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Greece: What lies in store?

GREEK Prime Minister Alexis Tsipras has called for a referendum on demands from foreign creditors. The referendum will be held on Sunday July 5. Greeks will vote on whether they accept the terms that international creditors have offered.

The Greek central bank set capital control measures on Sunday June 28 to prevent a bank run. This includes a six-day bank shutdown. All credit institutions in Greece, including branches of foreign banks, are affected. Cash machines will remain open, but cash withdrawals will be limited to €60.

Tourists are not impacted at this stage, as cash withdrawals with bank cards that have been issued by foreign banks can be used based on standard cash withdrawal limits. In addition, payments via cards to accounts within Greece will be allowed but payments and transfers to accounts outside Greece are now prohibited.

On Monday June 29 the European Commission accepted capital controls to stabilise the Greek banking system, even though the controls break EU laws on free capital movement.

The main rationale behind Tsipras’ decision to call for the referendum is the failure of negotiations between the Greek government and its foreign creditors, just a few days before the June 30 deadline. After having made sizeable concessions a week ago (including pension reforms and cuts in military spending) and after positive comments coming from international creditors, negotiations did not make progress the previous week.

Given uncertainties related to the outcome of the referendum, bank deposit outflows would have been massive if banks had opened on Monday. After deposits fell by roughly 22% between September 2014 and May 2015, outflows reached €1.2bn on June 22, meaning that bank deposits would have totally disappeared in no more than five months if this trend continued.

Such outflows could have been offset by higher liquidity provided by the European Central Bank, but it decided not to do so on June 28, on the back of rising insolvency risks weighing on Greek banks following the decision to call for a referendum.

Risks

Greece has defaulted on its €1.5bn loan to the International Monetary Fund maturing on June 30. Admittedly, there have been debates over the past two weeks to consider whether this non-payment would be a default or not (some rating agencies don’t define this kind of non-payment as a default), but Christine Lagarde of the IMF has said this is a default.

The outcome of the referendum is uncertain, even though the foreign lenders' plan would be accepted by a large margin according to polls released on June 28.

On the one hand, the majority of Greeks are still in favour of staying in the eurozone. But on the other hand, most Greeks are fed-up with austerity measures (in particular the youth and unemployed and retired people). Tsipras is backing the ‘No’ vote by saying the lender demands aim at “humiliation of the entire Greek people”.

Possible scenarios

A ‘Yes’ majority

An agreement with lenders is likely, as it has been validated by a popular vote. Risks of massive outflows from the banking system then abate, all the more since the ECB would likely support it. Capital controls could be abandoned comparatively quickly - and Greece stays in the eurozone.

However, Tsipras’ government would resign. That would open the door for an early election or the formation of a coalition government including notably the centrist To Potami party, the centre-right ND and the centre-left Pasok.

A ‘No’ majority

In this scenario, the ECB would stop providing Greek banks with liquidity and capital controls are likely to last. Foreign investment would therefore be limited for a long period of time. As a reminder, such measures have lasted two years in Cyprus, while Iceland has just softened some of the capital control measures it put in place in 2008.

Besides, when banks reopen, outflows would resume. The Greek central bank would be forced to issue a parallel currency (and de facto exiting the eurozone). Then a large-scale depreciation of the new currency could occur. Inflation would surge and the economy would likely fall in deep recession.

Less likely scenarios

President Prokopis Pavlopoulos cancels the referendum by June 5, or cancels its outcome if the referendum turnout is too low (less than 40%). Both scenarios would bring more uncertainty.

The rest of the eurozone is much less linked to Greece than in 2011-2012, as the private sector (especially eurozone banks) is not exposed to the Greek public debt anymore. However, we cannot exclude the risk of contagion through financial markets: sovereign spreads are likely to increase, especially in Portugal and to a lesser extent Ireland, Spain and Italy.

But if needed, the ECB could buy government bonds to offset this according to its bond buying programme. Equity markets are likely to be jittery, all the more since we are entering the European summer season which is usually prone to more volatility as exchanged volumes are lower.

And last but not least, business confidence could take a hit, although June data released last week is still well orientated in all countries, despite growing concerns about Greece in June. Besides, the euro is likely to depreciate further. “Safe haven” countries, mainly Germany, would benefit from lower sovereign bond yields. All in all this clearly poses downside risks to the eurozone’s weak but gradual recovery scenario.

*Julien Marcilly is chief economist of international credit insurer Coface.

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