Crisis in the Eurozone

The financial crisis in the Euro zone seems to have taken a turn for the worse with the parliamentary rejection of the proposed austerity package involving spending cuts and tax increase proposed in the budget by the Portuguese Prime Minister Jose Socrates. Following the resignation of the Prime Minister, Portugal becomes the third country in the Euro zone to ask for a bailout package from European Union and International Monetary Fund similar to those extended to Greece and Ireland last year. Meanwhile, chances have resurfaced of the need to restructure Greek debts which are expected to approach 160% of its annual output by 2013 - nearly double the level most economists see as sustainable and far bigger than those of Argentina when it defaulted in late 2001. International credit rating agencies have severely downgraded the credit ratings of several of the Euro zone economies like Portugal, Spain and Italy creating enormous hardships for these fledging economies to raise capital in the financial markets. At the same time political oppositions have grown in the creditor countries of the Euro zone to the huge financial bailouts for the fiscal prolificacies of the failing economies to keep them afloat from hard earned tax payer's money. Though economies facing credibility issues right now contribute a small part to the Euro zone Gross Domestic Product, Economists fear of a renewed contagion effect to be reverberated all across the Euro zone and ultimately to the still fragile world economy unless the crisis is contained to spread to the bigger of Euro zone countries like Spain, Italy and United Kingdom.

Crisis in the Euro zone

Deeply affected by the "sub prime crisis" in the United States, the European Economy is in the midst of the deepest recession since the 1930s.At the heart of the whole economic cauldron in Europe is the rising concern about the high level of government fiscal deficits and debt levels among different members of the Euro zone. The economic vulnerability of these nations now labeled as the "Sovereign Debt Crisis" erupted first in Greece. Ever since the adoption of Euro as domestic currency in 2001 the country had been heavily borrowing in the international financial markets taking advantage of the cheap interest rates to fund substantially the government budget and the current account deficits. The huge public expenditures and investment undertaken by the government were not matched by adequate revenue raising efforts, particularly the tax evasions and under ground economy continued unabated. Greek authorities continuously under-reported it's fiscal and Balance of Payment indicator to conform to the strict Euro norms. This heavy reliance on the international financial market made the Greek economy highly vulnerable to any shift in investor's confidence. Ill prepared to meet the financial crisis that hit the world economy following the 'sub-prime crisis' in USA investors confidence became jittery after the newly elected government in 2009 raised the fiscal deficit estimates to 12.7 percent from the earlier concealed figures of 6.7 percent of the Gross Domestic Product. Following the further raising of its fiscal deficit by European Union statistical wing to 13.6 percent international credit rating agencies rated its government bonds to the junk status highly raising their yields making difficult for the government to obtain fresh loans and creating doubts in investors mind about capabilities of the Greek authorities to make repayments. Total accumulated national debt in Greece has been estimated at $212 billion, about 120 percent of the Gross Domestic product of the country.

Spread of the Crisis

Economic vulnerabilities soon began to appear in other parts of the Euro zone. Next to fall in line was Ireland nick named 'Celtic tiger' for its robust economic growth in the 90s.Ireland became the first country in Europe to be hit by the global depressions. Much of the growth in Irish economy was built around the property market which witnessed a dramatic collapse in 2008.Government also needed to bail out the fragile banking system in the country creating a huge hole in its exchequer. Deficits ballooned further after a sharp deterioration in tax collections following recession and rise in unemployment benefit claims. An 85 billion euro rescue package has been agreed between the European Union and Ireland to help tackle the huge mismatch in the government finance. Following the rejection of austerity budget proposed by the Prime Minister, Portugal has become the third nation in the Euro zone to begun talks with the international authorities on a bail out package. Unlike Greece and Ireland which plunged into crisis after a sustained period of rapid growth economists attribute gradual loss of competitiveness of the Portuguese manufacturing and public finance mismanagement prime causes behind the crisis. Apart from these smaller economies crisis seems to be brewing in Spain a major Euro player where a number of commercial banks are facing insolvency and unemployment level has reached an alarmingly high level of 20 percent. Government deficits and debt have risen to a dismally high level in countries like Italy, Belgium and United Kingdom.

Structural factors behind the crisis

Current economic woes in the Euro zone are a direct fall-out of the financial meltdown that started in USA, paralyzing the world economy and leaving much of the Europe reeling under huge budget deficits and fiscal debt. After making available cheap credit for a long period to borrowing European economies lenders are taking a fresh look at borrowing country's capacity to repay their debts and discovering reasons for concern. Fiscally unsustainable level of government deficit and debt in many European countries has created fear among investors about defaulting on loans by Government. When debts rise to high levels their sustainability becomes a major concern making them highly vulnerable to changes in the lending rates and exposing borrowers to sudden shifts in market conditions and sentiments. Financial positions of many European banks continue to be vulnerable with low capitalization and high funding costs, many of them also exposed to highly toxic assets including government securities in troubled regions. Many economists attribute declining international competitiveness due to high production costs and decreasing productivity as an important factor behind the crisis. In particular, they mention of the abandonment of the national currencies by the Euro zone partners, devaluation of which would have allowed them to increase exports. Sluggish growth in these economies has reduced government tax collections while wage bills continue to mount especially in the public sector.

Response to the crisis

The 'sovereign debt crisis' has appeared as an eminent threat to the economic stability of the individual countries and the entire Euro zone. The national governments in various affected countries have launched fiscal consolidation measures comprising sharp expenditure cuts and tax increases. The Greek Parliament has passed an economic protection bill which involves increase in corporate, personal and real estate tax rates besides crackdown on tax evasions and improved social security contribution collections. Wide ranging reforms have also been committed in Greek public administration, health care and pension system. On structural fronts efforts have been made to increase economic competitiveness, fostering private sector development, and supporting research, technology and innovation.Portuggese authorities aim to reduce their fiscal deficit from an unsustainable high level of 8.3 percent to 2.8 percent through cut in welfare payments,defence expenditure and trimming of jobs in the private sector. Massive funds have also been pumped in the banking sector to keep them afloat. After denying for long Greece became the first country in the Euro zone to seek external assistance over its financial woes. A $110 billion bailout package was agreed between the Greek government, Euro zone members and International Monetary Funds to be spread over three years to prevent Greece from defaulting on its massive public debts. Ireland received a financial package of 113 billion dollar to help it strengthen its banking system and undertaking fiscal adjustments. Authorities have now begun talks of a possible Portuguese bail out that is estimated to be the tune of $80 billion. European Union countries have created a European Union Financial Stability facility to maintain financial stability in the region by providing financial assistance to members in difficulty.

Fallouts of the crisis

Economists fear of a contagion effect (financial crisis in one part of the world to other through the inter-linkages of financial institutions) to other members of the Euro zone and ultimately to the world economy unless the brewing economic difficulties are contained through necessary fiscal and monetary measures. On the most pessimistic note they point of the massive public debt in Greece estimated to be $290 billion, almost thrice the holdings of Lehman Brothers ($108 bn) defaulting on which started the world financial meltdown in 2007. Popular oppositions have also grown in the economies receiving bailouts over the harsh austerity measures imposed by the lending agencies in exchange of the bailouts.Labour unions in particular have become increasingly restive over the policy measures proposed which involve substantial wage-cuts to enhance competitiveness. People are expressing concerns also in the donor countries like Germany and Finland over the wisdom of financing fiscal prolificacies of defaulting countries by hard earned tax-money of others.

Conclusion

Still recovering from the disastrous consequences of the "sub-prime crisis" in US the world economy is ill prepared to cope with economic fallout in Europe. Recently in a meeting of the World Bank members the bank president strongly warned of the world economy to be just one shock behind the full-blown crisis unless issues like those in Euro zone, food scarcity and oil price rises from turmoil in the middle-east are adequately dealt with. The recession in Europe carries the fear of reduced trade flows across the world as Euro zone is an important trading block in the world economy. Given the complex financial relations across the national boundaries economist also fear repatriation of funds by European entities from developing nations like India affecting negatively Foreign Direct Investment, stock markets and foreign exchange reserves there. Tough time lies ahead for the national and international policy makers to bring back the world economy on a sustained growth path.