Greek vote 'oxi': High Grexit risk

PM Tsipras and his government prevail and remain the counterparty of the creditors in case of new negotiations

Will the Greek president resign as he suggested? If yes, new early elections

If ECB stops ELA, its game over for Greece in the euro area: Unlikely for now

Trust is lost. Will all countries support new expensive deal? What about IMF?

New deal will be time-consuming and conditionality will remain part of it

Direct fall-out referendum modest; Contagion probably limited, but risk for more upheaval not excluded

Long term effects on euro area and EU negative

PM Tsipras victorious in referendum

About one week ago Greek PM Tsipras rejected the final proposals from the creditors on the bailout conditions and called a referendum. He asked to vote No and the Greek people complied. A large majority of about 60% voted yesterday “No” to the proposal. From the European side, many officials said the real question was in fact whether Greece wanted to stay in the euro area or not. The Greek people, of which a large majority wants to stay in the euro area, clearly were not impressed by this threat and voted “No”. The Council of Europe said the referendum wasn’t in line with international accepted norms, which opens the possibility that the results will be challenged in courts. However, given the unexpected large majority, such a challenge is less likely. Many European leaders said the referendum hadn’t any object anymore, as the proposal didn’t exist anymore. While this is formally correct, the “No” vote gives a clear political signal that also European leaders cannot put aside easily. Prime Minister Tsipras said it would strengthen his position on the negotiation table and that a deal would soon be signed.

“No” vote raises possibility Grexit

Prime Minister Tsipras’ optimism on a fast deal is probably wishful thinking or at least that’s not how we interpret the situation. It is unthinkable that the European leaders will drop overnight the conditions (austerity) for a new bailout deal. It would set a precedent in Europe that would weaken the euro area maybe fatally in the longer term. Chancellor Merkel very clearly said that the bailout deal will be attached with conditions to avoid that the euro area becomes a transfer union and that the rules of the euro club needed to be respected. The deterioration of the Greek economy since the January elections makes it likely that the amount of the bailout needed to keep Greece functioning became a lot bigger. As the IMF may refuse to participate, the cost of an eventual bailout for the other euro countries (via the ESM or otherwise) will be higher. This should be reflected in still more stringent conditions for Greece and less appetite for euro countries to conclude such a deal.

New negotiations, while time is running out

New negotiations are certainly not excluded, even likely, but they won’t be easy while time is fast running out to avoid a default of the Greek banks (see lower) and its government. The bailout deal officially ended on June 30 and thus cannot be used anymore to secure money that is needed to avoid a default in the next days or at the latest on July 20 when Greek debt of €3.5B in possession of the ECB matures. A totally new agreement is needed under ESM, but the procedure is time consuming and various hurdles may prove to be stumbling blocks. Greece already asked for talks on a new deal. The EU Commission will assess whether they qualify for such a deal. This assessment may be given quite rapidly. Then, the 18 national governments (euro area countries) will have to agree on the opening of the negotiations. In some countries like Germany, the parliament will need to approve such talks. Also when a deal is eventually agreed, there is in many countries (including Germany), parliamentary approval needed. So, first there is the risk the Greek government, strengthened by the surprisingly comfortable majority, will still resist strong conditionality and ask for a haircut of its debt (30% and 20 year grace period uttered PM Tsipras recently, backed by the recent the IMF report on Greece). Second, the acrimonious negotiations in the past five months with an unpredictable Greek government has cost the Greek government almost all its political credit and so there might be strong opposition in the Eurogroup to start new negotiations or in any case to give the Greek government a more favourable treatment than before. German vice chancellor Gabriel said yesterday eve that by saying no to the EMU rules, it was difficult to imagine how to negotiate a multi‐billion deal with Greece. French president Hollande asked to respect the will of the Greek people. On Tuesday, a special Eurogroup and EU Summit will be held, while today Merkel and Hollande (and others) will hold bilateral talks.
The first indications are that Germany and France are not on the same line on the way to treat the Greek issue, as was already obvious last week.

Eurogroup president Dijsselbloem wrote in a letter to the Greek government that “We will come back to your request for financial stability support from the ESM only after and on the basis of the outcome of the referendum.” This suggests, but other interpretations are possible, that a “No” would make new negotiations with Tsipras more difficult or impossible. The “creditors” hoped on a “yes” or at least on a regime change in Greece, but that is now in the short time unlikely to happen.

Complication: President to resign?

The Greek president recently suggested he would resign if a Grexit became likely. Will he consider the “No” as such an event that leads to Grexit? Electing a new president needs a special majority in the parliament which might be difficult to secure for Syriza and thus lead to early elections. Given the results of the referendum and the recent election polls, Syriza may likely come out again as the winner, but it would cost precious time, which Greece doesn’t have and it wouldn’t make any deal easier to reach.

Will ECB keep ELA?

Greek banks heavily depended on Emergency Lending Assistance (ELA) to keep functioning as a bank run led to a drain of its deposit base. The ECB freezed the maximal amount of ELA lending at €89B after PM Tsipras called for a referendum. This obliged the government to close the banks till Tuesday and allow the Greek people to take a maximum of €60 a day from the ATM’s. Despite these measures, it is likely banks will run out of money in the next few days. It is impossible to keep the banks closed for much longer as it negatively affects the economy. The ECB will have to take a decision soon about ELA. If they stops it olurtright, it will doubtless push the banks into bankruptcy. ECB vice president Constancio said the ECB would be relying on the Greek vote when taking liquidity decisions because it affects the possibility of an agreement between Greece and its creditors. However, it is unlikely the ECB will suspend ELA directly unless it has the backing of the EMU political leaders. This won’t happen immediately. More likely, it will continue to freeze the ELA ceiling and possibly raise the haircut on Greek collateral, which might bring some Greek banks into problems, but not yet the banking system as such. The governor of Malta, Mr. Bonnici, suggested that the question of the collateral depended on the outcome of the referendum. As chances on default have risen with the “no” vote, a higher haircut would be logical. If one day, the ECB cuts or tapers the ELA, the Greek government would be obliged to issue IOU’s and nationalise its banking sector. That would be the prelude to issuing its own, new, currency in which case a Grexit would be unavoidable.
According to rumours, the Greek government would have contacted a private firm specialized in printing money for various countries. We expect the Greek banks to remain closed for at least another week. Anyway, the Greek banks at some point need a recapitalisation. In this respect, in Cyprus it occurred via the bail‐in of depositors. It might also be via nationalization or infusion (unlikely) of other countries like Russia.

Direct fall-out manageable?

The direct fall‐out of referendum and eventually Grexit are probably manageable. Economically, Greece’ GDP is slightly less than 2% of EMU GDP. Business and consumer sentiment may take a hit, affecting somewhat economic growth. It might be offset by ECB measure and eventually, but unlikely, by the Fed postponing the lift‐off. Financially, most of the Greek debt is in the hands of official creditors. So, the European banking sector might cope well with the uncertainties and the fall out of an eventual Grexit.

The contagion towards other peripherals has been modest overall in the past week. The outcome of the referendum and increased chances of Grexit should moderately widen peripheral spreads today. Also riskier assets like equities may take a hit, but also here contagion should remain contained. The euro should decline, but don’t expect a spectacular move. Why? First peripherals are growing again and are less vulnerable than a few years ago. Secondly, the ECB may accelerate its QE purchases and front‐load QE. The ESM may come to the rescue with loans, credit lines, bank recapitalization and primary (programme countries) or secondary (all countries) asset purchases, but under condition of a Memorandum of Understanding. Finally, there is still also the never used OMT programme.

For Greece, a Grexit would be dramatically. People would lose money (bail‐in?) with the economy collapsing.
Unemployment would rise even more. The new currency would be sharply devaluated versus the euro, pushing inflation higher. Greece may become more competitive, but gains may be modest as the internal devaluation of past years has had very little positive impact on exports.

Long term danger of a Grexit

The political fall‐out may take longer to manifest itself. First, the euro area may no longer be considered as a genuine monetary union, but more as a system of fixed, but adaptable FX rates. It might strengthen the ever stronger anti‐European parties still more, even as economic depression in Greece may push people to think twice before repeating the Greek adventure. Especially in Spain, nervousness may increase as they have to cope with an antiestablishment party Podemos and general elections are scheduled later this year. A Grexit may also weaken the EU and influence the British referendum, a bigger threat for Europe. The European idea of ever closer collaboration may be under more pressure.

Conclusion

The “No” at the Greek referendum complicates policymaking and brings a Grexit a giant step closer to materializing. We expect policymakers to try once more to find a modus vivendi with Greece, but the “No” has made things more difficult. Europe wants a deal with strong conditionality, while Greece rejected conditionality at the referendum. Is it reasonable to expect PM Tsipras to accept austerity now? An agreement on debt restructuring might be used as sweetener for accepting austerity by Greece, but even then the absence of trust in the Greek government will make many countries reticent to take that road. They will be suspicious whether the Greek government may take the effective measures needed to bring the austerity. The ECB may currently keep the ELA ceiling unchanged, but raise the haircut on Greek collateral. If no speedy deal is agreed, it is the ECB that may pull the trigger by stopping or tapering the ELA lending, which would result in a collapse of the banking sector, the issuance of IOU’s by the Greek government and finally the printing of a new currency.