Crunch Time For The Eurozone?

05.06.12

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The Eurozone crisis has been causing concern and uncertainty for long enough. We have witnessed various attempts to resolve the crisis, but recent events in Greece, not to mention gr

The Eurozone crisis has been causing concern and uncertainty for long enough. We have witnessed various attempts to resolve the crisis, but recent events in Greece, not to mention growing fears over Spain, only confirm that it is far from over. The coming months will be critical.

We can only hope that we will see a resolution, one way or another, before too long, but expect twists and turns along the way. Investors will need to be patient as they ride volatility caused by the uncertainty and any shocks. Since there is some risk of a run on banks in some countries, those with large cash deposits may be happier if they sought safer arrangements for their savings.

The inconclusive legislative elections on 6th May led to fears that Greece could soon default. The next elections are on 17th June. If anti-austerity forces, led by the resurgent SYRIZA party, form a government and repeal the bail-out agreement and nationalise banks, this could lead to a default and even an exit from the Eurozone. Alternatively there may be another inconclusive result, in which case political leaders would have to try to cobble together a national unity government (difficult if SYRIZA were to finish in the top three) or call a new election. On the other hand, if the centre holds and win enough votes to form a government, they are likely to renew their commitment to the bail out package. This would be the best outcome for Europe.

The first two outcomes were considered most likely, but polls over the 26-27 May weekend showed the conservative New Democracy party regaining a lead over SYRIZA.

Will Greece exit the Euro? Although the electorate voted against austerity, around three quarters want to stay in the Eurozone. SYRIZA says its opposition to the financial aid programme does not mean Greece would abandon the Euro. Whether the EU would let them have their cake and eat it, however, remains to be seen. Right now there seems to be a 50/50 chance that Greece will leave the Eurozone.

This is likely to lead to worse recession in Greece but, since it is only 2% of Eurozone gross domestic product (GDP), it would not cause much impact elsewhere. However there would be significant impact on capital flows. A large devaluation would lead to major losses ? Greece has total external liabilities (government, banking, corporate and household debt) of around ?420bn.

The big concern is over contagion from a Greek exit. There is the risk of capital flight from other Eurozone countries – Spain and Italy owe around ?2.3 trillion and Portugal ?480 billion. The total peripheral debt holdings from Greece, Spain, Portugal, Ireland and Italy amount to almost 20% of Eurozone bank assets.

The worst case scenario is that Greece leaves the Euro in a disorderly fashion and other countries follow suit, resulting in a significant capital flight. As the chances of Greece leaving the Euro increase, so does the risk of a run on banks in other countries.

Another scenario is that although Greece leaves the Eurozone, central banks take considerable action to contain the event (though it would still impact on markets).

The best case scenario is that European organisations adjust their policies and successfully ringfence the Greek problems. Markets would improve and the Eurozone economy slowly start to recover. We may see a move to full fiscal union. Member States would have to cede sovereignty, but it should avoid the dangers of contagion and the risk of peripheral states collapsing.

Even if Greece leaves, the Euro is likely to continue. There is a strong political commitment to the single currency. Leaders do not want to see its demise and also want to avoid the financial risks that go with a complete Eurozone breakup.

There is an emergency fund already available in Europe and in April agreement was reached to boost the International Monetary Fund?s (IMF) lending capacity by around ?340bn to build up an essential ?firewall?. However, there are concerns that if a larger country like Spain were to collapse, the fund would not be big enough, unless the European Central Bank (ECB) opted for full blown quantitative easing.

Concerns about Spain are growing, particularly its banks which are holding around ?300bn of ?problematic debts?, and how the government can afford to bail them out.

In the meantime, if you have concerns about your cash deposits, the sooner you investigate options to increase investor protection the sooner your peace of mind will improve. European banks do offer a bank deposit guarantee of ?100,000, but we do not yet know how it would withstand the collapse of a major bank in countries like Spain, Greece, France, Portugal, Cyprus etc, or what would happen if a government took steps to prevent a run on a bank.

There are arrangements which provide a higher level of investor protection than banks can offer. For example, if you have an investment bond issued by a Luxembourg regulated insurance company, your investment assets are completely protected should the company fail.

For advice on asset protection and reassurance that your money is protected as much as possible from institutional failure, consult a wealth manager like Blevins Franks.

By Bill Blevins, Blevins Franks Financial Correspondent

29th May 2012

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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