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Economists React: What Happens If Greece Leaves Euro Zone? - Real...

By Katie Martin and Laura Clarke

The prospect of Greece leaving the euro is the only thing anyone is talking about in the markets at the moment. It even has its own nickname: Grexit.

Nothing is certain here; Greece may or may not leave, and there’s a huge range of potential policy responses. So, making allowances for some guesswork, here’s a rundown of the latest on some economists’ and analysts’ views on what could happen next.

CAPITAL ECONOMICS: “Leaving the euro zone could indeed be the only way for these countries to avoid a sustained and damaging period of deflation [and] an exit and devaluation would result in a significant and lasting boost to a departing country’s competitiveness, potentially kick-starting an economic recovery.”The repercussions if Italy and Spain left would be immense, causing another deep recession. But for Greece, and possibly for the rest of the currency bloc, the advantage of regaining full control of monetary and fiscal policy is likely to outweigh the costs. “After a partial breakup, euro-zone policy makers may feel less need to set an example for weaker countries that have left, perhaps prompting looser monetary and fiscal policy. It may eventually result in all the existing euro-zone economies staging stronger and more balanced growth than if the euro zone remained intact.”

DEUTSCHE BANK: Amid all the concern about Greece leaving the euro altogether, Deutsche Bank suggests another path: introducing a parallel currency, which it nicknames the “Geuro,” to run alongside the remaining common currency. Leaving the euro altogether would cause economic, political and social chaos, the bank says, whereas a parallel currency would give the authorities “the power to stabilize the exchange rate of the Geuro…so as to keep the door open to a future return.”Rather than a clear-cut and fully voluntary process, Deutsche Bank thinks that a Greek exit would emerge as the unwanted conclusion of a series of micro-decisions on the austerity package, bank recapitalization and the role of the European Central Bank.In the long run, Greece could be better off out of the euro area, but the change to another currency regime would be extremely painful for the country in the nearer term, with a contraction in the economy and in disposable income worse than was seen in Russia and Argentina. Containing the damage from a euro exit would require swift action and a capacity for policy coordination that has seldom been seen since the beginning of the crisis.

JP MORGAN: There’s now a 50% chance of Greece leaving, up from 20% before the country’s politicians failed to produce a coalition government. Regional unemployment could be higher than “anything seen in the past half-century.” In terms of policy responses “the euro-system’s direct exposure appears manageable in the context of large revaluation gains but if losses exceed the readily available buffer, euro-zone sovereigns may be called upon to make immediate capital injections.”Among the paths it lays out from here, the “chaos scenario” for JP Morgan goes as follows: “outright victory by the Radical Left or significant influence in a coalition and declaration of a debt moratorium, which the ECB/International Monetary Fund/European Union troika would respond to by ending the financing program and denying Greece access to ECB borrowing. If Greece then introduced the drachma, EUR/USD would probably decline to 1.10 due to widespread capital flight from the region. If instead the government backtracked and re-engaged the troika given that 80% of the electorate favors retaining the euro, the currency would stabilize around 1.20.”A Greek departure is likely to be disruptive and disorderly, pushing the euro to around $1.15-1.10 against the dollar and causing a 2% drop in euro-zone gross domestic product.

CITIGROUP: “There are many scenarios for a Greek exit; almost all of them are likely to be euro negative for an extended period,” says the bank that coined the now-ubiquitous “Grexit.” If the process is managed, which the U.S. bank deems unlikely, expect a short, sharp selloff in the euro, with a subsequent rally up to $1.45 or higher. If Greece just dumps the austerity program and walks, the risk of contagion rises, and “the euro could begin to rally, but so much damage will have been done by then that it would begin its rally from a much lower level and probably not be anywhere close to the current level at the end of the year.”If the stronger countries were to break away, some see euro gains ahead, but Citi reckons that “this can take a very long time and is probably well beyond an investible horizon.” All in all, the outlook for the common currency is “not very promising…unless policy makers surprise with decisiveness.”Citi sees three possible scenarios for an exit; a managed departure with a firewall implemented to prevent contagion (which would push the euro to $1.20), a scenario where such a firewall is insufficient to prevent a euro-zone break-up or risk aversion (heralding a drop to $1.13) and a disorderly worst-case exit with excessive volatility in other markets. The latter scenario sees Citigroup forecasting that the euro could fall as low as $1.01.

NOMURA: “Without pretending to be precise about the effects involved, we think it is fair to say that a large swing in the current-account balance would be forced by a lack of capital inflows and inevitable capital flight,” Nomura says, stressing repeatedly that bank holidays may be needed to stem the flight of deposits.

DANSKE BANK: “We are in for a long period of uncertainty but we believe that ultimately a deal will be struck between the EU/IMF and Greece that keeps Greece in the euro and austerity will continue. The alternative is too severe for both the EU and Greece.” It notes that there is wide backing among the Greek population for the euro, with 81% in favor in the latest poll, and 54% of the Greek population supports sticking to the EU/IMF program.Danske lays out three scenarios for Greece: positive, negative and very negative.“In the positive scenario, the euro-pro and austerity-committed parties ultimately win the votes needed to continue implementing the program. This scenario would trigger a relief rally.“In the negative scenario, Syriza becomes the main party following the election. Despite its verbal resistance against the EU/IMF program having been fierce, it is likely to ‘calm down’ on the other side of the election.“In the very negative scenario, the game of chicken between Syriza and the EU/IMF gets out of control and ends with no agreement. The EU/IMF stop the support for Greece and the ECB no longer accepts Greek bonds as collateral. Greece effectively has to undergo the fiscal adjustment overnight. There is a severe run on the Greek banks. Greece defaults on its remaining public debt. The introduction of a new currency would take some time. This scenario would result in initial market chaos. Also, Spain and Italy are likely to come under pressure.”

HSBC: “On contagion, one would have to decide how impacted the market elsewhere in Europe would be by a Greek exit, and also how swift and aggressive the associated policy response from the European Central Bank would be. The latter could include a reopening of the ECB’s bond-buying program, additional long-term refinancing operations, or something more ground-breaking.” The bank has devised a scale for how damaging a Greek exit would be to the common currency as a whole. Broadly speaking, it reckons that the “best” outcome for the euro would involve the experience for Greece being as tough as possible. If it’s too easy, the temptation for others to leave would be greater, and the currency would be seen to be easily divisible.

BANK OF AMERICA-MERRILL LYNCH: “The risk of a Greek euro exit is rising, but so too are the incentives to keep Greece in.” If it does happen, expect a short, sharp shock to the euro’s exchange rate. “However, in the short run if the ECB responds decisively we believe risky assets, especially bank stocks and periphery bonds, may be prone to a short squeeze. In the longer run, exporters would have scope to outperform domestically geared stocks for a lengthy period.” In a separate note, the bank adds that “if Greece exits the euro, Greek oil demand drops one third… and in a disorderly euro breakup, demand could contract sharply, with profound implications for oil prices.” Brent oil prices could drop as low as $60 per barrel, from the $106 area now.

RBS: “There is already likely to be some form of Plan-B… [but] if contagion really kicks off then a thinly veiled form of monetary financing of debts may be on the table.” The bank reckons a Greek euro exit risks a total of EUR400 billion from bailouts, the ECB and Bank of Greece lending. The risk of capital flight is key. “We are most worried about deposit risk for the periphery, and we see plenty that can be done to alleviate these risks–crucially if there is the political willingness. For instance, allowing banks to access the EFSF/ESM [the European Financial Stability Facility and European Stability Mechanism, the euro zone's temporary and permanent rescue funds, respectively] directly. We have not thought that this was politically feasible but clearly there is a pain threshold that makes politicians take risks.” Alternatively, a euro-wide deposit insurance program would be a good idea, RBS says. For trade ideas, the bank says “we think the theme of market deterioration leading to a policy action translates into buying bonds at distressed levels, which looks closer now.”


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