tiểu luận causes and impacts of the european sovereign debt crisis on the global economy

DIPLOMATIC ACADEMY OF VIETNAM FACULTY OF INTERNATIONAL ECONOMICS EUROPEAN SOVEREIGN DEBT CRISIS: CAUSES AND IMPACTS ON THE GLOBAL ECONOMY Supervisor: NGUYEN THI THU HOAN Submitted by

DIPLOMATIC ACADEMY OF VIETNAM FACULTY OF INTERNATIONAL ECONOMICS

EUROPEAN SOVEREIGN DEBT CRISIS:

CAUSES AND IMPACTS

ON THE GLOBAL ECONOMY

Supervisor: NGUYEN THI THU HOAN

Submitted by: NGUYEN THANH CAT ANH

PHUNG KHANH CHI

May 2015

Page

B Causes and impacts of European sovereign debt crisis on global

C Solutions 16

Experiencing a long way of formation and development, the European Union recently has become one of the most powerful economic – currency centres globally Especially with the advent of the euro - one of the strongest currencies in the world monetary system has exacerbated the influence of the EU on the global economy Nevertheless, the debt crisis in the euro zone breaking out in late 2009 exhausted many European economies, and posed a challenge to the global economic development Besides that, the political and social impact of it is also very profound Not only shattering the lives of the European residents , but it also set out the risk of the disintegration of Euro zone and is the cause of many internal political disputes threating the stability of the EU- which is regarded as the largest economic union in the world Therefore, extensive research on the causes and the impact of the sovereign debt crisis in order to find appropriate solutions for this issue is very urgent and important The story of Europe has left a valuable lesson for the development of countries around the world, from the study of this issue, each government may have a particular perspective and draw lessons for their country, from which they can find the right solution to solve the problem of public debt in their nations

A THEORETICAL BASIS Definition of sovereign debt: Bonds issued by a national government in

a foreign currency, in order to finance the issuing country's growth Sovereign debt is generally a riskier investment when it comes from a developing country, and a safer investment when it comes from a developed country The stability of the issuing government is an important factor to consider, when assessing the risk of investing in sovereign debt, and sovereign credit ratings help investors weigh this risk

Definition of sovereign debt crisis: is financial and economical problem

happening as a nation cannot repay its government’s debts or debts guaranteed by its government It explores as the government debts are of unsafe levels compared the scale of the economy and the economy reaches low growth

The European sovereign debt crisis started in 2008, with the collapse of Ireland's banking system, and spread primarily to Greece and Portugal The debt crisis led to a crisis of confidence for European businesses and economies

B THE CAUSES AND IMPACTS OF EUROPEAN SOVEREIGN DEBT

CRISIS ON THE GLOBAL ECONOMY

I Causes:

1 Subjective causes:

1.1 Budget deficit:

Budget allocation for investment and consumption is unreasonable In the period 1992-2007, the Eurozone economy maintained a very high level of consumption for investment and pays too much attention on projects that did not bring economic effects in short term particularly in education Besides, domestic consumption was in an extremely high level

Table 1 Budget allocation for investment and consumption from 1992 to

2007 in Germany, Greece, Ireland, Portugal and Spain.

(Source: OECD)

The table illustrates that the typical 5 countries of Eurozone spent more than

60 percent of domestic expenditure in Consumption The figure for Investment during the period from 1992 to 2007 was more than 15 percent in most countries

Table 2 Budget deficit and sovereign debt in European countries

from 2009 to 2011

(Source: Report from EC, Bloomberg and Credit Agricole)

As can be seen in the table, in German, a typical developed economy, when the budget deficit increased from 4.1 percent to 5.3 percent in the two year

2009 and 2010, the sovereign debt rose consequently from 73 percent to 74.3 percent The same issue happened in France, Italia, Portugal and Ireland

- Extensive welfare policies:

This showed the level of development and stability of an economy With its high level of development, the European countries soon maintained a social security system and widespread social welfare However, the degree of population aging was more and more faster, the proportion of labors generating income for economies was low in comparison with the proportion

of people exceeding the age of working As a result, the social welfare policies put too much burden on the budget

+ According to a study by the European Central Bank (ECB) in 2012, the sum of pension was paid in 19 countries of European Union(EU) was five times as much as the total debt in these countries, which was around 30.000 billion euros

+ Higher unemployment benefits: In France, the unemployed can receive benefits approximately equal to the wages of their working Number of unemployment years allowed in Ireland was up to 4 years/ person The number of unemployment years with pensions can be up

to 4 years/ person in here

+ US per capita income $ 34,320 / person / year but only 19.4% of GDP was spent on welfare and social security, similar to Japan's, $ 25,130 / person / year and 18.6% However, the figure for EU members fluctuated from 20% to 38.2% In order to have money for these purposes, these countries had to raise taxes For instance, VAT

was up to 20% in EU nations while the figures for US and Korea was about 10%

- Budget revenue decrease:

This is most clearly in Greece with the problem of tax evasion, economic activity underground, systematic corruption According to WB, the informal economy in Greece accounts for 25-30% of GDP (compared with 15.6% of Vietnam's GDP, 11.3% of Japan’s GDP) According to Transparency International Organisation, in 2008, more than 13% of Greeks spent 750 million euro bribing leaders in public sector and private sector

1.2 Easy access to loans:

As a member of European Union then the Eurozone, these countries accessed with large markets and low interest loans, which led to increasing public expenditure in member nations

In 2009, Greece had a budget deficit of 9.8% real GDP But the figure was estimated at 6% of GDP by Greek Government, which mislead the market to continue to borrow at low interest rates

1.3 Low saving rate:

Reserve in public is an important source for government to spend or repay their debt in need Low domestic saving rates led to foreign borrowing for public spending

The average saving rate of Greece was only 11%, lower than 20% of Portugal, Italy, Spain during the 1900s

1.4 Trade deficit:

Many countries in Eurozone did not have strong export platforms to ensure the necessary foreign currency revenue for the national budget

Except Germany remaining surplus, France, Greece, Portugal, Spain and Italy were in the trade balance deficit In the period from 2002 to 2008, euro rose from $ 0.8 to $ 1.6

1.5 Lack of consistence between monetary and fiscal policies:

Although members of Eurozone used the same currency, monetary policies were decided by ECB Thus if there were any budget deficits, member nations’ government cannot issue more money to make up for them or devaluate their currency to increase export but raise borrowing Countries with less competitive ability and huge budget deficits had to issues governmental debenture with high rates of interest to borrow easily

2 Objective causes:

2.1 Impact of the Economic crisis from 2007 to 2008:

Deprive from the burst of real estate bubble and the crisis of the national credit system Governments launched the rescue package to prop up the economy and protect the banking system from the risk of collapse

Figure 1 Number of systemic banking crises starting in a given year

(Source: Journal of Economic Perspective)

Irish Government spent 50 billion euros to rescue six banks, which makes Ireland budget deficit grow up to 32%

The combined impact of domestic recession, banking-sector distress and the decline in risk appetite among international investors would fuel the conditions for a sovereign debt crisis

2.2 The impact of Credit Agencies:

Credit Rating is an assessment of the credit worthiness of a borrower in general terms or with respect to a particular debt or financial obligation Credit assessment and evaluation for companies and governments is generally done by a credit rating agency such as Standard & Poor’s or Moody’s

The move that raising or reducing the confidence could create a crisis of confidence

In France on January, 2012, as Standard & Poor's downgraded from AAA to

AA +, making deficit reduction target of 4.5% to end the year of France in trouble French Prime Minister Sarkozy at that time must immediately declare

to regain the AAA in any cost

II THE IMPACTS OF EUROPEAN SOVEREIGN DEBT CRISIS ON THE GLOBAL ECONOMY:

1 The devaluation of Euro:

The impact of the global recession in 2008 along with financial deficits in Eurozone countries, where the sovereign debt crisis was very serious, put a double pressure on the euro and made it severely be devaluated As one of the main and most powerful currencies in the world currency system, this situation had significantly negative effects on global financial market Investors gradually lost their belief in the euro, which caused a run on large scale from Eurozone to other safe - haven as London real estate market Frozen transactions, delayed investment, stagnated production and rising unemployment rate, all of these caused the euro lose the inherent power of one of the most important currencies in the world

Figure 2: The EUR Price Index

(Note: EUR Price Index measures the volatility of the euro against a basket of currencies consisting of 6 categories: USD, JPY, GBP, CAD, CHF,

SEK.)

(Source: Reuters)

Generally within 3 years after the global financial crisis (from early 2009 until 25/06/2012), the price index has fallen by 16.1% EUR (Figure ) The euro fell by 8.6% against the US dollar, down 15.8% compared to the British pound, down 20.5% against the Japanese yen, down 19.7% against the Swiss franc and down 24.5% compared to the Canadian dollar

in the period 2009-2012 In particular, within 1 years ago (6 / 2011-6 / 2012), the EUR Price Index decreased by 9.8%, in which, the euro fell by 12.3% against the US dollar, down 10% versus GB pound, down 13.7% compared with the Japanese yen (Calculated from data from Reuters to date 06.25.2012)

8 2009 2010 2011

Total global foreign

exchange reserves 5.3 6.7 7.3 8.2 9.3 10.2 USD (%) 65.5 64.1 64.1 62.0 61.8 62.1 EUR(%) 25.1 26.3 26.4 27.7 26.0 25.0

Table 3: Global foreign exchange reserves by currency

(Source: IMF Statistics Department Coffer Database, updated 30 June

2012)

Along with the devaluation, international status of the euro also was impacted negatively The world economy had been more volatile since the global financial and the European sovereign debt crisis, making governments tended to diversify foreign exchange reserves in order to reduce risks This caused the proportion of reserve in the euro to decline from 27.7 % in 2009 to 25.0 % at the end of 2011, although the euro was still the world’s second largest international reserve currency Meanwhile, the percentage of other currencies rose significantly from 3.2

% to 5.3 % within two years

2 Slow recoveries of global economy :

At this time, the global economy had just escaped from the financial crisis

in 2008, began having some signs of recovery as the result of stimulus packages launched by governments, the spending reductions, particularly the austerity policies in European countries, as well as tax rising, caused

a decrease in investment and hindered the economic recovery The economy developed slowly, even faced to double crisis, according to many experts Besides, sovereign debt crisis also had negative effects on the financial system, panicked the banks, made them tighten lending policy in the short term and caused the bailouts inaccessible to consumers

Country group name 200

8 200 9 201 0 201 1 201 2 201 3

World 2.80 -0.57 5.14 3.83 3.28 3.62 Major advanced economy

(G7) -0.36 -3.84 2.78 1.42 1.44 1.49 Euro area 0.37 -4.24 2.03 1.43 -0.41 0.16 Other advanced economies

(excluding G7 and Euro area) 1.68 -1.17 5.87 3.23 2.06 2.99 Newly industrialized Asian

economies 1.80 -0.73 8.50 4.03 2.14 3.60 Developing Asia 7.92 6.98 9.51 7.76 6.67 7.2 Latin America and the

Caribbean 4.25 -1.55 6.15 4.51 3.17 3.89 Middle East and North Africa 4.54 2.57 5.03 3.30 5.27 3.65

Table 4: The percent change of gross domestic product (with constant prices) of world economy and some country groups in

the period from 2008 to 2013

(Source: IMF, World Economic Database)

From 2007 to 2013, the percent change of global GDP decreased by 1.79% After the positive signs of recovery in 2010, with the effect of European sovereign debt crisis, the world economy faced a challenge again Within one year, the global growth rate fell from 5.14% to 3.83% Many country groups also suffered the same decrease, in which steepest fall was in newly industrialized Asian economies with 4.07% down From

2010 to 2013, all country categories’ percent change decreased

significantly The growth rate of groups dropped respectively by 1.29%

in G7 countries, 1.87% in Euro area and 2.88% in other advanced economies, while this figure in newly industrialized Asian nations was more dramatic, 4.9% This situation was also taken place with other country categories including developing Asia, Latin America, Middle East and North Africa

3 High unemployment rate:

The austerity measures of the governments, slow recovery along with bleak economic prospects caused many corporations make the decision

of delaying investment and downsizing to overcome the hard time Besides, a lot of companies and banks announced situation down and losses, even bankruptcy, all of these made the rate of unemployment rise alarmingly

Country group name 200

8 200 9 201 0 201 1 201 2 201 3

Major advanced economies

Euro area 7.65 9.65 10.2 10.2 11.3

9 12.05 Other advanced economies

(excluding G7 and Euro area) 3.93 5.34 5.24 4.72 4.67 4.60 Newly industrialized Asian

economies 3.40 4.33 4.02 3.57 3.54 3.48

Table 5: The unemployment rates in some country groups in the

period 2008 – 2013

(Source: IMF, World Economic Database)

After the European sovereign debt crisis, the employment rates in many regions was very high, particularly in Euro area, which was more than 10% From 2010 to 2012 the global jobless proportion has risen by 1.81%

The unemployment rates in European countries, especially Eurozone has always been the highest in the world At the end of 2012, a quarter of population of Greece and Spain was jobless, caused the proportion of