El-Erian Sees 85% Grexit Odds as ‘Massive’ Contraction Looms

Updated on
El-Erian Sees 85% Chance of Greece Leaving Euro Zone

Greece is heading for a “massive economic contraction” and is likely to be forced out of the euro zone, according to Mohamed El-Erian, the former chief executive at Pacific Investment Management Co.

Greece shut its banks and imposed capital controls in a dead-of-night announcement designed to avert the collapse of its financial system after a weekend of turmoil. People rushed to line up at ATMs and gas stations following Prime Minister Alexis Tsipras’s shock announcement late Friday of a July 5 referendum on austerity measures demanded by the country’s creditors.

“There’s an 85 percent probability that Greece will be forced to leave the euro zone” in the next few weeks, El-Erian said in an interview from New York. “What we are seeing here is what economists call the sudden stop, when the payment system stops. The logic of a sudden stop is a massive economic contraction, social unrest and it’s going to make continued membership of the euro zone very difficult for Greece.”

The euro dropped more 1 percent and Treasuries surged by the most since 2011 as the collapse of Greek rescue talks roiled global markets. The lack of trust on both sides now makes it very hard to see how there can be an agreement that would resolve the impasse, said El-Erian, who worked at the International Monetary Fund from 1983 to 1997. He is now chief economic adviser at Allianz SE and chairs President Barack Obama’s global development council.

No Compromises

“This has been an accident in the making for a number of years,” said El-Erian, who is also a Bloomberg View columnist. “It reflects an inability to understand each other’s point of view and an inability to compromise. Europe should have been much more forthcoming on debt reduction and Greece should have been much more forthcoming on implementing reforms.”

El-Erian said the European Central Bank will be a key player in trying to contain fallout across the region as the crisis threatens to undo much of the work that President Mario Draghi has done to shore up confidence in the euro as a leading currency of global trade.

While Greece accounts for less than 2 percent of the euro zone’s output, its exit would hurl the bloc into unknown territory by setting a precedent for other nations to reconsider membership.

Volatility Surges

Volatility in the euro jumped by the most since the 2008 global financial crisis and the currency dropped 1.4 percent top $1.1013 as of 5:43 a.m. in London.

Tuesday marks the expiry of Greece’s current bailout package as well as the deadline for a payment to the IMF.

While there’s no rule to say Greece would have to leave the euro if it skips that payment or fails to extend its financing arrangements, it may prove difficult to stay in if, for example, the country has to start printing its own currency to keep its financial system afloat.

El-Erian said that some sort of parallel currency may well be issued by Greece because the government has to find some way to pay its bills.

The former Pimco head’s pessimism on Greece’s chances for staying in the euro isn’t shared by the economist who coined the term “Grexit” in 2012.

Grexit Doubted

“We expect the referendum to result in a comfortable majority for the ‘Yes’ camp, and expect no Grexit this year and a lower risk of Grexit in subsequent years,” Citigroup Inc. economists including Ebrahim Rahbari wrote in a research note for clients on Sunday.

The Greek government’s determination to resist fiscal measures its creditors are asking stems from the devastating impact on the nation of five years of austerity. Unemployment has been at Great Depression levels for years and the country has seen a quarter of its gross domestic product wiped out.

The challenge is that the events of the past few days will further damage the crippled Mediterranean economy, even if it somehow hangs on to its place in the euro zone, El-Erian said.

“This is a tragic situation -- we must not forget that there are Greek citizens that have already been suffering for five years,” El Erian said. “They’ve seen their living standards cut, unemployment is running at 26 percent, youth unemployment is over 50 percent and they’re about to face an even bigger depression.”

For more, read this QuickTake: Greece's Fiscal Odyssey

Before it's here, it's on the Bloomberg Terminal. LEARN MORE