When a Country Defaults

How do you judge the credit worthiness –

  • Of an individual ? – On the basis of the individual’s financial standing
  • Of an organisation ? – On the basis of its fundamentals
  • And of a country ? – On the basis of the its economic stability

But I know these are not the only criteria you look into. There is an unwritten code of trust which forms the underlying of any credit transaction. This is where the daddy of all assets enters- Goodwill.

Goodwill is simply the reputation which the entity commands among its peers. It is the potential earning capacity or perceived market standing with a premium attached to it.

Judge it for yourself. Try comparing the repayment capacity of the chai-wallah in front of your college gate to that of chai-wallah turned Prime Minister Mr. Modi. Whatever differential comes in your mind is this asset. Now try monetising this feeling, and bang…you are taken aback for a moment. Here lies my point.

Take this thought to a global level. This is the stage where the nations borrow with nothing but a promise to repay each other in the foreseeable future. These long term borrowings are guaranteed by the Central Governments of the borrowing countries. What’s more… most of the countries on face of this planet, nearly all of them are in debt. Why to go anywhere else, India’s external borrowing is a fourth of its annual production- A massive USD 450Mn.

Think about Middle-Eastern and South Asian economies, anyone would hesitate to lend them some dough (for the obvious reasons), but having a similar feeling for “the developed countries” of the West could not be thought of till a decade back.

In this piece, we take one such country which is in the middle of an existential crisis, and its name would surprise you even more. As Wikipedia says ‘It is the birthplace of democracy, Western philosophy, the Olympic Games, Western literature, historiography, and political science, major scientific and mathematical principles’. Not enough. This land has been trodden upon by the Romans, and the Great Spartans. Correct- It’s the mighty Greece.

What a Shame –

A default by you and me is big enough to create problems for people around us. People who love us will surely make good the loss. But how does one explain a country turning away from its promise? The consequences are far reaching, the situation- delicate.

Take a close look at the figure below, it shows the extent as to how much everyone stands “exposed” in the Greece story –

 Figure 1: Breakdown of the Greek Debt

Greece Crisis Explained –

Spending more than you earn is the biggest financial mistake you can make. Some get this realisation early, some learn it the hard way – unfortunately Greece falls in the latter. After a switch to the euro from the drachma in 2002, the Greek public sector saw wages rise to unsustainable levels. The retirement age in the country was already very low accompanied with loads of benefits. Not only did Greece begin splurging more but their revenue was falling too. Tax evasion looted Greece of an estimated € 20Bn annually.

The extra expenditure led to deficits, with mammoth borrowings taken to meet this deficit. Come 2012, the debt levels were close to crossing twice the value of the Greek economy. (See Figure 2 below)

Result- A sovereign debt crisis ensued.

Just like the sub-prime crisis in 2008, this time it were the borrowings of Athens which were pumped down the throats of greedy investors all around the world in disguise of simple financial instruments.

Figure 2: Debt to GDP ratio of Greece over the years and projections

The 2 Bailouts-

Faced with an unescapable situation, the rest of Europe had to intervene. This led to the formation of Troika- a term used to describe a three party commission comprising of the European Commission, European Central Bank (ECB) and the International Monetary Fund (IMF) that organised loans to the governments of Greece and later on to Portugal, Ireland and Cyprus.

To prevent the Eurozone from failing, the countries had to support the defaulting nation. Greece was sanctioned € 240Bn (in two tranches) to handle the crisis – as if they believed that could happen. The bailout came with a flood of restrictions (read the infamous austerity measures) on how the regime was to be carried on further. Austerity measures are steps to control the non-plan expenditure (through cuts in wages, retirement benefits, allowances, subsidies, and other freebies)of the Government while at the same time aiming to increase the revenue (through increase in taxes, duties, fines and penalties).These measures were essential – After all a nation with a proven track record of being fiscally irresponsible, piled up in debt to its neck just could not have been trusted with such big an amount.

 Figure 3: A “simple” info-graphic detailing the possible breakouts upon the Greek default

 Figure4: The continuing volatility in Interest Yield of Greece starting

from 2009 shows the lack of investor confidence

The controls were meant to lead to fiscal consolidation and discipline. From crackdowns on those evading tax to privatisation of public assets, everything was done to prevent the country from going down. The measures however, were not received happily by the Greek public, leading to immediate riots and protests. With economic morale already down, Greece had to struggle socially this time.

Rather it is the Greeks who should give their nation a chance

The Present Situation

The public stood against the austerity measures so much that a left wing party won a legislative election for the first time ever in January 2015.. The ideology of the new Government, led by Mr. Alexis Tsipras, is to refuse the third proposed bailout from the Troika and to sit with the creditors to revamp the existing bond agreements and come out of this vicious cycle once and for all. As you read, discussions are going on Brussels over the possibilities and their probabilities

Indeed, a lot is riding on shoulders of the New Greek PM.

Wonder what Zeus would say to his mortals from the heavens above.

 

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