The euro tumbled to its lowest level against the dollar in nearly nine years over the weekend amid fears that Greece could exit the Eurozone, a scenario which has been dubbed “The Grexit”.
With a Greek election scheduled to take place on 25th January, Eurozone heavyweight Germany have piled pressure on the Greeks to vote the “right way” by stating the eurozone could cope with a Greek exit and that such an outcome would be almost inevitable if the “anti-austerity” Syriza party wins on 25 January.
The threat from Berlin seems reasonably clear: German chancellor Angela Merkel will not tolerate Syriza’s demand to write off a chunk of debt and Greeks who want to stay in the euro (which is said to be the majority) should vote for a mainstream party.
Whilst Germany’s stance is quite clear, there are several reasons why they should proceed with caution regarding the “Grexit”.
Firstly, a precedent would be set: countries could leave the euro. This would give Anti-euro parties in Spain, Portugal and Italy encouragement and renewed hope. Bond yields in fringe countries might shoot up on the renewed fears of a breakup. The job of the European Central Bank, after its tortuous progress to quantitative easing, would become harder.
Secondly, a Grexit would make sense for Athens only if accompanied by default, or default on the part of the debt not owed to the International Monetary Fund. That would be expensive and embarrassing for eurozone lenders since two bailouts would have failed. Voters would ask why so much time, energy and money was deployed in trying to keep the club intact in the first place.
Finally, a Grexit would happen against the wishes of the majority of Greeks, if the polls are correct. Investors would wonder if Germany would also be so upbeat about other accidental departures.
The most likely outcome, even if Syriza emerges victorious, is Greece once again dipping into the Euro bailout fund. Syriza, almost certainly, would have to govern in coalition with more reasonable parties and tone down its demands. For their part, Germany and others should be able to see that Greece, with a debt-to-GDP ratio of 170%, remains miles away from debt sustainability. In theory, then, there is scope for a deal: Athens would not get a debt write-off but could be given gentler conditions on its loans.
But that is only if the script follows past form. If Merkel is determined not to give an inch, as opposed to merely talking tough, it is a new game. Markets would tolerate a well-managed exit from the euro, which might benefit Greece in the long-run anyway. However, a chaotic, half-hearted exit would be very different.