Debt Crisis in Europe

The woes of the economic slowdown and financial crisis in 2011 is largely attributed to the debt crisis in Europe. This is not a recent happening and bubble started growing from as early as 2009. The 3 of the highest exposed countries; namely Greece, Ireland and Portugal, collectively account for six percent of Eurozone’s gross domestic product (GDP).

Greece is under a massive burden of debt, over 50% which according to financial analysts, ma become bad debt. There is a lot of pressure from institutions like BNP Paribas to write off a major part of the debt. Investors who have share in the huge debt of Greece, have taken reclusive protection in the form of credit default swaps. However, this may not be sufficient protection, in case the lending rates increase even more. As it is, the cost of capital is sky high in the European countries and the Euro is under severe stress from the tactics taken by Greece, which has somewhat affected its strength. Greece is attempting to corral as many investors as they can. The more bond holders they persuade, the more that Greece would benefit.

Ireland is in no way, better off. Even though these banks have received  significant bailout assistance from the European Union and the International Monetary Fund to cover the current insolvency, Ireland’s policy makers really need to figure out how to service this public debt, without triggering a shiver down its economy. Their bank’s are still balanced on a very fine needle, which may collapse at the smallest shock from any of its investors.  however, it is comforting that the latest Euro Plus Monitor reports that Ireland has somewhat progressed in dealing with its financial crisis, and the nation may grow self-sufficient from the second half of 2012 onwards.

Portugal may be a victim to successive rounds of speculation by pressure from bond traders, rating agencies and speculators. Today the nation may be on the verge of requesting a second bailout, and follow the path of Greece.

The European central bank may have to soon bow down to the financial pressure and start printing money, and there is almost a 50:50 convergence in mindset amongst economists that ECB should conduct outright quantitative easing (QE). attempts may be taken to increase the capitalization of European banks to the tune to 10% to ward of liquidity crisis.

That the European Central Bank and Germany have rejected calls from euro-zone political decision makers to bail out Italy and other struggling euro members by intervening massively in bond markets is of even greater discomfort. This may be an indicator of a gradually declining economic strength of these two super-institutions. The focus of these to fight inflation, may be a decision making point, however, as these institutions are pointing out, European countries need to make long term economic reforms to service the existing debt and stabilize the internal economy and the banks.  The European Central Bank is one of the very few strong institutions still with the capability to buy off significant portions of the Italian and Spanish debt. However, on the bright side, the European Union has agreed to a below-inflation budget increase for 2012 (which may even extend to the first quarter of 2013) as its members held ground against pressure from Brussels for a bigger increase.

Interestingly, the European Union sees the probably GDP growth in the next year (2012) at just 0.6%, down from its forecast just six months ago of 1.9%. However, it is interesting to note at this point that the 2011 forecast was cut to 1.6% from 1.8%. Due to the high cost of working capital and subdued credit demand, investments that may create value appear to be dwindling in nature.

Under such a situation, the bubble may grow till the early 2012 before it bursts, and finally economic reforms ushering in stability and prosperity may start from the second half of 2012. It may be late 2013 or even as late as the second half of 2014, that the affected countries will regain self-sufficiency and move on towards economic stability.

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Arpan Kar

Professor at Indian Institute of Management
Dr. Kar is a Professor in Information Systems Management in Indian Institute of Management (IIM), one of the top institutions in Business Management education globally. He has extensive experience in teaching, training, consultancy and research. He has over 35 high impact publications. Prior to joining academia, he has rich experience in Cognizant Business Consulting and IBM Research Laboratory. He is the Editor of Business Fundas.
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