Borrowing cost as a crucial factor for sustainable fiscal consolidation & for exiting the current crisis

Abstract

The Greek fiscal crisis which is evidenced in a sharp deterioration of public finances resulting in the highest public deficit and debt in the E.U. makes even more urgent the necessity to make accurate assessments of the problem so as to apply the appropriate policy measures. After repeated downgrades by all rating agencies in a period of a few months, along with the loss of access to financial markets in spring of 2010, the unaffordable cost of borrowing due to record high spreads, reached such levels that the necessary fiscal adjustment is now nearly impossible. The international support mechanism created by the IMF, European Commission & ECB in order to avoid sovereign default, and preserve Greece’s position as a member of the Euro-zone, was an urgent and necessary step. Besides the policy measures stated in the memorandum of understanding, which are an attempt to correct years of structural imbalances in Greek public finances, borrowing cost become a crucial factor for achieving the above targets. In this paper we try to present and explore the evolution of borrowing cost from Greece’s entry to the Euro-zone until the end of 2009 and its severe deterioration afterwards. As will be shown, at the close of 2009, borrowing cost became one of the most crucial component in restoring fiscal consolidation and discipline. The spill-over effects of the borrowing cost on the private sector- crowding out effects- following the loss of access to international financial markets by domestic banks, will be investigated. Also, necessary preconditions for sustainable markets and E.U. enforced fiscal discipline by appropriate policy measures to restore market’s confidence and reduce borrowing cost, will be discussed.