WHAT happens if the Greeks vote Oxi, or No, on Sunday? Of course, what might happen is that the Greek government's wishes are fulfilled and that creditors come back with a new, better, offer. But thoughts are now turning to the more likely scenarios—that Greece leaves the euro (Grexit) or is stuck in the position of being formally within the euro zone, but without access to ECB credit (dubbed Grimbo).
Three reports have just been published, a short blog from the Peterson Institute and longer (but private) reports from Standard & Poor's and Citigroup. They don't agree on all the details but they do suggest that the widely-touted benefits of Grexit (the reduction in debt service costs, the boost to competitiveness from a lower currency) need to be heavily qualified. S&P suggests that Greek GDP may be 20% lower than it would otherwise have been if Grexit occurs. The effect on the rest of Europe would be much more limited; perhaps a cut of 0.3%-0.5% in GDP growth over the next 1-2 years, says Citigroup.
The immediate impact of a No vote would presumably be that Greek banks will still be cut off from additional liquidity funding from the ECB. This would make it impossible for Greece to repay the various debts due over the next weeks and months (including money owed to the ECB). This will exacerbate the problem. As analysts at Citigroup write:
Under Grimbo, the Greek government is likely to default on all (or most) debt service (to both public and private debt holders, perhaps excluding bills; it is conceivable that some attempt may be made to continue debt service for private debt holders in the hope of regaining market access) for the foreseeable future. Under these circumstances, the ECB would be likely to go beyond the capping of emergency liquidity assistance decided on Sunday 28 June and attempt to withdraw partially or completely ELA to Greek banks.
The squeeze on the banks would be passed on to both the private sector and the Greek government, making it more difficult for the latter to pay wages and benefits. Citigroup's analysts add:
The Greek government would likely decide to issue scrip/IOUs to pay its domestic suppliers and possibly public sector wages and pensions and would impose stringent withdrawals and capital outflows.
The Greek government would agree to accept these IOUs as payment for taxes (this is the way that national currencies have often been established). But Gresham's law would apply (bad money drives out good); people would want to hand over the IOUs as payment and hoard their remaining euros, which would trade at a substantial premium.
Grimbo might last for months or years, perhaps while the Greek government tried to negotiate a new deal with creditors. But it would be shock to the economy, knocking a further 5% off GDP, and pushing inflation (the prices paid in IOU terms) up by as much as 40%.
Eventually, of course, the IOUs might become a new drachma, turning the Grimbo into a formal Grexit. Greek residents would see the euros currently in their bank accounts converted into this new currency. S&P estimates that this currency might initially decline by about 37%, but this would settle at 30%.
The good news is that Greece would save the money it was paying in interest to its foreign creditors. Total interest payments are 4.1% of GDP (a lot lower than they were before the crisis because the debt has been consolidated into low-interest bonds). But of course Greek banks are big holders of Greek debt, so this would presumably be converted into a drachma obligation. And both Greek banks and Greek companies have borrowed abroad in euros, leaving them with drachma revenues and euro liabilities. As Joseph Gagnon of the Peterson Institute writes:
banks and corporations that have borrowed in foreign markets would be unable to repay their debts. This is a risk for domestically oriented companies whose revenues would be converted to drachmas while their foreign debts remained fixed in euros. According to data from the International Monetary Fund (IMF) for year-end 2014, Greek private external liabilities were $156 billion, or 64 percent of GDP.
It is not all bad news. Those Greek banks and companies that have overseas assets would see the value of such assets (in drachma) shoot up. But these may not be the same institutions as those that have euro debts. There would be bankruptcies, crucially in the banking sector. All this would have severe effects on the domestic economy. In S&P's view, there would be:
a massive confidence shock, equivalent to four times the impact on Greece from the Lehman fallout.
All this sounds very gloomy, and some may feel that it is an attempt to scare the Greek electorate. What about Argentina which recovered from its default in 2001 after the initial chaos? What about Britain which rebounded after being chucked out of the Exchange Rate Mechanism in 1992? Argentina had the benefit of a bull market in commodities; British banks and companies largely had sterling, not euro, debts so the impact of devaluation was largely benign.
Yes, Greece could benefit from a surge in exports (largely tourism) and from the gain in competitiveness for the country's domestic producers (as imported goods would leap in price). Citigroup writes that Grexit would have a bigger short-term negative impact than Grimbo but offers greater scope for a rebound as the banking and credit system would start functioning again. However, there are big risks. In the short run, import price rises would be inflationary. Mr Gagnon writes:
A competent government would contain this initial price rise to around 10 or 15 percent through several measures. First, and most important, the government would affirm the statutory independence of the central bank, with job security for its governor and a mandate to achieve 2 percent inflation over the medium term. Second, the government would commit to maintaining a balanced budget indefinitely. Third, salaries of public workers and public pensions would be limited to 2 percent annual increases in drachma terms.
In short, this would involve exactly the kind of austerity that Syriza has promised to avoid. As Mr Gagnon notes:
the current government is already falling behind on tax collection, and it will be sorely tempted to reverse some of the draconian spending cuts of recent years. Greece will be shut off from international borrowing and its government will find it very difficult to borrow domestically. If the government does not maintain a balanced budget for the foreseeable future, the temptation to take control of the central bank to fund its deficit through money creation will be irresistible. Indeed, even a widespread perception that the government is likely to abandon fiscal balance could be enough to create a burst of inflation that the central bank would be forced to fight with high interest rates that could choke off economic growth. Greece’s history of relatively high inflation prior to joining the euro does not bode well for its credibility in this endeavour.
If not handled properly, a Venezuelan-style spiral of continual inflation and currency depreciation might set in. Much depends on your confidence in how Syriza will handle the aftermath.
