Grexit still a possibility, says Schroders Keith Wade
Keith Wade, chief economist at Schroders, believes that the Greek election results may have bought time to renegotiate its bailout terms with creditors, but that the country could still be facing an exit from the eurozone.
It was the result the market wanted, but the relief has been short lived. After an initial rally, equities have fallen back. Greece is now expected to be able to form a government, in the form of a coalition led by New Democracy, and achieve some lightening of th bailout conditions. Progress is unlikely to be straightforward and we would not be surprised to see doubts raised once more about euro membership, particularly as the economy is likely to remain mired in recession and the party with momentum in Greece is the anti-austerity Syriza, which made further gains at the weekend and is now the clear opposition. Furthermore, the troika will also be wary of conceding too much to Greece knowing that Ireland and Portugal will be watching and comparing the terms of their bailouts. However, Greece can be managed in the near term if the political will is there to provide funding.
The same may not be said of Spain, where ten year bond yields have risen above 7%. Even more worrying is the rise in short-term rates, with two year Spanish paper now trading near 5.5%. Clearly such rates put government debt on an unsustainable path with the cost of borrowing well ahead of economic growth. We await the results of the independent assessment of bank losses later this week, which will give us a clearer idea of the scale of the bank recapitalisation required in Spain. The concern is that this will push Spain’s public debt to GDP ratio towards 90%.
The real problem in Spain is growth, and our view remains that the combination of fiscal austerity, labour market reform and bank recapitalisation means that activity will stay weak, therefore maintaining the pressure for a bailout of the eurozone’s fourth largest economy. Given that the Spanish economy is twice the size of Portugal, Ireland and Greece combined, it is likely that any support would absorb much of the capacity of the European bailout fund (the ESM), estimated at around €500bn.
Clearly, following the election result in Greece we will have to revisit our view of a ‘Grexit’ in the third quarter. The test in the near term will be whether the new government can negotiate an amended bailout where the economy achieves fiscal stability over a longer time period and tightening is pushed out. Some Official Sector involvement (i.e. debt forgiveness by EU governments) may well also be needed. One measure of success will be if the tide of capital flight ebbs. However, it is a tall order and Greece may only have delayed, not dodged an eventual exit from the single currency.