Who is Exposed to Greek Debt?

In an earlier article linked here I looked at the European situation and, why it mattered to investors. In this article I will focus on Greece and the forthcoming elections.
US investors may think that US companes are immune but, unfortunately, this is not the case. Europe is significant and, the events in the forthcoming Greek elections will affect Europe. A hard default by Greece would cause significant issues for the European banking sector and the economy, and then ultimately the US.

For example, McDonald’s (NYSE: MCD) generates more than 40% of its revenues from Europe. For Apple (NASDAQ: AAPL), it's 24%, but Europe generated 46% revenue growth for the company on a yearly basis. Europe is obviously a key area for General Electric (NYSE: GE) and it actually cited the ‘European sovereign debt situation’ in its caution regarding forward looking statements. As for Coca Cola (NYSE: KO), in the last quarter, it generated more profits from its Europe segment than it did fromNorth America! Merck (NYSE: MRK) generates 30% of its sales from EMEA, but any slowdown will also hurt margins as medical bodies will not be keen to spend or may accelerate plans to buy generics.


So What is Happening in Greece and Who is Syriza?

The party (Syriza) that is growing in strength ahead of the election is a collection of disparate left wing entities that advocates such half-baked policies as halting privitizations, nationalising the banks, implementing a gradual increase in corporate taxes to 45%, not a single public sector worker is intended to be sacked and, the bailout packages are to be renegotiated after the election.

Syriza does not want to implement reforms, on the contrary it wants to roll back pension and wage cuts, and it wants to stimulate growth inGreecevia infrastructural investment. Oh and, one more thing. It wants the funding to come from the EU!

Most polls have New Democracy (ND) at 23-26% with Syriza at 20-23% and the formerly ruling PASOK at 12-14% with the rest being an assortment of Communists, Greens, the Far Right and Greek Independency candidates.

I think there are two key takeaways from this.

1. Greece will vote to stay in the Euro (all three leading parties want to stay in) and it will vote to renegotiate the bailout package. The flexibility from the EU-IMF is probably there in order to agree some negotiation.
2. The new Government -whether it includes Syriza or not- will be under heavy pressure not to agree to certain structural reforms in the package and even if it does, these reforms will come up against fierce resistance when the time comes to implement them.

It is worth noting that the head of the ND party, Antonis Samaras, has been a thorn in the side of PASOK’s attempts to implement reforms. He fought every single austerity package. He quarrelled with the EU over supporting the implementation of the current package. And this is the guy that the EU are hoping is going to implement the future reforms! In addition, he is supposed to do it in the face of Syriza in parliament and, against significant and increasingly violent, social unrest. A tall order.


Why Does Greece Matter?

Greece matters because if it defaults on its debt in a disorderly way, the knock on effects on the European banking system are significant. It could cause a collapse in confidence in the EuroZone. In fact, the Greek politicians know this and, it has been their main negotiating tool in extracting loans and political concessions from the EU.  A disorderly default would hurt everybody so whilst this threat hangs over Europe, there will be uncertainty. Unfortunately, markets and CEOs do not like uncertainty and, growth is being impaired inEuropeas a consequence.

The threat of a disorderly default comes from a political move by Greece after the election (not likely now), or a future move caused by an economic collapse from a bank run (possible), or significant social unrest and political instability caused by recession and ongoing friction with the EU (possible).

 

Note the US potential exposure and, the direct exposure of French banks. Ever wondered why the new French President was so keen on trying to get Eurobonds implemented?


What Happens After the Elections?

I have four scenarios.

History suggests the following sequence of events. A bailout package will be renegotiated. Markets might like this and go back to ‘risk-on’ for a while. Meanwhile, the structural reforms will not be implemented, because Greece’s polity neither believes in the reform program nor feels it was elected to enact it.  There will be more social upheaval and unrest in Greece. The possibility of a major bank run will ensue (Greece already has a strange kind of slow motion bank run in place) and, the odds of a hard default will increase.

Alternatively, the EuroZone could decide that the risk of keeping Greece in outweighs the risk of removing them from the Euro. It could ‘force ’Greece into an orderly default, then write down the debt and recapitalise the ECB from the losses on its balance sheet caused by Greece. Then it might engage in liquidity measures so it can recapitalise its banks and, reiterate support for Portugal and Ireland. Such a bold and aggressive move could remove uncertainty over a Greek disorderly default, improve sentiment and, jump start business confidence in Europe. Moreover, the voluntary private sector haircuts have already reduced some of the impact of a Greek default so the EuroZone may feel that now is the right time to do this.

The third outcome is a messy process of an indecisive election, followed by continual upheaval and uncertainty. This could hasten the application of my second scenario or it could exacerbate the problems inherent in pursuing the first.

The fourth scenario involves an extension of the terms, a successful implementation of the reform program, a period of political stability followed by a resumption of growth and a return of market confidence. I have little faith in this outcome!

Frankly, I would prefer the second option to be enacted but consider the first more likely. It is time for bold action and, it also time for the Greek people to have a viable option in front of them rather than be promised unrealistic outcomes by deluded politicians