Bangkok (The Nation/ANN) - There are a lot of concerns that Greece may opt out of the euro zone.
We can see from the strength of the anti-austerity vote in the Greek election on May 6 that again has drawn attention to the high risk of Greece leaving the euro area. This inconclusive election result has forced Greece to call a second general election for June 17.
The terms of Greece's recent bailout programme with the EU and IMF require a Greek government that is prepared to implement fiscal austerity measures by cutting spending significantly and consolidating its fiscal affairs.
An unstable, anti-austerity government coalition could undermine the willingness and ability of both Greece and its partners to keep the country within the euro. The possibility that such a scenario will be realised after the June 17 election has unnerved markets, though the election outcome remains uncertain.
Surveys immediately after the May 6 election indicated that support for the anti-austerity Coalition of the Radical Left was continuing to rise, suggesting that this anti-austerity party could potentially win the June 17 election.
In any case, while deeply disillusioned with austerity, based on a recent survey, 80 per cent of Greeks still want their country to stay in the euro zone.
Whatever the outcome of the June 17 election, the new leader will have to find middle ground between renegotiating the austerity plan on the one hand and fighting to stay in the euro zone on the other. This makes a compromise likely if European leaders show a degree of willingness to ease the austerity plan and/or come up with a limited set of growth-stimulating measures.
I anticipate that the incoming Greek government (of whatever composition) will be able to renegotiate the bailout conditions to some extent, so that both the new government and international lenders will be able to reach some agreement on financial assistance for Greece in return for some austerity measures.
From Greece's perspective, despite potential upsides to a hypothetical euro exit - such as lower debt interest payments, the restoration of external competitiveness and regaining of national sovereignty - Greece clearly has strong incentives to remain within the euro zone.
The most important are:
1) official support. By remaining in the euro zone, Greece will retain access to official financial support through its second bailout (worth 130 billion euros), which is sufficient to cover debt refinancing until the end of 2014, reducing the need for a default.
2) Fear of economic and financial costs. These include a high risk of banking-sector collapse; private-sector bankruptcies; the need to introduce capital controls to avoid capital flight; high inflation as the new currency depreciated; difficulties in importing vital products (such as energy); and transaction costs associated with the roll-out of a new currency.
3) Political fallout. In an extreme scenario, Greece might even face the loss of EU membership and associated benefits such as access to structural funds.
4) Popular support for the euro. Despite widespread public anger at austerity and the ensuing economic depression, the main political forces - and around 80 per cent of the public - remain in favour of euro membership.
However, from the perspective from elsewhere in the euro zone, members could contrive to push Greece out of the single currency in the next two years, irrespective of Greece's view. Under such a scenario, key members may come to believe that the financial costs associated with keeping Greece in the euro zone are too onerous.
Alternatively, if Greece refused to comply with the terms of its second debt restructuring, EU leaders may decide that they have no choice but to let Greece leave (rather than risk the moral hazard of allowing it to renege on its commitments while remaining in the euro zone).
Moreover, the belief that the bloc's firewall is strong enough to avoid major contagion from a Greek exit could lead to a sense of complacency. However, the balance of risks still suggests that euro-zone leaders will seek to avoid a Greek exit.
From the euro zone's perspective, the risks include:
1) Direct costs. The impact of a Greek exit via trade channels would be small, given the size of the Greek economy (2 per cent of euro-zone GDP). Losses through financial channels would be more disruptive.
Although European banks have reduced exposure to Greek sovereign debt, this has been offset by a sharp increase in the exposure of the official sector - creditor governments, the European Central Bank (ECB) and IMF. Since the latest debt restructuring, loans from the EU-IMF account for over half of Greece's total debt (roughly 333 billion euros or US$417 billion).
In addition to losses on debt holdings, the ECB would face losses on collateral from Greek banks (with total exposure of 177 billion euros ($146 billion), according to the International Institute for Finance). Euro-zone banks would have to book write-downs on around 28 billion euros ($35 billion) of lending to the Greek private sector.
2) Contagion. A Greek exit has the potential to frighten investors from other fiscally weak countries. Policy-makers would need to extend financing programmes for Ireland and Portugal, at a combined cost of around 35 billion euros ($43 billion) per year. Official support for banks would need to be extended, with the refinancing needs of Portugal and Ireland alone running into hundreds of billions of euros within a few years.
Interest rates for other countries would be likely to skyrocket (reflecting euro currency exit risk). For countries such as Spain or Italy, higher interest costs would need to be offset by tax increases or public-sector spending cuts, while lower bond prices would increase pressure on capital buffers at euro-zone banks, potentially crimping lending growth. Real economic activity would suffer throughout the euro zone.
3) Undermining the ECB. In the event of a Greek exit, the ECB's role in stabilising the euro zone would be decisive. The central bank would have to deliver substantial liquidity injections for euro-zone banks and expand the collateral base further. It could purchase more government bonds in secondary markets and extend purchases to other assets; it could also stop sterilising such purchases.
Such action would risk opening the way to unplanned and politically unacceptable transfers between member states, either through losses in the event of debt default (requiring taxpayers to recapitalise the ECB) or through higher inflation (which would affect individual countries in different ways).
4) Reduced appetite for deeper fiscal union. ECB action to stem contagion would have to be temporary, while fuller consideration was given to developing more permanent fiscal support mechanisms to eliminate the risks to the ECB's balance sheet of a euro-zone break-up.
The introduction of "euro bonds" would have to be discussed again, but opposition to further pooling of sovereignty would be intense, given moral hazard concerns in creditor countries.
5) Damage to EU institutions. A Greek exit would damage the public prestige of EU institutions and cause a loss of confidence in EU treaties.
On balance, I think that creditor governments currently see the costs of extending support to Greece (in both financial and political terms) as lower than the potential costs associated with a Greek exit - notably contagion to other euro-zone states.
For Thailand, the economic impact of a euro-zone break up would be severe. Turmoil in the euro zone and global financial markets would lead to massive capital flow volatility and a trade credit freeze that disrupts real sector economic activities. The grave consequences would be devastating for the European and world economy.
Let's hope that Greece's exit will not become a reality, but if it becomes inevitable, Greek and euro-zone policy-makers must be prepared to handle the consequences and an orderly transition back to the drachma.
Chodechai Suwanaporn is executive vice president, economics & energy policy, PTT Public Co., Ltd.
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