June 13, 2012
This is my 1st post realting to Economic scenarios and hopefully many will follow. Currently we are encountering varied issues all over the globe, let me list them down...
1) Japan - Aging population and deflation
2) USA - High unemployment, low growth, low rates of interest
3) China - Propety bubble, falling exports, slowing growth
4) European Union (EU) - High unemployment, high debt to GDP ratios, low growth
5) Australia - High unemployment, low growth
6) India - Low growth, weakening currency, high inflation
The common feature among all is Low Growth and High Unemployment. Precursor to our current state was the Financial Meltdown of 2007-08 and we are still in its aftermath. Let's begin with the EU, which is the main reason for the current crisis. EU countries are currently facing high debt to GDP ratios ( in the range of 70% to 150%), i.e. their debt levels are not sustainable with their current GDP and neither will their economies grow at such a rate that they can repay the interest or the principal. Let us see what led to such a situation for a few of the countries...
a) Greece - Greece's entry into the EU was done in haste and without adequate due diligence by the initial member countries, to shore up member nations that have adopted the Euro, so it could convert into Euro at a highly favourable exchange rate. Greek citizens suddenly became rich as they possessed a stronger currency. The Greek government started borrowing at very low rates due to their EU association. These reasons coupled with an unproductive economy, high social security benefits and low retirement age made them profligate. To sustain such high levels of social security benefits, the government got into a debt spiral in which they had to borrow more money to pay the interest on the initial debt. This situation was sustainable till the world markets were flush with liquidity, but the 2007-08 crisis which led to a trust-deficit made borrowings by such profligate economies expensive as liquidity dried up and lenders became sceptical. Now the government could not mend its ways hence they started borrowing at higher interest rates compared to other EU nations. Earlier they were borrowing at 2% - 3% now the rates rose to 7% for a ten year note, a country which doesn't have the means to even pay the interest on such loans and has a GDP growth rate of 1%-2% can't sustain such a high cost of debt. If Greece had the power to print the Euro it could have easily repaid these loans, but the EU doesn't have a monetary union which allows its member countries to print notes and get out of jail. The EU treaty has a mandated the European Central Bank (ECB) to expand money supply i.e print notes at a certain fixed level. Eventually it had to approach the member countries for a bail-out.
b) Ireland - It also had similar story as Greece and it also had to approach the EU countries for bail-out.
c) Iceland - A non-EU state had a huge boom in real estate prices, being a country having a small population such price rise was unsustainable and had attained bubble proportions. The exposure of 2of the largest banks of Iceland in real estate loans was higher than the GDP of Iceland, when the 2007-08 financial crisis struck it was the first nation to seek help, the real estate bubble burst which lead to huge non-performing loans following which the banks faced huge losses. These banks were bailed-out with government i.e. tax-payer and IMF borrowed funds. Iceland was in a favourable position because it could print its own currency which was severely devalued during the real-estate crash and due to which it could restrain foreign capital from leaving its shores.
d) Spain - Spain also saw a real-estate bubble which was propped up by Cajas (Loca Savings Bank are known as cajas), the typical case of sub-prime lending. Even its real estate bubble burst post the financial meltdown and the Cajas are sitting on potential NPAs of billions of dollars. Just a few days back the EU sanctioned a $100 billion bail-out package to re-capitalise these banks.
Similar story resonates around other EU nations like Portugal and Italy. Till now Iceland, Greece, Ireland and Portugal have received bail-out funds from EU and they have stopped issuing fresh notes as there is no market for their debt instruments. Greece's 10 year note has a yield of 27%. All the nations (except Iceland) approached the EU for assistance after the yield on their 10 year notes crossed 7%. As of today the yield on Spanish and Italian 10 year notes is 6.5% and 6% respectively and rising.
This the background of the current imbroglio and in the following post I shall provide further details with regards to the measures adopted by the EU, current state of the economy in the USA and China, and finally the impact of all this on India as well as our own follies.
Nice to see you writing on such serious topics ! Do come our with a following post and complete it . Good start "thumbs up"
ReplyDeleteThanks and shall definitely write the next one without fail
Delete