Greece Debt Drama: Are markets just overreacting?

The Greek crisis is taking all the headlines in business channels and discussions lately. The discussion has picked up pace as the Greek prime minister has called for a referendum on agreeing to the terms that have been put up by the lenders  which seek more austerity and cut in pensions etc from Greece. There is no endgame of this crisis unless Greece actually takes the step of moving out of Euro zone by itself. However when people correlate this crisis to Lehman Brothers collapse or the Global Financial Crisis they are way off the mark. 

The reasons for the same in simple terms are as follows
 

1. When Lehman collapsed in the year 2008 its total liabilities were around $ 600 billion. However given the extent of derivative positions that these financial institutions held at that time. The crisis was new at this stage and too many things were happening together and the entire financial industry not only in the United States but also globally were under stress. Many who were there in the financial markets at that time would remember the kind of rumours that went around about specific banks even in India. Interbank lending had come under stress and there were unprecedented redemptions out of global funds as well as domestic mutual funds.  Infact a mid sized Mutual Fund in India virtually collapsed and was sold overnight. Most Central Banks and Policy makers globally were not ready for the crisis and the response that had to follow. Moreover the germination of the crisis was from the largest economy of the world. 

2. The liabilities of Greece are well documented. As things stand the total market capitalization of all Greek stocks just stands at around $ 20 billion. As such even if the Greek stock markets closes down tomorrow the maximum loss to private shareholders would be not more than $ 10 billion. 

3. The total debt of Greece stands at around $ 400 billion. Around 50% of this is held by the Euro zone as part of the bailout of Greece & the ECB which is around  $ 200 billion.  On top of this are the bilateral loans given by Euro zone countries to Greece which is around $ 70 billion and $ 30 billion from the IMF. Even after this there is atleast 50% of the remaining that comes from the Euro zone itself. As such the exposure of investors outside the Euro zone to Greek debt is between $ 10-50 billion as per best estimates. 

4. The total debt of Greece is 175% of GDP. Unemployment in Greece is 25% and Greek GDP has fallen 25% over the last few years. The average percapita income has also declined to a similar extent. This size of debt is clearly unsustainable and in my view Greece has to default now or some years from now.  The best is for debtors to take a haircut now to reduce Greece’s debt to 90-110% of GDP with possibility of a clawback if the Greek economy recovers sharply and this becomes possible some years or decades down the line. However this is unlikely to happen given the egos involved. 

5. The ECB is buying around $ 75 billion of bonds every month. One month’s purchase is greater than the total external (out of Euro zone) liabilities of Greece. 

My overall view on the entire Greek endgame as Greece goes into a referendum to decide (more or less) whether to stay in the Euro zone or not is that Greece is irrelevant to the rest of the world ex of Euro zone. The impact of a possible Greek default and exit from Euro zone will be contained so well that most people are likely to be amazed by it. The global economy is in a recovery phase. The cash positions with global funds are high as fund managers turned wary of the impact of the Greek crisis. There are unlikely to be huge redemptions out of funds because of this crisis and as such the risks of any big selloff are low. 

The state of Euro zone is similar to the Indian PSU banks where the bad debt problem is no longer of the promoters of the companies but of the banks as the liabilities in many cases are so high that the companies are not solvent.  The question is whether to take the bitter pill now or wait in the hope that things will turnaround of their own as the macro situation improves. The contagion impact on other countries out of the PIGS grouping is virtually nonexistent today but was very high in the year 2012. 

In conclusion I believe that the worst for the Indian markets and the Indian economy are behind us now. We should see a strong market performance in the second half of this year despite the FED rate hike Bogey about which I will write later. Any short term sell off is unlikely to sustain.