Eurozone finance ministers met on Tuesday to discuss the Greek debt crisis following the country’s ‘No’ vote in its bailout referendum on 5 July. Lorenzo Codogno writes that while a Grexit remains unlikely, the risks have clearly increased since the referendum and the financial and economic situation in Greece may further deteriorate before a solution is in sight

Codogno, Lorenzo

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Jeroen Dijsselbloem, President of the Eurogroup, speaking before themeeting on 7 July. Credit: EU Council Eurozone (CC-BY-SA-3.0)7/7/2015Grexit remains unlikely, but time is against the Greekgovernmentblogs.lse.ac.uk/europpblog/2015/07/07/grexit-remains-unlikely-but-time-is-against-the-greek-government/Eurozone ﬁnance ministers met on Tuesday to discuss the Greek debt crisis following the country’s‘No’ vote in its bailout referendum on 5 July. Lorenzo Codogno writes that while a Grexit remainsunlikely, the risks have clearly increased since the referendum and the ﬁnancial and economicsituation in Greece may further deteriorate before a solution is in sight.Following the ‘No’ vote in the Greek referendum, there is deep uncertainty over what the possiblescenarios are now for Greece. This article addresses some of the key questions prompted by theresult. Firstly, what was the referendum all about? The question was certainly not easy to interpretfor the average Greek voter, but the overall message was clear. On paper, it was a vote on the creditors’ ﬁnancingpackage. More broadly, it was a conﬁdence vote on the Greek government and its attitude in the negotiations withcreditors and towards the conditionality required on Greece to get ﬁnancial support. At face value, however, it wasnot a referendum on the euro.From this perspective, the referendum was uselessand probably counterproductive, but it raisedfundamental issues. In fact, while the vote hasimmediate practical implications, it is also a soul-searching exercise for Europe, what it stands for,what kind of governance is the most appropriate forthe future.Countries must give up sovereignty as they entermonetary union, and it will become even truer as theEurozone moves toward ‘ever closer integration’.Moreover, the current governance implies anincremental withdrawal of sovereignty as a countryproceeds into a formal infringement procedure,implements a Memorandum of Understanding andgets ﬁnancing. A country cannot impose its own rulesat the expense of the others, especially if it has avery high debt versus the rest of the Eurozone.The current debate goes far beyond the Greeksituation. It goes straight to the heart of what European integration is all about, and thus it will have long-lastingimplications for the future of the Eurozone. This reasoning would lead me to a long discussion, while the purpose ofthis commentary is to pinpoint possible near-term developments.What next?At face value, a ‘no’ vote does automatically translate into plain rejection of the last-ditch bailout oﬀer by Greece’screditors. However, things may be more complex than that for a number of reasons. First, the text submitted to thereferendum was already obsolete as negotiations had advanced in the meantime. Tsipras said he would headstraight to Brussels if he gets a ‘no’ vote and he is expected to present proposals later today. Even more importantthan the vote, however, is the political reaction in Eurozone capitals, and especially in Berlin. If the attitude remains1/4constructive, proper negotiations will now resume, but time is of the essence here as the ﬁnancial/economic situationin Greece is deteriorating fast.Second, the fact that just over 61 per cent of Greek voters voted ‘no’ cannot be totally dismissed in Brussels and inthe other European countries, but the starting point of fresh negotiations is likely to be the end-point of the previousones. My guess is that creditors will initially be unwilling to change much with respect to the latest oﬀer. They havemade it perfectly clear that further debt relief will be on oﬀer only once Greece implements the programme. This isunlikely to have changed with the referendum. It is a sensible attempt to reward good behaviour and, if anything, thisstance may have hardened.Third, it is not clear whether there will be any room for further concessions by Eurozone governments with theirtaxpayers’ money (they have democratic mandates to honour as well) simply because Greek voters want them to doso. Tsipras has already completely lost trust among the creditors, and thus now he has a much more diﬃcult task.Fourth, there will likely be a need for some bridge ﬁnancing to avoid an immediate collapse of the Greek ﬁnancialsystem and this may prove particularly diﬃcult. The Greek government will have to conﬁrm the closure of Greekbanks and maybe even introduce IOUs or promissory notes for a while. Negotiations will likely take more than a fewdays.Is the current programme suitable?My guess is that the programme tabled by the Eurogroup on 25 June (voted at the referendum) will becomesubstantially diﬀerent over the next few days. It is apparent by now that the programme is inadequate to address thefundamental issues facing Greece. In particular, it has a short-term approach (understandably so, given the lack oftrust with regards to the ability of the Greek government to deliver); it does not address the long-term ﬁnancing issueof the economy (these needs would call for a 10-20 year “Marshall Plan” for Greece); it is heavily skewed towardshigher revenues (given the Greek government’s stance on spending cuts), which would not help Greece’s economicrecovery; it does not properly acknowledge the issue of aggregate demand (even the IMF is now fully on board withthis); and there is no attempt to provide any form of debt relief (creditors are unlikely to give Greece the beneﬁt of thedoubt, especially after the outcome of the vote), but the commitment should be clearly spelled out.Can a butterﬂy in Brazil cause a tornado in Texas?The knee-jerk reaction by ﬁnancial markets is likely to continue to be negative. Government bond spreads couldeasily widen sharply. This also depend on the signals coming from Athens: when the noise is conciliatory, with aconstructive attitude in ﬁnding an agreed solution, the widening of spreads may well prove temporary. However, ifthe perceived probability of Grexit increases, the widening of spreads and market turbulence may become morepronounced.In ﬁnancial markets, a butterﬂy in Brazil can cause a tornado in Texas. This event is more than just a butterﬂy andthe tornado can easily spread to a substantially larger area. Danes rejected the Maastricht Treaty in the 2 June 1992referendum with a tiny 50.7 per cent majority. It was widely perceived as a blow to the process of Europeanintegration (and, for a short while, indeed it was). It was suﬃcient to trigger the currency turmoil in 1992-1993. Sincethen, issues relating to European integration have been subject to greater scrutiny.The current situation is more delicate for Europe than the one back in 1992 and the sense of uneasiness for theEuropean integration process more pronounced. Moreover, the social and political backlash of the ﬁnancial andeconomic crisis in Europe has brought to the fore explicit opposition to European integration both in core Europeand in the periphery. For instance, I was shocked to see that, according to a poll, 49 per cent of Italians would vote‘no’ to the Greek referendum. Far-left and far-right populism is on the rise almost everywhere in Europe. The wholeconfrontation with Greece may have far-reaching political consequences. There could be political contagion in therest of Europe.2/4Aside from this, however, it is diﬃcult to see any mechanical channel through which contagion could spread inﬁnancial markets. The referendum was widely debated and ﬁnancial markets were prepared for the possibility of a‘no’ vote. In other words, the surprise outcome of the vote was not totally unexpected (while the Greek decision tocall for a referendum was a genuine surprise). The Greek exposure is almost entirely towards other Europeancountries and international institutions, which could more easily absorb losses. As a result, there is limited risk ofsetting in motion a spiral of ﬁnancial problems that leads to widespread changes in economic agents’ behaviour.This is particularly true for the European banking sector and institutional investors.In case of default also of the private side and/or exit from monetary union, the banking sector in Greece would de-facto be insolvent and it would have to be recapitalised. Still, the international exposure to the Greek banking sectorlooks limited and unlikely to trigger widespread contagion (Greek banks are present in some other countries, notablyin Bulgaria, Serbia, Romania and Turkey). To some extent, a default in Puerto Rico would produce much largercontagion as most of its debt is in the market.What can the ECB do?In the short term, the heavy lifting will have to come from the ECB. The ECB is expected to front-load assetpurchases undertaken as part of its quantitative easing programme should ﬁnancial markets drive up governmentbond spreads across Europe. It could easily double or triple, or even buy a multiple of its usual daily amounts ofbonds bought under the programme. The recent move to broaden the set of assets the ECB can buy is to beconsidered as part of the attempt to increase its ammunitions.Speciﬁcally on Greece, I doubt there will be any possibility for ELA extension before any political decision. The ECBcould provide technical assistance to the Bank of Greece for managing the liquidity situation, but I ﬁnd it diﬃcult tobelieve that it can provide any ﬁnancing before a political green light. Moreover, if a solution is not found by 20 Julyand Greece defaults on the ECB, even the current stock of ELA extended to the Greek banks will have to bereconsidered. In case turbulence continues, the ECB has a clear mandate to preserve ﬁnancial stability andsingleness of monetary union, and thus other tools may be introduced.Can the situation generate much-needed clariﬁcation within Europe?Some people argue that this Greek saga may lead to signiﬁcant steps toward integration in the Eurozone, a speed-up in the ever closer integration. I doubt it. Since the European political elections in May 2014, there has been aclear shift in sentiment toward Europe and the appetite for “more Europe” is probably at historical lows.In my view, the only signiﬁcant step that in the near future could prevent the spreading of tensions to other Eurozonecountries would be an unlimited insurance on the denomination of bank deposits across the Eurozone. In otherwords, European institutions would not guarantee the banks but the denomination of deposits to avoid futurepotential bank runs. Never say never, especially if the situation worsens signiﬁcantly. Yet, politically the situationdoes not look mature for any sizeable step toward more Europe, not even in the technical domain of economicgovernance or deposit insurance.Nevertheless, such an extreme event would justify a deep soul-searching exercise over the coming months. I thinkthis exercise is badly needed and it may eventually turn into a renewed commitment and a fresh relaunch of theintegration process. But it will take time.Bottom line: down but not outFinancial markets are braced for signiﬁcant tensions. The ECB has the tools to prevent contagion in the near term,but any step to provide liquidity support to Greece can only happen with political blessing. Grexit remains unlikely,but the risks have clearly increased. It would represent permanent damage to monetary union. European leaders willwork on a solution over the coming days to prevent Grexit by seeking a reasonable compromise with the Greek3/4government.Time plays against the Greek government. It may take at least a few days and the ﬁnancial/economic situation inGreece may further deteriorate before a solution is in sight. The immediate negative reaction by ﬁnancial marketsmay prove short-lived if an agreement is eventually reached.Please read our comments policy before commenting .Note: This article gives the views of the author, and not the position of EUROPP – European Politics and Policy, norof the London School of Economics.Shortened URL for this post: http://bit.ly/1fkr1uu _________________________________About the authorLorenzo Codogno – LSE, European InstituteLorenzo Codogno is Visiting Professor in Practice at the LSE’s European Institute. Prior to joiningLSE, Lorenzo Codogno was chief economist and director general at the Treasury Department of theItalian Ministry of Economy and Finance (May 2006-February 2015). In this capacity he served aschairman of the Economic Policy Committee, junior committee of Ecoﬁn, in 2010 and 2011. Hejoined the Ministry from Bank of America where he had worked over the previous 11 years. He wasmanaging director, senior economist and co-head of European Economics based in London. Beforethat we worked at the research department of Unicredit in Milan.4/4

Grexit remains unlikely, but time is against the Greek government

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