Context

Leaders of the sixteen EU member states have finally given the go ahead to an 110bn euro loan to Greece with the intention of preventing its debt crisis from spreading any further. This three-year loan comes with a condition that Greece should cut back on its public spending. The EU leaders have also put forward recommendations for a European Stabilization Mechanism to promote financial stability.

Furthermore, the EU leaders affirmed their commitment to speed up deficit reduction. They also decided to tighten EU’s budget policies, supervise deficits and competitiveness and use all the available means to bring stability to the region.

The package consists of strong measures to reduce public spending and raise the government’s revenue. Greece will be required to reduce wages and pensions, increase Value Added Tax (VAT) by 2% from the current 21% and raise taxes on tobacco, alcohol and fuel by at least 10%. The IMF had imposed a similar VAT requirement on Pakistan when it approved an emergency package worth $7.6bn dollars in November 2008 to prevent a balance of payments crisis.

Analysis

This financial assistance comes at a time when fears of Greece debt crisis threatening the continuance of the Euro as the combined currency of the EU are widespread. It is being hoped that the bail out will help mitigate fears of the crisis spreading from one indebted country of the EU to another.

The efforts for political union between the European countries gained momentum at the closing stages of the Cold War. The French were afraid of the prospect of a reunited Germany dominating Europe once more. In response, France engaged Germany in the process of the European building through the formation of a single currency for the region. The government of Germany accepted this wholeheartedly in exchange for the promise of more serious attempts towards political union between the European countries.

The introduction of the Euro and the establishment of the Eurozone was a major milestone in the history of Europe. The debt crisis in Greece is threatening to be a crucial setback or even a reversal of Europe’s unification process. This crisis is the consequence of a EU country spending extensively and mounting up its deficits, and therefore facing the likelihood of not being able to pay back its debts. It was then forced to plead to the EU member states to provide assistance with the repayment.

Europe’s PIGS (Portugal, Italy, Greece and Spain) had been extraordinarily extravagant in their spending and consumption levels, and hence have accumulated massive debts. Germany, on the other hand, has the highest rate of savings in Europe. Being the strongest economy in the EU, Germany is considered the most significant rescuer for Greece and other countries. However, the majority of the German public was strongly opposed to the German government and EU providing assistance to Greece to help steer itself out of crisis.

The main reason why this bail out was approved was the fear that if the Greek government can’t pay back its debt, it will definitely pave the way for a new wave of global financial meltdown, and will result in the remaining three PIGS countries to follow Greece’s trend. As the debt crisis in Greece intensifies, it has become commonplace to argue that the subsequent chain reactions will ultimately lead to the end of EU and reversal back to nationalism and protectionism.

IMF and Greece

The IMF has approved a 30bn euro three-year loan for Greece as part of a joint EU-IMF 110bn euro bail out package. The package consists of strong measures to reduce public spending and raise the government’s revenue. Greece will be required to reduce wages and pensions, increase Value Added Tax (VAT) by 2% from the current 21% and raise taxes on tobacco, alcohol and fuel by at least 10%. The package is designed to help the government reduce its deficit to below 3% by 2010 (from 13.6% in 2009) and put debt-to-GDP ratio on a downhill trajectory.

The IMF had imposed a similar VAT requirement on Pakistan when it approved an emergency package worth $7.6bn dollars in November 2008 to prevent a balance of payments crisis. The loan was subsequently increased to $11.3bn in July 2009. Pakistan received a third installment of $1.2bn in August last year, bringing the total payment to $5.148bn.

The Federal Board Of Revenue of Pakistan, which is in charge of tax collection, has proposed a VAT of 15%. Critics were quick to point out that the proposed VAT will add to inflation, reduce people’s spending power and slow down demand in a country that is already gripped with 13% annual rate of inflation and severe power shortages.

Likely impact of the EU crisis on Pakistan

The EU accounts for about 20% of Pakistan’s external trade. The Pakistani exports to the EU (mostly textile and clothing) amounted to 3.3 billion euros in 2008 and the EU exports to Pakistan (mostly machinery, and pharmaceutical and chemical products) amounted to 4.3 billion euros in the same year. The composition of Pakistani exports (and imports) to EU countries is shown in the linked graph.

As we can see from the linked table, Pakistan has been running trade imbalances with the EU for the last few years. This recent financial crisis is likely to further widen the country’s trade deficit. Pakistan is heavily relying on textile and clothing, which account for most of the country’s exports. In periods of crisis, people are less likely to spend on these products as much as they spend on necessities, particularly at a time when the customer confidence is at an all time low. The value of the Euro has fallen due to the fear that countries like Spain and Portugal could face similar crisis, which is likely to make imported products to Europe more expensive.

Pakistan has to change its over-reliance on textile and clothing if it is to improve its trade imbalances. High costs of production also get in the way of efforts to increase exports, making Pakistani products less competitive in international markets. To mention just one example, electricity tariffs in Pakistan are the highest in the world, which has a wide-ranging effect on the cost of production.

Tell Us What You Think

Feedback@politact.com

The post The Bailout for Greece and Implications for EU and Pakistan appeared first on Politact.

Context

Governments across the world greeted the second decade of the 21st century, wishing that the economic crisis of the last decade will become a tale of the past and the economic recovery could finally become a reality. Greece is the latest problem child for Europe. The current financial crisis in Greece can be attributed to immense spending in the past and the country’s social programs. The country’s total debt accounts for 115.1% of the GDP. What it precisely means is that Greece will never be able to fully pay off its debt unless some adjustment is made to the amount owed.

In addition to this, the country has an annual budget deficit of 13.6%, which surpasses the Eurozone maximum of 3% by a long way. This shows that not only did Greece spend a great deal in the past but the massive interest payments also prevented her from making progress.

Analysis

A government would normally try to borrow money by putting up its bonds for sale, in order to be able to finance its current debts whilst cutting on spending. However, it’s rather unfortunate for Greece that nobody wants to purchase the bonds due to the high risks involved. In other words, investors are looking for a very high rate of return if they are to invest in Greece bonds.

Both the Eurozone countries of the EU and the IMF have been attempting to help bail out Greece. The problem would’ve been easy to tackle had Greece been the only country in need of a bail out. There is a widespread fear of the Eurozone facing a domino effect, especially countries like Italy, Portugal, Ireland and Spain. The biggest cause of concern is Spain with an economy that is five times that of Greece. If Spain defaults, the whole of EU and eventually the entire world will be influenced.

In view of this situation, bail out appeared inevitable. Recommendations presented by the EU and the IMF entailed a three-year debt bail out plan valued at around 45bn euros in the first year, with a concessionary rate of interest of about 5%. The Eurozone would contribute around 30bn euros, with 8.4bn euros coming from Germany this year and up to 16.8bn euros by 2012.

This package was put forward prior to the summit on the Greece debt crisis. The public in Germany, the country which was supposed to be the largest contributor to the package, strongly opposed this proposal. Fingers were immediately pointed at the immensity of this amount, which is around 2bn euros more than the German family ministry’s annual budget.

As a result, the German government put forward a proposal at the summit that focused on preventing a bail out for the Greek economy. The German delegation provided assurance to the Greece government on precondition that it pays out punitive interest rates for the settlement of its debt, whilst clarifying that any aid would only be provided as a last option. In other words, what Germany meant was that Europe would not proffer Greece any more sympathetic conditions than those presently offered on the global financial markets.

What Germany was trying to achieve through these unsympathetic terms was to pressurize the Greece government to pursue its policy of massive spending cuts so as to convince the banks to provide credit to Greece at more favorable terms. In addition, Germany also wanted to make it clear to other heavily indebted countries of Europe not to expect easy payment from Brussels.

The crisis developing in the financial system of Greece is being seen as a continent-wide emergency as members recognize that there is no chance of the European Central Bank or the EU itself to lend a hand. The crisis is threatening to spread beyond Europe and into the countries of South Asia. The dependence of South Asian countries on trade is likely to make them vulnerable to the sharp decline in demand from the European economies. The Greek debt crisis is expected to further undermine the already declining investment flows into the developing economies of South Asia, intensifying the problems of some of the most fragile countries of the region.

Pakistan and the EU have traditionally enjoyed strong and cooperative trade ties, with the EU being Pakistan’s most significant trade partner. Pakistan has been pushing for preferred market access to Europe as the country’s integration into the global economy is vital for the its economic well being as well as for tackling extremist in the long run.

Pakistan has enjoyed very close relations with Germany over the decades. The bilateral trade between the two countries is growing steadily and both regularly share their thoughts on all the global matters of concern and support each other at the international level. Germany has always supported Pakistan by all possible means in her attempts to acquire access to the European markets.

Pakistan’s economy and trade have already been hit hard because of its leading role in the war against terror. Now this latest crisis in the EU could further worsen the situation for Pakistan. If people fear that Greece could go bankrupt, they will fear that Portugal and other countries will also go bankrupt. Once people get scared, they get scared about everything. This fear and lack of confidence will naturally lead to a fall in consumer demand. The EU is a vital export market for Pakistan and producers are relying on sending more goods to Europe.

This latest crisis can also influence the EU’s commitment to the war on terror. It might become extremely difficult to pay inducements to allies and tribesmen. The EU’s involvement in Iraq and Afghanistan will be viewed from the economic viewpoint, and more European taxpayers will support withdrawal. Hence, coalition partners are likely to opt for an early troop pull out in order to steer their home economies out of crisis.

Tell Us What You Think

Feedback@politact.com

The post The Greek Crisis and the Impact on the Af-Pak Theater appeared first on Politact.