Finance Management
Author:
Genre: Finance

ii. Why are economic commentators and other member nations of the EU worried about these nations?  Discuss the causes and consequences of increased sovereign risk associated with these three countries.

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Finance Management

Question-1

(ii)

The economic commentators and other member states of EU are worried about these nations because these three nations (Greece, Italy and Spain) are facing a debt crisis which means that they are facing a situation of not being able to repay the debt that these countries have taken. This will lead to these countries entering recession and its effect will reach the other European countries as well and they might also face similar problem. Causes and consequences of debt crisis faced by these countries are described below-

  • Greece- The country entered the Eurozone in 2001 with all the Convergence Criteria met by the country. However it was later revealed that the economic data provided by the government was manipulated and it never met the convergence criteria. The government deficit was higher than 3% and the Debt/GDP ratio was also higher than 0.6. As the economy was doing well before the debt crisis and the country had a socialist fabric, the government was lavish in its expenditures and spent lot of money. The government could do it because of the incoming funds from abroad for investments. But after the global financial crisis came up, the inflow of funds from abroad stopped and the government realized that its revenues are not enough to meet its expenditures and to repay the debt it has accumulated (European Council, 2010). Consequences of this situation were that the cost of borrowing in the country increased as the rating agencies around the world started reducing the credit worthiness of Greece economy. This also led to panic in Europe as the economists felt that debt crisis can spread to other countries as well.
  • Spain- The country had managed its finances nicely before the debt crisis. When the government realized that its deficits were high in 2009, it took austerity steps to reduce it which brought the sovereign debt in control. But due to burs of housing bubble and bailout required by the private banks made the country’s debt go up significantly. The bailout went straight to the private banks and thus it didn’t increase the sovereign debt but still it increased the national debt to 90% of GDP. The consequences of bailout package and the increased national debt were that they made Spain also a concern for investors across the world and the cost of borrowing increased significantly for the country. The interest rate for 10 year bonds even touched 7.7% in July 2012 due to this grim situation. This situation will further lead to country entering recession as the growth rate will decline due to high interest rates and the recession spreading to other Euro countries. (Schauble, 2011)
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