Greece – alea iacta non est

07 July 2015

The Greek debt drama that has been going on for more than half a year has moved into its final act. After a majority voted in Sunday’s referendum against further economic reform measures in exchange for additional rescue money from European creditors, both Greece and the Eurozone are facing the most uncertain times since the previous peak of the Eurozone crisis in summer 2012.

Being virtually insolvent, Greece has been kept afloat by rescue money from the International Monetary Fund (IMF) and its European creditors. At the same time, the European Central Bank (ECB) had been supporting the Greek banking system with emergency liquidity assistance (ELA) as it would otherwise have faced collapse. Last week, Greece came into arrears on a €1.6 billon IMF payment, being the first country to miss a payment since Zimbabwe defaulted on its IMF obligations in 2001.

Since 2010, the Greek economy seemed to make slow but gradual economic reform progress, achieving a primary surplus and returning to modest growth in 2014. This changed when a general election earlier this year brought the left-wing Syriza party, on the back of a campaign to renegotiate the current bailout agreement, to power. After six months of negotiations the two sides found themselves in a deadlock and Prime Minister Alexis Tsipras decided to call a referendum to ask the electorate whether the latest terms offered by the creditors should be accepted.

On Sunday, the Greek Electorate answered the question with a resounding “No” (however, voter turnout was relatively low), and as some creditors had tried to turn the referendum into a vote on Greece’s future in the Euro, on first glance it seemed that Greece’s days in the single currency are numbered.

However, The Greek population is still backing its government’s stance rejecting extensive reform programmes, while holding onto the assumption that the country can still remain in the Eurozone (which is most Greeks’ preferred option).  

Therefore, we see two base scenarios (including a number of sub-scenarios) as to the future of Greece in the European Monetary Union (EMU):

  1. Emboldened by the referendum outcome, the Greek government might continue its stance in upcoming bailout negotiations. The relationship between EU creditors and Greece is already somewhat strained, and popular pressure from creditor nations not to give in to demands for further unconditional rescue money, might lead to the situation where no agreement is reached. Even if the Greek Government can scrape through and meet pensions and civil servant wages over the next two weeks (which seems unlikely),  it is almost certain that they will be unable to meet a €3.5 billion payment to the ECB that is due on 20 July. At this point, the ECB could have little choice but to cut its current €89 billion ELA to the Greek banking system. It is unlikely that Greek banks would survive this. At the point when Greece lacks sufficient funds to make on-going payments, the Greek government would have to start paying pensions and civil servant salaries via a scrip currency (‘IOUs’) while covering current expenditure purely via tax receipts. At this point, the Greek economy could face an accelerating economic downward-spiral, including shortages in basic goods and medicines with potential social unrest as the situation becomes increasingly desperate. Restoring Greece’s position as a permanent member of the EMU would, at this junction, be a next to impossible task and the more likely scenario would be Greece adopting a new free floating currency.
  2. Cooler heads prevail and a strengthened Syriza party reaches an agreement with Greece’s creditors. Whether such an agreement would lead to sustainable structural reforms and debt forgiveness is far from certain, but hopes of this rose early this week with the resignation of Greek Finance Minister, Varoufakis. This was widely seen as a move to introduce more moderate representatives from Syriza to the potential next round of negotiations.

Greece account for circa 0.3% of global Gross Domestic Product (GDP), and controls to minimise contagion across the single currency area has been put in place since the Eurozone crisis. The ECB is currently undertaking their quantitative easing programme, purchasing €60 billion worth of fixed interest securities per month. Recently, this programme has been extended to include some private sector fixed-interest issuers and the ECB stands ready to protect the integrity of Eurozone financial markets if wider markets start experiencing adverse spill-over effects.

Economic conditions in the rest of the Euro area has recently improved somewhat but, as always, we do not encourage Trustees to take investment decisions based on short-term market movements or political events where the ex-ante outcomes are next to impossible to predict. Rather, the exploitation of these opportunities should in most cases be delegated to an unconstrained investment manager or operated via a mechanistic framework.

As with any good drama, the ending of the final act is hard to predict. We are monitoring the situation closely and recommend that Trustees speak with their usual investment consultant if they require more detail. 


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