How a Greek Exit Could Impact the Eurozone

Greece

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Franklin Allen on a Possible Greek Exit from the Eurozone

The prospect of the far left-wing Syriza party winning the Greek snap presidential elections on January 25 has heightened uncertainty within the European Union and other countries doing business with it. Pushing populist measures, Syriza (or the Coalition of the Radical Left) wants significant debt write-offs and freedom from the austerity measures that came with previous bailout packages — moves that could trigger Greece’s exit from the eurozone.

Those developments would set political and economic precedents and have a contagion effect among other EU countries that have bigger debt burdens, according to Wharton finance professor Franklin Allen. “Two countries that are big debtors where there is a chance populist parties may win are Italy and France, [but] their elections are at least a couple of years away,” he said. Allen is also a professor at Imperial College in London and heading its Brevan Howard Centre.

Germany appears willing to let Greece leave the EU, Allen noted, even as it has a lot of its money at stake in the debt recovery. But new questions would arise if Greece defaults on its debt. “If [Greece] does well, and starts to grow with a flexible exchange rate, then that can spell a lot of trouble for the eurozone Twitter ,” he said. “Other countries may decide that, ‘Greece did it and it is doing fine, so why don’t we [also] do it?'” On the other hand, if the Greek economy does not do well after an exit, “the eurozone will be much safer,” he added.

Allen shared his insights on the unfolding Greek situation on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

Triple Whammy

Greece’s troubles have been building up over the past eight years, during which the country has suffered three recessions and has seen its debt burden rise to a staggering 175% of its gross domestic product of $242 billion. The so-called ‘troika’ of the European Union, the European Central Bank and the International Monetary Fund put together two bailout packages in 2010 and 2011 totaling 240 billion euros ($285 million), and a third package of an estimated 17 billion euros ($20 billion) is in negotiations.

Amid all that, the country hurtled into an early general election after its parliament last week rejected Prime Minister Antonis Samaras’s presidential nominee. In the U.S., the Dow fell more than 300 points that day, driven by the resulting uncertainty in Greece and oil prices hitting new lows. With opposition party Syriza leading in the opinion polls, a ‘Grexit,’ or a Greek exit from the eurozone, seems a strong likelihood.

Write-offs Writ Large

Allen noted that most neutral observers do not see any way for Greece to repay its debt. The focus has to be on bringing down the debt level. Syriza wants to achieve that by negotiating a “restructuring,” which, according to Allen, is akin to writing off a significant part of the debt. Much of the debt owed to the private sector has already been written off in previous restructuring exercises, and at stake is mostly money owed to the ECB, the EU and the IMF, he said.

“Syriza … wants to take a traditional view, which is write off the debt, start increasing spending and stimulate the economy in a Keynesian fashion,” Allen said. “If they win and are successful in writing of the debt and staying in the eurozone or leaving it, there are likely to be big contagion effects to other countries.”

At the same time, Syriza is not a fan of the austerity plans that were put in place earlier with the bailout packages, said Allen. The Greek economy is under strain with its GDP down 25% in the latest year and high unemployment, also at 25%, he noted. “[Syriza leader Alexis] Tsipras believes it is time to stop this and change things by writing off the debt and starting to pursue people’s welfare rather than the creditors’ welfare,” Allen noted. “Under the current regime, it is not clear how long it will take to get back to any kind of normality, whether it is measured in years or decades.”

“If [Greece] does well [after exiting the EU] and starts to grow with a flexible exchange rate, then that can spell a lot of trouble for the eurozone.”

Uncertainty in the Process

The process by which Greece could work its way out of its debt overhang is also fueling worries, according to Allen. “They can negotiate. But if the European entities and the IMF say no, it’s a difficult question as to what would happen next,” he said. “Could they simply unilaterally say they will not pay the debt, just like Argentina did? What would be the sequence of events then? How would contracts that were written in euros be enforced? I don’t think there are good answers to those questions.”

The uncertainty over those issues will last at least three weeks until the election results are out, but could extend to months or longer if Syriza wins and forms the next government, said Allen. Another development that could alter the poll outcome is the recent entry of former Greek Prime Minister George Papandreou by forming a new party. Allen said that while pollsters expect Papandreou to get only about 5% of the vote, “that may matter because it may affect who wins.”

In the meantime, Germany faces a dilemma in how it should play its cards, Allen noted. “On the one hand, [the Germans] will ultimately have to pay a large proportion of any debt write-down. On the other hand, people have been saying [the country] shouldn’t interfere in Greek internal politics. They have a very tricky problem there.”

Even as Tsipras leads the pre-election polls, Allen pointed out that “a lot of posturing” is at play over how to deal with Greece’s debt, and “the reality may turn out to be quite different from what people are saying.” Samaras is hoping for “a change of heart” among voters and that they will “choose safety” by electing him instead of the relatively lesser known Tsipras, he added. “You never know what people do in the last minute.”

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