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May 21, 2012

Guesses about the Future of Greece and Europe

WSJ blog - As the prospect of Greece leaving the euro becomes more real by the day, economists are trying to figure out what would happen next to the economy and to the markets.

Guesses about the Future of Greece and Europe

ActionForex - We do not expect Greece to leave the euro. Note that there is wide backing among the Greek population (81% in favour in the latest poll) and 54% of the Greek population is in favour of sticking to the EU/IMF programme. The most recent polls suggest it is 50-50 between Syriza and ND on which party becomes the biggest after the election. We do not expect a 'Grexit' but acknowledge that the risk is real.

Three scenarios for Greece: positive, negative and very negative.

1. In the positive scenario, the euro-pro and austerity committed parties (mainly ND and PASOK) win increasing public support as we get closer to the election date and ultimately win the votes needed (possibly supported by Dimar) to continue implementing the programme. This scenario would trigger a relief rally.



2. In the negative scenario, Syriza becomes the main party following the election. Despite its verbal resistance against the EU/IMF programme having been fierce, it is likely to 'calm down' on the other side of the election. At the same time, the EU gives in and gives Greece an extra year to reach the programme targets and engage in significant EU-funded investment projects in Greece. Hence, both Syriza and the political leaders in the core countries bend over backwards to meet each other. This process would take some time following the election and it would, once again, feel as though we are looking down the abyss.

3. 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. Initially, there is confusion on whether Greece introduces a new currency or just sticks with the euro. The government issues IOUs to pay off public workers. After some time, the government could consider reintroducing the drachma but, at this stage, any conversation about deposits is close to irrelevant, as the capital flight has been severe. 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. The policy response from both the political leaders and the central banks is likely to be significant. However, there is a risk that this would not be enough to calm investors after the initial mayhem and that we could be in for 'Lehman Brothers' like stress in the markets.

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. It says a Greek exit would depress the country’s gross domestic product by five to 10 percentage points more than if it were to stay in. “That would put the peak-to-trough decline in Greek GDP at 25-30%, broadly matching the U.S. experience in the early 1930s.” In turn, that would take away around two percentage points of growth from the region.

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 term “Grexit”.


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 break-up, 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.

HSBC: 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.

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 €400 billion from bailouts, the ECB and Bank of Greece lending. The risk of capital flight is key.

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