Should Greece leave the Eurozone or not? This has been a recurring headline in the press for the last 8 months as the country's sovereign debt crisis has sparked fears of a potential exit from the Eurozone.
Despite two massive bailouts worth about €249bn from Eurozone member states and the International monetary Fund (IMF), Greece's membership of the Euro still remains at stake. About 70% of Greek government bonds were held by external investors including global banks. As a result, the bailout funds were primarily used to cover the maturing bonds and of course reduce the soaring budget deficits.
At the moment, the Greek government highlighted that the country will be short of cash by June end, resulting in an inability to reduce any existing debt and/or pay wages and pensions of civil servants.
Greece in a fiasco
Subject to the terms of the bailout, Greece had/has to stick to the spending cuts and fiscal discipline that had been agreed with other Eurozone nations and the IMF. Any breach will result in Greece's loans being withheld, forcing the country to default on its debt and might cost them a place in the Eurozone.
The country has struggled to form a government and the next presidential election scheduled for June 17 seem set to leave power in the hands of left-wing party Syriza that pledges to reject spending cuts. Conversely, polls conducted show that the majority of Greeks prefer the Euro as their currency but oppose to the austerity measures that has already led to mass poverty and high unemployment.
Greece is currently in the hands of a lethargic caretaker government who are unsure of whether to listen to the demands of the citizens or proceed with the cost-cutting plans. Until the new government has been formed, the European Union and the IMF are not willing to disburse any further aid to the country.
Investors wary of Greek default
In the midst of the financial chaos, Greece saw its chances of staying in the Eurozone fade away as millions of Euros were withdrawn from Greek accounts fuelled by fears of a bank run.
International credit rating agency Fitch, downgraded Greece's debt rating from C (highly vulnerable) to RD (restricted default). About 95% of the holders of Greek government bonds took part in the debt swap which caused heavy economic losses to private creditors. As a result, International Swaps and Derivatives Association (ISDA) acknowledged a credit event, implying that €3.5billion worth of credit default swaps would be initiated.
Some experts have argued that the best option for Greece is to regulate an orderly default on the nation's public debt and reintroduce a national currency such as its former Drachma at a devalued rate. It is apparent that regaining their old currency would bring about increased competitiveness but would this be enough to outweigh the costs of being axed from the Eurozone?
What if Greece leaves the Eurozone? What next...?
As the Greek economy continues to contract sharply, the nation may be forced to freeze loan payments to its creditors, which could result in a loss of confidence in the Eurozone Banking sector. All eyes are now on the June 17 elections. If the anti-austerity party wins, then Greece may have to kiss the Eurozone goodbye unless German Chancellor Angela Merkel mollifies her stance on cost-cutting. What if Greece leaves the Eurozone?
Greek crisis
Greek banks in Greece would be facing collapse. The funds locked up in bank accounts will either be withdrawn by ordinary Greeks (or external investors) or frozen. As the banks crumble, it will be difficult to borrow, making it even more difficult to trade and import goods. The Tourism sector which contributes 15% to the nation's Gross Domestic Product (GDP) could be rattled due to political chaos. This follows reports that Greece's GDP will fall by about 10% in 2013, 4% in 2014 and 5% in 2015.
National Debt Default
Prior to the 2010 and 2011 bailout agreements amounting to a whopping €239billion loan, there was a possibility that Greece was going to engineer an orderly default on all its debt. Experts had already estimated a 25%-90% chance of a default. An exit from the Eurozone will leave the country with no money to pay its creditors (mainly the IMF, ECB and Eurozone governments) as its net debt stands at €356billion (165.3% as proportion of GDP). Greece may be left with no choice but to restructure its debt - pay its creditors only a proportion of the debt, say 25%.
Potential for a Global Recession
The Eurozone economy narrowly escaped recession with 0% growth (better than anticipated -0.2%) for the first quarter of 2012. It is believed that the performance of Germany as a whole empowered to helping the Eurozone avoid recession. Greece quitting the Eurozone may force banks to cut down on lending and investors may cut investment with the Eurozone market. The several banks that have lent heavily to Europe, such as the French banks may collapse and this could spread worldwide, similar to the 2008 credit crunch.
As unemployment in Greece, Spain and Portugal are at record-highs (20.5%, 23% and 14.9% respectively), ordinary citizens may cut back on consumer spending. All of these would hinder growth, plunge the Eurozone into an abysmal recession and spread financial instability throughout Europe.
Euro' Currency Devaluation
It's no wonder why the powerhouses of the Eurozone (Germany and France) are urging Greece to do all it can to stay in the Eurozone. If Greece quits the Eurozone, one thing is most certain - the Euro would lose value in the currency markets. International trade will be more competitive and stable currencies such as the Dollar and Pound Sterling would rise in value.
Risk of Contagion
Currently, there are seven members of the European Union officially in recession: Portugal, Spain, Cyprus, Holland, Ireland, Slovenia and of course Greece. If Greece leaves the Eurozone, investors will be wary of lending to these struggling EU nations, should they require external aid. It could also become difficult for these nations to obtain sovereign debt. Though Greece accounts for just 2.5% of the Eurozone economy, it is feared that a Greece exit coupled with higher deficit position for Portugal and Spain could lead to a contagion that could murder the entire Euro edifice.
Devaluation of the national currency
Should Greece leave the Euro, the new currency (most probably the drachma) ‘will immediately fall by 60%', admits Citi bank. Businesses with debts in Euros may default as their income will be in the devalued drachma. Many Greek companies will record huge losses as foreign contract laws remain in Euros. The good news however is that in the longer term, the economy should benefit from a much more competitive exchange rate.
Should Greece exit the Eurozone, the government might have to print some money (quantitative easing) to cover its spending. Greece must feel a little relieved as newly elected French president Francois Holland blasts austerity in favour of joint euro bonds and quantitative easing by the ECB. Presently, Greece can't boost its economy and reduce national debt with monetary policy because it's a member of the Eurozone.
The fact that contingency plans have already been put in place for a Greek exit by Eurozone finance ministers makes us fear the worst. Moreover, one thing is certain - all eyes are now on the June 17 elections.
