Economic and Monetary Union

by Michele Chang

Summary of euro area countries that applied for financial assistance


Greece is rather unique than the other program countries in numerous ways. Its debt and deficits are larger, and its economy is more closed and less competitive. Moreover the weakness of its public administration, particularly its “tolerance for corruption” (Gros, Alcidi et al. 2014, p.35) made it a particularly challenging case. The Greek economy had long suffered from “endemic problems of low competitiveness, trade and investment imbalances, and fiscal mismanagement” (Featherstone 2011, p.193). Already in 2005 Eurostat declared that it could not validate its deficit figures, and the following year an IMF report noted the lack of fiscal transparency (Gouardo and Pisani-Ferry 2012).
The sovereign debt crisis began in November 2009 when interest rates on Greek sovereign bonds spiked as a result of the budget the new PASOK government had submitted to the European Commission (Arghyrou and Tsoukalis 2011) that included a much higher deficit level (12.8% of GDP, revised later to 13.6% instead of 3.6%) (Featherstone 2011, p.199). By January 2010, it was publicly acknowledged that Greek data had been unreliable for years due to “political pressures” (European Commission 2010b, p.4). The EU was slow to react despite the predictions of “an overwhelming majority of market analysts [who] forecasted a Greek default (Pagoulatos and Quaglia 2013, p.191).
Finally, in April 2010 the EU joined the IMF to promise €40-45b (€30b from euro area Member States and €10-15 billion from the IMF), which was increased on 3 May 2010 to an emergency loan facility of €110b (€80b from the euro area, €30b from the IMF). The ECB waived its requirement that Greek debt hold a high debt rating to be accepted as collateral (Kiekegaard 2010), and it continued lending to Greek banks and “thus provided, de facto, much quicker support than the later forthcoming from EU partner countries and the troika” (Gros, Alcidi et al. 2014, p.20). On 9 May, an extraordinary Ecofin meeting hammered out the details on the comprehensive package of measures designed to stem the crisis, including the EFSF and the EFSM.
The troika initially emphasized fiscal policy in its conditionality program for Greece, based on the assumption that growth would resume and unemployment would peak by 2012. Neither occurred; instead, unemployment soared to over 25% and real GDP dropped over 20%, exacerbating its debt-to-GDP levels (Sapir, Wolff et al. 2014). According to the IMF (2010e, p1), “risks to the program are high. The adjustment needs are unprecedented and will take time,” predicting that the necessary reforms were “bound to limit growth for a protracted period.”[1] Nevertheless, the level of the fall in output was unexpected, making it difficult for the government to comply with the fiscal targets set. Moreover, “many of the fiscal measures that were formally adopted by the Greek parliament were not fully implemented” (Gros, Alcidi et al. 2014, p.22).
Tensions continued to mount, exacerbated by the equivocating of the euro area regarding debt restructuring due to “political reluctance in Europe…the fear of moral hazard effects and the absence of effective mechanisms to contain its possible fallout” compared to the political difficulty of a generous bailout (Pisani-Ferry, Sapir and Wolff 2013, p.75). In July 2011, the European Council agreed that a new program was needed that included an extra €109b as well as “private sector involvement” (PSI, later known as “bail-in”) (European Council 2011), and on 26 October investors agreed to a “voluntary” haircut of 50 percent through the exchange of existing bonds against new bonds with longer maturities and lower interest rates. Its impact was mitigated by the need to limit the haircut to foreign private institutions, with Greek banks and other financial institutions receiving compensation for any losses in order to prevent the collapse of the Greek banking system (Gros, Alcidi et al. 2014).
Shortly after the announcement of the deal, Greek Prime Minister Papandreou called for a referendum on the new package. His EU partners were furious. Despite the subsequent retraction on 3 November, he resigned and new elections were set for May 2012. Greek bond yields continued to rise.
On 9 March, the Greek government used collective action clauses to compel holdouts to comply with a debt restructuring of €100b, leading to a “credit event” according to the International Swaps and Derivatives Association that prompted the payout of billions of dollars of CDS. The second Greek bailout was concluded in March 2012, and the new conditionality program placed more emphasis on employment and privatization. Despite the “minimal financial disruption” that it caused (Zettelmeyer, Trebesch and Gulati 2013, p.513), bond yields continued to rise. The 17 June elections gave pro-bailout party New Democracy a narrow victory, and the new coalition government announced further spending cuts.
Mario Draghi’s OMT announcement that summer alleviated much of the pressure. Since then, Greece experienced an improved current account balance (mainly due to lower imports) and lower interest payments (Sapir, Wolff et al. 2014). Nevertheless Greece’s economic conditions remain difficult, and the austerity policies pursued by the government contributed to rising populism (Vasilopoulou, Halikiopoulou, et al. 2014). This led to the election of the anti-austerity Syriza party in January 2015 (subsequent events are covered in the main text).


Prior to the outbreak of the global financial crisis, Ireland had experienced strong economic growth throughout the 1990s and was known as the “Celtic tiger,” benefitting from strong exports and prudent fiscal policy. After the introduction of the euro, lending conditions relaxed, Ireland’s financial sector grew rapidly and a housing bubble emerged; indeed, its household and non-financial corporate indebtedness ranked among the highest in the EU. Meanwhile, its external competitiveness declined as investment turned inward. Domestic banks’ total assets were 320% of GDP by 2006 (Commission 2011, p.9).
After the global financial crisis spread to Europe in September 2008, the Irish government offered a blanket guarantee for a period of two years for all Irish banks. The housing bubble popped, the crisis hit the real economy, and the stability of the financial system (which had strong exposure to the real estate sector) came under question. In September 2010, the Irish central bank confirms that the bailout of Anglo Irish Bank (nationalized in January 2009) could cost up to €34.3b, boosting its deficit to 32% of GDP. On 26 October, the government announced that in order to achieve its deficit target it would need additional measures that would amount to €15b (about 10% of its GDP). It bond yields soared past 9%. In November 2010, Ireland received an €85b bailout, with €35b earmarked for the financial system.
Ireland enjoyed a competitive, open and flexible economy, so the structural reforms demanded by its conditionality program were less onerous than in Greece or Portugal; most of its reforms focused on its banking sector (Sapir, Wolff et al. 2014). Fiscal adjustment took place mainly through expenditure cuts, and Ireland suffered a deep recession. However, “the primary driver of the recession in Ireland was the huge decline in housing construction, not austerity” (Gros, Alcidi et al. 2014, p.18). The maturity of its EFSM and EFSF loans were extended in 2011 (from 7.5 to 12.5 years) and again in 2013 (to 19.5 years).
On 14 November 2013, the Irish government announced its exit from its EU/IMF program without a pre-arranged precautionary credit facility. As per the two-pack (Article 14 of Regulation 472/2013), Ireland is also subject to post-program surveillance until it repays at least 75% of its loans, subject to regular reviews. Nevertheless Ireland continues to battle a large debt overhang, a domestic credit crunch despite its success in bank recapitalization and stabilization (Gros, Alicid et al. 2014).


Portugal did not experience a boom after introduction of the euro. Prior to the outbreak of the financial crisis, Portugal already suffered from high debt levels (public and private), weak growth and current account imbalances. Like in Ireland and Spain, Portugal faced the issue of large private debt becoming public once households and firms were unable to meet their debt obligations (Gros, Alcidi et al. 2014). In March 2011, Prime Minister Socrates resigned after his austerity budget was rejected by opposition parties. Bond yields spiked, and major credit ratings agencies downgraded Portugal’s sovereign debt rating.
The Portuguese government applied for assistance on 7 April 2011, and an Economic Adjustment Program was negotiated in May 2011 with the troika for €78 billion (EU/EFSM – €26 billion, Euro area/EFSF – €26 billion, IMF – about €26 billion). Its program included structural reforms, fiscal consolidation, and cleaning up the financial sector through recapitalization and deleveraging. Like the other program countries, Portugal needed to enact numerous austerity measures to comply with the bailout conditions.
A rift over austerity measures in the ruling coalition led to the resignation of Finance Minister Vítor Gaspar in July 2013. The liberalization of the energy, transportation and telecoms/postal markets led to the government raising €8.1b in asset sales, including shares in its postal service CTT-Correios de Portgual SA, utility EDP-Energias de Portugal SA, power and natural gas grid operator REN-Redes Energeticas Nacionais SA, and the sale of airline operator ANA-Aeroportos de Portugal SA (Lima 2014).
Structural reforms figured prominently in its conditionality program, given the lack of competitiveness of the economy. Some key reforms included making the labor market more flexible, freeing the business environment from red tape, and strengthening the regulatory framework (Commission 2014f). In some respects, the strategy seemed to work; Portugal’s current account went into surplus for the first time since the 1960s, and by 2013 exports amounted to about €10b, helping to offset the tightened fiscal policy (Gros, Alcidi et al. 2014). But the program did not reverse the decline in investment or the pattern of weak growth despite better export earnings (Sapir and Wolff 2014).
On 17 May 2014, Portugal exited its €78b bailout. Like Ireland, it declined access to a precautionary credit line. Despite the urging of the EU, the IMF and the ECB to consider such a credit line, Portuguese Prime Minister cited its “financial reserves for a year that will protect us from any external turbulence…[and] historically low” borrowing costs (Wise 2014). Its 10-year bond yields had dropped to 3.44 shortly before its exit, down almost 15 percent from its January 2012 high of 18 percent (though still higher than yields in Ireland, Spain and Italy) (Lima 2014).


In Spain, rapid credit expansion fueled a real estate bubble that burst after the global financial crisis. Spanish banks, particularly the cajas (unlisted savings and loan banks), were heavily exposed to the real estate sector. The government began restructuring in 2010, but the deep and protracted nature of the crisis raised funding costs for the Spanish government and Spanish banks. Though Spain and its banks initially fared well after the global financial crisis, “as in Ireland, the collapse of the real estate markets eventually led to a traditional banking crisis” (Royo 2013, p.152). Spain is also a bit unusual in that it was not its largest banks that faced trouble but its cajas.
Spain had experienced strong growth in the years prior to the crisis, and after the crisis the economy fell into a deep recession, suffering from the sharpest drop in domestic demand among the major euro area countries (more than double that of Germany, France and Italy) and high unemployment. As contagion from the sovereign debt crisis threatened to engulf Spain (an economy that was both too big to fail and too big to save), the government embarked on fiscal consolidation. In November 2011, voters rejected the ruling PSOE, and the PP achieved an overall majority in parliament. On 30 December PM Mariano Rajoy announced that Spain’s deficit would be over 8% of GDP (the official target was 6%), and the government committed to over €15b of new austerity policies.
In April 2012, a government bond auction failed to reach its target, so the government tried to bolster market confidence through an additional €10b budget cut. Bond yields continued to climb and crossed 6 percent for the first time since Rajoy had taken office in December 2011. In May, Spain’s largest mortgage lender Bankia was nationalized through a €23.5bn bailout. Spanish bond yields remained at the punishing rate of 6.5 percent. In June 2012, the Spanish government applied for a loan of up to €100 billion to recapitalize its banking sector (though channelled through the government); its own analysis estimated it would require €51-62 billion, and the government asked for additional funds as a margin of error. This marked the first use of the European Stability Mechanism. Although the initial market reaction was positive, just a few weeks later bond yields rose again, eventually crossing 7 percent.
On 3 December 2012, the government asked for a €39.47 billion disbursement of ESM notes that were transferred on 11 December 2012 to the Fondo Restructuración Bancaria (FROB), the bank recapitalization fund. On 28 January 2013, the government requested €1.86 billion, and the money (in the form of ESM notes) was transferred to the FROB on 5 February 2013.
In exchange for the assistance, bank-specific conditionality was attached: an asset quality review of the banking sector and stress tests of individual banks; recapitalization and restructuring of weak banks; troubled assets in banks receiving public funds were hived off into an external asset management company, Sociedad de Gestión de Activos Procedentes de la Reestructuración Bancaria—SAREB. The banking sector was further strengthened via “horizontal conditionality” (ESM FAQ).
Spain exited from its bailout program in January 2014 without a credit line. Although foreign investor confidence had returned and its labor market had stabilized, it still suffered an unemployment rate of 26 percent and “growth remains anemic” (Perez 2014).


Cyprus’ entry into the euro area in 2008 had been preceded by favorable economic conditions. Rising wages and strong credit growth supported domestic demand. The adoption of the euro in 2008 fuelled private sector indebtedness and a real estate bubble as its current account deficit soared. Shortly thereafter, Cyprus elected a communist president, Demetris Christofias, who started increasing government spending. In 2010, its large financial sector started running aground; it was heavily leveraged and overexposed to Greek sovereign debt (the Greek debt restructuring cost Cypriot banks about €4b). In addition, its banks were accused of money laundering (Commission 2013d; Sapir, Wolff et al. 2014). Despite warnings from the national central bank and the ECB, the government refused to undertake fiscal consolidation, and the government lost international capital market access in May 2011. In July, a power station explosion threw the economy into recession. By December 2011, the European Banking Authority ordered the two major banks, the Bank of Cyprus and Laiki, to strengthen its capital buffers by June 2012. Cyprus originally sought assistance from Russia, negotiating a €2.5b in December 2011 and attempting to rectify its fiscal position outside of an official programme. Despite its consolidation efforts, the deficit continued to deteriorate (Sapir, Wolff et al. 2014). The second Greek bailout and its concomitant PSI made Cyprus’ situation untenable. Nevertheless, it was able to hold on through its access to ECB assistance, specifically the collateral that Eurosystem banks could borrow and, once this was exhausted, emergency liquidity assistance (ELA) from the Central Bank of Cyprus (Jones 2015).
In June 2012, the three major ratings agencies downgraded Cyprus’ debt below investment grade, making it ineligible as collateral at the ECB. The ECB had made an exception when similar events happened to Greece, Portugal and Ireland, but the ECB was trying to send the government a signal (Orphanides 2013).
Although the Cypriot government made an initial request to the Commission on 25 June 2012, an economic adjustment program was not agreed upon by the troika until 2 April 2013. An initial memorandum of understanding was signed in late 2012. However when conservative president Nicos Anastasiades took power on 1 March 2013, he faced demands from other European Council members for a haircut on deposits. According to former central bank governor Athanasios Orphanides (2013), “Cyprus got caught up in the German election” that was expected in September 2013. Facing mounting public discontent over the numerous euro area bailouts over the last few years, the Eurogroup insisted that investors pay some of the costs for the failure of the financial system and established a “one-off stability levy” on deposits comprised of a wealth tax of 6.75% on deposits under €100,000 and 9.9% for those above. This was “sweeping in its scale and unprecedented in the three-year-old crisis” (Spiegel 2013b). When the Cypriot House of Representatives refused to approve the deal on 19 March, the ECB declared that Emergency Liquidity Assistance to Cyprus would cease as of 25 March (Sapir, Wolff et al. 2014), cutting off its last supply of financing.
The government established capital controls on 22 March and declared a bank holiday until 28 March (Sapir, Wolff et al. 2014).The total financial package was €10b, with the ESM giving €9b and the IMF the remaining €1b. On 28 March, the government reached a new deal with the troika that protected all deposits under €100,000 but impacting heavily those above. The new plan did not require parliamentary approval (unlike the first plan) because the losses on large depositors would be done through the restructuring of its two major banks, not a tax. The Bank of Cyprus was capitalized through shareholder and bondholder contributions (bail-in) as well as converting 47.5% of uninsured deposits into equity. The Cyprus Popular Bank (Laiki) enacted a full bail-in of shareholders and bondholders and a partial bail-in of uninsured depositors. Laiki was then separated: Legacy Laiki held uninsured deposits and received shares of the Bank of Cyprus, while the Bank of Cyprus received Laiki’s insured deposits along with certain assets and liabilities. Laiki’s uninsured depositors would thus be compensated through the liquidation of assets in Legacy Laiki (ESM FAQ). Cyprus’ conditionality program included the restructuration and downsizing of its financial institutions, strengthening banking supervision, fiscal consolidation, and structural reforms to improve competitiveness (ESM FAQ).
Remarks by Eurogroup chief Jeroen Dijsselbloem made shortly thereafter implied a new modus operandi for the euro area involving bail-in. The negative reaction this provoked prompted numerous actors, including several ECB Governing Council members and the European Commission, to deny that Cyprus constituted a “template” (Saigol 2013). Nevertheless, bail-ins quickly became enshrined in succeeding legislation, including those related to the banking union (see chapter 5).

[1] IMF staff report, ‘Request for Stand-By Arrangement’, 5 May, 2010