Citigroup economists Willem Buiter and Ebrahim Rabhari revised their predictions of a Greek exit from the eurozone—or “Grexit”—in the next 18 months up to 50 percent from 25-30 percent in November.
That’s not only because Greece’s failure to meet spending and austerity goals has angered the rest of the euro area and made other countries less willing to extend aid, but because the risks to the rest of the eurozone have been moderated as investors priced in this possibility.
However, halting tail risk is dependent on a few criteria, the most important being swift and strong action from EU leaders:
Clearly, the Grexit scenario that we describe here is subject to major downside risk, namely that exit fear contagion following Grexit could be much stronger than anticipated, leading to a sequence of sudden stops in the external financing of periphery sovereigns, banks and other private entities. Unless an official ECB/EFSF/ESM/IMF firewall/ big bazooka can deter or negate such a withdrawal of market funding, there could be a sequence of forced exits from the EA, reducing the euro area to a greater DM zone.
There is also some circumstantial evidence in historical bond yields and GDP growth which suggests that investors do consider Greece to be a distinct case from Portugal, Ireland, Spain, and Italy.
Still, Grexit is not Citigroup’s baseline scenario—Buiter and Rabhari expect that a Greek default will indeed provoke a credit event, and that future debt restructuring will have to happen, but that it will stay in the eurozone.
Grexit will only happen when Greece publicly flouts troika recommendations and has no chance of receiving aid.
“Grexit would likely take place in a context where Greece is no longer willing to make the minimum efforts necessary to be judged to be in compliance with the fiscal and structural reform demands of the Troika. Greece would not just have to fail to comply in substance, but would have to be sufficiently blatantly non-compliant to deprive the Troika of the fig-leaf of an ‘honest-albeit-insufficient effort to comply’.”
Source: Citigroup Global Markets
Greece will pass a currency law setting exchange rates and limiting those who can file suits against the Greek government in foreign courts.
“Grexit would effectively start with the urgent passage of a currency law through an emergency decree by the Greek government of the day. This law would stipulate one or more conversion rates between the old and the new Greek currency (which we will call the ‘New Drachma’)…
Besides one or more rate(s) of conversion, the currency law would likely also specify that the new currency is legal tender for payment and settlement of debt in the ‘relevant country’, i.e. Greece, including for the payment of public and private debt obligations (including bank loans, deposits, and securities) and other contracts, including wage and pension contracts.”
Source: Citigroup Global Markets
It will simultaneously impose strict capital controls to prevent capital flight.
“In our view, it is highly likely that Grexit would be accompanied by the imposition of strict capital controls. True, the Treaty (Art. 63) forbids any restrictions on capital or payment flows between EU member states, but we think that an exiting country, facing massive disruptions in its international capital account transactions would need to impose strict capital and foreign exchange controls following exit if some semblance of financial order is to be maintained.”
Source: Citigroup Global Markets
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See Also:
- Pressures Mount On Greece: Here’s What’s Ahead Tomorrow
- LIVE: Negotiations And Crisis In Greece
- STIGLITZ: The ECB Needs To Revise Its ‘Peculiar’ Stance On Greek Default