We need to make it clear that a final agreement with Greece won’t happen soon. The situation keeps deteriorating but a default is very unlikely in the coming weeks. No one is ready to take this risk. The ECB proved it when it raised ELA ceiling for Greek banks at the end of March. A political solution will be found but it will take time.
The real deadline for Greece is July 20th when the country will need to repay 3.5 billion euros to the ECB. Meanwhile, Greece is able to meet its financial obligations. The country has especially a cushion of 87 billion euros of financial assets in the form of participations in Greek public companies and banks. The latest report dates back to September 2014 therefore we can consider that amount has depreciated sharply in the past months. However, it is sufficient to pay the IMF in the coming weeks.
On the short term, the most likely scenario is a wobbly agreement in the form of small loans with deferred social promises from the Greek government in order to save time. This agreement may also include a debt maturity extension up to 50 years and impose capital controls to avoid a bank run. In March, withdrawals from Greek banks continued, reaching 2.5 billion euros, which is however less than the previous month. In total, nearly 22.3 billion euros have been withdrawn from Greek banks since the beginning of the year. This is a significant amount but it only represents about one-seventh of the total amount of bank deposits in January.
An intermediary agreement won’t be enough to solve the crisis because the Greek debt is still unsustainable. The extension of the repayment period up to 50 years is the most often mentioned solution by creditors but it won’t lower the weight of the total debt and it won’t give enough flexibility to the government to help stimulate economic growth. In this situation, Greece is almost doomed to fail and to go through a decade of austerity.
Greece needs a catharsis of its own to start over. Everyone knows that the only way out is a debt restructuring but it is politically sensitive at this moment. Talks about it may only happen in two or three years after the key elections in Spain (2015), France and Germany (2017). In a perfect world, the debt haircut should be around 50% or 60% but no EU member is prepared to accept such significant loss. A 30% haircut is more reasonable and could already be a good deal for Greece and its creditors.
In that case, the market reaction is unpredictable. A short-term trigger effect is possible and the Greek default could result in raising interest rate for indebted southern European countries, like Italy. Many hedge funds would see that credit event as an opportunity to make profit easily. However, the negative impact would certainly be very limited because the private sector is almost not exposed to Greece and the EU has many instruments to contain panic selling: the ECB QE, the OMT programme (Outright Monetary Transactions programme), the ESM (European Stability Mechanism) and the banking union. A default seems to be the least bad solution to end the Greek drama that represents a real risk for the European economic recovery.
By Christopher Dembik, Economist, Saxo Bank