With a Greek exit of the euro edging nearer, Nick Fitzpatrick looks at how one country could affect growth internationally.
Preparing for a complete collapse of the financial system may be a pointless exercise. If it happens – it happens. But another serious though less apocalyptic event – a Greek exit from the euro – has got fund managers and other firms to talk about the issue with an increased sense of urgency and reality.
Keith Wade, chief economist at Schroders, says a Greek exit may happen in the third quarter of the year after the general election in June when the country, which has turned against the austerity measures imposed upon it, fails to renegotiate the terms of its financial assistance.
“Greece and the EU are currently engaged in a game of financial chicken with both sides talking tough ahead of the general election on June 17th. We do not see a happy outcome and have brought forward a Greek departure from the euro to the third quarter of this year [from 2013] as the EU and ECB cut off funding,” he says in the firm’s Economic and Strategy Viewpoint paper this month.
Contagion
One of the main issues is contagion – that an exit would adversely affect growth in other countries. This danger is particularly prevalent in Italy and Spain. Money is already flowing out of Spanish corporate and individual bank accounts, posing the threat of underfunding in the banking system.
French banks have significant exposure to Greece, but the US also has exposure. Germany’s ‘official’ exposure that is, its government, central bank and government-backed organisations – to Greece is €84.5 billion out of a total official eurozone exposure of €291 billion, or just over 3% of eurozone GDP. Much of this would not be repaid if Greece exits.
Eurozone private sector exposure has reduced in recent years, but it is estimated that this is still around €96 billion.
Wade expects the ECB to have to pump liquidity into the system if Greece exits in order to control losses for the eurozone. This means more cheap loans to eurozone banks from the ECB’s Long – term Refinancing Initiative.
Action like this should help keep an exit orderly, which is Schroder’s main expectation, though on the other side of the exit eurozone growth will only be further depressed.
This will affect other parts of Europe and the world. In Europe out side of the eurozone, Wade says the impact on trade links with the eurozone would be felt most by Poland, Hungary and the Czech Republic. The UK would also be hit because about 10% of its GDP is in trade with the eurozone nations.
Beyond Europe
The rest of the world has lower but still significant exposure to the eurozone. China’s exposure is 7% of GDP and weaker exports to Europe have been a key part of the slowdown in China, Wade says.
About 18% of US exports are to the eurozone – around 2% ofGDP.
Commercial banks are expected to become less willing to lend after an exit and the UK, Japan and the US would employ more quantitative easing, whereby central banks pump money into the system by buying bonds from banks and other institutions to encourage them to lend.
“The weakness of the eurozone hits activity elsewhere through trade and heightened risk aversion in the financial sector. However, with the US continuing to grow, albeit weakly, and China avoiding a hard landing, the world economy is not expected to drop back into recession,” says Wade.
BNY Mellon’s economic outlook is for a global recession. Expecting the euro to survive in some form, Richard B. Hoey, chief economist, expects an economic decline in Southern Europe and slight declines or slight growth for several quarters in the UK and much of Northern Europe. The US will see near-trend growth, and there will be sustained but slower growth in China and other emerging market countries, he believes.
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