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Greece's election: Beginning of the end?

Publication Date : 15-06-2012


As the Euro-Asia tensions intensify, Thailand's exports slipped 3.67 per cent on year in April on falling demand in key markets while the Stock Exchange of Thailand Index has retreated over 7.5 per cent since May 3 when the SET hit a new 16-year high of 1,240.03 points.

The situation could be much worse if Greece exits the eurozone after the national election this Sunday and sends out contagious effects.

Economists and strategists are pondering two scenarios to follow the "Grexit" - the contagion is contained with new injections or the contagion spreads to the rest of Europe.

Forecasting growth of 3.5 per cent for Thailand, Standard Chartered Research sees the forecast dropping sharply to 1.5 per cent this year in the second scenario.

The good news is that since the worst-case scenario could produce unimaginable ruin for the global economy, now several observers are inclined to believe that Greece would remain in the eurozone no matter whether the anti-bailout or pro-bailout political party wins enough votes to form the government.

With the troubles with the regional banking sector at the boiling stage, the euro has weakened sharply against the US dollar. Banks in Europe are parking excess liquidity at the European Central Bank, while investors are willing to go long on US and German treasuries despite very low returns. In the end, if Greece leaves and the eurozone breaks up, in the region Germany's mark could strengthen remarkably to a level that it kills the country's export sector.

"Policymakers now realise that the cost of keeping Greece (in the zone) is high, but kicking it out could be more costly," said a strategist who asked not to be named. That convinced him that Greece would stay, voluntarily and with help from other European nations. That would require eurozone economies to work out mechanisms to support the single currency in the long run, which could involve the establishment of a banking union.

In its research note yesterday, Kiatnakin Securities assumes a better-than-expected aftermath from the Greek election.

Based on the latest election poll that predicts that conservative New Democracy would pull off a win against anti-bailout Syriza, the securities house is 100 per cent convinced that Greece would remain in the eurozone. The victory should ease all concerns lingering on since May 6.

While ND votes for the EU-IMF recovery programme tied to bailout loans, Syriza seeks to renegotiate some of its more painful provisions. Euro exit is not Syriza's plan, but seeking renegotiations may lead to no bailout at all and Greece may need to leave the eurozone and devalue its currency, the drachma, to survive.

Then, Greece's debt default is prominent and this is expected to send a ripple effect to directly and indirectly exposed European banks. As these banks are deleveraging, they are likely to cut off lending and this may affect Asian countries including Thailand.

Even before the latest developments in the Greek sovereign bond debacle, continental European banks were already reducing their exposure to Asia. According to the latest Bank for International Settlements data on international bank lending for the fourth quarter of 2011, continental European banks reduced their lending to Asia by 16 per cent, or US$91 billion, compared with the second quarter.

French banks were the most aggressive in reducing their loans outstanding, cutting them by 32.8 per cent in the second half, or $55.1 billion. German and Swiss banks were more modest in paring back their loans to Asia. During the period, ex-UK European bank lending to Thailand dropped by $1.5 billion.

In case of a contagious exit, turmoil in the financial markets - to the level seen in 2008 when Lehman Brothers went bankrupt and many US banks sought injections - is imminent. The foreign exchange markets would be in chaos, as euro holders would seek refuge. At a foreign bank, an experimental call-option for Germany's two-year bonds denominated in Deutsche marks shows investors are ready to buy, even with a 1-per-cent negative return.

Greece's economy would be derailed in case of an exit. As all systems are designed to serve with the euro, changes can't be done overnight. Meanwhile, it would take time to produce banknotes for domestic use.

Greece's main advantage in leaving the euro would be to devalue and, by boosting competitiveness, kick-start economic activity. However, Standard Chartered Research noted that Greece is a small, closed economy. Exports represent only 19 per cent of GDP, compared with 41 per cent for Germany. The benefits of devaluation would also be tempered, at least initially, by costlier imported inputs. Borrowing costs would stay high for both the government and the private sector in the face of high inflation and a high risk premium.

"Without global funding and no desire for drachma, Greece could not survive. Germany's currency would benefit largely, but at the expense of the export sector. As such, even if Syriza wins, I believe it would seek a secret negotiation with European leaders to have austerity measures softened, to the point that it won't lose face, if the bailout demands are not totally lifted," an economist said.

The scenario is very likely, given the bank runs in Spain. Spain’s borrowing rates yesterday hit a new high, nearly 7 per cent, not seen since the country joined the euro in 1999 after Moody's Investors Service downgraded the country's credit rating to one notch above junk bond status. Italy is feared to be the next with huge public debt. In a world where the Internet allows withdrawals anytime, anywhere, there is a question of how Europe can contain the bank runs and capital outflows.

This will deepen the recession in the euro area, and the world including Thailand will experience the impact. Despite Europe's weakness in recent years, it remains important to Asian exporters. Euro-area demand accounted for 11 per cent of Asia's total exports last year, down from an average of 12.3 per cent in 2007. The indirect impact of weakness in Europe via its effects on the US and China should also be noted.

It is not surprising that French President Francois Hollande yesterday warned Greeks that they risk being pushed out of the eurozone if they support anti-bailout parties in the election on Sunday.

Preventing a "Grexit" is apparently the first part of crisis ringfencing.


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