Debt crisis in Europe

Saief Mahmood It seems like almost everywhere you turn these days there is bad economic news. Unemployment rate remains high, poverty is exploding, U S government debt is wildly out of control and now Europe is on the verge of an economic collapse that could send the entire globe into a devastating financial panic. Since the adoption of the Euro as the single currency 12 years ago, the sovereign debt crisis in Europe has grown into the biggest challenge for the European Union (EU). Greece, Portugal and Ireland are virtually on life support. Italy and Spain also have serious problems. Germany and France seem to playing a calm and quite role but they are also heavily affected by the crisis of their neighbours. In July, 2011 European political leaders announced a second bailout proposal for Greece with the help of the European Financial Stability Fund. The fund was set up last year to facilitate low-cost loans for struggling EU members including Portugal and Ireland. Under the proposed reforms, the ?440 billion fund would be able to buy bonds issued by distressed euro area governments directly from investors in the secondary market. There are questions about the effectiveness of the stability fund. In particular, investors are concerned if Spain and Italy need to be rescued then there might not be sufficient money in the fund. In many Northern European nations, the idea of providing additional supports for countries that overspent is profoundly unpopular among voters. Greece, the country at the epic-centre of the crisis, is trying to secure its latest tranche of funds next month from international lenders, including the International Monetary Fund (IMF), to avoid a default. European banking system is under heavy pressure after the debt problems in Greece and Italy. According to the IMF, European banks face a ?200 billion credit risk stemming from direct exposure to government debt issued by Greece, Portugal, Ireland, Spain, Italy and Belgium. IMF estimated that the banks face a total credit risk of ?300 billion, including exposure to banks based in those troubled economies. The IMF and others have called on European banks to raise more capital to provide a buffer against potential losses on distressed sovereign debt. Many experts argue that the weaker members of the Euro zone will not be able to repay their debts and live without bailouts until economic activity resumes in a big way. Given the outlook for economic growth in Europe and around the world that seems unlikely. The European Central Bank expects growth of only 1.4 per cent to 1.8 per cent in 2011 and between 0.4 per cent and 2.2 per cent in 2012. Germany, the region's economic powerhouse, reported a paltry 0.1 per cent increase in second-quarter gross domestic product, compared with a more robust 1.3 per cent in the first quarter. The slowdown raises troubling questions about the long-term outlook for the Euro zone. Many analysts say that EU requires a fundamental change in the way it operates. The Euro zone nations have enjoyed the benefits of a shared currency and uniform monetary policy since 1999. However, in terms of fiscal policy the group has never had a common approach. The lack of coordination has resulted in a situation where stronger members of the union are now being forced to help support less competitive members that have spent beyond their means. There is an increasing fear that weaker members of EU may go bankrupt or they might be forced out from the elite group. On the other hand there is also a fear that stronger members may be reluctant to bail out the fiscally challenged neighbours. In spite of repeated assurance by the EU leaders a fiscal integration can be very challenging which requires rewriting the EU treaties. Many investors have been urging to a common form of debt, i.e., Eurobond but it would also increase the likelihood of down-gradation in credit rating of the stronger members. European Council officials have cautioned that issuing a new form of debt is not a long-term solution to Europe's debt crisis. Long term policies may deteriorate present situation, as immediate actions are needed to save the countries with critical financial conditions. These countries need to cut spending and increase the export. But the whole world cannot increase exports, because somebody has to import as well. So, the revival process may be very slow. The situation might be remedied with what the states have done throughout the ages - that is, with printing more money. This would be the most painless solution in the short term, but it would have long-term consequences. This could lead to an uncontrollable inflation rates, there would be no saving and with no saving there would be no investment. Ultimately, there is no perfect solution to the current problem. As always, the so-called mixed solutions will be adopted: spending will be cut and power centralised slightly while the inflation will increase without the European Central Bank's rules being changed. A few countries will probably leave the monetary union during the next four or five years. But for those optimistic investors in Europe hoping for a quick resolution to the debt crisis in Europe, which may bring some much-needed calm to financial markets, there is little doubt they are in for a long wait. Careful planning is needed for the tortuous process or else there might be more dark days ahead for Europe. The writer writes from the University of Dhaka. He can be reached at email: saief.mahmood@gmail.com