a decrease of approximately 67% This downward trend persisted until 2011, although there was a modest recovery beginning in 2012 Throughout this period, the implementation capital remained consistently low, averaging around $10 billion.
The recent shift in foreign investment is primarily due to inefficiencies in Europe and globally Vietnam stands out as a promising market, benefiting from socio-political stability; however, it faces challenges such as low overall effectiveness of foreign direct investment (FDI), characterized by small-scale projects with minimal value generation and limited capabilities Additionally, the slow distribution of FDI, lack of technological innovation, and project execution issues, along with imbalances across economic sectors and regions, as well as fraudulent activities, further complicate the investment landscape.
“real profit, fake losses” Bearing those disadvantages, Vietnam lost its competency and could not grasp the opportunity of the FDI flows shifted from Europe like other ASEAN economies b ODA
The fiscal consolidation plans in Europe have led to a decline in both Foreign Direct Investment (FDI) flows and Official Development Assistance (ODA) to Vietnam This trend is reflected in the changing dynamics of EU aid disbursements in the country.
Figure 3.4: The EU Evolution of Aid Disbursements in Vietnam (2007 – 2013)
From 2007 to 2013, the European Union allocated €3.6 billion in official development assistance, with 55% (€2 billion) provided as grants and the remaining €1.6 billion as loans However, as illustrated in Figure 3.4, the disbursement of this aid declined steadily during the deepening crisis from 2009 to 2012, reaching a low of nearly €0.4 billion.
2012 Throughout the period, the amount of granted ODA dropped by a half to €0.19bn while the amount of loan underwent a decline from 2010 and recovered back in 2013 at about €0.7bn
The European debt crisis adversely affected global Official Development Assistance (ODA) to Vietnam, as struggling economies in donor countries led to a decline in financial support Following a peak of $8.063 billion in 2010, Vietnam's ODA experienced a gradual decrease, with 2013 marking the third consecutive year of reduced aid flow.
$6.485bn in ODA and this movement is anticipated to continue in 2014 and 2015
Figure 3.5: ODA Commitment for Vietnam (2008 – 2013)
(Source: Vietnam Consultative Group) c Remittance
In 2009, Vietnam was reported with 18% of the remittance inflows coming from European countries, which ranked second after its biggest sender - North America, accounting for 71% (Human Development Report, 2009)
Despite predictions that high unemployment rates and economic recession from the European debt crisis would significantly reduce remittances to Vietnam, statistics revealed only a slight decline from $7.2 billion to $6.02 billion in 2009 Remarkably, remittances rebounded swiftly, reaching $11 billion in 2013 and $12 billion in 2014, securing Vietnam's position among the top 10 recipient countries for remittances, according to the World Bank.
Amid the ongoing debt crisis, foreign investors are increasingly targeting Vietnamese firms to diversify their portfolios and mitigate risks These investors benefit from advantageous conditions, such as lower taxes, tariffs, and borrowing rates, along with superior competencies and trademarks compared to local companies Consequently, this has led to heightened competition in the domestic market.
Public Debt in Vietnam
Vietnam's current sovereign debt challenges trace back to 2006 and earlier, stemming from its aggressive investment strategies aimed at achieving development goals The country achieved an impressive investment-to-GDP ratio, second only to China, while maintaining a significantly lower savings rate, leading to a substantial gap of 16-17% of GDP between the two rates This disparity is illustrated in Table 3.2, which highlights Vietnam's exceptionally high investment-to-saving ratio from 2005 to 2011.
Table 3.2: Vietnam’s Rate of Investment and Saving and GDP Growth Rate
Despite significant investments, the returns fell short, leading to an average budget deficit of 5% of GDP during the period, with a peak of 7% in 2009 due to the global financial crisis The table below provides an overview of Vietnamese government revenues and expenditures from 2006 to 2015.
Table 3.3: Vietnam’s State Budget Final Accounts and Plans (2006 – 2015)
From 2006 to 2012, tax and fee collections constituted a significant portion of Vietnam's government budget revenue, peaking at 24.6% in 2011 During this period, Vietnam had the highest tax rate in Asia, which hindered enterprise accumulation, reduced investment activities, and diminished the competitiveness of the private sector Despite substantial tax revenues, the growth in infrastructure and social welfare did not match expectations, potentially posing long-term barriers to economic development Projections indicate that taxes and fees may rise to 39.51% in the coming years Additionally, crude oil from foreign investments was a crucial source of government revenue, despite experiencing a decline until 2010.
The table highlights a paradox in the state-owned enterprises (SOEs) sector, which accounts for approximately 40% of GDP but generates only 13-14% of the budget's revenue Despite predictions of a significant increase in this sector's contribution over the next three years, potentially reaching nearly one-quarter of GDP, achieving these targets may prove challenging without necessary adjustments to investment strategies.
To sustain ongoing economic growth, the Vietnamese government has relied on foreign loans and increased credit issuance, leading to an inevitable rise in public debt By the end of 2014, public debt reached approximately $81.1 billion, accounting for 60.3% of the country's GDP, a ratio that is 2.2 times higher than previous levels.
In 2006, Vietnam's government debt was projected to rise significantly, reaching a record high of 64.9% in the coming years The Ministry of Finance reported an average debt growth rate of 10.5%, expected to increase to 19.9% by 2015 Over this period, government debt grew from 39% to 46.9% of GDP in 2014, while government-guaranteed debt and local authorities' debt were lower at 12.6% and 0.8%, respectively Additionally, there has been a notable shift from external to internal borrowing, with over half of loans sourced domestically in 2014 For comprehensive statistics on Vietnam's public debt, refer to Table 3.4 and Figure 3.6.
Table 3.4: Public Debt in Vietnam (2006 – 2014)
(Source: The Ministry of Finance & The Economist Intelligence Unit)
Figure 3.6: Public Debt Structure: Domestic and External Debt (2010 – 2014)
In 2014, the public debt per person in the region was approximately $897, according to the Economist Intelligence Unit, which was relatively low compared to other Asian countries such as China, with a debt of $1,204.41, and Indonesia, at $1,049.32.
Philippines ($1,346.67), and Thailand ($3,168.64) However, comparing to the data 10 years ago (which was only $210.5), the amount of debt quadrupled and would continue to grow in the next few years
A research report titled “Determining the Scope of Public Debt and Safe Debt Threshold of Vietnam in 2014 – 2020” by the Academy of Policy and Development highlighted that, as of 2013, Vietnam's debt-to-GDP ratio was significantly lower than the global average of 79.7% and the 95.7% seen in developed countries Mr Habib Rab, a Senior Economist at the World Bank Vietnam, noted that while Vietnam's public debt remains manageable, a rapid increase in debt levels could threaten the country's ability to handle future financial shocks.
Figure 3.7: Debt-to-GDP ratio of Vietnam and Other countries in the world (2013)
Lessons and Suggestions for Sovereign Debt Crisis Prevention in Vietnam
Some valuable lessons can be learned from the case of Europe so that the Vietnamese government can prevent itself from a sovereign debt crisis outbreak:
An effective governmental regulatory mechanism is essential for controlling financial activities and fund flows, emphasizing the importance of transparency, accurate sovereign debt calculations, and robust macro-level supervision This framework must also ensure social welfare needs are met while mobilizing resources for sustainable national development Additionally, greater discipline is required in adhering to approved spending plans, as actual expenditures have often surpassed projections Implementing spending limits with specific penalties for various sectors is recommended to enhance fiscal accountability.
To enhance government investment efficiency, it is essential to shift from reliance on state investments, which have not sufficiently addressed budget deficits, to increasing non-budget resources Long-term strategies should prioritize social and infrastructural development, transitioning from an extensive to an intensive growth model Additionally, the investment process must be revised and reformed to meet standardized criteria for public projects.
State-owned enterprises (SOEs) should focus on key industries that support socio-economic infrastructure and public services, ensuring macroeconomic stability To maintain a manageable size, excessive investment in SOEs must be limited This can be accomplished by promoting the equitization of SOEs, retaining only fully state-owned enterprises in critical sectors where private investment is either insufficient or absent.
To enhance the independence of the State Bank of Vietnam, it should prioritize maintaining market price stability over the government's directive to increase money supply for state-owned enterprises (SOEs) as a means of economic stimulation This approach is crucial, as an excessive money supply can lead to higher inflation rates and economic instability Therefore, a coordinated fiscal and monetary policy is essential for achieving macroeconomic stability.
Introducing medium-term budgeting, updated annually and aligned with Socio-Economic Development Plans (SEDP) and the Medium-Term Investment Plan (MTIP), is essential Currently, SEDPs span five years while the State Budget is annual, creating a disconnect A medium-term budget would project total revenue, spending, and borrowing for the next three to five years, allowing the government and public to better estimate the costs and affordability of development plans.
A comprehensive framework for local borrowing is crucial, as current local debt is managed outside the State Budget due to restrictions on local authorities running budget deficits It is recommended to integrate local borrowing into the State Budget, enhance local debt management capabilities, and establish borrowing limits aligned with the financial capacity of local authorities This approach would supply essential resources for addressing infrastructure needs in specific provinces while promoting responsible and transparent local borrowing for high-return public investments.
Implementing policies that align with these recommendations will enable Vietnam to create a safer and more secure environment, fostering growth and increasing opportunities to attract foreign investment.
Conclusions
The European sovereign debt crisis highlights the inherent flaws of the Euro, which initially united 17 European nations Since 2009, countries like the PIIGS and Cyprus have faced potential financial collapse, posing risks not only to Europe but also to the global economy This crisis has adversely affected Europe's economic systems and the livelihoods of its citizens, while also impacting developing nations such as Vietnam Research indicates that the crisis significantly influenced investment capital flow and domestic competitiveness, with trading activities showing less impact As Vietnam grapples with its exposure to the crisis and limited response capabilities, it faces the dual challenge of mitigating the effects of the Eurozone debt crisis and improving its government debt situation.
The European debt crisis offers valuable lessons for Vietnam in developing effective sovereign debt crisis prevention strategies Key guidelines include establishing a robust regulatory mechanism, enhancing investment management and outcomes, engaging local authorities, implementing medium-term budgeting, and recognizing the State Bank of Vietnam's critical role in financial sector stabilization To promote sustainable economic growth, the Vietnamese government should leverage debt sources more strategically and comprehensively for optimal returns.
Limitations of Research 45 LIST OF REFERENCES
The graduation thesis relies exclusively on secondary data, which limits its reliability and relevance due to the absence of primary data This approach restricts the analysis to basic evaluations of the available sources, hindering a comprehensive exploration of key topics such as Foreign Direct Investment (FDI) and Official Development Assistance (ODA) across various sectors in Vietnam Consequently, the paper falls short in comparing the effects of these factors on Vietnam versus other countries, as well as their broader global implications Additionally, the research lacks diverse methodologies, such as questionnaires and surveys, which could enhance the depth of the analysis.
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