Saturday, 3 March 2018

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. 


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.

World GDP Growth 2010-2016
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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