If Greece leaves eurozone, it will not be an absolute disaster

Written by Sunny Verma | Updated: May 24 2012, 07:38am hrs
A broader eurozone break-up would trigger an economic crisis worse than the one that followed the collapse of Lehman Brothers, said Rob Carnell, chief international economist, ING Vysya. It would almost certainly deliver a banking crash and a continent-wide collapse of the financial system. In an interview with Sunny Verma, Carnell dissects the European debt crisis and its likely impact on the world economy including India.

What is your diagnosis of the eurozone problem

The diagnosis of the eurozone is very very sick. Its not clear that politicians are delivering the right sort of medicine. The real problem for Europe is the massive stock of debt. In Greece, you have a debt-to-GDP ratio of 160%.

Is the sovereign debt crisis spiraling out of control

Well, in a sense that nobody is making any progress because the mechanisms being put in place are not working. Austerity packages are fine but you have to have growth.

Are you pro-austerity

You need some austerity. You cannot spend your way out of deficit. You cannot cap the deficit at current level, which is at 10%. I am not advocating a complete reversal of austerity but the way austerity has been implemented has been very front-loaded. It has been a push from Germany. But the fact is that you cannot improve your debt-to-GDP ratio when the growth is negative.

In the case of Spain, for example, they are now moving backwards because austerity is actually collapsing the economy. Its not credible; the bond yields are not coming down. This idea that you can have an expansionary fiscal contraction is not the reality of the current situation. Something else has to be tried. The credibly austere programme that is being forced upon Greece will not work.

What will be the impact on India The Reserve Bank of India says Indian corporates have $60 billion direct exposure to eurozone

I would be less concerned with the direct exposure than the indirect effects in terms of a damaged financial system. Because if this happens, that is if Greece leaves, it will not be an absolute disaster. But if there is a broader eurozone break-up that would almost certainly deliver a banking crash, which is going to be worse than the Lehmans, because then we are not talking of an isolated case, we are probably talking about a continent-wide collapse. That cannot be allowed to happen. You have to see that when it looks so horrific to assume, you have to rule that out.

Some say for Greece it makes political and economic sense to move out of the eurozone.

I will say exactly the opposite. The economic argument here is that if Greece leaves eurozone, their currency depreciates. In reality, Greeces tradeable goods sector is absolutely tiny, it doesnt even look like a proper economy. Companies may try to decide not doing business with Greece post its exist from the eurozone. Once Greece goes, the whole illusion of the eurozone is shattered. It may trigger Portugal leaving, Spain leaving.

Are firewalls created by the European leaders sufficient to contain the crisis

There are various firewalls ESFE (European Financial Stability Facility; $240 billion), ESM (European Stability Mechanism; $500 billion), only half of which is probably real money. Both these facilities can at best buy up to 12 months of debt that is maturing in all these peripheral economies.

That is not enough. So you need many such firewalls which give credibility to the idea that the problem can be ring-fenced, which is not happening now. Markets are panicking, they are looking at Greece elections. They do not see anything positive forthcoming from there.

What will be the natural progression of these events

I think it is virtually impossible to find that out right now because we are dealing with a multiple of binary events. Will Greece stay, will it go If it goes, will you get a contagion, and what would be the response. Will politicians bring in something more powerful! So, you are constantly moving from one probability to another.

What is the strongest probability

The most likely probability is that this crisis will continue for a very long time.

The eurozone doesnt manage, either with or without Greece, to find out a once-in-for-all solution. That puts in place an incredibly risk-averse environment. Eurozone may continue to drag for another 10 years but the possibility of it breaking up is not eliminated forever.