ET in the Classroom: Sovereign debt crisis

May 3, 2011, 06.32am IST

What is sovereign debt crisis?

Sovereign debt crisis means the sovereign government's borrowing from domestic and external markets is in excess of its capacity to repay, resulting in loan defaults requiring rescheduling of loans or bailout packages from other countries or multilateral institutions such as IMF.

How did the Greek crisis originate ?

The crisis in Greece surfaced in 2007-08 , when it came to be known that Greece was not in a situation to meet its repayment obligations to its external creditors. The budget deficit of Greece was in the range of 13.6% of its gross domestic product. The stock of debt was equivalent to 115% of the gross domestic product. The debt problem was further compounded by the fact that nearly three-fourths of the government debt was held by foreign institutions, particularly foreign banks. Not only was the high fiscal deficit a problem, it was also camouflaged by derivative hedging. Reportedly, investment banks misled investors into investing in government bonds of Greece by being secretive about the actual state of affairs. The rating agencies played accomplice and allegedly 'failed' to assess the correct fiscal position.

Who bailed out Greece?

Greece reached an agreement with IMF, the European Commission and the European Central Bank on a rigorous programme to stabilise its economy with the support of a $145-billion financing package against which the Greek government was required to implement fiscal measures, structural policies and financial sector reforms. Some of the points of the reform package were — reducing the fiscal deficit to 3% by 2014, pensions and wages to be reduced for three years, government entitlement programmes had to be curtailed and social security benefits cut.