Should Greece leave the eurozone?

2011-09-16József Péter Martin

There seems to be no solution to the Greek crisis – as yet. Some say Greece will leave the eurozone, which would ease its situation and that of the EU. What is the probability of a Greek secession?

Bad news continues to come from Greece, the most battered country of the eurozone. At the beginning of this week, the risk premium (CDS - credit default swap) on Greek bonds jumped to a new high, reaching 4,700 basis points on Monday. Just to compare: the same indicator for Hungarian securities also reached a two-and-a-half-year high, but still stood at tenth of the Greek premium, at around 470 basis points on Tuesday. In addition, the yield on 10-year Greek bonds soared to 24%, while it went to an incredibly high 70% (!) in the case of the two-year paper.

Market analysts have long been warning that an explicit state default in Greece seems to be inevitable. Bruegel, a Brussels think tank, came out with calculations already in February that Greece’s national debt, which stands at about 150% of GDP, cannot be outgrown, i.e. Athens will not be able to pay its obligations. Growing out the debt is simply impossible, since it would necessitate a primary budget balance surplus of around 8% over the next 20 years – a surplus of such a magnitude has not been seen anywhere in the past 50 years, apart from a few years in Norway. In this sense, Athens has been in de facto state default for months. Credit rating agencies rate Greek bonds “junk”; at Moody’s, Greece is on the same level as Cuba.

Seemingly, neither the privatization program that was launched in the spring and was hoped to bring around €50 billion into state coffers, nor the latest idea of introducing a property tax, are able to solve the double task of policymakers, i.e. stabilizing the budget and stimulating the economy. Neither of these indicators looks to be improving: the economy is seen contracting by 5%, and the budget deficit is still 9% of GDP this year, according to the Athens government. After the two bailouts of the last 16 months, the policies enacted to handle the crisis seem to be failing. Austerity measures are hindering growth and thus increasing debt as a percentage of GDP, while fiscal loosening would cause an immediate and unmanageable disaster on the bond market.

EU policymakers, above all German politicians, are trying to limit the effects of a likely explicit default as German banks are strongly exposed to Greece. This week’s statements by leading German politicians talk about a “controlled default” that would certainly include some across-the-board entitlement cuts (haircuts) and debt restructuring, but in a managed way.

However, some say Greece could leave the euro area either by itself, or will be forced to do so. According to billionaire financier George Soros, the EU would survive if Greece and Portugal abandoned the euro, which is probably true, technically. But despite its hopeless situation, I do not think Greece will leave the eurozone, for which there are at least three reasons.

Firstly, this would cause an even bigger tragedy to Greece, its old-new currency would depreciate tremendously and its asset prices would plunge. There would be even less chance of Athens paying back any of its obligations than when it was in the euro area. Consequently, western banks would suffer considerable losses.

Secondly, Greece’s GDP is less than 5% of the overall income of the EU, so its debt, in nominal terms, is not an impossibly insurmountable problem. To put it simply, there is money to save Greece, as there is money to save Portugal and Ireland, if it is necessary. Spain and Italy are a different issue: their debts simply cannot be bailed out by the EU. Just to get an idea of the magnitudes here: the combined debt of Greece, Ireland and Portugal by and large equals that of Spain, and the debt of these four countries equals that of Italy.

And thirdly, there is an argument concerning the logic of EU integration. It has never happened in the history of the EU that the integration process clearly and explicitly took a step back – towards disintegration. There have been periods where for a long time, the EU did not move toward “an ever closer union,” but, up to now, it has never openly stepped back. And although nothing can by completely excluded these days, as the crisis has already produced a number of unprecedented events, this break in the integration process that a Greek secession from the eurozone would mean seems to be improbable. If it happens, that may signify the beginning of the end not only for eurozone but also for the EU.

German politicians have pledged repeatedly that they want to save the euro and the EU by any means necessary. If this is so, then we can expect a controlled Greek default rather the exit of the Hellenic Republic.

Keywords:

eurozone  greece  cds spreads  

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