Chief Vitalstatistix of the legendary yet unnamed Gaul village always carried a shield over his head to prevent being hurt if the sky fell down. Should we all take such precautions following the Greek tragedy currently unfolding?
Both DEA secretary Mehrishi and Niti Aayog vice-chairman Panagariya have somewhat vaguely assured us that India will not be directly affected by the events of ‘messy Monday’ in Athens. But they have not clarified if we will remain unaffected by a possible ‘Grexit’ after the referendum on July 5.
This is in contrast to the warning sounded by RBI governor Raghuram Rajan, that the world could be headed towards Great Depression like conditions. He foresaw this downside if central banks persisted with their policies, already visible in Tokyo, Frankfurt and New York, of competitive devaluation to try and lift economic growth through a greater reliance on external demand in global market conditions that are likely to remain muted in the foreseeable future.
Therefore, before we either become unduly complacent or rush to buy the protective shield, it will be prudent to examine if a possible ‘Grexit’ from the eurozone, to which rating agencies are assigning a 60% probability, comes about on July 5. Stock markets without an exception, from Nikkei in Japan to Dow Jones in the US and our own Sensex and Nifty, tanked this Monday as the Greek drama unfolded.
But equity brokers are known to be skittish and suffer from ‘herding’ behaviour. All Asian markets including Nikkei, Hang Seng and Sensex had recovered yesterday, having shed their original fears. I suspect European markets will follow suit. This confirms my long held view that equity markets can never be a guide to good policy making.
A far better guide to global financial market conditions is given by yields on government bonds, which reflect investors’ perceptions of sovereign risks and their expectation of how likely is the spread of contagion from Greece. True to expectations, yields on German and UK government bonds declined significantly as investors rushed to safety.
But quite surprisingly, Monday also ended with yields declining on government bonds in Italy, Spain and Portugal! This was most unexpected because these economies could be considered most vulnerable to a contagion from Greece.
It is clear that the European Central Bank (ECB) and national monetary authorities have worked out a strategy to intervene heavily in government bond markets and prevent even the most vulnerable economy Italy, with public debt of more than 300% of GDP, from being impacted by the Greek contagion. ECB has had a long time to refine its response to a Greek default and it has clearly used its time to good effect.
Greece, with its GDP accounting for a mere 2%, is a very small part of the European economy. Its share of aggregate European public debt is similarly tiny. Moreover, 60% of Greece’s outstanding public debt of €323 billion is owed to official agencies like the European Stability Fund, EU’s Special Greek Facility and ECB. Financial markets seem to be signalling a ‘Grexit’ will not bring down the European monetary union.
Only about 16% of Greek sovereign bonds are owed to private banks, mostly French and German. These will either be secured by their respective governments or will be seen to be as far too small to have any major impact on global financial markets and economy.
Ultimately, Greece did not have the dubious advantage of being too large to fail. So the global economy and India will be spared the trauma of another financial sector meltdown as in 2008. However, the proud Greeks themselves will have to bear the huge costs of utter dishonesty, chicanery and anti-national behaviour in the past of their businessmen and policy makers.
India has marginal direct exposure to Greece. A global or even a European contagion from a probable ‘Grexit’ looks unlikely. Therefore, our policy makers in North Block and Mint Road need not be distracted by some degree of equity markets volatility.
India is not likely to suffer from capital flight to safety as our macroeconomic conditions are sound and medium term economic prospects look promising. This is a huge turnaround from 20 months ago when India was the most vulnerable among the ‘fragile five’ Brics economies.
The Greek drama will hopefully prod us into re-examining India’s position in the global economy and take necessary steps to exploit the opportunities offered by global markets, which may be in slow motion but still offer huge scope as our share of global trade remains an abysmal 2% or less.
We should aggressively expand public capital spending to improve infrastructure and trigger private investment, which remains weak. The relatively slower growth of aggregate world demand and volatility in foreign exchange markets requires a sharply focussed policy response to improve the competitiveness of both services and merchandise exports and expand our market shares. That is a direct and unambiguous lesson for us from the current Greek tragedy.