tiểu luận causes and impacts of the european sovereign debt crisis on the global economy

DIPLOMATIC ACADEMY OF VIETNAM
FACULTY OF INTERNATIONAL ECONOMICS

EUROPEAN SOVEREIGN DEBT CRISIS:

CAUSES AND IMPACTS
ON THE GLOBAL ECONOMY

Supervisor: NGUYEN THI THU HOAN
Submitted by: NGUYEN THANH CAT ANH

PHUNG KHANH CHI

May 2015


INDEX:
Page

A.
B.
C.

Introduction

3

Theoretical basis
Causes and impacts of European sovereign debt crisis on global
economy
Solutions

16

4

Conclusion

18

Sources

19

5


INTRODUCTION
Experiencing a long way of formation and development, the European
Union recently has become one of the most powerful economic –
currency centres globally. Especially with the advent of the euro - one of
the strongest currencies in the world monetary system has exacerbated
the influence of the EU on the global economy. Nevertheless, the debt
crisis in the euro zone breaking out in late 2009 exhausted many
European economies, and posed a challenge to the global economic
development. Besides that, the political and social impact of it is also very
profound. Not only shattering the lives of the European residents , but it
also set out the risk of the disintegration of Euro zone and is the cause of
many internal political disputes threating the stability of the EU- which is
regarded as the largest economic union in the world. Therefore, extensive
research on the causes and the impact of the sovereign debt crisis in
order to find appropriate solutions for this issue is very urgent and

important. The story of Europe has left a valuable lesson for the
development of countries around the world, from the study of this issue,
each government may have a particular perspective and draw lessons for
their country, from which they can find the right solution to solve the
problem of public debt in their nations


A.

THEORETICAL BASIS

Definition of sovereign debt: Bonds issued by a national government in
a foreign currency, in order to finance the issuing country's growth.
Sovereign debt is generally a riskier investment when it comes from a
developing country, and a safer investment when it comes from a
developed country. The stability of the issuing government is an
important factor to consider, when assessing the risk of investing in
sovereign debt, and sovereign credit ratings help investors weigh this
risk.
Definition of sovereign debt crisis: is financial and economical problem
happening as a nation cannot repay its government’s debts or debts
guaranteed by its government. It explores as the government debts are of
unsafe levels compared the scale of the economy and the economy reaches
low growth.
The European sovereign debt crisis started in 2008, with the collapse of
Ireland's banking system, and spread primarily to Greece and Portugal. The
debt crisis led to a crisis of confidence for European businesses and
economies.

B.

THE CAUSES AND IMPACTS OF EUROPEAN SOVEREIGN DEBT
CRISIS ON THE GLOBAL ECONOMY

I. Causes:
Subjective causes:
Budget deficit:
1.
1.1.

Budget allocation for investment and consumption is unreasonable. In the
period 1992-2007, the Eurozone economy maintained a very high level of
consumption for investment and pays too much attention on projects that did
not bring economic effects in short term particularly in education. Besides,
domestic consumption was in an extremely high level.

Table 1. Budget allocation for investment and consumption from 1992 to
2007 in Germany, Greece, Ireland, Portugal and Spain.
(Source: OECD)
The table illustrates that the typical 5 countries of Eurozone spent more than
60 percent of domestic expenditure in Consumption. The figure for
Investment during the period from 1992 to 2007 was more than 15 percent in
most countries.


Table 2. Budget deficit and sovereign debt in European countries
from 2009 to 2011
(Source: Report from EC, Bloomberg and Credit Agricole)
As can be seen in the table, in German, a typical developed economy, when

the budget deficit increased from 4.1 percent to 5.3 percent in the two year
2009 and 2010, the sovereign debt rose consequently from 73 percent to 74.3
percent. The same issue happened in France, Italia, Portugal and Ireland.
- Extensive welfare policies:
This showed the level of development and stability of an economy. With its
high level of development, the European countries soon maintained a social
security system and widespread social welfare. However, the degree of
population aging was more and more faster, the proportion of labors
generating income for economies was low in comparison with the proportion
of people exceeding the age of working. As a result, the social welfare
policies put too much burden on the budget.
+ According to a study by the European Central Bank (ECB) in 2012,
the sum of pension was paid in 19 countries of European Union(EU)
was five times as much as the total debt in these countries, which was
around 30.000 billion euros.
+ Higher unemployment benefits: In France, the unemployed can
receive benefits approximately equal to the wages of their working.
Number of unemployment years allowed in Ireland was up to 4
years/person. The number of unemployment years with pensions can
be up to 4 years/ person in here.
+ US per capita income $ 34,320 / person / year but only 19.4% of
GDP was spent on welfare and social security, similar to Japan's, $
25,130 / person / year and 18.6%. However, the figure for EU
members fluctuated from 20% to 38.2%. In order to have money for
these purposes, these countries had to raise taxes. For instance, VAT
was up to 20% in EU nations while the figures for US and Korea was
about 10%.


Budget revenue decrease:

This is most clearly in Greece with the problem of tax evasion, economic
activity underground, systematic corruption. According to WB, the informal
economy in Greece accounts for 25-30% of GDP (compared with 15.6% of
Vietnam's GDP, 11.3% of Japan’s GDP). According to Transparency
International Organisation, in 2008, more than 13% of Greeks spent 750
million euro bribing leaders in public sector and private sector.
-

1.2.

Easy access to loans:

As a member of European Union then the Eurozone, these countries accessed
with large markets and low interest loans, which led to increasing public
expenditure in member nations.
In 2009, Greece had a budget deficit of 9.8% real GDP. But the figure was
estimated at 6% of GDP by Greek Government, which mislead the market to
continue to borrow at low interest rates.
1.3.

Low saving rate:

Reserve in public is an important source for government to spend or repay
their debt in need. Low domestic saving rates led to foreign borrowing for
public spending.
The average saving rate of Greece was only 11%, lower than 20% of Portugal,
Italy, Spain during the 1900s.
1.4.

Trade deficit:

Many countries in Eurozone did not have strong export platforms to ensure
the necessary foreign currency revenue for the national budget.
Except Germany remaining surplus, France, Greece, Portugal, Spain and Italy
were in the trade balance deficit. In the period from 2002 to 2008, euro rose
from $ 0.8 to $ 1.6.
1.5.

Lack of consistence between monetary and fiscal policies:

Although members of Eurozone used the same currency, monetary policies
were decided by ECB. Thus if there were any budget deficits, member
nations’ government cannot issue more money to make up for them or
devaluate their currency to increase export but raise borrowing. Countries
with less competitive ability and huge budget deficits had to issues
governmental debenture with high rates of interest to borrow easily.
Objective causes:
Impact of the Economic crisis from 2007 to 2008:
2.
2.1.


Deprive from the burst of real estate bubble and the crisis of the national
credit system. Governments launched the rescue package to prop up the
economy and protect the banking system from the risk of collapse.

Figure 1. Number of systemic banking crises starting in a given year
(Source: Journal of Economic Perspective)
Irish Government spent 50 billion euros to rescue six banks, which makes
Ireland budget deficit grow up to 32%.

The combined impact of domestic recession, banking-sector distress and the
decline in risk appetite among international investors would fuel the
conditions for a sovereign debt crisis.
2.2.

The impact of Credit Agencies:

Credit Rating is an assessment of the credit worthiness of a borrower in
general terms or with respect to a particular debt or financial obligation.
Credit assessment and evaluation for companies and governments is generally
done by a credit rating agency such as Standard & Poor’s or Moody’s.
The move that raising or reducing the confidence could create a crisis of
confidence.
In France on January, 2012, as Standard & Poor's downgraded from AAA to
AA +, making deficit reduction target of 4.5% to end the year of France in


trouble. French Prime Minister Sarkozy at that time must immediately declare
to regain the AAA in any cost.
II. THE IMPACTS OF EUROPEAN SOVEREIGN DEBT CRISIS ON THE
GLOBAL ECONOMY:
1. The devaluation of Euro:
The impact of the global recession in 2008 along with financial deficits in
Eurozone countries, where the sovereign debt crisis was very serious, put
a double pressure on the euro and made it severely be devaluated. As one
of the main and most powerful currencies in the world currency system,
this situation had significantly negative effects on global financial market.
Investors gradually lost their belief in the euro, which caused a run on
large scale from Eurozone to other safe - haven as London real estate
market. Frozen transactions, delayed investment, stagnated production

and rising unemployment rate, all of these caused the euro lose the
inherent power of one of the most important currencies in the world.

Figure 2: The EUR Price Index
(Note: EUR Price Index measures the volatility of the euro against a
basket of currencies consisting of 6 categories: USD, JPY, GBP, CAD, CHF,
SEK.)
(Source: Reuters)
Generally within 3 years after the global financial crisis (from early 2009
until 25/06/2012), the price index has fallen by 16.1% EUR (Figure ). The


euro fell by 8.6% against the US dollar, down 15.8% compared to the
British pound, down 20.5% against the Japanese yen, down 19.7%
against the Swiss franc and down 24.5% compared to the Canadian dollar
in the period 2009-2012. In particular, within 1 years ago (6 / 2011-6 /
2012), the EUR Price Index decreased by 9.8%, in which, the euro fell by
12.3% against the US dollar, down 10% versus GB pound, down 13.7%
compared with the Japanese yen. (Calculated from data from Reuters to
date 06.25.2012).
Year
Total global foreign
exchange reserves
USD (%)
EUR(%)
JPY(%)
GBP(%)
Others(%)

2006

2007

2009

2010

2011

6.7

200
8
7.3

5.3

8.2

9.3

10.2

65.5
25.1
4.4
3.1
2.0

64.1

26.3
4.7
2.9
2.0

64.1
26.4
4.0
3.1
3.2

62.0
27.7
4.2
2.9
3.2

61.8
26.0
3.9
3.7
4.6

62.1
25.0
3.9
3.7
5.3

Table 3: Global foreign exchange reserves by currency

(Source: IMF Statistics Department Coffer Database, updated 30 June 2012)
Along with the devaluation, international status of the euro also was
impacted negatively. The world economy had been more volatile since the
global financial and the European sovereign debt crisis, making
governments tended to diversify foreign exchange reserves in order to
reduce risks. This caused the proportion of reserve in the euro to decline
from 27.7 % in 2009 to 25.0 % at the end of 2011, although the euro was
still the world’s second largest international reserve currency.
Meanwhile, the percentage of other currencies rose significantly from 3.2
% to 5.3 % within two years.
2.

Slow recoveries of global economy :

At this time, the global economy had just escaped from the financial crisis
in 2008, began having some signs of recovery as the result of stimulus
packages launched by governments, the spending reductions, particularly
the austerity policies in European countries, as well as tax rising, caused a
decrease in investment and hindered the economic recovery. The
economy developed slowly, even faced to double crisis, according to many


experts. Besides, sovereign debt crisis also had negative effects on the
financial system, panicked the banks, made them tighten lending policy in
the short term and caused the bailouts inaccessible to consumers.

Country group name

200
8

2.80
economy -0.36

World
Major advanced
(G7)
Euro area
Other advanced economies
(excluding G7 and Euro area)
Newly industrialized Asian
economies
Developing Asia
Latin America and the
Caribbean
Middle East and North Africa

200
9
-0.57
-3.84

201
0
5.14
2.78

201
1
3.83
1.42

201
2
3.28
1.44

0.37
1.68

-4.24 2.03
-1.17 5.87

1.43
3.23

-0.41 0.16
2.06 2.99

1.80

-0.73 8.50

4.03

2.14

3.60

7.92
4.25

6.98 9.51
-1.55 6.15

7.76
4.51

6.67
3.17

7.2
3.89

4.54

2.57

3.30

5.27

3.65

5.03

201
3
3.62
1.49

Table 4: The percent change of gross domestic product (with
constant prices) of world economy and some country groups in
the period from 2008 to 2013
(Source: IMF, World Economic Database)
From 2007 to 2013, the percent change of global GDP decreased by
1.79%. After the positive signs of recovery in 2010, with the effect of
European sovereign debt crisis, the world economy faced a challenge
again. Within one year, the global growth rate fell from 5.14% to 3.83%.
Many country groups also suffered the same decrease, in which steepest
fall was in newly industrialized Asian economies with 4.07% down. From
2010 to 2013, all country categories’ percent change decreased
significantly. The growth rate of groups dropped respectively by 1.29% in
G7 countries, 1.87% in Euro area and 2.88% in other advanced
economies, while this figure in newly industrialized Asian nations was
more dramatic, 4.9%. This situation was also taken place with other
country categories including developing Asia, Latin America, Middle East
and North Africa.


3.

High unemployment rate:

The austerity measures of the governments, slow recovery along with
bleak economic prospects caused many corporations make the decision
of delaying investment and downsizing to overcome the hard time.
Besides, a lot of companies and banks announced situation down and
losses, even bankruptcy, all of these made the rate of unemployment rise
alarmingly.

Country group name
Major advanced
(G7)
Euro area

200
8
economies 5.9

200
9
8.07

201
0
8.20

201
1
7.67

201
2
7.41

201
3
7.13

7.65

9.65

10.2

10.2

11.3
9
4.67

12.0
5
4.60

Other advanced economies 3.93 5.34 5.24 4.72
(excluding G7 and Euro area)
Newly industrialized Asian 3.40 4.33 4.02 3.57 3.54 3.48
economies
Table 5: The unemployment rates in some country groups in the
period 2008 – 2013
(Source: IMF, World Economic Database)
After the European sovereign debt crisis, the employment rates in many
regions was very high, particularly in Euro area, which was more than
10%. From 2010 to 2012 the global jobless proportion has risen by
1.81%.
The unemployment rates in European countries, especially Eurozone has
always been the highest in the world. At the end of 2012, a quarter of
population of Greece and Spain was jobless, caused the proportion of
Eurozone in general rising by 11,6%. Other nations including Portugal,

Ireland, EA 17, Italy and France also had high unemployment rates, which
was more than 10%.


Figure 3: The unemployment rates in the Euro area in 2012
(Source: Eurostat. The Wilder View)
4.

Global trade reduction:

Depart from the decrease of demand and low economic development,
global trade also faced with negative effects. From 2010 to 2012, the rate
of growth of global trade dropped by 1,14%. The crisis in 2007-2008
affected significantly the import and export situation of countries, with
ones influenced most seriously are Greece, Spain, Ireland and two biggest
economies in the world: the USA and China.
-

Import:

Country group name
World
Major advanced
(G7)
Euro area

200
8
2.88

2009

201
0
-10.85 12.6
3
economy -0.52 -11.88 11.6
2
0.49 -11.39 9.82

201
1
6.27

201
2
2.75

201
3
2.93

4.75

1.5

1.08

4.43

-1.11 0.26


Other advanced economies 4.21
(excluding G7 and Euro area)
Emerging
market
and 8.47
developing economies
ASEAN-5
6.65

-11.62 15.4
3
-8.03 14.4
3
-15.54 19.3
5
-16.07 21.9
4
-0.96 -0.24

5.91

1.80

2.79

9.17

5.75

5.58

9.41

6.62

3.14

Latin America and the 846
11.1 3.47 3.50
Caribbean
1
Middle East, North Africa, 15.5
0.96 9.89 7.63
Afghanistan and Pakistan
8
Table 6: The percentage change in volume of import of goods and
services in the period from 2008 to 2013
(Source: IMF, World Economic Outlook Database)
The percentage change of global import saw a significant decline in many
areas. Within 4 years from 2010 to 2013, this rate of world import
decreased by 9.7%. This situation also took place in all regions in the
world, except Middle East, North Africa, Afghanistan and Pakistan.
-

Export:

Country group name

World
Major advanced
(G7)
Euro area

economy

200
8
0.49

2009

1.78

-13.22

0.67

-12.76

-11.39

201
0
9.82
12.8
2
11.5
9

13.4
4
13.9
2
11.8
0
10.1
4

201
1
4.43

201 201
2
3
-1.11 0.26

5.66

2.38

1.46

6.43

2.35

1.44

Other advanced economies
4.08 -8.15
5.92 1.80 3.70
(excluding G7 and Euro area)
Emerging
market
and
4.33 -7.91
6.96 4.19 4.44
developing economies
ASEAN-5
-5.38
7.05 2.39 3.19
1.49
Latin America and the
0.66 -10.20
5.86 1.61 2.42
Caribbean
Middle East, North Africa,
3.92 -2.94 2.85 3.36 6.77 2.43
Afghanistan and Pakistan
Table 7: The percentage change in volume of export of goods and
services in the period from 2008 to 2013
(Source: IMF, World Economic Outlook Database)


Similar to import, the percentage change in volume of export also fell
remarkably. Excluding Middle East, North Africa, Afghanistan and
Pakistan, other country groups faced with a dramatic decline. From 2010
to 2013, this rate of world’s export dropped by 11.36%, mainly due to the

decrease of trading of advanced economies, particularly USA, China and
the EU.
5.

Gold price raised sharply:

With the spread of the debt crisis, the devaluation of the euro has
remarkably affected to panic psychology of investors, made them look to
precious metal as a safe solution. Gold is one of the precious metal and
the storage assets - traditional investing public. Gold's role as an
international means of payment have been established since the early
19th century under the gold standard. The biggest advantage of this
monetary regime is to limit the uncontrolled proliferation of credit and
public debt using cash statutory regime (not converted into gold) because
the central bank has the right to print money when necessary.
At this time, the gold price rose significantly, usually above 1300
USD/ounce. Particularly, in 2011, within 7 months from February to
September, the price increased from about 1300 to nearly 2000
USD/ounce(Figure 3). Not only gold, the price of platinum and silver also
saw an increase.


Figure 4: Gold price from the end of 2010 to early 2012.
(Source: goldprice.org)

C.

SOLUTIONS:

Solution from European countries: Reducing public spending

and raise taxes:

1.

Although bringing many political and social consequences, as well as
upsetting the lives of residents, in fact this is still the first measure that
the European nations apply and may be the most effective short-term
one. Simultaneously, it is also used as a requirement of three
organizations including the International Monetary Fund, the European
Union and the European Central Bank for the aid to help countries at risk
of debt default exit crisis.
- Greece: From 2010 to 2012, Greece had implemented cuts in allowances
and salaries of civil servants, and raised taxes to increase revenues for the
State budget.
- Ireland: In May 2010, Irish Government announced austerity and tax
increases of about 20% in the next 4 years, in which 3.8 billion USD
would be cut in social welfare and 1.9 billion USD increased by raising
tax. By 2011, the Irish Government continued to plan to reduce spending
by 12.4 billion over four years.
- Portugal: 2013, the Portuguese Government plans to save 5.3 billion
euros for the state budget, in which 600 million euros were expected to
be cut in public spending.


- Spain: In 2012, the Spanish government decided to suspend the
recruitment of personnel in the public sector and planned to reduce 8.9
billion euros in government expenditure.
- Italy: In 20111, the Italian Government adopted the programme of
spending cuts and increasing tax valued about 48 billion euros.
2. Solutions come from the International Monetary Fund, European

Union and European Central Bank: the financial stabilization
mechanisms.
These three organizations play a crucial role in shaping and
implementation of policies to revive Europe. Besides three measures
offered by the European Central Bank including buying up government
and private debt, unlimitedly purchasing government bonds of members
and restart swap agreement between EUR and USD with the support of
FED, the financial stabilization mechanism established by the European
Union and the International Monetary Fund also was expected to bring
positive results to the public debt crisis.
- European Financial Stabilisation Mechanism (EFSM): an emergency
fund takes capital from the financial markets and the budget of the
European Union under the guarantee of the European Commission. With
an initial budget of 48.5 billion euro used for bailout for Ireland and
Portugal, the aim of this mechanism is to maintain financial stability by
the aid for the European nations.
- European Financial Stabilisation Fund (EFSF): the long-term mechanism
coordinated between the European Union and International Monetary
Fund. The objective of this fund is to ensure the stability of European
finance by providing financial support for Eurozone countries when they
are in difficult period. This fund is authorized to lend up to 440 billion
euros and expected to expire on March 2013.
- European Stabilisation Mechanism (ESM): Originally founded as a
permanent Eurozone bailout fund replacing for the European Financial
Stabilisation Fund when this fund expires, with the initial budget of 700
billion euros. With this mechanism, Eurozone members may borrow
money to deal with the debt crisis, in exchange, they must carry out
financial reform and restructuring.

CONCLUSION

Looking back at the sovereign debt crisis in Europe, it can be concluded
that the causes of this crisis came primarily from the limitations in
managing the national budget of governments and the loose fiscal policy
of Europe. This made the European economy with the inherent
weaknesses become passive in responding to the crisis.
The debt crisis has seriously affected the world economy in general and
Europe in particular. Besides, its social and political consequences are
also remarkable. Not only overturning the lives of European residents,
the crisis also challenged the sustainability of the Eurozone and sparked
internal disagreements inside the European Union, threatened the
unitary process that this economic alliance pursues.
Many solutions have been put forward, in which the most noteworthy
was still the "austerity" policy applied by governments and the
stabilization mechanism established by the International Monetary Fund,
the European Union and the European Central Bank. Although certain
shortcomings still existed, these solutions have helped the Europe
countries against the threat of default and prevented a global economic
double-dip recession. At the same time, solving the public debt issue was
also the best way to help reconcile disputes, internal conflicts and ensure
the sustainability of the European Union.


SOURCES
1.
2.
3.
4.
5.

6.
7.
8.
9.

The International Monetary Fund:www.imf.org
Organization for Economic Co-operation and Development:
www.oecd.org
Journal of Economic Perspective
Eurostat: www.ec.europa.eu
Reuters: www.reuters.com
Gold Price: www.goldprice.org
/> />PhD. Dang Hoang Linh, Diplomatic Academy of Vietnam: “Khủng
hoảng nợ công Châu Âu và bài học kinh nghiệm đối với Việt Nam” ,
National Political Publishing House, 2014.