No Grexit: Why Greece Stayed in the Eurozone

Remy Davison

Remy Davison is Jean Monnet Chair in Politics and Economics, and Associate Director of the Monash European and EU Centre at Monash University.

Fiscal sovereignty is over for Greece. Decades of corruption, mismanagement and poor productivity culminated in the European Union (EU) assuming strict control of budgetary management, structural reforms and, by default, the entire Greek banking system, leaving legislators in Athens with a purely functional role.

In the 5th July referendum, Greeks voted an overwhelming ‘Oxi’ [‘No’] to the EU’s bailout conditions. Yet, by the 13th July, Prime Minister Alexis had agreed to Greece’s third bailout since 2010, an €86 billion injection of loans, coupled with €50 billion in compulsory asset sales and privatisations. Moreover, Athens will still need to repay the €320 billion (170% of GDP) it owes the European Central Bank (ECB) and the IMF, although loan maturities have been extended considerably.

If this represents the revolution Tsipras spoke of in January 2015, then the revolution will have to be postponed. Both Tsipras and his former finance minister, Yanis Varoufakis, declared from the outset that Greece wanted to remain within the Eurozone and to retain the euro currency. Once these parameters were established, Tsipras and Varoufakis essentially locked themselves into an iron cage. Declaring Eurozone membership non-negotiable handed Greece’s EU partners the initiative. It was the worst negotiating position Tsipras could have adopted; from that point onwards, Eurogroup leaders determined whether Greece would remain within the Eurozone, and the conditions under which the country would stay.

The first six months of Tspiras’ Syriza coalition may well become a textbook case in execrable economic and political management. Since the 2012 Greek financial crisis, which saw French and German banks, precipitously leveraged beyond even the dizzy heights of Lehman Brothers or Bear Stearns, take a 50% haircut for their imprudent lending (although the real face value, In 2012, Tsipras came close to winning the elections, but the conservative New Democracy government, which accepted the 2010 and 2012 bailout conditions, imposed the austerity measures demanded by the Troika: the ECB, the EU Commission and the IMF.

The measures were not unreasonable, particularly for a country where the government of Costas Simitis in 2001 had committed large-scale fraud by submitting falsified national accounts to the EU Commission that drastically understated the public debt and fiscal position of the Greek economy, thus sowing the seeds for the crisis of 2009–10. The Troika imposed zero interest on Greek bailout loans through 2022; the IMF and EU loans were discounted considerably on open market rates; and Greece would receive profits from Greek bonds that the ECB purchased.

In response to these strictures, Greek fiscal consolidation improved considerably, with Athens achieving a 1.0% primary surplus, albeit at the cost of 25% unemployment and seven consecutive quarters of negative economic growth. Yet, in 2013, Greek spending on pensions (as a percentage of GDP) remained the highest in the Eurozone. In 2014, the economy grew fractionally for three quarters, before returning to recession by mid-2015. Nevertheless, April 2014 saw Greece’s return to the bond market, with an over-subscribed €3 billion debt issue sold at a moderate 4.95% yield.

But the collapse of negotiations between Greece and the Eurogroup of finance ministers in late June 2015 precipitated a crisis. In an unprecedented move, a developed country announced it would default on an IMF loan. The Greek banking system itself, subsisting on the ECB’s Emergency Lending Assistance (ELA) program, was in danger of illiquidity, due to depositors withdrawing cash at alarming rates. Between 15–18 June, Greek banks were rapidly becoming depleted by €2 billion in withdrawals from the system. Consequently, the banks closed on 28 June, issuing only €60 per day to customers, while the government imposed capital controls. But capital flight was not new; between 2009 and 2015, both Greek consumers and firms had transferred hundreds of billions of euros to offshore banks. In effect, Greek banks had become a conduit for transferring from the capital accounts of surplus EU economies to third-party financial institutions.

There were zero options for Greece other than remaining within the euro currency area. The unpalatable alternative – a strategic retreat to the drachma – has not been suggested by any responsible economist. Even Paul Krugman, arch-critic of the EU currency union, sees the dangers of chaos superseding any potential gains deriving from competitive devaluation.

Had Tspiras and Varoufakis opted for Grexit, the challenges would have proven insuperable, even disregarding the complex challenges of introducing a new currency. Devaluation would be no panacea; indeed, it is a policy tool that wealthy economies employ to secure a competitive advantage without undertaking structural reforms to improve productivity or efficiency. But it does not work for states with dubious currencies, and even more dubious credit histories, seeking to manipulate exchange rates to their advantage. Greece could have defaulted on its sovereign debt, but it would have proven impossible for Athens to raise credit on international markets, as Argentina has found to its cost, forcing Buenos Aires to reach an accommodation with its creditors. The Bank of Greece could not defend a drachma peg against an avalanche of global currency speculation, leading inevitably to rampant inflation. In addition, devaluation would not have improved the Greek health sector: virtually all pharmaceuticals are imported, and medical costs would rise dramatically.

In light of the need to maintain Eurozone stability, the Eurogroup, together with the IMF, opted to agree on a third bailout for Greece, rather than facing the risk of contagion spreading to the EU’s recovering southern periphery, which would have threatened the viability of the euro area and member-states’ fragile economies. The transaction costs associated with bailing out Athens were considered to significantly outweigh an outright Greek default and Grexit, exacerbating the risk of contagion spreading to the periphery. That Greece’s problems re-emerged in 2015 was unsurprising: the largest tranche of debt bonds reached maturity this year, together with the biggest proportion of IMF repayments. Essentially, the Greek economy was excessively stressed by the size and frequency of repayments, including €3 billion due to the ECB in August 2015.

Now Athens must make the tough structural reforms, encompassing areas such as direct and indirect taxation, competition policy and privatisation, under the direct supervision of the EU Commission and the IMF. For now, Greece will remain within the Eurozone and is unlikely to be expelled, as there is no legal mechanism to do so. However, it is entirely possible that Athens could be temporarily suspended from the Eurozone if its legislators fail to live up to their side of the bailout bargain.


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