INTRODUCTION 1                                            GREECE LEAVING 2                        SEVERAL PROBLEM COUNTRIE...
■ IntroductionIntroductionAlternative euro break-up scenarios                             Greek banks’ capital, further de...
■ Greece leaving the euroGreece leaving the euro• The new Greek currency will devalue considerably            within a few...
■ Greece leaving the euroDetermining the currency is not straightforward               creasing the costs of companies and...
■ Greece leaving the euroexports picking up, increasing the tax revenues. If ex-                 The European central bank...
■ Several problem countries leaving the euroSeveral problem countries leaving the euro• Greece leaving may trigger a domin...
■ Several problem countries leaving the eurothe current situation. If the crisis comes to a head, claims      Losses of th...
■ Finland’s exit of its own accordFinland’s exit of its own accord• Finland can have two currencies in the beginning      ...
■ Split or breakup of the euroSplit or breakup of the euro• Germany’s exit leads to the breakup of the eurozone           ...
■ Split or breakup of the euroAn enormous extent of negotiations on the currency to be      Euribor is the most common ref...
■ Effects of the scenarios on the Finnish economy and marketEffects of the scenarios on the Finnish economy and marketsTab...
■ Effects of the scenarios on the Finnish economy and marketTable 4. Effects of the breakup of the eurozone on the interes...
■ Effects of the scenarios on the Finnish economy and marketTable 5a. Effects on a Finnish company’s foreign exchange hedg...
■ Effects of the scenarios on the Finnish economy and marketTable 5b. Effects on a Finnish company’s foreign exchange hedg...
■ Effects of the scenarios on the Finnish economy and marketTable 6. Effects on corporate bondsGreek exit                 ...
■ Effects of the scenarios on the Finnish economy and marketTable 7. Effects on the equity marketGreek exit               ...
For further information:Aki Kangasharju, Director, Head of                             ...
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What if-the-eurozone-breaks-up ? Finland’s exit of its own accord

  2. 2. ■ IntroductionIntroductionAlternative euro break-up scenarios Greek banks’ capital, further decrease their access to fi-The analysis explores four eurozone break-up scenarios: nancial markets and lead to a full-scale deposit flighti) Greece leaves the euro, ii) several countries in difficul- from Greek banks. It will not be possible to pay all of theties leave, iii) Finland exits on its own accord, and lastly deposits in Greek banks back. Furthermore, the purchas-iv) the entire eurozone splits up into two or breaks up al- ing power of Greek deposits will weaken considerablytogether. The considerations take into account the effects because the value of the new currency adopted by Greeceon both, the exiting country and the rest of the eurozone. will devalue.The analysis concludes with summarizing the effects ofthe different scenarios on Finlands economic develop- Exit of Greece may lead to a domino effectment, Finnish companies’ alternatives for interest rate Problems in the Greek banking sector may also be re-and currency hedging, corporate loan markets, and the flected in the banks of the other weak eurozone countries.equity market. Greece leaving the euro will stun the financial system, which leads to a total halt in banks’ access to financialWe take no stand on whether the eurozone will remain as markets in the weak countries. The banks, which are al-it is, or will it change or break up totally. The following ready dependent on the central bank, will have to in-only describes what we think is likely to happen should crease their use of central bank financing further, andchanges take place in the eurozone. There is naturally a banks in the problem countries will suffer from a depositconsiderable degree of uncertainty associated with the flight as speculations over their condition intensify.scenarios. Not all alternatives are reviewed; instead, theanalysis focuses on the most interesting ones. Credible firewalls are vital Getting the problems of the banking sectors of poorThe future of the eurozone depends on politicians countries under control requires the capital situation ofThe eurozone remaining in its current form is not up to their banks to be improved. In practice, governments willmoney, but rather politicians. So far, politicians in Eu- have to support the banks. As financing needs in therope’s creditor countries have trusted that aid packages problem countries increase while market access weakens,for weak partners will not hamper their success in future the role of crisis management framework will increaseelections. From the point of view of debtor countries, at further. The firewall created by the European temporaryleast for the time being, making the required economic and permanent stability mechanisms, the Internationalreforms has been more pleasant than diving into a new Monetary Fund (IMF) and the European Central Bankunknown with their own currency. (ECB) plays a significant role in managing the crisis. In particular, disconnecting the link between the teeteringHowever, the situation may change. If the composition of banking sector and the government is essential to calmthe eurozone changes, it will begin with the break-up of the situation down. The need for new aid packages willGreece, because the country has clearly fallen short of increase, but the spreading crisis will decrease the num-the agreed economic reforms, the depression has turned ber of countries providing support.out to be worse than initially estimated and the need for athird aid package is increasingly apparent. At the same If the course of events cannot be stopped, or actuallytime, the debate on the reasonability of the aid measures there is no will to stop it, the European financial systemhas intensified in the strong countries. The direct effects will come to a complete standstill no later than when theof Greece leaving the euro can be controlled, as many crisis spreads to the EU founder states Italy and France.kinds of preparations have already been made for it, such The problem banks will not be able to pay back theiras the private sector cutting down its operations in debts to the central bank. The problem banks’ increasingGreece. What has a bigger effect than the direct effects losses due to market value changes as well as the depres-are growing market expectations of whether the remain- sion in the real economy will consume their capital. Theing eurozone is sustainable and which countries would be problem banks will not be able to grant loans, and a cred-the next to leave. it crunch follows. The value of the euro will collapse. This may result in the euro being abolished similarly toGreece leaving the euro consumes Greek deposits the Soviet ruble or Yugoslavian Dinar, the collapse of theThe process of Greece leaving may lead to a series of financial system and, the motion of which are difficult to influenceonce it has begun. Expectations of breakup will lead to Germany’s exit destroys the euro systemeven the last foreign investors leaving the country, while In principle, the eurozone may also be changed by athe Greek will increasingly transfer their deposits to for- creditor country leaving the system. The exit of a smalleign banks. Greece will not be able to handle its debt if country, such as Finland, might remain an individualthe flow of aid money stops, which will lead to signifi- case, but a major country like Germany leaving wouldcant losses in Greek banks. The losses will consume collapse the entire euro area. LOKAKUU 20121 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  3. 3. ■ Greece leaving the euroGreece leaving the euro• The new Greek currency will devalue considerably within a few years (Figure 1). If one compares the stabil- ity of the Greek economy to Finland at the time and takes• Direct effects on euro countries manageable the considerable market mistrust in Greek political deci- sion-making into account, devaluation clearly exceedingRecent development in Greece the devaluation of the Finnish markka would be proba-Capital has been flowing out of the Greek financial sys- ble. Market mistrust is evident in, for example, the mar-tem for a long time. Foreign parties have repatriated their ket values of the new government bonds issued after theinvestments and domestic parties have withdrawn their rearrangement of Greek government bonds, which havedeposits and transferred their investments abroad. The decreased to below 40% of their face values.outbound flow of currency has been substituted by loansfrom the European Central Bank to Greek banks and the Figure 1. Devaluations in previous economic crisesinternational support packages granted to Greece. Greek 110 Pre-crisis exchangebanks have been shut almost completely out of the pri- rate = 100vate funding market, so they have resorted to central 90bank funding. Since the collateral required for centralbank funding has become scarce, banks are increasingly 70dependent on the emergency funding they receive fromthe national central bank. In emergency funding, theBank of Greek creates money and loans it to banks 50 Argentinaagainst central government guarantees. Finland 30 RussiaAnatomy of the exitIf the emergency funding to Greek banks is stopped, the Thailand 10banks’ liquidity will dry up and they will be forced to re- 91 92 92 93 94 95 96 97 98 99 00 01 02 03strict cash withdrawals by depositors. The public will in- Source: Reuters Ecowincreasingly store cash under their mattresses. Greekbanks’ assets in other countries will be frozen, and inter- Over the longer term, the exchange rate is determined onnational transactions can no longer be made through the basis of the balance of the country’s economy. Thethem. Greece will have to exit the euro system in nego- higher the current account deficit and unemploymenttiations with the euro countries, because funding will rate, the higher the devaluation pressure. The current ac-end. count deficit of Greece has improved in 2007–2011 be- cause the austerity measures have decreased importsGreek banks’ debts to the European Central Bank will be while exports have increased slightly (Figure 2). At thecompletely rearranged or their repayment period will be same time, however, the unemployment rate has in-extended. Theoretically speaking, the Greek central gov- creased to approximately 20%. In recent months, the un-ernment is liable for any losses resulting from the emer- employment rate in Greece has already gone up to somegency funding operations. A country’s exit of the euro 25%. The unemployment rate could be reduced throughand/or insolvency is likely to result in losses to the cen- stimulus measures, but funding the stimulus for an al-tral banks of the other euro countries via the European ready heavily indebted country is difficult.central bank system. Figure 2. Current account and unemployment rate,Greek currency will devalue significantly 2007–2011Greece will finally make the political decision on adopt- 10ing its own currency, the drachma. At first, various types Germany Current account, % of GDPof tender will be used before the new paper currency is 5printed. Deposits will be converted into drachmas. The Finlandeasiest way to implement the transition is to convert eu- Ireland 0ro-denominated deposits into drachmas at the rate of 1:1. 0 Italy 10 20 30The market value of the drachmas would naturally de- -5 Spaincrease. In the initial phase, drachma-denominated bankcheques and bearer bonds might work as the paper cur- Portugalrency. -10 GreeceDrachma will initially experience clear overshoots. TheFinnish markka, for example, devalued by over 30% in -15 Unemployment rate, %the 1990s after the currency was floated, until it stabi- Source: OECDlised at approximately 20% below the pre-crisis level2 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  4. 4. ■ Greece leaving the euroDetermining the currency is not straightforward creasing the costs of companies and households. InflationThe effects of the devaluation of the currency depend will accelerate and the unemployment rate increase, caus-significantly on whether existing contracts remain euro- ing social problems.denominated or are converted into drachmas. For exam-ple, would a Finnish travel agency have the right to pay The revenues of home-market companies will be drach-the agreed hotel rent in drachmas? There will be negotia- ma-denominated. Yet the companies will still have euro-tions, demonstrations and court rulings, also between denominated expenses, for example, for raw materials.domestic parties. The employees of export companies Costs will increase as the result of devaluation and com-and the tourism industry have better chances of receiving panies’ profitability will decrease. To the extent thatat least part of their income in euros than the employees loans are converted into drachmas, the direct effect onof home market companies. Lessors and creditors will try debt servicing ability will remain minor. On the otherto charge the agreed euro-denominated amount in euros hand, loans that remain euro-denominated would be in-while the tenants and debtors offer the corresponding creasingly difficult to repay. The domestic market willamount in drachmas. Banks are required to pay small- not benefit from the devaluation until export companiesscale depositors a minimum amount in euros. Vehement increase their personnel and investments.decisions will be made in the parliament. It is likely thatagreements under Greek law will be converted to drach- Greek government debt will be rearrangedmas, while foreign ones will remain in the euro/foreign The public sector has both domestic and foreign debt. Incurrency. Greece, government bonds are mainly held by domestic banks that have purchased them with ECB funding. For-Devaluation will benefit export companies eign debt is mainly to the other euro countries via two aidAt first, disturbances in international payments and the packages, the IMF and ECB. The devaluation of the newsignificant uncertainty over Greece’s future will hinder currency will increase the debt burden of the Greek pub-exports. Who will want to travel to a chaotic Greece lic sector should the debt remain in euros and public rev-where ATMs do not work and credit cards are not ac- enues mainly be in drachmas. Prior to the rearrangementcepted? However, over time the functioning of the socie- of the loans of the Greek private sector in spring 2012,ty will begin to recover, and the weakening of the cur- government debt was primarily in compliance withrency will benefit the export sector and tourism industry. Greek law, but the new bonds issued in the arrangementCompanies can transfer the devaluation benefit fully or follow UK legislation, making it more difficult to convertpartially to prices, which will decrease the euro- the loans to drachmas.denominated prices, which, in turn, will support the ex-port demand for the products. Improving demand will Figure 3. Consequences of Greek exitlead to the need for hiring new employees. In addition, Prices of imported Unwilligness to Difficulties in goods higher in the accept the new internationalthe improving performance will provide opportunities for new currency currency 1:1 paymentsnew investments. From the point of view of the nationaleconomy, devaluation is more beneficial the more its ef- Foreign trade comes Accelerating inflation Disorder, strikesfects are channelled into higher employment rates and to a standstillinvestments. The benefits of devaluation, on the otherhand, decrease the more wages and other production Decreasing realcosts increase. income (wages, The economy pensions) collapses Domestic demand collapsesIf the liabilities of an export company are converted into Uncertainty over the Inability to servicedrachmas, devaluation will decrease the liabilities in eu- future increases euro-denominated debtros, making it easier to cover them. The repayment of li-abilities that remain euro-denominated will only be made Source: Nordea Marketseasier through the higher profitability resulting from thedevaluation. Unfortunately for Greece, the country’s ex- Greece will announce that it cannot service its debts be-port sector is small. cause Greece will no longer receive the current support packages after the euro exit. However, attempts will beHome market parties suffer from devaluation made to negotiate on the timetables of debt servicing orDevaluation would initially be harmful to Greek home at least partial repayment, because exports picked up asmarket companies and consumers. Wages, pensions and the result of the devaluation increase tax revenues. Debt-other types of income will decrease in real terms once ors will demand their claims in courts. It is in Greece’sconverted into drachmas. Certainly, prices of domestic interest to pay the debt partially back in order to retain itsproducts and services will decrease equally, but imported EU membership. Partial repayment also contributes togoods will still carry the same euro-denominated prices. the return to the international financial markets.Euro-denominated prices of imported goods may evenincrease, with the uncertainty and disorders in payment The tax revenues of the Greek public economy have nottraffic making imports more difficult. One concrete ex- been sufficient to cover expenses, let alone debt interest,ample is the price of fuel, which is likely to go up, in- for a long time. Devaluation will help over time, with3 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  5. 5. ■ Greece leaving the euroexports picking up, increasing the tax revenues. If ex- The European central bank system has claims of slightlypenses can also be kept under control, the public econo- under EUR 150 billion from Greece. Slightly over twomy will begin to show a surplus. There will then be mon- thirds are from banks, the rest from the central govern-ey also for the expenses of servicing the rearranged ment. If Greece was to leave the eurozone, the extent toloans. A summary of the consequences of Greek exit is which the country would be able and willing to repay itsshown in Figure 3. debts to the euro system would be unclear. According to the narrow definition, the capital of the European centralDirect losses from Greek exit are minor bank system is only EUR 86 billion, so theoreticallyThe direct effects of Greece leaving the euro are limited speaking, the losses caused by a Greek euro exit mightfor Finland and also for the rest of the eurozone. Greece consume the capital in full. However, the balance sheetis a small country, others have already prepared for its of the central banking system includes approximatelyexit, and most of the government debt held by private in- EUR 450 billion in revaluation accounts due to the in-vestors has already been rearranged. Finland’s trade with crease in the value of the gold reserve, among others.Greece is slim, and the private sectors receivables are in- This increase in value has not been recognised as revenuesignificant. The public sector’s claims from Greece and therefore not as capital, either. These value changesamount to approximately EUR 6 billion (Table 1). could be used to cover the losses, so instead of the nar- row capital alone, it makes more sense to also examineThe effects of the Greek exit will be higher in the rest of the revaluation accounts when evaluating the balanceEurope than in Finland due to the closer trade relation- sheet of the central bank system. In addition to utilisationships and higher level of direct exposure. A Greek euro of the revaluation accounts, the euro countries can injectexit would hit France and Portugal the hardest, as these capital into the central bank system.countries have the highest claims from Greece comparedto the size of the economy. European banks will suffer In addition to trade relationships and direct claims,losses due to approximately EUR 60 billion of Greek ex- Greece leaving the euro would increase the general un-posure. However, in practice, most of the Greek govern- certainty, which will impair economic activity through-ment bonds are most likely already recognized at market out Europe. Also, the development of the euro followingvalue. Furthermore, several banks have been reducing Greece’s exit will have an essential impact on exports. Intheir Greece exposure in recent months, so the direct practice, reassuring the market after one country leaveslosses will remain considerably lower than the nominal that Greece will remain an isolated case will be crucialvalue presented herein. and difficult, and it will require significant support measures by the stability mechanisms and the ECB. TheTable 1. Claims from Greece, EUR billion, 03/2012 first reaction will be the weakening of the euro compared Spain Ireland Italy Greece Cyprus Portugal Total to other main currencies due to the uncertainty. The de-Finland 1 0.4 0.4 0.0 0.0 0.2 2Germany 110 74 105 5 6 21 322 valuation will support Finland’s and other euro countries’Belgium 10 17 9 0.2 0.2 1 38 exports to outside the eurozone, but increasing uncertain-France 91 19 263 31 2 16 423Netherlands 53 11 28 2 1 4 100 ty will impair exports more than this as a whole. After aAustria 3 1 14 1 2 1 22 weak country has left, the euro will become stronger inSweden 2 1 1 0.2 1 0.2 5Switzerland 15 10 17 2 1 2 46 the longer term, which will make adjustments in theUK 67 108 45 7 1 15 243 weakest countries remaining in the eurozone increasinglyTotal 353 243 482 48 15 60 1202 difficult, with exports suffering from the strong currency.Source: CEPS4 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  6. 6. ■ Several problem countries leaving the euroSeveral problem countries leaving the euro• Greece leaving may trigger a domino effect countries. Not all aid and claims will be lost; repayment depends on the severity of the economic problems and• Significant losses to the private and public sectors debt negotiations. The public support paid by the EU and IMF in summer 2012 to problem countries amounted toGreek exit may result in problem countries leaving approximately EUR 400 billion (Figure 4). Of this, Fin-A Greek euro exit will increase uncertainty in the other land accounted for some EUR 7.6 billion.problem countries in the eurozone (such as Portugal, Ita-ly, Ireland, Spain, Cyprus and Slovenia). It may exacer- Finland also has liabilities via the ECB. In practice, thebate the distress of the financial systems of the problem ECBs claims have emerged since 2007, when interbankcountries and accelerate deposit flight from problem lending dried up. Investors have withdrawn from fundingbanks. The problem countries’ need for support will in- the banks of the problem countries and transferred theircrease, and if there is no readiness to give support, the assets to safer countries. The banks of the problem coun-countries would leave the eurozone. The course of events tries have been forced to resort to the ECB via their ownwould be similar to that in Greece, although the conse- central banks in order to be able to repay depositors andquences of several countries leaving would be signifi- investors who are repatriating their assets. Correspond-cantly higher due to the financial interconnectedness both ingly, banks in countries deemed safer have made depos-in the countries leaving and those remaining in the euro- its in the ECB via their respective central banks. Thiszone. way, the central banks of the problem countries have ac- cumulated imputed debt in the payment system and safeIn the resulting smaller eurozone, investments and con- countries’ central banks imputed receivables that roughlysumption will crash after the collapse of general confi- correspond to the (net) receivables and debts of the coun-dence and the entire euro system having been called into tries’ financial systems to the European central bank sys-question. Devaluation decreases the purchasing power of tem (Figure 5).the countries exiting the euro, which will slow down theexports of countries remaining in the euro. Uncertainty Figure 5. Receivables in the central bank systemwill paralyse the economy of the eurozone, but the weak- 800 Germanyening of the euro compared to main currencies will help EUR billion 600 Netherlandsthe export sectors. Tension in the international financial Finlandmarket is increasing. Enormous credit losses will destabi- 400 Slovenialize in particular the weakest financial institutions in the 200 Franceeurozone, and even the ECB will be technically bankrupt. BelgiumThe ECB will support banks by offering them an unlim- 0 Austriaited amount of liquidity. The bank system is kept run- -200 Portugalning, but credit losses will consume the banks capital Greece -400and credit taps will remain dry. Ireland -600 ItalyFigure 4. Claims from problem countries 99 01 03 05 07 09 11 Spain IMF Source: Ifo, central banks 1400 EUR billion EFSF 1200 The entire euro system shoulders the credit risk related to EFSM bank financing and is liable for the repayment of deposits 1000 ESM in the ECB. The national central banks act as the media- 800 tors. If banks want to withdraw their deposits, the assets Portugal 600 will be raised from the public funds of the euro system. Ireland If, say, a loan granted to a Spanish bank results in credit 400 Greece IMF losses, the central banks of the system will carry the loss 200 in line with their ownership. Any credit losses to the Greece EU ECB will probably be divided among the remaining 0 ECB purchases shareholders in accordance with their ownership. Fin- Subsidies Subsidies ECB (GIIPS paid promised and CYP)* Central bank land’s liabilities currently correspond to its holding of receivables slightly under 2% in the ECB. The more countries exitSource: Ifo *) GIIPS=Greece, Ireland, Italy, Portugal, Spain, CYP=Cyprus the euro, the higher Finland’s ownership and liabilitiesFate of public claims uncertain will increase.It is probable that the debts of all countries leaving theeurozone will have to be rearranged, which will result in The claims of the euro system from the problem coun-losses to the public and private sectors of the eurozone tries are over EUR 950 billion, of which Finland’s share is approximately EUR 20 billion. These figures reflect5 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  7. 7. ■ Several problem countries leaving the eurothe current situation. If the crisis comes to a head, claims Losses of the private sectorfrom the problem countries financial systems will multi- The private sector will also suffer credit losses from itsply before the credit taps are turned off. In addition to the exposure. Finnish banks had slightly under EUR 2 billionproblem countries, the European Central Bank has claims of claims from the problem countries in March 2012. Thefrom other countries financial institutions whose solven- highest exposure is to Spanish would falter should the problem countries exit the eu-ro. Should the problem countries leave, their debt will be re- arranged and their bank systems will suffer. Companies’How the ECB’s credit losses are managed? opportunities for servicing euro-denominated loans areThe ECB’s credit losses can be managed in two ways. poor, and the number of bankruptcies will surge. The re-The first alternative is that the countries remaining in the maining eurozone will carry considerable losses fromeurozone will inject more capital into the ECB in order to these claims. However, the exposure is not only unidirec-strengthen its balance sheet. Obtaining capital from the tional. The problem countries’ companies and citizensmarket in one go is not sensible, and the ECB would have deposits in the banks of the remaining eurozone,probably accept government bonds as a payment. and these deposits and cash moved to safe havens will begin to be repatriated after the adoption of their ownAlternatively, the ECB could be allowed to continue to currency.operate with negative capital or keep the capital positivethrough bookkeeping means. The central bank can well This may result in a situation in which the indebted sec-operate even if the liabilities recognised on the balance tors of the problem countries firstly fail to service theirsheet exceed the assets, since the liabilities mainly con- debts to the core countries, and surplus companies andsist of euro-denominated paper currency and banks’ de- households subsequently aim to repatriate their assetsposits in the central bank. However, keeping inflation at held safe as deposits in the core countries.bay would be challenging for a central bank system oper-ating with negative capital. The central bank is a net Table 2. Bank exposure to the problem countries,debtor to the bank system, so interest payments to banks EUR billionwill have to be financed by creating new money. This is Public, Private Total % of GDPno problem with zero interest rates, but the losses of the EFSF/ECB (BIS) France 67 35 101 5.1%central bank system will increase if interest rates are in- Germany 89 11 99 3.9%creased in order to curb inflation. The ECB can change Italy 58 2 60 3.8%the situation by increasing banks reserve requirements Spain 39 1 40 3.7%considerably and stopping the payment of interest on re- Netherlands 19 3 21 3.6%serves. In this case, the central bank system will be capi- Belgium 11 1 12 3.2% Portugal 5 6 12 6.8%talised by, in practice, taxing banks. Reserves currently Austria 9 2 11 3.6%amount to only EUR 100 billion, so this would require Finland 6 0 6 3.1%multiplying the reserve requirements. Ireland 3 0 4 2.1% Total 306 59 365Amount of paper currency will be reduced Source: BISIn addition to credit losses, the amount of paper currencywill be a problem for the ECB. The amount of issued pa-per currency must be reduced as the eurozone gets small-er to match the needs of a smaller economic area. Infla-tion will accelerate if the cash in circulation in the exitcountries enters circulation in the remaining eurozonecountries. The Italians alone are estimated to have EUR150 billion in cash, which accounts for almost one sixthof the amount of cash in the entire eurozone. However,this sum is only three per cent of the total sum of cashand demand deposits.6 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  8. 8. ■ Finland’s exit of its own accordFinland’s exit of its own accord• Finland can have two currencies in the beginning whole, Finland’s foreign liabilities and receivables are fairly balanced, so the need for exchanging euros to• The development of the markka is not self-evident markkas and vice versa would neutralize each other, and the central bank’s need for action to stabilise the ex-Uncertainty over economic policy and currency change rate of the markka against the euro remains small.A strong country may also leave the eurozone if the lia-bilities related to the support packages need to be in- The development of the markka is not self-evidentcreased further. Finland’s exit of its own accord would Right after the currency peg ends, the exchange rate ofdiffer from a Greek exit, because a balanced national the markka may fluctuate even to a considerable extent,economy may, theoretically speaking, have two curren- depending on whether Finland is seen as a safe haven incies even for a long transition period, and peg the new the euro crisis or whether investors will withdraw theirmarkka to the euro at a rate of 1:1 during the transition assets from the small illiquid marginal market. In theperiod. In the best case scenario, the uncertainty would longer term, the development of the markka will dependbe temporary and impacts on Finnish economic devel- in particular on the growth outlook, inflation-related ex-opment remain limited. In practice, however, the impacts pectations and investors’ attitude towards the exchangedepend on investors’ moods and the general economic rate risk of a small currency. In any case, the value of thedevelopment, so the transition period may be problemat- markka will fluctuate more than that of the euro.ic. A minor strengthening caused by the relatively good bal-Initially, both currencies could be legal tender. Euros are ance of the Finnish economy may lead to a mass move-not automatically converted into markka. Instead, all de- ment of investors, which strengthens the currency strong-posits, debt and other agreements remain in euros until er than warranted by the situation of the real economy.deposits are transferred to markka-denominated accounts Such a positive cycle keeps interest rates low and sup-and parties amend their contracts. During the transition ports indebtedness and domestic demand. The recentperiod, the Bank of Finland exchanges euros and mark- weakening of the balance of current accounts intensifies,kas at a rate of 1:1 both ways. Eagerness to exchange will making the Finnish national economy increasingly de-depend on peoples expectations of the development of pendent on the moods of foreign investors.the value of the markka after the transition period. Thefinancial markets may have doubts as to the consistency Corporate and government funding more expensive?of Finnish economic policy, since Finland was known for On the other hand, the value of the markka may decreaseits devaluation cycles prior to joining the EU. Therefore, considerably because a small currency is not needed foran immediate liquidity crisis may emerge as early as in balancing investment portfolios in the same way as thethe transition period if eurozone investors withdraw their euro, a major currency. A significant proportion of theassets for fear that euros will not be safe in Finland. money invested in Finland during the euro era columnsRisk-averse eurozone investors who currently have in- from investors who have been looking for safe euro-vested in Finland to be safe might not be willing to carry denominated investments and are not willing to carry thethe exchange rate risk. In addition, the European Central exchange rate risk associated with a small fringe curren-Bank might not be willing to secure liquidity by lending a country that is about to leave the eurozone. If foreign investors leave the small Finnish market, theCurrency risk related to euro-denominated funding liquidity of Finnish markka-denominated listed equityFollowing the transition period, the markka will be al- and bond markets decreases, risk premiums increase andlowed to float against the euro and the markka will be high fluctuations in prices become more frequent.made the only legal tender. Existing commitments may Funding of banks, companies and the central governmentremain euro-denominated, because their unilateral becomes more difficult and expensive. Increasing finan-amendment would collapse Finland’s credit rating, and cial costs decrease consumer spending and willingness tothe balance of the Finnish national economy in any case invest. General confidence weakens, and it will be diffi-supports the rate of the markka against the euro remain- cult to restore it. Credit taps are tightened, the economying close to 1:1. enters a recession, and the debt servicing capacity of the public sector weakens. The credit rating of Finland willFinnish banks have more loans granted to the public than be placed under credit watch due to the exit-related un-deposits, and some of the loans have been financed by certainty, and the risk of the credit rating being loweredborrowing from the euro market. This results in an ex- will increase. Leaving the euro without exit from the EUchange rate risk to the banks. The Bank of Finland may is not simple.carry part of the currency risk by making long-term for-ward contracts with the banks, i.e. committing to ex-change the markka at a fixed rate in the future. On the7 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  9. 9. ■ Split or breakup of the euroSplit or breakup of the euro• Germany’s exit leads to the breakup of the eurozone Domino effect or German exit may collapse the euro A chain reaction starting with the exit of weak countries• An imputed euro and euribor will be created may lead to the entire eurozone breaking up. When ex- pectations of the exit of weak countries increase, capitalNorthern euro strengthens against the southern one flight to safe countries will accelerate, and the centralIf the eurozone splits up into northern and southern euro- banks of the weak countries will have to support their fi-zones, the northern euro will retain the current euro and nancial systems by printing more euros. There is the riskinstitutions because the head office of the ECB is in of a total collapse in the value of the currency with theGermany. The problem countries adopting the southern central banks printing euros without limits.euro will have to be able to establish a central bank sys-tem and paper currency of their own. Splitting the central The eurozone may also break up due to the exit of Ger-bank system of the old eurozone in two and clarifying the many, a large and strong financing country. If Germanyclaims will be a painstaking process. decides to leave, the other strong countries will follow in its footsteps. The entire eurozone will break up becauseThe northern euro will weaken against the other main the remaining countries in crisis will not have the com-currencies with significant uncertainty shaking all of Eu- mon political will to build the required institutions.rope. However, the northern euro will strengthen againstthe southern euro as capital flows to a safe haven in the Germany leaving the eurozone will plunge the country’smarkets of the relatively stronger countries. Northern eu- own financial system to a chaos, even though the countryro countries seem more stable compared to the southern as a whole is at a surplus. Germany will suffer lossesones, and they will not suffer from the outflow of capital when the private and public problem country exposuresto the same extent. have to be rearranged. The German economy will suffer from the tightening credit taps of the banking sector,The northern economies will suffer considerable losses weakening demand in the export demand in the formerdue to their receivables from the southern eurozone. The eurozone and the strengthening currency.northern financial system will require significant support,which will increase the countries national debts. Fur- German banks have received safe-haven deposits fromthermore, the northern economies’ exports to the south the southern eurozone, which will begin to be repatriatedwill suffer due to the strengthening currency and fall in when the situation clears up. There will be disputes overdemand in the southern eurozone. The economy will en- whether deposits moved from southern Europe to Ger-ter a recession, but it will benefit slightly from low inter- many can be converted to D-Marks. Their conversion toest rates and the weakening of the currency against other the new domestic currency would lead to a decrease inmajor currencies. the value of the deposits because the new domestic cur- rency will devalue. Germany, on the other hand, wantsThe euro of the southern eurozone would devalue only domestic deposits to be converted to the new, strongThe value of the southern euro made up of the weaker D-Mark. In this case, the amount of money in Germanycountries will decrease. Foreign capital will flee the will not increase exponentially, which will restrict the in-southern eurozone, frightened by devaluation pressures, flation pressure.and the bank system will suffer with deposits fleeing tosafety, stuffed into mattresses or moved abroad. The Breaking up of the eurozone will be chaoticeconomy of the southern eurozone will fall all the way If the entire eurozone breaks up, the European Centralinto a depression, as the debt rearrangements of the cen- Bank will be closed down and its tasks will be trans-tral governments and the increasing number of bankrupt- ferred back to the national central banks. The Europeancies will consume banks capital and accelerate the credit financial system will collapse and Europe will end up indepression. Gradually, the weak currency will support a credit depression, from which it will not recover for athe exports of the southern economies. long time. The central banks of all former member states will provide their banks with unlimited liquidity. TheIf the debt of the southern eurozone countries is convert- banks will need new capital. The complete breakup of theed into southern euros, their value in northern euros will eurozone will plunge the entire global financial systemdecrease. This will make it easier to repay the debt of the into full-scale chaos. The entire eurozone will enter a de-southern area, but the devaluation of the currency will re- pression, which will have long-lasting effects in all coun-sult in increasing losses to the north in the southern euro- On the other hand, if the debt remains in northerneuros, the debt burden of the southern eurozone will in-crease, which will increase the probability of debt rear-rangements.8 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  10. 10. ■ Split or breakup of the euroAn enormous extent of negotiations on the currency to be Euribor is the most common reference rate in the eur-used in agreements will follow. One option is to adopt an zone, and the quoting of euribor interest rates would endimputed euro exchange rate, determined as the weighted in case of a complete breakup of the eurozone. In thisaverage of the new currencies of the euro countries. Such case, a substitute should be found for the euribor rates. Ina currency already existed before the euro in the form of practice, the substitute could be formed out of the newthe ”ECU basket currency,” which was exchanged into national interbank interest rates as an imputed interesteuros at a rate of 1:1. The exchange rates of the strong rate.surplus countries will strengthen in proportion to the oth-er former eurozone countries. If the debt is in imputedeuros, the strengthening of the new currency would de-crease the euro-denominated debt. The debt of weak def-icit countries would have the same fate as Greece’s debtin case of a Greek exit.9 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  11. 11. ■ Effects of the scenarios on the Finnish economy and marketEffects of the scenarios on the Finnish economy and marketsTable 3. Impacts on the Finnish economy Nordea’s base line Greece leaves Problem countries Only Finland leaves The entire eurozone leave breaks up Economic growth Effects on Finland The direct effects on Effects on the Direct effects on will accelerate are minor, because Finland are higher development of the Finland are gradually from this direct Finnish trade than in the previous Finnish economy are extremely high year’s below 1% to with and Greek scenario, because the minor in the best almost 3% in 2014 exposure are small problem countries case scenario The European account for a large financial system will Unemployment will The indirect effects proportion of the Finland’s exit will collapse remain at will also be minor to eurozone and 30% of escalate the crisis of approximately 8% Finland because Finland’s exports are the eurozone and the Credit depression until 2014 Greece is a small to the eurozone outlook for country and many economic growth After a very deep Inflation will remain preparations have Eurozone will enter will become plunge, the economy at slightly over 2%, already been made a financial crisis and gloomier will begin to recover but will not exceed for a potential Greek depression that will around the third year 3% even in 2014 exit be more severe and The currency may following the longer than the 2009 fluctuate greatly breakup Current account Finlands export crisis after the transition deficit will remain demand will begin to period Risk of increasing moderate recover from the Finland’s losses inflation slump caused by the from the Once the temporary exit within as little as rearrangement of uncertainty clears a year bailout packages, up, Finland begins to euro system and recover from the private sector claims euro exit within a will be significant year The remaining eurozone and Finland will begin to recover from the breakup of the euro around the third year after the exit10 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  12. 12. ■ Effects of the scenarios on the Finnish economy and marketTable 4. Effects of the breakup of the eurozone on the interest rates and interest rate derivatives Greek exit Problem countries Only Finland leaves The entire eurozone leave breaks up If the Greek exit is The capitalisation need If Finland’s euro- The euro will be replaced controlled and based on a of banks is considerably denominated bonds are with an accounting mutual decision in the higher than in the converted into markka- currency similar to its eurozone, it is likely that preceding scenario. The denominated bonds, predecessor, the ECU, the capitalisation of the problem countries will being marginal which is calculated by banks of each eurozone adopt their own investment, they will be weighing the national country will be secured if currencies, and with the subject to selling currencies. capitalisation is devaluation, covering the pressures, and Finland’s The ECU interest rate perceived necessary. In existing euro- interest rates will calculated on the basis of this scenario of a denominated debt will increase. the national currencies controlled Greek exit, the become impossible. If will be higher than the economic outlook will the debts of the problem The same phenomenon Euribor rate. This will improve. The interest countries are converted will apply to the issuance result in upside pressure rates will normalise and into their own currencies, of new markka- to fixed interest rates. long-term interest rates this will result in losses denominated bonds, even will increase more than to the bearers of the if the old debt remains The consequences of the short-term rates. bonds due to the euro-denominated. entire eurozone breaking weakening of the up will be of such a scale If Greece exits in an currency. The risk of devaluation that the market reactions uncontrolled way, the of the markka and will be considerable and market will begin to Increasing risks for the accelerating inflation. significant uncertainty is price the possible exit of banking sector will Receive Finnish associated with other problem countries. create upside pressure on inflation. predicting them. Interest rates will remain Euribor interest rates, low, and the European increasing the difference Pay long-term fixed stability mechanisms and with the overnight Eonia interest. Receive Finnish the ECB will secure the interest rates. inflation. financing needs of the problem countries. This Receive expanding will subsequently Euribor-Eonia interest increase the inflation rate differential. Receive pressure. inflation (eurozone or Finland). Pay long-term fixed interest. Receive inflation (eurozone or Finland).11 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  13. 13. ■ Effects of the scenarios on the Finnish economy and marketTable 5a. Effects on a Finnish company’s foreign exchange hedging: company exports Greek exit Problem countries Only Finland leaves The entire eurozone leave breaks up There is the risk of euro- If all of the problem The markka will be The markka will be denominated receivables countries exit, the adopted as the expense adopted as the expense from Greece being situation has a rather currency, and the currency, and the converted to the new similar logic to that of a strengthening of the strengthening of the Greek currency, which Greek exit. The new markka is a risk. It is not markka is a risk. It is not will devalue currencies of these currently possible to currently possible to considerably against the countries would probably hedge against hedge against the new euro. devalue against the euro fluctuations in the value currencies. Hedging (of the remaining strong of the markka. using derivatives Demand will fall countries). correlating with credit considerably due to both Hedging exports to risk could be considered. the economic situation Direct hedging against, outside the eurozone and the weakening of the for example, the (e.g. USD) carries the Hedging exports to drachma. weakening of the Italian risk of the hedging being outside the eurozone lira is impossible. for changes in the (e.g. USD) carries the With regard to foreign Utilising the country’s exchange rate of the euro risk of the hedging being exchange risks, one bankruptcy probability but not of the markka. for changes in the should consider, for could be considered as a exchange rate of the new example, if it could be hedging option. The The most problematic basket currency ECU but possible to ensure the probability of Italy’s scenario is that the euro not of the markka. payment of the least euro exit is likely to will weaken significantly open deals in euros correlate with the and hedging with a The most problematic through contractual country’s bankruptcy forward contract results scenario is that the new arrangements. Risk of probability, in which in costs while the markka ECU basket currency the customer’s case credit risk strengthens. will weaken significantly insolvency. derivatives could be used Options are useful for and hedging with a for hedging against the this problem instead of a forward contract results exit. binding (forward, etc.) in costs while the markka hedge. strengthens. An option would hedge against the weakening of Options are useful for USD, for example, but this problem instead of a would not be binding in binding (forward, etc.) the event of a Finnish hedge. exit.12 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  14. 14. ■ Effects of the scenarios on the Finnish economy and marketTable 5b. Effects on a Finnish company’s foreign exchange hedging: company imports Greek exit Problem countries Only Finland leaves The entire eurozone leave breaks up The drachma weakens The situation has a The markka will be the The markka will be the and provides an similar logic to a Greek income currency, and income currency, and opportunity for exit. there is a risk of the there is a risk of the decreasing import prices. markka weakening markka weakening Specific hedging against The supplier’s expense against the purchase against the purchase this currency scenario is currency weakens and currencies. currencies. probably not as provides an opportunity necessary as for, e.g., an for decreasing import Forward contract involve Forward contracts export company. prices. the risk of the euro and involve the risk of the the markka developing in new ECU and the One could, for example, different directions. markka developing in as a contractual way Options, for example, different directions. consider how to reserve could be considered as Options, for example, an opportunity for the solution. could be considered as quickly renegotiating the the solution. purchase prices. Hedging purchases from the current eurozone Hedging purchases from countries is not directly the current eurozone possible. countries is not directly possible.Table 5c. Effects on a Finnish company’s foreign exchange hedging: foreign subsidiary Greek exit Problem countries Only Finland leaves The entire eurozone leave breaks up Local demand will Similar risks to a Greek The group’s home The group’s home decrease. In addition, exit. The risk of the currency will be the currency will be the there is a risk of the currency weakening markka, and there is a markka, and there is a drachma weakening and decreasing the value of risk of the markka risk of the markka decreasing the value of the holding. If the strengthening against the strengthening against the assets. One should national currency currency of the holdings. currency of the assets. In prepare for strong overshoots, the impact the event of a complete fluctuation, which has a could quickly affect the The impact in the event breakup of the euro, the considerable effect on group’s equity and of a Finnish exit will effect could be rapid and the group’s equity and balance sheet covenants. probably be not as great preparations for the balance sheet covenants, as, for example, in the weakening of, e.g., for instance. Local lending can be breakup of the entire equity and balance sheet considered as a potential eurozone, but there is a covenants would be As a sort of option, one natural hedge. risk of major changes on useful. Changes in the might think about the balance sheet. value of assets in whether a euro- Germany and other denominated loan taken To the extent that the strong countries might by the subsidiary locally Finnish parent’s external partly offset this. could function as a euro-denominated loans natural hedge: would the finance subsidiaries in Local funding could be a euro-denominated loan other Eurozone natural hedge. taken in Greece be countries, it is essential converted into drachmas, that the loans remain which would compensate euro-denominated. for the decrease in the euro-denominated value of the drachma assets?13 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  15. 15. ■ Effects of the scenarios on the Finnish economy and marketTable 6. Effects on corporate bondsGreek exit Problem countries Only Finland leaves The entire eurozone leave breaks up A majority of Greek The European corporate If Finland exits of its The number of companies will find bond market is already own accord, increasing bankruptcies and credit themselves in financial considerably mixed up, uncertainty and possible events will be extremely difficulties and a credit and the number of credit speculation concerning high – applies to all euro- event. events is significant also the next exit decisions denominated bonds. outside the problem are the most significant Because refinancing is For credit rating agencies, countries. indirect effect on the practically impossible, the conversion of the corporate bond market. there will also be currency of the bond The same principles as in defaults in bonds in other alone gives rise to a credit the case of Greece: Finnish export-driven currencies than euro. event. companies whose companies would suffer operations take place from continuous In contrast with the In the slightly longer outside the eurozone and uncertainty in Finland previous scenarios, the term, export companies Europe to a significant and the rest of Europe consequences to and subsidiaries of large extent are in the best alike. corporate bond markets international corporations position. are enormous also would be in the best In contrast with, for outside the eurozone and position. Sufficient Because the European example, the Greek exit Europe. liquidity plays a key role. financial market is mixed scenario, the transition up, an extensive funding period from the euro to In the longer run, the The effects on most base plays a key role, the markka could be normal regularities will Nordic companies would which includes a good long, and existing loans apply: extensive funding probably remain more relationship with major could possibly remain base, geographic limited than on French banks and access to euro-denominated. distribution, cyclicality companies, for example, financial markets outside and competitive due to the lower volume the eurozone The risks of Finnish situation. of exports and banks’ companies will increase risks. Non-cyclical companies in the form of currency Companies that are will fare better risks. critical for public activity operationally, but and safety and have taxation pressure on operations across borders these companies will are in the best position. increase hand in hand with the governments’ difficulties. Furthermore, the creditworthiness of state-linked companies will, relatively speaking, weaken the most due to no longer being supported by the government ownership.14 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  16. 16. ■ Effects of the scenarios on the Finnish economy and marketTable 7. Effects on the equity marketGreek exit Problem countries Only Finland leaves The entire eurozone leave breaks up The market is turbulent The markets will price in The short-term reactions Risk premiums will until the Greece-related a considerably higher are remarkable increase considerably, liabilities of companies risk than in the exit of turbulence, high risk and the pressures are and financial institutions Greece alone. premium and flight of comparable to the are fully known. foreign capital. development in 2008– Risk premiums will 2009. For Finnish companies, increase significantly, The longer-term the direct Greek and with particular consequences depend on Finland will remain exposure is small, and regard to cyclical and the value (and stability) underweighted in the pressure on valuation is indebted companies, the of the currency. The risk allocation of mainly caused by the pressures are comparable premium, however, will international investments general uncertainty. with the development in remain higher. (foreign ownership 2008-09. decreased following the Since the possibility of Lehman crisis and has an exit has already been The competition field not increased to a assessed and it has been will transform in sectors significant extent). possible to prepare for it, with competing capacity the market turbulence in southern Europe (e.g., Consumption and may remain short-lived. paper, steel). The strong investment demand will euro of the strong weaken significantly. countries will burden the competitiveness of The risk premium of exports. shares listed in Finland will increase at a steeper rate than the risk premiums of companies listed in capital markets perceived safer.15 WHAT IF THE EUROZONE BREAKS UP? │ OCTOBER 2012 NORDEA MARKETS
  17. 17. For further information:Aki Kangasharju, Director, Head of +358 9 165 59952Suvi Kosonen, +358 9 165 59002Nordea MarketsResearch FinlandAleksis Kiven katu 9, 00020 NORDEAnordeamarkets.comTel (09) 1651Nordea Markets is the name of the Markets departments of Nordea Bank Norge ASA, Nordea Bank AB (publ), Nordea Bank Finland Plc and Nordea Bank Danmark A/S.The information provided herein is intended for the sole use of the intended recipient. The views and other information provided herein are the current views of Nordea Markets as ofthe date of this document and are subject to change without notice. The views have been provided solely based on the information made available to Nordea Markets and for thepurposes of presenting the services made available by Nordea Markets. This notice does not substitute the judgement of the recipient.Nordea Markets is not and does not purport to be an adviser as to legal, taxation, accounting or regulatory matters in any jurisdiction. Relevant professional advice should always beobtained before making any investment or credit decision.This document may not be reproduced, distributed or published for any purpose without the prior written consent from Nordea Markets.