ABA Position Paper on Sovereign Debt Issues in Greece

Lessons from the Sovereign Debt Issues in Greece

1. In July 1997, Thailand plunged into crisis when the country’s central bank could no longer support the local currency, given mounting worries about slow growth, lack of competitiveness and high foreign debt. The contagion quickly spread to neighboring countries with similar weaknesses. In early 2010, Greece faced a similar crisis when the government could no longer borrow in the market at reasonable rates, given mounting worries about slow growth, lack of competitiveness and high foreign debt. The contagion quickly spread to neighboring European countries with similar weakness, particularly Portugal and Spain. The causes in both cases seem all too familiar, i.e. , unsustainable fiscal policies.


2. Greece experienced years of consistently higher inflation than the European Monetary Union average, competitiveness losses and record current account deficits but the global financial crisis brought things into a sharper focus. The causes are numerous but summing up, the crisis has been brought about by lack of proper mechanism for fiscal monitoring, mismanagement of public funds, falsified reporting, tax evasions and wide-spread corruption. With no proper mechanism for fiscal monitoring and imposing reforms the Greek government did not implement sound economic reforms thus allowing further deterioration.


3. The four main areas by which problems in Europe could impact Asia include:

  1. European Banks restrict their international bank lending, as roughly one-quarter of lending to Asia comes from Europe. Risk aversion could impact credit spreads within Asia both in terms of liquidity and cost of funding.
  2. The small overall exposure of Asian Portfolio investors to Greece and the peripheral Euro area economies, as well as the threat of euro-zone portfolio investors withdrawing from Asia. The impact is likely to be low as Asia’s investment in the vulnerable PIGS economies is less than 5% and conversely Euro area investment in Asian economies is largely concentrated in Australia, Japan, Korea, Hong Kong and China with the rest of emerging Asia accounting for little over 10%,
  3. Direct trade exposure (exports) if European growth slows, as well as additional competitive pressure from Europe-based companies if the euro weakens.
  4. The impact of Asian asset markets as the low interest rate environment in western markets will feed capital flows.


4. The steep fall in stock markets across Asia during the global financial crisis underscores the ever increasing impact of global linkages. It is, however, clear some countries will be affected more than others depending on their relative fiscal positions and extent of foreign borrowings.


2010 Policy advocacy2 700 x 4665. Asian government policy makers, economists, bankers, investors, and the general public can therefore learn a number of lessons from the background, causes, and responses to the sovereign debt crisis, coming as it is, so soon after the global financial crisis.

  1. There have been intermittent talks in Asia about a monetary union like the Euro Zone. The Greek debt crisis has taught us that such a measure should not be embraced without a careful thought about the regional relevance of such a measure. Integration into the Euro Zone gave Greece a false sense of security and though it was not in the same league as Germany or France, economically, the membership gave Greece easy access to cheap debts which it otherwise was not eligible to borrow.
  2. Greece finds itself in more than a problem of high debt. There is policy inflexibility caused by the fact that Greece does not control its own currency and cannot conduct its own monetary policy, being part of a larger union. Its options for dealing with its debt would have been more than steep spending cuts and large tax increases if it had its own currency to facilitate policy changes.
  3. The lesson here is the importance of continuing impact studies and research in Asia as global policy is based largely on research conducted in Western Countries. Asian Governments, policy makers, central bankers need to assess impact of global capital / liquidity standards (e.g. Basel 3) on their own economies and justify amendments modifications as required, whilst improving their influence in global policy making. Developing an ‘Asian Think Tank and Research Arm’ is a fore-runner to any plans of an Asian monetary union.
  4. The debt crisis was a precipitation of nearly a decade of underlying fiscal deficits in rich countries, funded by cheap borrowings and often masked by short lived surge in tax collections and assets bubbles. The problem has shown that there is no alternative to austerity even during times of plenty, as even better economies like Germany and France are only now planning expenditure cuts for the coming years.
  5. The less than creditable roles of rating agencies was once again brought into focus by the crisis. The risk rating agencies continued to classify Greek sovereign debt as investment grade not long before declaring it as risky and pushing up borrowing costs for Greece. There is a felt need for more effective supervision system for the work carried out by rating agencies. Policy measures to improve independence in terms of shareholdings and corporate governance aspects merits attention.
  6. There are huge social costs to restructuring public debts which needs sensitive handling as the general public can feel that they are being unjustly targeted for causes they cannot be as much blamed as their respective governments. The public demonstrations in Greece and more such public anger expected in other countries in similar plights could queer the pitch for Governments, saddled with large public debts, planning austerity measures. This underscores the need for quicker resolution mechanisms to prevent spread of the contagion in the event of a similar crisis in future. The procrastination of better off European countries, though for own justifiable reasons, to a quick bailout plan actually took the crisis to a much higher level. This delay drew parallel with a debatable view that if Lehman Brothers had been bailed out in time, whether the global financial crisis could have been less severe.
  7. Markets also, at times, respond irrationally during times of crisis and aggravate an already difficult situation. The behavior of the markets during the crisis made it even more difficult for the EU to put in place a cost-effective solution and the solution now worked out will not only increase the debt to GDP ratio to even more dangerous levels by 2014 but at costs which were driven up by market panic.
  8. It is important to recognize the similarities between what has taken place in Greece and prevalent situation elsewhere in Asia, where public debts continue to rise and promised governance reforms have not been undertaken. India and Japan, which also have huge public debts, but have mostly restricted sovereign market borrowings to local currency instruments and have not faced such a crisis, at least not yet, offer a different insight.
  9. Countries faced with a Greek type debt problem, must therefore introduce fiscal consolidation and extensive structural reforms addressing their competitiveness deficit vis-a-vis other similar countries in right earnest. These will definitely cause short term welfare losses raising internal opposition with socio-political costs, but no country can live beyond its means for long and harsh austerity measures taken now will go a long way in easing longer lasting pains later.
  10. Countries should also focus on strengthening the monitoring mechanism of quality/accuracy of economic/fiscal indicators so that timely measures can be taken to detect and prevent deterioration, if any ,of macroeconomic fundamentals. There is a need for a regulatory authority in each country overseeing Property and Capital Markets to contextually define ‘unsustainable growth’ and develop measurement of early warning systems to identify ‘bubbles’ with a view to taking necessary action to burst them in time.
  11. The final lesson from the Greek episode for all countries is the need to maintain fiscal prudence at all times. There is merit in containing the fiscal deficit to a level that is consistent with a country’s ability to meet the debt service payments. The assumption, that by running high fiscal deficits, a country can grow and ride out of problems needs a closer review by all concerned.
  12. Multilateral institutions like IMF should have powers, though unpalatable to many, to intervene in the budgets of chronic deficit countries to ensure more balanced budgets.


1 November 2010

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