The European Sovereign Debt Crisis - Essay Example

The European sovereign debt crisis Contents Contents 2 Introduction 3 Discussion 4 Conclusion 10 References 12 Introduction The Euro Sovereign debt crisis has attracted the financial market globally. The turmoil that was renewed in the global financial market was mainly related and associated by the policy makers and the users and this matter was discussed in the main meeting which was conducted internationally such as G 20 and G7. The topic mainly encompasses on the European debt crisis and its impact on the financial market. The impact of the euro debt crisis had a reasonable affect on the global financial market which is outside the euro market area. The remarkable effect of the crisis is the rise in the global risk together with the considerable impact on the negative equity return. The impact on the fall in equity is particularly more in the financial sector. The financial integration with the euro area turned to be insignificant. The financial development and the acceptance of the recipient country has reduced the channel for bonds but expanded it for the exchange rates. The euro debt crisis resulted in the fall in the equity market globally and a increase in the risk aversion globally, there was no remarkable change or modification in the long term bond yields of the government, the decline in the excess return in the financial sectors, a decrease in the value of the euro. Discussion The introduction of Euro resulted in the remarkable lower rate of interest that lead to the generation of capital in those countries but to the utter dismay the inflow of the capital is not always utilized for efficient use. The main problem is the European monetary union is unstable. The crisis policy that is dependent solely on the adoptive measures that the short term effect will lead to sowing of the seeds for the future crisis. When the debt crisis occurred in Greece the Euro zone has to face high sovereign debt crisis that includes the increase in the government debt, the widening of the bond yield spread, the fall and decrease in the euro exchange rate, that resulted in fall of confidence of the total financial market internationally. There are various possible reasons behind the small economy to trigger an influence on the financial market globally. In which the debt can be considered as the most important cause of the total spread of crisis. The foreign exchange market which is considered to be the most large and liquid market has deteriorated expectedly and also it fluctuated due to the European sovereign debt crisis. The foreign exchange market was experiencing volatility. The weakness of the financial market was due to the three elements in the financial market they are equity market, debt and funding of the banking sector (Deutsche Bank, 2012). There are practically no solutions for the debt problems that are faced by the small economies. There is number of offers that exist for the financial instruments which include its dependence on debt swaps for the mitigation and adoption of the change in the climate although the cost related to their transaction is relatively high. The world bank is developing a framework for the comprehensive debt that identifies and determines the problem of debt which is considered as a important and main element for the economic challenges that are faced by the small states (Schneider,. 2014). The impact of the government debt problem faced by the small economies and its impact on the financial market can be described as the inefficiencies developed within the economy, the weak governance leading to corruption, barriers to trade, a significant increase and decrease in the population, the absence of human capital or human resources, environmental capital are being over utilized (Taylor, 2011). Figure 1: Process of European sovereign Debt Crisis In September 2008 which caused a contagion in the US economy that spreads to the rest of the world. During the previous global economic turmoil the minor shock that is caused by the payment crisis of the Greek bond has resulted in the damage not only in the total euro zone but it spread over to the rest of the continents. This results in the inter connections of the various economies in the Euro zone and establishing trade among themselves and developing the relationship with the rest of the world. The Global financial crisis was a combination of the various factors namely the slow moving of the economic activity, the bailouts and the measure of the fiscal stimulus that has resulted to the increase in the fiscal deficits to the Gross development product ratios in the main developed economies and have increased the concern over the fiscal existence. The concern is mostly related to the euro countries which are exposed to various difficulties. For example the huge banking sector has become visible to the large housing success and failure, the sign of the uncompetitive economies by the repetition in the current account deficit and also the rise in the unemployment. The main reason for the sovereign debt crisis is the melt down in the financial market (Deutsche Bundes Bank Euro system, 2013). The consequences of the Sovereign debt crisis on the money market is The stridently increase in the spread between the interest rate for the safe and unsafe trading was the main reason for the malfunctioning of the European money market. With the beginning of the initial disorder there started a divergence in the money market spread (Morgan Stanley, 2011) Figure 2: Euribor Spread The movement towards the standardization of the transactions is more significant and prevalent in the unsecured part of the money market that is mainly occupied by the bilateral transactions. The short term securities money market acts as a standard (Guraziu and Zeqo, 2012). The insolvency has widened and spread over inconsistently. The crisis not only resulted in the cut in the interest rate remarkably and purchase of the asset program for the government and the bonds that are covered but also resulted in the unlimited provision of the liquidity through the allocation of the additional policy. The market structure reveals that there has been a movement from the unsecured segment of the money market to the secured segment of the money market. The euro money market areas have shown a downward trend in the transaction that is carried out in cross border as a result of the sovereign debt crisis. The efficient market hypothesis has been applied during the financial crisis (Stewart, Elliott and Tremlett, 2012). The value of the shares was much less on the Wall Street where the decrease and the downfall from the Europe have created fear that the US recovery is fading out. Figure 3: CDS Spread Taking into consideration the stress of the banks the useful and the important indicator of the spread are LIBOR-OIS, and the CDS of the banks spread. In the diagram given it resembles that the spread of the LIBOR –OIS has increased and expanded in the middle of the year 2011 in the European money market which is much more than that of the sterling and the dollar market the spread of the CDS has increased and expanded stridently in the middle of the year 2010 and it continued to expand and increase in 2011. There was somewhat downfall in the first half of the year 2012 but it geared up again in the second quarter of the year 2012. The difference between the US banks and the European spread CDS which was less and almost negligible before has widened presently (Singala, 2012). The risk and uncertainty of the default has been common in the financial market and the uncertainty and fear of the bank’s failure have become very significant during the financial crisis occurred globally. Impact of the Sovereign Debt Crisis on the Bond Markets The investors consider the sovereign bonds as the risk free assets with the assumption that the government is very powerful to fail and make default in making coupon payment for these instruments. During the stage and phase of the financial crisis it is expected from the government that it will provide help and assistance in order to raise and increase the taxes, adopt different methods for paying off the debts and creating money supply in the economy. Euro was established and introduced with the faith and confidence that the increase in the monetary and fiscal union around the countries will result in the fiscal harmony and solvency between these countries. Before the occurrence of this crisis the CDS and the bond rates for the members of the Euro zone were less than what could be expected. But when the crisis prevail both CDS and the bond rates has risen stridently for the members of the euro zone than it was predicted on the basis of the fiscal space that was available. The prologue of Euro has developed the effects of volatility spill over and the connections and relation for most of the European bond market. Figure 4: Government Bond Indices The indices in the bond market resemble the economic health to a large extent because the bonds are mostly government debts. The investors become disappointed on observing the negative self satisfying sentiments of the market .and about the bond market of the euro zone and responded and reacted by increasing the spread. In this figure it clearly resembles the movement of the bond index over a long period of time and it differentiates clearly the countries that are clustered together after the explosion of crisis (Stracca, 2013). Since the bonds are rated and positioned as useless by the credit rating agencies the yield curve which was constructed for these countries have increased and expanded above the rest. The countries like Germany, United Kingdom, Sweden and France have signified that there is a lower volatile movement that is echoing the hard action to hedge the deficit and stabilizing the economy. The movement of the ascendant pressure on the spread of foreign interest bond market and domestic bond market has been driven by bad news. The spill over of the discouraging news was found to be significant that comes from the GIIPS countries and non GIIPS countries (Ullah and Ahmed, 2014). Whenever there is an increase in the risk of the sovereign debt crisis in the euro zone, the value of the euro depreciates against the dollar of United States. The value of the euro that is calculated an estimated externally are more subject to change in the external market and is affected more by the vulnerable member countries than the member countries that are stable. The increase in the default risk of the large and the medium sized Euro zone banks results in depreciation of the euro whereas the default of the risk by small banks does not have relevant impact thus highlighting the importance of the bank with consideration to the exchange rate (Allen and Moessner, 2013). Figure 5: Euro Cross Exchange Rate Conclusion The impact of the sovereign debt crisis and its impact on the financial market have been highlighted in the couple of years of the past and it has influenced significantly in the financial markets. The significance of the euro debt crisis has lead to the development in the spread between Spanish and Italian versus bond yields of the German government that have determined the significant increase in the aversion of the global risk and the selling off the equities. The other impact and effect of the sovereign crisis is the depreciation in the value of euro whereas the effect of the yield on bond is usually low clear cut. It is found and observed that the government bond market in the most developed countries significance in the event of crisis. It is found that the economic and trade connection in the euro area are more stable and significant conduit for transfer of euro debt crisis. There is no proof of a significant financial channel. The financial integration related to the euro area is found to be irrelevant and the openness has a combined effect and impact. It can be concluded that the countries riskiness is identified as a subject for the exchange rates and bonds where for the safer countries there is a reduction in the contagion. References Allen, W.A. and Moessner. R., 2013. The liquidity consequences of the euro area sovereign debt crisis. Bank for international Settlements. [Pdf] Available at: http://www.bis.org/publ/work390.pdf. [Accessed 2 December 2014]. Browne, R., 2008. The Emerging Debt Problems of Small States. [Pdf] Available at: http://www.centralbank.org.bb/Publications/March2011ER/10The%20Emerging%20Debt%20Problems%20of%20Small%20States.pdf [Accessed 2 December 2014]. Deutsche Bank. 2012. Effects of the European Sovereign Debt Crisis on the International Debt Capital Markets – Opportunities for Sub Saharan African Sovereign Issuance. [Pdf]. 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