According to a January 12th report from Morgan Stanley Research, the odds of a “Grexit” from the Eurozone are quite small. In fact, MS analysts Jonathan Sheets and colleagues note “our sovereign credit strategists believe that risk/reward for long-end GGBs (Greek Government Bonds) is favourable.”
Greeks do not want to leave Eurozone
According to the MS report, the key consideration here is that although political volatility has increased for Greece, all the recent polls show that more than 70% of Greek voters want to stay in the Eurozone. Tsipras and Syriza understand this, and are unlikely to pursue a direct confrontation with the EU that could lead to a Grexit.
European pragmatism means compromise likely to prevent Grexit
SYRIZA is leading in all major polls in Greece. But things have not really moved much in recent months, and SYRIZA is still polling under the 40.4% of the overall vote required for a majority of parliament. This means there is a good chance that no party receives a large enough majority to form a government, which would force another round of elections (probably in March).
Europe has been reasonably pragmatic with its terms for Greek debt despite much “tough talk”. Greece has enjoyed both interest rate reductions and debt postponement, resulting in the net effect of debt reduction in all but name. Sheets and colleagues note that the sovereign credit team at Morgan Stanley calculate that Greece pays an effective net interest rate under 1% on its outstanding debt. The MS analysts say it’s clear that “There is precedent for European flexibility on debt terms, so long as it isn’t principal reduction and it comes in exchange for reform.”
Bond markets mispricing odds of Grexit
The MS sovereign credit team also points out that Greek government bonds have dropped all the way down to the low 50s, which implies an almost 20% probability of default and euro exit. This explains some of the broader market volatility lately, given that such a scenario would be a systemic shock in Europe, despite the relatively small size of the Greek economy.
The MS analysts argue that the ‘default and exit’ risk currently reflected in Greek bonds is fundamentally too high. They flesh out their perspective below. “Such a scenario appears unpopular with a large majority of Greek voters, and would require Europe to risk destabilizing its currency union, raising major questions around issues like currency controls, bank funding and EU membership.”
Finally, Sheets et al. highlight that there is no “roadmap” for a Grexit (or for any country to exit from the Eurozone), which makes it less likely simply based on human nature.