Capital flight to hurt Euro banking system: HSBC

The uncertainty in the global markets continues with apprehensions of a Greek exit from the eurozone. In an interview with CNBC-TV18, Arjuna Mahendran, MD and Head Investment Strategy Asia at HSBC Private Bank said that the uncertainty on Greece is likely to linger till June, when Greece is scheduled to go for a re-election.

Mahendran also sees a high probability of further liquidity infusion by the ECB. The possibility of banks runs leading to deficits in the European bank clearing systems is also not ruled out by him. Below is the edited transcript of the interview on CNBC-TV18. Also watch the accompanying video. Q: How do you see the next few weeks between now and the 17th of June play out with particular reference to what the EU Summit might throw up in a couple of days?
A: I think the tone of the meeting yesterday between the German and the new French Finance Minister was indicative of what to expect over the next month. Basically, the markets are stuck between a rock in a hard place.
On the one hand the French Finance Minister made it clear that they would like Europe to move expeditiously on issuing this euro bond that is jointly and severely backed by all the European euro zone member states. The Germans are insisting that there should be a fiscal compact in place, prior to the issuance of such a bond or else there is a danger that countries would misbehave. There will be no central control of finances within individual member's budgets.
That issue will not be resolved effectively until we have the Greek election and the French Parliamentary elections, which are due to take place around the same time in late June. I think the French, at least President Hollande and his advisors will not be able to come off the stand that they have taken. According to the French, the growth pact in Europe should take precedence over the austerity measures that have been put in place. Q: Would you say the events of the last couple of weeks though have raised the probability of a QE like event coming in the next few months. Has the US been pushed into a corner as well?
A: I think the US will probably wait a little longer before showing its hand as regards QE or any variant thereof. But, in Europe I think there is a fair chance that we will have some infusion of liquidity in the very near future. The bank runs that have started in Greece are now starting to emerge in other peripheral countries like Portugal and Spain, where the smarter investors or rather bank deposit holders are taking their euros out of local banks and transferring it to Germany, Switzerland or Asia as a safe haven.
Now that run is causing some problems within the European banking system also and this I think is the danger that we face in the next few weeks and perhaps even months. A lot of these local banks in places like Greece, Portugal and Spain are going to keep hemorrhaging their deposits off euros and as a consequence, they are going to be in deficit within the overall European banking clearing system.
The so called TARGET 2 system where already Greece owes 120 billion euros, Greek banks owe the Greek Central bank a 120 billion euros which in turn is owed to the other Central Banks across Europe. Today, we have heard that there has been a secret transfer of another 100 billion euros from the European Central Bank to the Greek Central Bank.
Already within the space of a month we have seen 220 billion euros of net flows into Greece. Those creditors out there, in the rest of Europe, are going to be left dangling if Greece really goes into a default situation which it is. Q: It is the emerging market currencies and Asian market currencies that seem to be bearing the brunt of this risk off even more than the equity markets. What have you made of that and do you expect to see more pressure, courtesy a spike in the dollar index or the dollar?
A: It's difficult to judge but, it seems there is a race to the bottom going on between countries who are facing slower economic growth as we proceed into the balance of 2012. Particularly, in Asia, there has been this tradition, specifically in East Asia, of devaluing one's currency to remain competitive and foster greater export growth. One suspects that maybe part of what's going on here.
Certainly, in countries like Korea they have kept their currency in parity terms quite weak over this whole recovery cycle. They have reaped huge benefits from that both in the technology space and in other auto maker exports etc.
I think that could be part of Central Banks casting a benign eye over weakening currencies, irrespective of the inflationary consequences because that's the only way they can export and keep their economies expanding. Q: Do you expect to see any flash points between now and the 17 June or do you think it is only after the results of the Greek elections that things will become clearer on which path we are headed from out there?
A: At the moment I would say the probability of a flash point occurring between now and 17 June is somewhere around 25% or thereabouts. But, it is increasing every day because of these imbalances that I spoke about in the banking system.
If the Greek banks keep accumulating these deficits vis-à-vis their counterparts across Europe and those deficits are contractually bound to happen within the clearing system amongst banks. We could end up in a situation where Greece is eventually forced to exit the euro zone before the elections and purely because of the mounting debts and the unsustainability of the situation. Q: What is the call on India amidst all this gloom and doom?
A: The trend we have seen amongst other Asian countries and I am sure the supplies to India haven't looked at the macro data for India recently. But, in China for instance, we have seen the growth of exports into Europe collapsing. It is now barely growing, which is quite significant because the euro zone is now China's largest export partner. It is a big deal if that is not growing.
I would suspect that this is the same for India. Of course, India is not as export dependent as China and the rest of east Asia.  Nevertheless, the extent to which financial institutions have been hit in the wake of what has happened at large in the US bank and the fact that markets are now becoming quite risk averse, this could mean for instance, export to India would probably will not see this sort of growth rates for the outsourcing activity that they have been undertaking in the past decade.
Definitely this is a dampening impact on global economic growth. Given that inflationary pressure is still lurking in the wings of India, China and all these emerging markets, I suspect that growth has to still take a back seat in the fight against inflation for the last three months at least. Q: Can markets such as ours be more sanguine about crude prices though and whether that part of the problem has cooled off at least for the second half of the year?
A: Yes. You are absolutely right. It is one of the funny things about global inflation at the moment and oil prices in particular. It seems that oil prices are waning, which is good because that does ease some of this inflationary pressure. In a sense oil prices are doing the work of interest rates it seems.
They rise when economy is waning and come off when these economies are slowing down. Apart from that it seems that low oil prices are symptoms of slower growth in emerging markets which is not necessarily a good thing though, it could eventually lead to some sort of recovery in activity, perhaps later in the year.