Originally Published 2015-01-15 00:00:00 Published on Jan 15, 2015
Greece may be far away from India but the lessons to be drawn are many. Bringing down fiscal deficit through harsh austerity measures has brought Greece to the brink. India should also not cut the important social sector spending in order to bridge the fiscal deficit.
Grexit and lessons for India

Global influences will be important for India this year because already due to the falling oil prices, India's retail inflation rate has come down to 5 per cent and the whole sale index of inflation is near zero. Similarly, the turmoil in Greece is likely to affect Indian stock markets as it did so in the recent past with signs of a Greek crisis and the Russian rouble's fall. Greece and India have a long history of connectedness starting from Alexander the Great coming to India in 326 BC and many of his tired and disgruntled army deciding to stay back in India.

Recently, there have been fears that Greece would leave the Eurozone, comprising of 18 countries. Germany as the biggest creditor of Greece is now prepared for Grexit (Angela Merkel said so). Greek's problems were exposed when in 2004 it was found by the European Commission that Greece had falsified its budget deficit data in the run up to joining the Eurozone.

As one of the pre conditions for joining the Eurozone was a fiscal deficit compact between members of not to allowing it to exceed 3 percent, Greece attempted to show a lower than actual deficit. But it soon had to acknowledge its huge public debt and plunged into a debt crisis. After the global financial crisis, in 2009 December a prominent credit rating agency downgraded Greece on ground that the government could default its ballooning debt. Spending cuts were announced by the Greek government in 2010 and the government spending received two rounds of austerity measures.

Austerity measures were severe and brought hardship on the people. The austerity and reform package involved reducing Greece's fiscal deficit from the high level of 13.6 percent of the GDP to 2.6 percent by 2014. To achieve this, the government had to cut public sector wages, freeze state funded pensions and strengthen tax collections.

It also involved reducing the number of local government units. Excessive amounts of private sector indebtedness and collapse of public confidence led the private sector to decrease spending in an attempt to save for rainy days ahead. It led to low demand for products and labour which further deepened the recession and made it even more difficult to generate tax revenue and reduce public debt.

Labour reforms included wage and benefit cuts to reduce costs and improve price competitiveness. Poverty increased and the social fallout of the crisis has been felt by all those who were laid off.

Yet the austerity measures were justified on the basis of a bailout package of $147 billion which was received by the government from the EU Commission, the European Central Bank and the IMF. In 2011 another bail out from the European Financial Stability Facility of 109 billion euros was given to Greece. By November 2011, 50 per cent of private debt was written off described as a 'haircut'. Further austerity measures led to unemployment jumping up to 26.8 per cent and youth unemployment at 60 per cent. In 2014 unemployment reached 28 per cent.

Greece has recovered a bit in the last few months and is showing positive GDP growth rate of 0.6 per cent and its budget is in surplus ( 1.5 bn euros for the first time since 2002) due to a record rise in tourism last year. But still it is not out of the woods and has a debt of 319 billion euros and would need to boost productivity and exports to stay afloat. If it leaves the euro and goes back to Drachma, it can manipulate the exchange rate and boost exports.

The anti austerity radical leftist Syriza party has vowed that if it comes to power in coming January 25th election under the leadership of Alexis Tsipras, there will be an increase in government spending and austerity measures will be eliminated.

What will be the impact of such a stance on the Eurozone and the world financial system is difficult to gauge at the moment. There could be a global turmoil and certainly other Euro members which are not doing so well like France and Italy could be impacted and they could also opt out of the Euro (contagion effect).

It is going to be a big jolt for the global financial system in any case and could lead to higher amounts of quantitative easing by Frankfurt based ECB to give a boost to the Eurozone countries in increasing demand. With interest rates nearly at zero, and inflation at a very low level, there is fear of deflation and deflationary pressure in the Eurozone similar to Japan's decade of deflation and low demand. This would harden the dollar against the Euro further.

India with its exports geared to the EU markets is already affected by slack demand from the Eurozone countries. India's export growth has been flat in the last one year due to subdued demand from the EU and US and Japan. But with a change of government both equities and debt FIIs were attracted to the Indian market in 2014 ( $42 billion). But the outflow of FIIs from Indian equities ( $161 million) is something worrisome. If RBI decides to lower interest rates more drastically than the recent 0.25 per cent, lower rates may attract more FIIs in equities. So the RBI has to decide whether it wants to lower interest rates further with an impending Greek crisis which may change the way in which FIIs are moving in Emerging Markets. FIIs have provided liquidity in the forex market and hence important-- otherwise there would be serious balance of payments crisis especially on the current account. Dependence on FIIs to bridge the gap in current account is risky however but they serve a purpose for Indian situation right now.

Greece may be far away from India but the lessons to be drawn are many. Bringing down fiscal deficit through harsh austerity measures has brought Greece to the brink. Throughout the Eurozone there is increasing criticism for austerity measures. India should also not cut the important social sector spending in order to bridge the fiscal deficit.

(The writer is a Senior Fellow at Observer Research Foundation, Delhi)

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David Rusnok

David Rusnok

David Rusnok Researcher Strengthening National Climate Policy Implementation (SNAPFI) project DIW Germany

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