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.”