Comment: Where now with the Greek debt crisis?

Following Greek prime minister Alex Tsipras' rejection of creditors' proposals for an extension of the bailout programme, the prospects of a Greek default - and consequently, a Grexit - look very high, writes Neil Blake, head of EMEA research at CBRE.

After encouraging signs that a deal might be struck as little as a week ago, the Greek situation suddenly lurched into crisis at the weekend when prime minister Alex Tsipras called a referendum for 5 July with a recommendation that the proposals be rejected (a 'no' vote).

Now the prospects of a Greek default look very high - and with it the chance of a Grexit.

The talk is whether we are approaching a Lehman-type event (or even a 'Sarajevo moment' to quote a UK economics editor) or if it is just the latest episode in a largely domestic Greek tragedy.

The next debt payment to the IMF is due today and Greece will be unable to make it, so a technical default looks certain which will turn into a full-on default if there is a 'no' vote on Sunday.

The more immediate problem, however, is the liquidity of the Greek banks. In the face of large-scale capital flight over the past six months, it has only been Emergency Liquidity Assistance (ELA) from the ECB that has kept Greek banks functioning.

Seven-day 'bank holiday'
The ECB has said that it will freeze the amount available at the €89 bn which was agreed last week and that no more will be forthcoming. It is not clear how much of the €89 bn is left, but it is unlikely to be enough to allow the banks to satisfy their depositors’ demands for very long and, as a result, the Greek government has had to announce a seven-day 'bank holiday' and a €60 per day limit on withdrawals from ATMs. This could be particularly problematic for a cash-dependent country like Greece, particularly if informal sources of credit dry up because of the uncertainty of the situation.

So, if the first to suffer is the Greek economy itself, what are the chances of this becoming a Lehman, or even a Sarajevo moment? In strict terms, where credit markets freeze because no one knows who is solvent and who is not, we are not looking at a Lehman moment.

Unlike in 2011-12 where this was a real danger, most of the Greek debt is now on national governments’ or inter-governmental organisations’ and not private banks’ balance sheets. This does not mean that a hit of €56 bn for the German government, for example, will not smart but there was never any chance of the creditors getting their money back in a hurry no matter what deal was agreed.

Rather than a downwards spiral of bank credit or financing problems for Greece’s creditors, the main issue, other than short-term uncertainty, is the potential Pandora’s Box effect of a country leaving what was meant to be an irrevocable monetary union.

If a Grexit happens, the concern is that markets will turn their attention to the bond markets of some of the other weaker members of the Eurozone when signs of economic or financial stress appear or that, they too, could see Greek-style runs on their banks.

Quantitative easing provides flexibility
The big positive here is that the ECB quantitative easing mandate (reinforced by the recent European Court of Justice ruling on its legitimacy and scope) gives it far greater flexibility to stabilise bank markets and the ELA facility stands ready to respond to any potential bank runs. In addition, the public finances of some of the peripheral Eurozone economies, particularly Spain and Ireland, are in much better shape than they were in 2011-12 (Spain and Ireland look likely to be the fastest-growing Western European economies in 2015).

The markets’ concerns, or otherwise, will soon show up in sovereign bond yield spreads. As of Friday, they were still very relaxed. The spread of yields of most southern European bonds over German bunds actually came in over the course of last week; so the next few days could be a whole new ball game.

Already this week the yield on German bunds has fallen about 20 bps (a flight to quality effect), while yields on Spanish, Portuguese and Italian bonds are up 25 bps. Reassuringly, yields on French bonds have also fallen which helps to assuage concern that the markets would also see France as a country at danger in a re-run of the 2011-12 European sovereign debt crisis.

The problem with the uncertainty over the situation is that it is difficult to say when it will end. Organising a referendum within such a short time frame is ambitious but it will still leave a void for a week. Even after the referendum results are in, it is unclear what will happen. The answer will be either a simple 'yes' or 'no' to the creditors’ proposals rather than a clear 'yes and stay in the euro' or 'no and leave the euro', therefore the crisis could drag on for weeks or months.

A 'no' vote (no to the creditors’ proposals) means an almost certain Grexit. This would involve the introduction of a new Drachma, ongoing capital controls (on hard currencies at least), and high inflation for a while as a result of devaluation.

Ironically, the high inflation would depress the real incomes of state employees and pensioners – the exact same groups that the Greek government has sought to protect throughout the negotiations.

Longer term, devaluation, followed by continued fiscal restraint could produce a newly competitive Greek economy where growth is able to resume. Policies that aim to offset the impact of high inflation on real incomes by increasing state benefits and wages, however, would threaten hyperinflation and a continuance of the crisis. Interestingly, a 'no' vote with a successful devaluation and return to competitiveness could pose the biggest long-term contagion threat if markets and indebted peripheral Eurozone countries see that that there is a prosperous life outside of the euro area.

What happens with a 'yes' vote is a little clearer. The Syriza government will resign rather than go beyond its 'red lines' on spending cuts but a new general election could take some time to organise. Eventually, the result might be the election of a more moderate government that is prepared to do business with Greece’s creditors.

This, in turn, might be rewarded with a more conciliatory attitude from the creditors, leading to a more balanced deal that offers some element of debt forgiveness in exchange for further spending cuts. All of this is still highly uncertain although, under such circumstances, there would be a very good chance that the ECB would relent and increase its ELA limit which would at least enable the banks to function properly again.

Concerns over the weekend’s developments and over the results of next Sunday’s poll have already been seen through early falls in equity prices and it looks like being a volatile week, or longer, for stock markets.

Capital controls
An immediate impact for all investors, real estate and others, will be that capital controls will make it difficult, if not impossible, for foreign investors to repatriate income from Greece. As far as the broader impact on European real estate is concerned, if the big downside risks do not materialise, we may see some reticence in decision making and a slowdown in deal volumes over the summer (where business is usually slow anyway) and then a bounceback which could be quite rapid if Syriza loses the election.

If there is a Grexit with an ongoing contagion crisis, however, there is a danger of a major drop in investor confidence with prime yields rising (though a flight to quality could have the opposite effect in some markets) and prime-secondary yield spreads moving out. Corporate confidence would also be hit with capital investment and leasing decisions put on hold and a fall in consumer confidence could hit retail. Eventually, new investment opportunities in Greece may open up but they could be a long time coming.

At present, we are closer to the 'downside scenario' than we were but we are not there yet. However, we will be watching the markets keenly over the coming days and weeks to see how market and policy reactions develop.

Neil Blake is head of EMEA Research at CBRE