Economic Conditions Malta

Overview

Malta's economic development is based on promotion of tourism and export-oriented manufacturing. Expansion in these two sectors was Malta's principal engine for strong growth in the 1990s. The country enjoyed rapid economic growth during most of the decade, fueled by the vibrant tourist and manufacturing sectors (mainly semi-conductors). Preparations for EU membership in 2004 spurred broad-based reform that helped mitigate structural impediments, especially by initiating the restructuring of the vast and inefficient public enterprise sector and liberalizing the trade regime. Largely as a consequence of liberalizing reforms, Malta experienced robust growth from 2005 to 2007, underpinned by foreign direct investment (FDI) and export diversification. Progress was also made in fiscal consolidation and in reducing direct public sector involvement in economic activities. On Jan. 1, 2008, Malta successfully adopted the euro, a crucial milestone in the government's growth-orientated reform agenda.

Malta's economy was hit by the global recession in 2009, although the downturn was less severe than that experienced by most other EU countries. Real GDP contracted in 2009 largely as a result of a decline in domestic demand, as investment and consumption fell significantly. While the drop in world trade also had an adverse impact on Malta's exports, the contribution of net exports to GDP was positive in 2009 as imports fell more substantially. During 2009, the government implemented a selective fiscal aid package providing financial assistance to specific manufacturing firms to support employment and investment. Despite the shortfall in revenues and the fiscal stimulus, the fiscal position improved in 2009 compared with that in 2008, reflecting the government policy of reducing or terminating subsidies to some sectors. The country's financial services industry performed particularly well as it is centered on the indigenous real estate market and is not highly leveraged. The global economic downturn and high electricity and water prices did hurt Malta's real economy, which is dependent on foreign trade, manufacturing - especially electronics and pharmaceuticals - and tourism, but growth bounced back as the global economy recovered in 2010. In early 2011, the EU ended excessive deficit procedures against Malta, after Malta had taken measures to correct an excessive deficit in 2010 and appeared likely to reach its deficit target in 2011. By September 2011, Moody's had downgraded Malta's sovereign credit rating.

In October 2011, the Times of Malta reported that the country had received funds from the European Union that totaled nearly twice as much as it passed on to the organization since it become a member in 2004. As such, it's safe to say that Malta is by far one of the biggest net beneficiaries of the EU's 27 members, according to EU's 2010 Financial Report. The largest portion of the funds received were connected to cohesion monies that were used to improve the island's infrastructure, including the re-building of new roads, new faculties at the University, the restoration of the bastions and the new Malta College of Arts, Science and Technology in Paola. Overall, fiscal stimulus measures contributed to a deterioration in Malta's public finances in 2011, leading the EU to warn Malta that it would risk sanctions if it failed to bring its deficit and debt levels within EU guidelines. In May 2012, the International Monetary Fund noted that Malta had taken effective action to correct its excessive fiscal deficit, shoring up confidence in the country's public finances. The IMF noted that Malta's structural fiscal adjustment was one of the largest among advanced countries. Looking ahead, the deficit was expected to fall further in 2012. Compared to euro area peers, Maltese banks continue to outperform in terms of profits and capital adequacy. But the fragile macroeconomic environment and sustained market volatility were expected to dampen export growth in 2012. With the euro area expected to go into a mild recession in 2012, the IMF predicted that Malta's real GDP growth in 2012 would be relatively modest and it was, although it grew stronger in the second half of the year than the first.

In the first half of 2013, Malta's central bank and the European Commission predicted that the Mediterranean country's economy would likely accelerate that year and next, driven by rising domestic demand and increased net exports. Malta's central bank governor, Josef Bonnici, noted that the country's banks had thus far weathered the financial crisis well but that it would be good to see more diversity in banks' lending portfolio. As of mid-2013, the unemployment rate stood at about 6.4 percent - or around half that of the euro zone. Debt as a proportion of GDP was below the euro zone average at 72 percent. The EU reopened an excessive deficit procedure against Malta in June 2013, having found that its forecasted deficit for the year was likely to exceed 3 percent of GDP.

But by December 2013, Malta's central bank said the economy was on track to accelerate, boosted by exports in 2013 and anticipated consumer demand in 2014. The central bank went on to say that core domestic banks were "highly capitalized, profitable and liquid." Meanwhile, in March 2014, Fitch Ratings affirmed Malta's long-term foreign and local currency Issuer Default Rating at "A," saying the economy was on the road to recovery.

In 2014, Malta led the Eurozone in growth, expanding by an estimated 3.5 percent. Also in 2014, the government began promoting public-private partnerships in the healthcare sector to establish Malta as a Mediterranean health hub for medical tourism, reduced residential and commercial energy tariffs by 25 percent. It also implemented a citizenship purchase program to increase government revenue and attract foreign investors. The government has implemented new programs, including free child care, to encourage increased labor participation. The high cost of borrowing and small labor market present potential constraints to future economic growth.

In February 2015, Malta's economy continued to weather the global crisis well, according to the IMF. Spillovers from turmoil in international financial markets were contained due to low reliance on external financing by the government and banks. Real GDP growth in Malta has been one of the highest in the euro area since the beginning of the crisis, supported by relatively diversified exports, a recent recovery in domestic demand, and a stable banking sector. Unemployment was close to historical lows and among the lowest in the euro area, noted the IMF. Growth was expected to remain robust in 2015 and 2016, supported by domestic demand. Inflation was projected to remain subdued.

Also in February 2015, Fitch Ratings affirmed Malta's long-term foreign and local currency Issuer Default Rating (IDRs) at 'A' with stable outlooks. Fitch estimated real GDP grew by 3.4 percent in 2014, better than in 2013 and higher than the eurozone average. It also projected potential growth to average 3 percent in 2015-16, continuing above the eurozone average.

In August 2016, Fitch Ratings affirmed Malta's long-term foreign and local currency Issuer Default Ratings at 'A' and revised the outlook to "positive" from "stable." The issue ratings on Malta's senior unsecured foreign and local currency bonds have also been affirmed at 'A'. Fitch pointed out that Malta's economic growth continued to outperform the eurozone average and peers in the first quarter of 2016 at 5.2 percent. The agency went on to say it expected growth to remain buoyant although moderating over 2016-2018 at 3.6 percent, driven by strong domestic demand. The impact of Brexit was likely to be negative but limited, as the decrease in tourist arrivals from the UK would likely be offset by those from elsewhere. Although house prices in Malta were rising due to a large influx of foreign workers, measures supporting first-time buyers and low unemployment, central bank studies showed prices were in line with fundamentals.

From 2014 through 2016, Malta led the euro zone in growth, expanding more than 4.5 percent per year.

By mid-2017, economic growth was estimated at about 6 percent, unemployment was at a record low of about 4 percent, and wages and pensions were rising.

The Labour government led by Prime Minister Joseph Muscat won re-election in June 2017 amidst allegations of corruption - namely improper business dealings - aimed at Muscat's wife and some of his associates. When Muscat - whose five-year term was to have ended in 2018 - called for the snap elections in May 2017, he said they were crucial in order to contest the corruption allegations he believed could end up negatively impacting the strong economy, according to a Reuters report.

In May 2017, Moody's revised upward its GDP growth forecast for Malta, projecting growth to occur at a faster rate than previously expected. The New York-based credit ratings agency said it expected the Malta economy to grow by 4.3 percent in 2017, up from the 3.4 percent rate it had forecast in January. It also revised growth forecasts for 2018 from 3.1 percent to 3.7 percent and confirmed the country's A3 rating.

In October 2017, the murder of a popular journalist who was largely viewed as an anti-corruption crusader put Malta in the spotlight.

The killing took place the same day that Daphne Caruana Galizia posted two items on her blog that separately ridiculed Malta's opposition leader for having rounded shoulders and calling another senior government official as a "crook."

Her death rocked Malta (the smallest nation in the European Union,) which had been hit by a wave of graft scandals, including accusations of money laundering and influence peddling in government -- all of which had been denied, according to Reuters.

By November 2017, the European Parliament had urged the European Commission to investigate Malta's adherence to the rule of law and voiced "serious concerns" about police independence and international money-laundering on the island. It also called publicly for the country to bring to justice whoever killed the journalist who had accused Malta's leaders of profiting from global corruption.

A Reuters review of EU and Maltese data found that the island nation has been slow to apply international guidelines on naming firms that do not take action against dubious practices, and the number of convictions and sanctions for money laundering has been low.

Malta has also consistently registered fewer reports of "suspect transactions" from banks, casinos and other financial operators than any other EU state, according to Reuters' data, despite having a disproportionately large financial sector.

GDP is estimated to have expanded by 6.4 percent in 2018, with Malta being one of the fastest growing countries in Europe post-crisis, "thanks to rapid rebalancing toward export-oriented services, notably remote gaming," according to the IMF. The government was also starting to explore new development areas around blockchain technology. Despite growth remaining robust, the IMF warned that "a cyclical peak may have been reached." Meanwhile, the fiscal balance was estimated to have registered a surplus in 2018, thanks to favorable economic conditions and buoyant proceeds from the Individual Investor Program.

In November 2019, Reuters reported that Malta's biggest bank had failed for years to detect or address risks involving thousands of payments, according to the European Central Bank (ECB). The bank detailed "severe shortcomings" that could have allowed money laundering or other criminal activities.

A confidential ECB report seen by Reuters said Bank of Valletta (BoV) BOV.MT had not dealt with a litany of risk management failings despite repeated warnings from the Frankfurt-based regulator stretching back to 2015.

The Maltese economy grew at a strong but slower pace in 2019. After surging to an estimated 7.3 percent in 2018, real GDP slowed to 4.4 percent in 2019. Domestic demand remained the main driver of growth, as weaker private consumption was partly offset by a one-off pick-up in business investment and strong increase in public consumption.

Meanwhile, strong employment creation in services helped reduce the unemployment rate to 3.4 percent in the fourth quarter of 2019. Preliminary estimates suggested some narrowing of the current account surplus to 8.4 percent in 2019, largely due to slower export growth reflecting weaker external demand.

In 2020, the government announced a sizeable package of measures aimed at supporting firms and households from the economic fallout of the coronavirus pandemic. On March 18, the government communicated a raft of one-off measures amounting to 1.8 billion euros (about 12 percent of GDP).

The measures include 210 million euros (about 1.5 percent of GDP) of direct injection to the economy, mainly through allowances to support businesses and workers, social assistance schemes and 35 million euros for healthcare spending; 700 million euros of tax deferrals for affected firms (about 4.5 percent of GDP); and 900 million euros of loan guarantees (6 percent of GDP).

On March 24, 2020, the government announced further fiscal support aimed at raising wage subsidies in the sectors hardest hit by COVID-19, according to the IMF. The measure was retroactive to March 9 and estimated to cost up to about 61 million euros (0.5 percent of GDP) per month. Healthcare spending was also revised upwards to more than 100 million euros (0.8 percent of GDP). Altogether, the full package amounted to roughly 15 percent of GDP, including about 4½ percent of GDP of direct support.

Updated in 2020; see Special Entries below for information about Europe's debt crisis.

Supplementary Sources: The Times of Malta, Reuters and the International Monetary Fund

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Special Entry 1:

Global credit crisis; effects felt in Europe

Summary:

A financial farrago, rooted in the credit crisis, became a global phenomenon by the start of October 2008. In the United States, after failure of the passage of a controversial bailout plan in the lower chamber of Congress, an amended piece of legislation finally passed through both houses of Congress. There were hopes that its passage would calm jitters on Wall Street and restore confidence in the country's financial regime. However, a volatile week on Wall Street followed, most sharply characterized by a precipitous 18 percent drop of the Dow Jones. With the situation requiring rapid and radical action, a new proposal for the government to bank stakes was gaining steam. Meanwhile, across the Atlantic in Europe, with banks also in jeopardy of failing, and with no coordinated efforts to stem the tide by varying countries of the European Union, there were rising anxieties not only about the resolving the financial crisis, but also about the viability of the European bloc. Nevertheless, European leaders were able to forge an agreement aimed at easing the credit crunch in that region of the world. Following is an exploration, first, of the situation in the United States, and, second, of the situation unfolding in Europe.

Report:

On Sept. 28, 2008, as the United States was reeling from the unfolding credit crisis, Europe's banking sector was also hit by its own woes when the Dutch operations of the European banking and insurance entity, Fortis, was partly nationalized in an effort to prevent its ultimate demise. Radical action was spurred by anxieties that Fortis was too much of a banking and financial giant to be allowed to fail. The Netherlands, Belgium and Luxembourg forged an agreement to contribute more than 11 billion euros (approximately US$16 billion) to shore up Fortis, whose share price fell precipitously due to worries about its bad debts.

A day later, the mortgage lender -- Bradford and Bingley -- in the United Kingdom was nationalized when the British government took control of the bank's mortgages and loans. Left out of the nationalization scheme were the savings and branch operations, which were sold off to Santander of Spain. Earlier, the struggling mortgage lender, Northern Rock, had itself been nationalized. The head of the British Treasury, Alistair Darling, indicated that "big steps" that would not normally be taken were in the offing, given the unprecedented nature of the credit crisis.

On the same day, financial woes came to a head in Iceland when the government was compelled to seize control of the country's third-largest bank , Glitnir, due to financial problems and fears that it would go insolvent. Iceland was said to be in serious financial trouble, given the fact that its liabilities were in gross excess of the country's GDP. Further action was anticipated in Iceland, as a result.

On Sept 30, 2008, another European bank -- Dexia -- was the victim of the intensifying global banking and financial crisis. In order to keep Dexia afloat, the governments of France, Belgium, and Luxembourg convened talks and agreed to contribute close to 6.5 billion euros (approximately US$9 billion) to keep Dexia from suffering a demise.

Only days later, the aforementioned Fortis bank returned to the forefront of the discussion in Europe. Belgian Prime Minister Yves Leterme said he was hoping to locate a new owner with the aim of restoring confidence in Fortis, and thusly, preventing a further downturn in the markets. Leterme said that the authorities were considering takeover bids for the Belgian operations of the company (the Dutch operations were nationalized as noted above.)

By Sept. 5, 2008, one of Germany's biggest banks, Hypo Real Estate, was at risk of failing. In response, German Chancellor Angela Merkel said she would exhaust all efforts to save the bank. A rescue plan by the government and banking institutions was eventually agreed upon at a cost of 50 billion euros (approximately US$70 billion). This agreement involved a higher cost than was previously discussed.

Meanwhile, as intimated above, Iceland was enduring further financial shocks to its entire banking system. As such, the government of Iceland was involved in intense discussions aimed at saving the country's financial regime, which were now at severe risk of collapse due to insolvency of the country's commercial banks.

Meanwhile, on Sept. 4, 2008, the leaders of key European states -- United Kingdom, France, Germany, and Italy -- met in the French capital city of Paris to discuss the financial farrago and to consider possible action. The talks, which were hosted by French President Nicolas Sarkozy, ended without consensus on what should be done to deal with the credit crisis, which was rapidly becoming a global phenomenon. The only thing that the four European countries agreed upon was that there would not be a grand rescue plan, akin to the type that was initiated in the United States. As well, they jointly called for more greater regulation and a coordinated response. To that latter end, President Nicolas Sarkozy said, "Each government will operate with its own methods and means, but in a coordinated manner."

This call came after Ireland took independent action to deal with the burgeoning financial crisis. Notably, the Irish government decided days earlier to fully guarantee all deposits in the country's major banks for a period of two years. The Greek government soon followed suit with a similar action. These actions by Ireland and Greece raised the ire of other European countries, and evoked questions of whether Ireland and Greece had violated any European Union charters. An investigation by the European Union was pending into whether or not Ireland's guarantee of all savings deposits was anti-competitive in nature.

Nevertheless, as anxieties about the safety of bank deposits rose across Europe, Ireland and Greece saw an influx of new banking customers from across the continent, presumably seeking the security of knowing their money would be safe amidst a financial meltdown. And even with questions rising about the decisions of the Irish and Greek government, the government of Germany decided to go down a similar path by guaranteeing all private bank accounts. For his part, British Prime Minister Gordon Brown said that his government would increase the limit on guaranteed bank deposits from £35,000 to £50,000.

In these various ways, it was clear that there was no concurrence among some of Europe's most important economies. In fact, despite the meeting in France, which called for coordination among the countries of the European bloc, there was no unified response to the global financial crisis. Instead, that meeting laid bare the divisions within the countries of the European Union, and called into question the very viability of the European bloc. Perhaps that question of viability would be answered at a forthcoming G8 summit, as recommended by those participating in the Paris talks.

A week later, another meeting of European leaders in Paris ended with concurrence that no large institution would be allowed to fail. The meeting, which was attended by leaders of euro zone countries, resulted in an agreement to guarantee loans between banks until the end of 2009, with an eye on easing the credit crunch. The proposal, which would apply in 15 countries, also included a plan for capital infusions by means of purchasing preference shares from banks. The United Kingdom, which is outside the euro zone, had already announced a similar strategy.

French President Nicolas Sarkozy argued that these unprecedented measures were of vital importance. The French leader said, "The crisis has over the past few days entered into a phase that makes it intolerable to opt for procrastination and a go-it-alone approach." He also tried to ease growing frustration that such measures would benefit the wealthy by explaining that the strategy would not constitute "a gift to banks."

While these developments were aimed at restoring confidence in the financial regime in Europe, Iceland continued to struggle. Indeed, the country's economy stood precipitously close to collapse. Three banks, including the country's largest one -- Kaupthing -- had to be rescued by the government and nationalized. Landsbanki and Glitnir had been taken over in the days prior. A spokesperson for Iceland's Financial Supervisory Authority said, "The action taken... was a necessary first step in achieving the objectives of the Icelandic government and parliament to ensure the continued orderly operation of domestic banking and the safety of domestic deposits."

With the country in a state of economic panic, trading on the OMX Nordic Exchange was suspended temporarily, although it was expected to reopen on October 13, 2008. Iceland's Prime Minister Geir Haarde said that his country was considering whether to seek assistance from the International Monetary Fund to weather the crisis.

Iceland was also ensconced in a mini-imbroglio with the United Kingdom over that country's decision to freeze Icelandic bank assets. At issue was the United Kingdon's reaction to the unfolding crisis in Iceland, which the British authorities said left deposits by its own citizens at risk. British Prime Minister Gordon Brown particularly condemned the government of Iceland for its poor stewardship of the situation and also its failure to guarantee British savers' deposits (Icelandic domestic deposits, by contrast, had been guaranteed by the country's Financial Supervisory Authority). That said, the United Kingdom Treasury was eventually able to arrange for some British deposits to Kaupthing to be moved under the control of ING Direct. There were also arrangements being made for a payout to Landsbanki's depositors.

According to the European Commission, European banks in early 2009 were in need of as much as several trillion in bailout funding. Impaired or toxic assets factored highly on the European Union bank balance sheets.

Overall, Eastern European countries borrowed heavily from Western European banks. Thus, if the currencies on the eastern part of the continent collapsed, effects would be felt in the western part of Europe as well. For example, Swiss banks that gave billions of credit to Eastern Europe cannot look forward to repayment anytime soon. As well, Austrian banks have had extensive exposure to Eastern Europe, and can anticipate a highly increased cost of insuring its debt.

German Finance Minister Peer Steinbrueck has warned that as many as 16 European Union countries will require assistance. Indeed, his statements suggest the need for a regional rescue effort. Of consideration is the fact that, according to the Maastricht Treaty, state-funded bailouts are prohibited.

By the close of February 2009, it was announced that the banking sectors in Central and Eastern Europe would receive a rescue package of $31 billion, via the European Bank for Reconstruction and Development (EBRD), the European Investment Bank (EIB) and the World Bank. The rescue package was aimed at assisting the survival of small financial institutions and included equity and debt financing, as well as access to credit and risk insurance aimed at encouraging lending.

Special Entry 2

Greece's Debt Crisis and Impact on the Euro Zone

Summary:

Attempts to resolve Greece's economic crisis have been at the forefront of the national agenda. There have also been serious concerns about Greece's economic viability across Europe and internationally. At issue have been deep anxieties about Greece defaulting on its debt, along with subsequent speculation about whether the European Union (EU) and the International Monetary Fund (IMF) would have to step in to prevent such an outcome. By April 2010, the prospects of Greece resolving the matter without help from some transnational body came to a head when the Papandreou administration formally said it would accept the EU-IMF financial rescue package to ensure debt service. But even with this move, Greece's credit rating was downgraded to junk status due to prevailing doubts that it will meet its debt obligations.

Crisis Landscape:

In December 2009, the new Greek head of government, Prime Minister George Papandreou, announced a series of harsh spending cuts in order to address the country's economic woes. He warned that without action such as a hiring freeze on public sector jobs, closure of overseas tourism offices, and decreased social security spending, Greece was at risk of "sinking under its debts." He also said that his country had "lost every trace of credibility" on the economic front and would have to "move immediately to a new social deal."

Fears of a government debt default in Europe emerged in the first week of February 2010, with all eyes focused on Greece. Of concern was the rising cost of insuring Greek debt against default, and fears were rising that a bailout by the International Monetary Fund might be in the offing.

For its part, the Greek government pledged to reduce its budget deficit by three percent of gross domestic product by 2012. That move was welcomed by the European Commission but met with the threat of strikes by Greece's largest union, which has railed against the prospect of austerity measures. By Feb. 10, 2010, the strike by the country's largest public sector union in Greece was going forward. Simultaneously, Prime Minister George Papandreou promised to "take any necessary measures" to reduce Greece's deficit including a freeze on public sector pay, increased taxes and the implementation of changes to the pension system.

The next day, leaders of the European Union said that while Greece had not asked for assistance, they stood ready to help ensure stability within the euro zone. A statement issued from a summit in Brussels read as follows: "We fully support the efforts of the Greek government and their commitment to do whatever is necessary, including adopting additional measures to ensure that the ambitious targets set in the stability program for 2010 and the following years are met." The statement, however, did not specify the nature of such support although there were indications that a loan might be in the offing. Following a meeting of European leaders on Feb. 11, 2010, Austria's Chancellor Werner Faymann explained the need to support fellow European Union member states saying, "It is important to have solidarity." However, he added, "We are not going to give the money as a present, it will be as loans."

Only a few days later, however, the news emerging from Europe was grimmer in regards to Greece's situation. As reported by the British publication, the Telegraph, the council of European Union finance ministers issued an ultimatum to Greece, warning that if that country did not comply with austerity measures by March 16, 2010, it would lose sovereign control over its tax and spend policies. The council also warned that the European Union would invoke Article 126.9 of the Lisbon Treaty to take control from Athens and impose requisite cuts. This threat was likely to have more of a practical effect on Greece than an earlier move by the European Union to suspend Greece's voting rights, although both measures indicated a severe blow to Greek sovereignty within the European bloc. From the point of view of the European Union, the verdict was that Greece's austerity plan contained insufficient spending cuts and uncoordinated measures, and compelled the need for such drastic action.

Perhaps not surprisingly, Greece took a different view. Greek Finance Minister George Papaconstantinou argued that his country was "doing enough" to reduce its public deficit from 12 percent to eight percent of GDP in 2010 by undertaking emergency fiscal cuts. Accordingly, Greece has also been reticent about taking further austerity measures, such as an increase in the value added tax or VAT, as well as further public sector wage cuts, which the European Central Bank has said might be necessary. But the rest of Europe was unlikely to receive Greece's claims on faith alone, given the emerging revelations that Wall Street likely helped Greece hide its balance sheets problem for the purpose of advancing euro zone accession.

By the third week of February 2010, as talks in Brussels commenced about the financial crisis in Greece, there was no consensus on the possible path toward helping stabilize the situation in that country. In fact, member states of the European Union appeared divided on the issue. Germany has said it wants to protect its own financial interests by constructing a "firewall" to prevent Greece's debt crisis from spiraling out of control. It was not known if that "firewall" was distinct from, or an actual euphemism for, a bailout for Greece funded by German funds. Certainly, Germany has been careful not to expressly state that it supports some sort of bailout measure for Greece, under the aegis of the European Union , using Germany funds. Indeed, Berlin would have to contend with an outraged domestic reaction, as well as a resistant coalition partner in government whose libertarian inclinations would leave them far from sanguine about such a move.

At the start of March 2010, in the face of pressure from the European Union, the Greek government agreed to a new package of austerity measures, including tax increases and spending cuts, aimed at resolving the budget crisis. The new package was met with approval from the European Union and the International Monetary Fund, who respectively hailed the move as evidence that Greece was taking necessary measures to reduce its precarious debt. The reactions of these two bodies were regarded as crucial, since Greece was hoping for German-funded assistance from the European Union, with the International Monetary Fund in line as an alternative avenue of assistance.

Nevertheless, since the measures included reductions in holiday bonuses paid to civil servants as well as a pension freeze, it effectively raised the ire of public sector workers and trade unions. From their point of view, the financial package would exact a punishing toll on the workers of the country. Not surprisingly, the country was hit by strikes with workers angrily protesting the deficit-cutting government measures detailed above. With schools closed, public transportation, flights and ferries at a halt, and garbage left uncollected, it was clear that the strike was in full-force. On the streets of Athens, striking workers registered discontent, while riot police were deployed across the city.

Regional Considerations:

Also at issue have been the fiscal challenges of Portugal and Spain, which like Greece, have to contend with debt and weakened public finances. One challenge for Spain is the fact that the central government (leaving the social security administration aside) controls only one-third of public sector spending. Accordingly, while the central government can set guidelines for the regional and municipal authorities, it has a fairly limited effect on overall fiscal policy. In Portugal, the government does not command a majority in parliament, effectively complicating the process of implementing fiscal policies, and necessitating broad national consensus on the matter of the country's economic health. Ireland, like Greece, suffers from budget deficits that exceed 12 percent of their economic output. However, Ireland's record in navigating difficult economic times (late 1980s, early 1990s) was believed to be in that country's favor.

Thusly, at the broader level, the European Union has been faced with the moral hazard of having to consider going down a similar path with Spain and Portugal, not to mention other European countries. Clearly, the European Union had no appetite for such a precedent being set in Greece. Not surprisingly, non-euro zone European Union members, such as the United Kingdom and Sweden, were recommending the International Monetary Fund route. They argued that an entity such as the IMF possessed the technocratic acumen and experience to orchestrate and supply a loan bailout to Greece.

Meanwhile, the Fitch ratings agency decided to downgrade Greece's credit rating two notches amidst anxieties that the country will be unable to solve its financial farrago without assistance from external parties. The downgrade was significant since Greece was now at risk of losing its investment grade status, at least according to Fitch. Greece retains marginally higher ratings with Moody's and Standard and Poor's. Earlier, Portugal's credit rating was also downgraded by the Fitch ratings agency over concerns regarding its debt woes. Ironically, the move by Fitch came weeks after Portugal passed an austerity budget aimed at reducing its high budget deficit. At the broader level, the decision to downgrade the credit ratings of both Greece and Portugal, along with attention on the possible rescue package for Greece, renewed anxieties about the problem of heavily indebted economies across the continent.

The situation in these European countries -- specifically on their debt burdens -- has focused attention concomitantly on the European Union where countries of the euro zone share currency but not economic policies, and whose collective fates would be affected by a devalued euro. Indeed, the euro itself has seen its value slide as a result of rising economic anxieties, and questions have once again surfaced regarding its viability.

Last Resort:

By late March 2010, a proposal was advanced to address Greece's debt crisis. The rescue package proposal was intended to be a last resort for Greece, should that country fail to borrow sufficient funds under normal conditions. It would require all euro zone countries to vote unanimously to fund individual loans to Greece, although not all countries would be required to contribute. No actual dollar amount was specified for the possible rescue package although there were suggestions that it would be valued at around 22 billion euro, with the lion's share of the funding being derived from the European Union (EU), and a small remained from the International Monetary Fund (IMF).

On April 10, 2010, euro zone countries agreed to fund up to 30 billion euros -- above the amount originally envisioned -- in emergency loans for debt-hit Greece. The price of the loans would be about five percent and in line with IMF formulas. The loans would not be activated by the euro zone; instead, it would be up to Greece to decide whether or not to avail itself of the funds, which would be co-financed by the IMF, although to what degree was unknown. For its part, Greece has said it does not want to go down the road of such loans, preferring to auction treasury bills. Greece was hoping that the very notion of an EU-IMF rescue package would ease volatile markets and advance an economic recovery, without actually having to activate the loans. However, such a path was viewed as potentially unavoidable, given the fact that Greece has no choice but to finance its debt obligations. As well, there have been the wider considerations at play -- that is, the impact on markets across Europe and the confidence in the euro.

By the close of April 2010, Greece officially requested that the EU-IMF "last resort" loan package be activated in order to deal with its debt-ridden economy and to prevent the unacceptable outcome of default by a sovereign European country. The EU and IMF responded by noting that they believed the details of the rescue plan could be worked through quickly. That being said, since much of the funding for the package would go through the EU, several euro zone countries will have to ratify the use of funds. For example, France would have to garner parliamentary approval for its contribution to Greece's rescue package. In Germany, where -- as discussed above -- the political ramifications of such a plan were expected to be pronounced -- German Chancellor Angela Merkel warned there would be "very strict conditions" attached to her country's contribution of assistance. As well, it was still to be determined how much the IMF would itself finance, along with interest rates by both the IMF and EU. With such hurdles yet to be crossed, it was unlikely that Greece would be in receipt of the much-needed funds until the second week of May 2010.

Meanwhile, Prime Minister George Papandreou expressed confidence in the path going forward. Speaking from the Aegean island of Kastellorizo, he said: "Our partners will decisively contribute to provide Greece the safe harbor that will allow us to rebuild our ship." But the Greek people were not easily assuaged by these words or the EU-IMF rescue package. Instead, they were still railing against the austerity measures enacted by the Greek government with tens of thousands of Greek civil servants taking to the streets to participate in mass strike.

Junk Status:

Further reluctance by Germany to fund the largest portion of the rescue package for Greece did not help the situation. In fact, with Greece acknowledging that it cannot service its forthcoming debt obligations without the EU-IMF loan, plus the realization that German funds will likely not come quickly, there were escalating fears that Greece could well default by May 19, 2010 -- a significant deadline when billions in bond payments would be due. Although Greek Finance Minister George Papaconstantinou insisted his country would "absolutely and without any doubt" service that debt, prevailing anxieties led another credit rating downgrade for Greece. Indeed, Standard and Poor's downgraded Greece's credit rating to junk status. That move, in addition to a slight downgrade to Portugal's debt on the basis of heightened risks, renewed attention to euro zone stability.

Update on Euro Crisis:

In May 2010, the European Union (EU) agreed on a euro stability package valued at 500 billion euros, aimed at preventing the aforementioned Greek debt crisis from deleteriously affecting other countries in the region. Countries within the EU's euro zone would be provided access to loans worth 440 billion euros and emergency funding of 60 billion euros from the EU. As well, the International Monetary Fund (IMF) would earmark an additional 250 billion euros. The European Commission would raise the funds in capital markets, using guarantees from the governments of member states, for the purpose of lending it to countries in economic crisis.

In addition, it was announced that the European Central Bank (ECB) was prepared to participate in exceptional market intervention measures, such as the purchase of euro zone government bonds, for the purpose of shoring up the value and viability of the euro currency.

These moves were aimed at defending the euro, which has seen its value drop precipitously as a result of the Greek debt crisis has gone on, and as anxieties have increased that a similarly disastrous fate could spread to other EU member states, such as Portugal, Spain, Italy and even Ireland. These mostly southern European economies were plagued not only by high deficits but also inherent structural economic weakness.

But even these overtures, as drastic as they might appear, would do little to address Europe's soaring public debt, according to some economic analysts. Indeed, among this core of economists, the argument resided that this rescue package could actually exacerbate the situation. Of concern has been the collective impact of low economic growth, high unemployment, and governments unwilling to take requisite austerity measures to not only decrease spending but also increase productivity. Rather than relying on heavy government spending to spur growth, governments in euro zone countries have opted to decrease their debt levels -- or at least to make the promise of moving in that direction. However, another core of economic analysts has argued that too much debt reduction -- without government stimulus -- could itself stymie economic growth. To this latter end, Daniel Gros of the Center for European Policy Studies warned that "the patient is dead before he can get up and walk."

Meanwhile, the economic crisis in Europe was spreading to the domestic political sphere in Germany. With the German cabinet of Chancellor Merkel poised to approve that country's part in the euro rescue deal, German voters issued a punishing blow to Merkel's conservatives in the state elections in North Rhine-Westphalia. The voters' reaction appeared to register discontent over the German federal government's decision. Germans, according to polling data, were already incensed over funding of the bailout plan for Greece. That separate package was also approved by the government and parliament.

Special Entry 3

The Greek debt crisis; effects on the euro zone, and the establishment of the European Financial Stability Facility

In recent years, a debt crisis has raged across the euro zone countries of the European Union (EU). In 2010, Greece stood as "ground zero" of the crisis, evoking deep anxieties about that country defaulting on its debt. Anxieties also increased that a similarly disastrous fate could spread to other EU member states, such as Portugal, Spain, Italy and even Ireland. These mostly southern European economies were plagued not only by high deficits but also inherent structural economic weakness, which could affect other countries in the euro zone in something of a contagion.

To stave off such a possibility, in 2010, the EU, in concert with the International Monetary Fund (IMF), agreed on a euro stability package, aimed at preventing the Greek debt crisis from deleteriously affecting other countries in the region. In addition, the European Central Bank (ECB) was prepared to participate in exceptional market intervention measures, such as the purchase of euro zone government bonds, for the purpose of shoring up the value and viability of the euro currency.

A year later in 2011, the Greek debt crisis was ongoing and Athens was in negotiations with the EU and the IMF to receive another tranche of its rescue package. Given the concerns about Greece's "highly uncertain growth prospects," as well as the prevailing burden of debt servicing and ultimate solvency, attention refocused on strategies to address the crisis. One option that surfaced was the restructuring of Greece's debt. In addition, there was the need for subsequent rescue loans for Greece.

In mid-July 2011, at an emergency euro zone summit, German Chancellor Angela Merkel cast the notion of another rescue package for Greece in some degree of doubt when she said that there would be no "spectacular" measures aimed at resolving Greece's debt crisis, such as the restructuring of Greek debt. The German chancellor made it clear that there needed to be a concrete plan for a second Greek rescue package, if there was any hope that the debt crisis in that country would be prevented from spreading across the euro zone. Ultimately, though, concurrence was reached on July 21, 2011, with a rescue package plan. The plan provides for the Germany-endorsed position that private lenders, including banks, would have to do their part in contributing to the package. Any measures that would allow Greece easier repayment terms could be viewed by credit rating agencies as acknowledgment that its borrowing was unsustainable -- and therefore, "partial default."

Greece was not the only country affected by the debt crisis. Already Ireland was the recipient of a rescue package and there was speculation that a second rescue package might be needed before the country could be cleared to return to capital markets. In Italy, that country was also dealing with economic challenges regarding stunted growth and an inability to reduce its dangerously high debt-to-GDP ratios -- one of the worst in the euro zone at 120 percent. In Italy's case, the notion of a rescue package was impossibly unaffordable, and raised expectation that Italy would not escape default. Spain was in a similar situation and was hoping that its austerity program (like the one being implemented in Italy) would help that country navigate its difficult economic waters. General expectations were that Spain might barely escape default because its debt-to-GDP ratio -- while poor -- was still better than that of Italy.

With the international community concerned about Europe's ability to solve its sovereign debt crisis, and the fear of financial contagion spreading across highly-indebted fellow euro zone member states, German Chancellor Angela Merkel and French President Nicolas Sarkozy were scheduled to meet on Aug. 16, 2011. The two European leaders were expected to discuss the situation and to work on effectively managing the euro zone. The decision for the two leaders to meet came as financial markets reacted negatively to the climate of insecurity sweeping over Europe. It was clear that investors had doubts about the ability of European governments to deal with the debt crisis, despite the funding of several rescue packages to the most imperiled economies of the euro zone.

Hopes for a comprehensive plan to address the situation were dashed after the meeting when the two European leaders emerged from the meeting and stressed the need for "true economic governance" for the euro zone. Merkel and Sarkozy championed closer economic and fiscal policy in the euro zone, such as the notion of budget measures included in the constitutions of euro zone member states. They called for a tax on financial transactions to raise more revenues. Investors reacted to these declarations by deeming them insufficient, and with economic analysts dismissing the plan as a missed opportunity. In fact, there had been warnings that Germany's demands for austerity would do little to aid in the thrust for economic recovery across Europe.

By the close of September 2011, the Bundestag, or lower house of parliament in Germany approved the expansion of a rescue fund for Europe's heavily indebted countries, known as the European Financial Stability Facility. The issue has been an extremely contentious one, with the participants of the global economy anxious for action to be taken in response to the debt crisis, but with German stakeholders incensed that they would be the major contributors to the rescue fund that would benefit countries, such as Greece. Indeed, the debt crisis in Europe has led to instability in the international markets and political imbroglios across the euro zone.

As Europe's largest economy, Germany's ratification of the rescue fund for the euro zone was a crucial step on the road to stabilization. The scenario evoked political ramification for German Chancellor Angela Merkel; while Chancellor Merkel received the necessary support in the parliament to approve the bailout fund, the measure left her ruling coalition weakened and could well negatively affect her grip on power in Germany in the future.

Regardless of the domestic political ramifications, the German ratification of the expansion of the European Financial Stability Facility breathed necessary life into the euro stabilization entity. With Austria and Finland also reaching agreements on the matter, only Slovakia was left to approve the measure. In the case of Austria, the approval in that country's parliament came after vituperative debate, with strong disapproval emanating from the right wing of that Austrian parliament. In Finland, approval required more than debate for passage. Finland was seeking collateral as security for its contribution to the euro zone bailout fund, which Greece -- as the main beneficiary -- agreed to provide. With this agreement forged, Finland agreed to withdraw its objections and move forward.

But concurrence on the expansion of the European Financial Stability Facility from Slovakia was not expected to come easily. Instead, one member of the coalition government warned that it would block approval in that country. In a nod to Slovaks who eschew the notion of a less wealthy Central European country having to pay for the mistakes of the more wealthy Greeks, the Freedom and Solidarity Party of Slovakia -- a participant in Prime Minister Radicova's coalition government -- had promised to oppose the move. With Slovakia positioned to be the main holdout in a scheme intended to stabilize the entire euro zone, there were high hopes for a compromise. Nevertheless, on Oct. 11, 2011, the parliament of Slovakia voted down the euro zone bailout expansion plan. Since the vote was also linked to a confidence motion, the center-right government of Prime Minister Iveta Radicova was also toppled in the vote, making the Slovakian government the latest political casualty in the economic debt crisis rocking Europe. A new vote took place two days later, and with support from the left wing opposition, the proposed expansion of the euro zone rescue fund was ratified, and a schedule for snap elections was secured.

Meanwhile, representatives of the International Monetary Fund, the European Union, and the European Central Bank, were set to review Greece's progress in reducing debt levels, and to make a decision on the release of the latest installment of bailout funds for that country. However, before a decision could be made, the finance ministers from the euro zone put the metaphoric "brakes" on the decision-making. After hours of talks in Luxembourg, the finance ministers from the 17-nation euro zone urged Greece to take on greater austerity measures and warned that banks in region should prepare for further challenges.

With a delay on the decision on releasing the latest tranche of bailout funds for Greece, it was yet to be seen if the IMF, EU, and ECB would ultimately recommend the release of bailout funds for Greece. Some deadlines of significance included mid-October 2011, when the decision would finally be made, and the actual release of funds to come (pending approval) at the close of October 2011. However, the current scenario suggested that Greece might not receive its needed installment of rescue funds until November 2011. To that end, as October 2011 entered its final week, finance ministers of the euro zone finally approved the tranche of rescue funds needed for Greece to escape disastrous default. The International Monetary Fund would also have to sign off on the release of the bail out money, but all expectations were that Athens would receive the much-needed funds by mid-November 2011.

In the backdrop of these developments have been fears that a Greek default could spark another banking crisis. The sense of anxiety was only exacerbated by news that the Franco-Belgian bank, Dexia, was in emergency talks, and that the credit ratings agency, Moody's, was considering downgrading the bank due to exposure to Greek debt.

Should Greece fail to service its debt commitments, there would be deleterious effects for the euro zone, European banks, and at the international level, there could be a seriously damaging influence on the global economy. Chairman of the euro zone finance ministers (known as the euro group), Prime Minister Jean-Claude Juncker of Luxembourg, foreclosed the possibility of a debt default by Greece, while simultaneously warning that Greece's private sector creditors should anticipate further losses on their Greek sovereign debt holdings - indeed, greater than the 21 percent "haircut" that was previously agreed upon months earlier.

It should be noted that there was a growing chorus of complaints about the slow and protracted political response to the debt crisis and concomitant euro zone challenges, which was largely due to the EU's institutional structure. As October 2011 entered its second week, French President Nicolas Sarkozy and German Chancellor Angela Merkel were pledging to do whatever was necessary to protect European banks from the debt crisis. That plan included the recapitalizing of European banks. The two European leaders also agreed to a plan that would amend the euro zone's operational structure to avoid the challenges detailed above. Notably, there would be accelerated economic coordination in the euro zone. Moreover, President Sarkozy and Chancellor Merkel concurred on addressing Greece's debt problems, and the need to restore market confidence.

By the start of December 2011, the leaders of the two biggest players in the euro zone -- French President Nicolas Sarkozy and German Chancellor Angela Merkel -- issued a joint call for serious changes to Europe's governing treaties, aimed at ameliorated economic governance for the 17 countries that make up the euro currency bloc. French President Sarkozy and German Chancellor Merkel met for talks on the matter in Paris as the euro zone countries continue to grapple with the regional debt crisis, emanating from Greece but extending across the euro bloc.

Included in their proposal were: (1) the creation of a monetary fund for Europe, (2) automatic penalties for countries that exceed European deficit limits, and (3) monthly meetings of European leaders. The proposal entailed compromises by both European leaders. President Sarkozy had to accept the notion of automatic sanctions for countries in violation of debt limit rules, while Chancellor Merkel had to accept that the European Court of Justice will not be empowered with the power of veto over budgets. Meanwhile, the European Stability Mechanism (ESM), which was intended to replace the European Financial Stability Facility in 2013, would be advanced earlier in 2012.

President Sarkozy said that they were looking to March 2012 to complete negotiations on the new treaty. Ideally, the new treaty would be ratified by all 27 member states of the European Union. However, if concurrence at that level proved impossible, then the 17 states of the euro zone would have to approve it. It should also be noted that European Council President Herman Van Rompuy has said that tougher budget rules for the euro zone may not require changing any existing European Union treaties. To that

President Sarkozy emphasized the imperative that such a crisis not re-emerge in the future. He said, "We are conscious of the gravity of the situation and of the responsibility that rests on our shoulders." For her part, Chancellor Merkel said her country, working in concert with France, was "absolutely determined" to maintain a stable euro. She also advocated for "structural changes which go beyond agreements."

While the new measures would certainly go a long way to addressing the issue of improved economic governance in the euro zone, they did not deal with the question of how many euro zone countries would deal with their debt challenges in a climate of low growth. Nevertheless, in the short run, the steadfast and unified message of intent by the two European leaders was, at least. expected to calm markets and facilitate lower borrowing costs for debt-ridden economies such as Italy, Spain, and Portugal.

Meanwhile, on Dec. 5, 2011, the credit ratings agency, Standard and Poor's, placed the countries of the euro zone on a "credit watch" with negative implications. Even power house economies of Germany and France were included in the move, which presaged a downgrade to come in the future. A day later, Standard and Poor's even warned that the euro zone bailout fund -- the European Financial Stability Facility -- could lose its own AAA rating. These moves have raised eyebrows across the world as regards the credibility of the ratings agency, which failed to warn the world of the sub-prime meltdown in 2008 that ultimately let to the global financial crisis. There were suggestions that this downgrade threat to euro zone countries, in conjunction with the downgrade of the United States months earlier following a particularly ferocious debt ceiling debate in that country, were evidence that the credit ratings agency was trying to "save face" by proving its tougher standards at this time. However, Standard and Poor's newly-discovered hard-line stance was being questioned by analysts, who pointed to the timing of the warning against euro zone countries. Indeed, this warning came precisely at a time when France and Germany were leading the charge in the European Union to solve the regional debt crisis, which has left the euro vulnerable, risked fragmenting the currency union, and which could yet imperil the fragile global economic recovery.

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On Jan. 13, 2012, the credit ratings agency, Standard & Poor's, stripped France of its sterling AAA credit rating, relegating France to AA+ status. Another ratings agency, Moody's, however, moved to maintain France's AAA rating, although it warned that France's deteriorating debt position placed pressure on the country's stable outlook. French authorities appeared to respond to the news with equanimity.

French Finance Minister Francois Baroin said, "It's not good news, but it's not a catastrophe." He also noted that the French government had no plans to enact either spending cuts or tax increases in response to the downgrade. Finance Minister Francois Baroin said, "It's not ratings agencies that decide French policy."

The ratings agency also downgraded Austria from its top notch AAA rating to AA+. The reduction on Austria's rating was partially attributable to the fact that it exports to Italy which is dealing with a recession, and that its banking subsidiaries in Hungary were facing losses.

Standard & Poor's downgraded Italy two notches from A to BBB+ Spain was in somewhat better shape than Italy although it was downgraded two notches from AA- to A. Slovakia was cut one notch from A+ to A. Slovenia was also cut one notch from AA- to A+. Following this trend, Malta was additionally cut one notch from A to A-.

Standard & Poor's, meanwhile, cut the credit of Portugal from BBB- to BB and Cyprus from BBB to BB+ -- junk status in both cases.

Belgium held steady with an AA rating, Estonia had no change to its AA- rating, and there was no shift from Ireland's BBB+ rating.

Germany, Finland, Luxembourg, and the Netherlands appeared to have escaped downgraded and held on to their AAA ratings.

As regards the status of the euro zone, Standard & Poor's also downgraded the European Union bailout fund -- the European Financial Stability Facility's (EFSF) -- from AAA to AA+. It should be noted that the decision to downgrade the EFSF was in keeping with the collective downgrades of individual European countries discussed above, since the rating is based on the ratings of the countries that guarantee the bailout fund. Should the EFSF obtain additional guarantees, it could recapture its AAA rating.

These developments made several countries the latest casualties in the ongoing sovereign debt crisis affecting Europe, and particularly, the countries of the euro zone. For its part, Standard & Poor's explained that it had taken these measures in response to the failed attempts by the leaders of the euro zone to deal with the ongoing debt crisis. Standard & Poor's released a statement that read as follows: "Today's rating actions are primarily driven by our assessment that the policy initiatives that have been taken by European policy makers in recent weeks may be insufficient to fully address ongoing systemic stresses in the euro zone."

The credit ratings agency went further and accused euro zone leaders of being unable to properly diagnose the causes of the crisis. Specifically, Standard & Poor's argued that the plan being advanced by leaders of the euro zone -- to limit governments' future borrowing -- was based upon an inaccurate understanding of the debt crisis. Standard & Poor's contention was that the challenge was not so much excessive borrowing, as much as it involved trade deficits and a loss of competitiveness by certain euro zone economies, including Italy and Spain.