Eurozone Crisis

What Awaits Europe?


In 2009, the newly elected Prime Minister of Greece discovered that his predecessor had tampered with state financial data and that his country’s budget deficit actually exceeded the Gross Domestic Product (GDP) by 15% instead of the reported 6%. That is how the economic crisis in Europe began. Soon thereafter, it came to light that debt problems were not unique to Greece; similar challenges were faced as well by the four other so-called PIIGS countries – Portugal, Italy, Ireland and Spain.

The European crisis was caused by two main factors: The first and most important factor was the integration of economies of various types and strength into a single-currency space. Integration of strong economies (for example, Germany) into the Eurozone helped stimulate exports, which, in turn, facilitated economic growth. Integration of weak economies in the same currency system had the opposite effect. Had the PIIGS countries maintained their own currencies, they would have naturally been weakened domestically and would just as naturally have encouraged domestic exports. Such a mechanism of “balancing” economy simply does not exist in a common currency space (Eurozone).

At first blush, joining the Eurozone seemed beneficial for weak economies. It made financial resources readily available to them. Individually, they would each have been unable to receive the cheap loans that Eurozone membership provided them. As a result, weak countries were able to fund numerous projects that would never have been financed had those countries retained their own currencies (because the price of investment capital would have been too high for them). Those projects artificially stimulated their economies and created multi-year economic growth. Because that growth was not natural, it ended in crisis. 

The second important factor causing the economic crisis has been the different budgetary/fiscal policies of Eurozone countries. Even though the Maastricht Treaty of 1992 obliges Member States of the European Union to impose certain limits on their national budget deficits (3% of GDP) and public debt (6% of GDP), almost none of the countries have observed those ceilings. For years, governments of Eurozone countries spent far more money than they ever collected in tax revenues. That only deepened their budget deficits and forced them to secure loans to finance their deficits. It was not until later that it became evident that those countries could not pay back the loans they had taken out years before.

One of the mechanisms that the European Union developed to overcome the crisis was the European Financial Stability Facility, or EFSF. That fund was created in May 2010 to assist EU countries with budgetary problems. A year after the EFSF mechanism was established, it became clear that it was good only for settling ongoing stages of the crisis (for example, helping Greece, Ireland and Portugal avert default by assisting them at the moment they had to pay off tens of millions of Euro in debt). The EFSF mechanism alone was not going to solve the larger problem once and for all. Unless common rules of game concerning budgetary/fiscal policy were developed and corresponding control mechanisms were established, certain Eurozone countries would continue to act irresponsibly (for instance, by assuming additional debt and increasing public expenditures beyond limits). Irresponsible countries could be assured that, in times of crisis, the economically strong Eurozone countries would again come to their rescue. By 2011, it was obvious that EU countries could not by themselves mobilize the financial resources necessary for the EFSF to service the debt accumulated by Eurozone member states. Hence, the EU began seeking money outside its borders – from the United States, China, Russia and various financial institutions.

The American Egan-Jones Ratings Company was the first agency to downgrade France’s historically top-notch credit rating. That was in early-December 2011. That same month, Standard & Poor’s, one of the world’s most respected rating agencies, put fifteen of the seventeen Eurozone countries under its special CreditWatch supervision, causing the Euro to weaken against other currencies. The Chinese Dagong Global Rating Company also downgraded France’s rating, citing the country’s sluggish economic growth. The International Monetary Fund (IMF) changed its growth forecast for Greece and declared that the country’s economy would shrink by 6% instead of the predicted 4.5% percent in 2011 and by 3% in 2012. The IMF prognosticated that the Eurozone, and concomitantly the world economy, could fall into a deep recession if Eurozone countries failed to mobilize their own resources and secure financial aid from other countries.

An anomalous (and, in some respects, an amusing) development happened in January 2012: Standard & Poor’s downgraded the rating of the European Financial Stability Facility at the same time that the credit rating agency Fitch announced its intention to downgrade the ratings of five Eurozone countries – Spain, Italy, Cyprus, Belgium and Slovenia. The European Commission expressed skepticism about the rating agencies’ reaction and explained through a representative that the Commission was better able to evaluate the real picture because it possessed specific information about each Eurozone country which was unavailable to the rating agencies.

By the end of 2011, the United States had come out against assigning the International Monetary Fund a leading role in pulling the Eurozone out of its crisis. U.S. Secretary of Treasury Timothy Geithner agreed that the IMF should play some role, but insisted that it would not be as the key player. While the United States expressed interest in a speedy resolution of the Eurozone crisis, Secretary Geithner said the countries responsible must themselves find corresponding financial resources. With U.S. participation accounting for nearly one fifth of the financial resources of the IMF, its position obviously carries weight. Before the U.S. position was made public, it had been rumored that the IMF would allocate 100-billion USD to the European Financial Stability Facility. Those rumors were denied by the German Finance Minister. In January 2012, new IMF head Christine Lagarde warned against a deep worldwide recession if agreement were not reached on at least three major issues: 1) significant increase of EFSF resources; 2) decrease in interest rate on the Euro by the European Central Bank and 3) allocation of an additional 500-billion USD to the IMF.

A new mechanism unveiled in December called for central banks of EU Member States to issue loans totaling about 200-billion Euros. The loans would be accumulated in the IMF and used to assist countries in crisis (most likely, Italy and Spain). The need for such a mechanism became urgent with the realization that the 440-billion-Euro EFSF fund could not be increased up to the necessary one-trillion-Euro level. When the German Bundesbank refused to participate, Russia agreed to allocate 10-billion USD to the IMF to help ease the Eurozone crisis if the European Union would launch negotiations with Russia on visa-free travel.

The purchase of treasury bonds by the European Central Bank (ECB) was seen as a possible source of financing the national budget deficits of those states experiencing crises. The ECB decided not to purchase treasury bonds, but agreed to provide loans on extended terms (up to three years) to commercial banks. After that extended three-year period, it will be up to the commercial banks to decide whether or not they want to issue loans to any of the states then still in crisis.

In December 2011, Eurozone countries drew up a new fiscal pact harkening back to the twenty-year-old Maastricht criteria. The new treaty, which reestablishes the same restrictions on budget deficits and foreign debt, has already been acceded to by all seventeen Eurozone countries, as well as six other EU Member States (Denmark, Latvia, Lithuania, Poland, Romania and Bulgaria) which are not part of the Eurozone. Britain and the Czech Republic have refused to sign the new treaty whereas Sweden and Hungary are still in the process of negotiations. Finland also does not intend to sign because, as its Foreign Minister declared, the new agreement was created with the aim of bypassing normal parliamentary procedures.

The new inter-governmental pact differs from the Maastricht Treaty in one significant respect; it envisages the creation of a monitoring system to ensure that Eurozone countries comply with their assumed fiscal obligations. Eurozone countries will now be obliged to submit drafts of their state budgets to the European Commission, which is authorized to demand the revision of any draft state budget that does not meet established norms. If any Eurozone country violates the limits set under the new treaty, the European Commission can impose corresponding sanctions for noncompliance. A non-complying country will need the support of an overwhelming majority of Eurozone countries to avoid sanctions of the European Commission.

In executing the treaty, signatory countries have ceded part of their sovereignty to the European Commission. That has naturally generated dissatisfaction among the populations of those countries. For example, a recent survey conducted in France suggests that more than half (52%) of French citizens are categorically opposed to the new pact brokered by their incumbent president.

Several European countries have expressed indignation about another French initiative to introduce the so-called Tobin tax, which envisages taxation of financial transactions. That initiative is most vehemently opposed by Great Britain, which has a highly developed financial market that would be primarily damaged by such a tax. As British Prime Minister David Cameron described it, introduction of the Tobin tax would be “simply crazy” and would cause a slowdown of economic growth and an increase in unemployment. The Czech Republic, Denmark and Sweden are similarly opposed to the French tax initiative.

How the Eurozone crisis will affect Georgia will depend largely on how and when the crisis ends. Some analysts reckon that the Eurozone will manage to overcome the crisis with the assistance of other countries and financial institutions. That still does not guarantee Eurozone stability; in the long term, centralization of the European economy (the exact direction in which the Eurozone is moving) threatens to produce negative results. In forthcoming years, the Eurozone and the EU economy in general may well achieve stability under conditions of slow growth. That is, unless the predictions of some well-known economists and financial analysts are realized and there is a withdrawal of one or more countries from the Eurozone, a division within the Eurozone – or its total disintegration.

With regard to Georgia, a number of points are important to bear in mind. This year Georgia launches negotiations with the European Union on the Deep and Comprehensive Free Trade Agreement (DCFTA). Completing the DCFTA could prove to be a protracted process given that the European Union is concentrating its political and economic resources entirely on settling internal problems. At the end of the day, the signing of the DCFTA is a political decision. If, due to its own internal problems, the European Union is not ready to sign the agreement, it could erect artificial obstacles for Georgia in the form of various EU requirements. Georgia had to fulfill similar requirements (which mainly relate to market regulation) before the European Union would even agree to start DCFTA negotiations.

Another important aspect is external trade with EU countries. The European Union is an important trade partner for Georgia with nearly 400-million USD in exports and 2-billion USD in imports. Any deepening of the crisis or a recession would adversely affect trade between Georgia and EU Member States. Any decrease in the purchasing capacity of Europeans could seriously damage exporters of Georgian products.

The effect of the Eurozone crisis on the inflow of foreign direct investments to Georgia is also an important consideration. Capital flow into the country is a significant prerequisite for our economic growth and employment. If Europe falls into a recession, private capital might start looking for a more stable and safer investment environment. Of utmost importance in this regard is Georgia’s ability in recent years to maintain macroeconomic stability and a liberal economic climate, to lower tax rates and to improve its credit ratings. All of these factors could play a positive role in encouraging the flow of free capital into Georgia in the event of a European recession.


This article first appeared in Tabula Georgian Issue # 86, published 6 February 2012.


Log in or Register