The Spectre of a Grexit Continues to Haunt the World

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Greece finally missed its debt repayment obligation($1.7 billion) to the International Monetary Fund (IMF) as the June 30 deadline passed yesterday. Significantly, this is the first time a European nation has defaulted on IMF debt payment. This also puts in jeopardy a $9 billion plus financial bailout package, which Greek authorities were trying to negotiate with the IMF so that wages and pension obligations could be met over the next two years.

With the prospect of receiving this crucial aid package becoming shaky and the government imposing capital controls and limits on daily ATM withdrawals, there is immense nervousness among Greek citizens as well as all across global markets. Though top analysts on Wall Street believe that Greece exiting the euro has been substantially factored in by world markets, there is always a strong post-event reaction in such cases.  However, currently there is some confidence that Greece can be easily ring-fenced as it is just 2% of the European economy with a GDP of roughly $250 billion.

The issue, however, is not just about Greece where government debt has ballooned from about 90% of GDP in 2009 to 174% of GDP in 2015. There are other vulnerable economies like Portugal, Ireland and Spain whose public debt to GDP ratios have gone up substantially since 2009 and are  in the range of 120% to 135% of GDP. Eurozone’s average debt to GDP ratio itself is 100%.

Long-term implications

So there is a long-term vulnerability of Eurozone which cannot be denied. One doesn’t know how Greece’s exit from the euro will solve the fundamental vulnerability of many of the other Euro economies whose debt burden has increased 70% to 80% over the past six years and were there is little sign of a robust return of growth and employment. In the past, Portugal and Ireland accepted tough IMF conditions on effecting huge cuts in redundancy packages for workers and freeing small businesses from collective bargaining obligations.

Essentially, the hit had to be taken by the working class. Greece too is being asked to accept such stringent conditions. However, the party in power, Syriza, is a coalition of radical left groups and it came to power in 2014 precisely to resist such humiliating conditions of austerity imposed by the IMF and other EU creditor nations the burden of which falls largely on the working class. For instance Greece is being asked to sharply cut its pension payments and implement labour reforms which reduce the bargaining power of workers and improve corporate profitability.

Since Prime Minister Alexis Tsipras can’t accept such humiliating terms, he has chosen to put them up for a referendum—Yes/No – on July 5.

At the eleventh hour before the IMF deadline for repayment expired on 30 June, Greece offered a deal to the European creditors that it would call off the referendum if the two-year aid package for Greece was cleared. The creditor nations led by Germany decided they would rather see the result of the referendum before taking any further call.

So all eyes are on the referendum to be conducted on 5 July. For the Greek voters it is big dilemma because the majority of them support staying with the Euro but at the same time don’t want to accept humiliating terms which impact vast numbers. There is also anger among Greek citizens at the prospect of not being able to withdraw more than 60 euros a day from the ATM.

High-wire act

There is obvious brinkmanship going on between Greece and its creditors. One doesn’t know where this will end.

If Greece is forced to exit the Euro there will be some damage to short term financial flows from the Eurozone. After all, Greece has borrowed $271 billion from the creditor nations, IMF and European Central bank. Experts say the bulk of Greek bonds are held by IMF, ECB or other Euro governments. Only about $40 billion are held privately. So it is felt that there would not be any large-scale panic sale of Greek government bonds, barring what is privately held, in the event of Greece’s exit from the euro.

However, what is not being disclosed is that some of the big private European banks in Germany, Spain, France, Italy, etc., continue to hold government bonds of vulnerable economies like Greece, Spain, Portugal and Ireland whose values have eroded but not been written down yet to reflect their true market value. At some point their values will have to be written down and Greece’s exit from euro will reignite fears about the prospect of sharp erosion in the value of government bonds lying in the balance sheet of private banks. This will constrain banks from lending liberally internationally.

It is here that India is likely to be hit in the short to medium term. Indian companies get over 40% of their dollar loans from European banks which dominate trade finance and other forms of innovative lending globally. So cost of funds could go up for India at a time when it is trying to get tens of billions of dollars to funds its infrastructure. This could lead to Indian companies depending more on Chinese banks to fund infrastructure as has been the experience these past few years, post the 2009 financial crisis.

No wonder the US authorities are also leaning on Germany to ensure that Greece doesn’t exit the euro. The unravelling of the euro area could set off new dynamics in financial flows in growing Asia. It must be remembered that the Chinese offered currency swap arrangements to over 25 vulnerable emerging economies after the 2009 financial crisis. The Chinese also offered financial assistance of an undisclosed amount to vulnerable eurozone economies by purchasing their government bonds.

Overall, after each big crisis there is some shift in the dynamics of financial flows  between the North and South, as well as within South nations. This one too could play out in interesting ways, especially if Greece were to exit the euro.

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