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Asia Business Development – Asia Business Consulting » The West’s fiscal debt crisis

SpirE-Journal 2011 Q3

The West’s fiscal debt crisis

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The West’s fiscal debt crisis

The European Union remains mired in crisis, lurching from one near-meltdown of confidence to the next. Across the Atlantic, Standard & Poor’s downgraded the quality of US sovereign debt in the wake of political gridlock in Washington. Will this be the time that Asia finally shows the world that it has de-coupled from the West? Or are we looking at another 2008-style recession?

The EU and US Debt Crisis: What does it mean for Asia and the Emerging World?

Moody’s estimates that sovereign debt jumped from 62% of the world’s GDP in 2007 to 85% in 2009. Most of this was fuelled by the developed economies of the West, which suffered output declines and also racked up more fiscal stimulus costs. 

The day of reckoning for these unsustainable debt levels now seems to be upon us. The European Union remains mired in deep crisis over how best to avoid a sovereign debt default event by Greece or the other teetering Southern European economies. And America has seen US Treasury debt paper downgraded by S&P after a political showdown in Washington between the House of Representatives and the President. 

In Asia and most other emerging markets, economic growth remains stable. Though signs of a slowdown are increasingly evident, the current state of Asian economies, particularly China and India, is a far cry from what it was in 2008-2009, let alone the Asian financial crisis of 1997-1999. What does the future hold for Asia and emerging markets as the West battles with the spectre of recession?

The genesis of the West’s current crisis

Since mid-2011, it seems that anything that is written about the financial situation in Europe (and to a lesser extent the US) becomes out-dated almost as soon as it is written. However a short overview of the current crisis is attempted below. 

The 17 member countries of the EU have historically suffered from a combination of high structural unemployment and heavy fiscal debt due to well-developed social safety nets. In 2010, serious concerns surfaced about the possibility of Greece defaulting on its sovereign debt. European politicians were anxious to avoid spiralling bond yields and a collapse of the Euro, not to mention a recession-causing blow to the banking system. They responded with a bail-out package for Greece in mid-2010 which, it is now clear, was woefully inadequate. 

A series of financial market crises of confidence followed, all relating to the debts of Greece, Portugal, Ireland and Italy. Each time this happened, the EU and ECB took fresh actions to shore up confidence, often after pointed criticism from the US and IMF – extensions of credit, guarantees of debt and so on. Each set of measures was more difficult to agree on than the last, and each failed to stabilize confidence once and for all. The crisis rolls on. 

In the US, the fiscal debt racked up under the Presidency of George W Bush (who reversed the fiscal surpluses of the late 1990s) worsened under President Obama, as funding flowed to successive wars in the Middle East, bank bail-outs and fiscal stimulus. The short-term economic effects of this were moderate – a weakening dollar and some inflation. 

What triggered the crisis of 2011 was political. After the mid-term elections of 2010, the right wing of the Republican Party decided to take a hard line against fiscal debt. The Republican-controlled House of Representatives (the lower house of “Parliament” in the US) refused to endorse an extension of the debt ceiling to pay off past debts without a guarantee of future deficit reduction. While agreement between the House and the White House was reached at the eleventh hour, S&P decided to downgrade the US credit rating. In its judgement, there was no path in sight towards long-term deficit reduction due to the confrontational mood in Washington. 

A closer look at European fundamentals

Portugal, Italy, Greece and Spain (the “PIGS”) are the four European Union nations whose economies are now troubling the entire Eurozone. This is due to the size of their fiscal debt versus GDP. Other factors like high unemployment (running at 20% in Spain, and at 40% for those under 40) make it hard for their governments to solve their own problems. These countries are considered to face a high risk of the government defaulting on its debts. 

In 2000 to 2007, Greece was one of the fastest growing economies in the Eurozone. Its GDP grew at 4.2% as foreign capital flooded the country. However, after the removal of the right wing-military Junta, the government wanted to bring the disgruntled left leaning portion of the population back into the economic mainstream. In order to do so, successive Greek governments customarily ran large budget deficits to finance public sector jobs, pensions and social security. The situation worsened after the 2008 financial crisis which led to the country’s two largest industries – tourism and shipping – seeing a 15% contraction in revenue by 2009. In January 2010, the Greek government was estima

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