Crisis in Greece still threatening the eurozone

By:
Jeremy Weltman
Published on:

Euromoney’s risk experts weigh up the various options as the ‘end-game’ nears.

Drachma euro-R-600
' A return to the drachma would generate a quick decline in the exchange rate, stimulating direct capital inflows and tourism'

Greece has slumped further down the global rankings in Euromoney’s country risk survey this year, to 122nd out of 186 countries, and is firmly rooted within the bottom of ECR’s five tiered categories containing the world’s worst default risks.

Its falling score trend – a whopping 39 points in total since 2010, and the largest of all the 186 countries surveyed – has continued in spite of the improvement in the economy aided by the bailouts, reforms and restructurings.

Greek GDP grew in 2014, by 0.8% in real terms, marking the first annual rise in seven years. The general government deficit narrowed to 3.5% of GDP from 12.3% in 2013, but risk experts were never fully convinced this had brought the crisis to an end.

 

Pessimistic overtones

There seems a general lack of willingness for a political resolution to a problem requiring around €50 billion-worth of additional financing and a write-down of existing liabilities. There has been no meeting of minds and no certainty an agreement can be found, with the clocking ticking down.

The primary fiscal situation – balancing revenue and expenditure, but excluding interest payments – is just one of the sticking points in the negotiations for concluding a new financing arrangement. Finding enough resources to repay its loans is harder still, with the recent IMF repayment using IMF-financed reserve funds.

Greek debt is 177% of GDP on a gross basis, although economists delving into the technicalities argue over the precise figure.

Paul Kazarian, investor and founder of Japonica Partners, believes it to be a 10th of that amount, based on international accounting principles. Others concur, noting that locked in to very low interest rates, Greek debt is manageable over the longer term.

And yet with bank deposit outflows speeding up, and the state rapidly running out of cash with wages and pensions payments looming, the worst possible outcome is fast approaching – "a disorderly default on European Central Bank (ECB) funding and the resulting shutdown of the ECB liquidity support for Greek banks", says Constantin Gurdgiev, adjunct professor at Trinity College Dublin (TCD).

"This would take place in July to August, when Greece is facing €6.7 billion of maturing ECB/Eurosystem liabilities, or even earlier as the country may find it difficult to roll-over maturing T-bills amounting to €3.2 billion in June and €3 billion in July," he adds.

Grexit not the only option

Not all risk experts are convinced Greece will leave the eurozone. The Greeks have changed their negotiating team. There is some common ground on streamlining VAT forming part of an overall strengthening of the tax system, and previous statements suggest there is some recognition of privatization and other structural reforms in spite of the ideological differences and the political fallout at home.

Euro policymakers have been keen to point out, moreover, that membership of the euro club is irreversible and that default does not invariably mean Greece would have to leave.

Some fiscal flexibility undoubtedly would be factored in, in return for a commitment to reform. Besides, a referendum looks likely to be held – probably in June – allowing Greek citizens to decide. Whether that entails arbitrating over the programme or euro membership per se  will need to be clarified.

In a special survey conducted among Euromoney’s 400-plus risk experts, 58.8% of respondents believe Greece will remain a eurozone member state.

However, Christian Richter, a UK-based principal lecturer taking part in the survey, mentions that he cannot see the Greek government reforming the country enough to turn it around, with or without the euro.

Phillip LeBel, emeritus professor of economics at Montclair State University, adds: "Like the UK, Greece can exit the euro and remain a member state in the EU."

"A return to the drachma would generate a quick decline in the exchange rate, stimulating direct capital inflows and tourism."

System-wide risks

The effects on individual member states are difficult to discern. Many countries are now improving thanks to lower oil prices and the ECB making the euro more competitive via quantitative easing, alongside some easing of austerity.

Reassuring words signalling that banking systems are firewalled are providing some additional comfort.

Indeed, eight of the region’s member states saw their risks fall (their scores rise) in the first months of this year, including Malta, Slovenia and, encouragingly, Italy and Portugal, now slowly turning their crises around.

Luxembourg, Finland, Netherlands, Germany and Austria, meanwhile, are all still rated tier one, which puts them among the safest credits worldwide.

Yet with the notable exception of the Baltic states, where investor risks have greatly diminished, all other eurozone sovereigns are on lower scores compared with 2010 – eight besides Greece have witnessed double-digit declines and there are seven in tier three (see chart), which are close to or already sub-investment grade.

TCD’s Gurdgiev is adamant there will be no winners from a Grexit, which would see "a rise in the cost of holding government debt across the eurozone, and euro-periphery yields rising more sharply to higher levels".

A mitigating factor is the improvement in primary fiscal deficits in recent years, although a longer period of economic stagnation and rising funding costs for eurozone banks would be expected, notably for those institutions with substantial exposures to the periphery.

"Monetizing Greece may cost €56 billion to €60 billion, but providing liquidity to the stressed banking system across the eurozone periphery would imply a magnitude of three-to-four times that," warns Gurdgiev.

For eurozone states with already-weakened banking sector risk scores, that could prove to be a bitter blow.

This article was originally published by ECR. To find out more, register for a free trial at  Euromoney Country Risk.