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Foreign Exchange

New drachma to plunge; new deutschemark only currency to escape euro break-up unscathed

Greece’s currency will plunge by more than 50% while Portugal’s will also tumble in the event of a break-up of the eurozone, highlighting the need for investors to take account of renumeration risk, according to Nomura.

In a stark warning to investors fretting over the future of the single currency, the bank estimates that the new drachma would fall by 57.6% against the dollar in the five years after the collapse of European monetary union, while the new escudo would drop by 47.2%. Nomura, which made its predictions based on EURUSD spot of $1.34 and by taking into account current real exchange rate misalignments and future inflation risks, forecast that the currencies of Ireland, Italy and Spain would all also fall by about 30%.

According to the analysis, only Germany would see the value of its currency rise, and then only by a marginal 1.3%.

 Fair value estimates for new national currencies after euro break-up

 Source: Nomura

Nomura said the estimates explicitly dealt with the medium-term concept of currency fair value, recognising that in the short-term there would be other influences on the exchange rate.

That is the experience from previous currency crises. The Argentine peso, for example, dropped by 72% in nominal terms in the five months following the break of the dollar peg, arguably more than what was justified from a real exchange rate perspective.

“Our estimates focus on a medium-term equilibrium concept, and we recognize that short-term dynamics could see undershooting relative to our estimates,” said Jens Nordvig, global head of G10 FX strategy at Nomura.

“This is especially the case, when a break-up scenario would involve capital controls, political instability, and a collapse in existing banking systems.”

Nordvig said the estimates should be seen as an initial attempt to gauge the magnitude of possible medium-term equilibrium effects.

“Regardless of the uncertainties involved, the estimates serve to highlight the significant depreciation risk associated with currency redenomination in a number of countries,” he added.

“And since the risk of a eurozone break-up is no longer negligible, investors will have to add redenomination risk to the list of standard risk factors they have to consider in their portfolios.”

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