Greece votes 'no' and enters limbo
The Greek referendum over the weekend returned a resounding 'no' to Europe's bailout offer. With 61.3% voting 'no', Prime Minister Tsipras has arguably increased his support compared to the 36% won in the last legislative election. In our view, the referendum result dramatically increases the risk of Grexit to around 75% due to a large number of obstacles that stand in the way of a new bailout.
Obstacles facing Greece
The first hurdle will be the European Central Bank’s (ECB) decision on the use of the Emergency Liquidity Assistance (ELA). This has been held constant at €89 billion since last week in exchange for Greece applying capital controls. The ECB is within its right to withdraw or reduce ELA access given that Greece is no longer in a bailout programme (the previous programme expired at the end of last month). If Greece re-applies for a bailout very soon, the ECB could decide that the negotiations are ongoing, which would permit it to maintain access to the facility. However, without an increase in ELA funds, Greece will run out of cash in the very near future.
Another hurdle is the European Financial Stability Facility (EFSF), which has already deemed Greece’s non-repayment to the IMF last week as a default event. It is within its right to recall all of the €140 billion it has lent to Greece, which would of course trigger a wider default.
Assuming it survives long enough, the Greek government is due to hold an auction on 10 July to refinance €2.25 billion worth of T-bills (short-dated government bonds). If the banks are not able to buy the new issuance, a sovereign default on the banks would be triggered.
Finally, if Greece manages to last until 20 July, it will need to repay about €3.5 billion to the ECB. If it fails to do this, it is highly likely that the ECB will end the country’s ELA access.
To make matters worse, the deterioration in the banks’ balance sheets could prompt the Single Supervisory Mechanism (SSM) to begin the Recovery and Resolution Process, which would bail-in depositors holding over a certain level of deposits (possibly €8,000). This was required in the case of Cyprus, but the Greek government could get around this by nationalising its banks. However, whether the ECB will look favourably on this is another matter for debate.
Muted reaction from Europe
The reaction from the rest of Europe has been muted so far. German Chancellor Angela Merkel and French President François Hollande will meet in Paris this evening, with a leaders’ summit expected for tomorrow afternoon. There appears to be some willingness to negotiate further, but there are rumours that some creditors are no longer supportive of keeping Greece in at any cost.
Note that a favourable outcome for Greece, Tsipras in particular, will deal a major blow for the leadership of Spain and Italy, both of which are fighting anti-austerity/establishment parties. Moreover, we doubt that European partners can truly trust Greece to implement any of the structural reforms it promises to do. Also, what stops Tsipras from simply calling for another referendum to reject the next bailout offer? The resignation of Greek Finance Minister Varoufakis will help, but will Greece really change its negotiation strategy if it is seen as working? The cycle has to stop which means that either both parties bend, or the union is broken.
Macroeconomic impact: reduced eurozone growth
Assuming Grexit plays out, we would expect a 50% devaluation in its new currency. This is likely to plunge Greece into a severe recession, with spiralling inflation caused by the rise in imported goods and services prices. For the rest of the eurozone, we would expect a slowdown over the rest of the year as companies and households hold back investment and spending. However, as the situation stabilises, we would expect a rebound in those activities.
Overall, our forecast for the eurozone (including Greece) would be reduced growth for 2015, from 1.4% to 1%, and from 1.6% to 0.8% for 2016. However, when Greece is excluded from the figures, growth in the rest of the eurozone would only be downgraded by 0.2 percentage points in both 2015 and 2016. At a global level, our baseline forecast for 2016 GDP growth would be 0.2 percentage points lower, with 0.1 percentage points higher inflation (all for Greece, the rest of the world is likely to see lower inflation).
Market impact: ongoing volatility
Financial markets are likely to remain very volatile. However, as it becomes apparent that exposure to Greece is very limited, European equities and peripheral bonds spreads will probably calm down again. The ECB may, however, have to intervene to help stop the contagion. In our view, the ECB has all of the policy tools it needs to contain market contagion, and the will to use them.