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While there are some clear economic benefits for Greece to exit the euro, the risks may outweigh the benefits. The most likely option is that a compromise will be struck, and that Greece will remain a member of both the euro and the EU.
1 June 2012
There are clear economic benefits to Greece leaving the euro, but the risks involved in an imminent exit could well outweigh these benefits in the short term. We estimate that if Greece left the euro now, it could still need between €67bn and €259bn in external short-term support, potentially split between the IMF, the eurozone and non-euro countries including the UK. These figures do not include longer-term support or contagion costs to the rest of the eurozone.
A Greek exit and the withdrawal of ECB support would almost certainly lead to the undercapitalised Greek banking sector collapsing. To avoid a massive bank run and huge losses to pensions, we estimate that banks and pensions funds between them would instantly need a €55bn injection of fresh capital, which would be difficult for Greece to afford without external support.
The new Greek Central Bank would also need to create at least €128bn worth of the new currency (63% of Greek GDP) in liquidity to help keep Greek banks afloat. This could trigger high levels of inflation, though these might only be temporary.
At the same time, however, the new Greek currency could devalue by around 30%, which could significantly increase chances of growth, including a potential boost to exports equivalent to 10% of GDP. However, any potential export gain could be diminished if the ‘stub euro’ weakens or demand in Europe decreases further. Unlike previous devaluations in Argentina and Iceland, Greece has few natural resources or industries to fall back on, which may limit the benefits of devaluation.
An exit and devaluation could also ease austerity and the pressure on the Greek people, particularly in the long term. However, Greece would still need to find immediate savings of at least €12bn to pay various bills, including hospital and social security expenditure.
Therefore, two steps would significantly boost the prospects of a managed Greek exit from the euro: first, the banking sector should be recapitalised, shrunk, consolidated and restructured. Secondly, a primary surplus should be achieved to allow the state to fund its day-to-day running costs without external help. This would make an exit far more appealing and potentially beneficial for Greece in the long-term.
Looking at five different options for Greece over the next year, and taking the factors above into consideration, we assign a 60% probability of a compromise being reached after the June Greek elections, involving a new Greek government (even if Syriza-led). This would see Greece remain in the eurozone. There is still a 25% probability of the country leaving the euro within the next year. We see a Greek default within the euro and the creation of a parallel currency as highly unlikely outcomes. The worst possible outcome would be if Greece left both the euro and the EU. However, even if a compromise is reached, unless Athens is put on permanent fiscal transfers, a Greek euro exit may now be matter of when, rather than if.
Contrary to popular belief, Greece would be able to exit the euro and still remain a full EU member, possibly using the EU treaties’ ‘flexibility clause’, followed shortly afterwards by a full treaty change. This would change Greece’s status from a euro to a non-euro member while allowing for temporary measures such as capital controls to be implemented. This would be a messy and highly unpredictable process, and all member states, including the UK, would have a veto over such changes, which could therefore be subject to various domestic political demands.
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