Tuesday, February 14, 2012

>The worst-case scenario for Greece and Portugal: What effects?

Let us assume that the worst-case scenario for Greece and Portugal unfolds: their fiscal solvency does not improve and they decide to default completely on their public debt, for all the holders.

- What would be the effects in that case?

- they would not leave the euro, given the weight of their imports;

- they would have to nationalise and recapitalise their banks;

- if their banks went bankrupt, the European System of Central Banks would incur losses on their holdings of Greek and Portuguese debt, both directly and as collateral for repos to Greek and Portuguese banks;

- the losses for other euro-zone banks (non-Greek or Portuguese) would amount to 0.2% of their total assets, which is very little; those for non-bank investors of all kinds would amount to 5% of their total assets, which is considerable;

- after the default, the fiscal solvency of Greece and Portugal would practically be restored; these two countries’ external solvency would be greatly improved;

- the contagion to other euro-zone government bonds would probably be quite limited, which would not have been the case one year ago.

We imagine that the worst-case scenario in Greece and Portugal unfolds: a total and across-the-board default on their public debt (Charts 1A and B). It may be impossible to avoid this default, given the irreversible deterioration in their fiscal solvency: negative growth (Chart 2), making the restrictive fiscal policies inefficient in terms of reducing the fiscal deficit (Charts 3A and B), which is already the case in Greece; fall in public (Chart 4A) and productive investment (Chart 4B), leading to a loss of potential growth.

To read the full report: WORST-CASE SCENARIO