Debt Crisis in Greece - Should the IMF Lend to Rescue the Country - Essay Example

The Debt Crisis in Greece: Should the IMF Lend to Rescue the Country? Name: Instructor: Course: Date: The Debt Crisis in Greece: Should the IMF Lend to Rescue the Country? The debt crisis currently affecting Greece is sending economic shockwaves across Europe and other parts of the world. As D’Anieri (2011) argues, the crisis began early last year when it emerged that Greece might fail to pay its financial obligations. Primarily, the crisis resulted due some factors arising from the recent global financial crisis, which served to worsen the already poor monetary policies in Greece. Low interest rates that were prevailing prior to the crisis encouraged Greece government to engage in extensive borrowing to finance public and pension services. However, despite this huge spending, the country could not raise enough revenue from taxes to supplement the borrowing because of massive tax evasions. Due to effects of the global economic crisis in 2008, the deficit between government spending and revenue increased, creating fear among the lenders about government’s ability to repay the debts. As a result, the lenders raised interest rates in a bid to cushion themselves against risks of default. This made it hard for Greece to repay the obligations amid dwindling tax revenues. As a member state of the Euro zone, the country was not in a position to develop and implement monetary policies to address the situation. As a result, the crisis spread to other Euro zone states through associated series of defaults (D’Anieri 2011). Majority of banks in the zone, which were the primary lenders to Greece, could also not pay their debts. Speculation in the zone about the ability of other nations (for example, Republic of Ireland) in similar situations to pay their financial obligations also worsened the consequences in Europe. To other parts of the world, the consequences of the crisis are being felt in the stock markets and banking sector, which have been registering poor performance throughout the year. Against this nature and consequences of the crisis, International Monetary Fund (IMF) should step in to provide financial assistance to help the situation. Need for IMF to Intervene IMF should intervene in this case to provide Greece with a breathing room to restructure its monetary policies. Financial assistance from the Washington-based agency can help Greece to restructure its monetary policy without the need to source funds from the markets. For instance, several months ago, the agency agreed to give financial assistance to Portugal, which was on a similar financial crisis as Greece. A press release from the agency indicated that the loan was meant to help Portugal stay away from seeking funds in the markets and at the same time, implement the agreed monetary policies (IMF 2011). Therefore, in the same sense, the help will give Greece humble time to cut its spending, restructure tax policies, and other policies that will enable it come out of the current debt crisis. The country seems submerged in the crisis due to extensive borrowing to finance public services and pension schemes. The assistance will make funds available to the government to support the services and schemes, while at the same time reducing borrowing. Restructuring the tax policies will eliminate political weaknesses that have been encouraging tax evasions by corporations and individuals. Therefore, within the given window of the assistance, Greece will have sufficient funds to pay its debts and finance its spending. IMF’s intervention can help to restore investor confidence, and in effect stabilize the markets within the Euro zone and around the world. Currently, speculation about risk of default by Greece is affecting not only financial and money markets within the country, but also markets in other countries, particularly Europe (Mattich 2011). Financial assistance by IMF will serve to pump funds into the Greece economy, encouraging investors to continue doing business in the country. With sound and efficient tax policies and systems, the country will then be able to collect enough taxes to pay its debts. Therefore, the country will stand in a position to pay debts owed to financial institutions within the country and Euro zone, which will prevent possibility of chain of defaults. Despite this, such intervention will also prevent consequences that may arise if the debt crisis is left to continue. If IMF fails to provide financial assistance, Greece will not be able to recover from the situation; therefore increasing chances of default. This is evident from the current situation of the country, even after receiving a bailout from the IMF, European Union, and European Central Bank. Early last year, the three bodies extended a bail out of over $150 billion to Greece, with austerity measures attached to it (Kakissis 2011). However, against these austerity measures, the likelihood of Greece defaulting is very high. Thus, if not given another bailout, the situation may worsen, causing financial crisis to the country. According to Mattich (2011), the immediate consequences of such situation will be felt by local banks. Default will mean cash crisis in the country, meaning the government will not pay debts owed to local banks. Local depositors will then hasten to withdraw their deposits from the banks, leaving them with no financial resources to do their businesses. This will create a domino effect in the economy, with government forfeiting some public services, and high rates of unemployment, among others. A default will also mean an exit of Greece from the European Union, as well as collapse of the country. Besides, the consequences will spread to affect immediate economies and other economies around the world. Financial institutions within the Euro zone will be greatly affected by a Greece default. They owe the country substantial amount of money, implying a default will translate to losses in form of write-offs. This will create domino effects in banking and money sectors in other regions of the world through series of defaults. Greece’s exit from European Union will mean increased likelihood of other nations (with similar situations) exiting from the union. Besides collapse of the union, this may result in another global financial crisis similar to the recent global economic recession that started in USA (BBC 2011). Need for IMF not to Intervene Despite there being an urgent and dire need for IMF to step in and rescue Greece, the risk of providing the assistance is high. From the situation, majority of lenders, including member states of European Union, believe that the chances of default by Greece are high. The impacts of the recent bailout program also support the worries of the lenders. According to Kakissis (2011), despite the country adopting most of the austerity measures attached to the program, such as tax hikes and massive cuts on spending, it has only been able to reduce its debts by about 5 percent. The country has also not started to repay the recent loan given by IMF, and given the current scenario, it will take several years to stand in a position to begin doing so. The two issues indicate that the likelihood that Greece will not pay back the financial assistance, in the event IMF extends it, is extremely high. This may not go well with other countries that provide funds to IMF, which may choose either to withdraw their support or to reduce financial allocations to IMF. This will mean diminished capability of IMF to execute its principal responsibility – providing financial assistance to countries in crisis (IMF 2011). Summary and Conclusion The current debt crisis in Greece can be attributed to the recent global economic downturn and poor economic policies in the country. Prior to the global financial crisis, low interest rates prompted Greece to engage in massive borrowing of funds to finance public services. In part, this trend led to laxity of the government in implementing and enforcing tax policies, which created a gateway for tax evasions by individuals and corporations. Increased spending and reduced revenues resulted in large fiscal deficit, hindering the ability of the country to pay back debts efficiently. Rise of interest rates during the economic crisis worsened the situation by increasing the amount of money Greece government owed to local, regional, and international lenders. All these issues plunged the country into a debt crisis, which prompted IMF, European Union, and European Central Bank to given the country a loan to prevent default. However, this did not work out as anticipated, and now the country has high chances of defaulting its debts and collapsing. Although the risks of default are high, this justifies the need for IMF to step in and give the country financial assistance to prevent such occurrence. Like in the case of Portugal, the loan will give the country a breathing space to restructure its monetary and tax policies, while at the same time finance public service without seeking funds from the markets. It will also restrain the spread of the crisis to other regions, as it was in the case of the recent global financial crisis. Given the nature of the current scenario in Greece, I believe that the country needs to reduce its spending and improve its tax policies. The country is in the situation because of poor and uncontrolled spending, which forced it to borrow extensively to support the pension scheme and public services. Moreover, the tax policies and structures seem ineffective, encouraging individuals and organizations to evade paying income and corporate taxes, which remain principal sources of revenue for any government. Together with financial assistance from IMF and other regional financial agencies, these two initiatives will greatly reduce the fiscal deficit, and in effect, enable the country to pay its debts. References BBC 2011, Greece’s debt crisis odyssey, News business, viewed 2 October 2011, D’Anieri, P 2011, International politics: power and purpose in global affairs, 2nd edn, Cengage Learning, Florence, KY. IMF executive board approves an €26 billion extended agreement for Portugal 2011, International Monetary Fund (IMF), viewed 2 October 2011, Kakissis, J 2011, One year after the bailout, Greece is still hurting, Time world, viewed 2 October 2011, Mattich, A 2011, Choice for EU: bail out Greece or bail your banks, The Wall Street Journal, viewed 2 October 2011, Read More