The global financial crisis of 2007-to-date is cited as being among the worst ever to affect the world since the credit crunch of the 1930s popularly known as the Great Depression. Coupled with the financial crises, a massive sovereign debt crisis advanced among leading national investors all over the globe and the most affected were the majority of European governments. The Eurozone crisis made it difficult for most nations to re-finance their debts leading to the creation of rescue packages and bailouts to prevent the collapse of economies that were in between the depth crises. Member states within the European Monetary Union (EMU) is expected to abide by the conditions stipulated under the Stability and Growth Pact of 1998 that requires all members to keep their budget deficits below a 3% ceiling ((Barth, and Greg 77; Mignone 180). This is a tough condition for most nations because of the grappling state of the global economy leading to an increased growth in debts and eventually the onset of the European Sovereign debt crisis. A sovereign debt risk involves the willingness and ability of a sovereign state to settle its debt obligations on time. This capacity is dependent upon certain economic fundamentals such that economic performance is measured in terms of fiscal health and growth rate whereas the level of public debt is compared to the GDP and the level of fiscal deficit.
The European Sovereign Debt Crisis
This refers to the prevailing unstable condition among 17 countries within the Eurozone and this situation is characterized by the inability of these nations to repay their entire debt obligations. The debt crisis begun in 2009 with Greece and eventually spread to affect countries such as Ireland, Portugal, Spain, and Italy in addition to increasing the possibilities of turning the entire Eurozone into massive recession.
Simply put, the European Sovereign Debt Crisis is composed of two facets, both of which occurred due to issues relating to investment and debt financing (Kelch 16) As such, debt growing and sovereign deficits grew to unmanageable levels while at the same time, financial institutions in Europe held large amounts of money belonging to the European sovereign debt. Equally, the same financial institutions held large amounts of real-estate assets worth of depressed euros.
Several key issues have been identified as having fueled the debt crisis. First, the changing nature of individual economies from being dependent on the industrial sector to being dependent on the service sector. Second, accepting the Euro (€) as a single currency within the European Union meant that countries were capable of borrowing funds at slightly lower rates, and more easily as compared to the case where they had their individual sovereign currencies. Third, governments within the European Union were given the option of creating new debts in efforts aimed at repaying old debts. As such, such governments continued borrowing more funds to enable them repay those funds borrowed forgetting that the real problem was being ignored in the process. Fourth, allowing countries that never met the convergence criteria into the Eurozone could have had a significant impact in contributing to the worsened situation. For instance, Greece admitted on November 22, 2004 that it lied about meeting the fiscal convergence criteria so that it could be allowed admittance into the Eurozone. Last, governments involved in the borrowing exercise borrowed more fund such that their revenues could keep up with the growing expenses and hence, they continued operating in trade deficits (Grauwe).
Effects to the European Monetary Union
The escalating sovereign debts in Portugal, Ireland, Italy, Greece, and Spain (PIIGS) brought a stressful financial period to the European Monetary Union. Admittance of breach of the convergence criteria in its fiscal policies was evidenced when it announced a fiscal deficit of 12.5 as compared to the required deficit of 3.5 %. While the sovereign debt problems in Iceland and the UAE offered hindsight of a possible bombshell in the financial markets, such risks were least expected to hit the PIIGS economies. In order to rollover its sovereign debts, the European Union and the European Monetary Union (EMU) offered help to Greece. However, financial help was not granted promptly before leveling severe criticisms of breaching EMU fiscal rules in addition to spending in excess of its means. Sooner, fear of the effects of Greece’s sovereign debt caused a jittery within the financial markets thereby leading to escalation of borrowing costs.
Rating agencies such as Standard & Poor and Fitch downgraded sovereign debts in Greece to mere junk status thereby leading to a leap of 10-year government bonds to levels beyond 11.24%. Equally, Portugal and Spain suffered a downgrade of their sovereign bonds. Continued downgrading of government issued debt has left Greece, Portugal, and Ireland in bad domestic economic climates.
History of the European Union, Eurozone, and the Euro
Undeniably, the root causes of the European Sovereign Debt Crisis occurred in part due to the existence of the Eurozone (Grahl). Historically, majority of leading European currencies were defined in form of precious metals particularly Gold and Silver. The collapse of the Bretton Woods Conference fueled the idea of creating a stable and free European Monetary Union where a common market would exist. Other than the need to eliminate custom barriers such as higher optimums from individual countries, the establishment of a single monetary system was seen as an ideal way of enhancing capital circulation and labor management across Europe (Grahl). The Rome Agreement of 1956 provided an ideal platform for singling out the aspects of the Eurozone. The Maastricht Treaty of 1992 led to the establishment of the European Union (EU), which required members to streamline their economies to fit certain requirements such as fiscal and monetary developments, budget deficits, price, inflation, and exchange rate developments (Aleš, and Jaromír 355). European countries willing to join Eleven founding members of the EU then established the Euro (€) on January 1, 1999 and most of these nations had to fulfill the requirements of the convergence criteria. Since then, countries that adopted the single currency have been a plethora of twists and turns.
The aid packages to several countries
The worsening debt levels of countries across the European Union and Europe at large coupled with the downgrading of debts for particular countries spurred major concerns leading to the creation of a rescue package to bring sanity to the financial situation. The European Financial Stability (EFSF) was formed govern the measures that would be used in disbursing the €750 billion rescue package to falling member economies (Yeoh 182). Greece’s deficit increases despite the government’s implementation of austerity measures aimed at curbing the deficit and calls from the EU to cut on spending. The Eurozone and the IMF were reluctant to offer a bailout package to Greece but instead offered a safety net of €22 bn (Yeoh 182). The fiscal problems turned serious amidst increased riots and protests. Risk of collapse of the Euro and failure of the EMU forced the EU and IMF to offer a €110 billion rescue package to Greece. In order to appease concerns raised by France and Germany, stiff conditions had to be attached to this facility. For instance, Greece was required to cut down drastically its deficit levels to levels not exceeding 3% of its GDP by 2014 (Yeoh 182). However, the debt condition in Greece worsens and it receives a second bailout package of €109 billion (Saurav, and Robert 150)
Spain also suffered a contagion of the sovereign debt crisis that needed an award of a rescue package of €440 billion from the European Union in addition to another €250 billion from the IMF. This move was undertaken to safeguard the stability of the Euro as well as saving the financial integrity of member states. The Irish republic also received a bailout award of €85 billion from the European Union in collaboration with the International Monetary Fund (Yeoh 182). To fulfill the requirements of this package, the Irish government passed on of the toughest budgets in its history. The sovereign debt crisis in Ireland was blamed on the activities of six key financial institutions particularly in the finance of properties.
The creation of a permanent bailout fund of €500 billion in February 2011 under the European Stability Mechanism. Portugal became a victim of its finances and calls for help from the European Union. A €78 billion bailout package is offered to Portugal by the Eurozone (EFSM and EFSF) and the IMF. Portugal was required to fulfill a budget deficit minimization from 5.9 % in 2010 to 3% by 2013 (Yeoh 182). Countries such as Cyprus had to depend on €2.5 billion loan from Russia to enable it manage its budget deficits and as well to enable it obtain means of re-financing the maturing debts. Italy also faced major budget deficits given its level of increasing debt over the overall level of GDP coupled with its lower economic growth rates (Bilotto, and Guercio 136; Bureau of European and Eurasian Affairs). Worse, a substantial percentage of its €1.9 trillion debt is set to mature by the end of 2012 hence the need for increased loans from capital markets (Bilotto, and Guercio 136).
European governing bodies
Management of the sovereign debt crisis called for the creation of specific governing bodies to provide a framework for managing the debt crisis. Other than austerity measures from sovereign states, the International Monetary Fund, and European Union, key institutions were created to guide the process of managing the European Sovereign debt crisis. These institutions include the European Financial Stabilization Mechanism and the European Financial Stability Facility (EFSF).
The EFSM is a special emergency program set up on 10 may 2010 to provide funds obtained from the financial markets. Funds raised through this program are backed by the EU budget as collateral. The European Commission supervises the EFSM and its sole purpose is to preserve the financial stability in the European Union through the provision of financial assistance to countries facing economic difficulties. The EFSM has been given the capacity and authority of raising funds totaling to €60 billion and has an AAA rating from leading rating agencies such as Standard & Poor’s, Fitch, and Moody’s.
The European Financial Stability Facility (EFSF) is an agency set up to provide financing to the Sovereign debt crisis in Europe and as well as restoring financial stability to troubled nations in the Eurozone. The European investment Bank provides administrative support and treasury management services to this institution based on an agreed service level contract. The EFSF is mandated by member states of the European Union to borrow funds totaling to €440 billion (Yeoh 182). The Portuguese and Irish bailout programs are allocated €250 billion out the €440 billion. The key functions of the EFSF includes safeguarding the financial stability of European nations by offering financial assistance, providing lending facilities in conjunction with the IMF and the European Commission, and guaranteeing commitments in terms of capital guarantees and associated interests on bonds issued by EFSF (Yeoh 182).
Effects of continued downgrading
The European sovereign debt crisis has continued to generate heated debates and varied interpretations regarding the roles played by credit rating agencies during the management of the crises and evaluation of financial markets (Arezki, Candelon, and Amadou 3). While the debt crisis has formed a theatre for downgrading the sovereign credit ratings, the entire process has contributed to the worsening economic situations in the affected states. Issues brought by the downgrading of the sovereign debt includes the widening levels of sovereign bonds, credit default swap spreads, and increased pressures on the performance of stock markets. Countries that have suffered the effects of the downgrading effects of the sovereign debt crisis include the Greece, Ireland, Portugal, and Spain.
Several effects can be associated with the downgrading of the European sovereign debt crisis. First, the profitability of banks in nations such as Ireland was immensely affected given that most banks within the Eurozone were holders of this debt (Barth, and Greg 77). The banks held this amounts both in their banking books and as well in their trading books. Its gets worse when banks hold these debts in other regions and this explains the spillover effects of the European sovereign debt crisis. The three major credit rating agencies responsible for downgrading sovereign debts for most nations in the Eurozone were Moody’s, Fitch, and Standard and Poor’s (S&P). These agencies downgraded most debts to mere junk status (BB+) based on the announcement of various types. This included rating changes (upgrades and downgrades), future rating changes, and positive and negative revision of outlook (Arezki, Candelon, and Amadou 5).
Downgrading led to worsened economic climates in most countries across the European Union. The European Commission predicted a slowed economic growth rate that put increased pressure on economic budgets of most countries. Slowed economic growth, increased costs of living, slowed markets, and worsened employment situation are some of the problems that affected countries that were downgraded. Greece accused the European Union of being incompetent and argued that it had suffered humiliation and blackmail. Equally, Italy blamed its downgrading from A to A+ to political considerations (Heinz 18). The Irish economy suffered a lot when due to exacerbation of the debt crisis and failure of its banking sector.
In summary, the Eurozone Sovereign Debt crisis can be deeply rooted to the dysfunction of a collective monetary union that lacked a political arm. The arrangement of having the Euro as the legal tender for all member states in the Eurozone can be blamed as being the fundamental cause of the crisis (Heinz 19). The monetary policy in the Eurozone remained was an exclusive responsibility of the European Central Bank. Similarly, the lack of a sovereign authority in terms of common currency meant that individual member states were unable of solving their own sovereign debt using their monetary measures.
With the difficult situation ahead and tough measures behind, Greece, Spain, Portugal, and Ireland are still under pressure to fulfill the Eurozone requirements of minimizing their overall debt deficits and debt levels. Undeniably, the events that unfolded following the European sovereign debt crisis indeed rattled most global markets in addition to creating worsened economic climates. Coupled with austere financial measures and downgrading effects from credit rating agencies, affected countries in the European Union faces tough challenges in their efforts of solving their sovereign debt crises.
Work Cited
Aleš, Bulír, and Jaromír Hurník. "Inflation convergence in the euro area: just another
gimmick?” Journal of Financial Economic Policy 1.4 (2009): 355 – 369
Arezki, Rabah, Candelon, Bertrand, and Amadou, Sy. Sovereign Rating News and
Financial Markets Spillovers: Evidence from the European Debt Crisis.
International Monetary Fund, 2011. Print
Barth, James, and Greg, Yun.” The Eurozone financial crisis: role of
interdependencies
between bank and sovereign risk", Journal of Financial Economic Policy, 4.1
(2012): 76 – 97
Bilotto, Antonella, and Guercio, Maria. “The management of corporate records in Italy:
traditional Practice and methods and digital environment”, Records
Management Journal 13.3 (2003): 136-146.
Bureau of European and Eurasian Affairs. Background Note: Italy, 12 May 2011. Web. 4
December 2011
Grahl, John. Global Finance and Social Europe. Massachusetts, Edwards Publishers.
2009. Print
Grauwe, Paul. Economics of Monetary Union, New York, Oxford. 2010. Print
Heinz, Duthel. European Debt Crisis 2011: Portugal, Ireland, Italy, Greece, Spain, and
Belgium. IAC Society. 2012. Print
Kelch, David. European Imbalances: Imbalances of the Eurozone. California:
Wadsworth. 2010. Print
Mignone, Mario B. Italy today: Facing the Challenges of the New Millennium. New
York: Lang Publishing. 2008. Print
Saurav, Roychoudhury, and Robert A. Lawson, "Economic freedom and sovereign
credit ratings and default risk,” Journal of Financial Economic Policy, 2.2
(2010):149 – 162
Yeoh, Peter. “Sovereign default restructuring options and challenges in the European
Monetary Union (EMU),” International Journal of Law and Management, 53.3
(2011): 182 - 198
