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Consequences of a Greek bankruptcy

Rolf Wenkel / sriFebruary 12, 2015

The new government in Athens is holding on to its position that it wouldn't seek an extension of the country's bailout program. Experts say this stance could lead to Greece's bankruptcy and its exit from the eurozone.

Krise Griechenland Symbolbild Euro Austritt
Image: picture-alliance/dpa/Panagiotou

Greece's international lenders insist that Athens should accept an extension of its bailout program. However, the country's new prime minister, Alexis Tsipras, can "swallow this bitter pill only if it is well-flavored," said Jörg Krämer, chief economist at Commerzbank. "A compromise might involve extending the maturity of bilateral loans to 50 years, suspending debt servicing for the first 10 years and reducing further the already low interest rates on Greek debt," Krämer told DW.

Additionally, the eurozone could propose an exchange deal to Athens, the economist added.

It could involve backflipping from the original demands mandating Greece to undertake privatizations and trimming down public services, if in return the new Greek government cracks down on tax evasion and widespread corruption, which was in any case one of the main electoral planks of the ruling party, Syriza, Krämer noted. The EU could also pay the final installment of the aid package amounting to 1.8 billion euros ($2 billion) as part of a compromise, he stressed.

No money supply

If the next meeting of eurozone finance ministers, due to take place on February 16, fails to agree on a way forward to resolve the standoff, then we would have to significantly increase the likelihood of a Greek default and exit from the monetary union, the Commerzbank economist underlined.

And a looming Greek default would also lead to the European Central Bank (ECB) turning off liquidity supply to the country's banks as the bonds held by these financial institutions would become worthless. The ECB's statutes don't allow it to support an insolvent banking system. Greece would be "switched off" from the ECB money supply, thus effectively forcing the country out of the currency union.

One alternative for Greece is to reintroduce the drachma, the nation's currency before entering the eurozone. Many experts believe this is the best way for Greece to regain its competitiveness as a drastically devalued drachma could boost the crisis-stricken country's tourism sector besides reviving the moribund economy's exports. The negative side, however, is that it also makes the country's imports much more expensive.

Griechenland Tourismus Ferienhaus
A new, devalued currency could be a boon for Greece's tourism industryImage: Fotolia/Pixel & Création

Drachma is not an option

Moreover, there are other problems. Even if Greece were to exit the eurozone, its debts would still remain - in euros - and they would have to be repaid. This already high debt would go through the roof, as Greeks would have to repay euro-denominated debts through a new and devalued currency.

While this scenario may prove catastrophic for Greek banks, international creditors to Greece could also face the risk of a total loss of their claims.

Another potential danger is the so-called bank runs, if the Greeks withdraw massive amounts of money from their bank accounts in a bid to hold on to their euros. Such a development would trigger a collapse of the nation's banks, leaving the entire Greek financial system in disarray.

Hard times

Greece is not in a position to finance its current levels of spending without new loans, however. The new government is facing many challenges ranging from preserving the country's social services to ensuring pay for public-sector workers and pensioners. Apart from that, Athens also has to deal with spending cuts that affect many areas such as public infrastructure, health and education, as well as waste collection.

What impact would a Greek bankruptcy have on Germany and the EU? "Greece's bankruptcy would cost Germany 80 billion euros, but the country's exit from the eurozone costs nothing, on the contrary," Hans-Werner Sinn, president of the Ifo Institute, a German economic think tank, wrote in the German business publication Wirtschaftswoche.

"Only if Greece leaves the eurozone, it can devalue its currency, gain competitiveness and be in a position to pay back anything at all," he pointed out.

The German government, meanwhile, believes that the consequences of a Grexit are now manageable, particularly as other troubled countries such as Spain, Portugal and Ireland now appear to have swung back to economic health.

Furthermore, the EU and the ECB have put in place a raft of measures aimed at preventing a contagion from Greece's exit to other euro area countries. The steps include the setting up of the European Stability Mechanism (ESM), which is equipped with 500 billion euros to assist eurozone nations in need of emergency assistance. The ECB's ultra-loose monetary policy, on the other hand, is expected to slowly but surely ensure Europe's economic recovery.