Signs of another Greek crisis

Jayshree Sengupta

Global influences will be important for India this year because already due to the falling oil prices, India’s retail inflation rate has come down to 5 per cent and the wholesale index of inflation is near zero. Similarly, the turmoil in Greece is likely to affect Indian stock markets as it did so on January 6, 2015, with signs of another Greek crisis and the Russian rouble’s fall.  

Recently there have been fears that Greece would leave the Eurozone, comprising 18 countries. Germany as the biggest creditor of Greece is now prepared for “Grexit” (Angela Merkel said so). Greece's problems were exposed when in 2004 it was found by the European Commission that Greece had falsified its budget deficit data in the run-up to joining the Eurozone.

As one of the pre-conditions for joining the Eurozone was a fiscal deficit compact between members of not allowing it to exceed 3 per cent, Greece had attempted to show a lower-than-actual deficit. But it soon had to acknowledge its huge public debt and plunged into a debt crisis. After the global financial crisis, in December 2009, a prominent credit rating agency downgraded Greece on the ground that the government could default on its ballooning debt. Spending cuts were announced by the Greek government in 2010 and the government spending received two rounds of austerity measures.

Austerity measures were severe and brought hardships on people. The austerity and reform package reduced Greece’s fiscal deficit from the high level of 13.6 per cent of the GDP to 2.6 per cent by 2014. To achieve this, the government had to cut public sector wages, freeze state-funded pensions and strengthen tax collections.

It also involved reducing the number of local government units. Excessive amounts of private sector indebtedness and collapse of public confidence led the private sector to decrease spending in an attempt to save for the rainy days ahead. It led to low demand for products and labour, which further deepened recession and made it even more difficult to generate tax revenue and reduce public debt.

 Labour reforms included wage and benefit cuts to reduce costs and improve price competitiveness. Poverty increased and the social fallout of the crisis has been felt by all those who were laid off. 

 Yet the austerity measures were justified on the basis of a bailout package of $147 billion which was received by the government from the European Commission, the European Central Bank and the IMF.  In 2011 another bailout from the European Financial Stability Facility of 109 billion euros was given to Greece. By November 2011, 50 per cent of the private debt was written off, described as a ‘haircut’. Further the austerity measures led to unemployment jumping up to 26.8 per cent and youth unemployment at 60 per cent. In 2014 unemployment reached 28 per cent. 

Greece has recovered a bit in the past few months and is showing a positive GDP growth rate of 0.6 per cent and its budget is in surplus (1.5 billion euros for the first time since 2002) due to a record rise in tourism last year. But still it is not out of the woods and has a debt of 319 billion euros and needs to boost productivity and exports to stay afloat. If it leaves the euro and goes back to Drachma, it can manipulate the exchange rate and boost exports.

The anti-austerity radical leftist Syriza party has vowed that if it comes to power in the forthcoming January 25 election under the leadership of Alexis Tsipras, there would be an increase in government spending and austerity measures would be eliminated. 

What the impact of such a stance will be on the Eurozone and the world financial system is difficult to gauge at the moment. There could be global turmoil. Certainly other Euro members, which are not doing so well like France and Italy, could be impacted and they could also opt out of the Euro (contagion effect).

It is going to be a big jolt for the global financial system in any case and could lead to higher amounts of quantitative easing by the Frankfurt-based ECB to give a boost to the Eurozone countries in increasing demand. With interest rates nearly at zero, and inflation at a very low level, there is fear of deflation and deflationary pressure in the Eurozone similar to Japan's decade of deflation and low demand. This would harden the dollar against the Euro further. The strengthening of the dollar and a likely rise in interest rates in the US on the back of a strong economic recovery could lead to FIIs’ return to the US.

 India’s export growth has been flat in the last one year due to subdued demand from the EU, the US and Japan.  But with a change of government in India, FIIs were attracted to both the equities and debt markets in 2014 ($42 billion came). But the recent outflow of FIIs from Indian equities ($161 million) is something worrisome. If the RBI decides to lower interest rates more drastically than the recent 0.25 per cent, lower rates may attract more FIIs in equities. So the RBI has to decide whether it wants to lower interest rates further with an impending Greek crisis which may change the direction in which FIIs are moving in the emerging markets. FIIs have provided liquidity in the forex market — otherwise there would be a serious balance of payments crisis, especially on the current account. Dependence on FIIs to bridge the gap in current account is risky however but they serve a purpose for the Indian situation right now.

Throughout the Eurozone there is an increasing criticism of austerity measures. India should also not cut the important social sector spending in order to bridge the fiscal deficit.