Photo: Demolition Dynamics
The latest signals out of Europe are very worrisome.The Papandreou government is being asked to do even MORE cutting than originally planned in order to get the next tranche of the bailout.
This would raise huge domestic problems, and, frankly, will kill the economy even more, making deficit goals that much harder to achieve. Meanwhile, the latest meeting of European Financial Ministers made no substantive progress on anything.
So the risk to those holding Greek debt remains large.
French financial stocks have taken another hit today sparked by expectations of a Moody's downgrade of French banks this week.
Back in June, Moody's had put three banks on review for a possible downgrade because if their exposure to the Greek domestic economy, in terms of sovereign debt and/or to the country's banking sector.
Romania and Bulgaria's private sectors, and their public sectors, are exposed to the Greek banking sector. If Greece's banking sector is slammed in a default, the result could be a lack of funding for the Romanian and Bulgarian sovereigns, private enterprises, or worse, according to Nomura (via FT Alphaville).
- A new Vienna Initiative: Despite an event in the Greek banking system those same banks are still required to maintain capital exposure into Emerging Europe. EBRD and EU provide support and other incentives to make this happen. Such a move however would be difficult and impose additional burdens on an already highly stressed Greek banking sector.
- Business slowdown (least bad outcome): Greek banks severely constrain lending in domestic subsidiaries as parent company funding crowds out domestic business. This is anti-growth for Romania and Bulgaria, though arguably it has already started to occur.
- Greek bank consolidation (bad outcome): Greek banks are forced to consolidate, perhaps into some form of good bank/bad bank set-up. Consolidation causes asset sales in Bulgaria and Romania. With limited foreign interest likely, government or domestic money would be needed, meaning net currency outflow. If a sale was not possible capital withdrawal would then be likely.
Capital withdrawal (very bad outcome): Greek banks are forced to draw down capital from subsidiary banks to shore up their own balance sheets. The capital flight causes balance of payments stress (requiring reserve utilization and in Romania's case potentially tapping the precautionary SBA).
- Subsidiary default threat (very bad outcome): Removal of parent company support causes domestic banks to default but EBRD and the Romanian/Bulgarian government step in and nationalize or cause consolidation within Romania to absorb the bank.
- Outright parent company default (worst outcome): Parent company support is removed, capital is withdrawn, there is a fire sale of Emerging Europe assets. (Even if Greek banks were nationalized or bailed out would the Greek government really want to support Romanian and Bulgarian subsidiaries?)
Austrian banks like Erste Bank, have positions in Eastern Europe which may come under threat if those countries slowdown as a result of a Greek default.
At the end of June however, Raiffeisen Bank International kept its exposure to Greek sovereign debt at zero, according to Reuters.
From a Fitch comment on May 24 (via Reuters):
'However, their individual ratings also consider Fitch's expectation that impaired loans in some (central and eastern European) markets have yet to peak and -- in the case of Erste and notably RBI -- the banks' only modest capitalisation if the forthcoming repayment of government participation capital and preparations for Basel III are taken into account,'
As of May JP Morgan (via The New York Times), estimated that the ECB owned about €40 billion in Greek bond debt after it had been buying Greek bonds in the open market for about a year. A 50% of write-down on Greek debt could cause €35 billion in losses to the ECB. The ECB had also lent an additional €91 billion to Greek banks.
In the event of a Greek default, that debt may become worthless, and the ECB may be forced to recapitalize through taxpayer funds, from the rest of the eurozone.
JP Morgan: There will be a flight to US treasuries and yields will fall there as a result of renewed risk aversion. This will widen spreads on high grade corporate bonds as a result.
Morgan Stanley: The Greek crisis will make the EMU much more concerned about who they let into the Euro zone in the future. They will start to check more economic criteria, such as external imbalances and budget positions.
The ECB kept interest rates steady at its last meeting. Intended to curb inflationary pressures on the eurozone, rate hikes may have to be halted if a Greek restructuring damages the continent's banking system.
Morgan Stanley: When the Greek economy slides, foreign workers from Albania and Bulgaria may lose jobs and stop sending home remittances. Also, FDI to Macedonia (7% of its GDP) and Bulgaria (8% of GDP) will decrease.
Note: Data from 2010.
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