Professional Documents
Culture Documents
Policy Brief
Vol. 2, No. 5
July 2015
Policy Challenge: With
the announcement of the
referendum in Greece, a Greek
exit from the euro area has
become a possible scenario. A
so-called Grexit would have
a high price for both sides. The
other euro area members should
be ready to take steps that
reestablish the credibility of the
euro area as a monetary union
built to last. If markets perceive
the euro area as just another
system of fixed exchange rates
that countries can leave and
join freely, this can drive the
monetary union apart.
Policy Recommendations: The
moment Grexit becomes likely,
political communication will be
key. An emergency euro area
summit should announce a
number of initiatives to bolster
the euro areas credibility.
Policymakers should commit to
the completion of the Banking
Union, including a pan-European
deposit insurance scheme. They
should nominate a president of
the euro area summit, establish
a regular meeting series, and
create a committee for euro
area affairs in the European
Parliament. Leaders should
also commit to discussing a
fiscal capacity and broader
institutional reforms for the euro
area.
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Europe Program
Policy Brief
flight and prevent a collapse of the banking sector, capital
controls have been introduced, which also rescind the free
movement of goods as one of the main promises of the
EUs single market.
For other euro area countries, contagion risks from Grexit
are lower than in 2012, due to a reduction of Greek debt in
balance sheets of European financial institutions and better
bank resolution capacities. Yet a major danger still persists:
in the case of a Greece exit, markets might perceive the
euro area as a fixed exchange rate regime rather than a
true currency union. Grexit would disprove the implicit
assumption that euro area membership is irrevocable. The
core peril with this phenomenon is the return not only of
country risk but also of irrational volatility, which drove up
the interest rate spreads of European peripheral bonds in
spring 2010 and de facto led to a market-driven spillover
of the sovereign debt crisis to other euro area member
states. These contagion effects could easily spread into
the banking sectors of Italy, Spain, and Portugal, where
domestic banks hold large shares of their governments
debt. There again could be an exacerbation of financial
fragmentation, and this time a bail-out might be too big to
handle by the European Stability Mechanism (ESM) and
the International Monetary Fund (IMF). At some point,
the European Central Bank (ECB) would then have to
make good on its Outright Monetary Transaction (OMT)
promise to do whatever it takes and purchase sovereign
bonds in the secondary markets.
System are paid back by U.S. states once a year to avoid the
accumulation of large imbalances. The German Bundesbanks exposure via the ECBs Target 2 claims against
Greece at the level of 30 billion would materialize in case
of Grexit, and Germany would have to take a write-down
on these balances.
From a broader EU perspective, Greece leaving the euro
area, despite all efforts since 2010 to help it get over the
sovereign debt crisis, would be perceived as a huge political
failure by the EUs international partners. Within the EU,
further disintegrative tendencies could be unleashed by
this breach of taboo, for instance by strengthening populist
movements that claim that their own country should also
withdraw from the euro area.
Moreover, a destabilized and financially and economically
devastated Greece would not only be an instability risk
on its own, it would also invite external influence, which
would most likely come from Russia and China. While
China has urged Greece to stay in the European Monetary
Union, it would probably embark on the further purchases
of strategic assets. Meanwhile, Russia would likely exert
economic and political influence in Greece and, through it,
in the EU. This also presents a challenge to Greeces neighbors in the Balkans, which could be further destabilized by
financial and political repercussions.
Scenarios for Greece
Greece faces pending insolvency due to the unsuccessful
negotiations over a new financial assistance program
with its creditors and passed deadlines of debt repayment to the International Monetary Fund. Since the ECB
revoked its waiver to accept Greek sovereign bonds from
Greek banks as collateral for fresh capital, Greek banks
were already entirely dependent on Emergency Liquidity
Assistance (ELA) provisions that were passed down from
the ECB through the Greek National Central Bank (NCB),
while Greek banks and the state were only illiquid but
not insolvent. As the Greek state, through the NCB, is
therefore the only means of funding for Greek banks, the
insolvency of one will almost certainly mean the insolvency
of the other. With these funds now also being frozen at
89 billion, capital flight increasing during negotiations,
and public default pending, the Greek government had to
declare a week-long bank holiday to prevent its banking
sector from sure bankruptcy, which would have initiated
July 2015
Europe Program
Policy Brief
its own default as well. According to the EUs strict rules
on risk contagion, a bankrupt Greek central bank would
have to be excluded from the eurosystem and its crossborder payment system Target 2. As a change of these rules
is as economically prudent as it is politically feasible, four
other scenarios are conceivable in the current situation:
1) Greece remains in the euro area under a conditional
agreement on financial assistance, 2) Greece remains in the
euro area without a new agreement and has to introduce a
parallel currency in order to pay domestic liabilities (fixed
and floating exchange rate option), 3) Greece keeps the
euro but leaves the euro area, and 4) Greece leaves the euro
area permanently and introduces the new drachma.
Scenario 1
In the first scenario, Greece and its creditors come to an
agreement and the country remains in the euro area with
the euro as its currency. However, given that Greece has
already missed payment deadlines that could eventually
trigger a cascade of claims ending in formal default, an
agreement at this point in time will require the commitment from creditors to alter Greeces debt repayment
schedule. In the short-term, the IMF would have to
accept a further delay in the repayment of loans instead
of declaring Greeces default, and the Council of the
European Financial Stability Facility (EFSF) would have
to forgo its right to call in the early repayment of loans
in case of such a statement by the IMF. In addition, a
comprehensive debt restructuring in the medium and long
term could be necessary as well. This outcome would still
minimize the costs for both Greece and its creditors. The
ECBs funding of banks through ELA would be replaced
by the original system of liquidity provision, as the ECB
would again accept Greek sovereign bonds as collateral for
loans. Depending on the degree of capital flight the Greek
banking sector has suffered during the debt negotiations,
A comprehensive debt
restructuring in the medium and
long term could be necessary as
well.
3
July 2015
Europe Program
Policy Brief
currency, it would not have access to the ECBs system to
attain fresh money. As the ECBs role as lender of last resort
disappears for Greece, every liquidity crisis in the Greek
banking sector automatically becomes a solvency crisis.
The only way to secure further funding would be if banks
were owned by foreign stakeholders, who would then
transfer the lender of last resort responsibility to their own
countries central banks.
Scenario 4
As a worst case scenario, the fourth option would be a full
blown Grexit with the introduction of a new drachma.
Without a bail-out agreement, Greeces central bank would
not be able to remain part of the ESCB system, and cross
border transactions could not be cleared via Target 2. Due
to massive capital flight risk, severe capital controls would
need to be introduced for the medium term. This would
by far have the most severe short-term disruptions for
the Greek economy and would also mean the necessity of
a haircut or restructuring on external public debt due to
the heavy devaluation of the new drachma. Furthermore,
external debt of the banking and business sectors would
also become unpayable for the same reason, as all external
debt would remain denominated in euros. Despite some
theoretical long-term benefits, the immediate impact of
redenomination would cause a severe recession and high
inflation.
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Europe Program
Policy Brief
influence on the mandate of a potential intergovernmental
conference. Opening treaty negotiations could allow
London to push a roll-back on integration, for instance by
questioning the free movement of people, or even the overall objective of an ever closer Union as the treaty states.
narios vulnerable to uncertainty. The evolution of perceptions, too, will affect the economic, political, and geopolitical consequences for the EU and for the broader South East
European region. Coherent and strategic communication is
part of the answer to this challenge.
July 2015
Europe Program
Policy Brief
an immediate step, they should nominate a president of
the summit. The heads of state and government should
establish a regular meeting series for a euro area summit
to increase the legitimacy of political leadership in the
euro area, and announce the creation of a subcommittee
for euro area affairs in the Economic and Monetary Affairs
(ECON) Committee of the European Parliament. Importantly, these steps can be implemented without a change
in primary law. For the euro area summit, the rules of
procedure have already been agreed upon in March 2013,3
but have been used only twice since then, as this summit
format was only reconvened on October 24, 2014 and June
22, 2015, not at least twice a year as stated in the rules of
procedure.
In addition to these measures (which serve to ensure
political dialogue and coordination on the highest level),
the eurogroup or the euro area summit should announce
immediate steps to help economic recovery in the hardesthit euro area countries. In order to achieve this objective,
necessary structural reforms, as well as the coordination of
public spending and financial aid, should be brought into a
better balance.
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Europe Program
Policy Brief
been outlined in the Four Presidents report in 2012 and
has reappeared in the Five Presidents report of June 2015.
Yet national leaders have so far not engaged in a serious
debate on the euro areas long-term perspective, mainly
for political reasons. The risks and benefits of introducing
a treasury and a fiscal capacity to the euro area should be
assessed in the broadest possible manner and should be
discussed publicly. The multiple crises in the euro area
since 2007-08 in fact provide ample input into a discussion of tools and policies that could have prevented the
underlying causes of the financial, sovereign debt, banking,
and economic crises, and which steps, beyond the Banking
Union, are necessary to increase the euro areas resilience.
Finally, euro area governments should announce that they
will assess the institutional set-up of the euro area with
the objective of improving transparency, efficiency, and
legitimacy of decision-making. So far, this political debate
has mainly concentrated on procedural improvements for
the European semester, which is the framework for the
coordination of economic and budgetary policy in the EU.
If, however, more elements of mutual insurance and risk
sharing are introduced as part of a completed Banking
Union, through a treasury and elements of a euro area
budget, stronger parliamentary control on the EU needs to
follow.
About GMF
The German Marshall Fund of the United States (GMF) strengthens
transatlantic cooperation on regional, national, and global challenges
and opportunities in the spirit of the Marshall Plan. GMF does this by
supporting individuals and institutions working in the transatlantic
sphere, by convening leaders and members of the policy and business
communities, by contributing research and analysis on transatlantic
topics, and by providing exchange opportunities to foster renewed
commitment to the transatlantic relationship. In addition, GMF supports a number of initiatives to strengthen democracies. Founded in
1972 as a non-partisan, non-profit organization through a gift from
Germany as a permanent memorial to Marshall Plan assistance, GMF
maintains a strong presence on both sides of the Atlantic. In addition
to its headquarters in Washington, DC, GMF has offices in Berlin,
Paris, Brussels, Belgrade, Ankara, Bucharest, and Warsaw. GMF also
has smaller representations in Bratislava, Turin, and Stockholm.
July 2015