Saturday, January 16, 2010

Greece’s Financial Troubles

Reuters, Analysts Give 20 Percent Chance Greece Will Need Bailout
Financial Times, Europe Cannot Afford a Greek Default
Bloomberg, Moody’s Says Greece, Portugal May Face ‘Slow Death’
Market News, Update: ECB Trichet: Rumors of Greece Eurozone Exit "Absurd"

Greece faces intense scrutiny after falling into its first recession in 16 years and becoming the Eurozone’s most indebted member with a budget deficit 12.7% of GDP, more than 4 times the allowable 3% deficit in the European Union (“EU”). Greece’s economic woes came as a surprise to many when Eurozone finance ministers revealed that Greece had been misrepresenting its budget deficit statistics for years. Greece’s Prime Minister George Papandreou has publically committed to an economic recovery plan to reduce the deficit to less than 3% by raising taxes and cutting expenditures in national defense and healthcare.

Foreign investors have not found comfort in Greece’s promises of reform and have demanded higher yield premiums on Greek debt because the country’s risk of default. After the news of Greece’s financial troubles were released, the cost of insurance products to protect against a Greek default—credit default swaps—also rose almost 50 basis points, their largest one-day increase on record. Analysts are skeptical that Greece can achieve a quick financial recovery. In December, Moody’s cut Greece’s credit rating from A1 to A2, and half of the agency’s analysts predict another downgrade below an A rating by the end of 2010.

Another challenge to Greece’s economic recovery is the downward cycle that financial troubles create. The more financially unstable an entity becomes, the higher its cost of funds, and the more difficult it is to return to profitability. One solution, like Greece’s recovery plan, is to raise taxes and cut costs, but these actions might lead to deflation and emigration which could further threaten the country’s social and economic stability. Another solution is financial aid from the IMF or a financial bailout by other EU members or the European Central Bank.

Some analysts suggest that if Greece does not receive economic support and were allowed to default, other EU countries would face increased scrutiny and credit downgrades because of their EU association. For example, Spain and Portugal are struggling economically, and a default in Greece could impact their credit ratings, increase their cost of funds, and reduce their chances of an economic recovery. Greece could also withdraw from the EU after a default to recover outside EU scrutiny, but such a move would probably weaken the EU’s image and be disastrous for its remaining members. Greece’s Finance Minister George Papaconstantinou said last week that there was no chance that Greece would require a financial bailout or leave the EU.

Twenty percent of analysts questioned predicted that Greece would need financial assistance within the next five years, but European Central Bank President Jean-Claude Trichet refuses to consider granting the country any special concessions to help alleviate its economic troubles. Some think this decision is a way of making an example of Greece for its financial deceptions.

Discussion Questions:
1. Why did it take years to discover Greece's budget problems?
2. Can Greece be held accoutable for its misgivings without harming innocent Greek citizens?

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