Grexit and a Greek Drachma That is 50% Weaker than the Euro

Grexit is an outcome that we believe both Greece and the European institutions do not want.

However, without new official loans, it could become inevitable later this year. New official loans require agreement on a program and reforms.

Delays and brinkmanship so far have increased risks. Although not our baseline, we have to start thinking what used to be unthinkable.

In this context, we organided a roundtable with our economists and strategists to discuss contagion and market implications from Grexit.

Some of these implications will be relevant if markets get more concerned about Grexit, even if Greece stays.

Triggers and the path towards Grexit

Greece may have enough cash for debt payments until the second half of June, but we also see risks. Liquidity, capital and asset quality risks have increased for the Greek banks.

As the ECB will stick to the rules, we note that the availability of ELA is conditional on banks' solvency and the value of their collateral holdings, post haircuts.

Without agreement on an official program, bank holidays and capital controls is how we think a Grexit scenario would start.

Grexit technical details and implications

We expect Greece to go back to recession this year, but the economy would suffer an unprecedented contraction after a Grexit.

A weaker currency would eventually help, but only if Greece implements the reforms that could have kept it in the Euro.

Greece could stay in the Euro after default only if agreement on an official program follows soon after.

Without access to cash, Athens would have to start issuing IOUs, but this would not be a sustained solution. A rough estimate would suggest 50% depreciation after Grexit, but it could be much worse in the short term.

Total Eurozone exposure to Greece through official loans and the ECB is of up to €320bn.

The ECB may have to record losses from Target 2 liabilities, but most likely less than what today's amount would suggest, while it has buffers to avoid recapitalization.

The Grexit implications for GGBs depend on the scenario that would unfold. However, equity value of Greek banks could be close to zero.

Assessing contagion and market implications

Should the probability of Grexit increase, we expect the Euro area institutions and strongest countries to "hug" the periphery to stem contagion.

However, risks may come back when another country gets into extreme financial difficulties.

A knee-jerk market reaction would be negative for the Euro, periphery rates, European equities and credit, and EEMEA assets.

However, the market implications afterwards would depend on how the rest of the Eurozone reacts and policies to limit contagion. The proper policy response may offer buying opportunities.