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: NGUYEN THANH CAT ANH PHUNG KHANH CHI May 2015 INDEX: Page A B C Introduction Theoretical basis Causes and impacts of European sovereign debt crisis on global economy Solutions 16 Conclusion 18 Sources 19 INTRODUCTION 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: Subjective causes: Budget deficit: 1.1 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 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 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 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 years/person The number of unemployment years with pensions can be up to 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 Objective causes: Impact of the Economic crisis from 2007 to 2008: 2.1 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 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: 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 categories: USD, JPY, GBP, CAD, CHF, SEK.) (Source: Reuters) Generally within 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 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) Year Total global foreign exchange reserves USD (%) EUR(%) JPY(%) GBP(%) Others(%) 2006 2007 2009 2010 2011 6.7 200 7.3 5.3 8.2 9.3 10.2 65.5 25.1 4.4 3.1 2.0 64.1 26.3 4.7 2.9 2.0 64.1 26.4 4.0 3.1 3.2 62.0 27.7 4.2 2.9 3.2 61.8 26.0 3.9 3.7 4.6 62.1 25.0 3.9 3.7 5.3 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 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 2.80 economy -0.36 World Major advanced (G7) Euro area Other advanced economies (excluding G7 and Euro area) Newly industrialized Asian economies Developing Asia Latin America and the Caribbean Middle East and North Africa 200 -0.57 -3.84 201 5.14 2.78 201 3.83 1.42 201 3.28 1.44 0.37 1.68 -4.24 2.03 -1.17 5.87 1.43 3.23 -0.41 0.16 2.06 2.99 1.80 -0.73 8.50 4.03 2.14 3.60 7.92 4.25 6.98 9.51 -1.55 6.15 7.76 4.51 6.67 3.17 7.2 3.89 4.54 2.57 3.30 5.27 3.65 5.03 201 3.62 1.49 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 Major advanced (G7) Euro area 200 economies 5.9 200 8.07 201 8.20 201 7.67 201 7.41 201 7.13 7.65 9.65 10.2 10.2 11.3 4.67 12.0 4.60 Other advanced economies 3.93 5.34 5.24 4.72 (excluding G7 and Euro area) Newly industrialized Asian 3.40 4.33 4.02 3.57 3.54 3.48 economies 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 Eurozone in general rising by 11,6% Other nations including Portugal, Ireland, EA 17, Italy and France also had high unemployment rates, which was more than 10% Figure 3: The unemployment rates in the Euro area in 2012 (Source: Eurostat The Wilder View) Global trade reduction: Depart from the decrease of demand and low economic development, global trade also faced with negative effects From 2010 to 2012, the rate of growth of global trade dropped by 1,14% The crisis in 2007-2008 affected significantly the import and export situation of countries, with ones influenced most seriously are Greece, Spain, Ireland and two biggest economies in the world: the USA and China - Import: Country group name World Major advanced (G7) Euro area 200 2.88 2009 201 -10.85 12.6 economy -0.52 -11.88 11.6 0.49 -11.39 9.82 201 6.27 201 2.75 201 2.93 4.75 1.5 1.08 4.43 -1.11 0.26 Other advanced economies 4.21 (excluding G7 and Euro area) Emerging market and 8.47 developing economies ASEAN-5 6.65 -11.62 15.4 -8.03 14.4 -15.54 19.3 -16.07 21.9 -0.96 -0.24 5.91 1.80 2.79 9.17 5.75 5.58 9.41 6.62 3.14 Latin America and the 846 11.1 3.47 3.50 Caribbean Middle East, North Africa, 15.5 0.96 9.89 7.63 Afghanistan and Pakistan Table 6: The percentage change in volume of import of goods and services in the period from 2008 to 2013 (Source: IMF, World Economic Outlook Database) The percentage change of global import saw a significant decline in many areas Within years from 2010 to 2013, this rate of world import decreased by 9.7% This situation also took place in all regions in the world, except Middle East, North Africa, Afghanistan and Pakistan - Export: Country group name World Major advanced (G7) Euro area economy 200 0.49 2009 1.78 -13.22 0.67 -12.76 -11.39 201 9.82 12.8 11.5 13.4 13.9 11.8 10.1 201 4.43 201 201 -1.11 0.26 5.66 2.38 1.46 6.43 2.35 1.44 Other advanced economies 4.08 -8.15 5.92 1.80 3.70 (excluding G7 and Euro area) Emerging market and 4.33 -7.91 6.96 4.19 4.44 developing economies ASEAN-5 -5.38 7.05 2.39 3.19 1.49 Latin America and the 0.66 -10.20 5.86 1.61 2.42 Caribbean Middle East, North Africa, 3.92 -2.94 2.85 3.36 6.77 2.43 Afghanistan and Pakistan Table 7: The percentage change in volume of export of goods and services in the period from 2008 to 2013 (Source: IMF, World Economic Outlook Database) Similar to import, the percentage change in volume of export also fell remarkably Excluding Middle East, North Africa, Afghanistan and Pakistan, other country groups faced with a dramatic decline From 2010 to 2013, this rate of world’s export dropped by 11.36%, mainly due to the decrease of trading of advanced economies, particularly USA, China and the EU Gold price raised sharply: With the spread of the debt crisis, the devaluation of the euro has remarkably affected to panic psychology of investors, made them look to precious metal as a safe solution Gold is one of the precious metal and the storage assets - traditional investing public Gold's role as an international means of payment have been established since the early 19th century under the gold standard The biggest advantage of this monetary regime is to limit the uncontrolled proliferation of credit and public debt using cash statutory regime (not converted into gold) because the central bank has the right to print money when necessary At this time, the gold price rose significantly, usually above 1300 USD/ounce Particularly, in 2011, within months from February to September, the price increased from about 1300 to nearly 2000 USD/ounce(Figure 3) Not only gold, the price of platinum and silver also saw an increase Figure 4: Gold price from the end of 2010 to early 2012 (Source: goldprice.org) C SOLUTIONS: Solution from European countries: Reducing public spending and raise taxes: Although bringing many political and social consequences, as well as upsetting the lives of residents, in fact this is still the first measure that the European nations apply and may be the most effective short-term one Simultaneously, it is also used as a requirement of three organizations including the International Monetary Fund, the European Union and the European Central Bank for the aid to help countries at risk of debt default exit crisis - Greece: From 2010 to 2012, Greece had implemented cuts in allowances and salaries of civil servants, and raised taxes to increase revenues for the State budget - Ireland: In May 2010, Irish Government announced austerity and tax increases of about 20% in the next years, in which 3.8 billion USD would be cut in social welfare and 1.9 billion USD increased by raising tax By 2011, the Irish Government continued to plan to reduce spending by 12.4 billion over four years - Portugal: 2013, the Portuguese Government plans to save 5.3 billion euros for the state budget, in which 600 million euros were expected to be cut in public spending - Spain: In 2012, the Spanish government decided to suspend the recruitment of personnel in the public sector and planned to reduce 8.9 billion euros in government expenditure - Italy: In 20111, the Italian Government adopted the programme of spending cuts and increasing tax valued about 48 billion euros Solutions come from the International Monetary Fund, European Union and European Central Bank: the financial stabilization mechanisms These three organizations play a crucial role in shaping and implementation of policies to revive Europe Besides three measures offered by the European Central Bank including buying up government and private debt, unlimitedly purchasing government bonds of members and restart swap agreement between EUR and USD with the support of FED, the financial stabilization mechanism established by the European Union and the International Monetary Fund also was expected to bring positive results to the public debt crisis - European Financial Stabilisation Mechanism (EFSM): an emergency fund takes capital from the financial markets and the budget of the European Union under the guarantee of the European Commission With an initial budget of 48.5 billion euro used for bailout for Ireland and Portugal, the aim of this mechanism is to maintain financial stability by the aid for the European nations - European Financial Stabilisation Fund (EFSF): the long-term mechanism coordinated between the European Union and International Monetary Fund The objective of this fund is to ensure the stability of European finance by providing financial support for Eurozone countries when they are in difficult period This fund is authorized to lend up to 440 billion euros and expected to expire on March 2013 - European Stabilisation Mechanism (ESM): Originally founded as a permanent Eurozone bailout fund replacing for the European Financial Stabilisation Fund when this fund expires, with the initial budget of 700 billion euros With this mechanism, Eurozone members may borrow money to deal with the debt crisis, in exchange, they must carry out financial reform and restructuring CONCLUSION Looking back at the sovereign debt crisis in Europe, it can be concluded that the causes of this crisis came primarily from the limitations in managing the national budget of governments and the loose fiscal policy of Europe This made the European economy with the inherent weaknesses become passive in responding to the crisis The debt crisis has seriously affected the world economy in general and Europe in particular Besides, its social and political consequences are also remarkable Not only overturning the lives of European residents, the crisis also challenged the sustainability of the Eurozone and sparked internal disagreements inside the European Union, threatened the unitary process that this economic alliance pursues Many solutions have been put forward, in which the most noteworthy was still the "austerity" policy applied by governments and the stabilization mechanism established by the International Monetary Fund, the European Union and the European Central Bank Although certain shortcomings still existed, these solutions have helped the Europe countries against the threat of default and prevented a global economic double-dip recession At the same time, solving the public debt issue was also the best way to help reconcile disputes, internal conflicts and ensure the sustainability of the European Union SOURCES The International Monetary Fund:www.imf.org Organization for Economic Co-operation and Development: www.oecd.org Journal of Economic Perspective Eurostat: www.ec.europa.eu Reuters: www.reuters.com Gold Price: www.goldprice.org http://vnexpress.net/cuoc-khung-hoang-no-cong-chau-au/topic15607.html http://doc.edu.vn/tai-lieu/tieu-luan-khung-hoang-no-cong-o-chauau-va-tac-dong-den-nen-kinh-te-the-gioi-28091/ PhD Dang Hoang Linh, Diplomatic Academy of Vietnam: “Khủng hoảng nợ công Châu Âu học kinh nghiệm Việt Nam” , National Political Publishing House, 2014  ... Introduction Theoretical basis Causes and impacts of European sovereign debt crisis on global economy Solutions 16 Conclusion 18 Sources 19 INTRODUCTION Experiencing a long way of formation and development,... declare to regain the AAA in any cost II THE IMPACTS OF EUROPEAN SOVEREIGN DEBT CRISIS ON THE GLOBAL ECONOMY: The devaluation of Euro: The impact of the global recession in 2008 along with financial... confidence for European businesses and economies B THE CAUSES AND IMPACTS OF EUROPEAN SOVEREIGN DEBT CRISIS ON THE GLOBAL ECONOMY I Causes: Subjective causes: Budget deficit: 1.1 Budget allocation for