Arthur Beesley: What happens in the event of a Greek default?

Greece has endured considerable hardship since the outburst of crisis in 2009 but worse would surely follow if it left the euro. The pain would only multiply.

The battered Greek economy was already at a standstill before the country’s banks and the stock market closed in advance of the referendum on the bailout next Sunday. Bad as all that is, it would be but the starting point for a new wave of trouble if the “Grexit” actually materialised.

But how would it happen in practice? At the root of it all is the failure of Greece and its creditors to agree terms to release a new round of rescue funds, money it desperately needs to meet mounting debt payments for weeks to come.

Default would cut off the country’s financial system from the euro zone, setting in train events which would leave Athens with no choice but to introduce IOUs as a replacement currency.

Shortages of fuel and medical imports would be in prospect. The price of such items would also rise because the value of the new drachma – or whatever it was called – would plummet against the euro and other big global currencies.

The focus now is on the non-payment of the €1.6 billion International Monetary Fund debt due last night. On its own, this does not herald catastrophe. Athens is simply in arrears and, as such, it is not entitled to further IMF disbursements. But the simultaneous expiry last night of the rescue 2012 programme means Greece cannot receive €7.2 billion in payment delayed since June 2014, a huge setback for the country.

These are the opening acts in a sequence which could spiral beyond control if it is not brought to a halt very soon.

At issue next are two forms of debt due this month, due to private creditors and the European Central Bank. The first is a €2 billion payment on maturing a short-term debt known as treasury bills, which must be paid to financial investors on July 10th. Further, smaller liabilities fall due in the following days.

Calling in the money

Failure to pay would be likely to trigger a cross-default which could lead commercial creditors of the Greek government to call in their money. Suppliers might refuse to provide further services without cash payments in advance.

That would be for starters. With €3.5 billion due to the ECB on July 20th, failure to pay this sum could close Greek banks. In the unlikely event that money is found, another €3.2 billion is due on August 20th. Default in either case would call into question some €89 billion in ECB aid for Greek banks, money they cannot survive without. Such aid is known as emergency liquidity assistance (ELA).

The ECB is reluctant to pull the plug, for that would be tantamount to an overt political act which would close the banks. Still, the €60 daily limit on bank withdrawals follows the ECB’s decision to put a ceiling on its support for the banks. As Greek banks run out of cash, there is some concern in official circles that the €60 limit might be reduced later this week.

Banks on the brink

Thus the banks are on the very brink. Although deposits of up to €100,000 are protected under European law, the withdrawal of ECB support would essentially close the financial system. This would curtail trade and markets, intensifying recession in a country already in the grip of unemployment at 25.6 per cent.

In sum, the cascade of non-payment would send Greece hurtling out of the euro to another currency.

“With capital controls in place, ELA discontinued, and shrivelling tax revenues as both the ability and willingness to pay taxes declines, the economic situation will come to a head sooner rather than later,” said rating agency Standard & Poor’s in a note.

“The euros at the government’s disposal would only suffice to make an ever smaller share of its payment obligations. The cash-strapped government could issue IOUs to pay employees, pensioners, and suppliers.

“These IOUs will, at a discount, begin to circulate as a secondary means of exchange and, over time, lead to a national currency, which would operate as legal tender in the country (this would formally be the exit moment) after the government had legislated to redenominate financial contracts wherever legally possible.”

There was more. “Greece is also highly dependent on the import of energy, food, and medicine, among other necessities.With a shortage of euros, even short-term trade financing might dry up, putting further downward pressure on economic prospects and the living conditions of the population,” said S&P.

“Shortages and poverty would become more widespread. We could also envisage a wave of litigation following any redenomination of contracts.

“An overwhelmed justice system could lead to prolonged economic and investment paralysis while these cases were being heard.”