Growth supportive, with risks, but also upside potential Greece is enjoying sustained but modest growth after several years of negative shocks.
However, external risks have increased and the lack of credit, weak capex and high uncertainty have kept the recovery weak. Our macro discussion points to the crucial importance of implementing key reforms. Political stability after the elections, but one tail risk After New Democracy (ND) comfortably won the EU and local elections in May, the polls ahead of the National Elections this Sunday suggest a similar outcome.
The question is whether ND will win absolute majority, or will need to form a coalition. Following formation of the new government, Greece can enjoy political stability as there is no any other election for the next 4 years. However, a tail risk is if ND cannot form a government, leading to another election in August and high uncertainty. Challenges for the new government The new government will have a window of opportunity to address a number of difficult challenges.
The fiscal situation may have gotten off track. The still very high stock of non-performing assets in the Greek banks remains Greece’s weak link and main obstacle to a faster recovery. The new government will also need to prove that Greece can turn a corner in structural reforms. Early progress in all three areas after the elections will be very important, in our view, to send a strong signal of a clear break with the past.
Bond outlook A confluence of factors supported the significant tightening in GGB spreads, but we see more potential ahead as the search for yield extends. GGBs could also outperform the rest of the periphery if the ECB decides to raise the cap it imposed on Greek banks' exposure to Greek government risk and/or the rating outlook improves, raising prospects of a QE inclusion at some stage in coming years.
If the elections provide for a clear majority and thereby signal political stability, we would recommend that investors position for further tightening in the 10y GGB-Bund spread. Risks would then be related to a deterioration in the Eurozone outlook or a sharp re-pricing in Bunds. The new government will also have to continue complying with the post program targets.