Debt Crisis in Europe

The PIIGS Sovereign-Debt Crisis

Ayman Kamal Moawad

Professor Hussein Soudi

International Finance

German University of Cairo

24 April 2011

Abstract

The PIIGS crisis has raised fears about the possible negative implications it poses to the world economy. Doubts have risen about the integrity of the European Union and its currency. The five countries faced their own strand of fiscal distress due to heavy borrowing practices, property bubbles and living above their means. What intensifies the problem is the inability of those nations to exercise their own monetary policy, but all have the euro as a common currency, if they have their own currencies they would have devalued it price to simulate their economy through more competitive export and would lessen the tough fiscal austerity measures required. The short term solution lies in providing a bailout loans to the troubled economies to solve budget deficit, but this is consider a reactive approach and will not be solving the core of the problem. The long term solution is to increase growth, improve productivity, reduce unemployment, increase competiveness and enhance their export capabilities. ?

Table of Contents

I. Introduction 4

II. Origins of the Crisis 6

A. Greece 7

B. Ireland 9

C. Portugal 10

D. Spain 11

E. Italy 12

III. European Union Response 13

IV. Possible Alternatives & Solutions 15

A. Debt Restructuring 15

B. Follow Britain Austerity Measures 15

C. Use of Foreign Investment 16

D. European Monetary Fund (EMF) 16

E. Exit from the European Monetary Union 16

V. Conclusion 17

VI. References 18

VII Bibliography 18

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I. Introduction

Due to the economic recession which started in 2008, several members of the European Union became historically known as PIIGS. These states include Portugal, Italy, Ireland, Greece and Spain and if combined together, they form the acronym PIIGS. The reason why these countries were grouped together is the substantial instability of their economies, which was an evident problem in 2009.

The PIIGS' fiscally troubled economies have triggered a severe crisis of confidence as well as the widening of bond yield spreads see Fig 1.These five — Portugal, Italy, Ireland, Greece, and Spain share a number of attributes high government (i.e. sovereign) debt, high unemployment, and weaker GDP growth — in short, troubling ingredients that could lead to a potential default on bond payments by their governments.

Fig 1 PIIGS bond yield spread compared to Germany

It isn't just high debt levels that have focused attention on these five; it's all about investor confidence in the countries, and how likely the world perceives they are to continue making regular interest payments on their government bonds. As far as the PIIGS countries are concerned, the rising of government deficits and debt levels as well as the downgrading of European government debt raised an alarm across the whole financial market.

Debt held by a nation's own citizens has less destructive consequences as the interest paid is returned to the domestic economy. External debt, if used to finance non-productive expenditure, is a different matter. Non-residents receive the interest on such debt, making the nation poorer with every interest payment. The PIGS's problem is that a significant share of their debt is external (see Table 1). (Cabral, 2010)

Table 1. Government debt, external debt, and Internal Investment Position at year-end 2009