Nikhil Kumar: Even the most orderly of Greek defaults could prompt unprecedented disorder

A senior EU official summed up the prevailing view in the markets yesterday when he said the idea of an orderly default by debt-laden Greece was "an illusion".

In fact, Marco Buti, the European Commission's director general for economic and financial affairs, said there "are two illusions". "The first is that it can make an orderly restructuring," he said, referring to the plans in July to involve the private sector in a reorganisation of the country's debt.

The second, he added, was the idea that Greece's debt woes could be contained. "The risk of contagion is enormous," he warned, once again echoing the fears rattling the markets.

Analysts agree, pointing out that an orderly default was "more or less" where policymakers signed off in July. The voluntary debt exchange offer, which will leave holders of Greek debt with losses or "haircuts" of about 21 per cent on bonds that mature before 2020, is an orderly way of easing Greece's burden, Marchel Alexandrovich, senior European economist at Jefferies, said.

"In a disorderly default Greece basically makes haircuts without consultation and walks away from its liabilities," he explained. Such a scenario would send panic through the system, as the market attempted to identify the biggest losers. "[Policymakers] will try to keep things as orderly as possible but you can't be certain of any kind of forecast in this environment."

A full-blown restructuring would also have to cover all sorts of eventualities, or risk seriously destabilising the financial system.

"All kinds of threats would have to be deflected if default were to be anything other than extremely disorderly," Stephen Lewis, chief economist at Monument Securities said in a circular to clients yesterday. "First of all, the Greek banks would need to be underpinned to avoid doubts about their solvency, setting off a contagious flight of funds from banks across Europe and beyond. Similarly, the French banking system would need capital support, if only because the financial markets believe French banks to be over-exposed to Greek sovereign risk."

And then there is the risk of contagion highlighted by Mr Buti. If Greece defaults, the markets will "instantaneously" begin speculating about other countries, Mr Alexandrovich warned. The list of candidates is long, he said, pointing to the other debt-laden countries on the Continent's periphery.