By Christopher Whittall, Wall Street Journal
Most analysts still believe the embattled Greek government will muddle through its negotiations with European creditors and pull back from the brink.
Even so, UBS rates strategists have laid out the potential outcomes of a Greece default, following a clamor of demand from investors on the subject.
Spolier alert: “In all cases, one could expect further strain on Greek bond markets and the Greek banking system as a result of non-payment,” the strategists say, who add that their base scenario is Greece remaining in the eurozone.
UBS outlines the two most likely routes for Greece to leave the euro.
The “fast route” would involve a rapid deposit withdrawal from Greek banks, and a subsequent refusal from the Eurosystem to finance Greek banks through an expansion of its Emergency Liquidity Assistance facility. (The ELA can be curtailed if Greek banks are judged to be insolvent, which could become a grim reality if deposit outflows accelerate. The latest figures show Greek bank deposits sank to a 10-year low in February).
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Deposit outflows could be triggered by Greece failing to pay out on a range of its debt obligations from government bonds, to public sector pensions or salaries, to money it owes to the International Monetary Fund.
The Greek government could impose capital controls to slow the bank run. But the government would probably have to refinance or even recapitalize Greek banks, creating a new currency to do so.
The “slow(er) route” would entail the cash-strapped Greek government swapping IOUs for euros in some of the payments it owes. This could start with its suppliers, then move to public sector pensions and salaries.
UBS points out that these IOUs wouldn’t be worth their face value. After all, investors only value short-dated Greek government bonds at around 75 cents on the euro. As a result, the purchasing power of these IOUs would be lower than that of the euro.
As more of these IOUs come into circulation, pressure would build on Greek banks to clear payments in them. Businesses and citizens would need to use them to pay their taxes. Euros would likely continue to drain out of Greece, and the local economy would come to rely even more heavily on these IOUs.
“Greece could (in theory, and just conceivably) remain in the euro under these circumstances”, the strategists say, but to all intents and purposes it would have already left.
