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BBC News - Q&A: Greek debt crisis

BUSINESS
13 February 2012 Last updated at 04:42 ET

Q&A: Greek debt crisis


Greek politicians have approved a bill on austerity measures needed for a new bailout. The austerity measures have been demanded by the EU, the International Monetary Fund (IMF) and the European Central Bank (ECB) - the so-called Troika - as a condition for handing over a further loan. The agreement will unlock the latest 130bn euros (108bn; $171bn) in bailout loans and allow a further 100bn-euro write-off of the country's debt to private banks. Athens faces loan repayments to private lenders of 14.4bn euros on 20 March which it cannot afford to pay and it has failed to cut its deficit. What's in the austerity package? European leaders are sceptical of Greece's ability to implement spending cuts, so in this latest round, they have been demanding measures that can be implemented quickly and simply. Greece was told to agree to further cuts in government spending equal to 1.5% of GDP,
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BBC News - Q&A: Greek debt crisis

cuts in pensions and thousands more civil service job cuts. But this time, the Troika also wants Greece to act to make its economy more competitive, principally by cutting the cost of doing business in Greece. The government was told to make its labour markets more flexible, to dramatically cut the minimum wage and to scrap a habit of paying a "holiday bonus" equal to one or two months' extra pay. It was also told to re-capitalise its banks, while ensuring they maintain their managerial independence. The reforms to pensions proved the most difficult to stomach, but the government now says a compromise has been reached. Hadn't Greece already implemented austerity measures? Greece had already previously agreed to far-reaching austerity measures. Taxes will increase by 3.38bn euros in 2013, following a 2.32bn euro increase in 2011. The increase includes a solidarity levy of between 1% and 5%, a cut in the tax-free threshold, a rise in VAT rates, and luxury taxes on yachts, pools and cars. In the public sector, pay will be cut and many bonuses scrapped. Some 30,000 public sector workers are to be suspended, wage bargaining will be suspended, and monthly pensions of above 1,000 euros cut by 20%. The government also aimed to raise about 50bn euros by 2020 from privatisations by selling land, utilities, ports, airports and mining rights, but recently this target has been revised down substantially because of the worsening economy. Will it work? That is the 130bn-euro question. The aim is to cut the Greek government's debt from 160%

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BBC News - Q&A: Greek debt crisis

of GDP to 120% of GDP by 2020. Despite the austerity measures taken so far, the Greek government still spends more than it receives in taxes. Some economists and Greek unions say the plan is doomed to fail. They argue that by making people poorer the measures will simply shrink the Greek economy, reducing tax revenues and increasing the deficit. But EU leaders argue that there is no choice, that spending needs to fall even if it hurts the economy in the short term. Further they argue that increasing competitiveness, by lowering wages for example, will attract business to Greece and thereby boost the economy and taxes. What happens if the deal falls through? Greece would not be able to pay back its lenders and would not have access to funds from the EU. Banks and bond holders would lose out - but much of the money they would lose has already been written off. The greater risk may be on the markets where investors may lose confidence in the eurozone's ability to deal with situations where countries are unable to pay their debts. Some economists and Greek unions say the plan is doomed to fail. They argue that by making people poorer the measures will simply shrink the Greek economy, reducing tax revenues and increasing the deficit. But EU leaders argue that there is no choice, that spending needs to fall even if it hurts the economy in the short term. Further they argue that increasing competitiveness, by lowering wages for example, will whilst much of the debt owed by Greece has been written off, Portugal, the Irish Republic, Italy and Spain also have large deficits and were they to find themselves in similar

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BBC News - Q&A: Greek debt crisis

situations it would be far more serious. Within Greece, the government would no longer be able to borrow money from anyone and may be unable to pay back its own banks triggering panic and possible bank closures. Greece could be forced to leave the eurozone and devalue its currency amidst political and economic turmoil. Why is Greece in trouble? Greece has been living beyond its means since even before it joined the euro. After it adopted the euro, public spending soared and public sector wages practically doubled. However, while money has flowed out of the government's coffers, its income has been hit by widespread tax evasion. When the global financial downturn hit, Greece was ill-prepared to cope. It was given 110bn euros of bailout loans in May 2010 to help it get through the crisis - and then in July 2011, it was earmarked to receive another 109bn euros. But that still was not considered enough. And so, in October 2011, the eurozone got banks to agree to a 50% "haircut" on their Greek holdings, alongside an enhanced 130bn-euro bailout. Since then, the economic situation in Greece has deteriorated further and the deal now on the table involves an even bigger debt write-off than previously consented to by the banks. Why did the crisis not end with the Greek bailout? Although Greece's troubles are the most extreme, they highlight problems in the eurozone that also apply to some other economies. Many other southern European countries ran up huge debts - government debts as well as household mortgage debts - during the past 10 years. They also enjoyed rapidly rising wage

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BBC News - Q&A: Greek debt crisis

levels. Now the bust has come, it is very hard for them to repay the debts. And the high wage levels leave their economies uncompetitive compared with, for example, Germany. Because they are inside the euro, these governments cannot rely on their central bank - the ECB - to lend them the money. Nor can they devalue their currencies to regain a competitive edge. Meanwhile, they are having to push through very painful spending cuts and tax rises to get their borrowing under control. But some analysts argue this is just pushing their economies into recession, cutting tax revenues. In the meantime, EU leaders are struggling to enhance the "firewall", in case any further countries prove unable to repay their debts. In October, they agreed that the new European Financial Stability Fund would have up to 1tn euros to guard against future sovereign debt crises. However, the money has yet to be raised. Recently, the IMF said it, too, would have money available. What does all this mean to the UK? According to figures from the Bank for International Settlements, UK banks hold a relatively small $3.4bn worth of Greek sovereign debt, compared with banks in Germany, which hold $22.6bn, and France, which hold $15bn. When you add in other forms of Greek debt, such as lending to private banks, those figures rise to $14.6bn for the UK, $34bn for Germany and $56.7bn for France. The UK government's direct contribution to any Greek bailout is limited to its participation as an IMF member. However, any knock-on from Greece's troubles would exacerbate the UK's exposure to Irish debt, which is larger.

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BBC News - Q&A: Greek debt crisis

And if it led to a major financial crisis, as well as a deep recession in the eurozone - the UK's main trading partner - the damage to the UK economy would be substantial.

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