There is no rest either for the wicked or for those, it seems, who work in the financial markets. Just as the currency, bond and stock markets were reconciling to the prospect of a delayed rate hike by the US Fed amid a gentle recovery in America and welcoming in the European money-printing or quantitative easing programme, the prospect of Greece leaving the euro zone in the near future has increased manifold. European finance ministers, apparently miffed by the new Greek government's lack of commitment to the rigours of the austerity programme that had been chalked out for it, are refusing to extend financial support.
The International Monetary Fund has also spurned Greece's request for extension of loan repayments that are due in May. Thus, a default on its Euro 1-billion repayment due in May seems imminent. While a default need not necessarily mean an immediate exit from the currency union, it certainly raises the probability of Greece having to quit, especially since Greece needs Euro 20-25 billion of assistance over 2015 to tide over its debt service obligations.
It might be somewhat difficult to fathom why markets both within and outside Europe have been relatively blase about the risk of Grexit. Thus, while Greece's sovereign bond yields have perked up, this hasn't spilt over to the bonds of other economies in the periphery. India's equity markets have been through a rough patch, but this time around it appears to have been due to local factors. There could be a couple of reasons why this is happening. Traders have grown used to Greece living constantly on the edge of precipice and not keeling over and thus hopes of a 'bailout at the eleventh hour' linger.
There is also the argument that Greece is a special case, both exceptionally profligate and pig-headed about reforms. Thus, Greece's example might not necessarily push others to go down that route. Many in the financial markets are betting on a scenario of default without Grexit. They believe that Greece will not get dumped by European leaders, as it will hurt Europe's and particularly German Chancellor Angela Merkel's geo-political ambitions.
We believe that the markets are underestimating the possible repercussions: exit from the union, however well managed, is unlikely to be orderly. For one thing, the panoply of financial support programmes that have provided succour to Greece entails that European sovereign states (that have funded the bailouts) rather than European banks will bear the brunt of Greece's exit and defaults. Thus the euro zone could see a fiscal problem getting tagged on to its current list of woes. Besides, at a broader level, Grexit would mark the failure of the euro project as a whole and raise serious questions about the region's fundamental policy architecture.
Again, while European leaders are likely to put their weight behind other economies on the periphery that face economic stress and affirm their commitment to keep the flock together, Greece's exit will give the burgeoning anti-austerity movements across the region a shot in the arm. In fact, if Greece's transition to its own currency and independent monetary policy is relatively smooth, the clamour for secession from the union is likely to rise.
Spain and Italy seem next in line for exit hobbled as they are with massive public debt and a fractured political system. However, the ripple effects might not stop at the periphery. There are extreme secessionist right and left wing parties on the rise in the 'core' as well (Marine Le Pen's Front National in France comes to mind) and their cause is likely to gain traction if Grexit does go through.
All this would mean that the euro will remain both depressed and volatile as the uncertainty regarding Grexit gets prolonged. Meanwhile, the dollar will continue to gain in strength, especially as the US Fed inevitably raises interest rates in the latter half of 2015. Periodic panic attacks could grip financial markets as the European drama unfolds.
Abheek Barua is chief economist, HDFC Bank. Bidisha Ganguly is Principal Economist, CII
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
