2nd November 2011

Schroders: Where does the Greek referendum leave the eurozone?

Greek Prime Minister George Papandreou stunned markets with his call for
a referendum to approve the package agreed in Brussels last week. Equally
surprised were his European Union partners, with both Berlin and Paris
saying they had no warning that this was coming.

Papandreou has now been invited to dine with Chancellor Merkel and President
Sarkozy this evening to discuss the Greek debt problem ahead of the G20
meeting. The idea of taking a leaf out of his finance minister's book and checking
into a clinic with "stomach pains" must seem quite appealing to the Greek PM.
The question now is: what is the road map for the eurozone?
It is possible, but unlikely, that the referendum will be called off; it is not a popular
move and the government could lose the vote of confidence on Friday which
would trigger a general election. Alternatively, the G20 could lean on Papandreou
to reconsider, but this might be seen as interfering with the sovereignty of
Greece.
The more likely prospect is that the current government survives the confidence
vote and goes on to hold a referendum in January. That means a period of
uncertainty where the markets will have to focus on Greek opinion polls and
politics. Current polls suggest the Greek people would vote against the EU
package, but in favour of remaining within the euro. Unfortunately that may not be
the choice, with many in the EU seeing continued membership of the euro as
conditional on acceptance of the package.

An important key to the outcome will be the position of the opposition. At present
they oppose the package and have said they would renegotiate. Should this
change, with say the formation of a national unity government, the prospects for a
positive referendum result would be increased. Such unity seems unlikely at this
point however, so the risk of Papandreou losing the referendum and then a
subsequent election is high. There then follows the risk of a stand off between
Greece and the EU, with the possibility of the euro losing one of its members.
In the meantime, the EU is set to work on fleshing out the details of the
agreement reached last week. However, progress on bolstering the EFSF and
banks' acceptance of haircuts will have to be made conditional on a positive
referendum. More immediately, there are questions on whether the IMF will
disburse the €2.2 billion tranche of the current aid package in mid-November if
the new aid package is in doubt.

The outlook was not particularly clear even before the latest developments and
we had expressed a number of concerns about the bank recapitalisation and the
leveraging of the EFSF. In our view the package was always likely to fail as, even
with unrealistic growth assumptions, it left Greece with a debt/ GDP ratio of
120%, which is still too high. Further restructuring of Greek debt was therefore
inevitable. Nonetheless, we did not expect last week's package to face such a
sudden death.

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