With this crisis exacerbating their financial troubles, Greece's government debt-to-GDP ratio soared from 97% at the end of 2008 to 174% more recently.
As such, the Greek Prime Minister, Alexis Tsipras, has argued for a major debt write-down from current levels. He further assured Greek citizens that a 'no' vote would strengthen their position in continued negotiations with Greece's creditors. While the chance for a speedy resolution to remain within the Eurozone still exists, the probability of this outcome is relatively low given tight deadlines and the resultant breach in trust following the decision to call a referendum.
The more likely outcome is for an extended period of prolonged negotiations to keep Greece in the Eurozone even if it calls for a new or reshuffled Greek government. However, this route still presents a moral hazard challenge to European Union (EU) creditors who have proposed pension cuts, value-added tax increases and other austerity measures for Greece.
Undesirable precedent
Should Germany and other EU creditors succumb to Greece's requests for less austerity and haircuts on debt, an undesirable precedent could be set for anti-austerity parties in peripheral Eurozone at a considerable political cost to incumbent governments.
The broader global economic consequences of a potential Greece exit from the Eurozone are unlikely to be catastrophic. Greece accounts for a mere 1.3% of EU GDP which is likely to contain any direct effects related to international trade. Peripheral markets have handled the prospect of Greece leaving the Eurozone better this time around, displaying more resilience compared to 2012.
A Barclays survey showed that less than a fifth of global investors view a Greece exit as a big negative for global markets, believing that buffers are now in place to limit contagion. Not only has the European Central Bank (ECB) stepped up liquidity support with their quantitative easing programme, but a European rescue fund (ESM) remains in place to finance sovereigns and recapitalise banks.
In addition, Greek exposure of European banks (mostly held by countries well-placed to handle a Greek debt default) has been reduced by over 80% since early 2010, while better economic fundamentals, in peripheral Eurozone in particular, present fewer systemic risks. Nevertheless, larger and longer-lasting contagion effects associated with Greece abandoning the euro cannot be ruled out and may only become evident over time given that no official EU rules exist to govern such an unprecedented move.
Arguably, the Greek economy is now in a precarious state following the imposition of capital controls and bank closures, while any new bail-out programme with creditors would have to include tough reforms to stand a chance of being ratified by Eurozone governments. The overwhelming 'no' vote further points to increasingly challenging negotiations as the outcome of the referendum highlighted that Greek citizens strongly advocate less austerity.
Protracted negotiations to stay in the Eurozone could still result in a so-called Grexit down the line, forcing the Greek government to commence circulating a parallel currency to meet payments as euro liquidity dries up. The €3.5bn coupon payment to the ECB, due 20 July, presents a more immediate risk as the ECB could withdraw emergency liquidity assistance to the Greek banking sector in case of non-payment, leaving the economy starved of euros. This would force Greece to print their own currency, which would likely trade at a significant discount to the euro.
A period of hyper-inflation could ensue, wiping out household savings in the near term. Economic uncertainty would prevail, discouraging investment and prompting a further decline in growth and a worse outcome on the fiscal deficit as revenues plummet.
Deutsche Bank has shown that following the Argentine crisis in 2001/02, economic growth recovered within a year to 9% from an 11% contraction on the back of a major currency devaluation. Likewise, a competitive currency could sustain economic growth in Greece over the longer term as net trade recovers.
In the short term, however, global risk aversion is likely to remain elevated which could keeping emerging market (EM) currencies, including the rand, under pressure, exacerbating SA's weak growth-high inflation scenario which is expected to play out over the next eighteen months.
As long as uncertainty prevails about Greece's post-referendum standing within the Eurozone, financial market volatility is likely to be the order of the day in the near term. During such a 'risk off' phase, perceived safe-haven currencies like the US dollar and Japanese yen are likely to strengthen, with resultant negative implications for dollar-denominated commodity prices and EM financial assets (currencies, debt and equities).
Whether there will be any longer-term adverse impact on global financial markets is dependent on whether there is Greek contagion into the broader global financial system. In this regard, the small size of the Greek economy and its financial markets and the diminished exposure of European banks to Greek debt should limit the transmission of the Greek debt issue into a negative broad global impact.
We would advise investors not to make big strategic changes to their portfolios during any short-term volatility in asset markets, but would encourage investors to view any market overreactions as opportunities to enhance strategic portfolio positions for long-term wealth creation.
