Column: Greek roulette

By: | Updated: February 24, 2015 11:30 AM

Debt default and exiting EU would be painful for Greece, but other EU nations will not get away unscathed either

The Latin phrase, Timeo Danaos et dona ferentes (Aeneid, Virgil), translates into “Beware of Greeks bearing gifts”. This old saying should have been heeded when 240 billion euro was provided by the EU, ECB and IMF to resuscitate the Greek economy in 2010. Greece, on its part had agreed to all the conditions that were placed especially on fiscal austerity, and the euro crisis seemed to be probably over. Strict cuts in expenditure, higher tax rates and extended working years with fewer pension payouts were all part of the deal which was accepted. But was there any guarantee that it would continue to comply with these conditions, especially as governments tend to change?

The issue has come to the fore today with the Syriza coming to power and the government is to be headed by Alex Tsipras whose election plank was to do what was best for Greece’s citizens, i.e., go back on its commitments to the euro-world and revert to its liberal policies on fiscal balances in particular.

Greece may have a story that could engender sympathy. GDP growth since 2009 has been negative indicating that a recovery was never on the cards. Between 2009 and 2013, the GDP declined by 28% on a cumulative basis. The unemployment level increased sharply to 27.3% in 2013 and this rate among the youth has been estimated to be over 50% (around 7.5% in Germany). This is not a good sign for any country. The government’s debt-to-GDP ratio rose from 120.4% in 2007 to 133.2% in 2009, before declining for two years and increasing again in 2012 to 163.6%; It is is estimated to be at 175% in 2014. The fiscal deficit is still around 12% of GDP.

The new PM has a five-point programme to keep his promises. First, the minimum wage is to increase from 580 euro to 750 euro per month. Second, the government has promised to provide 300 units of free power and food subsidy to households below the poverty line. Third, Tsipras would work to have some debt written off and also tie the same to economic growth rather than the budget. This argument will find support from economists given several countries have tied themselves to a slowdown by following the path of fiscal austerity. In the same length, it can be said that there would be a better chance of servicing debt if growth had taken place generating revenue which could be used to service debt.

Fourth, there is a move to scrap the tax on property while the last point on the agenda is to forge closer ties with Russia, which can be disturbing for the Western nations. Tsipras had, in fact, opposed the EU sanctions on Russia when the latter invaded Ukraine. Russia is already the largest trading partner and accounts for the large tourist inflow into Greece.

What could be the implications in case Greece was to default and then told to walk out of the alliance? Greece accounts for less than 0.5% of the population of the set of 19 euro countries and just about 2% of its GDP. A default on its loans could mean an exit from the alliance forever. The burden of adjustment has been on countries like Germany, Austria, Belgium, etc. which have followed prudence all along. It is unlikely that they would acquiesce to any further renegotiation with Greece or restructuring of debt and simultaneously allow it go on spending as it did earlier. This could mean Greece going back to the drachma or a new currency which will be severely devalued. What does this mean for the world economy?

First, it will set a precedent for all other recalcitrant nations that there would be no tolerance. Second, a run on the banks is but natural as deposit holders would try and draw out euros to be used elsewhere in future. Third, the banking system would collapse with capital already being scarce at just about 8%. NPAs were at a high of 33.5% in 2014 and have been increasing since 2009. Borrowers too would be unwilling to service their loans under these conditions.

Fourth, the cost of going to a new currency would be high and there would be reluctance for other nations to deal with the drachma to begin with. Fifth, foreign banks, especially other European banks that are holding on to Greek debt, would take a major hit as the government would not be able to repay debt since the total forex reserves are just around $6 billion. This will mean a pile up of bad assets in their home countries and probably some support from their respective governments. The CDS on Greek sovereign debt has gone up by 550 bps in the last fortnight. Sixth, the euro would tend to weaken further against the dollar until equilibrium returns. Last, the Greek economy would collapse sharply and enter another painful recession which can have serious social implications given the unrest that is already there in the country.

While the pain would be more for Greece in case of an exit, given the banking linkages and the debt extended by the troika—ECB, EC and IMF—there would be significant spillover effects across the region.

Greece has repayment deadlines for debt in March, July and August, and it looks unlikely that it would be able to meet these commitments and would have to go in for restructuring. Any decision to permit such a move would be contingent on the new government adhering to the austerity lines. Therefore, there is consternation on whether or not the Tsipras government will stick to the past commitments or break away given the domestic promises made at the time of elections. The next month would be critical for Greece and currency and stock markets across the globe as the absence of a solution would enhance volatility against uncertainty.

The author is chief economist, CARE Ratings. Views are personal

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