The world has been waiting for the Greek crisis to come to a head for five years but this has been postponed by a sequence of last-minute bailouts. Another could still happen at the time of writing. But it appears as though the referendum will go through and that could mean a final resolution of some kind. Any end to the Greek crisis should lead to a relief rally in global equities. If there is a Grexit, there will be relief because the bailouts will cease. Else, there will be another bailout and the crisis will be postponed yet again, for five months, or for two years, or somewhere in-between, depending on the terms.
Whatever happens, there will be temporary volatility in global markets through next week, as the new realities are discounted. One likely result is hardening of the dollar. In his book, ' Dollar Trap' (2014), economist Eswar S Prasad noted dollar assets attract defensive investment during a crisis and Grexit clearly qualifies.
Briefly, the US contributes about 20 per cent of global gross domestic product (GDP) and its trade (import and export) amounts to about 11 per cent of world trade. About 60 per cent of world trade is dollar-denominated. In times of trouble, even if the trouble has originated in America (as in the sub-prime crisis), there is a tendency for conservative investors to head for US Treasury Bills.
This trust in US government debt is due to multiple reasons. America is the world's largest economy. It has strong legal institutions and the US central bank, the Federal Reserve, is considered both politically independent and institutionally competent. So are other US institutions like the Securities and Exchange Commission, and the various stock and commodity exchanges. Finally, the US could, in extremis, settle external debts simply by printing its own currency.
There are several potential challengers to the dollar's supremacy - the Chinese renminbi, the euro, even purely digital currencies like the Bitcoin. But the euro has received a major setback and the RMB is not mature enough to pose a challenge. The dollar will remain the primary global currency for the forseeable future.
The euro is used by 28 nations across Europe (including Greece). The euro zone has a larger share of global GDP and a much larger share of the trade (16 per cent) than the US. But the currency has seen recurring trouble. The threat of a Grexit adds to the stress since other euro-nations like Portugal, Ireland, Spain and Italy, are also struggling to manage high government debt, high unemployment and economic recession. Even France, the second largest European economy, is struggling.
The RMB has capital account restrictions and is pegged inside a narrow range. It has gained acceptance as China's contribution to trade has grown. But there isn't enough trust in China's institutions to make RMB a serious global currency yet. China also has very volatile financial markets and a large shadow banking system, with opaque levels of bank debt.
Comparatively speaking, the US economy is in far better shape than other parts of the world. America has seen steady job creation, month after month, for five years. The Federal Reserve is getting set to raise interest rates.
Meanwhile, the euro zone is struggling to emerge from recession. The European Central Bank is trying a massive quantitative expansion. Writing off Greek debt won't make balance sheets healthier but it stems future rot. China has cut rates four times in 2015 and also released successively lower GDP estimates.
So, the US is a better bet than other big economies. If money flows back into America's bond markets and equities, the dollar will harden against most currencies. The one uncertainty is the political factor, with a new president guaranteed in 2017. But that is quite distant.
The dollar will harden further, as and when the Fed does raise policy rates. This effect of a harder dollar will also be felt by the rupee. If the rupee does fall versus the dollar, this will lead to investment interest in export-oriented sectors like information technology and pharmaceuticals. At the same time, companies and sectors with high European presence could see a bad quarter or two.
Amidst all this talk of global factors, one thing is easily overlooked. India's domestic economy is recovering. The gradual pace of recovery might disappoint many (including yours truly) but there does seem a recovery in progress. It would not be wrong to ignore Greece and the Foreign Institutional Investorperspective, and focus on Indian equity.
