Impact of failure of PIIGS countries to control their deficit over the future of Euro as a currency

Presented by:Akshat Solanki (04) Gagandeep Pahwa (14) Karabi Kachari (24) Nibish Baghel (34) Shamma Dhanwat (44)

EUROZONE
The Euro zone is an economic and monetary union (EMU) of seventeen European Union (EU) member states that have adopted the euro () as their common currency and sole legal tender: The euro zone currently consists of Austria, Belgium, Cyprus, Estonia, Finl and, France, Germany, Greece, Ireland, I taly, Luxembourg, Malta, The Netherlands, Portugal, Slovakia, Slovenia, and Spain. Monetary policy of the zone is the responsibility of the European Central Bank, though there is no common representation, governance or fiscal policy for the currency union.

The Maastricht Criteria

The Maastricht criteria (also known as the convergence criteria) are the criteria for European Union member states to enter the third stage of European Economic and Monetary Union (EMU) and adopt the euro as their currency. The 4 main criteria are based on Article 121(1) of the European Community Treaty. 1. Inflation rates: No more than 1.5 percentage points higher than the average of the three best performing (lowest inflation) member states of the EU. 2. Government finance: Annual government deficit: The ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3% at the end of the preceding fiscal year. If not, it is at least required to reach a level close to 3%. Government debt: The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. 3. Exchange rate: Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for two consecutive years and should not have devalued its currency during the period. 4. Long-term interest rates: The nominal long-term interest rate must not be more than 2 percentage points higher than in the three lowest inflation member states.

Problems faced by Euro zone countries

The key fact about the Euro zone is that it represents a MONETARY not a fiscal, ie government budget union, whose policy is set by the European Central Bank or ECB. The main job of the ECB is to set interest rates for the entire Euro zone. Ever since its inception, Euro zone members have been aware of a potential conflict between the fact that monetary policy is set by the ECB for the entire Euro-area, while government spending, i.e. fiscal, policy is managed by each country. The Currency devaluing factor: In the global recession years of 2008-09, While the UK was able to devalue the pound sterling as part of its policy response to this crisis, such a move was not available to members of the common currency area.

Question raised: How is it possible for a group of countries joined monetarily, but NOT in government spending policy, to deal with a situation when one government gets into trouble ???

PIIGS and their inevitable problems

PIIGS/PIGS refers to an unofficial group of countries including Portugal, Italy, Ireland, Greece and Spain. Considered to be the weaker economical section of Eurozone. Problems for PIIGS The significant problems for Spain and Ireland are quite similar to the US collapse of a bubbled housing market, leading to massive unemployment, and a stagnant economic dynamic. Still completely NON-transparent derivatives market, above all the socalled mortgage backed securities For Italy, Portugal and above all Greece, the main problem is government, aka sovereign, debt not structurally dissimilar to the crisis that hit Dubai just a short while ago, from which it had to be rescued by its oil-rich UAE brothers to the south in Abu Dhabi.

Why the problem still persists

Challenged those relatively weak governments to raise taxes and impose harsh spending cuts on a restive populace to bring down their deficits from over 10 percent of G.D.P. to the benchmark levels close to 3 percent of G.D.P. called for in the European treaty that created the euro. The first chart shows the yield on 2-yr sovereign debt for each of the PIIGS countries. The extremely high level of yields on Greek, Irish, and Portuguese bonds is the market's way of saying that a significant default is highly likely to occur.

What is the Source of the Problems?

While such moves are highly unpopular politically, a failure to do so could send government borrowing costs soaring, enriching those who are betting that Greece, Portugal, Spain and perhaps even Italy will not be able to follow through on their commitments. The standard explanation for the problems in some of the countries, e.g. Greece, is that lack of effective monitoring of government deficits within euro area countries and lack of enforcement of the rules on how much debt a country can have allowed excessive debt levels to accumulate. In other cases such as Spain, the problem wasnt irresponsible budget behaviour, it was the recession that caused the government budget to collapse. The deficit problems were made worse by the fact that countries within the euro area do not have the ability to use independent monetary policy.

Now

THE STATISTICS

By PresenterMedia.com

GDP of PIIGS
2500
2000 1500

2008
1000 500 0

2009 2010

GDP growth
2
1 0 -1 -2 -3 -4 -5 -6 -7 -8

2008 2009 2010

Fiscal Deficit as a percentage of GDP

16 14 12 10

8
6 4 2 0

2008

2009

Portugal Italy

Ireland

Greece

Spain

Debt to GDP Ratio

160 140 120 100 80 60 40 20 0

2008 2009 2010

Credit Ratings
MOODY'S PORTUGAL IRELAND ITALY GREECE SPAIN FITCH S&P Baa1 BBBBBB-

Baa1

BBB+

BBB+

Aa2

AA-

A+

B1

BB+

BB-

Aa2

AA+

AA

The Impact on the Euro

Monetary Impact Fall of the status of Euro as a potential replacement for dollar The depreciation of Euro leading to

Rising trade deficits Inflationary pressures Decreasing creditworthiness Volatility in stock markets Reduction in FDI and FII Increase in the interest rates for long term sovereign bonds

Political impact

Weaker countries thrown out/withdraw of the EMU (Economic and Monetary Union) Germany, France and other countries keep on bailing out the PIIGS countries until it becomes too hot to handle and ultimate breakdown of EMU

Monetary Impact
Monetary deflation incase there is decrease in

money supply with no government intervention

Euro

Monetary inflation incase there is money supply

incase the government does

Euro

Fall of the Status of Euro

PRETTIEST among the UGLIEST!!

What Is Fiscal Deficit?

Effects of the widening fiscal deficit

WIDENING

Combating Fiscal Deficit

Debt financing might temporarily stimulate the economy, but in the case of low productivity it will lead to further downfall
Austerity measures include:

Salary cuts for public sector employees

Increase in taxes on gas, tobacco & alcohol etc.

Debt Financing

DECREASING CREDIBILITY

RISING DEBT

CURRENCY DEPRECIATION

Due to depreciation of the currency, investors will sell Euro as fast as they can

EU Trade deficit- $1.6 Billion SourceFxstreet.com

Euro will lose its credibility and the supply of euros will increase (inflationary pressures also)

Consequently, even though exports become competitive due to Euro depreciation, there are not enough resources to produce those exports. Also, Since most of the countries (apart from Germany etc, are import dependent, it leads to a huge deficit)

Huge loss to Euro Zone

The inflow of FDIs and FIIs will fall sharply Stagnation of the economy (no growth prospects due to minimum capital formation) Credit rating of these countries will take a hit They will have to offer more interest on the long term sovereign bonds to attract investors

At the helm of affairsPolitical effects

Countries might be thrown out of EU, or might give up their membership to take control of their monetary policy

This might ultimately lead to the breakdown of EU as the goal of the common currency has been defeated.

Thank You