Greece debt crisis: Where next for Athens if it doesn’t pay?

The 9 questions you were too embarrassed to ask about the Greek debt crisis

Ben Chu@Benchu_
Tuesday 30 June 2015 08:52
Supporters of a No vote in the upcoming referendum at a rally at Syntagma Square, Athens
Supporters of a No vote in the upcoming referendum at a rally at Syntagma Square, Athens

Q | Why is 30 June the moment of truth for Greece?

A | Because unless a miracle occurs, Greece will become the first developed country in history to fail to repay money owed to the International Monetary Fund.

Athens is due to pay the Fund €1.6bn (£1.1bn) at 6pm Washington time (11pm) but it doesn’t have the cash to do so. And its creditors in the eurozone and the IMF are refusing to support Athens, after talks finally broke down on a cash-for-reforms deal at the weekend.

The die was cast when the Greek Prime Minister, Alexis Tsipras, called a national referendum on whether or not to accept the creditors’ demands for labour market reforms and more austerity.

Q | What does this mean for Greece and the eurozone?

A | More important than failing to pay the IMF is the fact that Greece will also become the first eurozone country since the single currency was formed in 1999 to miss a sovereign repayment.

In addition, Greece’s €240bn bailout agreement with the rest of the eurozone expires on Tuesday night – with nothing to replace it. These two facts will put tremendous pressure on the European Central Bank to cut off funding to Greece’s banks – which are only still alive because they have received extensive monetary support from it. The ECB has already said it will not give the Greek banks any extra funding to replace the rapid outflows of domestic deposits, forcing Athens to impose strict limits on cash withdrawals from 29 June.

The next step from the ECB could be to cut off funding altogether, which would make the banks insolvent. If the Greek banking system is faced with meltdown many experts think the country would ultimately leave the eurozone.

Q | Why are the financial markets not panicking?

A | Shares did fall across most of Europe. The Greek stock market was suspended of course. The euro slipped in value against the dollar and sterling. And bond yields in other vulnerable eurozone countries such as Italy and Spain ticked up. Yet the movements were all small relative to some of the violent swings in markets we’ve seen in recent years.

The reason is that most investors appear to think the mess in Greece is unlikely to create “contagion” in the rest of the eurozone. This is partly because European banks and investors have been steadily reducing their exposure to Greece over the past five years.

And it is partly because the European Central Bank’s president, Mario Draghi, in 2012 promised to use its full powers to protect reforming economies such as Italy, Spain and Portugal from attack by speculators.

Q | What does it mean to be in default?

A | Technically, the IMF suggests Greece will be in “arrears”, rather than in default. This means Athens would need to pay off those arrears before accessing any further support from the Fund.

The question is whether the European Central Bank will deem the arrears effectively the same as a default.

The ECB funds struggling Greek banks by allowing them to swap their holdings of Greek sovereign bonds for euros. If it judges those sovereign bonds to be compromised because of the IMF arrears, or because Greece is no longer in an official bailout programme, it could refuse to accept them as collateral, effectively cutting Greek banks off at the knees.

Q | What happens next?

A | Even if the ECB does not cut off Greek banks, it is likely to come under massive pressure to do so on 20 July when Greece is due to redeem €3.5bn of sovereign bonds held by the ECB.

Unlike the IMF repayment there would be no ambiguity about a failure to make this payment: it would be a straight default. And Greece, unless it quickly does a deal with its creditors, will be unable to make that payment. Another €3bn ECB bond payment is due on 20 August.

Q | When will Greeks be able to access their accounts?

A | A good deal hinges on how Greeks vote in the 5 July referendum. If a majority vote to accept the austerity and reform terms demanded by the eurozone and the IMF, then it is just conceivable that there could be deal after all – meaning that the threat of collapse would recede and the banks could allow Greeks to access their money in a matter of weeks.

Some eurozone officials hinted that a Yes vote would see talks restart. But if the Greeks vote No then it is likely to be a long time before the country’s banks function normally.

Capital controls imposed on Cyprus in 2013 were only lifted after two years. And there is a possibility that when Greece’s capital controls are eased depositors could find their money denominated in drachmas, and worth considerably less in real terms.

Q | Does it mean Greece will leave the euro?

A | Not necessarily. Even if Greece defaults and reintroduces its own currency again there is no automatic procedure for ejecting Greece from the single currency.

Yet if Greece were unable to tap funding from the European Central Bank and were using its own currency, Greece would be gaining little benefit from membership of the euro.

The head of the European Commission, Jean Claude Juncker, suggested a No vote in Sunday’s referendum would also result in Greece leaving the EU.

But however difficult Greece’s relations would become with the rest of the EU there exists no legal basis for ejecting the country from it.

Q | Can the Greek economy prosper outside the euro?

A | That is hard to answer. Economic theory suggests depressed states get a boost when they devalue their currencies because their exports instantly become more competitive. This is what happened to Britain when we left the European exchange rate mechanism in 1992. Argentina got a similar export boost when it broke its currency’s long-standing dollar peg in 2002.

But Greece is not a very strong exporting nation. Overseas sales of goods and services are relatively low relative to the country’s GDP. Greece’s top export is refined petroleum, which is priced in dollars and it relies on imported oil, which is also priced in dollars, all meaning that this industry would get little benefit from depreciation.

However, Greece also has quite a large tourist sector, worth about 15 per cent of GDP, which would certainly benefit from a devaluation. But set against that is the severe financial and social pain that would inevitably result from leaving the euro as the public confront the fact that their savings have been devalued at a stroke.

The Greek government could also try to ease the transition by printing money too liberally, creating damaging inflation.

Q | What does that mean for the euro?

A | The markets are betting that the eurozone will survive even if Greece leaves. Spain, which was in turmoil two years ago, is growing. Italy, also one of the bloc’s ailing giants, grew in the first quarter. Portugal is doing OK. But unemployment is still painfully high in all of these countries.

The established parties fear that the Greek crisis could energise anti-austerity movements in their own countries – such as Podemos in Spain and the Five Star Movement in Italy – which could join Syriza in upsetting the eurozone apple cart.

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