Gap between Greece and its lenders remains wide: are the markets ready?


Greece is fast running out of money, while the negotiations leading up to the next Eurozone finance ministers’ meeting at the end of the week to discuss the matter appear not to be fruitful. This once again brings to the fore the possibility of a Grexit, as Greece is likely to default soon, either within or outside the European single currency.

Mario Draghi of the ECB will have us believe that the eurozone is now better equipped to deal with the repercussions of such a development than it was before, although he does admit that a deterioration of the situation will mean sailing in uncharted waters. The hard-line approach by the lenders, spearheaded by the German Finance Minister Wolfgang Schaeuble is aiming to force the newly elected left-wing Greek government to back down and agree on the terms demanded by the lenders. They seem determined to push Greece to the edge and appear to thing that a Grexit would be a lesson, to punish Greece for its disobedience.

However, this is deemed a very risky approach and it is being criticized not only by the Greek side but from other independent analysts as well, especially from across the Atlantic. These voices point to the fact that a possible Grexit will have many adverse effects, not only on Greece and its direct lenders but to the overall Eurozone system and the global financial markets as a whole, not only in terms of credibility.

Contrary to the prevailing view held by many EU government and the ECB that Greece can be pushed out of the euro system with little collateral damage, Greece’s Finance Minister Yanis Varoufakis has stressed on many occasions that if Greece were to leave the euro zone, there would be an inevitable contagion effect. As he pointed out: “Anyone who toys with the idea of cutting off bits of the euro zone hoping the rest will survive is playing with fire. Some claim that the rest of Europe has been ring-fenced from Greece and that the ECB has tools at its disposal to amputate Greece, if need be, cauterize the wound and allow the rest of euro zone to carry on. I very much doubt that that is the case. Not just because of Greece but for any part of the union.

Inded, many are worried that a possible Grexit would not only inject massive disruption in financial markets in Greece, but that it could also greatly damage the credibility of the EU’s single currency and raise questions about the future of the remaining countries in the region. In fact, pushing Greece out of the eurozone would greatly restrict the region’s economic recovery as a whole. According to Varoufakis “Once the idea enters people’s minds that monetary union is not forever, speculation begins, who is next? That question is the solvent of any monetary union. Sooner or later it’s going to start raising interest rates, political tensions, capital flight.”

If both sides to this equation insist on their uncompromising positions the real question that begs for an answer for all stakeholders in the forex business, is whether the industry is ready and equipped to survive the ensuing conditions and extreme volatility ahead.

This is an especially interesting question, as it comes shortly after the shock caused in January by the Swiss National Bank. The Swiss franc crisis has already has some victims in the face of brokers who were not ready and lost heavily, even being driven out of business. Some others survived it due to sheer luck and a series of fortunate circumstances, while very few where those who could go on affected with business as usual because they were well prepared to handle the repercussions. However, the difference between the two events is that the Swiss franc decision was a very sudden move that could not have been anticipated, while the Greek crisis has been looming for a long time given the industry and its player time to prepare ahead and have in place contingency plans for all possible scenarios.

Nevertheless, if Greece defaults, this will not only spell trouble for the main lenders to the country – the International Monetary Fund (IMF), the European Financial Stability Mechanism (EFSF) and the European Central Bank (ECB), but it will definitely have a profound effect on the volatility and the volumes of the global foreign exchange markets. A Greek default will mean that the IMF and the ECB will lose more than if they agreed right now to forgive much of the debt claim some analysts, while the exact impact of a Greek exit on the currency market is difficult to forecast, although increased volatility is a certainty, especially when Greece’s payment deadlines to its lenders approaching.

Having said that, many analysts fear that especially in the aftermath of the SNB announcement, the forex industry is not prepared to handle a full scale Greek crisis, simply because most brokerages do not possess the necessary capital adequacy. This is exacerbated by the fact that not enough time has elapsed from the Swiss franc crisis so industry players did not have the time to redress and improve the shortcomings that the SNB event revealed that they had.

Many fear the domino effect that a Greek default and Grexit would have, pointing to the fact that although EU governments and the ECB seem to believe that this danger is contained, the U.S. Treasury and the Federal Reserve had thought the same about Lehman Brothers and we all know where that led.

While the IMF has already admitted that it could be facing various difficulties if Greece does not meet its payment requirements to the Fund, Europe is also quite heavily exposed to the possibility of a Greek default since the EFSF, the financial mechanism designed to backstop the European sovereign debt crisis from spreading is exposed to the Greek debt in the staggering amount of €142 billion. Although the countries to be affected the most would be Germany with €38.4 billion and France with €28.9 billion, what is more alarming is the expose of Italy which is €25.3 billion and Spain at €16.7 billion.  Given the dire situation that these two countries are already faced with, these amounts are definitely a loss they can’t possibly afford.

Moreover, the ECB is also heavily exposed to Greek debt since it holds €27 billion in Greek bonds, while another €110 billion have been lent by the central bank to the Greek commercial banks via the Emergency Liquidity Assistance program.

It appears that a compromise deal between Greece and its lenders would be the only safe way out, but it also seems that such a deal would only be possible if reached at the highest political level, since technocratic, low level talks have failed to push the situation nearer a mutually acceptable settlement. News in today says that German Chancellor Angela Merkel will meet with Greek Prime Minister Alexis Tsipras in an attempt to put things back on track once again. It remains to be seen whether both sides will mellow their rhetoric and firm positions to find middle ground, but whatever the outcome the markets are surely facing challenging times ahead once again.