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Starting Note : This is a long post and i am going to cover a lot of ground. I have tried to simplify and generalize in several cases to make a point.

Recently Newspaper's seem to emphasize the (negative) impact on Eastern markets every time developments in the Greek financial crisis move closer towards a possible exit from the Eurozone. In the older posts by my co-members we have described, What the crisis is all about and What will happen after the "NO" decision as per referendum. 

So I have a question that Why are we bothered? Why it will affect the East-Asian Market, mainly India?

But before going into this stuff, i will like to add some more stuffs about Greece crisis, more likely its introduction in my way.
So let's start.

IMAGINATION
Imagine a poor kid who joined a club of rich friends to run away from his aggressive next door neighbor. The poor kid hoped to get rich with his new connections. Instead, he was forced to overspend to keep up the appearance. Eventually the days of living beyond his means caught up to him.  He borrowed a lot. His friends acted as the guarantor to his debts. 

At some point, the poor kid was unable to repay the debt and the rich friends are now on the hook. The debt is quite enormous, but the wives of the rich friends don't want to risk their money to clear the debt of their poor friend. The debt is now due and no one is ready to pay. This has now strained a wide range of relationships and there is a huge risk of very messy breakups and divorces due to the financial problem.

Background

Starting from Charlemagne in the 8th century CE many European emperors had a grand vision to unite Europe. That resulted in over 1000 years of incessant warfare. 

After the second world war, unification attempts shifted from the power of the gun to the power of the currency. European powers along with the USA worked on a strong economic integration to prevent another world war. 

The first move was initiated in 1951 by a group of 6 countries - France, West Germany, Belgium, Netherlands, Luxembourg and Italy. These continental powers saw most of the action both the world wars. Thus, the economic integration started from there. The West European countries were next to each other, similar in their development and incomes and thus the integration was quite successful. 

However, in 1981 Greece was admitted into EU. This was unusual as Greece was way behind Western Europe in development. Greece was comparable to other eastern European countries and none of Eastern Europe was admitted into EU. For Western Europe, Greece was important for its historic connections as the center of the Byzantine empire. For Greece, the entry was important to protect itself from Turkey on the Cyprus issue. 

Ancient history clouded all logic. Greece was admitted to EU and later became a part of the Euro. Books were cooked to make it look like Greek economy was managed well and other Europeans governments looked the other way. 

Trouble

Free trade areas and economic integration often makes sense among comparable economies. However, Greece and rest of EU were quite dissimilar. Greek companies could not withstand the competition, while the wages of Greek employees were rapidly rising to level with rest of EU. 

The result was that unlike every other EU power who enjoyed economic gains by being a part of the EU, Greece receded. Its economy declined.
Premature accession

Creditors lent money to Greek governments to keep up their appearance of a rich country. Creditors lent money due to the EU brand. Eventually Greek governments gorged on so much debt that someday the game was coming to an end.

Starting from 2009, Greece has been unable to pay the debt and unable to restructure its economy. Going back to the example of poor lad, in the normal cases a poor lad could cut his expenses well and bring back to reality. However, being a part of the club he had little independence to do so. Greece had to put up with a strong currency and unable to weaken the currency to bring back competitiveness to its economy. 

Future


Greece should have never been in EU in the first place. And its continuation impacts both Greece and rest of EU. However, any divorce is messy no matter how incompatible the couple are. Their divorce could bring down a whole range of divorces and a probably end to the club. Or maybe the club could be strengthened by Greek's exit. No body is able to say which way things would head if Greek quits EU. That fear casts a deep shadow over the markets.

Impact on India



As we have seen the impact and recovery but i will try to highlight some what was originally assumed -

  1. India's largest trading partner is the EU. Trouble there will affect India's exports. India exports nearly $40 billion every year to EU [Rs. 2.4 lakh crores]
  2. World financial markets are closely linked. Just as kids in a class catch cold if just one kid gets it, financial markets get screwed if one market goes down. Investors in US and elsewhere would pull money out of India and other "foreign" stocks for the losses in Greece [basic human psychology is that if we get into trouble with one person, we avoid everyone similar to them]. When investors pull money away, Indian stock markets will crash. That will affect Indian companies.
  3. When world bond markets get into a problem, Indian government would find it tougher to borrow money and that would affect domestic investments & growth. It would also push down the currency [meaning imports will go up] and cause inflation.

Ring-a-ring o' Greeces,
A pocket full of promises,
A-tishoo! A-tishoo!
We all fall down.

Now the above point, "IMPACT ON INDIA" is so much of importance that markets fell due to it's fear only (i.e. ah this is going to happen, "speculation"). 

Coming to original heading, WHY? Now after explaining this stuff in my way I am able to give some explanation to this "why".

See, There are two fundamental things to understand here:
  1. World markets are deeply interlinked
  2. Human beings stereotype extensively

Deep linking of world markets

Let's say someone punctures a vein in your arm. Will your heart and brain be affected? You could say the arm is less important and quite far from the important organs. But, that belief is not going to save your life.

Greek crisis would not have been a big deal if it were not a part of EU. If it were outside the EU, it would have been another eastern european country to face crisis and the world would have easily ignored. However, by bleeding the EU it has touched a major vein. 

The ones who provided debt to Greece are important players in the world economy and if they take a loss there will be serious effects in rest of the world. Europe is the biggest trading partners for many of the countries in the world and trouble there would affect trade (especially exports) from other parts of the world. That would mean unemployment, poverty etc.

Emerging markets like India export a lot to Europe and thus they will suffer if Europe goes into a recession and reduces buying stuff. 

Human beings stereotype & psychology matters


One of the persistent myths about the financial market is that it is some rational entity focused entirely on facts. It is far from it. Psychology matters a lot, especially in the short and medium terms. Herd mentality is rampant. When somebody cries fire in a movie theater everyone runs to the exits - killing a lot in the stampede. 
This is why when Lehmann brothers collapsed in 2008, the whole financial market went berserk. The deep interlinking mattered as much as the psychology. Investors panicked about the value of the exotic assets they held and wanted to quickly cash out. 

When American investors lose money in Greece, they will quickly make conclusion about all the emerging markets and could exit enmasse. Partly because these investors invest in emerging markets through funds such as theVanguard FTSE Emerging Markets ETF. When Greece goes down, the fund goes down. The investors will look at their losses, make a quick conclusion and pull money out of the fund. When they pull money out of the fund, money exits markets such as India. 

To understand a bit more, you need to understand how investing works. A lot of ordinary investors pool their money to invest through an entity called a fund. This way, they could hire a smart person [or an algorithm] who could be managing these diverse investments. The fund [either mutual fund or exchange traded fund] would invest in a lot of related things. These are often called Foreign Institutional Investors (FIIs). When one of the investments in the fund goes into a loss, the investors see the loss. The investors behind the fund will pull money out anytime they see a big loss and put money when they see a gain.

Hope the above idea helped you to know "why" to some extent. :)

NOTE: The above explanation was originally posted by Balaji Vishwnathan on qoura. I have compiled some of his answers and posted them with some modifications to make this a talkative discussion. The whole credit for the content goes to him.


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