Greece Crises : Is default the only option?
Summary: The debate over "Greece sovereign debt crises as a tragedy or opportunity" has varied viewpoints. I believe that under the circumstances given in the case, it was not right to default by Greece on external debt as there were other measures such as total factor productivity through which we could reduce the fiscal deficit and convert it into fiscal surplus similar to the rest of the European union.
Main arguments in favor of the Greece not to default:
1. Penalties for sovereign default: There were provisions for penalties if a country defaulted on its external debt such as exclusion from further borrowing for some time, downgraded credit ratings and inability to borrow in your own currency.
2. Decrease in Labor productivity and TFP : From Exhibit 1, we can see that Total factor productivity and labor ...view middle of the document...
This could be reduced to gain competitive advantage in exports of services such as shipping & tourism.
3. High bond yields before joining EU : From Exhibit 3, we can see that after joining EU, the Greece was considered more safe investment destination because bond yields declined. But before 2001(before joining EU), the bond yield for Greece was higher as compared to Germany and Greece was able to sustain this high yield on debt without any crisis. This means it can still sustain high yield on bonds without default.
4. Inflation: From Exhibit 4, we can see that inflation rose faster in Greece than Germany in the period 2000-2010. According to the Fischer effect, the interest rate on Greek bonds must rise higher than Germany, but this did not happen (can be seen in Exhibit 3 from 2000-2005). So, the investor confidence was still with Greece and there was no need of default.
1. Fiscal stringency and deflation could undermine growth : The threat of default to undermine the whole European Union is larger than the threat of decline in growth of Greece. So. we can say that this may be the price paid by Greece for no fiscal prudency in the earlier years.
Greece joined the European Union in 2001. It had a long history of political turmoil and changes in the leadership in the past. During the joining with the EU, Greece didn't meet the minimum criteria set up for joining. It did not have the budget deficit less than 3 % of GDP in 2001. After the alignment with EU, it was given loan by IMF and Germany a number of times, but the investor confidence in Greek bonds didn't increase and they still demanded higher interest rates from Greece. As a result of this and after debt restructuring, the Greece had no option but to default on Sovereign debt. The default would lead whole of European union into crisis and there can be chances of bank runs as well. To avoid this, Greece must take austerity measures such as reduction in employment benefits, improvement in technology to increase total factor productivity and privatization of companies that were earlier nationalized.