The Law and Economics of Sovereign Debt Regulation

The Law and Economics of Sovereign Debt Regulation


International Monetary Fund (IMF) had been involved in recue actions for several years to European Union (EU) helping they battle sovereign debt crisis which arose in the year 2009 in various European Monetary Union (EMU) countries. Countries like Greece, Portugal and Ireland were benefitted through the programme participated by IMF for providing financial assistance and adjustment of economy. IMF took the initiative of contributing one third to the emergency fund of these economies. There are several questions that crop up regarding the interference of IMF in carrying out these rescue action. Questions like, *Why does IMF take the initiative of rescuing the debt struck countries in Europe? Or is it the drawback the institutions of European Union in dealing with such situations? *what can be the possible advantages and disadvantages of involving IMF on board? *had there been any difference in point of views in the meeting?

Greece Economic Crisis

There was a time when Greece was considered as one of the top economies in the world in terms of standard of living of the people with high per capita income. It held tenth position as a member of European Union in the year 1981.The development of tourism sector contributed largely to the economy adding upto 73% to its total GDP. The per capita GDP of the country was remarkable in the whole world.  In the early 2000’s, the tourism sector emerged as the reason for rising             it was found that Greece had been over-borrowing for developing its big projects. The level of borrowing was so huge that even European Union was astonished. In several reports it was revealed that the country became incapable of paying off their debts and unable to borrow further at such cheap rates.

Reason behind Greece Economic Crisis

The reason behind this condition has been elaborated below which will help in creating an understanding about Official Sector Intervention leading to debt crisis in an economy and recommendation regarding policies that can be undertaken to resolve these issues.

Let’s start with finding out reasons leading to such condition of Greece.When Greece was one of the good economies in the world, the Government kept borrowing huge amounts in order to develop the economy. This policy can be considered good only if the economy is receiving enough revenue in terms of tax for refunding these debts, otherwise not. But this was not the case with Greece. The tax revenue was not sufficient to meet the external debts incurred(Lynn, 2011). The debt burden on the economy was somewhere around 133% of the total GDP, which kept increasing with shrinking condition of the economy. This ultimately resulted in drop in credit ratings throughout the Euro zone and borrowing became costly for the country. Unless extreme steps are taken, a fear arose that, the government will declare bankruptcy and all the debts will be declared defaulting. Had the government taken this step it will not prove to be beneficial for the economy.

Greece – Initiative to deal with Crisis

Now the question arises as to what the country has done to deal with this disastrous situation.

The country has approached to a large financial institution for supporting them. Hence, IMF, European Central Union (ECU) and the EU came up to support the economy and bring stability. They decided to help Greece in such situation by providing it with enough funds which will help them meet their current debt but they have to commit something in return. The commitment that Greece had to make was that they will institute large scale cut in their budget in the coming months. These measures were an initiative of bringing out the economy from such crisis and establish control on the level of spending so that they can pay off some of the debts owed by them(Lynn, 2011). The motive of these institutions behind helping Greece come out of this situation of crisis was that, they knew if Greece becomes a defaulter in paying off the debts, the world will experience a huge economic turmoil compared to the one it experienced due to collapse of Lehman Brothers.

Opinion on this matter

The reason behind detailing the whole scenario above is to create an understanding about the economic crisis experienced by Greece and what initiative or “austerity measures” they have to implement in beating such crisis. The measures put forward are only for the reason of keeping the economy aware of them and abide forraisingfunds.The first measure is cutting down of spending, which are mostly seen in cases of pharmaceuticals ($1.319 billion cut), government and election spending ($389 million cut), defence budget (378 million cut). As per stipulation of IMF, Greece is required to cut down $530 million in public spending and an additional $431 million for keeping eye on the repayment of debts. As per reports, the country decided to sell off assets worth $66.3 billion and bring saturation in the job market thus cutting about 15,000 jobs by end of the current year. There are various other areas in which Greece has to deal such as, private creditors such as bondholders, which form a major part of the deal(Lykogiannis, 2002). They are trying to cut cost in this area through ‘haircut’. As a result of this the creditors might have to accept cuts of around 70% on their lending’s. Although this sounds worse on behalf of the creditors but they do not have any other option except acceptance to this. While going through the dealing ways of IMF and other institutions with Greece, it can be said that the decision is correct. Since, just lending of money in the form of bailout will not be a wise action. These ‘austerity measures’ will keep the economy aware of their responsibility and obligation. Had this been not done, it would have led to moral hazardfrom countries like Ireland and Portugal, who are facing the same crisis. The concept of ‘haircut’ may be or may not be a good idea for many. For those who do not have stake in Greece it might seem to be a good idea for them, but for those who hold stake in the country, might not feel the same(Lykogiannis, 2002).

The government is cutting down $398 million from pension funding, which does not seem to be a good decision. This is however the question of people’s lives. One of the morning dailies published the story of a personwho committed suicide,under the headline ‘Greek Suicide a Potent Symbol before Election’. The person chooses death to be more suitable option than scavenging for food as a result of losing pension fund. While browsing through the search engines several other cases like this was come across. Thus, the government is to be held responsible for this condition. The treatment that people are receiving from the government is not at all appreciable(Mitsakis, 2014). Thus the statement, ‘‘Official Sector Intervention extends a sovereign debt crisis rather than resolves it’’ is correct.

Now let’s discuss, what the condition of Euro is at present and how it can be saved?Due to economic crisis faced by several European countries, euro is in a severe problem. Currency of an economy faces trouble when there occurs huge deficit in the balance of payments. Since many countries are facing huge deficit, euro is getting impacted. This raises concern in the minds of people whether euro can hold its value as a medium of exchange. Hence, policies need to be framed in such a way that this situation can be overcome. EU needs to take measures which can be effective in tackling this situation. As per suggestion there are four aims which must be met. Firstly, determine which of the economies facing problem are?; secondly, be assured that banks in Europe can resist default, thirdly, instead of cutting down budget, promotion of growth is required and finally, implementing models which would help talking these situations. Hence, determination of which economies are in trouble is a big enquiry; if one gets missed out then it will not be possible to make a difference. Shoring of the banks is considered as one of the precautionary measures dealing with situations in which messy default will take place. In case such situations occur and the ECB (European Central Bank) fails to help, a global financial crisis may take place. Instead of relying solely on cutting down of budget, it is important to take initiative in promotion of growth. Moreover the idea of cutting back budgets and increasing tax burden of the people is not a wise measure as this would lead to further recession(Nezi, 2012). Hence, promotion of growthforms a major part of the plan, which will again boost confidence and support in appreciation of euro. Initiating a new model is very crucial at this point of time so as to ensure curbing the crisis. This is again going to be a time consuming factor and require votes and treaties between all the countries facing the same condition.

In order to achieve the things stated above, focus must be put in the way Mundell-Fleming model needs to be shifted. Since the government is looking forward to decrease level of spending, the IS curve (i.e. Investment/Saving curve) will shift to the left. The problem which may arise because of this is that, the local rate of interest will get lowered and apparently, the GDP will decline. This will lead to fall in the value of currency which is against the interest of Europe. This fall in the value of currency will lead to rise in cost of foreign goods. This is why focusing on budget cuts must not be the only motive, strategies needs to be undertaken towards growth of economy.Euro zone is required to do a lot of work. This magnitude cannot be solved so easily. In order to reach a solid solution die-heart strategies need to be implemented as otherwise it may create a very big financial crisis in the world. The situation caused now will lead many European countries into deep recession. This had been a cause of heavy spending by the government for the sake of development projects, etc. and getting into risk with their assets. It has been quoted by Herman Van Rompuy (President of European Union), “We are in a survival crisis”. Thus, it is important to survive with the Euro zone in order to survive with the European Union(Giannakis and Bruggeman, 2015).

As per Alogoskoufis, “Greece’s crisis is not simply a debt crisis. It is a dual confidence crisis, due to the mismanagement of the expectations of international creditors and domestic consumers and investors.”For resolving the crisis it is important to be confident on both the fronts. The main area where the Greek program has failed is to deal with the situation of crisis confidently. The programmes and policies undertaken by the Greek government needs to be modified in order to break this vicious circle. The government must consider these things if it wants to revive the economy once again(Giannakis and Bruggeman, 2015).


The report highlights on the economic turmoil faced by Greece and how it will result in financial crisis. Once, the economy was considered among the top economies in terms of the standard of living of the people. But due to wrong growth policies and over borrowing of the government the country saw tremendous fall in its economic position. The highly indebted economy approached to IMF and other financial institutions for support. In this report, we can see how IMF plays an important role in dealing with sovereign debt crisis. The mistakes of the government do not only impact the currency rates of the country but also the lives of the people resulting to unemployment. The researcher has given opinion on how to deal with such situation to the best of knowledge.


Giannakis, E. and Bruggeman, A. (2015). Economic crisis and regional resilience: Evidence from Greece. Papers in Regional Science, p.n/a-n/a.

Leonard, L. and Botetzagias, I. (2011). Sustainable politics and the crisis of the peripheries. Bingley, U.K.: Emerald.

Lykogiannis, A. (2002). Britain and the Greek economic crisis, 1944-1947. Columbia: University of Missouri Press.

Lynn, M. (2011). Bust. Hoboken, N.J.: Bloomberg Press.

Mitsakis, F. (2014). The Impact of Economic Crisis in Greece: Key Facts and an Overview of the Banking Sector. Business and Economic Research, 4(1), p.250.

Nezi, R. (2012). Economic voting under the economic crisis: Evidence from Greece. Electoral Studies, 31(3), pp.498-505.

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