Simon Kennedy London
FOR Europe, compromise with Greece looks increasingly costlier than contagion.
As German Chancellor Angela Merkel and her fellow euro-area leaders cast Greece’s July 5 referendum as a choice on whether to remain in the currency, the strategy suggests confidence the rest of the 19-country region is safe from any infection. Having spent five years dispensing aid and brokering deals with Athens, it also reflects a shift toward worrying that the bigger risk to the euro’s integrity lies in bowing to a member’s demands.
“Although the indirect costs of a Grexit could be significant, this does not mean that they would necessarily outweigh the costs associated with an excessive compromise,” said Torsten Slok, chief international economist at Deutsche Bank.
The euro fell against the dollar on the first working day after Greek Prime Minister Alexis Tsipras said he would put the latest proposals to the people and recommend they reject them. Merkel and French President François Hollande on Monday underscored the message that yielding to Greece might be more painful down the line.
Unpredictable path
“We could maybe say we’ll just give in,” Merkel said in a speech in Berlin. “But I say: in the medium and long term, we will suffer damage that way.”
The referendum may ultimately prove a “best of worlds” blessing if the Greeks rally around the international demands and pave the way for a less divisive government, according to Athanasios Vamvakidis, a strategist at Bank of America Merrill Lynch.
If that happens there would likely be willingness to provide Greece with some short-term financial support until fresh elections can be held.
“The path can be unpredictable, with potential for plenty of volatility on the way and still many implementation issues if the referendum is won,” Vamvakidis said.
Strengthening the hand of Europe’s paymasters is the difference between now and three years ago. Unlike in 2012, when two elections in six weeks and depositor outflows last pushed Greece to the brink, there is now a smaller risk that its woes will be transmitted elsewhere.
There is a permanent bailout fund and the European Central Bank has both its untapped outright monetary transactions programme and e1.1 trillion (R15.05 trillion) of quantitative easing that can likely be retooled.
Investors have reduced their exposure to Greece, European banks have been stress tested and countries such as Spain and Italy have worked to improve their economies and budgets.
“The euro zone has moved significantly since the last serious episode,” said Salman Ahmed, a global strategist at Lombard Odier Asset Management. “The current situation is more about political credibility of the euro zone rather than direct financial implications.”
At the same time, an exit by Greece would demonstrate how membership of the euro was no longer irrevocable, potentially triggering speculative attacks against other members.
Perhaps the greater risk of blinking on Greece is that other governments would be encouraged to also slip on economic reforms and budget cutting.
“The main contagion channel is political and European leaders are very much aware of this,” said Jean-Pierre Durante, head of financial-market research at Pictet Wealth Management. – Bloomberg