Economists React: What if Greece Exits the Euro Zone?

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Economists React: What if Greece Exits the Euro Zone?

By Katie Martin

As the prospect of Greece leaving the euro becomes more real by the day, economists are trying to figure out what would happen next, to the economy and to the markets.

Nothing is certain here; Greece may or may not leave, and there’s a huge range of potential policy responses. So, making allowances for some guesswork, here’s a rundown of some of their views.

JP MORGAN: There’s now a 50% chance of Greece leaving, up from 20% before the country’s politicians failed to produce a coalition government. It says a Greek exit would depress the country’s gross domestic product by five to 10 percentage points more than if it were to stay in. “That would put the peak-to-trough decline in Greek GDP at 25-30%, broadly matching the U.S. experience in the early 1930s.” In turn, that would take away around two percentage points of growth from the region. “This would put the current downturn in line with previous deep recessions, such as the mid-1970s and the early 1990s, but milder than the exceptionally deep recession of 2008/09, when area-wide GDP fell 5.5% from peak to trough,” the bank adds, warning that regional unemployment could be higher than “anything seen in the past half-century.”

CITIGROUP: “There are many scenarios for a Greek exit; almost all of them are likely to be euro negative for an extended period,” says the bank that coined the now-ubiquitous term “Grexit”. If the process is managed, which the U.S. bank deems unlikely, expect a short, sharp selloff in the euro, with a subsequent rally up to $1.45 or higher. If Greece just dumps the austerity program and walks, the risk of contagion rises, and “the euro could begin to rally, but so much damage will have been done by then that it would begin its rally from a much lower level and probably not be anywhere close to the current level at the end of the year.” If the stronger countries were to break away, some see euro gains ahead, but Citi reckons that “this can take a very long time and is probably well beyond an investible horizon.” All in all, the outlook for the common currency is “not very promising…unless policy makers surprise with decisiveness.”

NOMURA: “Without pretending to be precise about the effects involved, we think it is fair to say that a large swing in the current-account balance would be forced by a lack of capital inflows and inevitable capital flight,” Nomura says, stressing repeatedly that bank holidays may be needed to stem the flight of deposits.

HSBC: “On contagion, one would have to decide how impacted the market elsewhere in Europe would be by a Greek exit, and also how swift and aggressive the associated policy response from the European Central Bank would be. The latter could include a reopening of the ECB’s bond-buying program, additional long-term refinancing operations, or something more ground-breaking.” The bank has devised a scale for how damaging a Greek exit would be to the common currency as a whole. Broadly speaking, it reckons that the “best” outcome for the euro would involve the experience for Greece being as tough as possible. If it’s too easy, the temptation for others to leave would be greater, and the currency would be seen to be easily divisible.

BANK OF AMERICA-MERRILL LYNCH: “The risk of a Greek euro exit is rising, but so too are the incentives to keep Greece in.” If it does happen, expect a short, sharp shock to the euro’s exchange rate. “However, in the short run if the ECB responds decisively we believe risky assets, especially bank stocks and periphery bonds, may be prone to a short squeeze. In the longer run, exporters would have scope to outperform domestically geared stocks for a lengthy period.” In a separate note, the bank adds that “if Greece exits the euro, Greek oil demand drops one third… and in a disorderly euro break-up, demand could contract sharply, with profound implications for oil prices.” Brent oil prices could drop as low as $60 per barrel, from the $106 area now.

RBS: “There is already likely to be some form of Plan-B… [but] if contagion really kicks off then a thinly veiled form of monetary financing of debts may be on the table.” The bank reckons a Greek euro exit risks a total of EUR400 billion from bailouts, the ECB and Bank of Greece lending. The risk of capital flight is key. “We are most worried about deposit risk for the periphery, and we see plenty that can be done to alleviate these risks–crucially if there is the political willingness. For instance, allowing banks to access the EFSF/ESM [the European Financial Stability Facility and European Stability Mechanism, the euro zone's temporary and permanent rescue funds, respectively] directly. We have not thought that this was politically feasible but clearly there is a pain threshold that makes politicians take risks.” Alternatively, a euro-wide deposit insurance program would be a good idea, RBS says. For trade ideas, the bank says “we think the theme of market deterioration leading to a policy action translates into buying bonds at distressed levels, which looks closer now.”

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Not "IF", but "WHEN".....thx 20Mill