Market Mover - BNP PARIBAS - Investment Services India

leave the euro significantly lower. Under the first
scenario, Adjustment, the Greek authorities are
successful in implementing the required reforms and
slowly regain the confidence of markets. However,
this would be a slow process and still runs high risks,
suggesting that any euro recovery is likely to remain
limited. Although this would likely be the most
favourable outcome for the euro, much would still
depend on the developments in the other peripheral
countries, especially how Portugal and Spain
implement their reforms. Ultimately,
underperformance of the euro would still be expected
as a high risk premium would remain in place and
our EURUSD 1.27 year-end forecast would still be
achievable.
Under the second scenario, Financial Support or
bailout, Greece would effectively have to borrow the
credibility of other states or international institutions,
buying Greece time to carry out reforms. However,
although the announcement of a bailout may cause
an initial euro rebound, we would not expect this to
be sustained as the longer-term implications would
likely be extremely negative, with the issue of moral
hazard playing a major role. In fact we would expect
the EURUSD to come under even greater pressure
than in the first scenario, with EURUSD declines
likely to exceed our 1.27 forecast targeting at least
1.25 by year-end.
The third scenario examined was Debt Restructuring
or soft default. In this case, Greece would lose
credibility and fail to borrow credibility from
elsewhere, suggesting that it could encounter
problems meeting its obligations – forcing it to
restructure its debt. We would consider such an
outcome as outright euro bearish, especially if there
were spill-over effects into the rest of the European
periphery. Significant portfolio and capital outflows
from the eurozone would be seen. Under such
circumstances, EURUSD would be vulnerable to a
collapse towards the 1.10 area.
Disorderly Default was the fourth and final scenario
examined, where events unfolded beyond the control
of the Greek authorities. This would be clearly the
most bearish scenario for the euro, where the decline
in the currency would likely be very abrupt, with even
the 1.10 area exceeded.
Bailout will not support the euro
Given the extent of recent market rumours and
media speculation, some sort of assistance or aid
package to support Greece currently looks the more
likely outcome, although there still appears to be
significant disagreement with regards to how this
may be carried out, not to mention the legal issues
as to how this would be consistent with the
Maastricht Treaty. While the risk of moral hazard
30
20
10
0
-1 0
-2 0
-3 0
-4 0
-5 0
-6 0
-7 0
-8 0
-9 0
-100
Chart 3: Net Financial Positions (% GDP)
Portugal
96 97 98 99 00 01 02 03 04 05 06 07 08
Source: CEIC, BNP Paribas
Germany
Ireland
Greece
Chart 4: Public Debt as % of GDP
Ita ly
Spain
Public Debt (% GDP) 2008 2009 2010 2011
Sweden 38.0 42.1 43.6 44.1
Norway 49.9 54.3 50.6 45.2
UK 52.0 68.6 80.3 88.2
EMU 69.3 78.2 84.0 88.2
Greece 99.2 112.6 124.9 135.4
Spain 39.7 54.3 66.3 74.0
Portugal 66.3 77.4 84.6 91.1
Source: BNP Paribas
associated with such a solution has been discussed
in detail, the size and cost is currently conveniently
being overlooked. Some initial calculations by the
BNP Paribas Market Economics group based on past
bailout packages in emerging markets reveals that
such a solution will not be cheap. A bailout would
have to be large enough to convince markets that it
would be successful. Previous examples suggest
rescue packages need to be around 20% of GDP. In
the case of Greece this could be EUR 50bn, although
large it could be manageable. However, if a broader
bailout was required, including Portugal and Spain
than the cost could be a far greater, over EUR
300bn. So while the euro could take some initial
comfort from any bailout, the longer-term implications
would remain extremely bearish. Hence, we continue
to recommend using any EURUSD rebounds post
the EU summit to establish bearish strategies.
Indeed, in our view it is no longer a case of if to sell
the euro, but more a case of when to sell. Hence, we
recommend option strategies, such as downside
One-Touch strategies to provide protection against a
renewed EURUSD decline.
Ian Stannard 12 February 2010
Market Mover, Non-Objective Research Section
39
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