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Is Greece eventually moving towards a eurozone exit?
It was expected that multi-billion euro bailout packages and stringent austerity measures would create the desired effect and save Greece. But given the events post the 50% write down, which reduced Athens’ debt by €100 billion, it seems Greece’s exit from the eurozone is a ‘very real’ possibility.
Issue Date - 24/11/2011
On July 21, 2011, Angela Merkel, Germany’s Vice Chancellor convened an emergency meeting in Brussels (Belgium). Member states of the eurozone were summoned to take key decisions pertaining to addressing the crisis. But more importantly, the meeting called for deciding on the fate of Greece – which without more money being injected – was about to default on its overwhelming debt which stood at €91 billion. At the end of the meeting, Greece was granted yet another bailout worth a staggering €109 billion taking up the total amount of money pumped into the Hellenic Republic to €200 billion. The eurozone’s rescue fund – the European Financial Stability Facility (EFSF) – was also boosted by €190. While the repayment period was extended to 15 years from the erstwhile 7 years, interest on repayments over bailout funds was reduced to 3.5% from 5%. These relaxations not only indicated that keeping the Union intact was of paramount importance to the Europeans, but also convinced markets across the globe that Athens would not default on its debt – not in the near future at least.

But as it turns out, expecting anything out of the bargain was utter hogwash. An October 21st revaluation of Greece’s financial condition revealed that the EFSF – given its commitments to Ireland and Portugal apart from Greece – was not well equipped to support the mounting debt ailing Athens. A fresh analysis reveals that Greece would be needing €252 billion to finance its debt instead of the €109 billion agreed upon on July 21. Eurozone members realised that at this pace, Greece would end up eating into the funds reserved for Ireland, Portugal and Italy. As a result, another meeting was summoned on October 27. After more than 10 hours of negotiations, eurozone members finally came out with a supposed plan to save Greece – the private sector agreed to take a 50% cut on Greek bonds, which in turn reduced Greece’s debt by €100 billion. Prior to this, the Hellenic Republic’s debt burden amounted to 160% of the value of the economy. Now it has come down to 120%. Further, the deal also encompassed a bailout package of another €100 billion.

However, nothing seems to have changed. Instead of receding, yield on Greek bonds surged (yield on 10-year debt jumped 235 basis points in the week following the new arrangement). Moreover, Greece will only manage to repay its creditors if the recovery rate is strong. The possibilities of this happening look bleak once you consider that Greece would have a GDP equivalent to 2008 levels in 2015 (that makes it the slowest recovery in eurozone)!

As is evident, the austerity measures demanded by the eurozone and International Monetary Fund in lieu of these bailouts have proved to be counterproductive – having contracted 16.5% over the past three years, Greece’s GDP might shrink another 10% if spending does not increase. That seems very likely given that austerity is being used as yardstick for measuring improvements in the economy. An internal devaluation (lowering nominal wages and prices relative to other eurozone neighbours) could have been considered as a possible tool to save Greece. After all, it had worked with the Baltic countries where, in order to re-establish competitiveness, wages were slashed during 2008 and 2009. As a result, growth recoiled in Estonia, Latvia and Lithuania in 2010. But a cursory look into the dynamics of the Baltic nations makes it evidently clear that such a measure will not work with Greece. Take Estonia for instance. Theirs is primarily an export based economy (exports make up for 70% of GDP). Moreover, 2/3rd of exports are goods instead of services. Greece by contrast is starkly different. Having been intertwined closely with the eurozone, the economy is largely ‘closed’ with almost three quarters of demand coming from consumer spending. As against Estonia, exports represent just 20% of GDP. In fact, more than 50% of the exports are services based (tourism and maritime transportation). In essence, Greece is diametrically and fundamentally different from the Baltic nations in form and factor. If wages were slashed, it would result in demand falling drastically rendering the region in more trouble. Therefore, the concept of an internal devaluation stands grossly inapplicable in this case.

Given these circumstances, a possibility that was being silently debated has now taken the form of active discussion – disintegrating Greece from the eurozone. After all the bailouts and write downs, it does seem that Greece will eventually default on its debt and exit the union. Speaking to B&E, Mustafa Akcay, Assistant Director, Moody’s Analytics reveals that he does consider this to be a possibility but sounds cautious when he says, “An exit from the eurozone would be very costly, as well as difficult to manage. The scenario could become nightmarish for Greek financial institutions that have borrowed heavily from abroad.”

Whether Greece decides to exit the eurozone is a different case, but right now, EU leaders should do all they can in order to give Athens the incentives to stay back (even if it means revising the terms of the deal announced on October 27 and making them more favourable). Because if Greece decides to leave, then the broader ramifications for fellow EU nations would be overwhelming.

Amir Moin           

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