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In the Headlines: Greek Debt Crisis

Sunil Swami, Chief Investment Officer | JUN 29, 2015

A Greek Tragedy

Global stock markets are down sharply today on news from Greece.  Over the weekend, Greek Prime Minister Alexis Tsipras surprised financial markets by calling for a referendum on the latest proposed terms of a bailout extension from Greece's creditors – the International Monetary Fund (IMF), the European Central Bank (ECB) and the European Union (EU), collectively known as the European “troika.” The referendum is scheduled for Sunday, July 5.

Stunned by the unexpected decision, the European “troika” withdrew from negotiations and said that they would not release any more bailout funds.  This move led to a breakdown in talks on Saturday and has set Greece on a course to missing its scheduled payment of €1.6 billion to the IMF on Tuesday. Eurozone finance ministers on Saturday also turned down a request from Mr. Tsipras for an extension of the Tuesday payment to the IMF.

What's Happening Now?

With Greece expected to default on its debt obligations to the IMF, the ECB was forced to cap its emergency liquidity assistance (ELA) to Greek banks at current levels.  The ELA allowed Greek banks to post collateral other than Greek government debt — which the ECB said it would no longer accept — in exchange for receiving liquidity at elevated interest rates. The ECB is currently limiting the amount of capital available under the ELA at around €89 billion.

Without an increase in the ELA, Greece will likely run out of cash before the July 5 referendum.  In response the Greek government has announced the following measures to prevent a “run” on its banks:

  • Greek banks will remain closed until July 6.
  • Capital controls, including limiting the amount of money that can be withdrawn at an ATM to 60 euros per day until July 6.
  • The Athens stock exchange will remain closed while banks are closed.

Why do global financial markets care about Greece?

Greece is country of 11 million people with Gross Domestic Product of approximately $250 billion – not much bigger than the economy of Dallas/Fort Worth, TX.  Markets are reacting to the fear of contagion – problems seen in Greece will show up in other Eurozone countries like Portugal, Italy, and Spain.  Should Greece leave the Eurozone it might call into question the whole idea of the EU and begin unraveling the project of greater European integration.  Investors would have grounds to fear that other, larger countries could also abandon the euro. Trust in the common currency could evaporate.

What’s likely to happen?

We believe that the majority of Greeks want to stay in the Eurozone but do not like the austerity measures imposed by their creditors.  It is not clear how they will vote on July 5 or even if the referendum will take place. If the Greek population votes against Tsipras and accepts the program of austerity put before them, Tsipras will almost certainly need to call a new General Election. Under this scenario, Greece will get a temporary extension to the bailout program, and will remain part of the euro area until the new (presumably more euro friendly) government is elected.

If the Greeks vote against the bailout they are essentially voting to leave the Eurozone.  The likelihood of a Greek euro exit rises substantially and becomes the most likely outcome. If, as a group, Euro finance ministers decide to cut Greece loose, then the ECB will cut off funding to Greek banks to make this happen. With no prospect of new euros entering Greece and the banking system and the economy not functioning because of a liquidity shortage, the Greek government will have no choice but to introduce a parallel currency and effectively to eject itself from the euro area.

What should investors do?

Long-term investors should do nothing and live through the market turmoil as they have done in the past.  For investors who have been waiting for a market correction to enter the market or add to their equity holdings, this event should offer them a dip to be bought.  However, the situation remains fluid.  Should Greece decide to stay in the Euro, this will be a fairly short correction.  However, if Greece were to exit the Euro we are in uncharted territory with the potential for significant tail risk.  A lot will depend on policies the ECB implements to limit contagion.  The correction in equity markets might be longer and more severe before the recovery begins.

About the Author

Sunil Swami, Chief Investment Officer

Mr. Swami has decades of experience in the investment management and related fields.

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