“Ladies and gentlemen, please fasten your seatbelts.” Such a warning may not be out of place for Indian CFOs and treasurers as they prepare for another round of volatility in the global markets.

For little over a year now, Greece has continued to find a prominent position in the financial press. Though not in a complimentary tone.

The €110-billion EU bailout of Greece in May 2010 was aimed primarily at preventing a run on the other weak Eurozone countries, and to help ease the funding cost on the beleaguered country's national debt, which was slated to be around 115 per cent of the GDP at the time. In return, Greece was to make significant sacrifices by way of increased taxes, reduced pensions and public sector pay, and an increase in the retirement age.

Failed Bailout

The debate that we are seeing in recent weeks was easily predictable, and even European policymakers are now acknowledging what many analysts considered as inevitable. A year later, this bailout seems to have failed — first Ireland, and then Portugal were forced to go for similar bailouts under the enhanced EU-IMF mechanism — as interest rates on Greek debt are higher than they were before the bailout.

Ironically, the national debt to GDP for Greece is higher now than it stood last year, with further increases expected based on the current trajectory. Keen market observers rightfully concluded that a debt restructuring was only a matter of time — despite repeated denials from the Greek government and their desire to actively pursue speculators who whispered rumours of Greek restructuring around the Easter holiday weekend.

Behind the scenes, bankers, civil servants and politicians in the Eurozone are said to be working on possible restructuring scenarios, though it still remains unclear what form it would take — extending the bond maturities, haircuts, interest rate reductions, or combinations thereof.

The pain that such a restructuring would entail on financial markets is still being fully assessed. Aside from the direct impact on Greece economy, expectations of a similar restructuring in Ireland (and then Portugal) are likely to force investors and market participants to re-evaluate their exposure to European banks, and dry up liquidity in the interbank market. It could also cause violent moves in the euro exchange rate. Coming at a time when commodity prices and precious metals are volatile, and the warning shots fired by S&P towards the US credit rating, the impact may well be sharp and violent.

Volatility risk

Indian firms have a limited direct exposure to Greece, Ireland, or Portugal, but they will suffer nevertheless on account of the ebbs and tides of the volatility in the global markets.

Coming in the aftermath of natural and nuclear disasters in Japan, investor views towards the dollar, and increased risk aversion as well as market participants are likely to lean towards safety; and sharp movements in the institutional flows to India should be expected. Crude oil price is already complicating India's balance of payments and the subsidy bill, with the RBI and the government struggling to contain inflationary pressures.

Indian institutions and the corporate sector will be clearly impacted by the volatility in commodity inputs, the increased risk aversion, with a further impact on debt repayment, given the quantum of foreign currency borrowing in recent years, viewed against the unpredictable nature of the FII flows. Reactive risk management is passé, and proactive risk management is the new normal.

Many firms were unable to effectively manage the unprecedented market volatility in 2007-2008, leading to financial underperformance. This time around, there are ample red flags to alert the vigilant CFOs and treasurers on the inter-related nature of the risks that are coming, and the need to adopt a more holistic approach to manage their financial risks effectively and efficiently.

While the game plays out in Luxembourg, Berlin and Athens, there is still a window of opportunity to critically assess and implement a robust risk management strategy.

(The author is an Executive Director with KPMG. All views expressed are personal.)

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