Let us make in-depth study of the Eurozone crisis and its impact on Indian economy.


In 2010 the world again found itself in financial turmoil threatening another recession in the developed economies of the world, especially in European Euro land before the effects of global financial crisis (2007-09) had yet to fully wear off.

The new crisis emerged not due to hitherto toxic assets as was the case of 2007-09 sub-prime crisis but due to the threat of defaulting on payment of its debt by governments of European countries especially by Greek government. Some economists have put forward the view that this new crisis is continuation of the previous crisis of2007-09.

This is because to overcome recession or slowdown following the financial crisis (2007-09) the governments of various European countries increased their public expenditure by heavily borrowing, especially from foreign sources and thereby increasing significantly their sovereign debt. The problem of Greece and other European Countries is of huge sovereign debt on which annual interest has to paid and the repayment of the principal sum borrowed. This has created the risk of default on paying debt by these countries.


The global financial system seems to be very fragile. Though Greece accounted for less than 2 per cent of the combined GDP of the European Union (EU), yet it set that entire region in turmoil and terrified investors throughout the world. Greek crisis created a good deal of uncertainty about the returns from their investment by investors in Greece and other Euro land countries bonds.

As a result, during the Month of May 2010 stock market prices crashed not only in Europe but also in the USA and throughout Asia. Besides, the fears of double-dip recession and consequently large decline in stock market prices caused fall in world prices of commodities, crude oil and petroleum products. The price of crude oil went below $ 70 per barrel in May 2010.

Causes of Greek (Eurozone) Crisis:

Governments of Greece and other Euro countries ran up record debts to pull their economies out of the deepest slump in 2007-09 since the Great Depression of 1930s and are new experiencing problem of defaulting on sovereign debt. Countries like India are suffering because of wrong-doings of the developed countries.

While the US crisis of 2007-09 had broken out as most of the borrowers could not repay housing loans and therefore started defaulting on loan payments, in Greece and other European Countries, the problem has been created by governments which lived beyond their means and borrowed heavily thereby adding greatly to their debt burden which they are finding it difficult to repay now. Countries like Greece, Spain, Italy, Ireland and UK have been undertaking double-digit fiscal deficit.


According to a report, the fiscal deficit of Greece in 2009 was 13.6 per cent of GDP, that of UK 11.6 per cent, of Spain 11.2 per cent and Ireland 11 per cent. According to Joseph Stiglitz, such a huge fiscal deficit is clearly unsustainable and was bound to cause problem of defaulting on payment of debt that increased due to heavy borrowing to meet the large deficits.

Debt of Greece and other European countries is very large. At present public debt of Greece stands at 115 per cent of GDP and is estimated to rise to 150 per cent of GDP in 2014. This is in part due to the fact that Greece, Ireland, Spain has been incurring large fiscal deficit in the past and has been adding 14 per cent annually to its sovereign debt and partly because Greece has been experiencing negative growth of 4 to 5 per cent annually. Greece faced dilemma. Getting back to sustainable fiscal path required cutting annual fiscal deficit by 10% by reducing public expenditure and increasing taxes.

This was politically infeasible as it would have caused loss of a large number of jobs and therefore would have been resisted by the people who would protest vehemently as was actually revealed by widespread protests in 2010, 2011 and 2012. Besides, attempts to reduce fiscal deficit was likely to hamper economic growth which would lead to lower tax revenue in future. This is because withdrawing fiscal stimulus by cutting public expenditure and raising taxes will lower aggregate demand. These austerity measures in fact caused recession or lower GDP growth in European Countries.

It is worth mentioning that Greece had adopted Euro as its currency and no longer had its own currency. Therefore, because of its being locked into Euro, Greece could not devalue the currency so as to switch its aggregate expenditure from imports to exports.


In the absence of defaulting on debt, three possible options were available to Greece to overcome its debt crisis. First, Greece could withdraw from EU and revive its own currency and undertake its devaluation to expand exports and stimulate growth and thereby lower its debt burden.

With its ending of membership of EU and revival of its currency Greece could print its own currency to pay off a part of its internal debt and thus easing its fiscal burden. This also applies to other countries. However, this scenario was unlikely to happen since no European country including Greece is prepared to see its dismemberment as EU comes to their rescue whenever required.

Secondly, Greece could remain in the EU and adopt harsh austerity measures imposed by EU and IMF. Accordingly, it could drastically cut its public expenditure on the one hand and increase its taxes to raise revenue on the other to reduce its annual fiscal deficits which will help in solving its debt problem over time.

This, as pointed out above, was bound to be opposed and resisted strongly by the people and was therefore considered as politically infeasible. The third option to be adopted was to take only moderate and politically feasible austerity measures along with rescheduling of its debt. Note that austerity measures require fiscal compression, that is, cutting of public expenditure and raising taxes.

It is not only Greece that is affected by heavy debt problem, similar debt crisis is also faced by Spain, Portugal, Ireland, Italy and even UK. If Greece defaulted on its debt, it was likely to cause similar situation in these other European countries.

It was to prevent the fears of this contagion effect that EU in collaboration with IMF announced $ 1 trillion bail-out package for Greece and other Euro countries facing sovereign debt crisis so that these countries could repay their debt and interest on it. Besides, independent European Central Bank (ECB) was persuaded to announce that it would buy Greek government bonds to ease the pressure on redemption of Government bonds.

It would help the Greek government for tackling its debt crisis. It is worth mentioning that EU while announcing its bail-out package put the condition that Greece and other Euro countries would adopt austerity measures, that is, cut their public expenditure and raise taxes to increase revenue so as to reduce fiscal deficit.

In 2011 again sovereign debt crisis in Greece arose in serious form putting financial markets all over the world in turmoil. European Central Bank (ECB) again came to its rescue and purchased its bonds but put strict conditions that Greece would adopt severe austerity measures (i.e. cut its expenditure and raise its resources through higher taxes) so that it is able to reduce its debt burden.

Spread of Sovereign Debt Crisis to other European Countries:

In 2011 sovereign debt problem spread to other major economies of Eurozone such as Italy and Spain putting the whole Eurozone in the danger zone, that is, to the brink of default on their public debt. After some hesitation, in August 2011, European Central Bank (ECB) took emergency operations to bail them out. ECB purchased Italian and Spanish debt-bonds of the value of 22 billion Euro which was biggest bail-out operation undertaken by it so far. Besides, in Sept. 2011 private banks which had given loans to Greece and other debt-ridden European countries agreed to write off 50 per cent of their debt to these countries and thus providing great relief to them.


However, investors realised that bail-out package for Greece and other Euro countries facing sovereign debt crisis would only postpone the date of their being declared insolvent. As a result, investors not willing to take risk started selling the Greek bonds and Government bonds of other Euro countries and sending dollars to the US to invest there which they considered as quite safe. As a result, US dollar greatly appreciated and Euro greatly depreciated.

It is worth mentioning that some economists were of the view that adoption of harsh austerity measures by Greece and other European countries and therefore cutting public .expenditure and raising taxes as recommended by EU and IMF to solve their debt problem will not only hamper their recovery from the recession/slowdown following the global financial crisis (2002-07) but will also pose a risk to global economic recovery and growth and thus raising spectre of a double-dip recession, especially when the US in 2011 also faced a sovereign debt problem.

Barak Obama entered into a deal with the US Congress to raise the country’s debt ceiling and thus managed to avoid the default but the US economy was moving from bad to worse in 2011 and 2012 despite the quantitative easing (QE) policy pursued by the Federal Reserve.

In 2011 crisis seemed to be spreading to other European countries such as Spain, Ireland, Portugal, Italy, UK and even Hungary. The terrified investors exposed not only to Greek debt and its derivatives but also to the debts of other European countries. This resulted in great volatility in stock markets and foreign exchange markets throughout Europe, US and Asian countries. There was flight of capital from Greece and other European countries to the US in 2010 but in 2011, even the US was pushed into danger zone.


This caused a great turmoil in financial markets in Europe, US and even in Asia. If this financial turmoil continues, the global economy may again slip into recession. Reports were coming about the slow growth or near stagnation in not only large European countries but also of US. In France, the second-largest economy in the European Union after Germany, growth came to a standstill in 2010-11.

The growth in the United States also slowed down in 2010-11 and 2011-12. The second recession was already well under way in Greece and Portugal; growth in Spain, Italy and Britain was quite slow, domestic demand in Europe was weak and growth was dependent on sales from abroad, where signals indicated that they were shrinking.

According to a report in the week-end of Aug. 2011 there was 0.7% fall in industrial production in 17 nations of European Union (EU) in June 2011 compared with May 2011. With less economic growth, governments will collect less tax revenue. They will have more trouble in paying their debts.

That could make investors even more nervous and add to turmoil in the stock and bond markets, which will undercut business and consumer confidence, and will lead to yet slower growth, and ultimately recession. There is a real risk that there is a self-enforcing cycle under way here.


India did not escape from this new global crisis. The Indian exports to European countries and the US declined which adversely affected India’s industrial growth. The decline in India’s exports also brought about increase in current account deficit (CAD) to 4.2% of GDP in 2011-12 and further to around 5% GDP in 2012-13. Such a large current account deficit was unsustainable and was a matter of great concern. Besides, the large current account deficit in 2011 -12 and 2012-13 put pressure on the Indian rupee which sharply depreciated.

Eurozone Treaty:

Eurozone debt problem still remains unresolved threatening the breaking up of European union as well. In the first week of December 2011 European union summit was held in Berlin to make an attempt to solve Eurozone present debt crisis problem and to save Eurozone from splitting by preventing the future debt crisis.

At this summit a Eurozone treaty was forged to bring about a deeper integration in Eurozone. However, Britain was not a party to this treaty. In this treaty EU leaders agreed to lend up to $200 billion to an emergency lending facility of the IMF to help it aid Eurozone countries gripped by crises.

This is in addition to the 440 billion Euro for European Financial Stability Fund (EFSF) already established by European governments, and a permanent € 500 billion facility called the European Stability Mechanism which was to be established by June 2012.

This was in addition to the relief to Greece already provided by private banks in writing down and restructuring their loans up to 50%. Greek problem had not yet been solved that Spain, another important country of European Union, was gripped with a crisis in middle of the year 2012. Spain posed a bigger worry than Greece.


The Spanish government said that it would infuse 19 billion Euros into distressed real estate lender Bankia SA whose troubles had led to a run on Spanish institutions. Also the Bank of Spain warned that the country might sink deeper into a recession. Dealers were worried about Spain because it was a much larger economy and might prove more difficult to bail out by the larger economies of northern Europe.

These arrangements for bailing out stressed economies were expected to go a long way in dealing with the existing debt problem. But they do not deal with the fiscal problem that underlies the debt problem, namely, that most EU governments spend much more than the revenues they raise, especially in a variety of generous entitlement programmes of the welfare state.

Unless these governments conform to prudent fiscal rules that align their spending with their revenues, the sovereign debt problem will keep recurring. Hence the most significant achievement of the last EU summit was the agreement by all EU governments, except UK, to commit to a fiscal agreement.

While this was a major step forward, details of how this will work are yet to be worked out. However, an adverse development (in Mid-January 2012) has been the downgrading the Standard and Poor of rating of 9 EU countries which affected European Financial Stability Found (EFSE’s) credit worthiness and the available funds could fall short of needs again.

Standard and Poor downgraded the credit ratings of nine euro zone countries, while stripping France and Austria of their coveted triple-A status but not of EU paymaster Germany. Standard and Poor’s rating actions were primarily driven by its assessment that the policy initiatives that have been taken by European policy makers in recent weeks might be insufficient to fully address ongoing systemic stresses in the Eurozone. S&P cut the ratings of Italy, Spain, Portugal and Cyprus by two notches and the standing of France, Austria, Malta, Slovakia and Slovenia by one notch each. The move put highly, indebted Italy on the same BBB + level as Kazakhstan and pushed Portugal into junk status.

Crisis in Cyprus:

In March 2013, the important European country Cyprus faced with an acute debt burden problem. It may be noted that Cyprus has a large exposure to Greek debt and the second Greek bailout package in 2012 caused 56.9 billion hole in Cypriot budget. Now, because of its mounting debt burden it sought $ 13 billion from EU for its bail-out.


The EU asked the Cyprus government to raise funds of $ 5.8 billion itself before it sanctions its bailout. In order to raise these funds Cyprus government proposed a tax on deposits in its banks. This created a turmoil in stock and foreign exchange markets in the world as two thirds of $ 88.4 billion total deposits in banks of Cyprus was in foreign currency. However, the Cypriot Government said that Cyprus had no choice but to accept the EU’s bailout condition with levy on bank deposits or go bankrupt.

Cyprus is a routing centre for off share investment due to its low tax regime. Before these investments were to be transferred to other countries these investment funds were deposited in Cypriot banks. Imposition of tax on bank deposits, these investments were to be affected. The proposed tax on bank deposits set a dangerous precedent for countries needing to be bailed out, especially in the Eurozone area. Depositors’ savings were sacrosanct and tax on deposits sent a shiver across the entire Eurozone causing Euro to tumble and stock markets to dive.

As a good part of bank deposits in Cyprus amounting to $ 38 billion was Russian, the Russian President Putin opposed the tax on bank deposits describing it quite unfair and setting a dangerous president. Fortunately, the Cypriot parliament rejected its government proposal of imposing tax on bank deposits calling it as bank robbery. At the time of writing this piece Cyprus is pressing Russia to pump in funds to reduce its debt burden and to extend an existing 2.5 billion Russian loan.

It fellows from above that almost entire Eurozone is in crisis and in a state of stagnation and this Eurozone crisis has created uncertainty and risk which has prevented the investors from investing in bonds and shares of banks of this region. Besides, stagnation in European countries is responsible for slowdown in the Indian exports.

Cyprus Deal:

After a good deal of negotiations. Cyprus clinched a deal with international lenders to shut down its second-largest bank and inflict heavy losses on uninsured depositors, including wealthy Russians, in return for a Euro 10-billion ($13 billion) bailout plan.


The deal came hours before a deadline to avert a collapse of the banking system between President Nicos Anastasiades and heads of the European Union, the European Central Bank and the International Monetary Fund. Without a deal, Cyprus banking system would have collapsed and the country could have become the first to crash out of the European single currency (Euro).

Swiftly backed by euro zone finance ministers, the deal will spare the Cyprus a financial meltdown by winding down the largely state-owned Popular Bank of Cyprus, also known as Laiki, and shifting deposits below €100,000 to the Bank of Cyprus to create a “good bank”. Deposits above € 100,000 in both banks, which are not guaranteed under EU law will be frozen and used to pay Laiki’s debts and recapalise Bank of Cyprus through deposit/equity conversion. An EU spokesman said no tax on levy would be imposed on deposits in banks.

How did the Cyprus Crisis come about?

Cyprus, the smallest of the Eurozone economies, was a robust economy till about two years ago, characterized by relatively high economic growth, low levels of unemployment and healthy state of government finances. Cyprus accounts for a very small fraction of the Eurozone economy-about 0.2%.

But its banking sector is strongly linked to Greece, which itself has been hit by sovereign debt worries. Cypriot banks had given out loans to top Greek borrowers that had accounted for nearly 160% of Cyprus’s GDP. As the Greek economy ran into a crisis in 2010, it was the Cypriot banks that were among the hardest hit. A slowing economy also meant that the government did not have the adequate finances to bail out its banks.

Latest Change in Stance by EU and European Central Bank (ECB):

At long last there was a change in stance or thinking by EU and European Central Bank (ECB) in respect of solving the sovereign debt crisis. After the crises broke out in the late nineties in European countries such as Greece, Spain, Portugal, Italy, Ireland, EU and IMF joined together to bail them out of the crisis so as to keep the members within the union. For this purpose they imposed stringent austerity measures (cutting budget expenditure and raising taxes) so that they are able to pay back the loans taken.


The many debt-ridden countries like Greece, Ireland, Portugal, Spain and Italy were forced to accept these conditions in return for bailout loans to reassure the jittery bond markets that they would be able to repay the loans. Accordingly, they slashed their budget expenditure and raised more tax revenue to achieve surplus in their budgets.

However, for austerity measures they had to pay a heavy price as their economies landed in recession or slowdown in economic growth. The evidence grew that cutting government expenditure drastically and raising taxes were less effective in reducing deficits than initially thought and perhaps counter-productive. This is because as growth of the economies slowed down due to austerity measures, it made it difficult to raise enough tax revenue to balance the budget.

EU stance regarding the solution of sovereign debt problem changed in its summit meeting on March 14, 2013 at Brussels where they reviewed the austerity measures regarding their effectiveness in solving the sovereign debt problem. It was found that the unemployment in Eurozone reached a record level of 11.9 per cent (Average of 17 member countries of EU) and slowdown in economic growth in some of them and recession in others.

As a result, there was widespread discontent in European Countries such as Greece, Spain, Italy and Portugal which were forced to undertake austerity measures as a condition for their bailout by EU. In it’s submit at Brussels, leaders of EU agreed to relax the austerity conditions by postponing the budget cuts and higher deficit-cut targets by the debt-ridden European countries.

That is, the European Union slowed its enforcement of deficit limit until the region economy turned around. Accordingly, the countries like Greece and Spain which had been bailed out were given more time to repay the loans to the countries such as Germany. This means there was rescheduling of debt and thereby easing the pressures on then to cut budget deficits sharply through reducing government expenditure and raising taxes.

Thus due to recession that overtook the debt afflicted European Countries as a result of austerity measures financial leaders of EU and European Central Bank (ECB) realised their previous approach of strong austerity measures were wrong and now more emphasis was placed on reviving growth. This represents a clear shift from its earlier emphasis on stringent austerity measures to close budget deficits.

However, the new EU stance does not mean that countries have not to follow austerity measures but instead they only need more time to follow austerity measures that are needed to bring a country’s balanced budget in structural terms, that is, deficit excluding the effects of recession. And the EU commission has been asked to judge the performance of the debt-ridden countries in respect of their progress in reducing structural deficit. This provides the ailing countries more time to get their finances under control.

The change in recent stance of EU and European Central Bank implies that they have realised that their earlier stringent austerity measures imposed on their debt-ridden members did not deliver. As a result of these austerity measures Greece economy went into recession causing huge unemployment.

In Greece as a result of this recession unemployment shot up 27 per cent of labour force in January 2013. Portugal’s GDP dipped by 3.2 per cent in 2012 as its unemployment reached a record level of 17% of its labour force. Similarly, other European countries such as Spain, Ireland, Portugal, Italy experienced recessionary conditions as a result of adoption of austerity measures imposed by EU and IMF as a condition for their bailout. Prime Minister Mario Monty the supporter of austerity measures lost the elections in Italy held in February 2013.

Predictions by some economists, chiefly by Joseph Stiglitz that the austerity measures would harm growth and even bring about recession in the countries adopting them proved to be true. Austerity measures (cutting government expenditure) and raising taxes they argued would lower economic growth.

Not only would they lead to decrease in aggregate demand that adversely affect economic growth but lower growth would also mean loss of revenue for government which will make harder to close the budget gaps. Greece and Spain are running deficit more than their official target limit.

A growing number of European countries appear headed in the direction of less austerity no matter what the financial leaders EU decide because most people in their countries are opposed to the austerity policies of EU. Therefore, the new changed stance and rethinking about stringent austerity measures and therefore deciding in relaxing them would come as comfort to millions of Europeans, especially those living in countries that received bailouts, such as Greece, Ireland and Portugal. These countries remain un.der pressure to keep spending levels down and continue unpopular tax hikes even as they battle recession.

The Greek economy is in its sixth year of recession and the unemployment rate there has reached 27%. Portugal’s economy contracted 3.2% last year-its severest annual downturn since 1975—and its unemployment rate is at record 17.2%.

The rethinking about strict austerity measures was prompted by recession in Eurozone region which was expected to end in the second half of year 2013. However, Germany which played an important role in bailout of the debt-afflicted countries like Greece and Spain expressed reservation about relaxing austerity measures and decision of about postponing of budget cutting and deficit targets.

Germany’s Chancellor Angela Merkel said after the EU submit meeting that it was necessary to trim the budget deficits to promote growth and investment. But despite Germany’s reservations, EU in its summit meeting at Brussels in March 2013 decided about relaxing of austerity measures to overcome recession and revive growth in the region.

However, it seems this Eurozone treaty has failed to boost sentiments. Analysts are sceptical about long-term steps taken to overcome current crisis. Markets have considered it as too little and too late. Fall in capital inflows caused a crash in the Indian stock market and led to the sharp depreciation of the Indian rupee. EU’s agreement to sign treaty to foster deeper economic integration is definitely the route to take for the longer term but it is unclear how this would unfold in the short term.

However, if austerity measures become too stringent it could impact the global economy including India. A week Europe is a reality for at least the middle of the year 2014, though EU leaders have agreed on a treaty. That apart, a lot would depend on the manner of execution of this agreement.

Impact on India:

European debt crisis and fragile US recovery have contributed to the growth slowdown of the Indian economy by hurting our exports and affecting capital inflows into India. The capital outflows have resulted in crash in our stock markets that have affected investment sentiments of the corporate world.

The rupee’s depreciation, while aggravated by domestic speculative activity, is primarily traceable to the ongoing sovereign debt crisis in Europe. The value of rupee which was around 44.50 rupees to a US dollar in August 2011 fell to as low as 54 rupees to a dollar on December 15, 2011 and was around Rs. 54.8 to a US dollar in the first week of April 2013.

As observed during the crisis of 2008, the present crisis has again led to a large withdrawal of FII money from the Indian stock market, eroding its value. This large withdrawal of portfolio investments from India also led to the depreciation of the rupee.

The slowdown in GDP growth to 6.2 per cent in 2011-12 and 5 per cent in 2012-13 was partly due to Eurozone crisis. Eurozone debt crisis put a damper on India’s exports to Europe, the biggest destination for Indian exports as well as capital inflows into the Indian equity and debt markets. The government blamed European crisis as important reason for India’s slowdown in economic growth in recent years.

However, we think that current slowdown in economic growth is partly a result as pointed out above, of Eurozone debt crisis and overall global environment, especially slow recovery in the United States and stagnation in the European countries. Besides, increase in interest rates by RBI to fight inflation has led the corporate sector to defer investment has resulted in the drastic fall in output of capital goods.

However, in our view, the Indian economy will soon recover once these short-run problems are resolved. Once inflation is brought under control RBI will cut its interest rates which will give a push to investment that will boost industrial growth. If investment in infrastructure increases, as is expected now, this will lead to the expansion in domestic demand for capital goods.

This will ensure a higher growth rate in the next year, 2013-14. Besides, we still have the ability to achieve 8% per cent growth rate even on the basis of our domestic market. This is because, we still, on the supply side, have the fundamentals for higher growth rate.

These are high saving and investment rates which even in the year (2013-14) are around 30 per cent and 32 per cent respectively. However, to ensure higher growth in the next few years productivity of capital has to be raised through better governance and speedy implementation of stalled infrastructure products.