Risk of domino effect

Following the "No" vote in the Greek referendum on July 5th the spectre of Grexit is becoming increasingly likely unless euro zone leaders find a compromise with the Greek government before a crucial EU summit on July 12th. The EIU—the only major forecaster that predicted the "No" vote in the Greek referendum—believes that the risk of major market contagion from a possible Grexit would now be less severe than if Greece had exited the currency area in 2012. The first three months after Grexit would be likely to see limited financial-market contagion, but there are major concerns about further exits in the medium term. A key factor in mitigating contagion from a potential Grexit will lie in convincing markets that Greece is a unique case that will not be repeated in other euro zone countries. However, our survey shows that many business leaders are not convinced that Greece will remain an isolated case.

Although the repercussions of a Grexit may be manageable in the short term, there are major risks in the medium term. These include possible negative impacts on consumer sentiment in countries like Germany and the ability of governments like Spain and Italy to raise funds in the market. A Grexit would also remove the pretence that euro zone membership is irrevocable. Investors could increasingly lose confidence in the ability of other countries, especially in the euro area's Southern rim, to repay their debts and remain in the currency area.

The risk that this potential domino effect could eventually lead to the collapse of the euro area as a whole is highlighted in our survey: 11% of respondents believe that the euro will no longer exist as a currency in 10 years' time.

Grexit now increasingly likely

As these survey findings highlight once again, the current Greek crisis is about much more than Greece. In fact, survey respondents perceive Greece's investment environment now as more risky than that of Nigeria or Russia and only slightly less risky than Iraq's. Despite the risk of a domino effect of a Grexit mentioned above, the investment environments of the other vulnerable Southern euro zone countries—Portugal, Spain and Italy—are seen as less than half as risky as Greece's at the moment.

Given the rising risk of a Grexit and its possible negative implications for the viability of the euro zone as a whole, at least in the medium to long term, how likely is a Grexit? The EIU sees a likelihood of 60%. The business leaders surveyed for our flash poll also see Grexit as more likely than not: 62% of respondents rate the likelihood of Grexit over the next two years at 51% or over. A fifth (20%) rate the risk at 81% or higher.

ECB's response is crucial

Despite the political posturing on the Greek and EU sides, it is the ECB that is eventually likely to bring about a Grexit by withdrawing support from the Greek banking sector. A debt repayment that Greece has to make to the ECB on July 20th may act as a trigger for Grexit. What do business leaders say should be the ECB's response to the current standoff with Greece? Despite the risk of a domino effect, they tend to prefer a tougher line on Greece, possibly having in mind that a soft line on Greece could slow down the reform progress in other euro zone countries. Any weakness the EU shows now could create moral hazard ahead of an important election in Spain, where the radical left are expected to do well.

More than half of our survey respondents (60%) want the ECB to continue to freeze its support for the Greek banking sector until the Greek government agrees to the EU's bail-out terms. A relatively smaller share (28%) wants the ECB to supply additional emergency loans to Greek banks. Around 36% of senior executives want the ECB to step up purchases of euro zone government debt in response to the current crisis.

Business community unsure amid signs of resilience and opportunism

But how do business leaders themselves expect to react to the escalation of the crisis? Uncertainty is high: almost half of respondents do not know how their organisations are likely to react to the crisis. Unsurprisingly, business executives expect to decrease their exposure (in terms of selling assets or reducing investments, for example) in Greece (48% intend to do so) and the other Southern rim countries (31%).

However, some business leaders are surprisingly bullish—or opportunistic perhaps. Many respondents say that their organisations actually intend to increase their exposure (for example by buying distressed assets) to all of the euro zone (38% say they are likely to do this). European respondents are particularly keen on increasing their exposure to the euro zone: 43% intend to do so, while only 13% plan to decrease exposure. But other executives seem to seek opportunities elsewhere in Europe as a result of the Greek crisis: 40% of business leaders worldwide are likely to increase exposure to non-euro zone Europe.

Hence, the prospect for increased investment in the euro zone and wider Europe is reasonably good. However, the eyes of the business community in Europe—and the rest of the world—will remain on Greece these days given the rising risk of Grexit and its potential repercussions.

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For an infographic summarising the key survey findings and implications, click here.

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The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of The Economist Intelligence Unit Limited (EIU) or any other member of The Economist Group. The Economist Group (including the EIU) cannot accept any responsibility or liability for reliance by any person on this article or any of the information, opinions or conclusions set out in the article.