Three reasons to fear a ‘Grexit’

The attempts by the eurozone’s big beasts to bully Greeks into voting the “right” way in their general election have begun. Der Spiegel magazine reported at the weekend that the German government believes the eurozone could cope with a Greek exit from the single currency and that such an outcome would be almost inevitable if the “anti-austerity” Syriza party wins on 25 January. Inevitably, this was followed on Monday by a soft statement from the German government that nothing much has changed.

But this was not quite a denial of the Spiegel story. The threat from Berlin seems reasonably clear: German chancellor Angela Merkel will not tolerate Syriza's demand to write off a chunk of debt and Greeks who want to stay in the euro (which is said to be the majority) should vote for a mainstream party. Such meddling in other people's elections may work or backfire - it's impossible to say.

But Berlin ought to be careful about regarding Grexit - or Greece’s exit from the euro - so lightly. For at least three reasons, financial markets are unlikely to be relaxed, if the prospect ever becomes real.

First, a precedent would be set: countries can leave the euro. Anti-euro parties in Spain, Portugal and Italy would be encouraged. Bond yields in periphery countries might shoot up on the renewed fears of a breakup. The job of the European Central Bank, after its tortuous progress to quantitative easing, would become harder.

Second, Grexit would make sense for Athens only if accompanied by default, or default on the part of the debt not owed to the International Monetary Fund. That would be expensive and embarrassing for eurozone lenders since two bailouts would have failed. Voters would ask why so much time, energy and money was deployed in trying to keep the club intact in the first place.

Third, Grexit would happen against the wishes of the majority of Greeks, if the polls are correct. Investors would wonder if Germany would also be so sanguine about other accidental departures. It is true, of course, that the eurozone has better fire-fighting equipment than in 2010 or 2012, the last times the Greek crisis took centre-stage. There is a bigger bailout fund these days and a means for the ECB to support strugglers via a bond-buying mechanism. That's the basis of the apparent confidence in Berlin. Yet the power of the financial armoury lies in the fact that it has never been tested properly. As thinktank Capital Economics argues, "not only is the ECB's bond-buying power unproven, but it is unlikely that the bailout funds are big enough to resolve serious problems in a country like Italy."

The most likely outcome, even if Syriza emerges as the largest party, is another helping of euro-fudge. Syriza, almost certainly, would have to govern in coalition with more centrist parties and tone down its demands. For their part, Germany and others should be able to see that Greece, with a debt-to-GDP ratio of 170 per cent, remains miles away from debt sustainability.

In theory, then, there is scope for a deal: Athens would not get a debt write-off but could be given gentler conditions on its loans. But that is only if the script follows past form. If Merkel is determined not to give an inch, as opposed to merely talking tough, it is a new game. Markets would tolerate a well-managed exit from the euro, which might benefit Greece in the long-run anyway. But that’s the least likely outcome. A chaotic, half-hearted exit - not the way to bet, but clearly possible - would be very different.

Guardian