WHAT exactly is a 'disorderly debt default' in Europe and how would it affect Singapore?

 

Basically, a debt default occurs when a borrower - who may have issued bonds or taken loans - cannot pay creditors back on time.

 

In an orderly scenario, the borrower negotiates with its creditors - banks or bondholders - to extend or roll over the debt.

 

If the borrower is bankrupt, receivers seize its assets, sell them and try to pay creditors back.

 

Unfortunately, in today's globalised and complex markets, debt defaults are not that straightforward - especially when the defaulting borrowers are not just companies but entire countries.

 

If Greece defaults on its debt, the casualties will not just be its sovereign bond holders, who will take heavy capital losses.

 

All sorts of complex financial instruments, like credit default swaps that are linked to Greece's financial health, or the banks and institutions that hold Greek bonds, could fail.

 

The widening fallout could spark panic in financial markets as investors dump not only Greek bonds, but also Italian, Spanish and Portuguese bonds, and bank stocks as well. In the worst-case scenario, the endgame may be another full-blown financial crisis.

 

This could hit Singapore in three ways. The first and most direct way is through Singapore's exports. In a crisis, confidence plummets. In Europe, businesses will stop investing and consumers will stop spending.

 

Singapore's exports will be badly hit, given that the European Union is the country's largest export market with a 14.3per cent share.

 

Experience from the financial crisis in 2008 showed manufacturing will suffer the most. As production slows, jobs could be lost.

 

The second way that Singapore could be hit is via the many European banks that could run into trouble. European banks have traditionally been among the largest sources of credit and lending for companies in Asia. Should they suffer big losses and run out of capital, they could defensively pull funding back in a big way.

 

Already the International Monetary Fund says this is happening, with many European banks announcing some US$2trillion (S$2.5trillion) worth of reductions in assets in the region.

 

A more drastic pullback could lead to a credit crunch, with Asian banks still unable to make up the shortfall. This would create huge repercussions for businesses and the real economy as firms depend on bank lending to survive.

 

Lastly, a disorderly default situation in Europe could lead to investors pulling their money out from assets such as stocks and property, causing huge drops in value.

 

At the height of the market panic following the fall of Lehman Brothers, the Straits Times Index lost more than half its value between August 2008 and February 2009. Over-extended property investors could be mired in losses or even be in negative equity.

 

OCBC economist Selena Ling says these price falls may not be as drastic as in 2008, but a repeat of the pain experienced then cannot be ruled out.

 

Noting investor funds have stopped flowing into the region for six weeks now, she warned: 'Investors have taken to the sidelines and are watching. It's not become a fund outflow situation yet but it could very well happen.'