Greece: What does a default look like?

3rd October 2011

The Greek government said its 2011 deficit is forecast at 8.5% of Gross Domestic Product – better than last year's 10.5% but shy of the European Union/International Moneteary Fund imposed 7.6% target.

With few investors placing faith in anything out of Athens with a number, stock markets across Europe fell by up to 3.5% in early trading.  The FTSE lost just over 100 points – a 2% hit with banks especially hard hit.

Fears of a new move to break up the Euro saw it hit an eight month low against the resurgent dollar while even sterling strengthened against the single currency hitting €1.162. This is not what HM Treasury wants.

Stephen King, chief economist at HSBC, echoed mindfulmoney's recent discussion over the practical difficulties of untangling Greece (and other potential candidates for euro departure) from the single currency.  He told the FT:  "A euro break-up would be a disaster, threatening another Great Depression." He added:  "Disentangling the millions of contracts and cross-border assets would be a Herculean task that would surely threaten the fabric of the European financial system".

The problem is that whatever Greece does is wrong in the eyes of enough investors to make a negative difference. Over the weekend, its cabinet agreed to huge cuts including the dismissal of thousands of public sector workers according to the FT .  There are also moves to put a further 30,000 state sector workers on "permanent holiday" with 40% salary reductions.

But far from cheering markets, investors were left both to wonder whether the Greek government can do what it says – there was more rioting in an Athens suburb on Sunday – and, if it can sack that many, what will be the effect on GDP. Its economy has already contracted 5.5% this year – against estimates of 3.8% issued in May. Further lay-offs can only accelerate the decline.

So how will all this influence the "troika", the IMF, EU and European Central bank inspectors currently in Athens? They will decide whether Greece should get the €8bn bail-out instalment it needs to avoid going bust next month – bankruptcy is a move that could hit already reeling markets even harder.

The Greek finance ministry said on Sunday that its unpopular austerity measures would have to be adhered to even if the latest targets were to be met.

It said: "Three critical months remain to finish 2011, and the final estimate of 8.5% of GDP deficit can be achieved if the state mechanism and citizens respond accordingly."

It blamed an economic contraction this year of 5.5% – rather than May's 3.8% estimate – for the failure to meet deficit targets.

The question for most is not will Greece default on some or all of its debts – with knock-on effects on banks and wider economies across the world – but when.

Keith Wade, Chief Economist and Strategist at fund managers Schroders,  believes  the euro crisis has entered a new phase "as the EU and IMF have hardened their stance over Greece and are currently withholding the next tranche of the support package. Greece has responded but there seems to be a growing recognition that the game is up and a significant debt restructuring is needed."

He says: "There are three steps to an orderly default: support for the banks, the periphery and measures to boost growth. It seems unlikely that all three will be taken before the next G-20 meeting in October. Consequently the uncertainty will persist and weigh on markets. Ultimately the system needs to become a fiscal union to function and allow the natural recycling of surpluses to the deficit countries. Such a leap can be made, but it will be a close call as to whether the Euro will join the long list of failed currency unions."

He adds: "We have moved into a new phase in the Euro crisis. The latest IMF/ World bank meetings provided the backdrop for intense discussions on the future of the Euro and the need for action. The IMF and EU are currently withholding the next tranche of the rescue package for Greece as they are unhappy about the progress being made in implementing fiscal consolidation. Greece has now responded with more measures including a new property tax, which will be collected through electricity bills, and will inevitably prompt more strikes. However, as in the US, these measures are only kicking the can down the road and perhaps the most important development of the past month is the recognition by the EU, IMF and ECB (the troika) that Greece is broke and will not repay its debts. This is no longer seen as a liquidity problem, but as a solvency crisis."

Whatever course is taken is set to be a Greek tragedy for someone, according to experts polled by the BBC .

Their ideas to solve the crisis include a 50% write-down of Greece's government debts, strengthening big European banks that could be hit by any defaults by highly indebted governments, and boosting the size of the eurozone bailout fund from the European Financial Stability Facility (EFSF). But they all emphasise that bold thinking is needed – and that whatever course is taken, people will be hurt.

More from Mindful Money:

As Greece spirals towards default, we ask – what does this mean for Britain?

The logistics of Greece leaving the Euro

Sign up for our free email newsletter here.

Leave a Reply

Your email address will not be published. Required fields are marked *