Grexit can’t be ‘priced-in’, ECB backstop not endless
A Greek deal, should it take place as the market rally is suggesting, can always falter again, but it is irresponsible to suggest that a Grexit would be the less painful solution for Europe and will help reinforce discipline amongst member-nations, or that it has been ‘priced-in’ by the markets. This view, held by many in Europe, is predicated on the January 22 decision by the European Central Bank to launch a Fed-style bond purchase plan for hundreds of billions of euro. Were Greece to exit the euro, the traditional argument went, this would cause a European crisis as bond rates would start rising in other troubled countries like Portugal and Spain and they too, like Greece, would be tempted to abandon the euro—this is why, some weeks ago, Greek finance minister Yanis Varoufakis said “if little Greece, in order to survive, brings down the financial world, it can’t be our fault”. After the ECB’s January 22 decision, however, the moment bond prices rise, the ECB can theoretically buy enough bonds to keep rates low. In other words, one view is, Greece can go take a walk since it really doesn’t matter; indeed, given the speed at which citizens are withdrawing money from its banks—roughly a billion euros every day—the biggest loser will be the country’s banks which will soon go bankrupt if there is a Grexit; a contra-view is that once there is a Grexit, with no debts to pay immediately and the currency sharply devalued, Greece could bounce back faster.
While Greece will no doubt feel the pain first, the ECB may not be able to contain the possible contagion since one of the reasons why the bond-purchase promise has worked in the past has been the view that the euro will be preserved at all costs. Once it is known this is not so, there is no certainty the ECB’s actions will be as effective as in the past. A Grexit, in fact, also means the troika will have to live with Greece not repaying its loans—ironic, since some relaxations on repayment terms are the subject of the current dispute.
It can be no one’s case (see Hugo Dixon’s ‘The big fat Greek blame game’) that Greece didn’t drag its feet on deep-seated reforms or that the political posturing by the new government didn’t harden postures, but the problem has undoubtedly been worsened by the troika’s austerity measures. While the IMF had projected a 5% contraction in Greek GDP and stabilisation thereafter, real GDP fell a fourth as a result of austerity programmes—while Greece’s fiscal adjustment has been huge at 16% of GDP between 2009 and 2014, this has only worsened all fiscal parameters such as the debt-to-GDP ratio and the pensions-to-GDP ratio; had the economy grown, as it would have without stringent austerity, most of these ratios would have looked better. Also, the 2010 bailout, cited as a big concession to Greece, was really aimed at bailing out Greece’s private creditors. Any deal that takes place has to keep all of this in mind. Deeper pension reforms may be desirable—Greece’s retirement age is amongst the lowest in Europe—but this cannot be done in the face of a 28% or more unemployment rate. Only when both sides agree to their mistakes and accept that a Grexit will hurt both can an effective—as in realistic—solution be agreed upon.