Euro watch greece referendum what next 28 june 2015

Euro Watch Greece referendum: what next?

Group Economics Macro & Financial Markets Research Nick Kounis & Han de Jong , + 31 20 343 5616

28 June 2015 • • • • • •

We look at the implications of the calling of a Greek referendum The government will miss its IMF payment, while capital and deposit controls are likely There will be grave consequences for the already battered Greek economy Some damage to eurozone, but this is not 2011-2012, and economy should recover quickly Risk of Greek euro exit has risen, though it is not our base case Economic and financial damage could well push Greece back to the negotiating table

Tsipras drops a bombshell

Consequences of the referendum call

Greek Prime Minister Alexis Tsipras dramatically called a

We see five direct consequences from the Greek government's

referendum on Friday night. It is planned to be held on 5 July

decision to stop the negotiations, call a referendum and

and will ask the public whether they agree with the bail-out

campaign for a No vote.

plan that creditors are proposing to the Greek government. He and other members of his government have made it clear they

1.

will be campaigning for a rejection of the plan. So Mr Tsipras is

The current Greek bailout programme ends on 30 June, when

asking the Greek people for their permission for him to refuse

Greece is also scheduled to pay the IMF. So ironically, by 5

the plan and accept the consequences, which would at the

July the new bailout plan the Greek people would be asked to

least mean default. Here is how we currently assess the

vote for would technically no longer be on the table in any

situation:

case. The Greek government asked the Eurogroup for an

•

There still is time to go back to the negotiation table before

extension of a month. Without any further commitment from

the current bailout programme runs out this Tuesday.

the Greek government, the Eurogroup denied this.

• • •

•

Greece will run out of cash

If that does not happen, Greece will miss its IMF repayment and head for default.

Given the lack of an external financing programme, the Greek

The pace of cash withdrawal from Greek banks will

government will be unable to pay its debts in coming days and

accelerate, it is becoming a bank run.

weeks. First up is the IMF payment on 30 June. Missing an

The ECB may restrict the Greek central bank’s liquidity

IMF payment is not technically defined as a default by credit

support for Greek banks, which will initiate a banking

rating agencies. Furthermore, under normal IMF conditions a

crisis.

missed IMF payment is not registered as such for a while.

Opinion polls suggest a majority of Greeks may support a

However, Managing Director Lagarde has so far taken a tough

Yes vote. How this develops is unpredictable, but financial

approach and has said Greece would be declared to have

chaos during the next few days may persuade the

missed the payment on 1 July. The next major payment is on

electorate to vote in favour of the bailout.

20 July when government bonds held by the ECB are due.

•

New elections may become inevitable.

Failure to pay back the capital would be seen as a default. The

•

The ECB and the other policymakers will do what they can

government may also struggle to meet its domestic payments.

to guarantee financial stability in the eurozone. They now have a significant arsenal of tools at their disposal.

•

•

•

The initial reaction on financial markets may likely be very

2.

ECB may end liquidity support; deposit and capital controls look inevitable, a bank holiday likely

negative. We think that the authorities will be able to

Given the escalation of fears of default and Greek euro exit, it

restore calm relatively quickly.

seems very likely that deposit withdrawal will accelerate to a

Some economic damage will occur as confidence is

rapid pace with a major risk of a bank run. So far, the Greek

negatively affected, but the eurozone economy should

central bank has been providing emergency liquidity

regain its footing relatively quickly. This is not 2011/2012

assistance (ELA) to Greek banks to accommodate these cash

when the first Greek crisis pushed the eurozone into a

withdrawals. When the current bailout programme runs out and

recession.

is not replaced by a new one, the ECB may judge that Greek

The risk of a Greek exit from the euro has risen, though a

banks are no longer solvent due to the Greek government

large majority of Greeks want to remain part of the euro.

bonds they hold. As a result, the ECB may pull the plug on

The period of stress could still push Greece back to the

Greek banks and end the ELA liquidity support. This would

negotiating table at some point.

2

Greece referendum: what next? – 28 June 2015

imply significant financial instability with grave consequences

5.

for an already battered economy.

The scenario where Greece eventually initiates a process to

Risk of Greek euro exit has risen

exit the eurozone has become more likely, though it is not our Even if the ECB were to allow the Bank of Greece to continue

base case. The economic and financial deterioration could

its ELA support, deposit and capital controls will most likely be

push Greece back to the negotiating table, possibly even with

necessary to stem deposit flight and the Greek authorities may

a new government eventually or after an in-out euro

close the banks for a couple of days. Deposit flight eased

referendum. However, a euro exit scenario could instead

during the course of last week, but there were long lines at

materialise if the economic pain of staying in the euro without

many ATMs in Greece on Saturday following the

financing for the government and the banks was judged to be

announcement of the referendum.

too much by the Greek authorities and public. They may feel they could not accept the necessary conditions for a new

3.

New government may be necessary to get process

programme.

back on track There still is time for all parties involved to get back to the

A euro exit would not be good for Greece. In the first year at

negotiating table before the Tuesday deadline expires. It must

least it would mean an even more severe economic crash. The

be said that mutual trust between Greece and the institutions

weakness in the economy, banking stress and fiscal tightening

has sunk to a new low following the Greek government's

would be ‘complemented’ by a collapse in the value of the new

decision to end the negotiations, call for a referendum and

currency. Inflation would soar. The experience from countries

commit to campaign for a No vote. On their part, the Greek

that have exited currency boards is that eventually, the

government feels that the institutions were not flexible enough.

economy would adjust and rebound. However, in the

The first opinion polls suggest that a majority of the Greek

meantime, social hardship would become severe and there

population want the government to sign the deal, while an

would be a risk of serious political instability.

overwhelming majority are saying they want Greece to stay in the euro. Mr Tsipras has vowed that he will respect the

For the rest of the eurozone, there would most likely be more

outcome of the referendum, but he will, presumably, call for

financial stress, with peripheral government bonds and other

new elections should he lose the referendum.

Southern European assets leading the decline. During the previous Greek debt crisis in 2011/2012 the combination of

4.

ECB needs to ready the OMT

deteriorating confidence and spiking borrowing costs in a

Financial markets will most likely react badly to the

number of countries pushed the eurozone economy into a new

developments over the weekend. There is a risk that peripheral

recession. The consequences this time around will be much

government bond spreads surge to stress levels. The ECB

less severe. First, the Greek exposures of the rest of the

needs to be ready to activate its OMT programme to restore

eurozone are much less than in the past. In addition, as

calm if necessary. The Eurogroup put a lot of emphasis on the

discussed above, policymakers would intervene. There are

firewall the authorities have built over recent years in its

signs that confidence in the eurozone is being affected by the

statement on Saturday asserting that ‘euro area member

Greek crisis and some economic damage is likely. However,

states intend to make full use of all the instruments available to

we are assuming that calm will be restored relatively quickly. If

preserve the integrity and stability of the euro area. This will

that is the case, the economy should eventually regain its

complement any actions the European Central Bank may take

footing.

in full independence and in line with its mandate. EFSF and ESM remain the strong instruments with our full backing that

How the eurozone might develop after an exit by Greece is

they have always been’.

unclear. Investors may price in higher risk premiums for weaker eurozone countries. But we have to keep in mind that

The ECB could decide to step up QE. However, QE is skewed

the project of European integration stumbles from crisis to

toward core government bonds, while the OMT could focus on

crisis only to get more solid with every step.

‘unlimited’ purchases of peripheral government bonds. To qualify for the OMT, member states need to be in an ESM programme. However, this includes a precautionary credit line, which has very limited conditions. The ECB needs to make the plans necessary so that it can use the OMT quickly if market tensions escalate.

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Greece referendum: what next? – 28 June 2015

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