We still expect Greece will remain in the euro although the intensified 'chicken game' between Greece and its creditors has implied an increasing risk of 'Grexit'. The current situation with prevailing harsh negotiations was unavoidable, in our view. The Greek government needs to show that it fights until the very end seeking an easing of the Greek programme conditions. We have been in this situation before with Greece normally blinking eventually. This was also the case under the most recent stand-off in February. The reaction function reflects that 82% of the Greeks still want to remain in the euro, while Tsipras at the same time has promised his electorate more favourable conditions.
What could trigger a Greek default and a Grexit?
Greece is close to running out of money as the last EUR7.2bn tranche has not been released, as the government has not come up with the comprehensive economic reforms required under the current bail-out programme. Both Greece and its creditors repeatedly state that neither favours a 'Grexit'. However, it could still happen. A continuation of the ongoing 'chicken game' could result in a Greek incident, ending with Greece leaving the euro ('Grexident'). But a Greek default will not necessarily imply a Grexit. Greece has already been through an 'orderly default' with the PSI in February 2012 and is to this day still a member of the euro. In this paper, we consider the implications of 'what if'.
What are the first steps in a Grexit?
If Greece continues to refuse the austerity requirements on pension reforms, labour market, tax etc, Greece could simply run out of money. In this case, Greece would initially be in a liquidity crisis, which would transform into a full-blown banking and currency crisis: Greece would miss a debt obligation triggering a credit event where the ECB removes the Emergency Liquidity Assestance (ELA). The Greek banking sector would be insolvent and the removal of liquidity access implies that the initial bank run would be replaced by capital control, preventing capital from leaving the banking system and the country. The next step is then likely to be the introductions of the 'New Drachmar'.
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