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Impact of failure of PIIGS countries to

control their deficit over the future of

Euro as a currency

Presented by:-Akshat Solanki (04)

Gagandeep Pahwa (14)

Karabi Kachari (24)

Nibish Baghel (34)

Shamma Dhanwat (44)

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EUROZONE

The Euro zone is an economic andmonetary union (EMU) of seventeenEuropean Union (EU) member states thathave adopted the euro () as theircommon currency and sole legal tender:

The euro zone currently consistsof Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta,The Netherlands,Portugal, Slovakia, Slovenia, and Spain.

Monetary policy of the zone is theresponsibility of the European CentralBank, though there is no commonrepresentation, governance or fiscalpolicy for the currency union.

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The Maastricht Criteria

The Maastricht criteria (also known as the convergence criteria) are the criteria

for European Union member states to enter the third stage of European Economic andMonetary Union (EMU) and adopt the euro as their currency. The 4 main criteria are basedon Article 121(1) of the European Community Treaty.

1. Inflation rates: No more than 1.5 percentage points higher than the average of thethree best performing (lowest inflation) member states of the EU.

2. Government finance:Annual government deficit: The ratio of the annual government deficit to grossdomestic product (GDP) must not exceed 3% at the end of the preceding fiscal year. If not,it is at least required to reach a level close to 3%.

Government debt: The ratio of gross government debt to GDP must not exceed 60% atthe end of the preceding fiscal year.

3. Exchange rate: Applicant countries should have joined the exchange-ratemechanism (ERM II) under the European Monetary System (EMS) for two consecutiveyears and should not have devalued its currency during the period.

4. Long-term interest rates: The nominal long-term interest rate must not be more than2 percentage points higher than in the three lowest inflation member states.

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Problems faced by Euro zonecountries

The key fact about the Euro zone is that it represents a MONETARYnotafiscal, ie government budget union, whose policy is set by the EuropeanCentral Bank or ECB. The main job of the ECB is to set interest rates for theentire Euro zone.

Ever since its inception, Euro zone members have been aware of

a potential conflict between the fact that monetarypolicy is set by the ECBfor the entire Euro-area, while government spending, i.e. fiscal, policy ismanaged by each country.

The Currency devaluing factor: In the global recession years of 2008-09,While the UK was able to devalue the pound sterling as part of its policyresponse to this crisis, such a move was not available to members of thecommon currency area.

Question raised:

How is it possible for a group of countries joined monetarily, but NOT ingovernment spending policy, to deal with a situation when one governmentgets into trouble ???

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PIIGS and their inevitable problems

PIIGS/PIGS refers to an unofficial group of countries includingPortugal, Italy, Ireland, Greece and Spain.Considered to be the weaker economical section of Eurozone.

Problems for PIIGSThe significant problems for Spain and Ireland are quite similarto the US collapse of a bubbled housing market, leading tomassive unemployment, and a stagnant economic dynamic. Stillcompletely NON-transparent derivatives market, above all the so-called mortgage backed securitiesFor Italy, Portugal and above all Greece, the main problem isgovernment, aka sovereign, debt not structurally dissimilar tothe crisis that hit Dubai just a short while ago, from which it hadto be rescued by its oil-rich UAE brothers to the south in AbuDhabi.

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Why the problem still persists

Challenged those relatively weak governments to raise taxes and impose harsh spending

cuts on a restive populace to bring down their deficits from over 10 percent of G.D.P. to

the benchmark levels close to 3 percent of G.D.P. called for in the European treaty that

created the euro. The first chart shows the yield on 2-yr sovereign debt for each of the

PIIGS countries. The extremely high level of yields on Greek, Irish, and Portuguese bonds

is the market's way of saying that a significant default is highly likely to occur.

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What is the Source of the Problems?

While such moves are highly unpopular politically, a failure to doso could send government borrowing costs soaring, enrichingthose who are betting that Greece, Portugal, Spain and perhapseven Italy will not be able to follow through on theircommitments.

The standard explanation for the problems in some of thecountries, e.g. Greece, is that lack of effective monitoring ofgovernment deficits within euro area countries and lack ofenforcement of the rules on how much debt a country can haveallowed excessive debt levels to accumulate. In other cases suchas Spain, the problem wasnt irresponsible budget behaviour, itwas the recession that caused the government budget tocollapse.The deficit problems were made worse by the fact that countrieswithin the euro area do not have the ability to use independentmonetary policy.

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THE STATISTICS

Now

By PresenterMedia.com

http://www.presentermedia.com/mspp.htmlhttp://www.presentermedia.com/mspp.html

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GDP of PIIGS

0

500

1000

1500

2000

2500

2008

2009

2010

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GDP growth

-8-7

-6

-5

-4

-3

-2

-1

0

1

2

20082009

2010

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Fiscal Deficit as a percentage of GDP

0

2

4

6

8

10

12

14

16

Portugal ItalyIreland

GreeceSpain

2008

2009

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Debt to GDP Ratio

0

20

40

60

80

100

120

140

160

2008

20092010

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Credit Ratings

MOODY'S FITCH S&P

PORTUGAL Baa1 BBB- BBB-

IRELAND Baa1 BBB+ BBB+

ITALY Aa2 AA- A+

GREECE B1 BB+ BB-

SPAIN Aa2 AA+ AA

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The Impact on the Euro

Monetary Impact

Fall of the status of Euro as a potential replacement for dollar

The depreciation of Euro leading to Rising trade deficits Inflationary pressures Decreasing creditworthiness Volatility in stock markets Reduction in FDI and FII Increase in the interest rates for long term sovereign bonds

Political impact Weaker countries thrown out/withdraw of the EMU (Economic and

Monetary Union) Germany, France and other countries keep on bailing out the PIIGS

countries until it becomes too hot to handle and ultimate breakdown ofEMU

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Monetary Impact

Monetary deflation incase there is decrease inmoney supply with no government intervention

Euro

Monetary inflation incase there is money supplyincase the government does

Euro

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Fall of the Status of Euro

PRETTIEST among theUGLIEST!!

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What Is Fiscal Deficit?

Effects of the widening fiscaldeficit

WIDENING

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Combating Fiscal Deficit

Debt financing might temporarilystimulate the economy, but in the case oflow productivity it will lead to further

downfall

Austerity measures include: Salary cuts for public sector employees

Increase in taxes on gas, tobacco & alcoholetc.

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RISING DEBT

DECREASING

CREDIBILITY

CURRENCY

DEPRECIATION

Debt Financing

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Due to depreciation of the currency,

investors will sell Euro as fast as they

can

Euro will lose its credibility and the

supply of euros will increase

(inflationary pressures also)

Consequently, even though exports

become competitive due to Euro

depreciation, there are not enough

resources to produce those exports.

Also, Since most of the countries

(apart from Germany etc, are import

dependent, it leads to a huge deficit)

Huge

loss toEuro

Zone

EU Trade deficit- $1.6

Billion Source-

Fxstreet.com

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The inflow of FDIs and FIIs will fallsharply

Stagnation of the economy (no growth

prospects due to minimum capital

formation)

Credit rating of these countries will

take a hit

They will have to offer more interest on

the long term sovereign bonds to attractinvestors

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At the helm of affairs-

Political effects

Countries might be thrown

out of EU, or might give up

their membership to take

control of their monetary

policy

This might ultimately lead to the

breakdown of EU as the goal of

the common currency has been

defeated.

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Thank You