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Would Grexit be a tragedy for the EU?

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The Greek crisis has been a long, drawn-out saga that has deteriorated after talks between its government and European Union officials over restructuring the country’s debt failed to deliver any agreement.

Greece has days to strike a deal with its creditors or face a default on an existing €1.5bn (£1.1bn) loan repayment due to the IMF by the end of June, as well as €5.2bn in short-term bills.

The coming days could finally determine whether Greece defaults on its debt, potentially leaves the currency union or manages to negotiate a deal to remain in the euro area.

Given the uncertainty surrounding the negotiations, the outcome for Greece remains unclear. But what are the implications of the various scenarios that could unfold?

Scenario 1: Greece defaults and leaves the eurozone

A Greek default and exit would actually “not be that bad” for Greece because it would relieve the country of an “unbearable debt burden” and allow its economy to adjust through devaluation, according to Premier Asset Management senior investment manager Jake Robbins.

“However, just as US authorities thought that allowing Lehman’s to go bust would have no severe consequences across the financial system given its small size, Grexit may also have far reaching, unanticipated consequences,” he says.

JP Morgan Asset Management global market strategist Vincent Juvyns says the likelihood of a Greek compromise with EU officials before the end of June is low. However, exposure to Greece among other eurozone members is lower than it has been previously, so contagion risk is limited, he adds.

The European Financial Stability Facility currently holds the largest share of Greek debt at 47 per cent. This is followed by eurozone governments at 19 per cent and private investors who hold a relatively modest 12 per cent share, according to analysis by Columbia Threadneedle Investments.

“So it is the ‘institutions’, rather than private investors or privately-owned banks, which would take the biggest hit in the event of a default,” explain Columbia Threadneedle Investments fund managers Philip Dicken and Martin Harvey.

Royal London economist Ian Kernohan says the market generally reacts “to things it doesn’t expect”, so a Greek exit – in theory at least – shouldn’t shake the markets too severely. “In that case we’ll see risk assets selling off which will be a buying opportunity,” he says.

“We continue to see value in Europe, irrespective of a possible Grexit,” adds Juvyns.

He says: “Whilst economic momentum in the region is admittedly fragile, it is tangible and moving in the right direction. Periphery countries have undergone meaningful structural improvement, economies are healthier, the flow of credit is strengthening and the ECB is helping to reignite inflation with QE.”

However, Close Brothers Asset Management chief investment officer Nancy Curtin argues the implications of Greece’s departure from the monetary union would be significant.

She says: “A Grexit would highlight the structural vulnerabilities of the bloc – the lack of fiscal union to support monetary union, which remains a structural issue. A Grexit may also trigger a change in approach from the ECB. Firstly, it is possible we’ll see a fresh injection of liquidity to soften any blow of a Greek default, but in the longer term, we may see the ECB take on a more quasi ‘financial responsibility’ role, without the fiscal mechanism to balance economies.”

Scenario 2: Greece defaults but stays in the eurozone

Greece could default on its debt and remain in the eurozone, at least for a short period of time, experts say.

“If events deteriorate in the coming days, there is still serious debate on what actually constitutes a default and when this will eventually be declared by the rating agencies, however, this could still be weeks or months away,” says Old Mutual Global Investors fund manager Kevin Lilley, who manages the Old Mutual European Equity fund.

It is also difficult to judge any outcomes when the situation changes on a daily and sometimes hourly basis, add Dicken and Harvey.

“What is clear is that some form of Greek default cannot be ruled out,” they say.

“Absent any further support from the institutions, Greece will run out of cash on or before 30 June. At this stage, Greece would find it difficult to pay any benefits or indeed the salaries of state employees, throwing the country into chaos.”

Scenario 3: Greece secures a deal and stays in the eurozone

The best outcome would be some debt forgiveness by Greece’s creditors followed by a restructuring and extension of the remaining debt, Robbins says. He says this would allow Greece to lower its debt to GDP ratio and avoid further austerity plans.

He says: “Most likely seems to be yet another fudge with minor concessions from both sides and essentially booting the problem down the road another few months.”

In this case Robbins expects risk assets to rally, sovereign yields to compress and optimism over European economic growth to be beneficial for equity markets.

Lilley adds: “An agreement between the parties would likely spark a relief rally, but how sustainable this would be is dependent on the content and credibility of the package agreed.

“My portfolio is overweight in value stocks such as banks and very underweight expensive consumer staples and defensive stocks. Evidently, greater clarity over the Greek situation will benefit this strategy.”

Juvyns says there is a real sense of frustration across the investor community in Europe about the lack of resolution remains a major issue.

“Investors are waiting for the dust to settle, hence we’ve seen some bond investors slightly de-risking and reducing their exposure to the periphery in light of what will surely be further volatility and also because fixed income valuations have been stretched.  We think those are tactical moves rather than fundamental shifts.”

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Comments

There are 4 comments at the moment, we would love to hear your opinion too.

  1. Julian Stevens 22nd June 2015 at 3:53 pm

    The ECB, IMF and who knows how many other institutions to which Greece is massively in debt have made plain that leaving the EU will NOT relieve the country of its “unbearable debt burden”. Were it that easy, Greece might as well default and leave tomorrow, because it’s almost certainly never going to be able to repay its existing debts. It can’t even service them.

    Then again, if Greece does default on its debts and leaves the EU, what can be done to force it to repay what it clearly cannot? Its creditors can jump up and down and demand repayments ’til they’re blue in the face but, if the money isn’t there, the money isn’t there. What’s the point in pretending that it is or ever will be?

    In the words of the 1974 Steely Dan song (paraphrased) Greece is already years past no tomorrow. Is there really any point whatsoever in manufacturing from thin air countless more billions of Euros and throwing them into a bottomless pit, just to stave off for a few months longer the inevitable?

  2. Wesley Haslett 22nd June 2015 at 4:29 pm

    Who signed off on them joining in the first place
    Seems due diligence was not done

  3. No doubt we are all getting very bored with the interminable reports of Greece and their financial woes. That the Greek government is behaving like some second rate 6th form debating society does nothing to arouse sympathy with many.

    However the press seems fairly oblivious to the following points:
    1. When was the last time you went on holiday to Greece? In my own recent and longer experience, this is the country where it has all too often not been possible to pay by credit card – cash only. I wonder why? Also during my last visit to Crete (last year) I was surprised to fiind many Eastern European (some even non EU) and even some British young people being employed at the hotel. Why no Greek people where youth unemployment is almost 50%? Add to this that Greece is hardly a cheap place for a holiday (only surpassed by Italy for expense) and you don’t wonder why Turkey and Spain (who both have far better standards of hotels) are mopping up holiday business.
    2. No one seems to mention that Greece pays the most generous state pension (as expressed as a percentage of average salary) in the OECD, paying over 90% of pre-retirement earnings. They also have one of the earliest retirement ages. Juxtapose this against the well-known reluctance of Greeks to pay tax.
    3. Their total debt of €317 billion is about 180% of their GDP. Which equates to a debt of €28,800 per head of their 11 million population (£20,500). Their imports are twice as much as their exports.

    Greece is a basket case – no that’s an insult to basket cases. It was a mistake to let them in. Are we deluding ourselves that things will change? Won’t it be better to lance the boil have a painful (and hopefully short) recovery rather than continuing with this unending farce. If the Greek people prefer to delude themselves, we shouldn’t join in.

  4. Julian Stevens 22nd June 2015 at 5:46 pm

    No we shouldn’t join in, even partially. We should pull out ~ totally.

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