Greece Debt Crisis: Causes, Implications and Policy Options

INTRODUCTION After joining the Economic and Monetary Union (EMU) of the EU in 2001, Greece ran large deficits averaging 7 percent of GDP between 2003 and 2008. Although the outbreak of the global financial crisis in fall 2008, the Greek government borrowed heavily in international capital markets to fund government budget and current account deficits; as a result the government debt grew exceptionally large. In 2009, the budget deficit reached 15.6% of GDP, and the external debt reached 115% of GDP. The maturing debt obligations reached about 54 [euro] billion ($72.1 billion) for 2010 and the general government debt reached 147.3% of the GDP. Both Greece's budget deficit and external debt level are well above those permitted by the rules governing the EU's Economic and Monetary Union (EMU), which calls for budget deficit ceilings of 3% of GDP and external debt ceilings of 60% of GDP. 1-Greek Policy Responses The Greek government adopted sets of procedures to confront the crisis: 1-1 Fiscal Austerity In October 2009, the Greek government has unveiled three separate packages of fiscal austerity measures aimed at bringing Greece's government deficit down from an estimated 13.6% of GDP in 2009 to below 3% by 2012. In total, the measures are worth an estimated 16 [euro] billion ($21.6 billion), or 6.4% of GDP. In March 2010, the parliament approved another austerity measures which aimed to increase revenues through a rise in the average value-added tax rate. On the expenditure side as shown in figure (1), most of the spending cuts announced focused on the civil service. The Greek social security system has been facing chronic and structural problems (George Hondroyiannis and Evangelia Papapetrou (2002), thus the government decided to reduce pension funds, cuts in pay and non-pay expenses, a substantial increase in prices for services offered by SOEs, and limits on subsidization. The government also announced to tighten public regulation and restructure Greece's public administration by consolidating local governance structures through reducing the levels of local administrative authorities. 1-2 Long term structural reform The government announced wide-ranging reforms to the pension and health care systems and to Greece's public administration, and boosting Greek economic competitiveness by enhancing employment and economic growth, fostering private sector development, and supporting research, technology, and innovation. In spite of Greece's relatively drastic contractionary fiscal policies, and steps of the structural reform, the economic growth rate contracted by 2% in 2009, 2.5% in 2010 and by 0.7% in 2011, and registered unemployment reached 12.6% in 2010, as shown in the table (1). The Greek government tried attracting new foreign investment in Greece by boosting exports of goods and services, as well as focusing on trade and investment, shipping and tourism sectors using its geographic location. However Greek exports dropped in 2009 to 18.8% as shown in table (1), and Greek businesses have become increasingly uncompetitive in domestic and international markets. 1-3 Request financial assistance On April 2010, the Greek government requested financial assistance from other European countries and the IMF to help cover its maturing debt obligations. However European leaders and the IMF requested additional measures to meet budget deficit targets in exchange for financial assistance which included economic structural reforms, while Germany and France (which are providing the largest loan) requested sever austerity measures. Sebnem Kalemli et al. (2010) argue that it is important to provide liquidity to the banking sector during financial crises especially if the domestic banking sector is the main source of financing for the firms. 2-Possible Causes of the Crisis Greece's current economic problems have been caused by a mix of domestic and international factors. …