Euro watch 5 july 2015

Euro Watch Greece votes NO: what now?

Group Economics Macro & Financial Markets Research

Nick Kounis + 31 20 343 5616

5 July 2015 • • • • • • •

The Greek NO vote significantly reduces the chances of a deal, especially in the near term The ECB is unlikely to increase ELA to the banking system, which is running out of liquidity The Greek government may be forced to introduce a parallel currency – such as a system of IOUs The chance of an eventual Greek euro exit has risen sharply and looks more likely than not at this point The reaction of markets will be clearly negative, but we don’t see this as a ‘Lehman moment’ The authorities – especially the ECB – would intervene with force in case of severe stress Greece is set for a deep recession, but situation is manageable for the eurozone economy

Greece votes NO to creditor deal

Big risk there will be no agreement

The Greek public overwhelmingly voted ‘no’ to the deal offered

With the economic and fiscal outlook now weaker, that deal will

by creditors in the referendum held on Sunday. With most of

likely be tough and will, at the least, take a long time to

the votes counted, more than 60% voted against the deal. With

negotiate. Indeed, there is a big risk there will be no

polls suggesting that 80% of Greeks are in favour of remaining

agreement. First of all, there appears to be a serious lack of

in the euro, the result suggests that they bought into Prime

trust between the Eurogroup and the Syriza government.

Minister Tsipras’ claim that a ‘no’ vote would strengthen his

Second, the Greek government appears to be looking for

hand in negotiations. Indeed, Mr Tsipras and Finance Minister

upfront debt relief, while the Eurogroup seems only ready to

Varoufakis argued that a ‘no’ vote would allow the Greek

decide on this if Greece implements the measures in a

government to negotiate a better deal and stay in the euro.

programme.

Greek euro exit now more likely than not

Deal not completely off the table

Against this background we assess the main consequences of

To reach an agreement, one side or the other – or a

the ‘no’ vote. We do so in a very fluid and uncertain situation,

combination – would need to make major concessions. For

but these are our initial thoughts. In summary, it seems more

instance, the economic and financial deterioration could push

likely than not that Greece will leave the euro at this point (60%

Greece back to the negotiating table, possibly even with a new

chance). The prospects a deal with creditors have dimmed,

government eventually or after an in-out euro referendum. A

and in the meantime the Greek economy will suffer even more

middle way could be found, where incremental debt relief is

severe economic and financial pain. The introduction of a

exchanged for delivery of reforms by certain points in time.

parallel currency looks likely. The eurozone economy will be negatively impacted, but it should regain traction relatively

Liquidity situation at banks to deteriorate

quickly. We still attribute a large chance to an alternative

With no deal in the offing, the ECB seems unlikely to increase

scenario (40%), where Greece eventually reaches a deal with

the limit on ELA for the Greek banking system. Even with

creditors. The economic and financial deterioration could push

deposit and capital controls, the banks are suffering significant

Greece back to the negotiating table, possibly even with a new

liquidity pressures. So if the ECB continues to cap the limit at

government eventually or after an in-out euro referendum.

current levels – let alone restrict it further – the situation for the

Below we set out our views in more detail.

Greek banking system will become even worse. The supply of money to the economy will be further constrained and the

A deal is now less likely, especially in the near term

economy will suffer badly.

Following the ‘no’ vote, a deal between Greece and its creditors now looks less likely, especially in the near term.

Government will also run out of cash

Despite the Greek government’s claims, other eurozone

At the same time, the government is also running out of cash.

member states do not seem likely to take a softer stance and

The next major payment is on 20 July when government bonds

give in to their demands because of the ‘no’ vote. With the

held by the ECB are due (though there is a relative small

previous programme already expired, the Eurogroup will likely

Samurai bond due on 14 July). Failure to pay back the capital

insist that Greece requests a new two or three-year ESM

would be seen as a default. The government will also struggle

programme, which will involve fresh conditionality.

to meet its domestic payments.

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Greece votes NO: what now? – 5 July 2015

Introduction of a parallel currency a possibility

meantime, social hardship would become severe and there

In these circumstances, the Greek government could introduce

would be a risk of serious political instability.

a parallel currency. One type of parallel currency that has been speculated on in great detail has been IOUs, of the kind

Greek crisis manageable for eurozone

introduced by the State of California in the past. However, in

For the rest of the eurozone, there would most likely be more

the case of Greece, the problems in the banking system mean

financial stress, with peripheral government bonds and other

that banks would be unlikely to accept IOUs. This means IOUs

Southern European assets leading the decline. During the

would need to be issued, which were divisible and could be

previous Greek debt crisis in 2011/2012 the combination of

used as a more general medium of exchange. There is a

deteriorating confidence and spiking borrowing costs in a

major question mark whether this could work for long or

number of countries pushed the eurozone economy into a new

provide much relief.

recession. The consequences this time around will be much less severe. First, the Greek exposures of the rest of the

Greece could initiate process to exit

eurozone are much less than in the past. In addition, as

The scenario where Greece eventually initiates a process to

discussed above, policymakers would intervene to support the

exit the eurozone now looks increasingly likely. A euro exit

market. There are signs that confidence in the eurozone is

scenario could materialise if the economic pain of staying in

being affected by the Greek crisis and some economic

the euro without financing for the government and the banks

damage is likely. However, we are assuming that calm will be

was judged to be too much by the Greek authorities and

restored relatively quickly. If that is the case, the economy

public. They may feel they could not accept the necessary

should eventually regain its footing.

conditions for a new programme.

As we have noted previously, how the eurozone might develop Negative market reaction, but no Lehmann

after an exit by Greece is unclear. Investors may price in

Financial markets will most likely react negatively to these

higher risk premiums for weaker eurozone countries. But we

developments but we do not see this as a Lehmann moment.

have to keep in mind that the project of European integration

Exposures of the eurozone banking system to Greece are

stumbles from crisis to crisis only to get more solid with every

modest and relatively transparent. At the same time, we do not

step.

think other eurozone member states are in a similar situation to Greece and ready to follow in its footsteps.

Authorities to intervene with force if necessary There is a risk that peripheral government bond spreads surge to stress levels. In that event, the European authorities will react with force. In the near term, the ECB could decide to step up QE, but if that does not have the required impact, we would expect the central bank to activate the OMT. QE is skewed toward core government bonds, while the OMT could focus on ‘unlimited’ purchases of peripheral government bonds. To qualify for the OMT, member states need to be in an ESM programme. However, this includes a precautionary credit line, which has very limited conditions.

Greek economy looks to shrink sharply The deposit and capital controls, combined with the heightened uncertainty, will likely lead to a deep recession in Greece in coming quarters whatever happens next. A euro exit would make the situation even worse. In the first year at least it would mean an even more severe economic crash. The weakness in the economy, banking stress and fiscal tightening would be ‘complemented’ by a collapse in the value of the new currency. Inflation would soar. The experience from countries that have exited currency boards is that eventually, the economy would adjust and rebound. However, in the

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Greece votes NO: what now? – 5 July 2015

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