Economic Highlights

New Delhi, 19 February 2010

Greek Debt Crisis

A TRAGEDY FOR INDIA?

By Shivaji Sarkar

The southern and east European crisis has come at the most inopportune time for Finance Minister, Pranab Mukherjee. India is not directly affected by the phenomenon but it would not remain insulated as the crisis is hitting the European Union and the Euro has started crashing against both the US dollar and the British pound. It is being touted as one of the biggest crisis and if mishandled by the world policy establishment, this debacle is big enough to shatter the fragile banking systems of Western Europe and set off the Round-II of the financial blitzkrieg.

The crisis, it is apprehended, may lead to the process of breaking of the EU as a common market with a single currency. It has now engulfed Greece, which is on the brink of a sovereign debt default, while Spain, Portugal, Italy and Ireland already have their plates full of crises.

Greece is too tiny to hit India, many would argue. Besides, Indian institutions are not exposed to the Greek government bonds. This, however, does not insulate the country from rising insurance and interest rates across the world as investors feel concerned at uncertainties. It is likely to hit the emerging economies. India is stated to be the only emerging economy with a public debt level similar to that of Greece - almost 12 per cent.

The fear is that the Greek crisis is likely to have a cascading effect on the international finance. France and Switzerland are the two largest holders of Greek bonds. Their economies would start tottering and in all probability take Europe along with them.

The East European countries, including Russia, Ukraine and Latvia are also in the throes of one of the worst crisis having taken huge debt from West Europe. The currency chief at Morgan Stanley, Stephen Jen has said that Eastern Europe has borrowed $1.7 trillion abroad, much on short-term maturities. It must repay – or roll over – $400bn this year, equal to a third of the region's GDP. Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74 per cent of the entire $4.9 trillion portfolio of loans to emerging markets.

In Poland, 60 per cent of the mortgages are in Swiss francs. The zloty has just halved against the franc. Hungary, the Balkans, the Baltics, and Ukraine are all suffering variants of this story. Bad debts are rising. The European Bank for Reconstruction and Development (EBRD) says that bad debts will top 10 per cent and may reach 20 per cent. Europe's governments are making matters worse. Some are pressuring their banks to pull back, undercutting subsidiaries in East Europe. And, Athens has ordered Greek banks to pull out of the Balkans.

Clearly, accidents are waiting to happen across the region, but sadly the EU institutions don't have any framework to deal with these.  Worse, it may trigger a massive crisis with contagion spreading into the EU. However, the EU Constitution prevents any bail-out of a crisis-ridden EU country.  And, if the EU does not bail out, Greece has the option to delink from the Euro and revert to its old currency – drachma, which it had given up in 2002. This action would give Athens an option to devalue the currency and pep up its own economy and if the socialist government takes such a lead, it is feared that Italy and Spain may follow suit.

The spreading of the Greek disease to other debt-laden Eurozone members - Spain, Portugal, Ireland and even Belgium - would see the crisis move from the edge to the centre, threatening key Indian exports. This is so as the EU is India’s largest trade partner and a slowdown in Europe was a major reason for the collapse of Indian exports. Even in this fiscal, the India-EU bilateral trade in goods recorded an 18 per cent decline.

The bilateral trade in goods during January-June 2009 stood at €25.19 billion, about 18 per cent lower than the €30.54-billion in the corresponding period last year, official data available with the European Commission showed. Bilateral trade in goods had nearly doubled between 2004 and 2008. From a level of €33.52 billion in 2004, the bilateral trade moved up to €40 billion in 2005, €47 billion in 2006, €56 billion in 2007 and €61 billion in 2008.

Undoubtedly, India is grappling with a fall in exports. If the European banks get into a deeper crisis the efforts of the government to look for a better market would shatter hopes, further hitting sectors which were looking for higher exports. This apart, it might also hit foreign investment and growth pattern. If Europe slips into a crisis, which is looming large, foreign direct investment may take a severe hit stalling many ongoing projects.

India is already facing the problem of shrinking external commercial borrowings. Some of the Indian company acquisitions like Corus in the UK are likely to be shut. Tata had taken huge borrowings to finance its purchase. The developments might affect fortunes of these companies. A development thousands of miles away may take a chain of companies southward in India leading to job losses and other concomitant problems.

The eurozone was supposed to be a sea of economic tranquility, in which volatility would be abolished. Now it seems to be taking the world economy into tizzy. The Finance Minister has to look for ways not only to insulate the country from EU developments but also find out the path to maintain the growth even though may be at a lower level.

Prediction of the fate of Europe is not easy. The developments since 2008 point to a gradual loss of the eminent position it has been holding. Charting a course in such troubled times is not easy. It is an opportunity for India to develop its own system. It has to learn to reduce its dependence on the West. Barack Obama has given a call to Indian companies to invest in the troubled US. India needs to debate whether it should do that or look for avenues elsewhere. The time possibly has come to delink from the West and chart out an independent path to maintain its growth. --INFA

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