Background
As the global economy is on its way to recovery, developments in Greece and a few other European countries might have greater than expected implications. While many foresee another slowdown, others think that the issue has been resolved with IMF and EU’s timely intervention.
To understand the implications of the developments taking place in Greece in particular and the Euro zone in general, FICCI has undertaken a quick survey amongst economists. The survey was conducted during the period May 10, 2010 to May 28, 2010.
As part of the survey, a structured questionnaire was drawn up and circulated amongst economists for their inputs and views. Eleven economists of repute participated in the survey. These economists largely come from the banking and financial sector. The sample however also includes economists from industry and research institutions.
FICCI sought the views of economists on five key concerns arising from the crisis –
(1) Possibility of the sovereign debt crisis of Greece spilling over to other nations;
(2) Possibility of global economy seeing a double dip recession;
(3) Whether the bailout provided by IMF and EU was the right approach;
(4) Likely impact of Greece crisis on India and
(5) RBI’s monetary policy stance in the light of emerging European crisis
The feedback received from the participating economists was collated and analyzed and the views obtained are presented by FICCI. The findings of the survey represents the views of the leading economists and do not reflect the views of the writer.
♣ Economists’ views on whether sovereign debt crisis of Greece could spill over to other nations
The majority view on this issue is that ring fencing of the Greece problem may prove to be a challenging task and that there is a good chance that other vulnerable economies in the region such as Portugal, Spain and Ireland may face a situation similar to that of Greece given their already weak public finances. Economists have also pointed out that countries like France could also come under some pressure as the country’s banking sector has large exposure to some of the above mentioned countries.
The chance of the crisis spreading to other European countries through the banking channel is higher as the risk of default is the most crucial issue at this stage. Notably, foreign banks are exposed to the tune of US$ 236.2 billion of public and private debt in Greece and nearly a third of this is held by French Banks. Banks could act as the conduit that can rattle the ecosystem in other countries that have large exposure to Greece and lookalikes.
♣ Economists’ views on possibility of global economy seeing a double dip recession
Most economists ruled out the possibility of a double dip recession due to Greece debt crisis. They however agreed that the global economy could see a situation of ‘below to average growth rate’ in the short to medium term owing to the reduction in growth in the Euro zone. European countries with high fiscal deficit and high debt obligations have announced stringent austerity measures like cut in public expenditure, hike in tax rates and cut in wages for the public sector employees. Economists feel that such strict austerity measures will lead to a reduction in consumption and investment demand in the economy and put a break on growth. Further, as credit ratings of some of the economies get downgraded, it will become difficult for them to raise fresh money from the markets. Already signs of this happening are visible on the horizon. Economists feel that global investors could single out the weaker economies and be reluctant to divert resources to such regions. This would limit availability of funds for these countries and could put further pressure on their growth rates. Even countries like France and Italy are under pressure on account of strain on their banking sector which could undermine growth in the region.
In short, while one can expect global growth and global trade flows to see some moderation in the near term, the dip would be much smaller than what was seen during the 2008/09 great recession.
♣ Economists’ views on whether the bailout provided by IMF and EU was the right approach
There is a consensus amongst all economists that there was no option at this point in time other than bailing out Greece from this difficult situation. All the participating economists spoke in one voice on this issue.
Economists have pointed out that the traditional medicine (lowering interest rates and devaluing currency) of working out of such a problem is not available to countries such as Greece that are part of the Euro currency. These economies do not have the flexibility of devaluing their currencies and returning to the path of high growth and greater competitiveness. The EU and IMF could do little at this juncture except to prop up these economies with the bail- out package and help restore confidence in their bond issues.
Allowing Greece to default would have had long term repercussions as it would inflate the overall debt and fiscal deficit. This could have posed serious questions on the viability and the stability of EU region and their currency Euro.
The participating economists criticized the fact that there was no central agency in the Euro zone to monitor public finances of member countries. In fact this has been a major challenge right from the beginning when the EU came into being.
Economists have mentioned that EU is a heterogeneous grouping with there being differences amongst countries in terms of stage of economic development. Ensuring fiscal discipline in such a situation was always difficult. Anyhow, just like ECB, which coordinates the monetary policy for the EU, there should have been a monitoring agency for keeping a tab on the fiscal situation in different constituent countries.
♣ Economists’ views on likely impact of Greece Crisis on India
India’s Exports to the EU region Economists ruled out the possibility of any hit on India’s overall exports if the crisis remains restricted to Greece, as India’s exports to this affected country accounts for just 1 to 2 percent of our overall global exports. Further, the impact will still be marginal even if the crisis spreads to other PIIGS countries as India’s export to PIIGS is also limited.
However, a generalized and widespread slowdown in the EU region, as expected by a few, would be a negative development for Indian exports as EU region accounts for about a fifth of our total global exports.
An additional point towards which attention was drawn relates to availability of trade finance in the EU region. As banks in the EU region suffer losses, they could well cut down on their overall operations including the business of trade finance and in case this happens then like all countries India too would see a slowdown in exports to the EU region.
A small set of economists have said that this slowdown in exports could shave off about 0.25 to 0.5 percentage points from India’s GDP growth in the year 2010-11.
Capital inflows to India
Majority of the economists felt that there could be a knee-jerk reaction here as capital market is sentiment driven. With deleveraging expected to continue in the global markets, there is likely to be flight of capital from equity markets in emerging economies including India.
Further, debt related flows could also be lower as global financial market players hesitate to invest in non- dollar areas. Consequently, capital flows to India could be on the lower side in the next six months or so.
Liquidity situation
With majority of the economists expecting capital flows into India to slow down if not completely reverse in the coming six months, the liquidity situation is also expected to be a little tight in the days and months ahead.
Rupee value
With majority of the economists expecting the sell off pressure from FIIs in the Indian markets to continue from some time, the Rupee is expected to be under pressure in the near term. Already we have seen the Rupee depreciate against the US$ quite a bit in recent times. INR in fact posted its biggest weekly decline for the week ended May 21, 2010 in nearly 14 years, amidst concerns about euro zone’s growth prospects and implications for funds flows into India.
♣ Economists’ views on RBI’s monetary policy stance in light of emerging European crisis
Majority of the economists have pointed out that while concerns over inflation would last for some more time, concerns of liquidity are expected to build up fast on account of slowdown / reversal in capital flows, 3G payments, advance tax flows and overseas banks resources getting preempted due to the crisis.
They further added that RBI would ensure enough liquidity in the system to keep the growth momentum going, and may therefore not be in a hurry to raise interest rates. This camp was of the view that inflation is likely to dip in the second half of the year due to the high base effect in the same period last year. Also, if the monsoon this year is good as forecasted, the inflationary pressure would further ease. RBI can therefore be expected to act keeping in mind the liquidity situation and this would mean some pause in policy action.
While the above is the majority view, there is a feeling amongst a smaller set of participants that inflation will continue to be the focus of the central bank and it will continue with its current monetary policy stance of gradual tightening up. This set of economists were of the opinion that given the liquidity challenge at best you can expect that RBI would refrain from any intra policy date rate hikes. Finally, while RBI is expected to continue moving the rates up the quantum may be restricted to 25 bps.
♣ Economists’ views on whether sovereign debt crisis of Greece could spill over other nations
The developments taking place in Greece have raised a lot of concern on the ability of other European nations, which find themselves in the same predicament, to meet their financial obligations. While some of the other economies under the lens may not have the extreme combination of very high public debt and high fiscal deficit as seen in case of Greece, yet the situation is far from comfortable.
Data made available by the European Commission shows that debt to GDP ratio in case of Italy stands at 116 percent, in case of Portugal the figure is 77 percent, in case of Ireland 64 percent and Spain 53 percent. The budget deficit figure as a proportion of GDP for Italy is 5.3 percent, for Portugal 9.4 percent, for Ireland 14.3 percent and for Spain 11.2 percent. In case of Greece these numbers stand at 115 percent and 13.6 percent respectively.
Given the fragile situation prevailing in the Euro zone, FICCI asked the participating economists whether they see the sovereign debt crisis of Greece spilling over to other countries. The majority view on this issue is that ring fencing of the Greece problem may prove to be a challenging task and that there is a good chance that other vulnerable economies in the region such as Portugal, Spain and Ireland may face a situation similar to that of Greece given their already weak public finances. Economists have also pointed out that countries like France could also come under some pressure as the country’s banking sector has large exposure to some of the above mentioned countries.
In fact the chances of the crisis spreading to other European countries through the banking channel is higher as the risk of default is the most crucial issue at this stage. Notably, foreign banks are exposed to the tune of US$ 236.2 billion of public and private debt in Greece and nearly a third of this is held by French Banks. Banks could act as the conduit that can rattle the ecosystem in other countries that have large exposure to Greece and lookalikes.
Economists that participated in the FICCI survey also opined that given the large debt holdings of Greece, banks will have to mark down at least a part of it in the coming days. As this happens, capital base of banks will get eroded and this will limit their lending power. The consequent implication for liquidity in the region and beyond is thereof a matter of serious concern.
While the Euro zone economies are certainly in a difficult situation given the intricate linkages through the banking channels, economies of US and UK may not get affected much due to the Greece crisis according to majority of the participating economists.
♣ Economists’ views on possibility of global economy seeing a double dip recession
The ‘sudden’ problem in Greece has led many people to believe that this could impede the ongoing recovery in economic activity worldwide. Quite similar to corporations, countries would most likely traverse the path of ‘going slow on expansion’ and practice austerity in every aspect possible. While the US has voiced concerns over the Greece issue terming it as a ‘potentially serious setback’, Emerging economies in Asia too are vulnerable, said the IMF, recently. FICCI sought economist’s views on whether there exists a chance of a double dip recession.
Though most economists ruled out the possibility of a double dip recession due to Greece debt crisis, they agreed that the global economy could see a situation of ‘below to average growth rate’ in the short to medium term owing to the reduction in growth in the Euro zone.
They are of the opinion that unlike the financial meltdown that originated in US and had a global impact, the Greece debt crisis would have a targeted impact mostly on Euro zone. As mentioned earlier, some of the other EU countries like Spain, Portugal, Ireland and France could also see a growth momentum getting impacted. The chances of Germany having a downturn however have been ruled out. On the whole, the Euro Zone may see a reduction in overall growth rate.
European countries with high fiscal deficit and high debt obligations have announced stringent austerity measures like cut in public expenditure, hike in tax rates and cut in wages for the public sector employees. Economists feel that such strict austerity measures will inevitably lead to a reduction in consumption and investment demand in the economy and put a break on growth. This slowing down of the economy will have implications for government revenues as these depend on overall economic activity level.
Further, as credit ratings of some of the economies get downgraded, it will become difficult for them to raise fresh money from the markets. Already signs of this happening are visible on the horizon. Economists feel that global investors could single out the weaker economies and be reluctant to divert resources to such regions. This would limit availability of funds for these countries and could put further pressure on their growth rates. An additional point that emerged from the responses is that besides performance in the Euro zone, global growth would be affected by the way other economies react to the evolving situation. Notably, the first phase of recovery came on the back of massive stimulus packages that were announced by governments and central banks across countries. Already there are signs of some economies reversing these measures as they gear up to deal with other related macro issues such as inflation. Both India and China have taken such steps in the recent past. How countries calibrate their stimulus measures in 2010 will also have a bearing on global growth.
In short, while one can expect global growth and global trade flows to see some moderation in the near term, the dip would be significantly smaller than what was seen during the 2008/09 great recession.
♣ Economists’ views on whether the bailout provided by IMF and EU was the right approach
The financial-market selloff in the wake of the Greek debt crisis had started to resemble the situation following the collapse of US investment bank Lehman Brothers in autumn 2008. Given the way markets were reacting to this emerging problem in Greece, and the fact that it could spread to other parts of the Euro zone, some bold action was called for on part of the policy makers. Although initially there was a lot of resistance and flip flop seen on whether the Greek government should be supported in this hour of need, eventually a massive support package was sealed together by the IMF, EU and the ECB.
The program approved by the IMF’s Board makes about €5.5 billion immediately available to Greece from the Fund as part of joint financing with the European Union for a combined €20.0 billion in immediate financial support. In 2010, total IMF financing will amount to about €10 billion and will be partnered with about €30.0 billion committed by the EU. The joint financing means that Greece will not have to tap international financial markets until 2012, providing a breathing space for Greece to put its finances in order and get its economy back on track.
FICCI sought the opinion of economists on whether this was the right approach to deal with the situation and whether there was an alternate to the bailout provided by IMF and EU. Feedback received shows that there is a consensus amongst all economists that there was no option at this point in time other than bailing out Greece from this difficult situation. All the participating economists spoke in one voice on this issue.
Economists have pointed out that the traditional medicine (lowering interest rates and devaluing currency) of working out of such a problem is not available to countries such as Greece that are part of the Euro currency. These economies do not have the flexibility of devaluing their currencies and returning to the path of high growth and greater competitiveness. The EU and IMF could do little at this juncture except to prop up these economies with the bail- out package and help restore confidence in their bond issues.
The participants strongly mentioned that allowing Greece to default would have had long term repercussions as it would inflate the overall debt and fiscal deficit. This could have posed serious questions on the viability and the stability of EU region and their currency Euro. The participating economists have criticized the fact that there was no central agency in the Euro zone to monitor public finances of member countries. In fact this has been a major challenge right from the beginning when the EU came into being. Economists have mentioned that EU is a heterogeneous grouping with there being differences amongst countries in terms of stage of economic development.
Ensuring fiscal discipline in such a situation was always difficult. Anyhow, just like ECB, which coordinates the monetary policy for the EU, there should have been a monitoring agency for keeping a tab on the fiscal situation in different constituent countries. Economists have also opined that the bailout package will only prove to be a temporary relief for countries from this region. This arrangement would enable Greece to ward off an immediate default. However, medium to long term solvency issues remain. It is therefore important that countries like Greece plan out how their large stimulus packages would be paid off. There is an also urgent need to increase earning capacity. Survey respondents have mentioned that counties will have to maintain pressure on Greece to implement the austerity measures as promised as any deviation from the path of fiscal rectitude could seriously undermine the ongoing efforts to contain the crisis.
♣ Economists’ views on likely impact of Greece Crisis on India
No one is immune in this globally interconnected financial commune - this is the verdict from the economists that responded to FICCI’s questions on what impact Greece crisis could have on India. Economists have mentioned that there is adequate evidence now that indicates that there is nothing like ‘decoupling’ with respect to financial markets. While the impact on the trade because of the Greece crisis is something that we have to wait and see, the turbulence in the PIIGS economies has certainly started affecting other areas as is evident from the withdrawal of FIIs from Indian market. The economists outlined the following areas with varied degree of impact in our discussion with them.
India’s Exports to the EU region
Economists ruled out the possibility of any hit on India’s overall exports if the crisis remains restricted to Greece, as India’s exports to this affected country accounts for just 1 to 2 percent of our overall global exports. Further, the impact will still be marginal even if the crisis spreads to other PIIGS countries as India’s export to PIIGS is also limited.
The problems for India’s exports would magnify if the entire EU region gets into a downward spiral of growth. As mentioned earlier, growth in the EU region because of the evolving developments could slowdown in the near term. As economies undertake austerity measures, economic activity would suffer. A generalized and widespread slowdown in the EU region, as expected by a few, would be a negative development for Indian exports as EU region accounts for about a fifth of our total global exports.
An additional point towards which attention was drawn by the economists’ relates to availability of trade finance in the EU region. As banks in the EU region suffer losses, they could well cut down on their overall operations including the business of trade finance and in case this happens then like all countries India too would see a slowdown in exports to the EU region.
A small set of economists have said that this slowdown in exports could shave off about 0.25 to 0.5 percentage points from India’s GDP growth in the year 2010-11.
Source: FICCI Quick Survey on Greece Debt Crisis
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