The Greek Prime Minister, Alexis Tsipras rejected its creditors demands in return for bailout funds and called for a referendum on the bailout, leaving the door open for Greece to exit the Euro. Grexit will be the first for the Eurozone and markets across the world will be volatile as it remains to be seen how the exit will take place and what are its repercussions on the Euro.
Greece has delayed the payment of Euro 303 million that was to be made in the first week of June to the International Monetary Fund (IMF). Greece has now informed the IMF that it would bundle all the mandatory payments for the month of June 2015 and pay a total of Euro 1.6 billion by the end of the month. This move by Greece was not well received by the global markets as the probability of a default has now increased as a result. The question that arises is whether Greece should be bailed out or should it be allowed to default. What option is better for Greece or rather what option is better for the Eurozone? An exit from the Euro by Greece can have serious financial implications for most of the member nations and for the Eurosystem itself.
First of all it is very important to understand the conditions in which Greece became the member of the Eurozone. To explain this in simple terms, the economic conditions in Greece did not justify its entry into the Eurozone as other countries such as Germany and France had way better economic fundamentals. When economic fundamentals are sound a country can borrow at a cheaper interest rate as compared to other fundamentally developing economies and accumulate healthy levels of debt that can be repaid on the basis of healthy GDP growth, which takes care of the interest and principal payments.
Greece was not allowed to join when the Euro was established in 1999 for failing to meet the economic and fiscal criteria for membership. The Euro was established by the provisions in the 1992 Maastricht Treaty. To participate in the currency, member states were asked to meet strict criteria, such as a budget deficit of less than three per cent of their GDP, a debt ratio of less than sixty per cent of GDP (both of which were not strictly adhered to after introduction), low inflation, and interest rates close to the EU average. Belgium and Italy were allowed to join the Euro even though their public debt exceeded 100% of GDP. Accounting adjustment and manipulation allowed the weaker economies to join the Euro with no monitoring of management of economic fundamentals to prevent a catastrophe later, if any. Weaker members were allowed access to cheaper Euro credit which opened the floodgates to more borrowing and spending ultimately leading to a serious problem after the financial crisis of 2008.
Now the million Euro question is that would Greece be able to come out of this crisis even if it takes longer than necessary time to do so? The answer to this question lies in the fact that Greece as a nation has to fundamentally make its economy strong by doing the basic things right. This means taking the right economic decisions even though it may seem politically incorrect to do so at this point of time. Merely bailing out the economy would be a temporary solution that does not deny the inevitable in the future. Structural reforms should be the need of the hour and the Government should ask difficult questions to itself as to what is the core problem for the economy. Whether it is the rising unemployment or lack of core inflation or no inherent demand in the economy or no income in the hands of the public to buy goods and services or no capacity to help supply goods and services in the economy or no skilled labourers in the country to help create the necessary products and services that would be supplied.
Is it the lack of basic governance and fiscal discipline that is necessary? The list can go on as per the basic core problem that Greece faces and there is no solution in the long term that can otherwise help them solve the problem. Fundamentals have to be strong for any economy to prosper and without a robust basic structure any quantum and repeated number of bailouts would eventually fail and aggravate the situation to further complicated levels.
Why are the other member countries so keen for Greece to stay in the Eurozone? If the Eurozone fails to support Greece or makes the terms of any bail-out politically impossible for the country’s authorities to meet, Greece could default on its sovereign debt. The Eurozone would then face a big problem. The financial markets would quickly turn their attention to other Euro economies with unsustainable fiscal positions and poor growth prospects. Italy, Spain and Portugal would find themselves paying dramatically higher borrowing costs, raising the likelihood of further fiscal crises. Such a scenario would almost certainly deter the European Union’s remaining central and eastern European member states joining the Eurozone any time soon. And the political fallout would be huge. Moreover, if a Eurozone member defaults, the risk of it leaving the currency union cannot be completely discounted. If Greece defaulted and remained in the Eurozone it would still be deeply uncompetitive. The Greek government would still find it difficult to tap financial markets on affordable terms, because investors would be sceptical about growth prospects. Leaving the Eurozone and devaluing would be very high risk but provide a route back to growth, at least short-term, and that could prove a political necessity. A partial unravelling of the Eurozone would do the Eurosystem incalculable damage.
It looks like there would be problems for Greece even if it exits or stays in the Eurozone. The economy can only be brought on track by doing the basic things right even if it takes a long time to do so. Eurozone members are making it mandatory for Greece to follow certain measures because without them the economy is least likely to be brought on track in the short to medium term. All in all it is important for the Greek Government led by Alexis Tsipras to take tough economic decisions and not concentrate on keeping political promises because only right economic decisions would give them a political mandate the next time they are elected.