Grexit: Memo to the Greek prime minister

The Crisis at a Glance

Euro Area : The monetary union fundamentally lacks adjustment mechanisms to compensate for a lack of intra-regional nominal exchange rate adjustment. 1999-07 was phase of strong capital flows to peripheral countries; sharp reversal of these flows since has become increasingly stressful. Limited intra-regional labor mobility and, especially, pooled fiscal resources, puts adjustment burden on deficit countries’ government finances and creditworthiness. Financing programs currently funded by the EFSF, to be replaced by the ESM starting july 2012 following agreement on a new set of fiscal rules and changes to bailout funds, including the availability of a full €500 billion lending capacity from july on.

The Crisis at a Glance

Greece: Sovereign lost bond markets access in May 2010. Dependent since on IMF7EU loans to fund fiscal deficit and redeem maturing term debt. General government debt rose to €360 billion at end-2011, of which €73 billion was owed to the IMF/EU. Eventual return to markets still considered doubtful despite €107 billion in debt reduction, reduced interest costs and deferred maturities under debt restructuring terms now agreed with private bondholders. Economy in deep recession; competitiveness inproving under pressure of high unemployment and large reductions in public sector wages but lagging reforms continue to hamper adjustment and constrain activity. Implementation will remain difficult amid rising popular discontent and lost faith in political leadership.

Options for the Greek Government

• Continue course, by further implementing austerity measures, staying in the Eurozone.• Greece defaults on its public debt, but decides to stay in the Eurozone.• Greece defaults on its public debt and abandons the Eurozone.

Accept austerity measures – Stay in the Eurozone

Pros•Credibility

Currency and Interest Rate stability inspires confidence in the international investment community

Enables smaller countries and local firms to borrow at much lower cost from the markets

•Economic Integration Growth for Euro Zone Overall

Increased growth prospects of all membersHomogenization of political, institutional and

financial regulatory environment creates a robust system

•Increased Trade & Capital InflowsMinimal transaction costs (i.e. Currency Risk)

•Fiscal Support Mechanisms (“Cohesion Fund”) / Access to EU Structural Funds

Investment Fund since 1994 to help reduce economic and social disparities

•Implementation of structural changesStructural changes required to be done within

the Greek economy•Greece to remain a member of the European Union

Cons•Austerity Measures

Austerity measures deepen the economic recession. Current estimates indicate -5.6% GDP Growth for 2011, -2.6% for 2012

•Civil UnrestIncreasing discontent against EU policies and the domestic political establishment

•No current cohesive plan to spur investments and growth

Current memorandum lacks planning for future growth opportunities

Disorderly Default on Public Debt – Stay in the EurozonePros

•CredibilityCurrency and Interest Rate stability inspires

confidence in international investment community

Enables smaller countries and local firms to borrow at much lower cost from the markets

•Increased Trade & Capital InflowsMinimal transaction costs (i.e. Currency Risk)

•Fiscal Support Mechanisms (“Cohesion Fund”) / Access to EU Structural Funds

Investment Fund since 1994 to help reduce economic and social disparities

•Implementation of structural changesStructural changes required to be done within

the Greek economy•Fiscal Metrics become sustainable faster

Cons•Huge losses on domestic Greek Debt creditors/ Bank runs

Collapse of the domestic banking system and pension system

•Breach of Capital Markets TrustMarkets have a strong memory– return on public markets may be severely prolonged

•Contagion effectOnce Greece abandons the Eurozone, the entire Southern periphery may come under speculation attack

Disorderly Default on Public Debt – Leave the EurozonePros

•Independence of monetary policyRegain control over money supply and floating exchange rate

•Increased Trade & Capital InflowsA weaker exchange rate could pose a valuable investment thesis for investors or foreign importers

•Avoidance of prolonged recession/ austerity measures

Economic and employment growth may resume right away•Fiscal Metric become sustainable sooner

Cons•Huge losses on domestic Greek Debt creditors/ Bank runs

Collapse of the domestic banking system and pension system

•Drachmatization of all EUR assets and liabilitiesLosses on EUR denominated holders of Greek claims

•Excessive Macroeconomic ImbalancesInflation would shoot up 30%-40%

•Breach of Capital Markets TrustMarkets find it hard to forgive – return on public markets may be severely prolonged

• Trade, Tariffs and ProtectionismIn the event of a domestic devaluation

foreign unions are likely to greet the new currency with increased protectionist sentiment•Departure from the EU

A country departing from the Eurozone is departing from the Union as well

•Contagion effectOnce Greece abandons the Eurozone, the entire Southern periphery may come under speculation attack

Recommendation

Promising signs for a brighter futureSigns of fiscal convergence: Public debt evolution looks promising – given completion of the PSI and the

realization of $50bio in privatization revenue. Primary Balance deficit reduced from -11% FY09 to -2% FY11.

New Memorandum passed last week by 2/3 of the Greek Parliament shows political unity on a common goal.

Specific sectors of the Greek Economy to start enjoying the benefits of real currency devaluation, with tourism receipts in 2011 showing a 20% increase.

But more things need to be accomplishedThe long-anticipated privatization plan of state owned enterprises needs to start realising.

Greek politicians and policy makers need to abandon practices of the past and unite under the common goal of saving the country from a financial disaster.

European authorities need to provide the Greek public with a promising vision. A new Marshall plan for Greece needs to be devised mobilizing EU structural funds and institutions (EIB)

Eliminate the deflationary bias with the ECB acting as a lender of last resort or through the issuance of Eurobonds.

European countries and primarily Germany need to abandon the public critical stance against the Greek people and become part of the problem’s solution rather than a source of conservatism and ambiguity

Thesis: Stay in the Eurozone, while orderly restructure public debt

Thesis: Stay in the Eurozone, while orderly restructure public debt

Appendix

Appendix

AppendixInflation Levels in core Eurozone

economiesInflation Levels in core Eurozone

economies German Benefits from the Euro AdaptionGerman Benefits from the Euro Adaption

AppendixCreditors of Greek DebtCreditors of Greek Debt

Appendix