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Misery ahead

5 Jul 2015 By Hugo Dixon

The question Greeks answered on Sunday’s referendum ballot paper didn’t mention the euro. But after the people gave an emphatic “No” to proposals from the country’s creditors, Greece will struggle to stay in the single currency. Even if it does, all routes will bring economic hardship and social tension.

The first way of avoiding a reversion to Greece’s pre-euro currency would be if euro zone partners and the International Monetary Fund cut Alexis Tsipras a significantly better deal than they were offering 10 days ago. This is what the radical left prime minister said would result from a “No” vote. The government even promised to do a deal within 48 hours.

But the creditors probably won’t buckle. They would prefer to keep Greece in the euro if possible – for both financial and geopolitical reasons. But many of the leaders are fed up with Athens’ rhetoric and negotiating style. The day before the referendum, for example, Finance Minister Yanis Varoufakis accused them of terrorism. Parliamentarians and electorates in some countries, such as Germany, are hostile to the idea of granting more soft loans to Greece.

The euro zone countries seem to have steeled themselves to the likelihood of a “Grexit” since talks broke down. Since then, despite the fact that Greece has closed its banks, financial contagion has been minimal. Several countries such as Spain will be nervous that, if they now cut Athens a soft deal, radical parties in their own countries will grow in strength.

What’s more, since Tsipras called his referendum, the country’s old bailout programme has expired and the country’s economic prospects have deteriorated. A comprehensive new deal for Greece would probably require around 70 billion euros. It is hard to see why the creditors would lend such a large sum of money to a government they don’t trust.

This doesn’t mean that the euro zone will refuse to talk to Greece. But they are likely to take a measured approach rather than snapping to attention. They probably won’t rush to provide debt relief, one of Tsipras’ key demands. They will also attach lots of conditions to any money they lend and insist on intrusive monitoring. Meanwhile, the European Central Bank seems unlikely to increase the amount of liquidity it is providing to Greece’s banks.

All this will be frustrating for Tsipras. Not only is the bank closure already hitting society and the economy, the cash machines could run out in days.

What’s more, things will take an even more dramatic turn for the worse on July 20, when Athens is due to pay the ECB 3.5 billion euros. If Greece misses that payment, the central bank will probably conclude that the state is bust and, because of the way the country’s banks are connected to the government, that they are insolvent too.

A bust bank is a more serious matter than a bank holiday. People would be unable to use their credit cards or make electronic transfers. Tourists, who are currently unaffected by the capital controls, would no longer be able to extract cash. That would hardly be a good advertisement for Greece’s most important industry. The economy would go into a tailspin.

Before the banks could be reopened, they would need to be recapitalised. One way to do this would be for Greece to leave the euro. The government could then print drachmas and invest those in the banks. The other option would be to “bail in” depositors – taking a portion of their savings and converting them into capital.

Since Tsipras has promised to do neither, he would be in a terrible bind. Indeed, it is possible that the strains on his government would become so great that it would fall. His majority is fairly slim, so there wouldn’t need to be that many defectors before he lost a vote of confidence.

That said, given the fat margin in the referendum, Tsipras looks secure for the moment. He might therefore be tempted to introduce a new currency, either to replace the euro or to run alongside it. Not only would this enable him to reopen the banks, it would also allow him to pay out salaries and pensions. The new currency would immediately fall to a big discount to the euro, perhaps half its value.

Were Tsipras determined to do this, his euro zone creditors might be willing to discuss a “velvet divorce”. This would involve giving Greece some transitional aid to reduce the most severe humanitarian hardship while allowing the country to stay in the European Union.

But the process of getting there will not be easy. Not only would it be a legal quagmire; it is not clear that the Greek people would let Tsipras bring back the drachma. The pro-European opposition would argue that he did not have a mandate to do so, as he has insisted that Sunday’s referendum was not about the euro.

Tsipras might also need a 60 percent majority in parliament, which he doesn’t have, to change the country’s currency, although the constitution isn’t absolutely clear on this point. If he insisted on going ahead, it is also possible that the country’s president would resign. In that scenario, there would probably have to be new elections – and, depending on what had happened in the intervening period, Tsipras might lose. If so, Greece might still hang on in the euro by its fingertips.

If this all sounds like a lot of “coulds” and “mights”, it’s because after the people’s “No” vote, Greece is sailing in uncharted waters. What is certain is that there is much more misery ahead.


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