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The Impact of the Greek Debt Crisis on Indian Markets
Jul 2, 2015

In today's world the nexus of economic activity is inevitable. As the global financial system grows more integrated the chance of systemic risk spreading to other countries is higher, as is evident with the situation in the Eurozone. Greece has defaulted on making payments of 1.6 billion Euros to the IMF on Tuesday. If the situation escalates resulting in Greece exiting the Eurozone the effects could be widespread if not catastrophic to the Euro.

Most of Greek debt is held by quasi-governmental institutions. Germany does not want Greece to leave the euro as Germany has been a major beneficiary of Greece being in the euro. It has kept the Euro depressed which has given Germany a major trade advantage. If the euro blows apart and the deutsche mark starts trading again, Germany will get priced out as a major exporter. Germany has a vested interest in Greece staying in the Eurozone and is also the highest holder of Greek debt.

The Greek Prime Minister Alexi Tsipras had called for a referendum on July 5 to let the people of Greece decide whether they want to accept the terms of the creditors for a bailout deal. Greece had made a sudden move this Wednesday by accepting the bailout deal with minor changes which came as a relief to the markets. The European Union is due to hold a conference this week. This came after opinion polls showed that majority of Greeks were willing to vote against the bailout deal in the referendum. Athens decided to propose a new two-year loan agreement and a debt rescheduling after Prime Minister Tsipras might be willing to scrap the referendum on bailout terms. However German chancellor Angela Merkel said on Wednesday there will be no negotiations on a new bailout for Greece before Sunday's referendum.

If the creditors accept the Greeks terms of the bailout, the IMF will extend an offer to them which would calm the markets. If not then it would lead to Greeks exit of the Eurozone. The contagion effects of a Grexit (a Greek exit from the Eurozone) would be manageable as Greece contributes less than 2% of the Eurozone GDP. However a Grexit will lead to volatility across debt, equity and currency markets, leading portfolio investors to reassess their positions. Investors would flock to quality debt instruments such as U.S. treasuries, resulting in strengthening of the dollar against major currencies.

Greece would then have to reintroduce its old currency the Drachma which would be greatly devalued. The debt would still have to be paid in euros however and will have to be paid in the new devalued currency which would further increase the countries debt burden. The benefit of a devalued currency would lead to higher exports and spur growth. However there would be widespread unemployment and the countries import bill will rise. This will be the nadir of an economy already in tatters, mired with a current unemployment rate of 25% and almost 50% youth unemployment.

The U.S. Federal Reserve Chairperson, Ms Janet Yellen's remarks that interest rates are likely to rise this year has also made global markets jittery. Due to the nature of integration of the global financial markets, emerging markets face the highest risk of volatility. Any uncertainty in the continuation/withdrawal of U.S. monetary policy puts the rupee on edge. If the fed hikes interest rates the search for higher yields and volatility in Indian markets could result in a reversal of capital flows from emerging markets to safe havens such as the U.S.

The situation in Greece and fed policy will have a direct impact on Indian financial markets. India seems to be better prepared to deal with volatility now than it was in the past. Governor Raghuram Rajan had cited in Stockholm last Wednesday that the Indian economy would see through any impact of the Greece crisis. According to Rajan, one factor helping India was its stronger foreign exchange reserves, which are at an all-time high.

How is the Indian economy poised to face global headwinds?

The Greece crises, Fed Monetary Policy and the outlook of Indian monsoons will have a bearing on the value of the rupee. With the dollar strengthening, the rupee will remain under pressure. The rupee could breach 64 anytime and could also head towards 65. This will affect importing companies and epically those with unhedged forex positions. In the interim, the RBI is expected to stem the rise in the rupee. So far, the RBI has intervened through state run banks to arrest volatility in the rupee.

Indian companies with exposure to Europe are also worried a weakening euro will lower export revenue and increase costs. Businesses that have a high exposure to the Eurozone will face higher cost of funds as well as lower revenues due to currency conversion cost which would arise from currency volatility in the Euro region.

Traders have lost appetite for Indian bonds due to concerns pertaining to Greece. The RBI might have to cancel more bond auctions on Friday due to higher yields quoted by traders, as they lose appetite for bonds.

On the commodities front crude oil prices slipped while some sheen seems to have returned back to gold. Oil prices dropped to a three week low while gold prices rose to a one week high on the backdrop of the crises in Greece. Gold rose to 1,186.91 dollars but later gave up those gains as investors were wary of its longer term outlook. Gold usually benefits from market uncertainties as investors view it as a safe haven during times of crises.

Foreign Institutional Investors (FIIs) turned bullish on Indian equity markets. As reported by the economic times dated 29th June, 2015, FII's bought index futures worth more than 1 billion dollars last week suggesting that they are bullish on the Indian market. Sentiment might have improved considerably as all the negative news has already been factored into the markets. Although a further correction cannot be ruled out before the nifty starts its up move towards 8600 levels again. Indian equity markets could also face high volatility this week due to global uncertainties.

What should be your approach?

Movement of INR against USD would largely affect the asset prices in India. If Greece exits Eurozone, chances are likely that, Euro would find more support and USD may become weaker. However, if referendum in Greece favours its membership in the European Union, Euro might fall and USD would rise. Strong dollar means lower commodity prices globally; still, weaker INR against USD may confine the downward movement of gold and other commodities in India. Rising USD and rising U.S. treasuries may make Indian bonds less favourable.

If the market correction is solely a Greece induced one then it would be a wise decision to buy into it. However corporate earnings season will be a key determinant. It is safe to say that Greece is small and Indian fundamentals are strong. But India can't be completely insulated from the impact of a Greek default. However it is likely that lenders would show some leniency to Greece and a solution would materialize to the end of this crisis.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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