A temporary agreement based on the deal that was “on the table” before the Greek side walked out of the negotiations
July 8, 2015: A majority of Greek electorate voted to reject the proposed bailout “deal”. We now see two possible scenarios. A temporary agreement based on the deal that was “on the table” before the Greek side walked out of the negotiations. Or a breakdown of negotiations, an explicit default by Greece on its obligations to the ECB, followed by a cut-off of support for the Greek banking system by the ECB.
In Sunday’s referendum, Greek voters delivered a clear “no” verdict on the tax and reform proposals of the institutions: EU Commission, European Central Bank (ECB) and IMF. Contrary to our base case, the majority of voters thus followed prime minister Tsipras and his party’s recommendation. What happens next?
Temporary Deadlock in Negotiations Likely
The Greek government is, in our view, likely to interpret the “no” vote as an endorsement of its tough negotiating stance in the past months. It will thus, in our view, resist signing on to the existing proposals of the creditors without some further “sweeteners.” Conversely, creditor governments will, in our view, likely find it hard to make additional concessions to a Greek government that has campaigned against their proposal. Hence, we would expect at least a temporary stalemate in the negotiations.
Greek Economic Crisis May Force the Situation
We expect banks to remain closed, with the emergency liquidity assistance (ELA) frozen for now at 90 bn euro. With banks closed and financial as well as economic stresses worsening, we would, however, not expect the stalemate to last long. It seems likely to us that the Greek government will very soon need to request financial support from the EU and the ECB (the IMF will not be able to provide any support so long as Greek arrears have not been cleared). Even with only 60 euro per person being withdrawn every day by depositors, the banking system would soon run out of cash. While the ECB will, in our view, be reluctant to provide additional Emergency Liquidity Assistance, it will, we think, likely help to at least stabilize the banking system so long as political negotiations have again started.
Positive Scenario: Temporary Agreement Consisting of Limited Financial Support against Reform Commitment, and a Hint at Debt Rescheduling
As regards the creditors, it seems unlikely to us that they can refuse to negotiate with the Greek government, which was democratically elected and just vindicated in the referendum. Moreover, it appears that the two sides were in fact very close to an agreement just before the Greek side walked out of the negotiations. Hence, it seems to us that an agreement can be reached. The key “sweetener” for Greece would, in our view, be an indication that the rescheduling of Greek debt will be on the agenda in a second step. Note that the recent assessment by the IMF that Greek debt is not sustainable should make such a concession easier. The agreement would, in our view, also be made easier, if the Greek government were broadened to include some opposition forces. That said, any further concessions by the creditor side will likely generate substantial domestic opposition, e.g. in Germany, so predictions on the final outcome are quite uncertain.
Negative Scenario: Breakdown of Negotiations, Default and Eventual Euro Exit
The negative scenario is that negotiations between Greece and the creditors do not restart or break down early. In this case, an explicit default of Greece on its 3.5 bn euro obligations to the ECB on 20 July becomes much more likely (Greece also seems quite likely to miss the repayment of a yen-denominated bond on 14 July. These bonds are mainly held by private investors, so this would constitute a formal default incident). Under such circumstances, the ECB in its supervisory function, would most likely need to declare the Greek banks insolvent. Further liquidity assistance could then not be provided. A full-fledged banking crisis is expected to follow. Given severe cash shortages, the Greek government might then begin to issue IOUs, as a first step to euro exit (Grexit). Note, however, that such a step is not legal under EU Treaties, would be highly controversial politically in Greece and is also technically extremely difficult to accomplish.
Economic and Political Fallout in the Eurozone
The precise economic impact of the Greek “no” on the rest of the Eurozone is very difficult to assess. However, given that the Greek economy constitutes less than 2 percent of Eurozone GDP, the direct impact should, in our view, be quite limited. The main risk is, in our opinion, contagion via financial markets, especially a tightening of financial conditions in the Eurozone periphery as credit spreads rise. However, given the various mechanisms and institutions which have been created to stabilize the monetary union, in particular the enhanced tools at the disposal of the ECB, we believe the economic fallout of a “no” would be contained. The political fallout of the Greek vote is similarly difficult to judge. The positive case would be a “pulling together” of the Eurozone politically, with reform efforts accelerated; the negative case would be an increase in fragmentation.
Referendum’s Impact on Markets
In the short term, a risk-off environment could prevail, especially if uncertainty spreads to other peripheral countries. Investments in more defensive sectors could pay off, provided negotiations between Greece and its creditors are unsuccessful. For clients wishing to maintain their stock exposure, dividend stocks may pay out in the coming weeks. As for bonds, yesterday’s “no” vote increased the probability of a Grexit, putting pressure on Greek corporates.
Focus on Shorter-Dated Solid Investment Grade Names
As we expect credit markets to remain in risk-off mode today, credit spreads will most likely widen. Focus will be on European peripherals. Investors will be concerned about a potential spillover into Portugal, Italy and Spain, and France too could return to the spotlight, in our view. At this stage, we recommend focusing on shorter-dated solid investment grade names to avoid substantial volatility in these uncertain markets. We would avoid lower-rated European high-yield bonds at this stage due to increased volatility.
Oliver Adler is Head of Economic Research at Credit Suisse