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FUNDAMENTAL ANALYSIS

Greece and the Eurozone:

Scenario analysis

Greece,  Eurozone, Scenario analysis, Fundamental, Analysis, Grexit, fx trader, forex

2 Jul 2015

The situation surrounding Greece and the Eurozone is gathering a head of steam. Developments in recent weeks have led to a real fear that the Greek government will default on its debt repayments to the International Monetary Fund, European Union and European Central Bank. This has led to an emergency meeting between Eurozone leaders, in an effort to broker a last minute deal between Greece and its creditors. 

This has happened because there’s a real possibility that Greece could leave the euro if it defaults on its debts. Often referred to as a ‘Grexit’, it throws up all kind of uncertainties, making it difficult to identify potential implications for all European parties involved. However, one thing’s for certain: a Grexit will bring violent volatility to the markets. But before we explore the potential impact, let’s recap the current state of play.

Why is Greece in this position?

After the global financial crisis, Greece found itself in a significant amount of debt following a decade of high public sector spending and increased public sector wage levels. What’s more, Greece’s inability to effectively collect income tax revenue left it unable to cope with its rising debts.

This resulted in the International Monetary Fund, European Union and European Central Bank - collectively known as the Troika - providing a €110 billion bailout in 2010. A second €130 billion bailout from the Troika was required one year later in 2011, due to Greece’s worsening recession and inability to meet the original bailout package terms.

In December 2012, the Troika denied Greece a third debt relief package despite concerns over the state of the Greek economy. Instead, it gave the green light to an adjustment package for existing debt repayments. This involved both the International Monetary Fund and European Central Bank agreeing to write-off Greece’s debt interest payments until the year 2020, along with a consensus on lower interest rates and longer repayment periods. However, the International Monetary Fund used this written-off debt to fund a new €8.2 billion bailout loan for Greece, which is due to be paid back, at regular intervals, until the first quarter of 2016.

Needless to say, the Troika’s original bailout packages caused the Greek government to tighten its fiscal policies and embark on a period of austerity. This has caused significant financial difficulty for many Greek businesses and families, with a large proportion of the population becoming disenchanted with the political establishment and the wider European project.

This was reflected in 2015’s Greek legislative election, which resulted in the formation of a Syriza led government, receiving 36.3% of the popular vote. The party campaigned on an anti-austerity message and promised renegotiations on debt repayment terms with the Troika. To give some context as to how much public opinion has shifted in recent times, Syriza (known as a radical left party) only enjoyed 4.6% of the popular vote in 2009’s Greek legislative election.

It’s this recent political development in Greece which has seen investors, businesses and Eurozone advocates become anxious. However, an emergency meeting between Eurozone leaders on Monday 22 June has increased hopes that an agreement can be reached.

Important deadlines are looming

Greece is due to pay the International Monetary Fund a €1.6 billion loan repayment on June 30. This coincides with a €1.5 billion bill for Greek public sector wages and pensions. At this moment in time, there is friction between the Greek government and the International Monetary Fund, as Greek officials have announced that they don’t have the money to make its next loan repayment.

In an effort to reach a compromise, Eurozone leaders have met at an emergency summit to try and push Greek economic reform, in an attempt to ensure bailout loans can be paid back. Originally, creditors asked for Greek pensions to be reduced by 1% of Greek GDP, as it’s estimated that pensions can be attributed to 16% of Greek GDP. An increase in VAT on electricity and medicine bills has also been touted by creditors.

The problem here is that these requests are political red lines for the Greek government. They are reluctant to touch pension spending and increase taxes on commodities. Their argument is that the International Monetary Fund is not doing enough to help tackle tax evasion, and is instead focused on tax rises. The counter-argument is that Greek officials are not offering any watertight proposals for effective economic reform.

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