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Greek contagion: who is susceptible?

Hans Timmer's picture

As Greece’s debt crisis escalated, analysts and the media have so far mostly focused on possible spillovers to countries in Southwestern Europe and on weakening of the euro.

It is striking that for weeks, financial markets have not been exceptionally worried about strong contagion to emerging economies, even though there are vulnerabilities in emerging Eastern Europe and European banks are heavily invested in emerging economies all around the world.

So should financial markets be more worried? For now, the credit quality for most developing-country sovereigns have held up and indeed improved in 2010, with 15 upgrades and only 2 downgrades (as of end April 2010). This is another example of how, compared to 10 years ago, the source of economic problems and risks are shifting from developing to high-income countries. But will this resilience last? How susceptible are developing countries when the European turmoil continues?

To enable closer monitoring of spillovers from the Greek debt crisis to market sentiment across the globe, the Prospects Group constructed a so-called "contagion monitor" for internal use. Using daily data for 60 countries (31 high-income, 27 middle-income, and 2 low-income countries), the contagion monitor combines: changes in sovereign spreads; changes in domestic 3-month commercial interest rates; changes in stock-market indices; and changes in nominal exchange rates into a single  indicator that summarizes "market deterioration".

Each of the four indicators has been normalized (i.e. they are measured in deviation from the average change and divided by the standard deviation of those changes) to ensure that the four building blocks have a comparable contribution to the combined measure. The normalization also carries other advantages. For example, it makes exchange rate changes independent of the numeraire currency.

It is important to note that the resulting index:

  • shows relative deterioration (if all countries experience the same worsening in the financial markets, the index will show no change for all countries);
  • only measures recent changes in the markets, not the overall shape of financial markets. A country can still be vulnerable even if markets improved in recent weeks;
  • is, unlike vulnerability indices, not designed to have predictive power. Instead, it registers changes in market sentiment that have already taken place.


There is no need in this blog to focus on individual countries (this is an attempt to observe the market, not to influence it….). But, taking end-March 2010 as a reference point for changes in financial indicators, a very interesting pattern emerges. I invite you to click on "play" in the beautiful illustration below, designed by David Horowitz.

High income

The dynamic bar chart shows the relative deterioration in financial markets, with high-income countries in gloomy blue and developing countries in fresh green (but don’t read too much into the color scheme). Downward pointing bars show the relative deterioration of financial markets since end-March. The longer the bar, the worse the relative relapse. Upward pointing bars indicate relative improvement.

In early April the deterioration was almost completely concentrated in high-income countries. Almost without exception, developing countries were on the positive side of the spectrum. That remained the case throughout April.

But in May the situation started to change. A few developing countries showed pressure on their currencies, upward pressure on their interest rates or drops in their stock markets. And that only got worse as May progressed. The latest observation in the chart shows a much more equal distribution. That is partly because the situation in Europe has cooled down somewhat, but partly also because we can no longer assume that emerging countries are unaffected by Europe’s debt problems. It is one of the clearest signs yet that traditional fiscal stimulus has reached its limits and is increasingly becoming part of the problem instead of the solution.

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