Q&A: Greece's economic crisis

Q&A: Greece's economic crisis

Greece has a debt of more than 13 per cent of its GDP for 2009 [EPA]
Greece is undergoing financial turmoil over its $400bn debt, with increasingly expensive repayments and a continually downgraded credit rating.

The country's credit rating has been lowered to junk status, a risk level that will now force many groups to stop investing in the country's bonds.

Consequently, Athens has even less money to pay back its huge loans and there are now fears that its problems will spread to other EU nations and some countries further afield.

The country's so-called austerity measures, a combination of severe cuts to public expenditure and increases in taxes, has met widespread public opposition.

The European Union and the International Monetary Fund (IMF) have agreed a $143bn bailout package over three years to to help pay its immediate debts but the package still needs to be approved by the 15 other countries in the euro zone.

Why is Greece facing this crisis?

Greece's debt rose to more than 13 per cent of its gross domestic product (GDP) in 2009.

The Mediterranean nation incurred annual budget deficits of billions of dollars via overspending in several areas.

These included benefit programmes, the public sector and government committees, as well as loss making utilities, such as Olympic Airways, the national airline, that was eventually privatised in 2008.

The government's benevolence allowed civil servants to retire in their 40s and permitted their unmarried or divorced daughters to collect their pension after they had died, the latter at a cost of about $70 million annually by some estimates.

As tensions with Turkey have continued, Greece has also spent far more than most other EU members on arms, about six per cent of its GDP in 2009.

However, about 80 per cent of the defence budget is spent on administrative and staff payments.

The costs of paying off this debt have spiralled since October 2009, when Greece revealed that its budget deficit was double previous estimates.

The announcement led to continued credit rating downgrades, meaning that increasingly investors did not want to buy the government's bonds, making it harder for Greece to gain the finance needed to pay back debt and shore up the economy.

Investors have also not been reassured by measures taken by both the Greek government and the EU to restore confidence in the country's finances.

With the downgrade of its credit rating to junk status on April 27, Greece could not secure the money it needs from the open market to pay its debt and thus had to go to the EU and IMF for bailout money.

What are the main effects of the crisis?

With the downgrade to a junk credit rating, Greece's debt became one of the most costly in the world for investors to insure.

Fears mounted that this will affect other nations using the single European currency - the euro.

Therefore, investors have been scarred off putting their finance into euro zone nations with high debt such as Portugal, Spain and Italy.

Consequently, these countries now have less money coming into their economies meaning that they are less likely be able to make payments for their own debts.

The euro has fallen to a one-year low against the US dollar due to the crisis.

This has hit US exports since they have become more expensive for euro zone nations to buy, reducing their demand.

What austerity measures is Greece taking to reduce its debt?

Greece has introduced a number of austerity measures in order to tackle its debt, leading to widespread public opposition.

The measures include cutting civil servants' bonuses - for instance, those given for speaking a foreign language and Christmas and Easter windfalls - by between 12 and 30 per cent, saving about $2.25bn.

It has pledged to trim social security payments further by raising the retirement age and will ban early retirement.

The state pension will also be frozen, saving $600m.

It is raising VAT to 21 per cent from the current rate of 19 per cent, raising $1.7bn and is to introduce a two per cent supplemental gas tax to bring in $600m.

The main VAT rate will be increased by 2 percentage points to 23 per cent.

Excise taxes on fuel, cigarettes and alcohol will be increased by a further 10 per cent.

In addition, the government has said that it will merge some state firms and sell stakes in others, in a measure to limit losses.

Military spending is to be scaled back, with arms purchases limited to 0.7 per cent of GDP in 2010.

Where is the bailout coming from?

The EU and IMF has offered three-year loan package of $143bn to Greece.

One third of the package is coming from the IMF and the rest from Greece's 15 partner countries in the euro zone.

The 15 countries will extend loans to Greece with interest rates of about 5 per cent - higher than those they face themselves, but far lower than the prohibitive rates of about 10 per cent that Greece faces at the moment on the international market.

The package must be approved by each government of the 15 other euro zone members before it can be handed over to Athens.

If approved, the first payment will be made before Greece’s next bond redemption on May 19.

Initially Athens decided not to take up the aid, preferring instead to secure finance on the open market whenever possible, but when that was no longer possible Greece had to ask for the aid package.

Will the aid and austerity measures succeed?

Greece has to make a debt payment of $11.2bn on May 19. If a deal on the aid package is not secured before then the country could default on its debt or have its debt restructured.

Increased austerity measures could have a detrimental effect.

Cuts will reduce citizens' income and reduce spending. This has the potential to lead Greece into an even more severe recession, meaning a weaker economy and a reduced ability to repay debts.

Increased unemployment felt during such a recession and cuts to key services could also lead to social unrest.

Some economists expect Greece's GDP to shrink by three per cent even if deficit cutting measures are only moderately successful.

That is one per cent more than hoped for by the EU and IMF as part of their bailout package.