Citi chief economist Willem Buiter is credited with inventing the term Grexit (or Greek exit from the Euro) according to William L. Watts of MarketWatch. Only a year ago, big firms, countries (and panicked pundits) were preparing for Greece to exit the Eurozone and start using its old Drachma currency. Now not only do few see that as a possibility but even Buiter has thrown in the towel. According to a new report from Citi, Buiter sees a Grexit as unlikely. Below is a segment from the famous analyst discussing this issue from a report released today by Citi.
Grexit Postponed, Euro Area Economy Still Weak
The euro area economy remains weak, and GDP has now fallen for six consecutive quarters. Growth prospects remain poor, and we expect that the euro area will continue to underperform versus official forecasts and the consensus in 2014 and 2015. Nevertheless, we have become a bit less gloomy on euro area growth for next year, and we are raising our 2014 growth forecast from minus 0.3% last month to 0.0% this month (while pulling our 2013 forecast down from minus 0.6% to minus 0.7%).
This upgrade reflects two main factors. First, with the drift to accepting deficit slippage amidst economic weakness and low government bond spreads, fiscal headwinds in the weak periphery economies should be less severe than seemed likely a few months ago. The IMF has scaled back its forecast for the average (unweighted) structural fiscal tightening in Italy, Spain, Portugal, Greece and Ireland in 2013 to 1.2% of GDP from 1.8% of GDP in its late-2012 forecast. Second, we are no longer including Grexit at the start of 2014 in our base case.
High Risk Of Grexit In Coming Years
We still believe that there is a fairly high risk of Grexit in coming years, but no longer put it in our base case at any particular date. This partly reflects a lower risk of Grexit, but also a sense that, with creditor nations taking a more relaxed line on fiscal targets and Greece’s coalition government holding together, triggers for Grexit as early as 2014 have receded markedly. The chosen date was always somewhat arbitrary, but to construct a consistent forecast we pencilled in sizeable Grexit-related uncertainties and financial strains around that date, hitting the 2014 growth outlook4. That intensified headwind is now absent in our forecast.
Even so, the euro area still faces major headwinds from fiscal drag, poor credit availability and high private debts in many periphery countries. Our forecast implies that real GDP will not regain the pre-recession-peak (Q1-08) until 2017, with GDP per head below its peak for even longer. The marked decline in sovereign bond spreads has not fed through to narrower lending spreads on SME loans in periphery countries, which remain around record highs. Moreover, ECB surveys show high refusal rates for SME loan applications in periphery countries, hinting at non-price restrictions on credit availability.
As economic weakness in periphery economies feeds through to high and rising NPL rates, foreign banks have continued to cut exposure to periphery economies over the last year and domestic banks face continued pressure to lift capital ratios and deleverage further. As a result, credit growth in periphery economies remains deeply negative. The drag from poor bank credit availability is heightened by the major role in periphery economies played by small firms (who are more likely to be dependent on bank finance): more than 75% of employment in Italy, Spain, Portugal, and Cyprus is in firms with less than 250 employees, compared to 53% of employment in the UK.
We expect that the ECB will cut the refi rate again later this year, but this will probably have little further effect given the low level of overnight rates. Nominal GDP growth is probably below 1% this year, and many periphery countries already have shrinking nominal GDP. However, we do not expect the ECB will implement more far-reaching monetary measures (eg negative deposit rate, QE) unless outright euro area deflation is imminent or the euro appreciates markedly. Various credit easing schemes are under discussion, perhaps involving the EIB. But we suspect actual policies will prove underwhelming. To be powerfully effective, a credit easing scheme would have to provide not just relatively cheap funding to the banks, but would also require a fiscal body to accept sizeable credit risk.
The periphery countries themselves lack the fiscal capability to do this, and creditor nations are (understandably) unwilling to accept it or to allow European institutions to accept it on a large scale. Over time, the mix of persistent economic weakness and nearterm tolerance of deficit slippage implies that the periphery countries will continue to face escalating general government debt/GDP ratios. We continue to expect that financial market strains will oblige Italy and Spain to enter some form of ESM program and access the OMT facility at some point. Longer term, we believe there are sizeable risks of restructuring of government and/or bank liabilities in a range of euro area countries, and this may extend to privately-held liabilities as well as official exposures.
Further Reading UK Banks Preparing for the Return of the Greek Drachma
