With the IMF meeting over the weekend sparking renewed speculation around the solution to the Greek debt crisis, Stewart Robertson, senior economist at Aviva Investors believes that a default on parts of Greece’s debt is the most likely outcome.
- Greek default could lead to recession in Europe but not necessarily to a seizure of global financial markets, says Aviva Investors
With the IMF meeting over the weekend sparking renewed speculation around the solution to the Greek debt crisis, Stewart Robertson, senior economist at Aviva Investors believes that a default on parts of Greece’s debt is the most likely outcome. However, while a default could exacerbate a recession across the Eurozone, it would not lead inevitably to a seizure of global financial markets of the extent seen at the collapse of Lehman Brothers in 2008. While this risk exists, there are many actions the relevant authorities can yet take to avoid such an outcome.
Robertson said: “Europe must wake up and act to end the Greek drama and minimise potential contagion. There is simply too much debt in the Greek system, and progress will be difficult until there is greater acceptance that the debt cannot be paid back, that assets need to be written down and the system recapitalised. The debt trap must logically end in some form of default.”
According to Robertson, experiences in South America and elsewhere have shown that orderly restructuring and reduction of foreign debts can restore debt sustainability, competitiveness and growth. However, this often involves inflationary surges and currency devaluations, both of which are unavailable to Greece within the Eurozone. Greece and other vulnerable countries instead have the following options:
- A much weaker euro exchange rate
- Sudden large improvements in productivity from structural reforms
- Huge reductions in prices and wages
- A new and devalued currency.
With the first three options unlikely, the last – a new and devalued currency - raises a key question: will Greece remain part of the Eurozone area, or exit and adopt some form of "new" drachma?
Robertson believes an exit is plausible. The euro has weakened as worries about the future of the single currency have increased in recent months. However, in the longer term it could strengthen on the view that a smaller selection of stronger nations will share the currency in the future.
Robertson further outlines short-term risks a Greek default could trigger which investors will need to navigate carefully:
- Market volatility: Even the possibility of default has spooked markets several times over the summer, and big falls in risk assets, especially equities, are to be expected in the event of a Greek default. Quite how badly mauled the European banking system would be is uncertain. There could be government takeovers of several European banks. In addition, yields on other peripheral bond markets could soar, pushing them closer to bailout, default or restructuring.
- Contagion: Consequently, contagion is a risk that will need to be carefully managed by the European authorities. A Greek default fractures the idea that default is impossible for a Eurozone nation and attention would instantaneously switch to others. It is therefore vital for other vulnerable countries – Portugal, Ireland, Spain and Italy – to use the time before a Greek default to put their economies and public finances on a sustainable path.
- Recession: A Greek default would heighten the risk of a renewed, deeper recession in Europe and elsewhere. If the European banking system implodes as a result of the euro crisis, this could swiftly be transmitted elsewhere across financial markets channels in a similar manner to 2007/8. Hence the European Central Bank (ECB) might be forced into acting more aggressively, perhaps pursuing more explicit Quantitative Easing type programmes and cutting interest rates close to 0% by early next year.
A default would not automatically lead to a Lehman style seizure in financial markets, but it would raise the risk of such an outcome so relevant authorities need to act swiftly.
Robertson concluded: “However the Eurozone problems are resolved over the longer run, there is a clear feeling today that the crisis is coming to another 'head'. While the Eurozone may well look different in the future, in my opinion it will continue to exist. And it should not be forgotten that the ECB can – if it has to – do much more to curb the economy and that the fiscal situation for the zone overall, is manageable.
"While there is potential for disruption and turmoil in the Eurozone, there is also the possibility of some form of workable solution being born out of the crisis. Sentiment and markets will remain volatile for some time yet and investors must act accordingly: after the big equity market falls, upside potential is clearly there. But there is much to be said for cautious, hedged investment portfolios.”
-ends-
For more information contact:
Wendy Svirakova
Corporate Affairs
Aviva Investors
+44 (0)20 7809 8810
Notes to editors:
- Unless stated otherwise any opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors). They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature.
Aviva Investors
Aviva Investors is the global asset management business of Aviva plc. The business delivers investment management solutions, services and client-driven performance to clients worldwide. Aviva Investors operates in 16 countries in Asia Pacific, Europe, North America and the United Kingdom with assets under management of £269 billion at 30 June 2011.
Aviva plc
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