Main scenario: Greece remains in the euro We still expect Greece will remain in the euro although the intensified ‘chicken game’ between Greece and its creditors has implied an increasing risk of ‘Grexit’. The current situation with prevailing harsh negotiations was unavoidable, in our view. The Greek government needs to show that it fights until the very end seeking an easing of the Greek programme conditions. We have been in this situation before with Greece normally blinking eventually. This was also the case under the most recent stand-off in February.
The reaction function reflects that 82% of the Greeks still want to remain in the euro, while Tsipras at the same time has promised his electorate more favourable conditions. Higher Grexit risk – but no euro break-up risk What could trigger a Greek default and a Grexit? Greece is close to running out of money as the last EUR7.2bn tranche has not been released, as the government has not come up with the comprehensive economic reforms required under the current bail-out programme.
Both Greece and its creditors repeatedly state that neither favours a ‘Grexit’. However, it could still happen. A continuation of the ongoing ‘chicken game’ could result in a Greek incident, ending with Greece leaving the euro (‘Grexident’). But a Greek default will not necessarily imply a Grexit. Greece has already been through an ‘orderly default’ with the PSI in February 2012 and is to this day still a member of the euro. In this paper, we consider the implications of ‘what if’.
ECB repayment Grexit – what if? Don’t expect any solution before the summer crunch time 2 | 22 April 2015 www.danskeresearch.com Grexit – Grexit what if? – what if? What are the first steps in a Grexit? If Greece continues to refuse the austerity requirements on pension reforms, labour market, tax etc, Greece could simply run out of money. In this case, Greece would initially be in a liquidity crisis, which would transform into a full-blown banking and currency crisis: Greece would miss a debt obligation triggering a credit event where the ECB removes the Emergency Liquidity Assestance (ELA).
The Greek banking sector would be insolvent and the removal of liquidity access implies that the initial bank run would be replaced by capital control, preventing capital from leaving the banking system and the country. The next step is then likely to be the introductions of the ‘New Drachmar’. When is the risk of a Grexit highest? The risk of a Grexit increases as we approach summer. Greece has two large repayments (SMP holdings) to the ECB totalling EUR6.7bn. Ahead of this, Greece must repay EUR3bn to the IMF with EUR772mn due 12 May.
Following Greece’s latest decree on mandatory transfer of cash balances of local government entities to the central bank (see Reuters), the needs should be covered through end May. Would a Grexit result in a euro break-up? No, a ‘Grexit’ would NOT result in a euro break-up. The euro area is in a much better shape to deal with a Grexit compared to both 2010 and 2012. Greek public debt has been ‘transferred’ from the private to the public sector, and the other peripheral countries’ current account and fiscal deficits have been reduced significantly while the growth outlook is improving. But such a scenario would clearly be unchartered territory and just the fact that it has been compared with the Lehman situation in 2008 (i.e. deemed ‘OK to fail’) implies that risky assets are set to be under pressure.
Much less contagion today than in 2012 … but periphery market has reacted to recent Greek turmoil Source: Bloomberg, Macrobond and Danske Bank Source: Bloomberg, Macrobond and Danske Bank How would other euro leaders respond to a Grexit? The Eurogroup would clearly signal that the coalition is even stronger without Greece. The heads of states and governments are likely to gather and jointly present the unity. Note, that Irish and Portuguese finance ministers have been among the hardliners when it comes to Greece.
Public opinion in these countries does not seem in favour of granting Greece additional help. The risk of ‘who’s next’ is no longer a real market scare. But what about Spain and the positive sentiment towards Podemos? Compared to Greece, the pressure on Spain is very limited as it has implemented economic reforms, the economy is recovering and the unemployment rate is declining. 3 | 22 April 2015 www.danskeresearch.com Grexit – Grexit what if? – what if? The risk of anti-establishment parties like Podemos gaining power is creating attention, however. But Podemos’s popularity has faded in 2015 and it does not look to be the largest party. However, it will be seated in the parliament and it will affect negotiations. What about the longer term when a new country is in trouble?
Whether countries in the future could opt for leaving the euro will depend on Greece’s performance after the exit. However, another ‘chicken game’ might be less likely, as the threat of being kicked out of the euro is more real. In the longer term, we do not expect the option of leaving the euro will lead to a higher default premium on sovereign debt, as it should already be priced in that member states have the possibility to default on their debt as Greece did with the PSI in 2012. How would the ECB react to a Grexit? The ECB will do ‘whatever it takes’ to limit contagion in the sovereign bond market. At this weekend’s IMF spring meeting, Draghi underlined that the ECB can do more, saying ‘we have enough instruments at this point in time with OMT, QE which, though they have been designed for other purposes, they would certainly be used at a crisis time if needed’.
