Fallout to extend beyond borders

Athens: Spiralling inflation. A collapsed banking system. Hundreds of billions of dollars in unpayable debts and likely isolation from the world financial community. That much Greece can count on — at least initially — if its political paralysis continues and it leaves the euro.

But the fallout would extend well beyond Greece's borders, and analysts have been struggling to grasp whether it would upend markets as the collapse of Lehman Brothers did in 2008 or — if Europe's financial systems prove durable and its politicians adept in response — simply pass with a shrug.

There could be immediate risks to the Spanish and Italian economies: Tens of billions of dollars have left those nations in recent months as investors doubt their ability to both control rising public debt and boost their economies from recession.

Earlier patterns

A Greek departure from the euro would, officials and analysts fear, push the lack of confidence in the Eurozone to another level, accelerate that capital flight and leave one or both nations close to collapse. It is a pattern reminiscent of what happened in Latin America and Asia in the 1990s, and it is the most likely way that a Greek exit from the euro could ignite a global round of financial contagion.

The risks were highlighted on Thursday when the Moody's rating agency cut its assessment of Spanish banks, saying it had less confidence in the ability of the Spanish government to support the country's financial system.

If the crisis "turns to bigger players like Spain and Italy, through so many channels — trade, capital flows — it becomes global pretty quickly," Rebecca Patterson, chief market strategist with JPMorgan Asset Management, said. "If you own a Spanish bond what would you do? Even if in the long term it works out, there are other things to do with your portfolio....What are we advising? We are staying away."

That strategy of euro avoidance is one reason the interest rates Spain must pay to borrow money have risen to levels that officials in Madrid acknowledge they cannot sustain for long. Interest rates on some shorter-term bonds have nearly doubled this year; longer-term Spanish bonds are now being resold on secondary markets at rates equivalent to five percentage points a year more than Germany pays.

Most analysts and officials agree it will only get worse if Greece drops the euro — an event for which there is no procedure, guidebook or precedent.

There are potential bene-fits to an exit, although they would take time to become clear. By controlling its own money supply and exchange rates, the country could make its exports more competitive and help set the stage for recovery. Officials in Athens could also count on help from their central bank in financing government deficits rather than being dependent on the stricter rules of the European Central Bank in Frankfurt, which prohibit financing of government debts.

Immediate impact

But the immediate impact would be severe for Greece, according to recent analyses by the International Monetary Fund (IMF) and others, which foresaw rapid price rises, a deep economic downturn and a possible loss of social order.

Analysts asked about even rough historical analogies mention anything from the printing of Confederate dollars during the Civil War to the difficult division of debts among the former Soviet states and the collapse 20 years ago of an effort to keep European exchange rates in close line with Germany's deutschemark.

How much worse would it get for others, and for how long? Greece itself is now considered less of a global threat. Since its problems became apparent in the autumn of 2009, banks, pension funds and other investors have steadily pulled out.

According to the Bank for International Settlements, foreign banks had $244 billion (Dh896.26 billion) in loans, investments and other Greek holdings as of September 2008. At the end of last year, that was down to $96 billion, and is likely far lower now following a writedown that cut the value of the country's privately held government bonds.

Of the country's $430 billion in outstanding public debt, well over half is owed to the IMF, the European Central Bank and other European institutions.