Spectre of Grexit rises again

CALM BEFORE THE STORM? The Academy of Athens in Greece. Athens is engaged in a very high-stakes game of poker, and it reportedly has already made plans to potentially nationalise the banking sector and introduce a parallel currency to pay bills in the event that its cash reserves are exhausted.


    Apr 23, 2015

    Spectre of Grexit rises again

    AS EUROPEAN Union finance ministers prepare to meet tomorrow, Greece issued a legislative decree on Monday to tap pockets of cash reserves across the public sector. The money is believed to be needed to pay civil service salaries and pensions this month, plus potentially paying off the next tranche of International Monetary Fund (IMF) loan repayments next month.

    In the absence of new loans from its creditors, this latest episode highlights how cash-strapped the country has become. In effect, Athens is engaged in a very high-stakes game of poker and it reportedly has already made plans to potentially nationalise the banking sector and introduce a parallel currency to pay bills in the event that its cash reserves are exhausted.


    In yet another indicator of the growing concern over the crisis, the European Central Bank's vice-president, Vitor Constancio, has raised the possibility of the introduction of capital controls to prevent capital flight. Such controls were last used in the euro zone in Cyprus when that country underwent its own banking-sector problems.

    While the intensifying crisis in Greece could yet be resolved before next month's repayments to the IMF, this is far from sure. And no developed country has fallen into arrears to the IMF or any other Bretton Woods institution, highlighting the risky nature of the territory the country may be headed into.

    This, in turn, raises the issue of a potential Greek exit from the euro (the so-called Grexit). The prospects for such a rupturing of the euro zone - with the possible economic earthquake this could bring - have grown since Syriza's coming to power in January, which saw a radical-left party win power for the first time in the EU in years.

    Syriza is the Greek "Coalition of the Radical Left", comprising a broad spectrum of socialists and communists, anti-fascists, environmentalists, anti-globalisation campaigners and human-rights advocates. It came together only in 2012 as a single political group, rather than an alliance of multiple different parties.

    As Syriza fell just short of an absolute majority in the Greek Parliament in January's election, it formed a coalition with the conservative Independent Greeks party, which shares a strong anti-bailout position. This has reinforced Syriza's instincts that the country's economic "humiliation" must come to an end.


    Greek Prime Minister Alexis Tsipiras insists he wants Greece to keep the euro, but does not appear to have a clear strategy for negotiating with creditors. What he has repeatedly warned of are "major clashes" that are needed with these international creditors to ease the country's debt burden, which is over a staggering 175 per cent of its gross domestic product (GDP).

    Earlier this month, he agreed to meet Russian President Vladimir Putin. The session, billed as routine, had originally been planned for next month but was brought forward. While most Greek officials have dismissed the idea of receiving Russian aid, Defence Minister Panos Kammenos has floated the idea in public. And Russian Foreign Minister Sergei Lavrov has indicated that a Greek request would be considered if made.

    The meeting was most likely an attempt by Mr Tsipras to raise pressure on Greek's creditors before April 9, when a loan tranche of roughly 450 million euros (S$650 million) was due. However, it will raise fears in some circles of a potential pivot towards Moscow in the event that relationships between Athens and its creditors break down completely.

    While Grexit cannot therefore be dismissed, some market participants appear to be more sanguine about this possibility today as compared to a few years ago. In part, this is because of the changed ownership of Greek public debt. Today, more than 80 per cent of Greece's public debt is owned by institutional investors, whereas private investors held the vast bulk of Greek bonds in 2011. This may mean that further turmoil in Athens will not spread significant contagion through the euro zone.

    Nonetheless, Grexit would still be highly unpredictable. Some have noted the potential parallels with 2008, when it was widely assumed that the international financial system was sufficiently resilient to manage the collapse of a single major bank (Lehman Brothers).


    The IMF has also asserted that it is not yet clear what the true contagion risk would be from Grexit. However, the fact that it is likely to have a significant economic fallout for Europe is reflected by estimates that, even under the mildest of financial-stress scenarios, there would potentially be a contraction in euro-zone GDP of at least 1.5 per cent. This is greater than the current contribution of the Greek economy.

    Moreover, the fact that euro-zone membership would be shown to be reversible could change investor perceptions of risk. A deep Greek loan write-down would also undermine the capacity of the European Financial Stability Facility to borrow, or present it with higher borrowing costs.

    Whether or not Grexit happens, increased sabre-rattling from Athens could heighten investors' fears over the strength of populist and euro-sceptic parties in other euro-zone countries. In this respect, the Greek election result represented the first rumblings this year of potential political and economic earthquakes on the European horizon.

    It is perhaps Spain, which will also hold an election this year, which has the strongest parallels with Greece. The Spanish economy has suffered a major economic downturn that has fuelled the rise of anti-establishment, radical-left party Podemos - founded only last year - which is currently a very strong second in the polls behind the ruling right-of-centre People's Party. Meanwhile, the long-established Socialist Party is in third place, but might yet win power in a coalition with Podemos at the next election.

    Taken overall, the next few weeks could be crucial in resolving whether Greece remains in the euro zone. Exit is still not a foregone conclusion, but the prospects will increase if the country fails to agree on new loans from its creditors soon.


    The writer is an associate at LSE IDEAS (the Centre for International Affairs, Diplomacy and Strategy) at the London School of Economics, and a former British government special adviser.