Posted in Finance Articles, Total Reads: 1282
, Published on 04 March 2015
Considered to be one of the most significant aftermaths of the Global Recession (2007-08), the Greek Depression  has seen Greece involved in a long-drawn struggle to emerge out of a spell of high structural deficits and debt-to-GDP ratio levels. With fears regarding the debt crisis emerging in late 2009 amidst a slew of equity research reports downgrading Greek bonds & swaps, the “depression” was rendered its present form with the publication of the consolidated 5-year Greek fiscal reports in early 2010 which resulted in Greek bonds being assigned “junk bond” status by all the leading credit-rating agencies.
This led to the Eurozone countries (a panel comprising of the Finance Ministers of the region), the European Central Bank (ECB) and the International Monetary fund, henceforth referred to as “the Troika” , hand out a 3-year long sop worth € 110 billion to Greece so as to help it ameliorate its financial performance. Alas, the proposed measure has done little in achieving what it intended to as the issues afflicting Greece have only increased over the years and have made the dubious solvency of the nation the quintessential “Achille’s Heel” for the Eurozone.
Greek debt vis-a-vis the average debt in Eurozone over the years (Source: Wikipedia)
The volatility in Greece has only further intensified in the recent past with fears coming to the fore regarding Greece exiting from the 28-member European Union. The victory of the anti-austerity Leftist Syriza Party in the recently concluded Greek Parliamentary Elections further added fuel to fire as the party came in with the mandate of rejecting the austere economic sanctions imposed on Greece by the Troika. The economic significance of this victory can be best highlighted by simple numerical tokens: the Athens Stock Exchange crashed by a staggering 30% and the Greek bond yields fell to 5.6% (close to their lowest ever) . Greece’s pull-out from the Euro fiat-currency system (popularly referred to as the “Grexit”) would be a watershed event with far-reaching geopolitical & economic implications, assuming that they choose to restructure their debt obligations with the EU, as it would not only cause a paradigmatic shift in the trade relationships with Greece pulling closer to Russia but would also have a possible spill-over effect in the Eurozone thereby mitigating the recovery cycles of its weaker factions viz. Spain and Italy. One of the key issues responsible for the high amount of volatility attributed to a possible Grexit is the completely alien nature of such an event, i.e. the withdrawal of a nation from a systematic currency system has not occurred in the past. Thus, there are a host of speculations regarding the extent of damage done in the short-run, if this event were to occur, depending upon whether the Greek withdrawal is sudden or is gradual. The closest prototype of something similar would be Argentina’s withdrawal from its pegged fixed exchange rate with Brazil, but this too would provide very little reference as the scale of EU, coupled with Greece’s entrenchment in the region, is unprecedented in scale.
There are differing views regarding the long-run impact of Greece’s withdrawal from the Euro currency system. With Germany assuming the position of the patriarch of a fractious family, the withdrawal of a persistent trouble-maker like Greece could in fact help the Troika to operate efficiently in the future albeit the initial hiccup caused by Grexit as their 27-member polity would then comprise purely of co-operating elements who could work together for the greater good of the region. This would in fact enable the EU to implement the policy changes occurring in tandem with the renewed round of US-styled Quantitative Easing announced in mid-January by Mario Draghi, the head of the ECB. The only possible caveat could be the possibility of the political and economic chaos multiplying manifold as a result of the withdrawal of other countries from the EU in quick succession, with the threat of withdrawal from Spain, France and Portugal being the most imminent ones. Thus, a wildfire of sorts could result in mammoth capital losses for Germany losing € 1.5 to 2 trillion in a period extending till 2020 . On the flipside, if we consider the losses Greece could potentially incur as a result of a Grexit, then the burgeoning loss of brand equity associated with an exit from the EU system would certainly figure as the most prominent one.
We can state with a certain degree of certitude that this would lead to the Greek currency starting at a significantly low level just to make its goods & services competitive in the international market. Foreign currency inflows would become critically low and interest rates in Greece would possibly surge to all-time high levels in the initial phase. At this stage, Greece would try to pull all the stops available to it just to increase the capital vitality of its banks thereby leading to its Euro reserve further diminishing. Thus, Greece would possibly have to enter deals with other countries via promissory notes, which could emerge as the default currency of the country in its initial stages as an economy independent of the EU. All these would only add to the mounting fiscal and monetary constraints on Greece and might even lead to it getting into a “liquidity trap” of sorts. These might set the precedence for a scenario wherein it would become close to impossible for Greece to gather credit from private investors, not that the present scenario is particularly “august”. Hence, it is quite intuitive that the barriers to exit for Greece are incredibly high in this scenario. Some pundits might argue that Greece could possibly attempt to convert all its outstanding debt into the new currency, but the probability of that happening is indeed low given that the EU came into being as a solitary body wielding a great deal of power by virtue of a gradual sequence of changes which involved the cessation of several formal/informal contracts and entrenchment in several others, thereby making it very difficult for a member country to leave its auspices. Thus, the probability of Greece leaving the Euro Zone on its own volition would be quite low according to me from the stand-point of economic payoff. However, circumstances could turn out to be such that it might compel Greece to reluctantly leave the EU in an ad-hoc, multi-stage manner.
Average growth rate of GDP in Greece vis-a-vis the average for Europe (Source: Wikipedia)
Let us now focus on what has transpired very recently in this geopolitical tug-of-war. On February 22, the Eurozone led by Wolfgang Schaeuble forced the ruling Syriza party to extend the bailout plans originally in place despite the party being on a plank which is ideologically opposite. Greece’s inability to re-negotiate its pile of debt (mostly resting with other nations and the IMF) has been viewed as a direct impact ECB’s pressure to the Greek economic system by restricting the loans offered to it and is being perceived primarily as a defeat to the new “rockstar” of Greek economics, Yanis Varoufakis- the Greek financial minister . Although the announcement was followed by the Tsipras-led Greece government widely circulating a white paper containing a set of reforms which would accompany the new development, most strategists view this as only a means to somehow safeguard their dignity and resolution in the face of a compromise. Consequently, the perceived threat of Grexit occurring have been quelled for some time. Steel-nerved Greek security-holders who held on to their assets were the ones who laughed all the way to the bank as these announcements yielded an impetus to Greek financial fixed income securities resulting in a return as exceptional as 11%.
Amidst all this volatility, the announcement of an emergency meeting by the Spanish financial minister, in the wake of Greece’s inability to come up with agreeable policy reforms pertaining to the amendment of the austere sanctions imposed on them, goes a long way in highlighting Greece’s complete isolation despite being a member of the EU since its inception. Although the implications at the moment indicate that Greece won’t withdraw from the Euro currency system at least in the next 3 months, the threat of a staged Greek withdrawal occurring in the future are far from extinct. The possibility of such a withdrawal however depends a lot on how the scenarios shape up in the upcoming 3 months with several thorns posing as threats to the Troika’s halcyon intervals. One thing is certain: if Greece ceases to pose any threat whatsoever to the EU’s stability and completely falls in line, then this would go on to highlight the immense power of the EU’s patriarch, Germany, and the inability of the weaker member states to rise up to the German power.
This article has been authored by Srinjoy Ganguly from IIM Ahmedabad
 Paris, Anastasia, Sotirios Dedes, and Nikolaos Lampridis. "Greek financial crisis." Global Business and Management Research 3.3 (2011): 319-341.
 Buiter, Willem, and Ebrahim Rahbari. "The European Central Bank as lender of last resort for sovereigns in the eurozone." JCMS: Journal of Common Market Studies 50.s2 (2012): 6-35.