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The Euro Zone


Greece’s disorderly exit from the euro zone would have adverse impacts on states in Eastern Europe, either directly or via their integration with the euro zone.

Photo: Theophilos Papadopoulos/Double Trouble



Recent Developments


  • The cost of debt servicing will raise public debt to 187.8% of GDP in 2016, up from 180.2% in 2015, according to official forecasts.


  • Leaked documents suggest the IMF has privately discussed driving Greece to the point of bankruptcy to force its European creditors to grant the government debt relief


  • Greece’s financial problems are being exacerbated by the refugee crisis, which HSBC has estimated will cost the government EUR4bn a year, or 2% of annual GDP


  • Greece is experiencing widespread civil unrest, including a short-lived blockade of its northern border by farmers, which the government was unable to bring to an end.


  • The government is deepening relations with Russia, an alternative source of funds, launching the Cross-Cultural Year and finalising plans to host a Russian naval base.





Greece is experiencing a profound financial and political crisis. Following its adoption of the euro last decade, all sectors of the economy built up excessive debts which they are struggling to service and repay. Without its own currency, the government is dependent on emergency funding from international creditors - the IMF, the ECB, the Euro-Group and the European Stability Mechanism – which extended it a third, EUR86bn bailout package in July last year. In return, the government is obliged to undertake a far-reaching programme of fiscal and structural reform intended to put the country on a sound financial footing in the longer term.


The government’s attempts to meet the terms of the bailout have fairly good, but are far from sufficient to end its financial woes. On the upside, the government recorded a primary surplus (raising more in tax than it spent, excepting debt servicing) of EUR3bn in January and February this year, following new rounds of tax rises and spending cuts.


However, as in previous years, the economy has continued to shrink, by 0.8% year on year in Q1, which is having the effect of raising debt in proportion to GDP, even as the government tries to narrow the overall budget deficit. Meanwhile, living standards for Greeks continue to decline in the face of rising taxes, falling public spending and epic rates of unemployment – around 25% nationally and over 50% among youth – which has led to some of the worst poverty rates in the EU. To make matters worse, the prospects for the all-important tourism sector have been adversely affected by the migrant crisis, which will further undermine the economy this year.


Unsurprisingly, resistance to fiscal cutbacks is intense. Many within the ruling Syriza party oppose austerity, leading to defections and a narrowing majority in parliament. The formal opposition is opposed. Public hostility to the government policy is intense, leading various interest near-term future and a similar proportion blames Syriza, in which Greeks originally invested their hopes, for their ongoing economic woes.


Against this backdrop, the Greek government has asked for leniency from its creditors in its attempts to meet the conditions for the release of further tranches of funding. Greece’s difficulties in compliance have exposed a serious difference of view between the IMF, which views the Greek issue in a technocratic manner, and the European institutions (dominated by Germany) which take a more political view.


In its simplest form, the IMF is insisting on full compliance with the targets set out in the July bailout package - which will involve massive cuts to pensions and social security pending this year and next - while arguing that Greece cannot achieve these in the absence of debt relief by its European creditors. Until this happens, the IMF is refusing to extend any funding.


By contrast, the European institutions are refusing to offer debt relief, which would undermine public support for their flagship project of monetary union, but are instead willing to make concessions on the targets set out in the bailout package – even as it publicly admonishes Greece for delays in compliance with the benchmarks set out in the bailout plan.


The IMF is sufficiently sceptical that this approach will work that it has discussed the possibility of engineering a ‘credit event’ which brings Greece to the point of bankruptcy and force the Europeans to grant debt relief. In the meantime, for as long as the government is unable to get on top of its debts, and by extension, to relax the programme of austerity which would allow its economy to grow, its future in the euro zone is at risk.


As Greece’s crisis mounts, Eastern Europe has prepared for the potential fallout: a direct shock to economies in Greece’s near neighbourhood, such as Albania, Bulgaria, Macedonia, Romania and Serbia, which are highly integrated with Greece, via trade, investment, financial systems and labour markets; and an indirect shock to those states further afield which are dependent economically on stability in the euro zone. Governments in the Balkans have instructed their banks to minimize their exposure to the Greek government and, as far as possible, to the Greek banking system while those further afield, such as Poland, Hungary and the Czech Republic, have refused to join the euro, despite a treaty obligation to the contrary.


The one consolation for Greece’s immediate neighbours is that, as taxes rise, many Greek firms have re-registered in Bulgaria, boosting revenues to the Bulgarian treasury; and many Albanian migrant workers have returned to their home country, bringing money and skills to the local economy.





In the short term, Greece is likely to remain a part of the euro zone, but in the longer term, a disorderly exit is the most probable outcome. A best-case scenario will see Greece slowly begin to stabilise its economy, as the reforms being imposed by its international creditors raise the country’s international competitiveness and put the public finances on a stable footing. In the meantime, the bailout package will provide the liquidity Greece needs eventual pending agreement by Greece’s creditors on debt relief, which could significantly ease its financial burden.


However, matters are unlikely to turn out so well. For one thing, the evidence suggests that Greece lacks the wherewithal to accept further austerity after years of belt-tightening, given widespread opposition to austerity, and the weakness of the government. Equally importantly, even if Greece implements the required reforms, this may not achieve the intended result for the reasons why austerity has hitherto failed to lift Greece out of its crisis: that austerity induces recession, which lowers tax receipts and increases debt in relative terms, requiring even deeper cuts, in a continuing spiral of decline. Research by Prognos AG suggest that, on current trends, GDP will continue to decline until the mid-2020s and debt as a proportion of GDP will continue to rise, reaching 245% of GDP by 2022. In reality, politics would probably prevent Greece remaining on this course.


Grexit would have adverse consequences for the economies of Eastern Europe, which would need to manage the impacts of an economically crippled state in their vicinity. The severity of this is unclear since there is no precedent for a state leaving the euro zone. However, there is a risk that a disorderly Greek exit could spread contagion to other parts of the euro zone’s periphery, causing renewed crisis, while Greece itself could retreat into political authoritarianism and economic protectionism.



Immediate Impacts


  • A Greek departure from the euro zone would cause turbulence in exchange rates as investors re-calculated political risk in Europe.


  • The perception of increased risk could lead to higher financing costs for governments across the region.


  • Slovakia, Slovenia and the Baltic States would take a loss on their bilateral loans to Greece via their participation in the euro zone’s bailout programme.




Potential Impacts


  • Economies across Eastern Europe could suffer a severe indirect shock as a result of a renewed crisis in the euro zone caused by contagion from Greece.


  • A decline in Greece’s economic situation could accelerate a trend for democratic backsliding in the Balkans.


  • A rapprochement between Greece and Russia in the wake of a Grexit could lead to new fault lines in the Balkans, generating regional instability.



  • Economies across

  • astern Europe could suffer a severe indirect shock as a result of a renewed crisis in the euro zone caused by contagion from Greece.


  • A decline in Greece’s economic situation could accelerate a trend for democratic backsliding in the Balkans.

  • A rapprochement between Greece and Russia in the wake of a Grexit could lead to new fault lines in the Balkans, generating regional instability.



Photo: xxx

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