The Greek debt crisis

Greece’s economic reforms, which led to it abandoning the drachma as its currency in favour of the euro in 2002, made it easier for the country to borrow money.
Greece went on a big, debt-funded spending spree, including paying for high-profile projects such as the 2004 Athens Olympics, which went well over its budget.
The country was hit by the downturn, which meant it had to spend more on benefits and received less in taxes. There were also doubts about the accuracy of its economic statistics.
Greece’s economic problems meant lenders started charging higher interest rates to lend it money. Widespread tax evasion also hit the government’s coffers.
There have been demonstrations against the government’s austerity measures to deal with its debt, such as cuts to public sector pay and pensions, reduced benefits and increased taxes.
In July 2011, Eurozone leaders and the IMF agreed to lend Greece 109bn euros ($155bn, £96.3bn) – a year after it was granted access to a 110bn euro rescue package.
Eurozone ministers were worried that if Greece was to default there would be a risk of contagion to other economies. They hope the package will resolve Greece’s debt crisis and shore up the euro.

Q&A: How Greek crisis affects UK

Greece and its huge debts have weighed on the eurozone for more than a year.

The country has been bailed out twice – and investors still fear a default.

In October, the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF) said they had reached a new agreement with Greece on reforms to put the nation back on track.

The three-point plan included expanding the single currency’s bailout fund to 1tn euros, banks being forced raise more capital to protect themselves against losses resulting from any future defaults, and some banks accepting a loss of 50% on their Greek debt.

This was soon after thrown into doubt by the Greek prime minister’s announcement of a referendum on the EU’s efforts to bail out its stricken economy.

That issue has now been put to bed, but fears over Greece and whether it might be forced to leave the eurozone persist.

Why is Greece in trouble?

Greece has been living beyond its means since even before it joined the euro, and its rising level of debt has placed a huge strain on the country’s economy.

The Greek government borrowed heavily and went on something of a spending spree after it adopted the euro.

Public spending soared and public sector wages practically doubled in the past decade. It has more than 340bn euros of debt – for a country of 11 million people.

However, as the money flowed out of the government’s coffers, tax income was hit because of widespread tax evasion.

When the global financial downturn hit, Greece was ill-prepared to cope.

It was given 110bn euros of bailout loans in May 2010 to help it get through the crisis – and then in July 2011, it was earmarked to receive another 109bn euros.

But that still was not considered enough. Another summit was called in October in Brussels to solve the crisis once and for all.

There has been much public opposition to the austerity programme
Why did the crisis not end with the Greek bailout?

The aim of the original Greece bailout was to contain the crisis.

That did not happen. Both Portugal and the Irish Republic needed a bailout too because of their debts.

Then Greece needed a second bailout, worth 109bn euros.

In July this year, eurozone leaders proposed a plan that would see private lenders to Greece writing off about 20% of the money they originally lent.

But bond yields continued to rise on Spanish and Italian debt – leading to fears that their huge economies will need to be bailed out too.

The failure of Franco-Belgian lender Dexia also added to woes – French and German banks are large holders of Greek debt.

The eurozone rescue fund – the European Financial Stability Facility – was 440bn euros, nowhere near big enough to deal with that scenario.

And so, in October, the eurozone agreed to expand the EFSF to 1tn euros and got banks to agree to a 50% “haircut” on their Greek holdings.

But then Greece’s Prime Minister George Papandreou shocked European leaders by calling a referendum on the bailout package.

That led the leaders of Germany and France, as well as the IMF, to declare that Athens would not receive its next tranche of emergency aid until the referendum had passed.

Mr Papandreou, amid much confusion over his position, has backed down over the referendum and it appears the new deal will take effect.

But the question of Greece leaving the euro was raised for the first time by angry eurozone leaders in the days that followed.

What would happen if Greece defaulted?

Strictly speaking, a default occurs when a borrower has broken the terms of a loan or other debt, for example if a borrower misses a payment. The term is also loosely used to mean any situation that makes clear that a borrower can no longer repay its debts in full, such as bankruptcy or a debt restructuring.
A default can have a number of important implications. If a borrower is in default on any one debt, then all of its lenders may be able to demand that the borrower immediately repay them. Lenders may also be required to write off their losses on the loans they have made.
Europe’s banks are big holders of Greek debt, with perhaps $50bn-$60bn outstanding. An “orderly” default could mean a substantial part of this debt being rescheduled so that repayments are pushed back decades. A “disorderly” default could mean much of this debt not being repaid – ever.

Either way, it would be extremely painful for banks and bondholders.

What’s more, Greek banks are exposed to the sovereign debts of their country. They would need new capital, and it is likely some would need nationalising. A crisis of confidence could spark a run on the banks as people withdrew their money, making the problem worse.

A Greek exit from the euro is seen by some as inevitable if the country defaulted. The big question would then be, what about other heavily-indebted nations in the eurozone?

It might be a repeat of the collapse of Lehman Brothers, which sparked the credit crunch that pushed Europe and the US into recession.

What does all this mean to the UK?

According to figures from the Bank for International Settlements, UK banks hold a relatively small $3.4bn worth of Greek sovereign debt, compared with banks in Germany, which hold $22.6bn, and France, which hold $15bn.

When you add in other forms of Greek debt, such as lending to private banks, those figures rise to $14.6bn for the UK, $34bn for Germany and $56.7bn for France.

However, any knock-on from Greece’s troubles would exacerbate the UK’s exposure to Irish debt, which is larger.

The UK’s direct contribution to any Greek bailout is limited to its participation as an IMF member. But the indirect effect of a Greek default on the UK would be incalculable.

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