The past couple of months have been plagued by fears over the Eurozone crisis. The uncertainty over the Eurozone and the prospect of a break up of the Euro has placed the markets in turmoil.
The European ministers and the markets have stopped talking about Greece for the time being. The banks, politicians and markets have finally caught up with the fact that Greece is technically insolvent and has been for a while now. We believe it is likely that the process has begun to initiate an orderly exit of Greece from the Euro (dubbed the “Grexit”). It takes months to design and print a new currency and an orderly exit is likely to take place toward the latter part of 2012 or early 2013. A Greek exit is inevitable and an orderly exit could enable the markets and the fragile economy to cope with the transition. However, a disorderly exit could have significant repercussions to the markets and the entire banking sector. Attention has therefore been drawn to Spain where the current turmoil could have repercussions for the rest of the Eurozone.
The Spanish economy is in financial difficulty. Low productivity, record unemployment and the rising cost of debt is creating a major issue for one of the largest economies in the Eurozone. The Spanish prime minister has recently announced that Spain have had problems recapitalising the Spanish Banks and is facing a banking crisis. Quite simply, the government does not have the necessary resources to bail out its failing banks. The recent nationalisation of Bankia, Spain’s third largest bank has caused tremors in the markets, made worse by rumours that Bankia requires a further bail out. Last week, Spain made a request to the European Central Bank (ECB) for a direct injection of capital into the Spanish banks, something that has never been sanctioned before in Europe. Credit ratings agency Fitch has responded by downgrading Spain's credit rating from A to BBB status due to concerns over the outlook for the Spanish Banks. The credit downgrade will further exacerbate the problems in Span as it will put upward pressure on the cost of borrowing. The politicians in Europe will need to react quickly to the growing crisis and come up with a plan to prevent the possibility of a Spanish bank run which could severely damage the economy and trigger a breakup of the Eurozone.
The British Pound has continued to strengthen against the Euro due to the growing uncertainty over Europe. The Pound is now trading at a rate of 1.24 against the Euro. The Pound is trading at 1.55 against the US dollar.
China has responded to the growing crisis by cutting interest rates by 0.25 percent, the first cut since November 2008. The Chinese economy has been slowing as China begins to feel the effect of the Eurozone crisis. It is hoped that the interest rate cut will provided added stimulus to the economy and maintain China’s competitiveness.
Focus has also turned to India where the economy is slowing significantly as private direct investment begins to dry up. This has been followed by a slump in the currency and investors are beginning to pull their money out of the country.