There are a number of reasons that Grexit is far more likely to happen this time round than it was back in the crisis of 2010/11
With Greece having thrown down the gauntlet to its creditors at the tail end of last week, the stage is set for a default on their IMF debts.
Whether they default on payments due to other creditors remains to be seen, and whether or not they will remain a part of the Euro is also unclear. Indeed, a departure from the Euro isn’t what’s on the table in the Greek referendum, but it is clear that there is a willingness to cut Greece loose that hasn’t been there in the past.
There are a number of reasons that Grexit is far more likely to happen this time round than it was back in the crisis of 2010/11. But why are markets comparatively unmoved by the whole ordeal this time compared to when the last time Grexit was a real prospect back in 2010/11? Last time, it plunged the entire Eurozone in to a full blown crisis and sent yields on ‘peripheral’ economies (Portugal, Spain and Italy in particular) above levels that would have been sustainable in the long term.
The difference in circumstances partly explain the different attitudes of the Eurozone leaders. This time round, the willpower of the rest of the Eurozone to rescue Greece has completely evaporated. Indeed, judging by the rhetoric from Eurozone officials it seems that many are actively looking forward to washing their hands of a state that has been a lingering headache and something of an embarrassment for the single currency region. Safe in the knowledge that the threat of contagion is limited and more manageable than it was previously, they seem to have concluded that they can rid themselves of Greece without any real economic kickback. The election of a Syriza led government was also a tipping point in the attitude of European leaders towards the debt talks as the Greek willingness to engage in any meaningful reform on major sticking points such as pensions disappeared, and with it any real appetite of the IMF and European Union to contemplate releasing further bailout funds.
There are a number of reasons behind this willingness to cut Greece loose that didn’t exist in 2011 beyond the political reasons, however. First and foremost, the anticipated effect on Eurozone growth is likely to be relatively minor, and will not plunge the region in to recession this time. It was forecast by PwC that it would only shave around 0.5% of growth off Eurozone GDP growth in the first year, with a quick rebound thereafter. With projected growth of 1.5% this year, it is certainly a storm the Eurozone economy would be anticipated to survive without too much trouble.
In addition to this, Eurozone Quantitative Easing has been a game changer. Although it didn’t officially start until March this year, its eventual announcement and the anticipation of its arrival sent yields on the so called “peripheral states” tumbling. The interest rate on Italy’s benchmark 10 year bonds have tumbled from a high of 7.2% in 2011 to 2.1%, with Spain also embarking on a similar path from a high of 7.2% in 2012 to 2.2% now. The result in states like Portugal has been even more remarkable with yields dropping from an eye watering rate of 15% to 2.7% currently. With €1 trillion of firepower now at its disposal, the European Central Bank won’t have too much trouble holding down the yields of the states that came under attack in 2011. The mere knowledge that this tool is at their disposal (which it wasn’t in 2010/11) means that markets are unlikely to test the resolve of the ECB.
What’s more, the risk of contagion to the European financial sector now is minimal. Almost 80% of Greek’s debt is held by European Governments through bilateral loans, the IMF or European Central Bank, or the European Financial Stability Fund. With almost all of the debt now ‘publicly’ held, the risk of any knock on effect being felt by European banks is virtually non-existent. Unfortunately, it’s taxpayers who will take the hit but they already did so the moment the money was thrown at Greece.
Make no mistake about it- the last five years have been about buying time and minimising the exposure of banks to any fallout from this very situation. The European banks have essentially been bailed out and allowed to offload their previously sizeable holdings of Greek government debt to the extent that what they still hold is of little significance. While European banks had €128bn worth of Greek bonds on their books in 2008, this had dropped to a comparatively paltry sum of €12bn by the start of 2014. Total foreign bank claims against Greece have also dropped from $245bn to $32bn at the end of 2014. Still a big number, granted, but a drop in the ocean when spread across the entire financial sector- especially when you consider the fact that the largest banks have been fined almost $250bn by their regulators since 2008.
But what about Greece? What Greece is really after is debt relief, but without strings attached. It’s plainly clear that the IMF and European Union aren’t willing to entertain that idea and would rather drag it through a default than write off its debt without any structural reform. Although it’s likely to default on its debts anyway, the Eurozone and the IMF no longer believe that they are negotiating in good faith with a government that is willing to reform and ensure their economy is put on a path of sustainability and will condemn them to an unplanned default. As a result of this, Greece will have to reap the consequences of being shut of the debt markets for a period of time as well as having its banks cut off from ECB liquidity support- which could be the trigger point for Greece leaving the Euro. This would leave Greece with two options- find another creditor (potentially Russia) or print the money from the Bank of Greece. The former would most probably get them slung out of the European Union whilst the latter would see the value of the current fall off a cliff edge and stoke inflation.
Whatever happens in the long term, the coming weeks and months ahead for the people of Greece appear daunting, but European leaders and the IMF no longer seem to give a damn.
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