Domino effect of Greece is a possibility: Henderson Global

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German Chancellor Angela Merkel said on Tuesday that Europe was doing everything in its power to prevent Greece from defaulting on its debt and cautioned that an exit from the euro zone would unleash "domino effects" and should be avoided at all costs. Christopher Palmer of Henderson Global Investors says that the market, however, certainly have priced in practically a certainty of some form of Greek default and perhaps, a euro exit at this point.

Speaking to CNBC-TV18, he says that the right thing for Greece to do at this point is to try to figure out a way to improve its current account situation.

Below is the edited transcript of the interview. Also watch the accompanying videos.

Q: How is the European market receiving the statement from Merkel? Isn't it a positive statement that she would do everything politically to keep the eurozone united?

A: I think one needs to put it in the context of which euro she is trying to defend at this point of time and which are going to be the ongoing member countries. That appears to be part of the strategy to keep the core euro intact. But market certainly have priced in practically a certainty of some form of Greek default and perhaps, a euro exit at this point. So one need to read beyond her initial statement and figure out what it is they are planning after perhaps, this inevitable Greek default occurs.

Q: Do you think Greece will move forward on what needs to be done at this point and the downward reaction on the European indices right now could be more a function of their cost to bailout countries like Greece, given the hard stance that people like Merkel have been taking?

A: Predominantly coming from emerging market stand point, the right thing for Greece to do at this point is to try to figure out a way to improve its current account situation. The classic pathway for emerging market economy would be to devalue and exit a fixed exchange rate, and try and increase its competitiveness in a more competitive world.

That could involve some type of default, Greece's bonds are trading now only about 40 cents on the dollar. So the likelihood of a default appears a certainty. They wouldn't be giving up much by going down this pathway since it's untenable to maintain the interest rates and balance sheet that the Greek government has to finance at this point.

That aside, I think the idea of the 'Domino Effect' over the so-called idiosyncratic risk for Europe is something that Europeans authorities need to be quite aware of. There are other countries which people could throw into the same basket as Greece, and I think that should be their number one priority- looking beyond this Greek event which has some ramifications for European banks and European bank earnings, but to maybe try to hold the line at Greece.

Q: So how are the markets interpreting the turn of events, are they beginning to have less and less faith that Greece will stay put?

A: I think this is an event that has quite a lot of uncertainty for European investors because they haven't had to really contemplate the idea that someone left the euro or would leave the euro. So no one is quite sure what it means in terms of settlement of existing credits, how some of the inter-company loans will be settled, going forward. There could be quite a lot of legal challenges too to Greece. So the markets are behaving in a classic uncertainty environment where people are looking at their portfolios and saying, I don't want to hold any of these border-line state's sovereign bonds which could be a mistake, of course because some of them maybe perfectly able to weather the storm.

I think there have been too much focus on Greece, and not enough focus on helping the countries around the periphery, which are not as poorly off as Greece to weather the storm. Other wise, they still have the so-called domino effect.

Q: In the last few days, we have seen our rupee depreciate to almost Rs 47 which is more than a year low. In the event that Greek defaults and you probably have a catastrophe in Europe, what implications will it have for emerging markets?

A: When we look back at events of 2008, we have certain indices of risk rapidly approaching where they were in 2008. That means to me that investors are trying to move into safer asset classes, even if it is only temporarily while they see what kind of challenges Greek default and exit means. So you will see the dollar probably do a bit better. But the dollar's underlying fundamentals are not particularly strong either. So it won't be a particularly long period of dollar strength, more like what we saw in 2008.

But we see most emerging market currencies actually having begun to sell-off recently. We know its been one of the areas investors have been sheltering in, and when you get this crowding effect of people sheltering in one thing, be it gold, or emerging market currencies, or debts, or developed market 30-year bonds, valuations and the underlying risks in the overall market place begins to bleed into those markets. That is probably more of what we are seeing now that it is just the risk bleeding into those markets rather than any underlying shift in fundamentals.

With regards to India specifically, all I would say is there is quite a lot of talk in the market that India is about to change its interest rate policies and that could be quite a secular risk for the Indian currency as it transitions from the very high interest rate environment right now and an inverted yield-curve. Perhaps, policy changes over the next 6 months could have an impact on the so-called carry-trade investors who are looking at India.

Q: What is the buzz on India is the expectation that rates get higher or that the rate cycle has peaked?

A: I think all countries, particularly in the BRICs, but also countries which are peripheral to BRICs, have been conducting these so-called macro-prudential policy measures. They need to step back and see higher interest rates policies and conservative policies with regards to bank reserves, how will that impact growth? Should events in Europe lead to a higher period of volatility, and perhaps, many uncertainties about global growth? My belief is and the market's belief is that we see a general easing policy by many of the BRIC Central Banks in their own time for their own reasons. I think its important to maintain credibility but they will go for growth because the shock to growth globally isn't unknown. If 2008 is any guide, and G20 meetings of 2009 are any guide, we will see some compensatory fiscal and monetary policy movements by certain countries particularly, China and Brazil seemed to be the best positioned to do this. But India and Russia and other players seem to have a role to play in this as well.

Q: How is the market taking to the news that Italy has asked China to buy its bonds, and what are the levels you are watching in the euro-dollar?

A: We don't want to say it's the last resort; I would have to say the Italian move with the Chinese appears to be in very early stages. It is simply, perhaps even a technical discussion at this point. So I don't want to read much more into it than that. Investors right now are very cautious and they are reacting to each piece of information as if it is the last straw, the straw that is going to break the camel's back. In fact, we know the Central banks and Governments have lots of policy measures at their disposal. So I wouldn't say they have reached the end of the line, the Italians, but the market is being quite dramatic recently and people maybe thinking that sort of thing.