The decisive victory for the ‘no’ camp in this weekend’s Greek referendum has taken most people by surprise. Greece has taken a big step closer to ‘Grexit’ and a big leap into the unknown. This is a game-changer for Greece – if the situation is mishandled, it will also be a game-changer for the eurozone. Policy makers and politicians have critical decisions to make in the days ahead. Investors will naturally be on edge until the picture becomes clearer.
What happens next in Greece?
The immediate impact of the referendum will be to greatly intensify financial and economic pressures in Greece. Now without a bailout, Greece will struggle to find the cash to pay for pensions and public sector wages. The government’s only option may be to make these payments in some form of IOUs in the weeks ahead.
The health of Greek banks will continue to deteriorate rapidly even with continued European Central Bank (ECB) support, and more dramatically if that is capped or reduced. Press reports over the weekend suggest that some banks are within days of running out of cash – other reports warn of imminent haircuts to deposits, to support a bank recapitalisation. Against this backdrop, depositors will be increasingly desperate to get their money out of the banks, which means that the authorities will have to continue to limit access to withdrawals through bank closures and capital controls – and might well have to tighten restrictions further.
Although more than 60% of Greek voters should be happy that they got the referendum outcome they were looking for, the result will do nothing to alleviate the grim living conditions they face in the days ahead. Closed banks are only part of the problem. Greece is already experiencing shortages of food, medicine and other essentials and a big drop in tourist bookings. It would not be a surprise to see major social unrest.
How will Europe respond?
The developments of the last few weeks have severed much of Greece’s access to the eurozone financial assistance that has been keeping its economy functioning. While the country exercised its democratic authority in holding the referendum, the response of the rest of the eurozone will play a major part in determining Greece’s economic future. The ECB’s reaction will be hugely important, both this week and beyond. Any decision to withdraw liquidity assistance to the Greek banks in the days ahead would push some into bankruptcy. While we think that the central bank will show leniency in the near term, 20 July will present a more challenging decision for the ECB. That is when Greece is due to pay the central bank €3.5bn – money that the Greek government will not be able to find without some bailout assistance. If Greece defaults, the ECB is likely to restrict liquidity assistance to the Greek banks, potentially leaving Athens with no option but to print its own money, thereby pushing Greece closer to ‘Grexit’.
Although the Greek government has spoken positively about the prospect of getting another bailout from the eurozone in the near term, reaching a deal will be very challenging given the hostile tone of recent discussions and the lack of trust on both sides. The scale of the deterioration in the Greek economy in recent weeks means that Greece now needs a bigger bailout than the one it rejected a few weeks ago and it needs it urgently. It will be difficult for many eurozone leaders, particularly in those countries where anti-austerity parties have been gaining support, to advocate a deal on that scale so quickly, without alienating their domestic voters. Still, this morning’s resignation of Greece’s adversarial finance minister, Yanis Varoufakis, should be seen as a symbolic gesture of conciliation from Greece that might help to improve the tone of the discussions. The meetings of the German and French leaders today and eurozone finance ministers on Tuesday will give important insights into how the process will develop from here on.
Impact on financial markets
Unsurprisingly, the first reaction from financial markets has been a pick-up in risk aversion. Greek bonds and equities have fallen sharply, but elsewhere equities have seen quite modest falls and bond spreads for other peripheral economies within the eurozone have widened only slightly. Overall the response has been relatively subdued with investors wary of, rather than immediately worried about, a wider euro crisis.
At this stage, we see the Greek referendum as more of a one-off shock to European markets than a major systemic crisis. Greece is small – less than 2% of eurozone GDP – and direct private sector exposure to Greece is modest. Furthermore, the ECB is much better equipped to stem contagion than it was in 2011-12 and is likely to react forcefully if market turbulence leads to a warranted tightening of monetary conditions. Still, given that few investors constructed their portfolios with a Greek ‘no’ vote in mind and most are likely to be reducing risk at this time of the year, we think it is right to remain cautious until this fluid, fast-changing situation has been more clearly resolved.
