Update on the crisis in Greece

Posted On Monday, Jul 06, 2015

As was probably expected, the Greek populace has given a thumbs down to the referendum of accepting the terms of the creditors, with around 60 % voting a "No" for further austerity measures. This has hugely increased the chance of Greece exiting the Euro zone.

The Prime Minister of Greece, Mr. Alexis Tsipras had called for this referendum after the IMF (International Monetary Fund) and the EU (European Union) refused a moratorium of 2 years requested by the Greece government. Greece was required to pay €1.7 billion to the IMF on the 29th June 2015, for which it required further loans.

The Greece government’s current account deficit was around 14 % of GDP in year 2009 and fiscal deficit of 18 % of GDP. Initially, private creditors where ready to fund Greece’s borrowing but as the Greece did not make any adjustments to reduce fiscal deficit, private creditors pulled the plug. Lenders of last resort like IMF, ECB, and other sovereign countries had to bail out Greece. They agreed to fund Greece provided they implement the structural programme which included cutting wages and pensions to its citizens. Tax increase was not possible as the economy was going through a tough phase.

Due to these measures, unemployment increased from 9 % in 2009 to 25 % from 2013 onwards and continued to remain at these levels creating unrest amongst the Greeks. The bulk of the correction has to be taken by job losses and contraction of GDP. Greece’s GDP has fallen 5 years in a row. After two bailout packages, which led to further cuts in wages and pension, the citizens of Greece made their displeasure heard and elected Tsipras as the Prime Minister who came to power on the mandate of not cutting wages and pensions and a moratorium on payment of debt.

What’s next for Greece and the world?
All eyes are now on European Central Bank to meet on Greece. All European Union leaders are set to meet on Tuesday – 7th July, 2015. One of the key decisions will be made by the ECB whether to continue providing liquidity to Greek banks. It seems highly unlikely that the ECB will render these deliberations pointless by immediately torpedoing the Greek financial system.

What the ECB needs to consider is the ripple effect that will be felt throughout Europe and the world if the talks with Greece fail. If Greece exits the Eurozone – countries like Portugal, Spain and even Italy may follow suit – like a house of cards, collapsing in on itself; leading to an even bigger crisis.

What are its implications for India -
The failure of Greece is not such a big event for the Indian economy, as most of its debt is owned by government of other countries. The European central Bank has ring-fenced other EU countries by stating it would buy the bonds of EU countries. In the Indian context, the effect is not expected to be high as the exposure is very low. The Greece issue would however increase risk aversion towards emerging markets, which would affect capital flows to the Indian markets on a temporary basis.

Source: Data compiled by Quantum AMC.

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