The Sovereign Debt Crisis of Europe : Why everyone attributes the slowness in their economy to Europe?

Sovereign debt crisis is something that everyone has heard of but very few people know it from within.

The term itself is so heavy that most of us think of leaving it to the professionals while the general take away is that there is some financial crisis going on in Europe because of which the risk of decreased economic growth is looming over our businesses and jobs.

When you get involved in a discussion in college or at work during lunch hours, the topic of Europe’s economic crisis must have surfaced several times by now, but, have you been able to contribute to the discussion more than by just saying that the economic growth of European nations is not good which has affected our businesses too? If yes then good.

Well, certainly after reading this complete article you will be able to contribute much more to the discussions of worldly matters and not only that you will emerge as an inquisitive and knowledgeable person too.

This article will not directly take you to the topic ‘What Sovereign Debt Crisis is? ’ but it will first make you familiar with a few terms after which comprehending Sovereign Debt crisis will become a piece of cake.

So, let’s start!!

What is a Sovereign Bond?

A country needs money to run its operations, for its government backed banks, for providing basic infrastructure to its citizens, for its army, navy, air force, for building hospitals, providing health care, running employment programs and many more.

A country’s central government’s source of revenue is the money received from the tax payers which are the earning citizens of the country. Due to different expenditures, many times government falls short of money in its treasury because of which it becomes mandatory for the government to borrow money from people who are in the state of lending it.

The country therefore issues sovereign bonds based on which it borrows money from foreign investors and countries.

The bonds are generally issued in the denomination of foreign currency, however, the country can also issue bonds in its own currency but this totally depends on how stable the currency of the country is.

If the country is stable and is not going to through a social upset or a coup d'etat (pardon me if I am exaggerating here) then it doesn’t face any problem in issuing bonds in its own currency.

The treasury bills which are generally issued in countries like India and The United States are short term examples of such bonds.

What is Sovereign Debt?

As stated above, when the country issues sovereign bond it borrows money from other countries as well as investors, it therefore incurs debt.

Suppose you are an investor with tons of dollars in your bank account and you are finding sources to invest your money. It comes to your notice that country ‘X’ is issuing sovereign bonds in the denomination of dollars because it needs money to support development in the country.

When you provide money to country ‘X’ you now hold the sovereign bond issued by the country and ‘X’ owes you the amount of dollars you invested which it will have to return you with timely interest after a specified time period.

Now, as an investor you cannot right away lend money to ‘X’. There are ‘n’ number of factors which you will take into consideration before lending money such as the currency stability of the country, social status inside the country and above all, the sovereign debt rankings.

It is obvious that when the sovereign debt rankings are good then only you will take the decision to invest in the country ‘X’

What is budget deficit?

The budget deficit occurs when a government’s expenditures outrun its revenues. 

The budget deficit may occur due to several reasons like when the government spends a lot on its infrastructure, its development plans, its army, navy, air force and its public but it doesn’t receive enough money in the form of tax from its earning citizens due to various tax evasion strategies.

The budget deficit clearly indicates how healthy a country is. If the budget is balanced i.e. expenditure = revenue, it increases the confidence of the investors to invest money in the country. 

It generally indicates to the entire world that the business growth is faster as the economic growth runs fine.

The budget deficit hurts the sovereign debt of a country. Why?

It is obvious that if a government spends amount X on its people and due to corrupt bureaucrats as well as politicians and some of the corrupt citizens it receives only 2% of its expenditure in the form of taxes then how will it be able to pay the debt?

This is a major factor in slowing down the economic growth because of which the government raises taxes and reduces public expenditure which impacts employment rate too.  Sometimes these measure which a government adapt to are also known as Austerity Measures.

When did the Sovereign Debt Crisis start?

The Sovereign debt crisis is said to have started in the year 2008 when the banking system of Iceland collapsed.

The banking system collapses when the borrowers of the money from the bank are unable to repay their debt and no way is the bank able to recover the money from them. When there are too many defaulters like such, the bank itself goes bankrupt and has no money to run its operations.

The peripheral countries of the Eurozone like Italy, Spain, Portugal, Greece, Cyprus were also unable to pay their sovereign or national debt due to the slow economic growth. 

Read -> Brexit: Read in short but know it completely 

A strong reason of the sovereign debt crisis is believed to be the recession of the year 2008 which was caused when the asset bubble burst in the United States and in a few countries of Europe.

Greece was worst affected by the sovereign debt crisis.

When an investor or an investment country seeks to invest in another country they check its sovereign debt rankings which indicate if the country would be able to repay its debt or not.

The then existing government of Greece revealed that the previous government reported wrong numbers of budget deficit. 

To save its reputation, it reported that the budget deficit was too low but in reality it was huge which proved to be a major cause of the slow economic growth.

Since, Greece was nowhere near to pay its debt hence its debt rankings plummeted at the lowest possible level which meant there was no more money coming in from the investors.

As a result, a bail out was organized by the European Eastern bank and International Monetary Fund in exchange of implementing austerity measures.

The austerity measures when implemented asks a country to keep the public expenditure as low as possible and increase the taxes which itself reduces the economic growth as when the public expenditure is low how will the citizens be empowered to spend more apart from their needs to make the businesses profitable.

If the businesses are not profitable, the industrial output will drop which results in businesses not borrowing enough from banks and when the supply of the money is more than the demand the purchasing power of the money reduces which in turn affects currency ratings.

Apart from Greece, the debt rankings of Spain, Italy, Cyprus, Portugal also fell down and it was believed that Euro was on the verge of collapsing as these countries along with 14 others share Euro as their currency.

Impact on world economy

Bilateral trades are important for any country to grow such that it can make money from its natural resources, minerals as well as the local labour and talent.

A lot of countries, Asian countries as China and India and many more were and still are in trade with the European countries particularly the European Union countries (28).

Due to the lack of economic growth, the consumption demand reduced in the affected countries. When the demand was reduced it affected the countries which were responsible for supplying to the demand.

Source  : World Bank Data

The businesses were hit in other countries too and imagine those companies whose only clients were the businesses in the affected countries such as Spain, Portugal, Cyprus, and Italy.

It was recorded in the year 2012, as a result of this crisis, the annual growth rate of the entire world economy reduced by 0.65% and the global unemployment rate increased by 1.81%.

The Indian IT firms most of whose business came from the United States and Europe were affected deeply by both ‘The 2008 recession’ as well as ‘The Eurozone debt crisis’.

China was another nation affected by the Eurozone Crisis as we all know, that it has an upper hand in the entire world when it comes to machinery, electronics as well as raw material processing.

All its exports were affected which contributing to the decrease in its economic growth.

The exports of The United States which is believed to have multiple trade ties with the Britain and other nations of Europe were also affected even when it was recovering from the collapse of its asset bubble.

Conclusion

The Eurozone crisis really hurt the world economy deeply and the world is still recovering from it.

With huge budget deficits on the books, it is a challenge for the governments to increase the consumption demand by keeping the public expenditure low to improve the economic growth. Without improved economic growth, the debt issue is very difficult to be solved.

However, my job thorough this article is not to suggest what governments should do but inform you guys about this topic of Sovereign debt crisis.

So, did you enjoy reading this article?

Do you know anything more about this topic ? If so, I will be happy to include it in this article.

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Brexit: Read in short but know it completely

What is the European Union?

The European Union can be described as a single body which has 28 countries within its purview. It was created post World War II to increase economic and political friendliness among European countries by introducing the concept of free trade and free movement of people across borders of its member countries.

So, if one towel is made by a brand in one country it can be sold in any of the member countries without custom duty, tariffs and taxes.

Suppose, if a towel is made by a reputed brand in India and it were to sell in Sri Lanka then its cost will increase due to numerous tariffs and custom duties, lowering the margin of the company and so, lowering the profit.

The towel will not be able to compete in the local market due to high costs and the brand won't be able to obtain the profit it would have in India.

On the contrary, if a towel is made in any of the countries of EU then it can be sold in any other country at the same cost, thus the margin in the home country and any of the other 27 countries remain the same and thus the profit.

The borders of the countries are also not sealed for each other which means that a citizen of France going to Germany will not be subjected to the checks and formalities, which he would go through while visiting The United States.

The euro is the official currency of European Union. 

19 of the 28 member states have adopted euro as their official currency and it is the most traded currency in the foreign exchange market second to the US Dollar.

Below are the member states of EU with underlined states having their official currency as Euro.

Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain , Sweden, United Kingdom

What is Brexit?

As you already know, Brexit is the combination of 'Britain + exit', referring its exit from the European Union. 

Britain is still a part of European Union and is going to officially leave EU on 29^th March 2019 almost 2 years after the current PM of Britain Theresa May gave nod to the exit process.

Now, a question would pop up in your mind why after 2 years? The answer is because of 'the Article 50' which came into effect in 2009 especially for the member countries. 
Let me make it clear that before 2009 there was clear provision for any of the member countries to leave EU.

So, under Article 50 the minimum period of separation is 2 years which can be extended too depending on the negotiations involved.

The negotiations are particularly related to how much the countries owe to each other, the rights of the citizens (in this case the UK people living in the EU countries and the EU people who migrated to UK)

Why Brexit?

Britishers who voted for Brexit feel that their jobs are taken by the immigrants. The immigration is quite easy due to free movement of people, goods, services etc across the EU countries .

This means that any person residing in Austria can come to Britain and work there if he is willing to live a more prosperous life basing his decision on the strong currency power of the GBP.

The EU created a single market. In a single market the services, goods, products and people can move freely between the two countries. 

The idea behind single market was to keep the prices as low as possible, create jobs and facilitate trade among the countries.

When there is a free movement of people, generally talented people from poorer countries than Britain emigrate there and take up the jobs of average Britons which creates antipathy towards the immigrants.

The Britons also blame the foreign students who occupy the seats - which they think belong to them - in reputed educational institutions of Britain.

3 universities in top 10 universities of the World are in Britain; the facts and figures also indicate that most of the noble laureates have studied in British Universities. 

Also, the quality of the education provided in Britain is exceptional. These are reasons enough to attract students from around the world to study in Britain.

Surveys have indicated that it is this antipathy towards immigrants that is majorly responsible for the majority voting in favor of the Brexit.

For and Against Brexit

A referendum poll was held on 23^rd June 2016 in which about 72% of the population came out to vote in favor or against Brexit.

The then prime minister of Britain David Cameron was against Brexit as he held the view that it would negatively affect Britain’s economy and would make its GDP plummet.

However, the view of David Cameron and other economists couldn’t stop the majority from going in favor of Brexit. About 52% voted to leave the EU and around 48% were against it.

On losing the poll, David Cameron resigned from the seat of the Prime minister and Theresa May took over as the new Prime Minister of Britain. 

Initially, she was also not supportive of Brexit but eventually she agreed with the majority.

Political Factor on Brexit

History indicates that Britain has always preferred a separate national and social identity. It joined the EU in 1973 much later than 1957 when the EU was actually formed.

Britain never accepted euro as its currency. 
Britons perceive Britain as a separate continent altogether separated by the English Channel from the rest of the Europe.

Britons while narrating their vacation plan do not explicitly mention travelling to France and Switzerland rather they mention going to Europe. Even local travel companies on their street hoardings use texts such as ‘4 days 3 nights in Europe’.

These reasons reflect that apart from xenophobic sentiment there is a political desire to materialize the notion of being a separate identity.

Speculation on the economy

Economists and political officials who were against Brexit speculated that Britain would fall in an immediate economic crisis as Europe is Britain’s important export market and a phenomenal source of FDI.

Exiting the single market would mean impacting the trade with other countries, surging of the prices as well as losing FDI too.

The immigrants also form a large chunk of the labour force. With the free movement of people stopped, the labor force will be impacted in medium to long term.

But, on the contrary, the speculation of immediate economic crisis proved to be incorrect. 

The GDP growth in 2016 came out to be stronger post Brexit referendum with Q3 and Q4 showing an increase in GDP compared to previous quarters.

Only the pound fell sharply against the dollar with rising inflation halting the consumer spending.

The number of employed personnel kept increasing with employment rate currently standing at 75.1% in 2017. 

The unemployment rate witnessed a continued decrease from 8% in 2013 to 4.3% in 2017.

Many forecasters and Economists believe that the economic circumstances will change in 2017 and 18 with Brexit impairing the growth in medium to long term.

Northern Ireland Border dispute

There were 3 issues which needed to be sorted in phase 1 of the talks. Two of them, financial settlements and citizens’ rights have already been sorted but the third one which is still under arguments and discussions is the Northern Ireland border dispute.

The Northern Ireland separated from the Republic of Ireland in 1922 and since then 

it has been a part of UK. 

A lot of trade happens between the two countries and the border is open for the people to travel freely between them. Daily thousands of citizens of both the countries cross borders for trade and travel purposes.

However, with Brexit in picture, UK will exit the single market which will stop the free movement of people between the two countries which will mean a lot of check posts to be installed and the entire border to be sealed.

This will negatively impact the export market of the Northern Ireland, 25% of which is dependent on the Republic of Ireland.  

This will result in a hike in prices by imposing of new tariffs for sure reducing the trade.

Also, the government of the republic of Ireland fears that the installation of a hard border will not be taken well by the local traders and will result into protests.

An alternative approach was proposed which marked Britain to exit the EU but not exit the single market and the customs union but this proposal was rejected by the British government in order to honor its commitments of a complete Brexit.

Unless and until, the Northern Ireland border issue is resolved Brexit will not move into phase II which will make things more difficult considering in picture the deadline of 29^th March 2019.

Second Referendum

Opinion Polls held in Dec’2017 revealed that the opinions of the majority of Britons and the UK government have started parting ways.

The negotiated amount of 50 billion pounds that UK will have to pay to the EU on leaving has created an opposite sentiment among the masses of UK.

According to the latest Survation survey, around 50% of Britons now think that a second referendum should be held after the government’s final negotiations with the EU, 34% are still in favor of Brexit and 16% had no answer to this question, however, the government is still fixed on its stance of a hard Brexit.

Whatever it may be

No one can exactly predict what the condition of the Britain’s economy will be after Brexit. 
Will it have to start over? Or will it get better with controlled migration, more jobs and education opportunities for the locals?

Well, our agenda in this article is not to express any opinions. 

But, no one has stopped you from expressing yourself in the comments section.

So, did you understand all about Brexit?

Was it properly explained in the article?

What are the chances that you would be referring this article to friends and family?

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