By Anthony Warr.
Greece’s financial and economic difficulties have been ongoing for some years now. However, recent events involving Greece and its European partners have raised the risk of default and possible withdrawal from the eurozone. This has created a media frenzy, not to mention playing with investor emotion.
What’s happened so far?
These are the facts that we know to date:
- The Greek government has announced plans to hold a referendum on 5 July on the terms of a proposed euro 7.2 billion bailout package;
- This package is conditional on the implementation of a series of new austerity measures affecting pensions, sales tax and budget targets;
- The Greek government is encouraging its citizens to vote “no” but the size of the “yes” vote demonstrations on Tuesday led some to question whether the government has misread the situation;
- A “yes” vote would likely see Prime Minister Alexis Tsipras resign, potentially paving the way for a more realistic combination of debt forgiveness and agreement of reforms;
- The situation is very confusing. Assuming the referendum goes ahead, they will be voting on an offer which has now been taken off the table;
- The current debacle is a product of failure of the two sides to understand each other’s point of view and an unwillingness to compromise. The eurozone finance ministers refused to extend the current financial assistance agreement (ie bailout package) with Greece beyond its 30 June expiry The International Monetary Fund (IMF) has confirmed that a euro 1.6 billion loan repayment due on 30 June has not been repaid. Greece also requested an extension of its repayment obligations;
- Last ditch attempts to broker a deal continue, but the outcome remains uncertain;
- Faced with growing cash withdrawals by Greece’s citizens, the European Central Bank (ECB) will maintain (but not increase at this point) the Emergency Liquidity Assistance to Greek banks. In a bid to contain the risk of a run on Greek banks, Greece’s authorities imposed an extended bank holiday (at least to the 5 July) and placed caps on cash withdrawals; and
- Tsipras may have underestimated the difficulty of navigating the referendum both politically and economically. Bank closure places increasing hardship on its citizens and a deflationary shock to a country that is already in depression.
While the chance of another last minute compromise and further negotiations between Greece and its creditors can’t be ruled out, the risk of a default by Greece on all its debt commitments is high (the failure to meet the IMF payment does not represent a default credit event), as is the potential for its departure from the eurozone. Aside from the euro 1.5 billion loan repayment that is now due, the next crucial date is July 20 when Greece has to make a euro 3.5 billion payment to the ECB. In the absence of an agreement being reached between now and that date, uncertainty will continue and markets are more than likely to be volatile.
Our observations
The situation remains fluid, but we are able to make the following observations:
- Greece’s desperate situation is not new news and the eurozone is in a far stronger position to contend with the consequences of default than it was 3-5 years ago. For example, the exposure of European banks to Greece is much lower. The bulk of Greek debt is now publicly owned, including by institutions like the IMF, ECB and European Commission who are in a far stronger position to bear losses in the event of default.
- The economic consequences of a Greek default and possible exit from the eurozone should be very limited (though painful for the Greek population). Greece represents only 2% of euro area GDP and just 0.3% of world GDP.
- The ECB’s aggressive Quantitative Easing (QE) program will help dilute the consequences for the eurozone should default occur. The ECB can be expected to expand the QE program as required to protect peripheral countries.
- In the event of a Greek exit, the consensus is that there will be limited fallout for the weaker eurozone nations. However we are aware that monetary unions fail when there is loss of confidence which triggers mass withdrawals from the banks. Depositors need to believe that their country will remain a euro member. A Greek exit would demonstrate that euro membership is not irreversible.
Portfolio Implications
From a portfolio perspective, WARR HUNT portfolios have a negligible direct exposure to Greek securities. However market volatility will likely persist while the situation remains unresolved. The potential for volatility is increased by lack of liquidity in some markets as investors stand on the sidelines.
As I write, the Greek Prime Minister has indicated he will give ground to creditors and all of the major European markets are showing a bounce back from the falls of the last few days. There is a strong evidence that European other developed markets have been factoring in the crisis in Greece for sometime.
What we do know, is that there is no consistent evidence to suggest that investors can predict the impact of these sort of events on markets. Instead, investors are best to build their portfolios around known factors of return, diversify broadly and stay disciplined.
______________________________________________________________________________