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EU Leaders Need an Emergency Plan B for Greece

Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”
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After finance officials failed to reach an agreement on Greece on Thursday, European leaders wisely decided to hold an emergency summit Monday. Although the main objective is to break the deadlock opposing Greece and its creditors, this gathering should have a second important goal: unifying 18 euro-zone members around a Plan B if efforts to salvage the 19th member, Greece, falter again.

QuickTake Greece's Fiscal Odyssey

The primary aim of the summit is to deliver the long-sought accord that would keep Greece solvent, and within the currency union. Without such an agreement on both policies and emergency financing, it would be a matter of days before Greece's banking system imploded. Then the government would have to impose capital controls, default on debt and supplier obligations, and issue IOUs to meet domestic payments.

Despite the urgency, success is highly uncertain. I place the probability of a good outcome at slightly less than 50 percent. And the reason for my limited optimism has to do with the difference between what is necessary and what is both necessary and sufficient.

Related: Greece Default Watch

Averting an ugly accident that would make Greece's continued euro membership virtually impossible would require the highest political authorities in Europe to be flexible, courageous and open to compromise. At this stage, a positive outcome could only be achieved through a collective political initiative that involves the heads of government of the euro zone. Yet even such an unprecedented display of cohesion would probably be insufficient, for at least three reasons:

First, the recent public acrimony and the ugliness in the relationship between Greece and its creditors, including the virulent accusations and counter-accusations, make it very hard for any of the sides to sell an agreement to their own domestic constituencies. Without domestic support, including approval by national parliaments in certain countries (including Germany and Greece), no agreement could be implemented.

Second, the International Monetary Fund and, to a lesser extent, the European Central Bank, have little appetite for a renewed commitment to a politically driven process that has insufficient economic and financial underpinnings. Yet without new commitments of funds, it will be hard for these institutions to receive payment from Greece on the substantial obligations that come due in the next five weeks.

Third, the deteriorating economic and financial situation in Greece has made any corrective measures even more challenging to implement. This is particularly true when it comes to the banking system, which is stuck with lots of Greek government bond holdings, and is teetering under the pressures of large deposit outflows and rising nonperforming loans.

Given these circumstances, the euro-zone leaders who will meet Monday would be well advised to supplement their deliberations on Greece with serious discussions of a Plan B -- namely, how to respond to a “Graccident” in a way that protects other members of the currency union and the integrity of this important regional integration project.

At a minimum, the leaders would need to agree on a collective stance should Greece's exit become inevitable and, second, to commit their regional institutions and facilities (particularly the ECB, European Financial Stability Facility, European Stability Mechanism and the European Investment Bank) to do whatever it takes to contain contagion.

These regional initiatives would need to be supported by renewed national commitments to economic reforms, particularly in peripheral countries such as Cyprus, Italy, Portugal and Spain that would be tested by markets if Greece were to leave the euro.

It is far from certain that Monday’s summit will manage to bridge what is now a sizeable gap between Greece and its creditors, especially if the two sides are to agree on a solution that extends beyond yet another short-term Band-Aid. But the gathering can, and must, play a pivotal role in minimizing the risks of durable spillover to the rest of the euro zone and the global economy. On this goal, at least, it has a good chance of succeeding.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Mohamed A. El-Erian at melerian@bloomberg.net

To contact the editor on this story:
Max Berley at mberley@bloomberg.net