13/09/2011: Global contagion from Greece

In the torrent of newsflow from the euro area, we are forgetting about the wider geography of implications of the Greek default. Here are some of the points in addition to my comment to today's article on the topic in Canada's Globe & Mail (article here).

There are two core pathways through which the Greek default will have an adverse impact on banking and sovereign risk valuations outside the euro zone. Firstly, there is the direct impact via foreign banks exposure to Greek debt. These range from small to medium sized and can be concentrated in a small number of institutions in each country. Secondly, there is a number of inter-linked second order effects, which tend to have much larger implications once propagated across the global financial system.

Direct impacts include:

• Japanese banks hold $432 million in Greek debt
• U.S. banks hold $1.5 billion in Greek debt
• UK banks hold $3.4 billion in Greek debt
• Bulgaria has bank credit exposure of $13.5bn to Greece (banks and sovereign debt)
  
• Serbia's exposure is about $7 billion
• Romania's banking system is tied into $20.2 billion of exposures to Greek banks and sovereign debt
  
• Turkey $30.4 bn exposure
  
• Poland $8.0 bn
• Croatia, Hungary and the Czech Republic combined are exposed to some $460 million.

Indirect impact:

Were Greece to default, core euro area banks - Deutsche Bank (including Deutsche Post) carries ca €2.94 billion exposure, Commerzbank (€2.9 billion), but also SocGen, Credit Agricole, Commerz Bank etc will come under severe pressure to recapitalize. German banks have combined exposure to Greece of ca $22.65 billion, French banks $14.96 billion. Cross positions vis-a-vis Greek banks (with their exposure to Greek sovereign bonds of $62.8 billion) imply strong spill-overs. Thus, Greek default can lead to a severe liquidity crunch and flight to safety of deposits from not only Greek and euro area banks, but from a number of closely inter-connected banking systems, especially those with close trading and investment links to the European Economic Community.

This is bound to induce contagion across the entire euro area and spill overs to euro area banks cross links to Eastern and Central Europe and beyond. In effect, Romanian and Bulgarian banking systems are heavily dependent on Greek banks and their own banks collapse will put huge pressures on Hungary. The ripple effects of this can reach as far as Ukraine and Turkey.

There are other interesting cross-links worth looking at. Greek default can trigger default across Cyprus banking sector which holds ca $28.3bn exposure to Greek banks and sovereign debts (156% of Cypriot GDP). With 30% recovery rate on Greek default, Cyprus is facing with recapitalization bill for its banks to the tune of 10% of GDP. This, irony has it, can put pressure on Russian deposits in Cyprus and capital flows between Cyprus and CIS, which are massive - note that Cyprus is the largest single FDI transfer point for Russia with CB of Russia estimating that in 2007-2010 Cyprus banks channeled some 42bn USD worth of FDI to Russia.

To sum up, Greek default - which will inevitably combine sovereign and banking sectors defaults - will trigger a large-scale revaluation of assets and risk-weightings across a broad range of Eastern and Central European Economies, including Turkey, in effect slamming the breaks on the only growth engine within the European Economic Community and its nearest neighbours.

But there is a global cost to the Greek default as well, which rests with significant dislocations of risk-linked investment markets (equities and corporate debt), insurance and derivative products. The multiplier effects, consistent with 2008-2010 financial markets experience, suggest that magnification of Greek default costs across the global economy can reach 4 times the original volume of default itself. With 50% recovery rate on Greek liabilities, this implies a total expected cost of ca €240 billion, and with 30% recovery rate currently appearing to be more realistic, the propagated effects can sum up to €340 billion.