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Bankruptcy in Greece: The Wider Impact of Grexit
It does not seem likely that Greece will survive its fresh round of difficulties. It has failed repeatedly in implementing the financial reforms that came as a bargain for its bailout program. The richer nations face stiff opposition to any further pumping of taxpayer money in saving the ailing Euro zone nations. Grexit, or exit of Greece from Euro, is fast becoming a possibility. While Greece will face total chaos after exiting Euro, the move will help it regain its strength slowly over time. However, the impact of Grexit will not remain limited to Greece and some experts fear a domino effect in the Euro zone.
Is contagion a possibility?
If it happens, Greece will be the first nation to leave Euro and revert to its home currency (Drachma) and other troubled member nations may follow the suite. In the 1990s, the new common currency Euro brought together economically strong and weak countries. The currency and consequently, the exchange rates became uniform, but not the internal policies. Countries, like Spain, Portugal, Greece, Italy, and Ireland chose cheap debt over productivity. These were the countries, where labor cost in the inefficient public sector increased several times faster than the value of money. According to the ECB President, Mario Draghi, “The consequences of misguided fiscal policies in a monetary union are too severe to remain self-policed.” Today, these nations are plagued by the extreme imbalance among their debt situation, GDP growth, inflation, and interest rates. The strong valuation of Euro, driven by rich nations, does not allow the likes of Spain, Portugal, Italy, and Ireland any competitive advantage. Returning to their devalued currencies can offer them some competitiveness. However, the immediate trouble that will ensue is expected to remain a sufficient deterrence, unless these nations are also pushed to the edge.
Will a meltdown follow?
The first impact of Grexit will be a change in investor perspective about weaker nations, including Spain, Portugal, Italy, and Ireland. The speculation about a possible exit of these nations will increase, leading to lost investor confidence and increased cost of borrowing. Increased cost of borrowing will act as a double blow to already ailing nations. If they are pushed to edge, new bailout efforts will be required. Nations, like Spain are big economies and their bailouts will be much costlier. According to an estimate, the Spanish bailout will amount up to EUR 1 trillion! The silver lining is that the ECB (European Central Bank) has its coffers overflowing and is planning to put a damage control system in place. Under the new system, there will be a cap on interest rate on borrowings of these countries. Europe being a preferred investment destination, investors are likely to comply. If the yields rise beyond the stated levels, the ECB will buy the sovereign securities in secondary market operations. However, this plan may be difficult to administer in practice. Also, the system is still on paper only and therefore, the timing of the Greek exist from Euro will also have a bearing on the outcome.
Elsewhere in the economy, the investors will lose some confidence in Euro on the fear of uncertainty in the region. They will seek safe haven options, such as US Dollar or gold. As a result, Euro will slide against the major currencies. Stock markets will also suffer due to the flight of capital, economic uncertainty, and devaluation of Euro.
So far, everything is a speculation and an estimate at best. The continuance of Greece in the Euro zone only a remote possibility, but there is still time to prevent other members from meeting the same fate. If there is political consensus among the rich nations and the policies from nodal agencies is implemented quickly, the integrity of the Euro zone can still be preserved.