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The Greek debt conundrum, explained

The Greek parliament will vote on further austerity measures Sunday – the latest effort to alleviate a crisis that has careened between an EU bent on austerity and a resistant Greek public.

By Correspondent / February 10, 2012

Protesters shout anti-austerity slogans outside the Greek Parliament in Athens, Friday, Feb. 10. Thousands took to the streets of Athens as unions launched a two-day strike against planned austerity measures on Friday, a day after Greece's crucial international bailout was put in limbo by its partners in the 17-nation eurozone.

Petros Giannakouris/AP

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Berlin

For almost two years, the Greek government and European Union officials have been convening in meeting rooms to figure out how to rescue the Greek economy as protesters throng the streets of Athens, angry over growing austerity. Meanwhile, the possibility of a default looms. 

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Why is the Greek economy in trouble?

Greece has very high sovereign debt – in 2011 the state owed around €350 billion ($461.6 billion), or 160 percent of GDP, the highest rate in Europe. It has also lost the trust of private investors – it can’t borrow anymore to meet its obligations. 

When Greece joined the eurozone in 2001, it misreported its real level of public borrowing in order to meet the entry guidelines. It got access to cheap capital, because the euro offered  much lower interest rates than the drachma. Money poured into the country and wages, particularly in the public sector, rose significantly, although at the same time tax evasion and corruption were endemic.

In 2009, newly elected Prime Minister George Papandeou revised the budget deficit figures, implying that his predecessors had "cooked the books." Greece's credit ratings started to slide. In the same year, the Greek government estimated the size of the black market, the untaxed economy, to be about 30 percent of the declared economy.

In 2010 Greece’s debt rating was lowered to “junk” status and the interest rates on Greek bonds rose to a level that made borrowing unsustainable, requiring Greece to seek international help from the European Union and International Monetary Fund. The country was told that it had to undergo severe budget cuts and tough austerity measures – a cure, some critics say, that has become part of the problem.

“Greece is trying to massively reduce its public borrowing without anything to offset these measures, like [devaluing] the currency,” says Simon Tilford, Chief Economist at the London-based Centre for European Reform. “So the cuts in spending become self-defeating because the economy is contracting faster than they can implement cuts.”

Could Greece go bankrupt?

In a sense, it already has. “Under no plausible scenario could Greece service its public, and, for that matter, its private debts,” says Mr. Tilford. “It is fair to say that, yes, Greece is insolvent.”

For months now, the Greek government has been negotiating with its private creditors about the size of a "haircut," a debt forgiveness that the EU, the European Central Bank (ECB) and the IMF have demanded before they give more financial aid to Athens. A restructuring of Greek debt – the deal negotiated at the moment foresees a write-off of about 70 percent – amounts to what is referred to as an orderly default.

But the deal hasn’t been finalized yet. Some private banks and hedge funds oppose it, possibly in hopes of getting back a larger share by holding out or on cashing credit default swaps, insurance policies against default.

On March 20, Greece needs to pay back €14.5 billion ($19.1 billion). If it does not get fresh money until then, it will have to declare bankruptcy – a “messy” default.

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