5 July 2015

There are three broad scenarios from here following the Greek referendum. They are laid out below in order of likelihood.

 1. Grexit – either with or without new negotiations

This could happen either with or without new negotiations. Negotiations may take place but prove fruitless with the creditors offering the same deal as before. Or they may just refuse to talk at all. Either way the ECB would likely have to cut off ELA to Greek banks. This could be done a number of ways either by significantly capping the level available (down to €500m) or by significantly increasing the collateral needed to borrow under ELA. This would eventually precipitate the need for Greece to begin printing/creating its own currency to help fund Greek banks and avert a financial collapse. This could be done by immediately creating a new currency and moving to a new single currency system or introducing a parallel currency to cover domestic transactions before it is officially turned into the new Drachma.

It is likely and possible that Greece exits the Eurozone but stays within the EU. This would be to the advantage of all involved to minimise the economic pain for Greece and to maintain geopolitical and social stability in the country. However, a Grexit would probably require changes to the EU treaties to ensure legal certainty for the new Greek currency, to allow for a clear devaluation and to allow Greece to set up the necessary economic institutions (such as a central bank) outside the Eurosystem. As we suggested back in 2012, this could be done using the ‘flexibility clause’ (Article 352) in the EU treaties in the short term with a full treaty change used in the medium to longer term to clear up the number of uncertainties the event would raise. As the chart below shows, many countries have large exposures to Greece and would likely face some losses as Greece would default as it exits the Eurozone.

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On top of this, it is likely that Greece would need technical expertise to aid its transition but also financial aid. The banks would have to be restructured and recapitalised, which the government cannot afford to do and there is little in terms of liabilities to bail-in (other than deposits which would be politically painful to do). The newly separate Bank of Greece would need assistance from the ECB and IMF to help manage its new currency, not least because it may not have significant foreign exchange reserves. One final point here is that many Greeks want to stay in the Euro, as such taking any course of action to leave could require a new democratic mandate – i.e. new elections or even another referendum.

2. New negotiations leading to a deal

This is the expectation of the Greek government, but we have always seen it as rather unlikely. It seems possible that Eurozone leaders will consider new discussions with Greece though some, such as Germany, will have to get approval from their parliaments to do so. It is very possible that just the questions of whether or not to hold talks with Greece let alone what deal to offer them will split the Eurozone and EU institutions as we noted in the intro to our live blog. This will be explified by a Franco-German split with France likely being more lenient, at least to start with.

Even if new negotiations do take place they will likely take some time. As the table below shows, it has often take countries between a week and a month to negotiate a new bailout deal which will then need to be approved by Eurozone parliaments. Even though there are months of talks behind Greece and its creditors, there are a number of differences still and a new programme will mean a new memorandum being drawn up and accepted by all sides.

It is hard to see the offer from the Eurozone changing significantly since throughout the negotiations they presented a largely united front. As such the conditions of any deal will likely be largely the same, though maybe some small tweaks can be made. As we noted on Friday, the role of the IMF has become more complicated and it’s not clear whether they could be part of any deal or if the Eurozone would go ahead without them. Negotiations will have to take account of a number of national issues from the German Parliament and constitutional constraints to the upcoming Spanish elections (the government will not want to do anything which might cede ground to Podemos).

All that said, theoretically a broader deal could be struck which allows for ESM funding to pay off the ECB and IMF over the coming years combined with a rescheduling of all Eurozone debt to further reduce rates and lengthen maturities (though there is little room to do the former). The promise of investment via a number of different sources (EU budget and Juncker investment fund for example though room for manoeuvre here is limited) may also help smooth the way. This could also be combined with a promise to discuss debt relief in the future, particularly around the bilateral loans for the first bailout which would prove the easiest of the official sector loans to restructure (though still tricky). This would have to be worked into future plans for Eurozone integration as any transfer between two countries will be legally challenged in Germany and seen to break the treaties. As the chart below shows, given how much debt is owned by official creditors, it is hard to restructure Greek debt without them taking large losses.

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However, the fallout of such a deal could be significant. It would undermine the credibility of the Eurozone given its stance so far. It would also likely trigger requests for more leniency from other bailout countries, though of course they may not want to be lumped in with Greece. It would be hard not to encourage people in Spain to vote for Podemos if such a deal was offered to the much smaller economy of Greece. For better or worse this deal would realign the nature of the Eurozone’s response to the crisis.

3. Greek limbo (Grimbo)

Theoretically, Greece could live in a limbo inside the euro with capital controls in place and some kind of parallel currency circulating. However we have always seen this as very unlikely. The question we have to ask is: why?

In the end, living in such limbo would be incredibly painful for the Greek economy. Furthermore, it would mean doing so without a clear end game in sight. Unless this situation is simply buying time for a new government to come into place and resume some kind of bailout with the creditors (this seems unlikely given the strong No) then there seems to be little benefit. It would also be of little benefit to the Eurozone as it would mean uncertainty hangs over it for even longer and hampers any future planning. There would have to be a clear path back for Greece in one way or another for this approach to be worthwhile. Given the No vote, this would mean the creditors changing their position. The main reason to consider this option a possibility is that the majority of Greeks still want to stay in the Euro, however, after experience the depression of a limbo situation with Grexit the only alternatively, that could change.

What does this mean for Europe?

It is a profound change. Possibly the first in the five years of crisis. The Eurozone will either have to capitulate to Greece, in turn changing its entire modus operandi and probably unleashing the first fiscal transfer between states via a write off of Greek debt. Or Greece will have to leave the Eurozone. In which case the EU and the Eurozone will be fundamentally changed. The EU will have to reconsider its ‘ever closer union’ mantra and accept that its flawed approach and inflexible institutions have helped precipitate the downfall of one of its guiding principles. The Eurozone will need to set out a clearer path for its future and make the case, in concrete policy terms, for why other countries will not be next. This will likely mean moving towards deeper integration and a significant intervention from the ECB to stem any market concerns.

For Greece the outcome is unlikely to be positive for the economy in the short term. Even if negotitiations take place they will take some time and capital controls will likely still be needed pushing it further into depression. If there is a Grexit the transition would be painful but longer term prospects may be better. That said, its not clear that a Syriza led government would use the time and space afforded by a devaluation to reform the economy and make it more competitive and business friendly as is needed.