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Stopping Grexit

29 June 2015 By Hugo Dixon

The chance of Greece quitting the euro has risen sharply. But a so-called Grexit can still be stopped, despite dramatic weekend developments which saw Athens declare a six-day bank holiday after talks with its creditors broke down.The most obvious way of avoiding a Grexit is if the people vote to accept the bailout terms offered by euro zone countries and the International Monetary Fund in a referendum set for July 5. But even if they do that, it’s not certain Greece will avoid a return to the drachma.

The Greek people’s initial inclination will be to vote “no”. They are tired of austerity and have been told by Alexis Tsipras, the country’s radical left prime minister, that the creditors’ proposals amount to a humiliating ultimatum.

Tsipras ramped up the pressure when he announced the bank holiday on June 28. He accused euro zone countries of trying to blackmail the Greek people in an attempt to undermine democracy.

After Tsipras announced the referendum on Saturday and made clear he would be campaigning for “no”, euro zone finance ministers refused to extend the current bailout programme after it runs out on June 30. This then caused the European Central Bank to cap the amount of emergency liquidity that Greece’s central bank can pump into its lenders.

With people lining up to take money out of cash machines, Athens had no alternative but to impose draconian controls. People will be able to take just 60 euros per day out of their accounts. When Cyprus introduced capital controls two years ago, the limit was 300 euros a day. The Greek controls are much more stringent because Athens is fighting its creditors, whereas Nicosia was cooperating with them.

Tsipras has sought to play on the Greek people’s affronted pride. But as the days wear on, fear about what lies ahead may become a more prevalent emotion.

A key factor in the referendum will be what the electorate think they are voting for. If they believe that voting “no” amounts to quitting the euro, they will probably vote “yes”. But if they think they are just voting to reject the creditors’ proposals, they may well vote “no”.

Tsipras argues that rejecting the creditors’ demands doesn’t amount to quitting the euro. But it is hard to see the country surviving for long without a functioning banking system. And if the people vote “no”, the most plausible way of reopening the banks would be to bring back the drachma.

Meanwhile, Tsipras seems to hope Greece’s creditors might cut him a softer deal after the people voted “no”. But this seems implausible, as does the idea that they will sweeten the terms in the next few days and so persuade the prime minister to campaign for “yes”.

Barring a miracle, Athens will not be able to repay 1.5 billion euros it owes the IMF on June 30. Without a new bailout deal, it won’t be able to repay the European Central Bank on July 20 either. It will then be hard to pretend the government isn’t bust.

The banks will also be insolvent. Not only are they directly exposed to the government because they have lent it money; nearly half their capital is made up of so-called deferred tax assets, effectively an allowance that takes account of the fact that their taxes will be lower in the future because they have made so many losses in the past. What’s more, their bad loans, which are already huge, will rise further as the economy will tank.

The ECB, which supervises Greek banks, will probably then conclude that they cannot reopen until they have been recapitalised. But given that the euro zone won’t give Athens any more money, the only way of doing this will be to confiscate a portion of people’s deposits and convert them into new bank shares.

Something like this happened in Cyprus two years ago, which is one reason it endured capital controls and stayed in the euro. But, again, there is a big difference with Greece. In Cyprus, the “haircut” applied only to uninsured deposits over 100,000 euros and many of these were owned by Russians who couldn’t vote. In Greece, even small savers would be hit. It is hard to see Tsipras either having the guts to do this or surviving as prime minister if he did.

So in practice, voting “no” is highly likely to be a vote to bring back the drachma. The currency would then plummet, inflation would skyrocket and, during the transition, there would be shortages of basic imported commodities like petrol and medicine.

If the Greeks reflect on all this, they may vote “yes” in the coming referendum – though the fact that there is less than a week before the vote means that there’s not much time to retreat from their initial emotional reaction.

But even if they vote “yes”, it’s not clear that Greece will stay in the euro. For a start, Tsipras may try to hang onto power. If he does, the creditors won’t want to do a deal with him. They have so little trust in him that they now don’t believe he would implement any programme.

A more likely outcome is that Tsipras resigns as prime minister, leading to new elections. But even that is problematic, as the opposition is so fragmented that the prime minister could win such a vote even after losing the referendum. It is hard to imagine what would happen then.

On the other hand, the opposition might create a united front and win the election. If so, the creditors would presumably be willing to restart negotiations on a deal as they might trust the new government more than Tsipras. But it would still be tricky to get the show back on the road after the economy has gone into reverse, the government has defaulted and the bailout programme has expired.

Nevertheless, given the misery that awaits the Greeks if the country quits the euro, one hopes that they find some kind of way to avoid it. 


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