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Eurozone warned of complacency over impact of potential Greek exit

Elaine Moore and Joel Lewin
A man adjusts a Greek flag ahead of the visit of Greek Prime Minister Alexis Tsipras at the European Commission headquarters in Brussels February 4, 2015.
Yves Herman | Reuters

Eurozone quantitative easing was launched to save the single currency bloc. But it may end up making it easier to break the eurozone apart.

Since it was launched this month, the European Central Bank's open-ended program of €60 billion a month in asset purchases has succeeded in dropping government borrowing costs to record lows. By weakening the euro, it has also boosted exports, sent equities soaring and raised hopes of a eurozone recovery.

But in so doing, it may also be masking the pain of a potential Greek exit from the euro — a prospect that once terrified financial markets and the country's eurozone partners but no longer seems so frightening to them.

"For the moment, everything is being artificially hidden by the QE," said Philippe Gudin de Vallerin, chief Europe economist at Barclays.

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Just how consequential a Greek eurozone exit, or Grexit, might be has become one of the most urgent questions for the 19-member currency bloc as a new hard-left government in Athens runs out of cash and is clashing with its creditors.

Many eurozone officials now doubt that Greece has the funds to cover both €1.7 billion for government salaries and pensions this month and a €450 million payment to the International Monetary Fund due on April 9.

Erik Nielsen, chief economist at UniCredit, believes that Greece's leaving the eurozone would be a disaster for the country but not the wider region — in part because of quantitative easing.

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"I assume we would see a significant pick-up in migration, and if I'm right that Greek GDP [gross domestic product] were to drop by another 20-40 percent, then that would of course have effects on trading partners, particularly the Balkans," he said.

"But it's all manageable . . . Nobody in their right mind would start shortening other peripheral debts to any significant extent so long as we have QE."

Mr Gudin de Vallerin, however, worries about sending a message that eurozone membership is not irreversible — something that might prompt investors to view Italy, Spain, Portugal and other peripheral members through a harsher lens.

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"It would show that you can get out if you want," he said. "The next time growth slows and markets realize how high debt levels are in Europe, investors will ask: which country will leave the eurozone next?"

While always restating their desire to keep Greece in the eurozone, European governments are warning that they will not rescue Athens at all costs.

"What we have now in place would certainly allow us to survive [Grexit]," Johan Van Overtveldt, the Belgian finance minister, told the Financial Times this month. "Nobody talks too much about that very openly but my feeling is [the view] is quite present around the table."

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Such comments may be intended as a message to Greece's Syriza-led government in bruising negotiations over new financing. To the extent that creditors believe they could survive a Grexit, they deprive Athens of leverage it enjoyed in previous bailout talks.

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In addition to quantitative easing, they also point to the disentanglement of Europe's financial sector from Greece as well as the backstops erected during the eurozone crisis.

Since 2012, European policy makers have introduced the European Stability Mechanism, a permanent rescue fund designed to limit financial chaos that might arise from an event such as a Greek exit. At the same time, European bank exposure to Greece has fallen from €175 billion in 2008 to €42 billion. The bulk of the country's debt is now in the hands of the EU, the ECB and IMF instead of the private sector.

However, some worry that complacency has crept in. "Financial markets seem remarkably relaxed about a potential Grexit; they believe that either it will not happen, or it will not matter. That belief deserves to be challenged," Tidjane Thiam, the new chief executive of Credit Suisse, told the Financial Times this month.

Even though Greece's output is only about 2 percent of eurozone GDP — not much bigger than that of the cities of Madrid or Milan — Markus Allenspach, head of fixed income research at Julius Baer private bank, argued that a Grexit could still have systemic consequences.

He cited the example of Heta, the Austrian asset resolution company. Vienna's decision to order a 15-month moratorium on principal and interest payments for bonds issued by Heta meant that Düsseldorfer Hypothekenbank, a small German property lender, had to be rescued because of its exposure.

Mr Allenspach said: "It is fair to assume that a Grexit would cause massive impairments on loans to Greek banks in the first round, followed by impairments on loans to neighboring central European countries."

The prospect of such impairments is not reflected in market valuations, he added.

This may be because there is a lack of investor consensus about the prospect of a Grexit. Even as Greece's tussles with its creditors become more rancorous, analysts such as Phyllis Papadavid, senior global currency strategist at BNP Paribas, regard Grexit as a "low probability" event.

But if it were to happen, then investors' new-found confidence in a recovering eurozone would be damaged.

"One of the pillars of a monetary union is the commitment of each member to staying in," Ms Papadavid said. "If one member leaves it shakes those pillars of mutual commitment and economic partnership."