Greece

While most still think of Greece as an isolated case, I think we should to pay more attention to what is unfolding there, just as they did for Dubai a few months ago. With time, we will see Greece as part of a much direct outcome of the global financial crisis and is becoming an important influence on valuations in many markets around the world.

There is no solution to the country’s debt issued without a deep and sustained policy effort. Given the initial conditions and the existing policy framework anchored on adherence to a fixed exchange rate via the euro, such adjustment is difficult and not sufficient. With the recent surge in borrowing costs and the disruptions in the normal functioning of government and corporate markets, we may see such spill over in Ireland, Italy, Portugal and Spain as a signal to the gradual widening in market risk spreads.

The world is still in the second and third innings of the de-leveraging process as years of excessive debt accumulation cannot be reversed in 18 months and it will take at least another 5-6 years to play out, possibly longer. We know that US sovereign debt has risen as fast as private debt has declined and the picture is similar in many other countries, providing support for the argument that all we have achieved so far is to move liabilities from private to public balance sheets, effectively burdening tomorrow’s tax payers.

At I write these lines, Greek credit default swaps – measuring the cost of insurance against a Greek sovereign default have exploded. Greece has in fact been in defaults in 105 of the last 200 years, so never say never. To bail out Greece may look manageable, but having to save all PIGGS – Portugal, Italy, Ireland and Spain would overwhelm the EU. Obviously, with low interest rates we currently enjoy, one could argue that a higher debt-to-GDP ratio could be sustained and that is essentially correct as long as interest rates remain low and should rates rise, which they almost certainly will as sovereign debt increasingly becomes junk.

Danske Bank demonstrated that in order to bring debt-to-GDP ratio to 60% by 2020, Greece, being in the most precarious position, would need to shave 4% off its budget every year and if that is going to happen, the implications on socio-political front can be depressive. Towards the end of last week, it became apparent that there might be some appetite for rescuing Greece, although few details are currently available. I am not convinced that there is a strong consensus in favour of a rescue package. Most of the positive vibes have come from Spain, whereas Germany and France have been decidedly less forthcoming. The outlook goes from murky to unbelievably grim!