Greek Debt Crisis - Case Study Example

GREEK DEBT CRISIS University’s Name Submitted by (your name) Subject Tutor Date of submission GREEK DEBT CRISIS Country risk refers to the risk of investing in a country which is dependent on the changes on business environment which may lead to reduction in the value of assets in a particular country; it may also reduce the operating profits of companies or investors in general. Country risk analysis assesses the potential risks and rewards associated with making investments and doing business in a country. Some of the factors that may increase the riskiness of a country may include currency controls, devaluation changes and political instability indicated by mass riots, civil war and other effects of government’s instability. The underdeveloped countries face various financial situations that are out of their capability. These situations call demanded that these countries’ finance divisions to make arrangements meant to obtain the money that they so desperately need. The most common approach that they apply is borrowing from the international financial institutions operating in the countries. The loans agreed upon by the two parties involved, and they have to fulfill the requirements that they place. The countries more often than not fail in making timely payments. This makes the market players to go into frenzy since the stability of the international finance institutions is in a status of jeopardy. This paper attempts to look at the occurrence of these situations which is the country conflict in relation to Greece. In addition, the paper looks at the international lending and the essential dilemmas caused by international lending to sovereign debtors. The paper also attempts to correlate the debt crisis situation in Greece and theory of country risk while drawing practical examples from Greece and other countries. Identifying the genesis of the debt crisis in Greece is paramount to discussing the country risk posed to the potential and already existing investors in the country. The country is the poorest among the one that make up the euro zone and this poses a question on how the country gained access to the Euro zone. This was simply by not indicating the real debt situation in the country. Misrepresentation of information concerning the debt situation seemed like the right thing to do at that point in time as that was when the country had an interest of joining the trading block (Wagner, 2012). Evaluate the risk of investing in Greece The Greek Economy has in the recent past been faced with great debt crisis, It’s among the European sovereign-debt crises (Haidar, 2012). Recent research (Higgins, Mathew 2011 and George Matlock 2010) shows that in the late 2009, investors developed much fear of sovereign debt crisis with regard to Greece’s ability to meet its debt obligations. This was due to the increased government debt levels. As a result of this reluctance by investors to invest in the country, it led to a crisis of confidence indicated by a widening of bond yield spreads and cost of risk insurance on credit defaults swaps as compared to other countries in the Euro zone especially Germany (Financial mirror.com and Financial Times, 2010) There are several indicators that show a country’s risk of investment; • Substantial government expenditures yielding low rates of return, • A high rate of money expansion especially when combined with a relatively fixed exchange rate, • A political system that accepts the citizens to demand the government responsibility for maintaining and expanding the nation’s standard of living through the public sector spending and regulations, • Vast state owned firms run for the benefit of their managers and workers, • Barriers to the smooth adjustment of the economy to changing relative prices through price control, interest rates ceilings and trade restrictions. In 2009 investors became suspicious of a sovereign debt crisis. This was due to the Government’s inability to manage its debt standards. The government’s debt created much concern to investors in the financial market because these bonds were very expensive.In April 2010, the Greek government debt went to a junk bond status; this is a high yield bond which has a lower credit rating level compared to other bonds e.g. treasury bonds. As a result, private capital markets were no longer available for Greece as a financing source. Euro zone leaders agreed that all private creditors holding Greek government bonds should sign a deal to accept lower interest rates and a 53.5% face value loss. This would reduce the public debt by a margin of 110 billion Euros. On May 2010 Euro zone countries and International Monetary Fund (IMF) agreed to give $110 billion loan to Greece on the following conditions; Privatization of Government Assets. Implementation of structural reforms. Put in place some measures for restoration of fiscal balance. The above conditions were not met by the Greek government because of the recession in the economy hence more time was required. There was also restructuring of Greek public debt held by private creditors. In the first week of this month, the legislation passed the conditional labor market reform and midterm fiscal plan 2013-16 despite opposition from other quarters. The government passed the bill on the Fiscal Budget for 2013.The Troika Surveillance report was finally released in this month. The report gives the results for the Greek Economy, reforms, privatization Program and debt sustainability. The Euro group met this work to discuss on the extra bailout and debt structure whereby the debt structure was confirmed by the European Commission official Autumn Economic forecast 2012, and it stated that if no new extra debt restructures then the debt-to-GDP will rise from 177% to 1887% in 2013. The Government’s political stability has a great impact in determining the risk of a particular country; this was manifested in the Greek government where in the mid-May 2012 the crisis and difficulty in forming a new coalition government after elections, led to strong speculation Greece would have to leave the Euro zone this view was supported by Xypolia llia in the London progressive journal (June 2012). This led to a high level of political risk due to the complications businesses and governments face resulting from political decisions; as a result portfolio investors are exposed to financial losses and change of perception. These indicators show the level of risk that potential investors are exposed to in their desired interest in committing their funds to invest in Greece. Investing in Greece poses a lot of risks as per current standings. This happens despite various mitigating actions taken both by the countries outside the euro zone and the ones in the zone. Most of the indicators that the investors seek in making decisions about international investments are negative in Greece. The country went on a spending spree immediately after joining the trading block. The money spent came from loans in form international financiers. These financiers are mainly from Germany and France. This, however, does not mean that the international finance institutions based in the two countries are the only ones affected by the debt crisis in Greece. Britain and Belgium are also having problems. The above named situations make investing in Greece a tricky affair (Carbaugh, 2010). Relative size of the government as an indicator of country risk is low. Whereby, the size of the government is the percentage of debt relative to the country’s GDP. The government size in Greece was 13.6% in 2006. This was the highest at that point. The country has also acquired delay tactics in order to buy time for the repayment of loans. Athens opted to borrow money from the ECB and the IMF. This is unorthodox since the debt did not reduce by any significant margin. The relative size of government still stands at the initial state despite the measure (Wagner, 2012). Athens also indulged in investing activities that did not meet the threshold to attract substantial returns. The government opted to indulge in construction of roads which by itself is a smart move, but failed in making backing up the resources by significant tax collection. These made the government lack money used in paying the creditors. It also increased risk of defaulting. The Greek government also embarked on ambitious welfare activities which were over ambitious to the financial situation of the country. These indicators of country risk are so high that a potential investor can have qualms when investing in Greece (Wagner, 2012). How could a company reduce exposure to host government takeover However attractive investing in a foreign country might be due to the available economic projection, investing there might prove to be financially disastrous if the host government inflicts financial penalties on a company or if unfavorable events takes place in the political dome. The most severe of all country risk is that of the host government takeover. The host government being the sovereign in the country of operation may hurt any of the multinational companies in many ways. These ways could be direct or indirect. The direct ways that a host government can use is by enforcement of various forms of restrictions to the company operating in the country (Carbaugh, 2010). These restrictions are imposing of requirements of the company that are not applicable to other companies that have a local basis or inclination. The host government may impose restrictions on funds transfers between the company and the host country. The government may also resort to heavy funding or extension of subsidies and other incentives to locally based companies. The multinationals may be hurt by the host government when it does away with the requirements that ensure fair play. These could be in for of avoidance of the restrictions pertaining to copyrighted materials and patents (Wagner, 2012). Changes in government as seen in the recently concluded election in Greece result in changes in policy towards foreign investors; either favorable or unfavorable. They can discourage foreign investors through imposing restrictions such as import quotas. An investor will be able to adapt export marketing strategies accordingly as a reaction to the new laws. However, the above risks are not the most endangering to a multinational company. There is always the possibility of the government taking over a multinational from the original owners. This reality calls for stringent application of measures aimed at avoiding this possibility. The measures that can be adopted by a multinational include use of a short term horizon or goals. The goal of this approach is to strive towards recovery of cash flows quickly (Wagner, 2012). An investor will be able to get some relief by purchasing insurance against country risks; a good example is the Overseas Private Investment Corporation (OPIC) of the US government that covers risk of expropriation. Most developed countries have investment guarantee programmes that partly insure the risks of host country government takeovers, wars or blockage of fund transfers. However, a subsidiary must weigh the benefits if the insurance against the cost of the policy’s premium, While the insurance may reduce the risk at a cost, it does not by itself prevent losses arising from host country risk factors (Madura, 1995). Another way is for the company to invest in a project with a shorter payback period (still with a positive Net Present Value [NPV]); this will be of great benefit in the event of expropriation since losses are minimized. A company will have gone a step further in reducing risk in the foreign country by adopting a unique technology or exclusive supplies. This will prove difficult for the host government to take over the operations of the subsidiary due to its exceptional products or technology. The local labour in the host country may exert much pressure on the government especially if there is a high unemployment rate. To reduce this pressure, the company may opt to hire local residents, this will ease the strain. The local banks on the other hand are important stakeholders in the financial sector, hence are valued by the government. An investing company can borrow from these banks hence become their immediate clients. Such a move will reduce the local banks pressure on the government. Apply the use of a short term horizon - in this technique the recovery of cash flow quickly is concentrated on. When the perceived risk is higher, then the discount rate that should be applied to the project’s cash flow should also be higher. By estimating how the cash flows could be affected by each form of risk, the probability distribution of the net present value of the project can be determined. The investing company will reduce the risk of host government takeover by involving the local stakeholders in their operations, this goes a long way in reducing complains targeted on the government. In addition, the company may resort to the use of unique and complicated supplies technology. By use of this approach, the subsidiary is safer from a takeover since the host government may not be in a position of operating the company even after the takeover (Carbaugh, 2010). The subsidiary company may also hire local labor. This serves as a safeguard to the subsidiary company since the employees can put pressure on the government not to pursue the company for a takeover. The company may borrow local funds to avoid a takeover since the banks could apply pressure on government in case of a takeover. Other strategies that can be applied by the company are the use of project finance and taking of local insurance (Carbaugh, 2010). Conclusion In conclusion, Greece’s poor commercial environment is a serious worry to investors as credit risk is extremely high. Because of its financial state, there is a chance that it will pull out of the Eurozone. Greece’s gross domestic product is also observed to have remained static without indicators of growth since 2008. Investors would not be happy and willing to pump their investment in a sinking hence the threat of choosing othe r blocs compared to Greece. This is explained by the loss of depositors’ trust by the National Bank of Greece (NYS:NBG) and the rising unemployment crisis in the country. Internal and external battles, or even the threat of war, can have devastating effects on investors’ choice of Greece as an investment destination. Bureaucracy in Greece’s government processes and registration procedure can complicate investors’ decisions to settle at Greece as an investment hub. Corruption and poor governance can increase the cost of conducting business in Greece. If investors attain reduced profits or revenues from their investments they tend to look for alternative investment elsewhere. References Carbaugh, R. (2010) International Economics. New York: Cengage Learning, p.319-330. Haidar, J; 2012: Sovereign credit risk in euro zone. Vol 13. Higgins, M; Klitgaard, T; 2011: Saving imbalances and the Euro area sovereign debt crisis. Wagner, D. (2012) Managing Country Risk: A Practitioner's Guide to Effective Cross-Border Risk. London: CRC Press, p.42-100. Matlock, G; 2010: peripheral euro zone government spread widens. Xypolia, llia; June 2012: “sory folks the wake is over”, London progressive journal. Alice COUNTRY RISK IN GREECE Country Risk Theory The country risk theory analyses the nature of credit relations between developed and developing counties thus making use of recent advances in the economy. It is concerned with the roles of of borrowers, lenders and of various public authorities who mediate between the two groups. Country Risk refers to a collection of risks associated with investing in a foreign country and they vary from country to country with some countries having high enough risk to discourage much foreign investment thus reducing the expected return. The causes of country risk include; polical, macroeconomic mismanagement, war or labour unrest which result in work stoppages. &nb sp; Political changes may come about due to a change in leadership,control by a rulling party or war. Institution of new economic policies may result in expropriation of assets, nationalisation of private companies,currency controls, innability to expatriate profits and high taxes and tarrifs. Countries may also pursue unsound monetary policy resulting in inflation, recession, higher interest rate sand shortages in hard currency reserves on a macroeconomic level. Furthermore, sovereign risk is a subject of risk specifically related to the government or one of its agencies refusing to comply with terms of loan agreement. The importance of country risk • Used to monitor countries where the investors are thriving in doing business, • as a measurement tool to avoid conducting business in countries with excessive risk or losses, and • Country risk analysis can help investors in making long-term investment or financing decisions. Key indicators of country risk There are several indicators that show a country’s risk of investment. They include; • A substantial government expenditures yielding low rates of return, • A high rate of money expansion especially when combined with a relatively fixed exchange rate, • A political system that accepts the citizens to demand the government responsibility for maintaining and expanding the nation’s standard of living through the public sector spending and regulations, • Vast state owned firms run for the benefit of their managers and workers, • Barriers to the smooth adjustment of the economy to changing relative prices through price control, interest rates ceilings and trade restrictions. Risks of investing in Greece. Grecee’s poor commercial environment is a serious worry to investors as credit risk is extremely high. Because of its financial state, there is a chance that it will pull out of the eurozone. Greece’s gross domestic product is also observed to have remained static without indicators of growth since 2008. Investors would not be happy and willing to pump their investment in a sinking hence the threat of choosing othe r blocs compared to Greece. This is explained by the loss of depositors’ trust by the National Bank of Greece (NYS:NBG) and the rising unemployment crisis in the country. Internal and external battles, or even the threat of war, can have devastating effects on investors’ choice of Greece as an investment destination. Bureaucracy in Greece’s government processes and registration procedure can complicate investors’ decisions to settle at Greece as an investment hub. Corruption and poor governance can increase the cost of conducting business in Greece. If investors attain reduced profits or revenues from their investments they tend to look for alternative investment elsewhere. Reducing exposure to host government takeover The following strategies can be used by investing firms to reduce the chances of a takeover by the host government; a) b) Reliance on unique source of supplies -in this case the host government will not be able to takeover and operate the subsidiary successfully. c) Hiring of local labor - through the hiring of local employees, pressure will be applied on their government hence no takeover will take place easily. d) Purchase of insurance - when an investment guarantee programs are offered by the home country, host country or an international agency, there will be insurance of various forms of country risk hence takeover will be difficult to take place. e) Borrow local funds - by borrowing local funds from the country’s bank, a pressure will be applied on its government leading to low chances of takeover. TABLE OF CONTENTS 1. Introduction 2. Labour market reforms 3. Key Risk Indicators 4. Government Takeover 5. Conclusion 6. References CASE STUDY GREEK GOVERNMENT – DEBT CRISIS In 2009 investors became suspicious of a sovereign debt crisis. This was due to the Government’s inability to manage its debt standards. The government’s debt created much concern to investors in the financial market because these bonds were very expensive. On May 2010 Euro zone countries and International Monetary Fund (IMF) agreed to give $110 billion loan to Greece on the following conditions; 1. Privatization of Government Assets. 2. Implementation of structural reforms. 3. Put in place some measures for restoration of fiscal balance. The above conditions were not met by the Greece because of the recession in the economy hence more time was required. There was also restructuring of Greek public debt held by private creditors. In the first week of this month, the legislation passed the conditional labor market reform and midterm fiscal plan 2013-16 despite opposition from other Mps. There was a land mark on Nov. 11, 2012 when the Mps passed the bill on the Fiscal Budget for 2013. The Troika Surveillance report was finally released in this month. The report gives the results for the Greek Economy, reforms, privatization Program and debt sustainability. The Euro group met this work to discus on the extra bailout and debt structure whereby the debt structure was confirmed by the European Commission official Autumn Economic forecast 2012, and it stated that if no new extra debt restructure then the debt-to-GDP will rise from 177% to 1887% in 2013. LABOUR MARKET REFORMS This functions through the interaction of workers and employers in an economy. There is compensation and measurement in relation to labor. Economists’ measure labor in terms of hours worked, total wages, or efficiency. Total cost = Fixed cost + Variable cost TC = F.C + V.C Economic rent+ Total compensation – Opportunity cost Income = Total Compensation + Unearned income DEMAND FOR LABOUR Labour demand is a derived demand Marginal Revenue product MRP = Price of the product or service marginal Physical product If MRP is greater than Marginal Cost, there is a likelihood of employing an additional worker. When we look at the overall economy of the Greek Country, there are several unemployment namely; 1. Frictional unemployment – Takes time for people to find and settle into new jobs 2. Structural Unemployment - there is the mismatch between the skills and other attributes of labor force and those demanded by employers 3. Natural rate of unemployment – this is the combination of frictional and structural that excludes cyclical contributions of unemployment for example recessions. 4. Demand deficient unemployment This is derived as (AE=C+I+G+(X-M)) Where; AE- Aggregate Expedition C- Consumption Spending D- Increasing investment spending G- Increasing Government Spending (Greece) (X-M) – Net of Exports minus Imports KEY RISK INDICATORS A key risk indicator (KRI) gives a warning on the potential event that may affect the investment or project in any given country. In relation to the Greece I identify five types of risks which are likely to be present in the economy; 1. Financial risk 2. Political risk 3. Credit risk 4. Political risk insurance 5. War risk insurance A. FINANCIAL RISK This is associated with, model risk, operational risk, market risk in a given country. B. POLITICAL RISK These are faced by investors, corporations in a given country and it affects the economy if this is political instability. C. POLITICAL RISK INSURANCE This is available for different types of political risk for example; civil unrest, war or terrorism. Government expropriation or confiscation of assets. Business interruption. D. CREDIT RISK Refers to the risk that a borrower will default on any type of debt by failing to make payments which he is obligated to do. E. WAR RISK INSURANCE Covers damage incase of war, including invasim, insurrection, rebellion and hijacking. GOVERNMENT TAKEOVER The company could reduce exposure to host government takeover by; 1. Operating within the scope of the business. 2. Following the laid down rules and regulations. 3. Does not manufacture firearms. 4. The company does not manufacture illegal products which are prohibited by law. 5. The company is registered as per the company’s act (CAP) CONCLUSION By the Greece county investors evaluating and understanding the above risk indicators the company will reduce explosion to host government take over hence growth and sustainability of the economy. REFERENCE: 1. Richard Blundel and Thomas Masurdy, 2008 “Labour supply” The new palgrance Dictionary of economics, 2nd Edition 2. Assar windbreak and Dennis J. Snower 1986 “Wage setting, unemployment and insider-outsider relations” American Economic Review PP.2235-239 3. John R. Hicks 1932, 2nd Ed. 1963. The theory of wages. London. Macmillan Read More