11 June 2015

Significant immediate disruption within the EU

On balance we still believe Greece will stay in the euro, just. But a Grexit is closer than ever and if it were to happen it would cause huge disruption in the Eurozone and EU. As such it would completely change the nature of any other negotiations going on in the EU.

From the UK’s perspective, it would become very difficult in the immediate term to get anyone to discuss other kinds of EU reform. It would completely derail David Cameron’s current timeline for the negotiations and the eventual EU referendum. It’s not clear whether he would still be able to hold the referendum as scheduled, though rowing back on this would be hugely difficult domestically.

The risk would be that there would be little real discussion of reform but the referendum would be held anyway. This would likely result in a close vote and could see the worst of all worlds appearing, which is a slight vote to stay in which is seen as backing for the status quo in the EU. Of course, the lack of reform could also increase the chances of Brexit. There could also be an increased feeling in the UK that staying in the EU would be tying the country to a bloc (the single currency) in decline and disarray.

Important questions raised after immediate disruption

However, once this immediate disruption is over, the picture could look very different. As we explained in the case of Brexit, Grexit is similarly not just about the event but what happens in response to it.

With a country leaving the Eurozone there would be an unprecedented shift in the status of the EU. It would no longer be all countries moving towards closer integration, while powers will de facto have flown backwards as well as forwards. It would enshrine the nature of a multi-tier EU, where there are countries that are outside the Eurozone and are unlikely to join. This would need to be legally accounted for and the EU would need to have a clear reassessment of what being a member means. For those that have followed the UK-EU debate, these are many of the same questions and issues the UK has been raising. This of course assumes that Greece is able to stay inside the EU, which would be up for debate, but which we believe is likley (see here)

Furthermore, the Eurozone would also have to take its own response to a Grexit. As IMF Chief Economist Olivier Blanchard said in April:

if the Greek exit does happen I think it is a way [for the Europeans] to appease the markets by proceeding further with the fiscal union; that would certainly be the right move.

So, in response to Grexit it seems quite possible that the Eurozone would look towards further integration. Not necessarily or only because Greece was holding it back, but simply because the market would be looking for answers and reassurances. If the Eurozone did nothing in response to a Grexit, then it seems likely questions would begin being asked about other countries. This could be put off in the short term by ECB action – such as expanded bond buying – but not for too long. With a move to deeper integration, the Eurozone would have to face up to questions around the status of non-Eurozone states and their position in the EU. This would essentially bring forward the current Eurozone timeline by four or five years.

At some point, and I would think quite quickly, the EU would have to find a way to clearly reconcile an event which questions some of its founding principles and which changes its fundamental structure with its current institutional and legal set up. This would mean changing the EU treaties to account for these points. But there are of course no guarantees on what time frame this would happen in.

After the initial disruption, I would expect many of the reform points which the UK is pushing to very quickly move to the top of the agenda following a Grexit, as they are issues which would now definitively have to be settled. If this is done properly then it could well help avert a Brexit. Of course, if the EU proves itself to be too inflexible to adapt and change even in the face of a Grexit, it may well become seen as a club which the UK does not want to be a member of (and probably rightly so).