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Aon Retirement and Investment Blog

The Aftermath of the Greek Referendum

Referendum results
 
In the end, a promise from the government in the run-up to the Greek referendum - a new deal with less austerity and debt write-offs - swung the result substantially towards a ‘no’ vote (61% no/39% yes).    
 
That the current situation results from a referendum on a non-existent deal is frustrating to many stakeholders.  The message strongly presented to the electorate that voting ‘no’ would secure Greece a better deal provides additional levels of frustration, as it was only an opinion and not a guaranteed outcome.  That said, the creditors’ stance must also bear an important part of the blame for the post-referendum situation.  As noted in our post last week, it has been clear for many years that Greece would not be able to repay its official debts even if it had stayed the austerity course prescribed.   The EU leadership, facing the disapproval of national electorates, remains unable to acknowledge the extent of unpayable debt.

A Greek departure from the euro is now becoming the dominant scenario
 
This result further ratchets up the risk of a Greek divorce from the euro.    Overnight, this has moved to the most probable (though far from certain) scenario, in our view. This will not be about Greece leaving the euro but about the euro leaving Greece.  Over several years, euros leaving Greece is exactly what has already happened, since deposits in the Greek banking system have been falling for some years and are now only a little over half the levels they were at in 2010. 
 
Emergency liquidity assistance (ELA) extended to Greek banks by the ECB has been the only way in which Greek banks have continued to function despite these withdrawals.  This liquidity (€78bn at the end of May) has kept Greek banks afloat.   The moment that the ECB decides to do things differently will be a point of no return.  The ECB could of course withdraw its assistance entirely, but even if it imposed a ‘haircut’ on the collateral offered to secure this assistance, it’s likely the game would be up for Greek banks.  At that point, the Central Bank of Greece is likely to have to step in with another currency (it cannot issue euros) to prevent the financial system from complete seizure.  Greek banks would issue these to depositors (consumers/businesses) as a kind of IOU, and the market will quickly establish a value for this vis-a-vis the euro. This would pave the way for what would become a parallel currency in Greece, which would then de facto become the currency that displaces the euro.  
 
The formal trigger for all this to happen could be the non-payment of €3.5bn due to the ECB on the 20th of July.  However, the ECB may not even wait until then.   
 
Another deal?
 
Only another rescue programme stands in the way.  This is possible, but it is becoming less likely.   Much bad blood has been spilt between the EU and the Greek government in the past fortnight, and the political obstacles to another deal, especially one that needs to be struck at short notice, are now quite high.  The resignation of Finance Minister Varoufakis on Monday morning (7/6/2015), supposedly to improve the outlook for another round of negotiations is of only marginal help. 
 
It is true that the threat of Greece being forced out of the euro and worries over an upcoming default to the ECB will concentrate minds;  we have to see what tonight’s meeting between Merkel and Hollande and tomorrow’s summit brings (7/6 and 7/7/2015 respectively).   However, the best offer that might now be put on the table, if there is one at all, is likely to be the same deal that was offered Greece a week ago and which was then rejected. To offer a softer deal (less austerity and debt relief) would inflict severe damage on the EU creditor governments after such a referendum result and set moral hazard bells ringing.  In hindsight, had the EU creditors conceded on some debt relief and softened austerity terms earlier, we might now be in a different situation. At this time, the window for compromise has shrunk markedly.   Pressure from the IMF and the US could potentially still yield concessions, but it would look odd if Merkel/Schäuble were to go along with a softer approach after such a referendum result.
 
Market impact
 
So far, the market impact appears very muted, considering the further rise in the probability of a Greek exit from the euro.  Even European equities are down only marginally at the time of writing.  After some early weakness on the news overnight, the euro has reversed course and is now broadly unchanged against the US dollar.  It may be that this is because markets believe that the window for a deal still remains open.  Or it could be that having had 5 years to put Greece into perspective, even a disorderly exit from the euro is not being seen to be hugely impacting. 
 
We partly agree with the latter for the reasons we have noted earlier (most Greek external debt is not traded in the markets, and Greek banks’ relationships are now mainly with the ECB, not with other international banks).  Even so, a Greek exit can hardly be that easily shrugged aside.  This is for two reasons. First, a large default within the Euro system (default to ECB and various EU governments) will have resulted. Second, joining the euro will have been seen as a two way process, not the irrevocable path generally always envisaged. Both of these will leave a mark.  Consequently, it is too early to dismiss the rising likelihood of a Greek exit from the euro as having very limited impact.  If Greek exit from the euro happens, it will drag economic confidence in the region down and lead to more risk awareness from investors investing in sovereigns and businesses, both of which would impact European assets.  Even though the ECB has some firewalls it can use to combat market nerves, we see the rising likelihood of a Greek exit as putting a dampener on the outlook for European equities and credit, both on a relative and absolute basis.  The euro is also likely to weaken as these impacts are digested.  Should the currency weaken markedly, the stresses on other markets, particularly the US, would increase.  
 
The situation still remains highly fluid and it is likely that some attempts will still be made to keep Greece in.  The odds of these succeeding are getting longer.
 
Tapan Datta is the head of the Global Asset Allocation team and works out of the London office.

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