The Heathrow-bound aircraft departs from Bangalore. It takes off steadily with the pilot and co-pilot switching seats regularly to drive the flight. It lies to the Air-Traffic station that it has fuel for the entire journey. Suddenly it realizes that the fuel is alarmingly low in the aircraft. The aircraft carrier has not paid for fuel it has used in the past; thereby it couldn’t get much of a refuel. With over 25% of the journey left, the flight is eyeing a crash. Adhering the advice it has already turned off the flight amenities to sustain the journey. The passengers are protesting for the same. What is going to happen?
This is the story of Greece which is eyeing a severe economic crash due to balance of payments problem. But why did Greece land in this situation which would be the first developed nation to turn bankrupt? Let’s understand the same.
How did this start?
It started after the end of the military rule in 1974. Don’t be shocked by it. This is the truth. Once the military rule ended (because Turkey did not recognize the government as legitimate, thereby ending the military unity during their 7-year rule), a new democratically elected government took place. In order to keep the people happy, the Greece Socialist Party and the New Democratic Party which alternated power started giving more sops to the people like giving more government jobs to people, starting of public-sector enterprises, etc.
Public sector enterprises like what we had in India before 1991, still dominate the Greece business. They account to a large amount of debt which Greece holds, currently standing at 175% of the total GDP. That means it would require spending upto earnings of 1.75 years to pay the debt completely.
But how is this related to the current debt. Greece immediately after the military rule in 1974 experienced an inflation of around 35%, which it reduced by printing more money, or rather deflating the currency. It did get some stability in the economy, but it cannot be covered up completely. To relate this, India deflated its currency on June 6, 1966 (called as black Monday) by 57%. We did pay the price for the same mistake in 1991.
Greece failed to understand the same. It started issuing more bonds, which were available at an interest rate of over 20%. If a country gets bonds, it must use it to recover the economic situation. Rather the populistic government which held power tried to give more sops like pension schemes, early retirement age, bonuses to government employees, etc. It has reached a situation where 1 out of 5 people have a government job within the working age criteria. Their bonuses were not dependent on productivity, rather on meeting political interests.
This was also accompanied by an economy called as the “black economy”. In Greece, transactions in cash are not under the purview of taxation. This accounts to 24.3% of the GDP of Greece. Currency swaps in which Euro is transferred into dollars and yen using fictitious exchange rates is rampant, allowed Greeks to keep money safe in other countries. For example out of the touted $20 Billion Greek foreign deposits, only 1% is taxable. People who criticize the Demonetization move in India, the currency in the market got a check done by the government which to an extent eliminated the black economy. Cash hoarding exists, but there is a check on the notes in circulation. The expenditure by Greece accounts to have increased by 87% between 2004-09 with an increase in tax revenues by only 31%, which had indicated a problem in the coming days.
Greece embraces Euro
Here comes the twist. The country which had a debt of over 100% as compared to the GDP shouldn’t have been allowed into the Euro currency. But Greece wanted to revive its economy and regain investors trust.
Trust? Yes. A country which devalues its currency on a regular basis isn’t trusted by investors as they stand a chance to lose value for their investments in the country. This is where the entire game began. In 1992, the inflation was at 25%, the debt to GDP ratio was beyond 100%, budget deficit was at 12% which makes Greece a nation which is not eligible for entering the Euro currency. The Maastricht Treaty states that for any nation to enter the Euro currency, it has to reduce its budget deficit to 3%, inflation less than 1.5% and debt-to-GDP ratio to 60%.
It reported that it had achieved the same 2001, thereby formally entering the Euro Currency. The investors forgot about the Greece’s past and started investing in Greece, thereby becoming the second-fastest growing economy in the European Union.
Two things changed everything
The 2008 economic crisis did impact the Greece economy. It lost influx of funds from foreign investors; the growing economy became stagnant in that year. Then came the report of Goldman Sachs which said that Greece had misreported the figures to get into the European Union.
Suddenly everything turned awry for Greece. Within a span of seven years the economy shrank by 26%, Unemployment increased to 30%, deposits in banks from an all-time high of 240 Billion Euros reduced to 125 Billion Euros and the bad days started. This was the reason why a ceiling limit of 60 Euro withdrawals was enacted.
It did get three bailouts from the financial institutions, but failed to adhere to their conditions. The conditions were legitimate. Reduce the spending and increase tax revenues. Instead of adhering to these terms, they chose to fund the public spending by giving away government bonds at high interest rates. When the bonds lost value among private investors, they resorted to increasing tax revenues and reduction in spending.
Why is Greece not able to pay off its loans?
One out of five people in Greece are people who survive on pensions given by the government. The government is not interested in increasing the contribution of salaries in the pension schemes, rather expects fuelling of this by tax revenues. Young population is angry over this kind of a system, has found loopholes to save money. Other youth are a victim of rampant unemployment.
The government recently has increased the taxes in the country, but the economy is not in a position to pay off so much in the tax revenues, so that the government can pay off their debts.
Foreign players are not interested in investing in the country, the government is not keen to change the rules of retirement or lay off government employees. Greece accounts to the largest government working employees, who have been paid well thanks to the schemes implemented since 1974. The government cannot deflate the currency as it has lost autonomy. The tourism revenues is at all time low, thanks to lack of funds to spend within Greece. The ceiling for withdrawal is only for Greek residents, while visitors cannot withdraw money from the Greek banks. Some interested parties in setting up facilities in Greece are standing back thanks to increase in cost of employing labour.
There is a way out. Cancellation of all kinds of useless expenditure, laying off employees, using bailout funds in the right manner can get the country back on track. If Germany could do it, then why not Greece?