Breaking Point: Will India be affected by the Crisis in Greece?

Greece has reached breaking point in its relations with Europe with 30 June being the last date by which Greece has to repay the €1.6 billion loan installment due to IMF. With Alexis Tsipras, the young Prime Minister of Greece, shutting all banks for six days and freezing trading in the stock exchange, Greece has effectively closed all chances of averting the default. In fact, on 29 June itself, Greece indicated that it will not be making the due payment thereby sealing its fate as a defaulter and once again setting the European and global economy on an uncertain future. Earlier, Alexis Tsipras tried to negotiate with the European Central Bank for an extension of the debt repayment deadline but was turned down. In a move surprising all, the Greek PM has called for a referendum on Sunday, 5 July inviting the people to vote in favour or against further austerity measures. A ‘NO’ vote could result in Greece exiting the EU, unless there is a last minute understanding between the government and lenders, which seems very unlikely at this stage, given the statement by Christine Lagarde of the IMF that the government in Greece has had its opportunity and no further extension of the loan repayment period will be granted. Jean-Claude Juncker, the President of the European Commission, tried to broker a last minute deal between Greece and its lenders. He, however, expressed exasperation at the breakdown of negotiations, and on Greece’s decision to hold a public referendum. Europe now braces itself for a volatile period of economic uncertainty. The big question for India is – how is the crisis going to affect India? Before we try and figure that out, we need to know how the crisis started in the first place.

Understanding the ‘How & Why’ of the crisis

The genesis of the present crisis dates back to 2001 when Greece joined the EU. Greece is an economy that largely depends upon heritage and leisure based tourism, given its ancient culture and long history. In order to meet the strict norms of qualification for EU membership, the government in Greece imposed austerity measures and controlled profligate spending. However, once it became an EU member, Greece once again went back to easing controls on spending, which resulted in an increasing gap between expenditure and revenue. Along with this, came the bad decision by the then government in Greece, to go ahead and organise the Athens Olympics in 2004, which was awarded to it much earlier. Greece was in no position to fund the Olympics, much less pay off the debt, subsequently. Organising the games in 2004 cost Greece €9 billion and resulted in Greece running up a public debt € 168 billion, with the deficit climbing to 6.1% of its GDP and debt reaching 110.6% of GDP. This began to ring bells of concern amongst the European lenders of the time, as the prescribed norm in EU for containing deficit was half the prevailing figure. By 2005, Greece became the first country to come under the fiscal watch of the EU.

US Subprime Mortgage Hit Greece Hard

While the crisis in Greece was reaching crisis levels, another crisis was emerging in the United States, the subprime mortgage. This coincided with the US going into recession between 2007 and 2009, triggering a worldwide financial crisis. Greece, too, was impacted, which further burdened an already overburdened economy. The EU which was already facing a banking system crisis began to shift to sovereign debt crisis, led by Greece. By 2010, Greece was staring at bankruptcy and by 2011, the country’s public-debt-to-GDP ratio had reached 165%. With the economy shrinking and unemployment at levels high, Greece had to receive a bailout to avert a total collapse. The troika of lenders that included IMF, ECB and the EU, imposed strict conditions on Greece. The resulting austerity measures led to a decline in government spending, higher inflation and increased unemployment. The problem was that Greece had to cut expenditure to pay off the loan taken, therefore most of its revenues that came from a declining economy, went back to the lenders in the form of interest and principal amount due, leaving very little for the government to invest in other sectors that could boost the economy. The resulting debt trap has now squeezed the government further where it finds itself in a corner, with no solution in sight and loan default a certainty. If people vote against austerity measures in the referendum on 5 July, Greece will find itself isolated economically and politically, with no strength to stand up on its own.

How vulnerable is the global financial system to the emerging situation in Greece?

This time around, the governments are better prepared to handle the crisis, especially since it has been emerging over time. The ECB has taken protection measures over time by buying Eurozone government bonds and thereby insulating governments from volatile situations in the financial markets. The ECB is watching the situation carefully and is ready to infuse more capital by way of bond and other purchases, to ensure the impact on other member states remains contained. Fortunately, other EU members such as Ireland, Spain and Portugal have progressively adopted austerity measures and are less likely to be vulnerable to the emerging crisis in Greece. In the aftermath of 2010, most international investors including banks had reduced their exposure to Greece, selling off their bonds to mostly private investors who were willing to hedge their bets on a turnaround in the economy. That hasn’t happened and therefore, it’s these private investors who will end up taking a major hit in the merging crisis.

Geopolitical impact of GREXIT

A Greece exit or GREXIT, will lead to not just financial turmoil in the global economy but also to its political isolation. Greece is a member of NATO and by exiting EU, it may be forced to move closer to Russia seeking a bailout. Russia, however, is itself facing isolation in Europe and therefore, as an existing member of NATO, Greece may place itself in a peculiar situation, with no clarity for either Greece, EU or NATO, on what political scenario will emerge from this situation.

Finally, is India vulnerable to the impending crisis?

Yes and no. India has been preparing for this day and RBI Governor Raghuram Rajan has assured that the government is well prepared with adequate forex buffer to withstand the impending volatility in the international financial system. The markets in India, however, saw volatility yesterday in reaction to Greece’s announcement that it would not pay the loan installment to IMF. As a result, on 29 June Sensex dropped 600 points before closing the day down 167 points, while Nifty dropped 62 points, to close the day at Rs 8,318. The Rupee lost 0.29 paise to the dollar closing at Rs 63.73. Gold traded at Rs 26,950 per 10 grams, Rs 240 higher, while silver gained Rs 300 to touch Rs 36,700 per kg. Global markets, were heading South on 29 June, with the Dow Industrial Average 1.97% lower, S&P 500 2.09% lower, and the Nasdaq Composite ending 2.4% down. India, with its $355 billion in forex reserves, CAD at less than 1.5% and inflation remaining in control, is better placed to handle any emerging situation. The resilience was showing on 30 June morning with the markets showing a recovery as on 1100 hrs IST, with Sensex up 37 points around 27,679 region and the Nifty in the region of 8,333, up 14 points.

India well placed to ride out the crisis

India may see a slowdown in the global economy which will impact its projected growth, however, with the economy growing mainly on account of domestic demand, India is better placed to ride out the impending international slowdown. The extent of the impact remains to be seen. Read More: What is GST: How will it change India Sensex, Rupee Vs Dollar, and Gold Rate – Do they reflect our economic outlook? Is India Heading Towards Another Economic Crisis? Positive signs for Indian economy – what does it mean? Important facts about Indian Economy Rupee Free Fall: Cause and Consequence Why is the Indian Rupee Depreciating? Investment Risks to Economy – Caution Is the Watchword for RBI Economic Reforms in India: BJP Government Keen on Taking Tough Calls A Parallel Economy of Bribe FDI Norms for NRIs Relaxed – Foreign Investments Anticipated Effects of Poor Monsoon on the Indian Economy and various sectors How Inward Remittances impact the Indian Economy Monsoons and the Indian economy