Grexit? Fidelity comments on the recent developments in Greece

Below, a note from Dierk Brandenburg, our Senior Sovereign Analyst on the recent developments and outlook.

Tsipras claimed his place among the most rebellious of European leaders this weekend by turning down the last offer by the creditors and putting it instead to referendum next Sunday. A referendum does not automatically trigger Grexit, but as outlined below a full scale government default is now very likely in view of the inevitable delays ahead. One thing could lead to another from here, unless the politics in Greece change drastically in the next couple of weeks. The immediate Eurozone response will focus on limiting contagion by offering more liquidity to banks, if necessary, and retool QE where possible (accelerate purchases, potentially weaken the capital key). Should other Eurozone countries lose market access, the OMT and ESM are available if governments ask for them. Most governments front loaded issuance this year, so I doubt there is an immediate risk here. Overall I expect a fairly robust political response, and the circumstances in Greece are sufficiently unique not to allow for any parallels.

Fundamentally, a Greek referendum would have been a very good idea, had it come a month ago but now it's simply too late. Since Tsipras had already endorsed the referendum with a No (OXI) vote late on Friday, creditors thought it made little sense on Saturday to consider the Greek request to extend the program, which now ends as scheduled on Tuesday. For practical purposes it means that the creditors' offer that is now subject to referendum in Greece next Sunday already no longer exists.

Yesterday, the ECB duly froze the ELA ahead of Tuesday's program expiry, which means the banks in Greece and the stock market are closed until further notice, at least until after the referendum early next week.

With the latest bailout programme expiring the moment Greece fails to repay the IMF tomorrow, the question posed in the referendum is going to be rather meaningless, with the vote itself more a confidence vote on the current government.

There is the remote chance that the referendum does not take place because a new government comes in at short notice or because it's declared unconstitutional (Referendums can only be called with 4 weeks’ notice, cannot be about fiscal matters and need a minimum participation of 40% of the Greek population) The outcome of the referendum is likely to be “Yes”, given the preference most Greeks have voiced for the EUR up to now, but the water will get muddied by all parties over the coming days and there are no reliable polls available, yet.

In any case, things won't change much unless Tsipras resigns or calls new elections (which would take a minimum of 4 weeks), soon. Only a new government would have sufficient credibility to resume negotiations with the Troika and regain access to EUR funding with a 3rd program that is now required.

Without a new government it will be impossible to reopen the banks, and even then capital controls, once in place, will remain in place for a long time. That will depress confidence and economic activity and lead to a larger shadow economy that is already estimated at close to 20pct of GDP. Fears of cash shortages will also damage this summer's tourism, though cashless payments are likely to be unaffected if the Cyprus experience is anything to go by.

Given the likely further deterioration in Greek collateral, the ECB will eventually start closing down banks, if the political picture doesn't change. One question is whether the Greek government can roll its T-Bills (owned by the banks) in the coming weeks or default on these as well. Higher ELA haircuts will lead to bank defaults.

Looking at the new situation, it's now very likely that the ECB will not get paid on 20 July, in addition to the IMF and the EUR 2.5bn of unpaid bills the government is believed to have accumulated this year. How long pensions and public sector wages can be paid in full in EUR is not clear.

In terms of cross default, the IMF has a month until end-July to declare a default, which would then give the ESM the ability to accelerate the EUR 140bn EFSF loans. That is unlikely to happen in the current environment as there are no payments due for a couple of years. The ECB's SMP bonds are mainly under Greek national law and have no cross default. As "old indebtedness" they are not covered by the indentures of the EFSF loans and the GGBs.

In contrast, the traded GGBs will trigger cross default only if the EFSF accelerates or the T-Bills default, and even then it would be up to holders to accelerate, which again is unlikely. International law and collective action clauses prevent unilateral re-denomination or haircuts in case of a Grexit, unless bond holders agree.

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