Strong rumours continue to abound that Greece will default on its loan repayments and leave the single currency zone. Euro zone finance minister did not satisfy with Greece latest reform plans during a meeting of finance ministers in Riga on last Friday. As a result, Euro zone finance ministers did not approve to deliver the remaining 7.2 billion euros in frozen bailout funds. Greece government may run out of money in the short term, leading to a higher possibility of a default and Grexit. How should investors interpret a Grexit blowout?
Political but not economic risks
Time was running out for Greece as it is running out of funding. However, Greek government wishes to borrow money on an easier terms and not sticking to his original tough austerity plan. However, Euro Union, European Central Bank and IMF refuse to relax the loan agreement, because they consider this action would signal to other debtor countries that it’s possible to relax a loan agreement by political pressure.
The market is worried about the tail risk of Grexit situation due to a credit default. If Greece quit the Euro Area, it is no doubt that Greece will face the currency and system bank crisis. From the past experience, Greece economy may lead to a serious economic problem. But Grexit has a limited charge to Euro Area economy. European Central Bank has reiterated many times that it would do whatever it can and even increase the scale of QE to recover the faith of Euro Area.
The Greece economic impact of Grexit
Data Source: Guosen Securities
Greek default necessary but Grexit is not
As Greek’s lost is much higher than that of the Euro Area, the possibility of Grexit is highly unlikely. We forecast emergency funding will be delivered if Greece government runs out of money. The real question is at the end of July. EU, European Central Bank and IMF will have to decide whether to provide a new loan agreement to Greek. During this period, Greece needs to submit a reform proposal.
An agreement on reforms is all that needed to unblock the Greek impasse at least for the next two or three months. A comparison of Syriza’s manifesto, leaked lists from government and creditors’ recommendations shows that both sides already agree on most of the reforms on the negotiating table. Some stumbling blocks remain, notably on collective lay-offs. While defaulting on the IMF and ECB maybe an option, but default is not synonymous with exit. In addition, Greece, facing increasing financial pressures, will have a bigger incentive to compromise. In the coming weeks, it would be unwise to rule out the possibility of positive developments from the negotiation.
Once Greece agrees on a reform program with creditors, it should be back on track to make it through the rest of 2015. Euro Area has positive outlook right now. Investors should not lose the faith of Euro Area just because of Grexit situation.