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Comment: Tensions to persist in euro zone periphery

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Richard Walsh (pictured), Head of Emerging Markets at Lombard Odier Investment Managers, on emerging market exposure to the Eurozone’s periphery…

The likelihood of a full-blown debt crisis in Greece has recently declined, but we expect tensions to persist in the euro zone periphery. Greece has now to implement its just-adopted consolidation package, which may further aggravate social tensions; Portugal needs to overhaul its economy to restore competitiveness; Irish banks are still shut out of capital markets; Spain is struggling to meet fiscal targets and markets are increasingly concerned about the health of Italy’s financial sector.

Market tensions in the euro area tend to translate into higher sovereign spreads in Emerging Markets. Further spells of stress, potentially of a higher magnitude than those experienced recently, are likely in the coming months. Exposure to Spain is concentrated in Latin America while Eastern Europe is most exposed to Greece.

Any disorderly default in the peripheral euro zone would lead to a re-pricing of risk in Emerging Markets, plummeting commodity prices and lower growth. That would exacerbate the fiscal problems of developed economies, including the US. A debt crisis in the periphery would also dent depositors’ confidence in banks.

Every time there’s a bout of stress in the euro zone’s periphery, sovereign spreads in emerging markets tend to widen. Serious stress in the form of a disorderly default would reverse the compression we’ve seen in Emerging Market spreads since 2008, creating higher financing costs and lower growth in many of them.

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