Thursday, June 14, 2012

How will the Greek exit from Euro impact us?

There have been many recent news items saying that if Greece left the Euro zone, it will have devastating effect on the global economy and we are not insulated enough - that set me thinking as to what would happen to India and my view is that nothing much will happen to us – we are reasonably safe.

First let us see what will happen to Greece, and then we will see what will happen to us in India.

As we all know, elections are scheduled in Greece this week and there is a 50% plus chance that the Greek will vote for the party opposed to the austerity measures imposed through agreements with IMF and ECB. If the new government goes back on its austerity agreements, the Greek government will not be supported by further infusions of credit from IMF and ECB – this will result in the Greek government running out of funds in a month or two –but before that there will be a run on the banks –Greek citizens would like to take their cash out of banks and that will trigger a banking crisis.  In order to avoid that, the Greek government will need to launch its own currency immediately and leave the Euro zone. In order to be globally competitive, the new currency will need to be pegged at an estimated 30% lower than the current Euro. This will create inflationary conditions in Greece –the interest rates will go up, cost of doing business will go up and Greek economy will be in a recessionary state for a few years – they will need to pull themselves out of this mess over time by improving their competitiveness and productivity.

Now what will happen to the rest of the world and especially to India - If Greece exits the Euro zone, there will be flight of capital away from other “high risk” countries like Spain and Italy. The cost of borrowing in these countries will go up. Investors would move to safe haven currencies and currently US is the preferred safe haven. The Dollar would strengthen against the Euro.  That would mean that the Indian Rupee would be under pressure on account of the strengthening US Dollar –Indian Rupee would depreciate a bit further – this would put further pressure on Inflation in India as imports will become costlier. It will surely put pressure on the Indian economy – but as we know, the Indian Rupee has already lost about 20% of its value in the past 12 months –so we will live to see this further slide due to Greek exit and we will survive.

India’s trade with Greece is negligible and devaluation of Greek currency will not leave us poorer. India’s trade with Europe will survive as the movement of Rupee vs the Euro will not be impacted much.

So the exit of Greece from the Euro will at best devalue our Rupee a bit more –beyond that, I do not expect much to happen in the short term.

In the long term, if this exit opens up the doors for the exit of other countries like Spain and Italy (which is highly unlikely), then it could have some impact – otherwise we are insulated reasonably well from this event.