Has a Greek exit from the euro zone become inevitable—and desirable? After years of holding back the flood, some European leaders appeared ready to let Greece go after an anti-austerity backlash in May 6 elections left the country without a government. “The future of Greece in the euro zone now lies in Greece’s hands,” said Guido Westerwelle, the German foreign minister, in a speech to the lower house of parliament in Berlin on May 11. “Solidarity is not a one-way street.”
The issue is whether Europe should keep financing a project that hasn’t succeeded and that the supposed beneficiary may not even want. Over the past two years Greece has repeatedly failed to meet the fiscal targets it agreed to in exchange for hundreds of billions in bailouts. A May 12 poll showed 78 percent of Greeks want to keep the euro. Yet the polls also show rising support for the anti-austerity Syriza Party, which favors scrapping what it terms “barbaric” bailout agreements. Syriza could become the biggest vote-getter in new elections now planned for June.
Renegotiating the bailout accords to give Greece more breathing room is possible but “would not set a good example” for other governments that are struggling to enforce austerity measures, Willem Buiter, an economist for Citigroup Global Markets, wrote in a recent research note. He puts the odds of Greece leaving the euro at better than 50 percent. That mirrors the results of a Bloomberg News poll of investors and analysts, released on May 11, that found 57 percent predicting an exit before yearend.
Still, Greece may get another reprieve. “We wouldn’t close ourselves off to a debate over extending the deadlines” for attaining budget targets, Luxembourg Prime Minister Jean-Claude Juncker said on May 14 after euro area finance ministers met to discuss the situation. German Chancellor Angela Merkel and French President François Hollande, meeting hours after his May 15 inauguration, said Europe was prepared to offer Greece unspecified measures to spur growth so long as Athens stuck with the austerity plan. “I see the suffering and challenges that the Greeks feel,” Hollande said.
Greece’s neighbors have reasons to be lenient. Athens said on May 15 that it only has enough cash to last until July. If the bailout tap is turned off, the government could be forced as early as midsummer to turn back to the drachma—devalued by at least 40 percent against the euro, most economists reckon—to keep the country functioning.
That, in turn, would trigger an uncontrolled default on Greece’s euro-denominated debt. It’s a scenario no one wants—including the International Monetary Fund and European institutions that have extended tens of billions in loans to Greece. The European Central Bank, as well as foreign creditors of Greek companies, banks, and households, also would be big losers (table). Greece’s foreign liabilities, both public and private, total €424 billion ($543 billion), more than the economy of Switzerland. “There’s lots of money on the table that could be lost,” says Marchel Alexandrovich, European financial economist at Jefferies International in London.
Default fears are already spooking investors in other countries, such as Spain and Italy, where bond prices have tumbled in the past few days. Greece, meanwhile, appears on the verge of a bank run: Depositors withdrew some €700 million on May 14, and the Central Bank warned the situation could worsen.
Politics, rather than economics, could dictate Europe’s next move. Germany’s insistence on discipline leaves it increasingly isolated, as governments across the Continent face unrest over fiscal tightening. Hollande was elected on an anti-austerity platform, and the Greeks are clearly hoping he’ll champion their cause with Merkel. The new French president “is on the European South’s side,” says Constantinos Michalos, president of the Athens Chamber of Commerce and Industry. “You cannot keep on milking a cow without feeding it.”