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Gerard Moore 22 / February / 20

Eurozonecollapsescenarios current macroeconomic situation Greece

Eurozonecollapsescenarios Earlydefault Greece
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Eurozonecollapsescenarios: Greece, Greece-Portugalexit

We distinguish two scenarios: “late default” and “early default”. Perhaps the EU understands that the exit of Greece or Portugal on the planned debt paths in the near future is impossible. There are even certain hints in this in the IMF report on Greece of March 16, in particular, it is indicated that among the countries that have taken the path of "internal devaluation", not one has reached the goal, and those countries that continue to follow this path, the Baltic countries, forced to deal with a severe recession. The IMF notes that Greece does not have the necessary elements of success - a counter cyclical fiscal policy, the ability to increase public debt during the reform period.

Under these conditions, taking into account historical experience, the EU is gaining time to complete structural reforms in other countries, in particular in Spain and Italy, and strengthen the financial system of Europe. Greece’s output will be delayed until the completion of the European Stability Mechanism - ESM summer 2012-2013. And the recapitalization of eurozone banks with increasing levels of capital, July-September 2012.

First, we will consider the scenario of early default, which can occur as a mess, since the events of the spring of 2012, so far, in our opinion, are developing according to this scenario.

The current macroeconomic situation and recent events show that Greece may become the first country to leave the eurozone, despite the fact that it does not have a primary budget surplus. So, according to the latest forecasts of economists of the European Commission in May, Greece is no longer able to hit the target for the primary budget surplus in 2013 if it does not dare to take additional measures of budgetary savings in the near future: instead of a target of + 1.8% of GDP, it will face a deficit at the level of 2% of GDP.

The IMF requires strict adherence to goals, the troika continues to help. Greece agrees to these conditions, which leads to widespread dissatisfaction with the ongoing reforms, with the growing influence of supporters of the exit from the eurozone after the April 2012 elections. Growth prospects are further deteriorating, and reform is becoming more difficult.

Dissatisfaction with the reforms has already resulted in an inability to form a coalition in the Greek parliament and to appoint a prime minister. There were fears that opponents of the idea of budget savings would come to power, who believe that Greece could safely increase government spending, since fears of the spread of the negative consequences of Greece’s withdrawal from the eurozone will force European politicians to finance Greece in the future.

The IMF, once again ascertaining the fact of a violation of standards, either hints or openly declares its refusal to allocate the next tranche of assistance. This failure may occur already in the summer-autumn of 2012.

The press began to appear statements by senior EU officials and individual countries that the exit of Greece, in principle, is possible, and the exit itself was actively discussed. Hints of refusal of help have already come from Angela Merkel, who demanded strict adherence to the agreed plan to reduce government spending. IMF Director Christine Lagarde stated that "the IMF must be technically prepared for Greece to exit." Of the 4.2 billion euros approved for distribution in May 2012, the troika decided to hold the allocation of 1 billion euros until June, when new assessments of Greece's funding needs will appear.

The population of Greece, foreshadowing the proximity of default and devaluation, begins a "raid on banks", a financial crisis begins in the country. The capital account is closed, bank holidays are announced. Greece refuses the euro, leaves the EU and switches to the old currency. The formal procedure itself involves a notification nature, while the parties agree on the conditions for subsequent cooperation. The failure to form a government led to a fall in deposits in just two days, May 14-15, by € 700 million, or 0.75%.

Markets pay attention to other countries, Portugal, Ireland, as well as countries with potential problems like Spain. The value of their debt falls. A decrease in the cost of debt of these countries can also occur due to the fact that, for example, Spanish banks from November 2011 brought their investments in Spanish government bonds to 263 billion euros, increasing them by 47% and using part as collateral for two LTRO. The desire to monetize debt into assets in euros on fears of a country's exit from the eurozone could trigger sales of assets denominated in euros, which will become an additional reason for the triggering of the second trigger - an increase in returns.

Italy and Spain do not have time to implement structural reforms and are forced to restructure government debt no later than in 2013. Perhaps also come out of the eurozone. The situation could be worsened by the banking crisis. The crisis extends to France and Belgium, which will also be forced to resort to debt restructuring.

An important point with the implementation of triggers is that problem countries will be unable to make payments to private creditors. Restructuring programs according to Goldman Sachs lead to an increase in the share of debt on the balance sheets of national central banks and pension funds. Thus, there is a feeling that the decision on default is more political than economic. The scenario of selective default of Greece, Portugal, and Ireland is not ruled out. This scenario provides for a smaller effect of dominoes on the debt markets of other countries, which is important for stability in Italy and Spain, where a large share of public debt is on the balance sheet of the private sector. In this case, the collapse of the eurozone can be avoided.

Another option for the rapid collapse of the eurozone involves the triggest of the banking crisis trigger in Spain and Portugal, a weak reaction from the ECB. Then the growing tensions in the financial sector and the risks of new bank failures do not find a proper response from the European Bank, which focuses on the idea of price stability and fiscal consolidation as a way to solve the problems of the eurozone, instead of another round of monetary easing. In this case, the most real way out of the eurozone of Greece, to a lesser extent Spain.


If you follow this scenario, then the ECB will need additional intervention closer to the end of the year for another resolution of the crisis in the money market, if not in the form of a third LTRO, then in the form of an expansion of the Spanish bond purchase program in the debt markets. Greece will not leave the eurozone until the end of 2013, when elections will be held in Germany in the fall of 2013 and structural reforms in Italy and Spain will be completed. To delay time, the ECB may well go for further measures to pump the economy economically. The latest negative statistics on the situation in the eurozone economy, a decrease in the PMI index in April and industrial production in March increase the likelihood of such a development. Here, not only Greece may be the first country to come out. It could also be Portugal.

After the elections in Germany in the fall of 2013 for some time, after another violation of the standards of the “troika”, the IMF refuses to provide the next tranche. The population, expecting a default and devaluation in Greece, begins a "raid on banks."

The exit of Greece could activate the second trigger and provoke the exit of Portugal and Ireland, as well as possibly restructuring the debt of Spain and Italy with an interval of six months to a year, in the middle-end of 2015. Whether Italy and Spain will resort to writing off part of the debt or its restructuring will depend on the ECB's aggressiveness in providing liquidity and in filling the ESM fund, the size of the fund itself will most likely be increased. Thus, the continuation of the policy of cutting rates by the ECB, the third LTRO are definitely triggers of this more “positive” scenario of the collapse of the eurozone.


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