Bonds, Currencies, Emerging Markets, Stocks

Greek Economic Growth Could Immediately Plunge 25% Following Grexit, S&P Warns

greece-financialStandard & Poor’s (S&P) has warned that a possible Grexit would bring ‘very significant’ consequences to the Greek economy, and they are putting the odds of an exit at 50 percent, according to a report published on Thursday.

The rating agency says that without the support of the Eurosystem, which it estimates at over 70 percent of Greek gross domestic product (GDP), Greece’s payment system would shut down and its banks would not be able to operate. Greece would also permanently lose access to financing from the European Central Bank (ECB), which would create a serious foreign currency shortage for the private and public sectors.

According to the S&P, in the event of a Grexit, the country’s real GDP will immediately plunge 25 percent and will still be 20 percent below the baseline after four years, according to the report. Unemployment will spike above 29 percent and will only gradually come down.

Chart courtesy of S&P

Chart courtesy of S&P

According to data from the Bank of Greece (BoG), Greek banks have lost €35 billion in deposits between November 2014 and April 2015, however S&P estimates that outflows reached €54 billion or 30 percent of GDP by the end of June.

Following a Grexit, S&P expects a “massive confidence shock” to hit the Greek economy, equivalent to four times the impact on Greece from the Lehman fallout, which will adversely impact investment spending.

A Grexit would also imply that Greece switches back to the drachma (GDR). The S&P estimates that markets would push the drachma down from its pre-conversion rate of GDR340/€1 to GDR540/€1 in the fourth quarter of 2015, and then over the following few quarters, expects a partial rebound to GDR440/€1, an overall drop of about 30%.

S&P warned that a more severe stress assumption would include a 50% devaluation versus the euro and/or the freezing of all deposits held with Greek banks.

As Greece suffers, the rest of the Eurozone would be relatively unscathed, the S&P says, as Greece is a small economy and traditionally more closed than many of its other small counterparts in the bloc, therefore the direct trade effects of an exit for other economies would be small.

The most significant impact of a Grexit would be felt in capital markets, where it would drive up yields.  S&P believes that the ECB’s QE program would eventually be able to cap the rise in yields, however a currency risk premium is likely to be permanent.

Greece became the first developed nation to default of its international debt obligations after failing to make a €1.55 billion ($1.73 billion) payment to the International Monetary Fund (IMF) which was due by the end of June 30.

Missing a payment to the IMF is referred to as arrears, or money that is owed that should have been paid earlier, where the IMF will not provide financing until the arrears has been cleared.

The missed payment by Greece could now trigger a cross-default on Greece’s multibillion-dollar commitments to the European Financial Stability Fund (EFSF).

On Monday, Fitch Ratings downgraded Greek banks to a restricted default (RD), then on Tuesday downgraded Greece’s sovereign rating by one notch to ‘CC’ from ‘CCC.

On Monday, Standard & Poor’s (S&P) downgraded Greece’s rating from CCC to CCC-, and put the odds of an exit from the Eurozone at 50 percent. On Tuesday, S&P downgraded its ratings on four Greek banks to selective default.

The former CEO of PIMCO, Mohamed El-Erian, recently said that there is a 85 percent probability that Greece will be forced to leave the Eurozone and that the country is heading for a “massive economic contraction”.

Legendary investor Jim Rogers recently said in an interview: “if you ask me what they should do – is just go ahead and go bankrupt, get it over with and start it over.”

The missed payment by Greece comes at a particularly troublesome time as the country imposed capital controls, shut its banks, and closed its stock markets until further notice on Sunday in order to avert a collapse of its financial system.  This was following Greek Prime Minister Alexis Tsipras’s shock announcement late on Friday night of a July 5 referendum on austerity measures demanded by the country’s creditors.

Index provider MSCI warned on Monday that the closure of the Athens stock market and the imposition of capital controls could lead to Greece’s relegation from the benchmark emerging markets index and its reclassification as a “standalone” market.

Should Greece be reclassified to “standalone” it would join the ranks of such countries as Botswana and Zimbabwe as countries that the MSCI say do not meet minimum liquidity requirements, their markets are partially or fully closed to foreign investors, and stock lending or short selling are either not developed or prohibited.

MSCI had previously downgraded Greece to emerging market status in November 2013.

Ahead of Sunday’s referendum vote, a poll that was commissioned by Bloomberg showed that voters are split as 43 percent of those polled plan to vote “no” to reject the austerity demanded by creditors in exchange for financial aid, and 42.5 percent plan to vote “yes” to accept the conditions.

Greek Referendum Vote 1

Chart courtesy of Bloomberg

Greek Referendum Vote 2

Chart courtesy of Bloomberg

The same poll showed that 81 percent believed that remaining in the euro offered the best prospects for the future, whereas 14 percent wanted to switch back to a national currency.

Greek Referendum Vote 3

Chart courtesy of Bloomberg


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