European sovereign debt crisis

Abstract

The crisis that developed in Greece in April this year brought the critical issue of sovereign debt accumulated by the European countries back in prime focus. Although the Greece problem has been temporarily patched by a 110 billion euro rescue package, the state of other countries particularly Portugal, Italy, Ireland and Spain is not looking that good. The debt situation in Ireland had caused huge concerns as recent as last week. The situation is ominous as once a country is caught in a debt trap, its bond ratings are downgraded leading to higher borrowing costs and hence additional difficulty to recover from the crisis. This crisis is not limited to just a few nations but has the capability to damage the entire euro zone. The future of euro is in the balance and the response of the bigger economies like Germany and France are not boosting confidence. The impact of the crisis was felt not only in the European region but also in countries which has trade relations with them. An ultimatum has been given to many of the euro zone nations to reduce the fiscal deficit levels. Many of the nations have taken up austerity measures in this regard. The commitment and chance of success of these measures is now anybody’s guess. Another puzzling question is whether it is the right step currently to tighten fiscal stimulus in a world that is just coming out of a major recession. If more countries demonstrate high risk of default, that will be a severe blow to the survival of the euro. One option of rescuing a defaulting country is to devalue the currency and that is not possible as long as euro exists as a common currency. This crisis has posed a large number of questions which are yet to be answered. It has made the policy makers wonder about the right direction while framing monetary and fiscal policies and about regulating financial institutions. The decisions to make about the fiscal tightening, rescue package, future of euro has to be evaluated after analyzing the plenty of consequences that can occur in each case. Its impact on developing countries like India which has strong trade relations with the euro zone also has to be studied. At the manager level it is always necessary to be aware and be prepared of the possibilities that can develop in the euro zone. We were motivated to do this research considering the current relevance and criticality of the above questions. Further this topic is of mutual interest to India and France and hence was an ideal topic of study for the HEC IIMB Exchange Programme.