Economics. Greek update: closer to the abyss. 17 June 2015

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1 Greek update: closer to the abyss A dangerous game: Judging by their public comments, Greece s radical political leaders are threatening an imminent Greek economic suicide to force Europe and the IMF to abandon their respective rulebooks. Whether they are bluffing, as the majority of Greeks seem to believe according to opinion polls, only they can know. The rhetoric from Athens sounds more like the start of a blame game than a prelude to compromise. The Greek problem can still be solved easily if the government changes tack: But with every semi-deadline that Greece misses and with every rude word that the Greek radicals hurl at their creditors, the damage already done to Greece gets worse. That, in turn, makes it more difficult for lenders to negotiate and ratify a new deal. We can group possible outcomes in three stylised scenarios: A deal in June: Greek prime minister Alexis Tsipras backs down at the last minute, accepting some face-saving concessions from lenders. The current bailout gets extended in time for Greece to pay the EUR1.6bn due to the IMF on 30 June or shortly thereafter. Greece gets slowly back on track. Probability: 35%. Greece stays in the euro after political change in Athens: No deal in June. But the gap between what most Greeks want, namely to keep the euro even if that means some short-term pain, and the Syriza stance leads to a political change as Greece descends into a deepening recession once Athens starts to miss payments to its lenders and, shortly thereafter, to its own population. That political change could be a split within Syriza, with the left-wing radicals leaving the party, a new coalition, new elections or a referendum on staying in the euro. Probability: 25%. Grexit: Running out of money and refusing to strike a deal with the only willing creditors it has, Greece eventually issues its own currency. IOUs or other interim stop-gaps turn into a new drachma. We raise the Grexit risk from 30% to 40%. Deadlines in Europe are rarely cast in stone, but time constraints do matter. Greece is de facto broke. The longer it takes for Greek leaders to accept the offer which European Commission president Jean-Claude Juncker presented to Mr Tsipras on 10 June, the more difficult it will be for lenders to ratify the deal. How things may play out in detail is hard to predict. In order to not lose the blame game, all sides seem reluctant to take decisive steps. Key dates to watch are: 17 June: ECB discusses its support for Greek banks. If the ECB scales down its support, the banks could be bust and/or run out of money shortly afterwards. 18 June: Eurogroup meeting of finance ministers. A deal looks unlikely. 21 June: Potential emergency eurozone summit June: Regular EU summit. This could be the very last chance to strike a deal in time for Greece to pay the IMF EUR1.6bn on 30 June or shortly thereafter. 20 July: Greece has to repay EUR3.5bn bonds held by the ECB. If Greece misses this payment, it would be even more difficult for the EC to keep Greek banks afloat by pretending that they are solvent. Contagion risks: Expect some volatility, yes, but the eurozone has spent the past three years strengthening its defences against contagion. Markets know that the ECB would do whatever it takes to prevent serious contagion, for instance by activating its OMT lifeline for Spain and Italy on top of its regular bond purchases. Private sector exposure to Greece is too small to pose a systemic risk. Contagion is under control. Economic impact: For Greece, it gets worse by the day. For the eurozone, we expect the sheer noise to cause a small dent to business confidence now but no major impact. Key macro views reports Understanding Germany a last golden decade ahead 13 October 2010 Euro crisis: the role of the ECB 29 July 2011 Saving the euro: the case for an ECB yield cap 26 June 2012 ECB ABS purchases: expanding the toolbox 8 May 2013 Mind the court: the top event risk in Europe 31 May 2013 The lessons of the crisis: what Europe needs 27 June 2014 ECB: question is not if, but when and what? 2 December 2014 Euro Plus Monitor 2014: from pain to gain 18 December 2014 Global Outlook 2015: oil, Putin and Greece 6 January 2015 Greek election: : the reality shock ahead 26 January June 2015 Dr Holger Schmieding Chief Economist

2 Greece: the sorry state of affairs Athens has rejected the ready to sign deal offered to them by Mr Juncker on behalf of Greece s international creditors. Instead of using the room for flexibility within the main parameters of that offer, for instance to trade some cuts in pension entitlements for less military spending, Mr Tsipras has called the offer absurd. The Greek side has hardened its position and its rhetoric. Instead of honouring the agreement on extending the bailout until 30 June 2015, which Greece signed on 20 February, Greece is demanding a completely different approach with major upfront debt relief and virtually no cuts in pension entitlements. By accusing the IMF of criminal responsibility for Greece s misery, Mr Tsipras is burning rather than building bridges. Some of their rhetoric suggests that Greece s radical leaders see themselves as lone heroes who would rather go down fighting than to acknowledge reality. In reaction to the Greek rhetoric and the lack of Greek action, attitudes of lenders seem to be hardening as well. For the sake of their own credibility and that of their rulebooks, neither Europe nor the IMF can be seen as ultimately rewarding Greece for its hardline stance. Europe wants to keep Greece in the euro and, as usual, is ready to be flexible. Deadlines can be fudged for a while, compromises are rarely perfect, ways to kick a can down the road can usually be found. But amid the scary Greek rhetoric, contingency planning is coming to the fore. Only Greece could impose capital controls and restrictions on deposit withdrawals. Athens will probably not resort to that in order to avoid getting the public blame for it. But according to some media reports, the ECB may consider restricting Greek access to its payments systems. 69.7% of Greeks want to stay in the euro no matter what, according to a GPO poll published yesterday. However, 54.3% still agree with their government s negotiating strategy. 67.8% believe that the standoff will end in a compromise with concessions made mainly by the Greek side. In essence, the majority of Greeks seem to think that their government, after playing hardball now to get softer conditions for new loans, will eventually get reasonable. That points to a rude awakening in Athens if Mr Tsipras does not change tack soon and strike a deal in June. The politics in Greece could get noisy. For starters, both the pro-euro and anti-euro forces are reportedly planning public rallies in Athens later today. We have to watch out for news about potential ultimatums. Will eurozone finance ministers on Thursday turn the ready to sign offer brokered by Merkel/Hollande and presented by Mr Juncker last week into a formal take it or leave it offer? At this stage, we do not yet expect the ECB to issue a formal ultimatum to Greece today, announcing the end of emergency liquidity assistance or a reduction in other kinds of support for Greek banks if Greece does not strike a deal within a few days. The ECB would only pull the plug if it has full political backing for that. Instead, clear warnings from top ECB officials are likely. However, we expect the ECB and Eurogroup to align their positions very closely. If finance ministers wanted to put maximum pressure on Greece fast, warnings from the ECB may come close to a de facto ultimatum shortly. If Greece misses its payment to the IMF on 30 June, the country would not be officially in default yet. It would enter a grey area instead. But if Greece cannot repay the bonds held at the ECB on 20 July, the default could become official. With the Greek tax take likely to fall by even more than GDP as Greeks scramble to hold on to the euros they have, Athens may well have problems paying wages, pensions and welfare benefits in July, while it may still manage to do so in June. If Greece does not strike a deal in June, it could turn into a very hot summer in Athens. 2

3 Contagion risks? Greece is tiny, just 1.8% of eurozone GDP by now. The euro crisis has always been about contagion risks. Fortunately, the region has spent the past three years strengthening its defences against contagion risks. Systemic contagion through sovereign bond markets is now highly unlikely thanks to the ECB. The European Court of Justice made it plain yesterday that the ECB s OMT programme is legal. As markets know this, the programme probably does not have to be activated to keep Spain and Italy out of harm s way Contagion through the banking system has become very unlikely. Few banks outside Greece are still exposed to serious Greek risks. And with banking union, the eurozone can deal with isolated problems easily. No political contagion. The Greek case provides a sobering example of the damage that populists can do once in power. The risk that voters elsewhere would want to follow the Greek example and vote Syriza-type radicals into power looks very small. Economic impact For Greece, the economic situation and outlook are getting worse by the day. For the eurozone, uncertainty is bad for business confidence and investment. We expect the Greek noise to cause a modest correction in business confidence and to restrain the rebound in eurozone business investment slightly over the next few months. That is part of our forecast of 1.4% GDP growth for Once the uncertainty fades, with either a deal or Grexit, confidence and investment in the eurozone will recover, probably with a very audible sigh of relief. 3

4 Disclaimer This document was compiled by the above mentioned authors of the economics department of Joh. Berenberg, Gossler & Co. KG (hereinafter referred to as the Bank ). The Bank has made any effort to carefully research and process all information. The information has been obtained from sources which we believe to be reliable such as, for example, Thomson Reuters, Bloomberg and the relevant specialised press. However, we do not assume liability for the correctness and completeness of all information given. The provided information has not been checked by a third party, especially an independent auditing firm. We explicitly point to the stated date of preparation. The information given can become incorrect due to passage of time and/or as a result of legal, political, economic or other changes. We do not assume responsibility to indicate such changes and/or to publish an updated document. The forecasts contained in this document or other statements on rates of return, capital gains or other accession are the personal opinion of the author and we do not assume liability for the realisation of these. This document is only for information purposes. It does not constitute a financial analysis within the meaning of 34b or 31 Subs. 2 of the German Securities Trading Act (Wertpapierhandelsgesetz), no investment advice or recommendation to buy financial instruments. It does not replace consulting regarding legal, tax or financial matters. Remarks regarding foreign investors The preparation of this document is subject to regulation by German law. The distribution of this document in other jurisdictions may be restricted by law, and persons, into whose possession this document comes, should inform themselves about, and observe, any such restrictions. United Kingdom This document is meant exclusively for institutional investors and market professionals, but not for private customers. It is not for distribution to or the use of private investors or private customers. United States of America This document has been prepared exclusively by Joh. Berenberg, Gossler & Co. KG. Although Berenberg Capital Markets LLC, an affiliate of the Bank and registered US broker-dealer, distributes this document to certain customers, Berenberg Capital Markets LLC does not provide input into its contents, nor does this document constitute research of Berenberg Capital Markets LLC. In addition, this document is meant exclusively for institutional investors and market professionals, but not for private customers. It is not for distribution to or the use of private investors or private customers. This document is classified as objective for the purposes of FINRA rules. Please contact Berenberg Capital Markets LLC ( ), if you require additional information. Copyright The Bank reserves all the rights in this document. No part of the document or its content may be rewritten, copied, photocopied or duplicated in any form by any means or redistributed without the Bank s prior written consent. June 2015 Joh. Berenberg, Gossler & Co. KG 4

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