Here are some basic country risk definitions for one’s edification.
Country risk: A collection of risks associated with investing in a foreign country.
Political risk: The risk that an investment’s returns could suffer as a result of political changes or instability in a country.
Sovereign risk: The risk that a foreign central bank will alter its foreign-exchange regulations thereby significantly reducing or completely nulling the value of foreign-exchange contracts.
Credit risk: The risk of a government becoming unwilling or unable to meet its loan obligations.
Economic risk: The risk that macroeconomic conditions will affect an investment.
Geostrategic risk: The risk that international events, such as wars or diplomatic initiatives, will damage business or financial interests.
With Greece comprising just two percent of the European Union’s economy, one might wonder why policymakers are so troubled by the prospects of a Greek exit. The simple answer is that strategic risks greatly outweigh economic and financial ones.
On the economic front, EU countries are not overly reliant on the Greek market for their exports, so the economic loss would be marginal. Additionally, European banks are more insulated from a Greek default than they were in 2010, as most of the debt is held by foreign governments, the ECB and IMF. Financial contagion would be averted.
The strategic risks, however, may be pronounced. First, entry into the euro zone was considered permanent and inviolable. Smashing through this assumption would set a terrible precedent by rupturing this principle of inviolability. Fears that other highly indebted nations such as Portugal and Spain could exit during a future crisis would no longer seem irrational. This could adversely impact the euro’s strength and usage as an international currency.
But the more acute worry is strategic. A Grexit could damage the EU and NATO since Greece would remain a member of both. Having a disgruntled, resentful, economic basket case within the EU would prove cancerous, as it would inflame political divisions already present within the 28 nation bloc. An imploding and resentful Greece would also be susceptible to Russian influence, likely hindering NATO’s ability to act and threatening its unity. These strategic issues cannot be underestimated and make a Grexit truly worrisome.
Believe it or not, today’s Greek financial crisis is hardly unique, as sovereign debt crises are fairly common. As a result, the policy prescriptions are fairly straightforward and well known. The bottom line? The crisis will persist unless the debt is partially forgiven. Any other method, such as extending the debt repayment schedule or lowering the interest rate, will merely prolong the nation’s economic misery. Of course, the most effective debt crisis resolutions include strict conditions for debt forgiveness; structural economic reforms such as product and labor market reforms are needed too. But until policy makers implement this tried and true formula for resolving sovereign debt crises, Greece’s economic malaise will continue.