The Greek Tragedy

These days the happenings in the Financial Markets are more thrilling than any Hollywood or Bollywood block buster and more tear-jerking than the art films of Bengali cinema of yesteryear. Greece is teetering on the precipice of sovereign default of repayment of loan to IMF. Greece has been struggling for some time with its External debt standing at 177% of its GDP. As an economy it has not been growing and with the dollar strengthening against the Euro the debt has grown larger in the recent months in dollar terms.

Greece has been living beyond its means, a small country which has about half the population of Mumbai had accumulated debt to the extent of 350 billion dollars. An aging population, more than liberal social benefits, retirement pension starting from 48 years, no manufacturing and high-cost tourism denominated in Euro characterized the economy of Greece. More shockingly, the country admitted that it has been falsifying its annual budgetary deficits, When the deficit had long crossed 13% of GDP, they were reporting under 5%!!

The main creditors are the IMF , European Central Bank and the European Commission . They have been forcing upon Greece austerity measures, essentially raising taxes and reducing govt doles, and urging its govt to cut down the deficits right from 2008/2009. Greece promised to cut down its deficit to 3% but could never do it in the face of political opposition. Such austerity measures in an economy like India would have reduced inflation, improved the investment climate and hence growth in jobs. incomes and consumption. There was no inflation in Greece in the first place, tied as it was to the European monetary union. Therefore the reduction in government spending lead to a rapidly shrinking economy ( the economy shrank 25% as a result of these measures!) which ironically only worsened the repayment capacity of the economy. Further loans of given by the IMF and others were therefore used to pay the previous loans back, a la circular debt made famous by the Pakistani energy sector.

When Lehman brothers went down under, the American Federal reserve pumped in 800 billion dollars. America also lives much beyond its means. America raises its debt denominated in its own currency from all forex surplus nations. India has about 350 billion dollars of surplus foreign exchange most of which is parked in American Govt bonds at less than 2% interest rate!! China parks trillions of dollars in American bonds for want of better alternative. The bonds issued by America are exactly as unconscionable as those issued by Greece.

However, America is America and Greece is Greece. It is like me borrowing 50 lacs vs Ambani raising 5000 crores! I may have to sing and dance for raising 50 lacs while Ambani can raise 5000 crores in less than half an hour. More than this lay analogy, the more important reason is the TINA factor enjoyed by the dollar. If you recall pre-university economics, only dollar is able to perform the 4 functions of money in the Global context :

1. General Acceptance
2. Store of value
3. Measure of Value
4. Medium of exchange

If any country has surplus foreign exchange, if it has to deploy it usefully , it has to 'store' in dollar bonds which means lending to America! So the world is hooked to American debt as There Is No Alternative and America is spending itself to glory from the money lent to it by its lenders. This means that as the balance of payments surpluses for any major economy , America gets more money to spend on itself!

Let us go back to Greece. The austerity measures attempted by the government came at a high political cost. The incumbent Government was voted out in the recent elections and a leftist cabal took over. In the last year, the Tspiras led government did nothing to shore up the economy, worse they played to the gallery and impaired whatever will and capacity was there in the polity to reform and repay. Now an installment repayment of about 1.6 billion dollars is due and as of writing this piece, Tspiras has decided to put it up to his people for a referendum whether to leave exit from euro zone or not. It is a Hobson's choice; if it is a 'Yes', Greece will have to exit Euro and face the consequences, if it is 'No' this leftist government will have to quit office as they would not be able to stand up to IMF conditionality for austerity, a pre-condition for agreeing to restructure its debt. Greece needs to borrow even to pay this 1.6 billion dollars. Many more such installments are due to creditors in the next one year and Greece needs revolving credit before it reworks and restructures the economy for which now there is no political will.

What if they fail to pay and exit Euro go and go back its original currency Dracha? First of all it will signal the end of Euro and hence politically, the disintegration of Europe. European monetary union was formed as a political move to integrate 19 countries of Europe. It was mooted by a Canadian economist who is now comfortably retired, but still calls economists from the western world to his resort in Canada for an annual Thinkfest on world economic matters. I have forgot his name, requesting readers to comment if they know. The countries were to retain their Fiscal sovereignty ( control over government spending ) but vest their monetary authority with a European Central Bank. The idea was that everybody will pay by the rules of the game and will not pull the plug in their own self-interest as the consequences of doing so will be horrendous. Now this basis, just an assumption all along, has come to serious question. If Greece does the unthinkable, the other economies of Mediterranean Europe like Italy, Spain or Portugal with heads just above water, will be looked upon with suspicion and their borrowing costs will go up for they are also big borrowers ( debt > 100% of GDP) . People in those countries will start moving their Euro deposits to safer countries like Germany and it will cause a run on their banks. These are larger economies and their default, leave alone Europe, will push the world economy into a payment crisis of sorts and hence into a recession. American dollar will further strengthen and countries whose currencies are linked to dollar ( INR is linked to a basket of currencies where dollar is prominent) will see their exchange rate plummet. However, export will not go up even when exchange rate plummets as there will be recession all round, while imports , being primarily Petroleum products, will not go down even when Brent crude rates go down in dollar value significantly. Overall, America will only gain. So I personally think the world will not allow this to happen.

Besides, Drachas will be severely much devalued currency. It will push inflation sky high in Greece with unthinkable political consequences for the government that takes the step.

If the referendum is 'No', Greece will face political turmoil and Tspiras , having won the elections opposing IMF and its conditionality, will have to resign. The moot point is , will more belt tightening help. It did not do so in the first place. We again have a circular question staring at us.

Who said economics is a boring subject ?  

Just to think of it that only last year we implemented for our client SEPA functionality  ( Single Eurpean Payment Area ) for their Banking operations,  things are fast a-changing!

P.S.
If you have FCNR deposits in dollars hold on to them.  It is also good time to invest in gold ETF.  If Euro come downs in esteem in the four functions of money listed above, people will move to dollars, yen and gold.  Beware, I am no expert.