Greek Post-Referendum Update
ERIC LASCELLES – GREEK POST-REFERENDUM UPDATE
As at overnight July 5–6, 2015
The Greek referendum has yielded a resounding 61% victory for the “no” camp. This defies polls from earlier in the
summer that put around 70% of Greeks in favour of remaining within the eurozone, and the distinct majority in favour
of accepting the creditors’ bailout offer. The result also runs contrary to the general rule of referendums – as
demonstrated most recently by Scotland’s referendum on independence – in which polls generally exaggerate the
electorate’s ultimate willingness to defy the status quo. Evidently, the Syriza campaign to frame a “no” vote as a
rejection of Greece’s humiliation at the hands of its European creditors hit the mark.
This substantial “no” victory is undeniably the worst-case scenario. It substantially increases the odds that Greece
fails to secure a bailout and ultimately leaves the eurozone. It also materially worsens Greece’s economic
environment and raises questions about the Eurozone’s long-run viability.
From an investment perspective, the market’s response has been surprisingly slight so far. In theory, markets were
not fully priced for this outcome and a market recoil of as much as twice the magnitude of last week’s decline would
seem appropriate. Consistent with the prior market response, risk assets should suffer. Global equities should
decline, with a particularly sharp reaction within Europe. Sovereign bond yields should venture in two very different
directions, with “core” countries enjoying lower yields on a safe haven bid, versus other nations such as Greece and
the rest of southern Europe suffering the opposite trend. The euro should theoretically decline, though it has proven
surprisingly resilient to other recent disappointments.
As to whether there will be significant further market movements after the initial Monday recoil, it depends on how
politicians respond and whether the European Central Bank (ECB) steps in to intervene. Let us review the two main
scenarios and a few sub-scenarios.
Bailout probability: 40%
Interpreted literally, the referendum merely asked whether Greeks wished to accept the terms of the creditors’ latest
bailout offer. As such, the “no” can be viewed strictly as a rejection of that particular offer, bolstering the Greek
government’s bargaining position and forcing the creditors to come back to the table with a more favourable offer.
In theory, all parties continue to theoretically wish for Greece to remain within the eurozone. Greek polls demonstrate
this quite clearly – in fact, the latest polls show that a rising proportion of Greeks wish to remain in the eurozone even
as they reject the referendum – and there are rumours that Syriza is seeking support from opposition parties to
bolster its credibility in negotiations. The country’s Finance Minister has now resigned, removing a key impediment to
any deal. European political leaders have long espoused a similar desire to keep the eurozone intact. As such, a deal
remains within reach. Do not forget that market pressure has been a key catalyst for past bailout solutions, and the
market pressure is certainly now on.
We strongly suspect Europe will make another effort to reach a deal with Greece, offering somewhat more favourable
terms. A meeting between Angela Merkel (Chancellor of Germany) and François Hollande (President of France) will
occur on Monday night, followed by a summit on Tuesday. Areas of potential concession include Greece’s desire for
further debt relief (bolstered by the International Monetary Fund (IMF)’s recent debt-sustainability analysis), an easier
fiscal target (a necessity given Greece’s rapidly deteriorating fiscal position) and some form of recapitalization for
Greek banks (six months of fleeing depositors render this an unavoidable part of any package). But European leaders
are still likely to insist on structural reforms, and may insist on something resembling a national unity government for
Greece.
Greek Post-Referendum Update
Whether the creditors will prove willing to offer everything that Greece demands is very much another question, which
is why we have reduced the odds of a successful Greek bailout that returns the country to a sustainable path to just
40%, substantially down from our prior 60% estimate.
The ECB is unlikely to force Greece’s hand by cancelling its existing emergency loan assistance (ELA) program just
yet. The program will likely remain capped at its current level until negotiations either succeed or fail.
The situation is frankly quite frustrating in that Greece had seemingly begun to turn an economic corner in 2014. Its
public debt burden – while high – is not especially onerous given prior debt relief involving reduced interest rates and
delayed maturity dates. Moreover, the country was returning to economic growth, had recovered all of the wage
competitiveness that it had lost since the turn of the millennium and had managed to shrink its fiscal deficit from an
eye-watering 16% to just 2% of GDP. In short, the hard work was largely done, even if the economic suffering had not
yet substantially unwound.
Alas, the election of Greece’s far-left government eroded all of that in short order as plummeting confidence returned
the economy to recession, sent the country’s borrowing costs soaring, reduced tax compliance (worsening the deficit)
and prompted the emptying of bank coffers. Syriza also backtracked on prior economic reforms and refused to
implement further growth- and sustainability-enhancing measures, ultimately leading to the withholding of bailout
funds.
No bailout probability: 60%
For the first time, we now believe that the more likely scenario (60% probability) is that Greece fails to secure
sustainable bailout funding.
This scenario is based on several observations:
 Greece has already failed to repay an IMF loan that came due on June 30th. Although this is not yet technically a
default until the IMF director informs her board, it is an enormous leap in that direction.
 The rest of the world arguably interprets the Greek referendum as a vote to exit the eurozone.
 Greece is rapidly running out of time given the capital flight from its banks and additional public debt payments
coming due over July. These problems will now accelerate after the vote, and it is almost impossible that Greek
banks will reopen this week as planned. In fact, the banks will likely run out of cash before mid-week.
 Europe is rightly skeptical of Syriza’s willingness and ability to actually implement any reforms it commits to.
 Northern Europe seems philosophically opposed to further debt relief, though this may be posturing given that the
creditors have already provided debt relief to Greece once before.
 Eastern Europe balks at providing additional funds to a country whose per capita income is substantially in excess
of their own, though they have nevertheless complied before.
 Southern European leaders fear that significant capitulation on Greece could tilt their own electorates toward far-left
parties. This is a particularly acute concern in Spain and Portugal given elections this fall.
 European leaders have increasingly grown weary of the perpetual Greek drama, and recent contingency planning
suggests a newfound willingness to let Greece exit the eurozone.
 Strictly, June 30th was the deadline for releasing the second bailout’s final allotment of funds, requiring some tricky
legal maneuvering even if all parties agree to unlock the remaining funds.
 A new third bailout package is possible (indeed, it is arguably necessary for Greece’s medium-run viability within
the eurozone, even if the final tranche of the second bailout were released) and already requested by Greece, but
would require passage through all 19 eurozone parliaments – a time-consuming and difficult task.
 Meanwhile, bolstered by the “no” victory, Greek negotiators may again prove overly bellicose in their negotiating
tactics and aggressive in their demands.
Greek Post-Referendum Update
Viewed through a different lens, a clear pattern is emerging for Greece: at every juncture over the past eight months,
the worst of the available paths has been selected. In late 2014, a Greek election was entirely unnecessary, but
nevertheless occurred after the prior Greek government proved incapable of agreeing upon a figurehead president.
The election then went poorly via the election of far-left Syriza. Furthermore, Syriza managed to capture a sufficient
fraction of the seats that it did not have to partner with a moderate party. Then, Syriza proved to be every bit as
radical as its campaign platform had suggested, failing to tack to the centre as most parties do once in power. To this
end, Syriza refused to comply with previously agreed-upon bailout conditions, and proved an extraordinarily difficult
negotiating partner both in style and substance. The referendum call had always been a possible but seemingly
unlikely step until it happened. The failure to make an IMF loan payment was the latest disappointment on June 30th.
Finally, the referendum yielded the worst-case “no” vote. Given all of this, it seems wise to budget for yet another
disappointment – namely, a failure to strike a bailout over the coming weeks, then likely a eurozone exit sometime
thereafter.
Greece’s future trajectory should become much clearer over the next week – when Europe will signal its willingness to
negotiate once again with Greece – with its fate likely sealed one way or the other over the next few weeks as those
negotiations occur in the lead-up to a major ECB debt repayment due on July 20th.
Grexit odds
If Greece fails to secure an additional bailout from its creditors, it will very likely lead to its eventual exit from the
eurozone.
A eurozone exit could result from any of the following:
 A massive default on Greece’s public debt given the country’s inability to reconcile its debt servicing costs with
public spending obligations in the absence of additional bailout funding.
 Alternately, the country could introduce IOU payments that would temporarily reconcile these needs, but the IOUs
would effectively function as a secondary currency, eventually morphing into a new official currency.
 A desire for a new weaker currency to restore competitiveness and allow the economy to begin growing again.
 The need for a new currency under Greek control so as to print money and recapitalize the banking sector.
Let us acknowledge that there is a slim chance that even if the country fails to secure a new bailout, it might manage
to remain as a sort of zombie state within the eurozone. This scenario would likely involve a significant default on its
public debt and longstanding capital controls on its banks, but no actual new currency or exit from the eurozone.
On the other hand, even if Greece does manage to secure a further bailout from its creditors, there is a non-trivial
chance that it proves incapable of fully complying with the terms, resulting in some future cessation of payments and
then a eurozone exit. Recall that the country had a poor record of implementing agreed-upon structural reforms even
when a moderate government was in place. In contrast, the current government has been actively reversing reforms.
Politically, the country is likely to remain quite unstable given what is effectively a battle between its rich and poor: tax
evasion is most extreme in the professional class and the country’s social transfers are unusually generous to the rich
relative to the poor. To its credit, Syriza has sought to tackle this problem, but to little effect so far given entrenched
interests.
These competing secondary scenarios roughly cancel out one another, leaving the odds of Greece tilting toward a
eurozone exit over the next year at around 60% as well.
Greek Post-Referendum Update
Contagion channels
As we have discussed in prior reports on Greece, the central contagion concerns have little to do with the Greek
economy, which is quite small. Similarly, foreign banks now have less than 50 billion euros of exposure to Greece,
and most of it is from fairly healthy countries with the ability to absorb any losses. Private investors have largely exited
from Greek markets.
The real concerns are confidence, official lenders and contagion.
The confidence effect is hard to gauge, but negative Greek developments undeniably hurt risk appetite around the
world, impacting financial markets and – to a lesser extent – economic activity.
Official lenders are on the hook for hundreds of billions of euros in Greek public debt. A large-scale default would
wipe out their capital base, requiring a significant refunding effort mostly by European nations. They are capable of
this given that the total costs would likely amount to no more than 2% of the eurozone’s GDP, but this would still be a
significant blow.
The contagion risk can be broken into near-term and long-term concerns. The near-term concerns are that the market
might extrapolate Greek problems onto Italy, Spain or Portugal. This would be quite problematic in that Italy and
Spain are arguably too big to save were they to encounter turbulence on the level of Greece. Fortunately, this still
seems to be a fairly unlikely scenario given the relative compliance of those country’s governments (though fall
elections render that assessment uncertain in Spain and Portugal), plus the creation of a much more comprehensive
set of shielding mechanisms over the past five years, including a single bank regulator, the ESM bailout fund, and the
ECB’s quantitative easing and OMT bond-buying programs. In fairness, the system still lacks significant fiscal
transfers or a single bank deposit insurance fund, so it should be described as improved but imperfect.
The long-term contagion concerns are also serious, though potentially with less immediate relevance. The problem
boils down to this: if one country can leave the eurozone, why not another? And if exiting the eurozone becomes a
threat during every financial crisis, it could eventually prove unworkable. Of course, this is all highly speculative and
the opposite outcome is also possible: this crisis could encourage a further fusing together of the eurozone, perhaps
remedying some of the remaining holes in the system. But let us first see whether Greece actually exits.
Conclusion
To conclude, it is still entirely conceivable that Greece manages to pen a new bailout deal with Europe and lives to
fight another day. However, the odds have shifted away from this as the most likely single scenario. Currently, Greece
appears more likely than not to fail in its bailout negotiations and, ultimately, exit from the eurozone.
Greek Post-Referendum Update
All opinions and forward-looking statements contained in this document constitute our judgment as of June 29, 2015,
are subject to change without notice and are provided in good faith but without legal responsibility. Forward-looking
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