The result of the Greece parliamentary election on Sunday gave the proausterity conservative and socialist parties, New Democracy and Pasok, enough votes to form a ruling coalition. With 99% of ballots counted Sunday night, New Democracy had 30% of the vote, compared with 27% for Syriza. Pasok was third with 12%.
This is the best election outcome for financial markets as it means Greece will stay in the eurozone, at least in the short term. Investors feared a win by the anti-bailout leftist Syriza party, or an inconclusive result, which would lead to more political instability in Greece. The election outcome is in line with our base-case scenario outlined in our Macro note released on 15 June (Greek election: A vote for the euro).
New Democracy party, which came in first, has earlier pledged to continue cooperating with Europe. We now expect a New Democracy led coalition will be formed with Pasok that commits to the targets of the Troika’s program and follows through with the agreed austerity measures. The Troika might agree to some softening of the conditions of the bailout.
This would allow Greece to remain in the euro area for some time. However, as we already wrote in our Macro note, in our opinion, even with a pro-bailout government in parliament, it would most certainly experience difficulties meeting the Troika’s targets. The Greek public is tired with austerity measures and pressure would continue to build against unpopular cost-cutting, bringing with it the increased likelihood of social unrest. The sustainability of the government could also be an issue, with radical opposition parties being a disruptive force in the continuation of the austerity program.
If Greece continued to miss the austerity targets, while at the same time ring-fencing measures were successfully implemented – to the extent that an isolated Greek exit seemed possible – this could at some point drive a political decision to force Greece out of the eurozone. We assign a 60% probability to Grexit in the next year or two. This is our base-case scenario in the medium-term.
With this vote's outcome in Greece we are likely to some near-term gains for beaten down equity markets. We expect WIG20 to turn positive and the zloty to strengthen today, in a short-term relief that Greece’s election did not lead to an escalation of the euro zone's crisis. Asian markets already reacted positively - in Asian trading Tokyo's Nikkei was up 1.8%, and Hong Kong's Hang Seng Index gained 1.0%.