EM Rundown: What Would Grexit Mean for EM FX?

Markets are off to a bit of a slow start this week as uncertainty reigns surrounding Greece’s promised list of reforms. As part of Friday’s 4-month bailout agreement, the Greek government vowed to have a list of austerity reforms completed today for review by the Eurogroup tomorrow, so that the country could receive additional funds by the end of the week; unfortunately, Greek policymakers were unable to hit this deadline and are now planning on sending over the list of reforms tomorrow morning.
 
Greece’s failure to hit even its first hurdle on time raises concern that the rest of this week’s bailout process could encounter some additional snags, but we remain optimistic that Greece and her creditors will be able to meet Saturday’s drop-dead date for additional funds. Even if the rest of the bailout goes smoothly though, it will only extend Greece’s solvency for another four months, leaving the feared Grexit scenario very much in play. Such a development, if it grows more likely later this week or in June, could have a dramatic spillover impact on major EM currencies.
 
First and foremost, it’s important to note that the impact of a Grexit on other economies will depend heavily on how well European policymakers are able to limit any ensuing financial contagion. If the Eurozone essentially decides to “kick Greece out” of the euro, EU policymakers will have more time to prepare markets and the ECB will be more prepared to inject liquidity into the European financial system as necessary. In this scenario, the impact on EM FX will likely be limited as long as authorities can effectively quarantine Greece’s banks from the rest of the Eurozone.
 
Alternatively, if Greece unexpectedly opts to leave the Eurozone of its own accord, the impact could be far broader. In this case, contagion would be most likely to hit other Emerging European economies; in FX terms, currencies with close ties to the European banking system, including the Polish Zloty (PLN), Hungarian forint (HUF), and Turkish lira (TRY) may be the first to come under selling pressure. If the ensuing fears spread further, currencies of countries with large current account deficits or heavy debt loads could be the next shoe to drop, notably including the South African rand (ZAR) and Thai baht (THB).
 
As a final note, both Hungary (Tuesday, expected to hold at 2.1%) and Turkey (Tuesday, 25bps cut to 7.5% expected)  face potentially high-impact central bank meetings this week as well, so volatility in the EM FX space may be primed for a pickup this week regardless of what happens in Greece.