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Perspective Required - Do You Speak Greek? November 2, 2011
The latest turn in developments has stunned both policy makers and markets who believed that a deal had been in place. We view the potential scenarios unfolding within Greece, as well as the implications we foresee for the European markets going forward.
Author : iFAST Research Team

Untitled Document
  • Greece's Prime Minister stunned the market by announcing a confidence vote on his government and a referendum on the latest bailout package
  • the announcement has put into jeopardy the assumption that greece would accept the bailout package without much resistance
  • A disorderly default by greece and its departure from the euro remains most unlikely amongst the 4 potential scenarios
  • Greek debt default while sizeable, is not unsurmountable by both markets and policy makers
  • shoring up of confidence in the financial sector will be key to preventing a repeat of 2008
  • Instability will be short-lived as the combination of a leveraged EFSF and austerity measures comes into effect
  • earlier conservatism is maintained without further downgrade of earnings expectations
  • Continue to underweight european equity portfolio allocation, focus on 5 more attractive star rated regions

Greece stunned global markets on 1 November 2011 with news that Prime Minister Papandreou intended to hold both a confidence vote with respect to his government as well as a referendum to the public at large on their acceptance of the second aid program. Markets reacted negatively to the news with equities selling off, bond yields of Italian debt climbing and bond yields of traditional risk-free assets such as German bunds and US treasuries falling.

The decision by Papandreou caught markets off-guard and sent policy makers in Europe scrambling for information as they were uninformed and thus unprepared for the bombshell. The hard fought agreement, hammered out over 2 weeks in October, saw 3 key points being in consensus:

1) Haircut: An agreement that private investors (mainly financial institutions) would voluntarily take a 50% haircut on Greek sovereigns

2) Bank Reinforcement: A recapitalisation of European banks to a Core Tier 1 equity ratio of 9% to withstand the haircuts and potential market repercussions. The recapitalisation of the banks was expected to be in the region of approximately EUR 106 billion and would have to be fulfilled by June 2012

3) EFSF 2.0: Leveraging of the European Financial Stability Facility’s remaining EUR 250 billion (after the bailouts of Portugal, Ireland and Greece) to approximately EUR 1 trillion through either insuring a portion of sovereign debt or the creation of a special purpose vehicle (SPV) to involve private investors

Given what we now know, it would be prudent to reassess the current situation (drama) unfolding in Europe. In this article, we seek to highlight the potential scenarios unfolding within Greece, as well as the implications we foresee for the European markets.

the current situation in greece

Reports coming out of the newswires indicate that Papandreou’s government has been weakened following his shock move as a lawmaker defected from his party, leaving the governing party with 152 seats in the 300-seat chamber. Vasso Papandreou, an unrelated lawmaker, called for the formation of a national unity government while four lawmakers have slammed the plans for the referendum with six members of the party calling on the PM to resign in a joint letter. Recent polls by Kapa Research SA have indicated that over 40% of those polled oppose the acceptance of another bailout package while 70% have favoured the continued participation in the Euro, leaving one with no real conclusion.

With that background behind us, we view the various combinations the confidence vote and referendum are able to result in:

Scenario 1: Nothing changes and both events are successful?
Assuming both events are successful, the implementation of the 2nd bailout package should continue as per planned, and markets should return to normalcy.

Scenario 2: Government changes but the Greeks want to remain in the Euro?
Should the confidence vote fail, a change in the Greek government should be due. A change in the government should not result in a material change to the implementation of the 2nd bailout package but might add an unnecessary layer of complexity, in terms of dealing with a new politician, to what is already a challenging situation in Europe.

Scenario 3: Government remains but the Greeks want out?
The failure of the referendum would result in Greece rejecting the 2nd bailout package and would almost certainly ensure a sovereign default and triggering credit default swaps (CDS). A default by the Greeks would not spell the end of the world as markets seemingly had been pricing in such an event with CDS showing an almost 97% probability. In spite of defaulting on their debt, the Greeks would not need to leave the Euro as the departure of a member is required to be ratified by all members of the single monetary region. Such a scenario would be more beneficial to the world as a whole as compared to the reintroduction of the Drachma (Greece’s historic currency), which would result in the revaluation of Greek assets across the world, leaving a big entangled mess with the probability of assets losing value due to the devaluation of the Drachma.

Scenario 4: Everybody wants out?
Perhaps the worst possible combination of results. This scenario would certainly see the Greeks default in a disorderly fashion and most likely spell a return to the Drachma, a picture which we do not believe will come to bear. Nonetheless, under this scenario, financial markets would be distressed and the future of the European Monetary Union would come under doubt. Corporations, both financial and non-financial, around the world would have to subject their Greek assets to be re-valued to the Drachma and probably result in a devaluation of the assets and book values. De-leveraging of and adjustments to balance sheets would be inevitable.  

implications & assessment

While Greece hangs precariously from a thread, it would be best to take things into perspective and assess the situation with facts. The relatively small nature of the Greek economy (2.21% of 2Q 2011 Eurozone GDP) is a blessing in disguise as should the Greek economy somehow disappear overnight, the Eurozone as a whole would not be left paralysed without the Mediterranean nation and should resume its progress and development (albeit after an initial shock). As mentioned earlier, the departure of Greece from the Eurozone is rather unlikely (at this point in time) as it would require all the members to agree to the removal, perhaps a key point.

The amount of Greek debt, while sizeable, is not insurmountable for decisive policy and market absorption. Currently, Greek debt stands at Eur 350 billion (with the majority being held by Greek banks), an amount which is dwarfed by the Financial Crisis which saw USD 1.7 trillion written down or written off globally by financial institutions between 3Q 2007 – 2Q 2009. Unlike today, during that gut-wrenching period, many banks and financial institutions had yet to mark their assets to market, whereas stricter regulations today have resulted in the financial sector doing so on a regular basis. Furthermore, many banks have begun to de-leverage their books and reduce/suspend future dividend payouts in order to reach the prescribed Core Tier 1 ratio of 9%.

In terms of holders of Greek sovereign debt, a significant majority (58.7%) of Greek debt lies within its own banking system and not with the other European banks as seen in Chart 1. Thus, the firewalling of Greece is one of the imperatives which Europe has to ensure to prevent contagion to other peripheral nations.

Chart 1

With the above in mind and a great example set by the US on how to tackle a debt crisis to follow, a complete write-off of Greek debt (while not impossible, remains improbable) should not bear a similar effect to what was seen in 2007-2009 when the market and governments were figuring things out for the first time, as given that a 50% haircut on Greek debt would result in a capital shortfall of Eur 106 billion for financial institutions, a 100% complete write-off should result in a shortfall of approximately Eur 200-230 billion, a figure which is less than half the size of the USD 700 billion Troubled Asset Relief Program (of which only USD 400 billion was used) which the US Treasury created back in 2008. With history being a good teacher of the future, a similar program should have no issue in dealing with the direct potential fallout from a Greek default. Upon the shoring up of confidence as per 2008, private investors will likely follow up with investments into the financial sector, further strengthening the capital ratios of the banks.

While the factual evidence points to a relatively small direct impact should the Greek economy somehow disappear and its debt default, the damage it will do to market confidence as well as political stability in the Eurozone remains unknown and perhaps unquantifiable. The financial instability caused by the bombshell has caused initial shockwaves across the global financial industry, with yields on Italian sovereigns reaching all new euro-era highs. We do not believe that financial instability will be allowed to persist in the Eurozone given the coordinated actions of the European and other major Central Bank(s) (ensuring liquidity in credit markets, purchasing Italian and Spanish bonds) and, with pressure from global leaders, the recent found resolve amongst European leaders.

Upon the finalisation of the details of the EFSF’s enhancement and its subsequent launch, we expect financial stability to be significantly improved. The involvement of international bodies such as the IMF, G20 as well as the unofficial bodies such as the BRIC nations should provide well-received and critical international support.

While the initial shock has left markets reeling with fears that a similar episode could replay itself between Spain and Italy, we believe that at this juncture, this is unlikely. Given that Italy and Spain have already embarked on austerity measures to bring their debt levels down to acceptable levels over the next few years, their issue is not one of insolvency but that of liquidity, which the European Central Bank is aware of and is attempting to resolve (re: international central banks’ coordinated actions). Furthermore, their own leaders have become sacrificial lambs by deciding to press on with the painful choice of taking the ill-tasting medicine now for the better of their countries (with the Italian PM Berlusconi looking to bring further forward plans for a balanced budget) while sacrificing their political careers. Jean-Claude Juncker, the prime minister of Luxembourg and one of the key personnel on the European stage said it best by commenting: “We all know what to do, but we don’t know how to get re-elected once we have done it.”


will earnings be impacted?

Our existing in-house earnings estimates for the Eurozone are currently significantly lower than consensus estimates due to our conservatism and expectations of a mild recession in Europe for 3Q 2011 – 2Q 2012 in the range of a -1% contraction. Table 1 below presents a comparison of ours and consensus earnings for the continent for the quarters to come, as can be seen, we had adjusted our earnings significantly downwards in a conservative fashion and currently maintain our outlook.


Table 1: European Earning Estimates

IFAST Estimates
on 22 Aug 2011

Consensus Estimates
as of 22 Aug 2011

Consensus Estimates
as of 2 Nov 2011

iFAST Conservatism
Latest Consensus Estimates

2Q 2011 (actual)





3Q 2011*





4Q 2011*





1Q 2012





2Q 2012*





3Q 2012*





4Q 2012*





1Q 2013*





2Q 2013*





Source: Bloomberg, iFAST compilations
*denotes forecasts
Data as of 1 Nov 2011

While no further adjustments have been effected as of the time of writing, we will continue to scrutinise developments on the continent and tweak our forecasts of both GDP growth and earnings in light of future events, reports and expectations.


While the crisis, which once seemed to be on the mend, now catching markets by surprise with a twist in developments, continues to drag on and feed volatility, our cautious stance towards the European continent is retained - We continue to advise investors to underweight the European region for their equity portion of their portfolio.

The latest turn in developments has stunned both policy makers and markets who believed that a deal had been in place. With further developments to come, we continue to recommend investors maintain a well-diversified portfolio to help buffer shocks and reduce unsystematic risks. Despite the standalone attractiveness of the European market which boasts potential upside of 22% by 2013 (as of 1 November 2011), with several 5 Star rated regions and markets even more attractive both on a standalone and relative basis, investment opportunities are there to be seized by investors.


Related Articles:

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Top Markets 3Q 2011: A Quarter Pounder

Looking Past The Current Turmoil - Upgrading 12 Markets; Downgrading Europe
Europe: Under Recessionary Pressure

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