EU and the Eurozone

CrisisRahul Reddy Jan 2012

European Union Confederation of 27 Countries

Established by Maastricht Treaty 1993

Latest amendments in Lisbon Treaty 2009

Preceded by Communities ECSC (Coal and Steel)

Euratom (Atomic energy)

EEC

Objectives Open Borders – Schengen Agreement

Single Market – Goods, Capital and People

Customs Union – Single External Tariff

Competition

Agriculture and Fisheries

Monetary Union

Common Foreign and Security Policy

How does it work? European Parliament & Council of EU

Legislature

European Commission Executive arm comprising of 27

commissioners

European Central Bank Monetary Policy

Fiscal Deficit Basics FD is shortfall of Government Revenue

against its spending

FD is financed by Borrowings

Rise in interest rates

Monetization

Inflation and currency Devaluation

Trade Deficit Basics TD is shortfall of exports w.r.t to Imports

TD has to be financed Forex Borrowings

Rise in interest rates

FDI/FII inflows

Trade Deficit has to be balanced by Surplus of Capital flows

Leads of Currency Devaluation Cheaper exports and costlier imports

Tendency to close the Trade Deficit

Eurozone Crisis In a nutshell

Portugal, Spain, Greece Trade Deficit especially with Germany

High Fiscal Deficit

Common Currency & Monetary Union Cannot devalue currency

Cannot Monetize FD

Interest rates kept artificially low

The Results German loans finance imports from Germany

Borrowings to finance FD keep rising

Portugal and Greece High Fiscal Deficits

Low growth economy Low Tax revenues

High Government Spending Govt Employment

Pensions and Subsidies

FD 9-10%

Ireland Failure of 6 Major Banks

Property bubble

Irish Government Bailout Protect Depositors and Shareholders

Bill upto $ 100 bn

FD upto 32.4% of GDP

Solutions Bailouts

Loan write downs upto 50%

Interest rate cuts

Austerity measures to cut FD to 3%

European Financial Stability Facility Created by 27 member countries

Bonds from German market

$ 440 bn can go upto 1 Tn

Other players – IMF, ECB etc

Is the worst over? Not really

Essentially stop gap measures

Austerity measures Low growth Lower Taxes

Long term solutions Fiscal Discipline imposed by EU (Fiscal Union)

Solve trade imbalances

Promote exports curtail imports

Growth is imperative

Worst Case scenario Sovereign Debt Default

Banks take a hit, possible banking collapse

Rating agencies downgrade debt further

EU Breaks up ECB and Germany refuse to pay the bill

Greece Portugal etc leave monetary union

Devalue currency w.r.t. Euro

Debt Default, Bank Collapses and Flight of capital,

Virus spreads to USA and Asia Markets tumble, FII’s pullout money

Recession part 2

Lessons Live within your means

Lesson for Individuals, Corporates and Countries

Separation of Fiscal and Monetary Policy

Sustainability of Bailouts Air India, BSNL Etc

Irreversibility of Government spending Government Employees

Subsidies & Pensions

The Decline of the West

Decline of the West Asia is the new growth Engine

US and Europe share of world GDP will keep falling

Protectionism or Globalization?

Subsidies and Welfare state

US subprime crisis and Eurozone Preceded by cheap credit and excess liquidity

Hi leveraging of Financial Institutions

Soaring asset bubbles – esp. Real estate

Crisis spreads across boundaries and sectors rapidly