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Worst-case scenario

February 28, 2012

A possible bankruptcy in Athens is still on the table despite the latest bailout agreement. But what would actually happen if Greece were to leave the eurozone?

The parliament in Athens
Image: picture alliance/Robert Geiss

Last October, banks and financial institutions agreed at an EU summit to write off 50 percent of Greece's obligations in an orderly partial bankruptcy. That decision will this week be put in practice. By mid-March it will become clear which private investors will take part in the planned debt writedown, and if the cancelation of 100 billion euros will in fact come about. The European Financial Stability Facility (EFSF) and the International Monetary Fund (IMF) would then help ease the remaining debt burden with a second bailout package worth 130 billion euros.

But if the eurozone were to put a stop to further rescue measures and demand that Greece leave the single currency, as German Interior Minister Hans-Peter Friedrich envisions, we would end up with the following scenario:

Economic chaos

If it comes to a sudden bankruptcy, then the southeastern European country would fall into economic chaos. The national government in Athens would no longer be able to pay state officials, water and electricity would be shut off and companies would slide one after the other into insolvency. Athens would also stop servicing its debt. That would affect, above all, Greek banks because the state owes them around 60 billion euros.

"Greek banks would experience a run on their deposits," Christian Schulz, a financial analyst with the Berenberg Bank in London, told DW. "Greek investors might try to withdraw their money from the bank and send as much of it as possible abroad."

Exit possible

Greece would experience a deep financial and economic crisis and an exit from the 17-member eurozone could then follow. There is no legal foundation or precedent for such a scenario, although contingency plans are being considered.

Bank of Greece
Is it time for Greece to leave the single currency?Image: AP

"Some are already playing with the idea that Greece could leave the EU for a very short period and then immediately re-enter," Jürgen Matthes with the Cologne Institute of Economic Research, told DW.

Greece would then be treated like the 10 other EU member states that either have chosen not to adopt the euro or who are not ready to introduce the currency.

Contagion effect

The Greek government could then attempt to re-introduce the old drachma. The new drachma would be devalued by up to 50 percent compared to the euro, according to experts. Greek exports would indeed become immediately more competitive, yet that would hardly make the situation easier for Greece because the country's obligations would still be denominated in the euro, Matthes said.

"That would make Greece's debt burden much higher," he continued. "And that would lead to an even larger debt write-off."

That would potentially have drastic consequences for the banks of other European countries because they have lent the Greek state around 120 billion euro. Europe would be able to absorb this hit. It's not the bankruptcy of one particular bank or another that has created concern, but rather a contagion within the eurozone that would choke the economies of entire nations.

In this context, Italy has already been named as the greatest concern. Most experts believe that the Italian economy is robust.

"But Italy carries a very high sovereign debt burden that has to be constantly refinanced," Schulz, from Berenberg Bank, said. "If the markets cannot give Italy the means to refinance anymore, then Italy could slide into bankruptcy."

Worst-case scenario

Chinese premier Wen Jiabao
If the eurozone goes belly up, foreign intervention would likely be necessaryImage: AP

Italy already is receiving help from the European Central Bank (ECB). Because the risk premiums for Italian government bonds have reached record highs, the ECB has stepped in and begun buying the bonds in order to keep Italy's interest rates at a manageable level. If Italy suffocated under its interest rates and became insolvent, then the future existence of the eurozone could no longer be guaranteed.

"France would then be affected and it would become difficult to imagine how the eurozone could continue to exist in its current state," Schulz said.

The global financial system would risk collapsing. In order to bring the situation under some semblance of control, Europe would need help from abroad.

"In the end you would be in a situation where you would definitely need help from outside, from China and other states," Matthes said. "That is a scenario that nobody wants to imagine in detail."

Author: Zhang Danhong / slk, ji
Editor: Joanna Impey