Would it be a tragedy if Greece left the euro?

James Bevan Chief Investment Officer at CCLA Investment Management Ltd

Greece would be hit hard in the short term if it left the euro but the longer-term picture is brighter 

While many commentators regard the Greek economy as in dire straits, the data reveal that while Greece suffered six years of consecutive negative growth, leading the economy to lose more than 25 per cent of GDP from its 2008 peak, it moved out of recession in early 2014. 

The adjustment has been extreme, but it helped to reduce most of the imbalances of the economy. The current account is now in surplus, after reaching a deficit of 15 per cent of GDP in the mid-2000s. To a large extent fiscal imbalances have been addressed as well, with Greece having recently reached a primary surplus.

As for competitiveness, price and cost indicators, such as unit labour costs, have improved significantly in recent years, although there remains more to be done for Greece to be internationally competitive.

The crisis has re-emerged because with both the public and the external debt still huge, the new government wants to focus on accelerating growth. It sees easier fiscal policy and reducing the debt burden as key requirements, but such ideas are at odds with prior agreements made with Europe and the IMF. 

If Greece can reach a compromise agreement with the troika, it has a chance to support demand and remove the uncertainties that corrode confidence, thereby consolidating the recent improvements, and setting the stage for a significant rebound in growth. An agreement does look to be the most likely scenario, as both sides have much to gain – and have much at risk.

If, however, a compromise agreement cannot be reached, Greece could either default or leave the euro, which would result in default as Greece would retain euro-denominated obligations, and the scale of net foreign debt would be unsupportable. Seventy per cent of Greek debt is owned by the EFSF (European Financial Stability Fund) and ECB – and all the debt repayments are due to the ECB and the IMF over the next two years. So if Greece were to default, then the other eurozone countries would have to bear direct losses, with Germany having to pay around a quarter, and indirect losses would likely be much higher.

The short-term pain for Greece from default and leaving the euro would be immense. There would be capital flight requiring the imposition of capital controls, perhaps 60 per cent currency devaluation, and the costs of borrowing in international markets would soar by perhaps seven percentage points. The hit to the economy could be another decline of a quarter, with an immediate fall in exports given trade disruption and the absence of trade finance, and new credit would be constrained by shrinkage of bank balance sheets. 

But Greek consumers could be left well off particularly if they withdrew deposits prior to conversion, and the cheaper currency would in due course support a resurgence of exports, tourism and import substitution.  

Justin Oliver, Deputy Chief Investment Officer, Canaccord Genuity Wealth Management

The austerity burdens placed on Greece by the troika are unsustainable 

On one side of the Greek equation we have the troika of the ECB, IMF and European Commission who wish to ensure that any debt renegotiation does not offer Greece a “free lunch” and that the ruling Syriza party remain heavily incentivised to pursue much need structural reform. On the other, even the staunchest advocate of the euro must surely have some sympathy with the argument that it seems a cruel punishment to expect the Greek populace to suffer another 30 or 40 years of severe austerity for the distinction of remaining a euro member.

Greece’s current debt burden is equal to 177 per cent of GDP. This is unsustainable. Secondly, imposing austerity measure upon austerity measure onto the Greek economy is not the answer. These will cause the economy to contract at a faster pace than the debt burden is reduced, with the counter-productive result that the debt-to-GDP metrics for Greece actually deteriorate. Thirdly, Greece’s recent budgetary performance is not that heinous. During 2014, a primary budget surplus of Ä1.9bn equated to just 1 per cent of GDP, a significant improvement on previous years. However, it is unrealistic to expect this surplus to reach 3 per cent in 2015, and 4.5 per cent in 2016, as demanded in some quarters.

At the time of writing, financial markets are implying there is a 38 per cent chance of a Greek exit (Grexit) from the euro. Jean-Claude Trichet, the former ECB president, has warned that, even now, it would be extremely dangerous for the eurozone if Greece were to leave, while leading business figures have also highlighted the dangers. Could the euro survive without Greece? Yes. But could it survive without Greece, Spain and Portugal? 

Should Grexit come to pass, it is inevitable the borrowing costs of “peripheral” euro members would rise markedly. At present, Portuguese 10 year government bonds yield just 1.7 per cent. Bizarrely, this is below the cost of borrowing for the US and UK governments. By contrast, the safety of German bunds would be heightened and the 0.3 per cent yield on 10 year German government debt would likely move into negative territory.

Meanwhile, there is undoubted value on offer in European equity markets. On a cyclically adjusted basis, at the end of January, US equities traded on a price-earnings ratio approximately double that of their European counterparts. All other things being equal, there would be every expectation that this valuation gap will close, irrespective of Greece’s destiny.

The Economist in 1999, opined that a future member of the eurozone would be incapable of pursuing structural reforms and bent on redistributing income. This country would be looking to ease monetary policy and stimulate with government spending, with a labour market in woeful need of reform. Red-tape and an over regulated service sector would all be impediments to growth. Greece surely? No, the country referred to was Germany. Clearly there is hope for even the most imperilled economy.  

Markus Allenspach, Head of Fixed Income Research, Bank Julius Baer & Co. Ltd.

The victory of anti-austerity forces in Greece is a sign more must be done to stimulate growth across Europe

The resurrection of the Greek crisis raises a series of questions for European investment managers, ranging from the accuracy of fiscal data to the link between banks and sovereigns, three months after the start of the European Banking Union.

The urgent need for short-term financing comes as a very negative surprise. Athens warns that tax revenues were down by one quarter in the year to January 2015, and that it faces a serious insolvency risk. The under-reporting of Greece’s fiscal deficit and debt was one of the triggers of the European debt crisis in 2010. A set of tough rules and controls was agreed in 2012 to restore investors’ confidence and to enforce fiscal discipline, the so-called “Fiscal Compact”. If Greece now has much less cash at hand than previously reported fiscal data would suggest, the question must be asked again about the accuracy of the Greek data in particular, and about the system of checks and balances within the euro area in general.

In contrast to the US, the UK or Iceland, the heads of the EU put emphasis on austerity not growth. Indeed, the Greek government has shrunk by one quarter since 2010, and the jobless rate stands close to 27 per cent. The victory of the anti-austerity forces in Greece, but also their support in other euro area member states, is a clear message to Brussels and Frankfurt that more has to be done to stimulate growth than just calling for labour market reforms and pushing  down yields of government bonds from a very low level to an extra-ordinarily low level.  

The primary target of the European Banking Union, which came into force in November 2014, is to break the link between government debt and bank problems. The yields of Italian and Spanish government bonds could decline not least because Madrid and Rome seemed to be relieved from the need to support their ailing banks. We now see in the case of Greece, however, that there is still a close relationship between the state and large banks.

The renewed Greek crisis has not affected the other peripheral euro members yet. Seemingly, the huge demand from the ECB for government bonds is a powerful instrument to cover all the problems of the euro area member states, or at least those whose bonds are eligible for purchases. 

Experience with the Fed’s QE programme shows, however, that its influence is limited over time. In other words, the problems mentioned above will become very prominent in many eurozone states once the ECB slows its purchases. Investors should thus not neglect their homework and stick to markets with convincing fundamentals.  

G. Scott Clemons, Chief Investment Strategist Brown Brothers Harriman & Co.

Grexit would be bad for Brusssels but poses less risk for financial markets than five years ago

It is a truism of financial markets that the most anticipated risk is least dangerous, while the least anticipated risk is most dangerous. 

The so-called troika of the eurozone member countries, the IMF and the ECB first agreed to backstop Greek sovereign debt in May 2010. That initial bailout has been supplemented repeatedly since then, and the new Greek government, by seeking to renegotiate prior terms, is currently asking for a further extension and enhancement to the support already offered by Greece’s European neighbours. This is not breaking news. Surely the Greek crisis falls into the category of most apparent risks.

External support may be a necessary condition to restore economic stability to Greece, but, as the last five years have demonstrated, it is not a sufficient condition. Bailouts buy time, but they work only if the recipient country takes advantage of that time to enact structural reform, improve tax collection, liberate the labour market, increase productivity and remove other obstacles to organic economic growth. That is a statement not just about Greece, but about any country facing economic malaise. Low interest rates and balance sheet operations do not solve problems. They just create breathing room for governments to make difficult decisions. Greece still faces those decisions, as do other countries which would be ill-advised to rely on easy monetary policy as a panacea.

Yet there is a silver lining. The very extent of the crisis has resulted in the serendipitous concentration of Greek sovereign debt in the accounts of supranational institutions. Of about €315bn of outstanding Greek sovereign debt, roughly 69 per cent is held by the EFSF and IMF, with an additional 9 per cent held by the ECB. That leaves about 20 per cent in the hands of private investors, down sharply from the onset of the crisis five years ago. That concentration lowers the contagion risk of a Greek default or exit from the euro. A “Grexit” makes for a bad day in Brussels, but poses far less systemic risk to global financial markets than it did five years ago.

Investors should not be distracted by the Greek tragedy to the extent they lose sight of the ultimate driver of market value – corporate earnings.  We retain our modest exposure to select European equities, focusing on businesses able to grow in spite of sluggish economic activity, and trade at a discount to the fundamental value of the business. We do not believe current yields on sovereign debt in Europe reflect the associated risk  and therefore have no exposure to European bonds.