5 January 2015

Has Grexit become economically simpler?

An article in the Der Spiegel over the weekend claimed that the German government now considers a Greek exit from the euro manageable. With far left Syriza – who has vowed a write down and renegotiation of Greece’s debt – leading in the polls ahead of the snap elections in Greece, someone is clearly trying to send Athens a message. But would Grexit now be easier?

Back in June 2012 Open Europe published an analysis of whether, in the short term, Greece would be better off inside or outside the Eurozone – the report is certainly worth a re-read. In the paper we concluded that, due to a number of uncertainties, Greece would be better off staying inside and would likely do so. But given the current climate it is worth revisiting this question.

Interestingly, from an economic perspective – the issue we will deal with in this blog – it has now probably become easier and more profitable for Greece to leave the Eurozone (it would also be less costly for the Eurozone). That said, the political and technical challenges remain substantial – we will deal with this in the second part, to be published tomorrow.

Grexit would not necessarily flatten the domestic banking sector

In the report we note that one of the key factors limiting the benefits from an exit was Greece’s severely undercapitalised banking sector which remained reliant on ECB liquidity. As the graph below shows, Greek banks reliance on central bank liquidity (both the ECB and Bank of Greece Emergency Liquidity Assistance) has fallen by 72% (€113bn). Greek banks have also been recapitalised and consolidated – €48.2bn has been injected, while their exposure to the domestic sovereign was reduced significantly under the previous debt restructuring.

150105_Open_Europe_graph2_ itemprop=Source: Open Europe

This stark shift means that, compared to previously, the Greek banking sector could plausibly survive the shock of an exit, while the liquidity which needs to be injected by the central bank could be contained. This in turn makes management of the new currencies value much easier.That said, the banking sector is not without its problems. As the recent bank stress tests showed it remains heavily reliant on deferred tax assets as a source of core tier one capital. In fact, they account for over 40% (€25bn+) of Greek banks core capital. The reliability of this as a source of capital could be questioned in an exit, since it is fundamentally reliant on the health of the state. Greek banks also continue to struggle with a lack of profitability.

Greece’s economy may have bottomed out

On top of this the Greek economy seems to have bottomed out – or in economic jargon reached its ‘macro-inflection point’. As the chart below shows, as of 2014, the Greek government is running a primary surplus, the current account is in slight surplus and the economy is growing again. This means that Greece is no longer reliant on foreign inflows and that the government could fund itself on a daily basis (assuming it defaults on debt and no longer pays out interest). While this may seem like a reason to stay in the euro (‘the worst is over’ line of argument), it can equally be applied to making an exit more profitable and feasible since the government is more self-sustaining and devaluation could have more impact.

150105_Open_Europe_graph_ itemprop=Source: Open Europe

Of course, all this needs to be considered with caution, since questions abound about how lasting the reforms and consolidation which Greece has made are. If these falter or were undone the situation may look quite different. There is no doubt Greece continues to have a huge range of economic problems – long term unemployment, lack of growth industries and poor business climate to name but a few. Furthermore, as we argue in the report, it’s not entirely clear how much of a boost devaluation would really bring for Greece, while the economy could still struggle to deal with a shock the size of a change in currency.

What is clear, is that the economic calculation from a Greek perspective has shifted since 2012. As many have already noted, it has also changed from a broader Eurozone perspective. With the banking union and a more active ECB the Eurozone is better placed to contain any contagion from a Grexit – though the jitters are yet to spill-over into any other markets, encouraging the view of Greece as a very special case. Private sector exposure is also much lower, though public sector exposure is much higher due to the huge bailouts given to Greece. This suggests the debate and negotiations could be even tougher than last time around.

This is just one part of the tricky equation. Stay tuned for our second part which will look at some of the political, technical and legal questions around a Grexit.