The risk of Grexit continues to loom over the Eurozone. While both sides face intense internal political pressures, Eurozone leaders are unlikely to gamble with the systemic risk of a Greek exit.
Some Eurozone leaders have lost patience with Greece and appear to believe that a Greek exit from the Eurozone is inevitable and even desirable.
Some argue that a Grexit would be a catastrophe for Greece, but not the Eurozone, which has ring-fenced itself against contagion. They offer four main arguments to support this view:
- Banking sector exposure to Greek debt has been dramatically reduced. Overseas banks exposure to Greece fell from 128 billion euros in 2008 to 12 billion euros in September 2013, and the Eurozone banking sector is much stronger now than it was in 2010-11.
- Austerity is working: except for Greece, all the other peripheral bail-out countries (Portugal, Ireland and Spain) have exited their bail-outs, and their economies have begun to recover.
- The Euro area emerged from recession in 2014 and growth is picking up, helped by low international oil prices, euro depreciation and quantitative easing (QE).
- Greece is the odd man out in terms of its indebtedness, growth and competitiveness.
It is difficult, however, not to treat these arguments as negotiating tactics, and there are two interrelated reasons for this. Firstly, there is the well known fact that Eurozone leaders do not want Greece to exit the Eurozone. The reason behind this reluctance has to do with the unknown risks of a Grexit.
How can one assess, for instance, the potential psychology of investor responses? How can one assess the path and the magnitude of the contagion effects when the spider web of financial connections is not well understood? What about the political consequences? If Greece left the Euro, would this be a sufficient signal for others to do so as well?
If others did follow Greece’s lead, a banking crisis would most likely ensue, as Southern European depositors would flock to their banks to withdraw their savings. There are structural reasons for this, mainly to do with the absence of a debt mutualisation mechanism in the Eurozone, and a genuine banking union where the ECB can directly recapitalize Eurozone banks.
A deal is highly likely
Because of the reasons outlined above, Europe will most likely not gamble with the existence of the Eurozone. However, this does not imply that they are not prepared to take things to the brink – they are most likely willing to settle a deal at the 11th hour.
The timing of such an agreement will be linked to Greece’s debt service schedule in the coming months. They will probably meet their domestic obligations through May, if a deal is agreed on May 11 for a release of a portion of the 7.2 billion euro bailout.
If an agreement for a new program is not reached by June, Greece will not be able to service large payments falling due to the ECB in July. Consequently, a deal in May for a release of a portion of the bailout is likely, coupled with a postponement of any discussion over labor and pension reforms in June.
On the other hand, the situation is complicated by the fact that both sides are facing intense internal political pressures. The Greek premier is still facing enormous pressures not to abandon ‘’red lines’’ over wages and pensions, while Europeans are not willing to risk labor market reforms, renegotiations of bailout programs, and the strengthening of populist parties across Europe.
Consequently, the likelihood of a deal ranges from likely to highly likely, but do not expect the Greeks to abandon their red lines. Within this context, the likelihood of a referendum and some form of a parallel currency ranges from likely to highly likely.
A deal then is highly likely because Greece’s creditors are seriously concerned about the uncertain consequences of a Grexit. They are likely to yield to Greek demands if the latter offer their creditors their greatest fear: a threat to the stability and existence of the Eurozone.