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.
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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