Earlier this week, a journalist began our conversation by saying, “Whatever is on your mind, promise me we’re not going to talk about Greece.” After more than five years of a Greek drama that would have made Sophocles proud, most of us have become fatigued with hearing and reading about Greece’s debt problems, the one issue that just won’t go away.
But unfortunately, despite our fatigue, the Greek saga continues to influence investor behavior. This week, characterized by violent swings in equity markets, is a case in point. Much of the recent stock market volatility can be attributed to shifting perceptions about whether Greece and its creditors will reach a deal, or whether markets will have to contend with a default, capital controls and a potential Greek exit.
Looking forward, Greece will likely continue to be a source of headline risk. My short- and long-term outlook for Greece–including my take on the most likely outcome to the saga–helps explain why.
The most likely scenario is still a deal
While the last 72 hours have been characterized by manic swings in sentiment, Greece and its creditors are inching closer on the critical issues of Greece’s primary surplus, value-added tax (VAT) and pension reforms. Real differences remain, but both sides are motivated to finesse the differences and sign a deal.
Europe is still justifiably nervous over the economic and, potentially more important, political implications of a Greek exit. And despite all the posturing, the Greek government is equally motivated. While the Syriza political party ran on a campaign to end austerity, the present government has no mandate to leave the euro. That said, given that time is quickly running out, a deal may miss the official deadline of June 30th. Under that scenario, there may still be a need to, at least temporarily, impose some form of capital controls to prevent an even bigger exodus of funds from Greek banks.
The real issue isn’t debt sustainability, it’s growth
Investors have focused on the Greek government’s Olympian-sized debt burden, roughly 180 percent of gross domestic product (GDP). While this is well into the danger zone, the near-term implications are less dire than you would expect. Almost all of this debt is held by public sector creditors, not private investors. From Greece’s perspective, financing the debt has been made much easier by numerous maturity extensions and rate cuts. The end result is that the debt doesn’t create a particularly burdensome obligation, at least not in the near term.
The bigger problem is a lack of growth. Greece suffered through a brutal depression. While growth rebounded last year, recent uncertainty has extinguished the recovery. Making matters worse, Greece’s current list of proposals is heavy on taxation and light on reform. While a compromise is likely to be found, given the present government’s agenda, any deal is likely to be temporary and do little to address the country’s long-term structural problems.
In the near-term an exit from the euro wouldn’t be catastrophic, but long-term implications are less clear
While a Greek exit from the euro isn’t my base case scenario, where it to happen, the fallout would be less severe than it might have been in years past. Thank the European Central Bank (ECB)’s quantitative easing (QE) operation for better capitalized banks and firmer finances in the other peripheral countries. As a result, a Greek exit would probably not generate the same contagion risk as it might have in 2012. However, the longer-term implications are unknown. Membership in the euro was supposed to be irreversible. A Greek exit nullifies that view.
For investors, the key take away is that headlines out of Greece will remain a risk to markets for the foreseeable future. Even assuming a short-term deal is struck, this won’t be the last time we all find ourselves, reluctantly, still talking about Greece.
Sources: Bloomberg, BlackRock Research