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Tuesday, June 19, 2012

Do the election results mark a turning point for Greece? Think again...

Over on the Spectator's Coffee House blog, we argue,
Things in Greece could have been worse after the election, but that fact can’t be hailed as a ‘turning point’. Assuming that Greek political leaders form a coalition and push ahead with EU-mandated reforms, which is a very likely outcome given that Greece may only have enough cash in its coffers to soldier on for another month, any such government will inevitably include parties that completely disagree on how to resolve the crisis. The only glue would be the fear of economic catastrophe.
This uneasy government would be ill-suited to withstand pressure from Syriza and the rest, who will spare no effort in blaming it for the inevitable economic pain. The threat of new elections, which would probably lead to Greece's exit from the Eurozone, will constantly hang over the country’s head like the famous sword of Damocles.
A great deal of hope is being placed on the new government’s ability to renegotiate the terms of the EU-IMF bailout programme. At the G20 summit in Mexico, Angela Merkel went a long way to play down these expectations. This suggests that the upcoming revision will largely be a superficial exercise. Greece may obtain a slight reduction in the interest rates, an extension of the debt repayment deadlines, a few billion for investment, and perhaps even be given some slack on its deficit reduction targets. However, the thrust of the bailout agreement will stay the same — and many of the conditions will remain unachievable and poorly targeted at the substance of Greece’s problems, such as the dramatic loss of competitiveness since it joined the euro, and a number of systemic flaws in the country’s administration.    
So should Greece leave the Eurozone as fast as it can? The euro crisis has proved that Greece should never have joined the single currency in the first place, and the benefits of Greece trying to re-build its economy outside the Eurozone are well-documented. However, if Greece left the euro now, the risks involved would very likely outweigh these benefits in the short term. Our estimate is that, if Greece exited today, it would need external financial assistance worth up to €259 billion — or else face the serious threat of hyperinflation and a banking sector collapse. Given the blind alley down which Europe has led Greece, this is the unfortunate reality, failing to take these issues into consideration could lead to a terrible outcome for all, including the UK. 
Having said that, the key question about the future of Greece’s euro membership will not go away; and it will have to be answered, sooner or later. The impression is that, once Greece manages to balance its budget and put its ailing banking sector back in decent shape, dropping the euro will look a more sensible, even desirable, alternative — especially if the Greek budget is to be drafted in Brussels on a permanent basis.

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