Understanding The Euro Crisis: A Quick Analysis

Posted on January 19, 2012 in GlobeScope

By Apurva Desai:

It’s 2012 and the much talked about prediction of the world ending might prove to be true in pure economic terms.

The negligent bubble of a crisis which started in Greece more than two years ago, was ignored as a minor worry by the Greek government itself, forget the rest of the world. All of us were busy worrying about the relapse of the American recession to concentrate on anything else.

So, where did it all lead to?

The answer to this is frightening, to say the least. For the past year, everyone is just trying to assess the damage that has been caused, or that will be caused. The truth is, it’s still not over, and nobody knows if the worst is actually over.

So here are my two cents to and about the Great Euro Crisis!

Cause: The Globalisation of Finance

Every report that is issued with respect to the crisis enumerates a million different reasons for the crisis. If you read between the lines, you shall realize that there is just one cause for it: The massive integration which went horribly wrong. We may word it differently, but the crux is the same.

The Birth of Euro Crisis

The Countries Involved

Greece

From late 2009, fears of a debt crisis developed among investors concerning Greece’s ability to meet its debt obligations due to strong increase in government debt levels. This led to a crisis of confidence, indicated by a widening of bond yield spreads. Downgrading of Greek government debt to junk bond status also created an alarm in the financial markets. In mid 2010, IMF agreed to loan out a €110 billion loan to Greece, conditional on the implementation of harsh austerity measures.

In October 2011, Eurozone leaders also agreed on a proposal to write off 50% of Greek debt owed to private creditors. Even after so many write offs and monetary help, Greece is still struggling to bounce back.

Ireland

Ireland’s crisis was led largely by it’s real estate bubble. The Irish government did not indulge in any extravagant spending, but made the mistake of guaranteeing the six main Irish-based banks who had financed the property crisis.

Ireland has a vast progress in dealing with its financial crisis, and is expected to stand on its own feet again and finance itself without any external support from the second half of 2012 onwards.

United Kingdom

As the whole of the debt crisis is interlocked, UK is not far from danger. UK is very much at risk from a domino-fall of defaults and called on banks to build up more capital when financial conditions allowed. The country has one of the highest debt levels, and hence is facing the tune of the same.

Italy

Italy’s deficit of 4.6 percent of GDP in 2010 was similar to Germany’s at 4.3 percent and less than that of the U.K. and France. It’s debt has increased to almost 120 percent of GDP (U.S. $2.4 trillion in 2010) and economic growth was lower than the EU average for over a decade. This has led investors to view Italian bonds more and more as a risky asset.

What Next?

So the crisis is down and about, it is spreading faster than the plague, but we are still clueless as to how exactly is it affecting the world and us.

The U.S. economy could likely weather a further slowdown, or even a modest contraction in Europe. But a prolonged slump may delay the U.S. recovery that is now starting to translate into a noticeable reduction in unemployment.

Europe’s woes translate directly into problems for South America, where the new powerhouse Brazil has shifted its worries from an over excited economy to an alarming slowdown stimulated by the euro turmoil.

China, which has the European Union as its top trade partner, the export growth has begun to weaken in the past two months and is expected to decline further as Europe heads toward recession. The Chinese economy’s expansion is expected to slow to around 8% in 2012 from more than 9% in 2011.

While 8% growth would be appreciable almost anywhere else, it can be a problem in China where the system is geared for super-high growth rates befitting a country that has grown on average 10% annually for the past 30 years.

The exports in China are going down and hitting new loans everyday. Now there are even signs that the currency is suffering as investors start to pull out.

That could prompt China to stimulate its economy, but it has less room to do so, because it already has a series of non performing loans from the earlier round of crisis, which included heavy bank lending.

Indian Effect

The country’s industrial output has shrunk down to 5.1% in October from a year ago and the government has now downgraded its 2012 growth forecast to 7.25% from as high as 9% previously.

With investors pulling out due to speculation that the RBI will cut down the interest rates, the rupee has taken a big dent, falling to an all-time low against the American dollar, with almost 56 rupees equaling a dollar.

India’s foreign trade account is hovering around a negative $10 billion per month, but that is no worse than several years ago and it is hard to detect a deteriorating pattern.

In conclusion, India is battling with the are-we, are-we-not affected by the crisis. With the emotions and sensibilities pointing towards the obvious effect, the statistically minded optimists refuse to believe so.

What do we do in the meanwhile?

Not exchange rupees for dollars, ofcourse.

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