Greece’s shock announcement of a 5 July referendum on the terms of its bailout has taken it closer to a euro exit (Grexit). However, we believe this is still a distant prospect.
The government may be recommending a ‘no’ vote in Sunday’s referendum, but opinion polls point to Greek voters supporting the changes demanded by the creditors – largely because of fears over Greece exiting the euro. 70 per cent of Greeks want to stay in the euro, according to the polls.
A positive outcome to the referendum could kick start negotiations between Greece and the European Commission, and broaden the discussion to a third bailout, tighter fiscal conditions and structural reform, albeit against a backdrop of ongoing capital controls and a recession in Greece.
This could also spell the end for Greece’s Prime Minister, Alexis Tsipras, as a changed Greek administration will likely be necessary to lead the next round of talks, possibly a national unity government.
A ‘no’ vote does not mean automatic Grexit, but it is difficult to see how the stalemate between Greece and its creditors could persist indefinitely.
Capital controls would gradually strangle Greece’s economy, and the European Central Bank (ECB) might decide that the banks had become insolvent and no longer eligible for emergency liquidity assistance. Starved of outside finance, the government might have to resort to issuing IOUs to cover public sector pay.
It is possible for Greece to exit the EMU and keep the euro as its national currency – Kosovo and Montenegro have the euro as their national currency and are not part of the EMU.
In any event, whatever the outcome of Sunday’s referendum, we expect capital controls to be in place for a prolonged period
However, in reality this is not a viable option for Greece’s economy. Its central bank would not be able to adjust monetary policy to suit the domestic economy, nor act as a lender of last resort. This means that Greece still wouldn’t be able sort its fundamental problem of low competitiveness which, temporarily, can be best solved by devaluing its currency.
Eventually, pressure would grow for a Greece to adopt its own national currency, most likely a return to the drachma.
Capital controls will last
While uncertainty will persist over the course of next week, some things are clear. With the ECB capping the emergency liquidity assistance at EUR89 billon, it will be difficult for the Greek banks to cope with ongoing deposit withdrawals. Additionally, Greece is likely to struggle to pay public sector salaries and pensions.
The European Commission is keeping the door open for negotiations on improved proposals and while there is talk, there is hope. In any event, whatever the outcome of Sunday’s referendum, we expect capital controls to be in place for a prolonged period.
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