A disorderly exit by Greece from the eurozone that sparks a systemic crisis in Europe could lead to a severe recession in Canada, warns a new report.

With concerns about Greece’s future on the rise, following its recent inconclusive elections, TD Economics examines the possible ramifications of its exit from the eurozone for Canada. It warns that in a worst-case scenario, a more-vulnerable Canadian economy could be hurt worse by the resulting market turmoil than it was by the 2008 recession.

According to the report, Canada’s direct trade exposure to Europe is fairly small, at just 10% of total merchandise exports, and direct financial exposure is rather slight, too. TD says the Canadian economy is most likely to feel indirect effects — through the impact of global financial market turmoil, and lower commodity prices.

However, given that the Canadian economy is in a more fragile position than it was back in 2008, in the event of a worst-case scenario, where a Greek exit leads to a systemic crisis in Europe, TD predicts, “Canada’s economy would endure a severe recession, with the decline being substantially worse than that experienced during the 2008/2009 recession.”

If Greece does exit the eurozone, it will be a major financial shock, TD says. “Financial markets will immediately start to speculate that other countries will follow suit. Ireland, Portugal and Spain will come under the most financial distress,” it suggests.

If European policymakers are unable to stem the contagion, it could become a systemic event. “A systemic global banking crisis would weigh heavily on Canadian financial markets,” TD says. Investors would likely flee to U.S. dollar-denominated investments, and the loonie would weaken substantially against the U.S. dollar, it suggests.

“And with commodity prices likely falling amid concerns over a weakening global economy world equity markets would tumble. With Canada’s heavy focus on commodities, the S&P/TSX would likely be hit particularly hard in the aftermath of a disorderly Greek exit from the eurozone,” it says.

While the Canadian banks have little direct exposure, concerns about counterparty risk would likely disrupt the interbank funding markets, and raise bank funding costs once again, TD notes. This could lead the Bank of Canada to cut the overnight rate to its lower bound of 0.25%, it suggests, and possibly to further unconventional easing measures, if necessary.

In the real economy, TD notes that Canada is more vulnerable now than it was heading into the last major recession due to excessive household debt, and a housing market that TD believes is 10%-15% overvalued. “A global financial crisis could be a major catalyst for a sharp housing market correction and household deleveraging,” it says. And, Canadian governments would have less room to stimulate compared to the previous crisis.

While it still expects Canada’s economy to see moderate growth, with household debt and housing prices coming down gradually over time, it says “a disorderly exit of Greece from the eurozone represents the number one risk to Canada’s economic outlook.”