Without a big haircut in Greece, the chances are poor
Now that the Greeks have voted overwhelmingly against the austerity measures—the final result was a 61% for ‘No’ as opposed to opinion polls which suggested a very close finish—both sides need to act calmly; the resignation of Greek finance minister Yanis Varoufakis augurs well for negotiations given how polarising a figure he was. Indeed, the magnitude of the ‘No’ vote comes as a surprise given the disaster that awaits Greece. With the banks running on the goodwill of the European Central Bank (ECB) and running out of cash, it is just a matter of time before no more withdrawals will be possible. A lot now depends on how the ECB reacts, certainly Greece’s default of a 3.5 billion euro repayment on July 20 will harden its stance. Were the ECB to not extend credit to Greek banks, the drachma will have to be reintroduced to capitalise banks and, more likely, ordinary Greek depositors will have to take a haircut to recapitalise the banks. Reintroduction of the drachma will be accompanied by hyperinflation and the lack of faith in the currency will almost certainly mean a shortage of goods that Greece imported such as petroleum products. If the Greeks voted ‘No’ despite this, it means they were convinced the future was worse with the austerity measures—not surprising, perhaps, given the economy has already collapsed a fourth since 2008.
For the troika, the path ahead is even more treacherous. For starters, to keep interest rates down in the PIIGS countries, the ECB will have to ratchet up its bond purchases, and there is no certainty that will do the trick since with Greece’s potential exit, there is no certainty that countries like Portugal and Italy will remain in the euro—in which case, interest rates may remain high despite bond purchases by the ECB. The flipside is that bailing out Greece will not only give more ammunition to opposition parties within Germany, it will lead to demands to lessen austerity within countries like Portugal and Italy. But, as India’s then executive director to the IMF, Arvind Virmani had pointed out in May 2010, the proposed austerity measures were so large, ‘it is a mammoth burden that the economy could hardly bear … there is concern that default/restructuring is inevitable’. Indeed, most of the bailout money in 2010 was not used to lower Greece’s debt, it was used to bail out private creditors who should have known better and should have been forced to take haircuts. This time around, when negotiations start, the troika would do well to pay heed to the latest IMF report which says ‘given the fragile debt dynamics, further concessions are necessary to restore debt sustainability’ and then goes on to talk of a ‘full write-off of the stock outstanding in the GLF facility (53 billion euro) or any other similar operation’. The important thing for German politicians to keep in mind is that while it is true Greece has slipped up badly in terms of its work ethic—indeed, Greece should never have been admitted to the euro given its poor finances even then—Germany has also benefited enormously from the euro since, without it, the Deutsche mark would have appreciated more and cut considerably into German competitiveness. No monetary union works without a fiscal one—that’s why, in the case of India, rich states like Gujarat and Maharashtra transfer considerable funds to poorer ones like Bihar and Jharkhand.