Its incredible and wierd to think that a tiny economy like Greece with $310 Billion GDP(<0.5% of world GDP) could threaten to engulf and freeze the world financial markets with the prospect of Greek default on soverign debt payments. The experts are predicting that the damaging impact of such an event could be more catastrophic than Lehman bankruptcy due to the contagion effect it will unleash on european banks and PIGS nations like Italy and Spain.

Why is the prospect of Greece default such a big nightmare when we had bigger economies like ASEAN nations and Arzentina going the default way earlier and recovering strongly? 

The answer lies in few factors like world economy and financial markets becoming much more integrated than ever before and Greece being an intergral part of the European Union with one single currency. 

The financial markets have never been more integrated and coupled because of seamless flow of information, hot funds(hedge & FII) and cross country investments. A sneeze in US markets leads to pneumonia in European and emerging markets and Vice-versa. Whenever there is a big negative event , these floating funds and investments become risk averse and flow back to so called “safe heavens” like USD($) and Gold. This in turn leads to havoc for all the asset classes and markets , especially equity markets.

European union is a wierd amalagamation of nations which has achieved currency and monetary union with no poltical and fiscal union. The nations are practically free to persue their fiscal plans with high budget deficits and debts without much restrictions from the European Union or ECB. Consequently many nations(Primarily the PIIGS – Portugal, Ireland, Italy, Greece and Spain) spent their way to prosperity for many decades till they landed up in the current situation. All these expenditure was funded through sovereign debt issue which was readily lapped up by European banks. For example , Greece debt of about $400 Billion is being held by Greek banks, French and German banks. Hence if Greece defaults , all these banks will have to writedown their Greek govt bonds and would not be able to borrow using the bonds as collateral. Also,there could be an attack on Italy and Spain sovereign bonds(by short sellers) leading to sudden increase in yeilds for these bonds to the level of junk bonds. All these events could lead to meltdown of Euro financial markets which in turn would lead to meltdown of world financial markets. 

Thirdly , Since Greece shares the same currency as other Euro nations , it is not free to devalue its currency to emerge out of this situation strongly like ASEAN nations and Arzentina . Neither  it can exit from EU so easily to launch its own currency. 

So , whats the solution?

Greece Default is an inevitable event due to hopeless situation in Greece – economic depression, high unemeployment, lower tax collection, high labor rates and non-competitive economy.

Disorderly Greece default is not a feasible solution as it will lead to the above mentioned catastrophic situation of Euro zone meltdown . The only solution is a managed and or orderly default. EU leaders like Germany and France are trying their best to find a way for orderly default , e.g. debt restructuring of Greece debt when banks/lenders may have to write off half the Greek debt of $400 Billion, recapitalizing the Euro banks so that they could withstand the partial writedown of Greece as well as other PIIGS nations debts. 

The time is running out on Europe and next 3-4 weeks are very crucial for reaching a conclusion on the blueprint of orderly default and start executing the same. EU leaders like Merkel and Sarkozy(Gernan and French leaders) have pledged to come out with a blue-print on Euro banks re-capitalization in next 3 weeks today. However , this may solve the Euro banking crisis but is not going to be the silver bullet for solving Greece and other PIIGS sovereign debt crisis. That could be done only through Greek debt restructuring and making the Greek economy competitive through rationalization of Euro currency exchange rates and Greek labor costs or through orderly exit of Greece from EU. Similar steps along with reigning in fiscal deficits and spends needs to happen in other PIIGS nations too.

Whats the implications for other emerging markets like India and retail investors like us ?

These are very uncertain times for the equity markets all over the world including India , especially October and November. Its impossible to predict the market moves in next 4-6 weeks. It could go either ways sharply depending upon how the Euro leaders behave and execute their plans.

Indian economy is also getting saddled with new problems , apart from inflation and high interest rates like collapse of new capital investments, Industrial production(measured by IIP)slowing down ,downgrades of earning estimates for leading blue chip sensex companies and policy/ reform paralysis at the central govt level.  However , these are short term hiccups with silver lining already appearing in the dark clouds like inflation predicted to go down with better monsoon and commodity price cotrrections as well as Govt. planning to come out with reforms/policies in winter sessions. Long term India growth story with 14-15% nominal growth rates(7-8% real growth rates) in the next few decades is still very much intact.

Value investment gurus like Graham and Warren say that the time of uncertainties are the best times to invest in equities. This is an opportunity to buy fundamentally solid businesses with sustainable competive advantage with competent management as most of the quality stocks are available at attractive prices.Fundamentally solid companies like BHEL , REC(Rural Electric corporation), Bank of Baroda, Axis Bank, L&T, GAIL and Jain Irrigation are trading at near 52 weeks lows at an excellent discount to their intrinsic long term values . Invest with 3-5 years horizon to get handsome gains.

In short term(next 3-4 months), market could  get worse (due to unfolding global events in Europe) before it gets better .Hence , keep some funds(15-20%) in cash or other liquid investments over the next few months so that you could buy selective stocks at every dip, using those funds .  Invest with 3-5 years horizon as the prices are attractive which will ensure good “margin of safety

Happy reading and Investing.