Financial contagion unlikely even if Greece defaults

External accounts of emerging markets stronger than in 2011-12

Reverberations of the Greek crisis reached global financial markets on Monday, with the Hellenic Republic opting for a referendum on July 5. The referendum will see people of Greece voting for or against the bailout conditions imposed by its creditors. With Greece failing to reach an agreement with the troika of lenders over the weekend, it is expected to default on a €1.5-billion payment to the International Monetary Fund on Tuesday, which could pave the way for its eventual exit from the Euro zone. Even though the Greek crisis has been brewing for a while now, it reached a crescendo over the weekend when all bailout talks failed. Like other global markets, the Sensex, too, ended the day in the red.

A Greek default will lead to some skittishness in the markets over the near-term, but a contagion appears unlikely. Greece is a small economy and accounts for less than two per cent of the GDP of the Euro zone. However, a pullback by European banks from Asian markets remains a key risk. If European banks cut back on their exposure to Asia, then a sell-off in emerging market is a possibility. According to Nomura's economics team, the Bank for International Settlements’ consolidated banking statistics show that besides Asia’s two financial entrepôts – Hong Kong and Singapore – the economy most exposed to European bank claims on an immediate borrower and ultimate risk basis is Malaysia. Also, unlike in 2012-13, most of Greek sovereign debt is held by European governments.

Market strategists don’t expect a contagion as the European Central Bank (ECB) has been preparing for a Greek tragedy for some time now. In case there is a contagion-like situation, the ECB is prepared to take steps like unconditional LTRO (long-term refinancing option) and also dip into its €500-billion stability fund to support currency and bond markets. The governing council of the ECB “is determined to use all the instruments available within its mandate” required to balance risks to price stability. The interbank rates in Europe are currently stable. It suggests ample liquidity from central banks is available. Compared with Lehman Brothers’ bankruptcy filing and the European sovereign debt crisis of 2011-2012, Edelweiss Securities believes the interbank markets are much calmer. The risk that will persist for a little longer is that of a sell-off in currency markets. A Greece-related sell-off in Asian currencies is a possibility, but a short-lived one. Also, the external balances of emerging markets have steadily improved over the past 12 months on weak oil prices, which would come to the rescue in case of a knee-jerk reaction.