Greek Debt Crisis - Application of Country Risk to Crisis - Statistics Project Example

Greek Debt Crisis Course Code and Name Professor’s Name University Name City, State Date of Submission TABLE OF CONTENTS CHAPTER ONE 1.0 introduction…………………………………………………………………...............3 CHAPTER TWO 2.0 Greece debt crisis…………………………………………………………………...…4 3.0 History of crisis……………………………………………………………………...……4 Membership to European Union……………………………………………………………………………………...4 Reasons for the crisis…………………………………………………………………………………….…5 Country risk…………………………………………………………………………........6 Application of country risk to crisis……………………………………………………………………………………....11 CHAPTER THREE 4.0 Ways to reduce exposure to hostile government take-over ………..……………17 CHAPTER FOUR 5.0 Conclusion …………..……………………….…………………………..…………..20 6.0References.....................................................................................................................22 CHAPTER ONE INTRODUCTION The report is based upon the Greece debt crisis and looks in depth at how the Greece government has submerged in debt as well as a recession coupled with growing racism and a humanitarian crisis that has led to protests and social disruptions by its citizens and currently requires a bail-out plan from the IMF and the euro zone countries to help lower the debt levels. The Greece government is marred by massive corruption, tax evasion and uncontrollable government spending in sectors such as the military that do not generate any economic growth for the country (Lyn 2011). The report also looks at how the economy has worsened over the years from 1827 at a government budget deficit of 3% of the GDP to 12.7% deficit of the GDP in 2009 and is on an increasing trend. The report indicates the high risk nature of investing in Greece, corruption in government and lack of transparency in government. An overview of the history, the reasons of the Greece crisis, country risk and its application to the Greek crises is also looked into. The report finalizes on the strategies the companies can take to reduce exposure to host government take over and the decision strategy for an investor who seeks to make a return from the country. The recommendation for investors who seek opportunities in the country, is that they should not invest in the country due to the risky nature involved as a result of government corruption, high rates of taxation, lower interest rates on returns, high recession, falling economy and company sales, job cuts in the various industries in the country, growing racism and social disruptions as a result of strict fiscal austerity measures and failure by the government to secure enough funds for its bail-out plan from the IMF and the euro zone countries. The economic growth of the country is lower due to uncontrolled government spending compared to its revenue almost leading the country into bankruptcy. CHAPTER TWO The Greece debt crisis has evolved over the years to become one of the top most crises among the European sovereign debt crises. The government has had the debt crisis four times during the years 1827, 1843, 1893 and 1932 respectively but without a large budget deficit at 3% of the GDP that was regarded as minimal compared to the year 2009 when the budget deficit increased to 12.7% of the GDP requiring the country to seek a bailout plan from the European Union and the International Monetary Fund. Greece did not escape the outcome of the financial crisis and gained public attention as a result of the crisis (Mitsopoulos & Pelagidis 2011). The government expenditure exceeds the revenue collected and the debt repayment obligation is difficult since the government is unable to cover the loan interest. Greece became a member of the European Union in 1999 amid concerns that the fiscal statistical figures were misreported making it impossible to accurately determine the growth in GDP, budget deficit and public debt levels. In the year 2010, the euro zone countries and the IMF agreed on a conditional €110 billion bailout loan for Greece (Lyn 2011). The bailout plan would take place in several disbursements ranging from 2010 to 2013 giving the country more time and money to restore its economy and repay its debt. Political risk arose when the budget debt increased from 12.7% to 13.7% revealing lack of transparency in data collection and misreported statistical figures all in an attempt to hide the actual level of Greek debt. The Greece government has suffered for many years due to its tax income generation falling below the expected level of income due to a rise in yearly tax evasion costs amounting to well over $20 billion per year. The cost of financing government debt has risen over the years from 1999 to 2009 and uncontrollable government spending has increased the real budget deficit to 12.7% of the GDP (Nelson & Mix 2010).This rise in budget deficit levels is in an effort to finance public sector jobs, pensions and other social benefits. In order to keep within the monetary union guidelines, the government had misreported over the years the country’s official economic statistics. The Greece government had paid banks millions of dollars in fees to arrange for transactions that hid the actual level of borrowing. This deal had been undertaken by the successive Greece governments to enable it continue spending while hiding the actual deficit from the European Union (Lyn 2011). The rate of GDP growth rate reduced by 2.5% in 2009 as a result of consumer spending and falling tax revenues. The uncontrollable spending by the government in terms of more jobs and higher pay has also led to the bloated budget deficit (Mitsopoulos & Pelagidis 2011). Panic has increased among the investors due to the fact that the country may be unable to refinance its debt and may require a bailout plan. This is an indicator of the high levels of corruption within government and lack of transparency in the use of government funds and the high risk involved in investing in the country. Below, is a diagram showing how the Greece government has attempted to control corruption levels from the years beginning 2006 to 2011 as undertaken by the individual citizens. Greek Debt Crisis Country risk analysis involves looking at all the political and economic factors that influence the investors decisions in relation to a whole range of risks ranging from strikes, rebellions, economic risk, exchange rate risk, sovereign risk, political risk and transfer risk which involves the locking of capital in foreign countries as a result of government actions and restrictions (Mitsopoulos & Pelagidis 2011). When investing abroad it is necessary to consider country risk since it can reduce the expected return on investments in foreign countries. Country risk differs from one country to another depending on the political and economic conditions prevailing in that country and some country risk do not have an effective hedge. In regard to the Greek debt crisis the investors feared the government’s inability to meet its debt obligation due to an increase in government debt levels. A crisis in confidence arose indicated by a widening of bond yield increases and the cost of risk insurance on credit default swap compared to other countries in the euro zone. The country risk factors range from government spending, tax evasion and corruption (Lyn 2011). The high spending in government increased by 87% against an increase of only 31% in the tax revenues leading to budget deficits. These deficits were further fueled by a large and inefficient public administration, costly pensions and health care systems, tax evasion and fiscal irresponsibility. Huge fiscal imbalances developed during the past six years from 2004 to 2009. The high government deficit led to reforms of the ineffective tax collection system and the resorting to high taxes. The Greek economy was the fastest growing in the euro zone from 2000 to 2007 growing at an annual rate of 4.3% compared to a Eurozone average of 3.1% (Mitsopoulos & Pelagidis 2011 ). The government needed to implement the economic reforms to improve competitiveness by reducing salaries and bureaucracy and to redirect much of the current government spending from non-growth sectors like the military to growth stimulating sectors (Nelson & Mix 2010). The government tax income each year is below the expected level. Tax evasion costs for the government amount to over $20billion dollars per year (Lyn 2011). Tax evasion is rampant in Greece due to the high rates of taxation, excessive regulations, complex tax codes and inefficiency in the public sector. The Greece government had for so many years misreported the official economic statistics to keep in line with the monetary union guidelines (Mitsopoulos & Pelagidis 2011). The successive Greek governments hid the actual deficit from the European Union to continue spending. This is an indicator of corruption within the government. There was also a cross currency swap where billion worth of Greek debts and loans were converted into dollars and yen at a fictitious exchange rate by Goldman Sachs thus hiding the true extent of the loans owed by the country. The local industries in Greece are suffering from declining international competitiveness. The high relative wages and low productivity is the primary cause. Since the adoption of the euro, wages increased at an annual rate of 5% double the average Euro zone rate(Mitsopoulos & Pelagidis 2011 ). Greek exports grew at 3.8% per year, a half the rate of those countries’ imports from other trading partners. These are some of the contributing factors to the country’s deficit. Political and fiscal irresponsibility is indicated by the huge fiscal imbalances and the government deficit is lower hence the resolve to raise the taxes, implement economic reforms and expropriation of property (Lyn 2011). The amount and extent of corruption is revealed by tax evasion and the hiding of the actual amount of the country’s debts through currency conversions at fictitious exchange rates. Level of tax rates have been increased for example, the value added tax, extraordinary tax on company profits, special tax returns on high pensions and increase in property prices due to high taxes. The increase in government spending in non- growth stimulating sectors like the military instead of investing in technology and industrialization has rendered the country into a financial crisis (Mauldin & Tepper 2011). The effects of the debt crisis are; worsening of the recession from 2008 to 2011, imposition of strict fiscal austerity in exchange for European funding, social disruptions among the population where children are given up for adoption and some citizens turning to the NGO’s for healthcare treatment, unemployment of half of the young people in Greece and an increase in the suicide rates. Also the country’s GDP has declined over the years with a lowering government deficit. There were also massive protests against the passing of austerity measures by parliament and the labor market reform in order to secure a continued flow of bailout funds from the Troika (Cline 2012). An alarm in the financial markets arose as a result of the downgrading of the government debt to junk bond that private capital markets were practically unavailable for Greece as a funding source. GDP growth rates were lower and the government debt level had not reduced during the good years with strong economic growth and indication that large deficits could no longer be sustained if the implementation of economic reforms to improve competitiveness was delayed. The Greek debt compared to the Euro zone countries is very high hence the country had to seek a bailout loan. The risk of investing in Greece is quite high in relation to the country risk analysis that shows that the government is heavily in debt hence unable to meet its debt obligations and is relying on bailouts to try and offset its debts and develop the entire economic wellbeing of the country (Lynn, 2011). The key indicators of country risk in this case are as follows; 1. Political risk It does exist in Greece currently. The main reason for this risk is the structural weaknesses regarding tax collection whereby the government is raising tax rates instead of strengthening the tax collection departments. Social tensions caused by fiscal austerity resulted in political and economic turmoil in the country and has led to civil disobedience expressed in terms of strikes, riots and protests throughout the city streets (Lynn, 2011).The tax burden is offending the general public in terms of direct tax affecting their purchasing power and also impacting on the revenues of MNC’s and the local manufacturing industries. In my opinion, the investor confidence in the country is eroded due to the increased costs of conducting business by the multi- national companies and reduced revenues. Bureaucracy in government has complicated businesses. Appropriate changes in tax systems and labor laws need to be undertaken for effective conduct of business operations. Weak tax collection systems and social disruptions could in the real world situation lead to a country’s default. Political risk can have devastating effects on a country and on the investor confidence leading to withdrawal of investments in a country for fear of a massive loss on capital invested. The charts below illustrate this information clearly. 2. Attitude of Local Customers Some consumers can be very loyal to the locally manufactured commodities compared to imports from other countries other than the host country. It can be viewed in Greece in terms of shipping and locally manufactured medicines because these are the specializations of this country but they lack hi-tech industry and need MNC’s for technological component. This in my opinion hinders the country from producing high quality superior goods and optimizing on its production efficiency or at full potential. This reduces revenue for a country in terms of foreign exchange for specialization exports and increases the costs of production involved in outsourcing for this services. Investors are willing to invest in such a situation but may be barred by the prevailing political and economic conditions. 3. Currency Inconvertibility It is the exchange of earnings for goods by the parent multinational company since the foreign currency cannot be converted into other currencies. It is a big concern for MNC’s in Greece currently since it is suffering through several crises and has a high transfer risk which reflects the heavy tax burden and low government revenues. This is one of the reasons as to why coca cola quit the Athens Stock Exchange, citing the volatility of the Greek operating environment and the illiquidity of the Athens exchange. Greece was in the 57th position on the Transparency International Corruption perception index in 2008. Corruption is a problem that needs to be eradicated in making a more sound business environment. This is a major problem since MNC’s and investors want conversion of funds from one currency to another. This has the effect of hindering the expansion of industries and limits the growth of a business. In my own opinion, investors and big companies should avoid getting into a country with such restrictions. 4. Exchange Rate Risk The rate of exchange is important since it determines the earnings received by an investor or a government from a foreign country. Monetary instability in a country like Greece where the Euro is generally weak may hinder domestic and foreign investments since the returns to be made from the investment are very minimal. An appropriate currency control measure should be adopted by a country to secure its earnings from foreign countries. Exchange rate risk is present in Greece due to the falling economy and the rising debt of Greece levels. Since Greece is a member of the euro zone, rising tension in a zone would definitely impact on the currency value and weaken the Euro as a result. In my opinion, investing in the country would minimize returns and maximize on the costs. 5. Economic Risk It is the chance that macroeconomic conditions like exchange rates, government regulation or political instability will affect investments in a foreign country. A recession can severely reduce the demand for local goods. Financial distress can also cause the government to restrict MNC operations. In the country of Greece, there is a recession and political instability characterized by social tensions and disruptions. Such a country in reality and in my own opinion is risky and dangerous to invest in since an investor or company may lose all the investments or may end up making continued losses for a long time period. There are also increased rate of interests that exacerbate the cost of borrowing for investors and hence no major development projects are undertaken in a country. Below are charts showing the country’s spending and revenues, GDP, debt levels and country’s risk ratings. 6. Sovereign Risk This risk does not exist formally because the government did not announce that it went bankrupt and could not pay any of the remaining debts both local and foreign. But their statistics show that their liabilities increase in proportion to their assets or revenues but still are hopeful in getting financial help from the European Union and the European central bank to avoid this risk with surety. The figure below shows the comparison of the Greece government revenue and expenditure between the years 2002 to 2012 respectively. CHAPTER THREE A company may reduce exposure to the host government takeover in the following ways; Using a short term horizon The strategy is aimed at recovering the cash flows quickly in case of a threat to the company. Expropriation is such a threat that can occur due to war, civil unrest, terrorism and revolution. In using this method, a company can collect its dues frequently and in case of such a threat, it is able to move its machinery to its subsidiaries or can phase out its investments by selling its assets to the local investors or the government. By doing this a company can recover its cash flows quickly therefore minimizing the event of expropriation losses. Greece is facing social tension and civil disturbances so the MNC’s in that country can use a short term horizon technique in cases where the problem persists for a longer duration. This will save on time and money and enable the companies to conduct their businesses without any disruptions. Relying on unique supplies or technology This strategy involves using the latest technology and incorporating it in business to maximize on returns. It also prevents the host government from taking over the subsidiary and operating it successfully. If the subsidiary is relying on supplies from the headquarters or sister subsidiaries and those cannot be produced locally then host government’s takeover would not be fruitful because the MNC will cut off those supplies which are necessary for the production process. The same case applies to production technology whereby if the MNC hides its technology then the government cannot run the company without that technology and would be less interested to take over the company. This is a good strategy in cases whereby a company is making huge returns and is in a country like Greece that is faced with many economic, social and political conditions. This also reduces on over reliance on the host government for technical and financial support. Hiring local labor This strategy means that local labor is utilized in the production process of goods and services. By hiring local labor MNC’s can create pressure against government takeover but it has limitations in that after the takeover the host government will run the company with the same labor force so they can negotiate with each other in severe cases. A takeover means that local employees work is disrupted and they may lose their jobs rendering them unable to support their families and their other basic needs. The livelihoods of the employees may be shattered and hence a takeover would be the least option for the host government to take. Borrowing local funds Borrowing funds from local banks and trade stocks of the company at local stock exchanges can also help the MNC to build pressure for being safe from host government’s takeover. A government takeover would be to reduce the probability that the banks would receive their loan repayment. It will just affect the temporary cash flows of local banks and investors so if the government assures them of their safe-end then maybe both parties will compromise with the government. The local banks can convince or put pressure on the government to back down on the takeover to avoid losing their money to clients, investors and multinational companies who owe the bank various amounts of money. This helps local banks to remain in business without any government interference. Purchase of insurance Investments guarantee programs provided by the host country insure against the various forms of country risks. It can help MNCs to cover their exposure for such an action. But it is also a partial cover because insurance cannot cover the whole exposure. It may include some specific assets for a particular time period and the most important thing is the cost and benefit analysis for the insurance policy in that how much is the MNC paying for covering its assets and what they will get at the end of the day. This is important since it ensures that the country is secure in doing business both locally and internationally. The company in case of losses is also able to recover its assets though not at full value hence reducing the chances of a total and massive loss. The MNC’s are able to transfer the risk exposed to them to the insurance company hence they cannot completely shut down or run out of business. The World Bank has formed a legal body called MIGA (Multilateral Investment Guarantee Agency) which provides insurance to multinational corporations for their direct foreign investments in third world countries. This institution gives cover to MNCs in case of breach of contract, currency inconvertibility, expropriation, war and civil disturbance. CHAPTER FOUR CONCLUSION The Greece debt crisis is a major challenge for the country and as such the government needs to come up with sound economic and political policies to ensure that the country is able to refinance its debt and at the same time consider its citizens by reducing tax rates and expenditure cuts to avoid protests. The country should also seek help from the euro zone countries and the international monetary fund in order to reduce the debt. The European Union should also help Greece in restoring its falling economy as job cuts and company sales continue to decline. Greece as a country is facing a humanitarian crisis and increasing racism and therefore the euro zone countries stability hang in the balance if there is no adequate bail out plans in store for the country. As an investor in the country, and after evaluating critically the country risk involved in the Greece debt crisis I would not invest in the country due to the high risk involved, government corruption and lower interest rate on returns as a measure by the government to increase its revenue to offset the debt and pay the money owed to IMF and the EU. The country is also facing growing racism and a humanitarian crisis that has led church groups to appeal to the European Union to help the nation. The country is also facing its worst business cycles and shipping and tourism that are major foreign exchange earners are hard hit by recession which has also led to companies experiencing low sales and have had to cut jobs. The imposition by the government of strict fiscal austerity measures has a positive impact of lowering borrowing costs and social disruption which could have a negative impact on investment and growth in the longer term. Examples of three famous companies affected by the Greece debt crisis are CORALLIA, CONSTELEX and BELL LABS. References List Cline, W. R. (2012). Resolving the European debt crisis. Washington, DC: Peterson Institute for International Economics. http://www.wikinvest.com/wiki/Greece%27s_Sovereign_Debt_Crisis Lynn, M. (2011).Bust: Greece, the Euro, and the sovereign debt crisis. Hoboken, N.J.: Bloomberg Press. http://en.wikipedia.org/wiki/Greek_government-debt_crisis Mauldin, J. & Tepper, J. (2011).Endgame: the end of the debt supercycle and how it changes everything. Hoboken, N.J.: John Wiley. Mitsopoulos, M., &Pelagidis, T. (2011).Understanding the crisis in Greece. Basingstoke: Palgrave Macmillan. http://www.bis.org/forum/research.htm Nelson, R. M., Belkin, P., & Mix, D. E. (2010).Greece's debt crisis overview, policy responses, and implications. Washington, D.C.: Congressional Research Service. Read More