Eurozone: Referendum, chaos, Grexit?

On Friday night, the course of the negotiations on the end of the second Greek programme took another unexpected twist. A crucial week for Greece and the Eurozone lies ahead. No one knows how this week will end or what will happen after Sunday. However, it increasingly looks as if there are only two options left: new elections or Grexit. Tsipras’ move is now another climax in the increasingly disturbed relationship between the Greek government and the rest of the Eurozone. Capital controls, bank holidays and increased uncertainty will accompany Greece on its way to the 5 July referendum. Whether this road will eventually end with the Grexit is still too early to tell, even though the probability of a Grexit has clearly increased over the last days. In short, absent a last-minute miracle, Greece is looking into an unprecedented financial and political future in the coming days. Whether this future will eventually also include the Grexit is currently impossible to tell. The expiration of the official bailout programme and the reimbursement of the IMF, both due on Tuesday, will in our view not automatically lead to a default and further turbulences. All involved Eurozone players will probably want to keep the situation as contained as possible, at least until next Sunday. Comments from Eurozone finance minsters suggest that the door for new negotiations in the days ahead of the referendum is closed, though not fully locked. The most interesting question is what will be next. As we have seen so often in the Greek crisis, nothing is granted. It is very hard to exactly forecast what will happen. Even the Greek government returning to the negotiations between now and Tuesday night cannot be excluded entirely. In our view, without fresh money from creditors, Greece is likely to be in arrears on a €1.6bn payment due on Tuesday to the IMF. While credit agencies have not classified this as it lent to Greece on the back of the missed payment to the IMF. Of course, this is very unlikely to happen. In our view, Greece will not technically default in the days leading to the referendum, neither as a consequence of not paying the IMF nor as a consequence of the end of the bailout programme. Another issue, however, is whether the Greek government can actually pay public salaries and pensions at the end of the month. Cash withdrawals from Greek banks have accelerated in recent days. It was therefore almost a holiday. At the writing of this note, it is unclear whether Greek banks will only close for one day or for the entire week. Such capital controls and one or several bank holidays, might have been the price, the ECB had asked to continue with ELA. For the ECB, the tricky question is how to deal with this new situation. An ECB referendum is not part of the ECB’s rulebook. This means that the ECB will have to take technical decisions on ELA, which in fact have political implications. In our view, the ECB will continue with ELA until the referendum. It can argue that up to the referendum the solvency of Greek banks has not significantly changed from last week. At least in the ECB’s eyes. Moreover, in our view, the ECB will be very hesitant to increase political pressure on Greece just a couple of days before the entire Greek population can make use of a democratic right. The days leading to the Greek referendum should therefore be dominated by uncertainty and possibly financial market turbulences – at least in Greece. It does not look as if peripheral spreads will widen significantly, given that financial markets will probably regard the entire crisis as a Greek crisis and contagion should be limited. If we are wrong and financial markets go crazy, the Eurozone has sufficient instruments to fight contagion. In our view, the ECB’s OMT programme might only be a remote option. The more efficient tool to fight short-term volatility would be QE. It would also help the ECB to solve its front-loading problem. With volatility but no chaos in the rest of the Eurozone in the coming days is our base case scenario, the other question is what will happen on (or better: after) Sunday. It is impossible for us to forecast the outcome of the referendum, but we can at least sense the domestic political strategy behind the latest twist in the Greek drama. As the creditors’ proposals cross a number of “red lines” of the Greek government, Tsipras is risking a break-up of the government or his own party. A YES vote would give him the authority to clinch a deal with the creditors without losing face because of broken electoral promises. In this case we would probably see the five-month extension of the current programme, during which a total of €15.5bn of financial support would be provided. This would allow the Greek government to implement the structural reforms, which could then lead to a third programme and some limited form of debt restructuring. This still looks a feasible scenario as in a poll on Saturday, published in the To Vimanewspaper, 57.5% of Greeks said the government should close a deal with the creditors, while two-thirds want Greece to remain in the Eurozone. However, this scenario basically means that the Greek problems will continue to haunt the Eurozone economy for some time to come. With a Greek government that has not been very co-operative until now and doesn’t seem to have the will to implement market-oriented reforms, one can already anticipate a new stand-off when the extension of the programme would end in November. A defiant Greek government is actually recommending the Greek population to vote NO. If this were to be the outcome, then we would be back to square one: the Greek population wants to remain in the Eurozone without accepting the terms of the creditor nations. However, the fatigue amongst the creditor nations with the negotiating tactics of the Greek government has reached the point, that a Greek exit from the Eurozone is now considered as a viable alternative. According to The Guardian, Merkel told Tsipras that the vote was “a choice between the euro and the drachma”. A NO vote would not necessarily immediately lead to a Greek exit. We might actually see Greece also default on the ECB reimbursement on 20 July, without adverse consequences. However, this would necessitate the ECB to continue providing ELA to the Greek banks (already a stretch) and capital controls and limits on bank withdrawals will have to remain in place to avoid a collapse of the banking sector. However, a “no” vote and a default on the bond held by the ECB, even if not technically, is very likely to trigger an end to ELA. As a consequence, Greek banks would need to be recapitalsied (and/or nationalised) with money the Greek government does not have. IOUs or a dual currency would be the solution and, consequently, lead to a Grexit (see also our earlier note with an Q&A on the Grexit). In all cases, one thing seems quite sure: the recession in Greece would most probably deepen and more unrest is to be anticipated. The Greek mythology offers lots of interesting stories. Many of these stories seem to come back in the current Greek crisis, which took another unexpected and exciting twist over the weekend. Looking at the latest events, we see memories of Hydra and Hubris. Hydra was the serpent-like water monster with reptilian traits, which possessed many heads. For each head cut off, it grew two more. Hybris, or Hubris, on the other hand was the goddess of insolence, violence, reckless pride, arrogance and outrageous behaviour. Or simply put, an excess of ambition, pride, etc,ultimately causing the transgressor's ruin. Parallels with the current Greek crisis are obvious. Looking beyond the coming days and the next weekend, the Greek referendum does not only mark a new climax in the Greek crisis but also the end of muddling through in the Eurozone – even if the Greek people vote in favour of the proposal and indirectly of their membership in the Eurozone. Will there now be a series of referenda on the Eurozone membership? It is time to speed up institutional reforms and make the monetary union sustainable. The latest report of the five European presidents was supposed to kick-start the discussions. Discussions which should quickly shift to warp speed, if the Eurozone wants to consign Greek mythologies back to the realms of fantasy.