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Motilal Oswal

By Motilal Oswal 17-May-2010 | 10:43

The crisis in Greece crystallises the worries about the dire state of the public finances in many countries around the world. The fact that a Greek default is even considered possible is a fundamental shock to confidence in the world order. For a start, Greece has been seen as an advanced economy, if only by virtue of its membership of the euro-zone. As such, the shock value of a sovereign default in Greece could be much larger than the frequent defaults in emerging markets. We have to wait and see the events unfolding till May-19th (the day by when Greece should have paid 12 billion dollars to her lenders)


What’s more, the pressure will inevitably increase on other weaker members of the monetary union, notably Portugal, Ireland and perhaps Spain and Italy (PIIGS). That pressure would be all the greater if Greece were to leave the union and then, in time, be perceived to be doing better outside than in. The contagion from a Greek default could also spread to much larger economies where the public finances are also fragile, including the UK and, perhaps the biggest risk of all, Japan.


What’s more, even if Greece is rescued, the appetite for another bailout would surely be limited. Greece might therefore end up as the next Bear Stearns – the last to be bailed out before patience finally runs out, and some other country is allowed to default.


The dollar is also likely to strengthen further. Indeed, safe haven demand for the US currency is likely to be even greater than it was in late 2008 given the concerns over the future of the euro and the much worse state of the public finances in Japan.


The Greek crisis could also be the catalyst for a long overdue correction in the prices of most commodities. Many participants in these markets seem to assume that the world economy is returning to the strong growth that fuelled the commodity price boom from 2004 to 2007 as if nothing has happened in the meantime. In contrast, I expect big falls in commodity prices especially crude oil and copper. While this may good news for consumers, a collapse in commodity prices could be a big shock for financial markets. It could be very bad news for many emerging economies including India.


It is surely now or never for gold. Safe haven demand should be strong and rising given that gold is not dependent on the creditworthiness of any government. Despite this, current gold prices of around $1163/oz are still some way below the peak of $1227/oz seen in December last year. Gold’s failure to set new highs in dollar terms most likely reflects the resilience of the US currency, still-low inflation and the lack of any new impetus from central bank buying. Prices would spike higher in the event of an actual Greek default. But, gold may fallback to much lower levels by year-end as the dollar rises further and global deflation fears return.


Back home, economy is on an upswing, inflation remains stubbornly high, and RBI has started to lift policy rates. Worries over contagion from Greece have curbed the rise in Asian markets including India, but Asia has deleveraged since its mid-to-late 1990s crisis and there is not much to worry. Rollovers have been strong at 82% indicating that markets are likely to remain strong in the near future.