Grexit: Whose Loss will it be?

As Greece goes to Parliamentary elections on 25th January, I scratch my head to understand the classic Greek conundrum. On one hand a private poll survey suggests that roughly 70% - 75% of Greeks want their country to stay in the European Union (EU). Yet on the other hand, pre-poll election surveys indicate Syriza, the radical left (and anti-Euro) party, is the most preferred choice of Greek voters. It is a foregone conclusion that Mr. Alexis Tsipras, the leader of Syriza, would be the new Prime Minister of Greece come February when all previous IMF bailout packages to Greece cease to exist. This requires Mr. Tsipras to negotiate the new terms and conditions for further bailout packages with the 'troika' (i.e. the European Commission, the International Monetary Fund (IMF) and the European Central Bank) in return for tough austerity measures. Renegotiating new terms and conditions with 'troika' seeking a fresh bailout means explaining not just to the voters who would have elected him on the plank of putting an end to the austerity program unleashed by the so-called 'outside forces', but also to the shenanigan militant comrades within his party. Therefore, the billion dollar question haunting everyone now is will Mr. Tsipras, if elected on 25th January, come to the negotiating table or will he do the (un)expected - the Grexit which could implode the Eurozone.

If indeed Greece decides to exit the Eurozone, who will be at a loss? Greece or the EU? What are the costs and consequences for Greece and the EU? To begin with, many Euro skeptics prognosticate that it is advantage Greece because exiting the Eurozone means replacing the Euro with the Greek Drachma. The Greek Central Bank would sever its ties with the European Central Bank, thus paving the way for independent monetary policy in Greece. It is widely estimated by various independent analysts that the Drachma would devalue by roughly 60% against the Euro upon its redebut. Contrary to many Euro skeptics, I see more trouble than its worth. Firstly, in the post economic crises scenarios, devaluation often helps those economies which are largely export driven (e.g. Germany, the Netherlands, China, Singapore to name a few). For import dependent country like Greece devaluation is a bane, not boon. Even before the crisis struck Greece, its total exports were roughly 32 billion Euros while its imports were about 60 billion Euros, leaving a trade deficit close to 30 billion Euros. For an economy which piled up debt worth 176% of its GDP, financing trade deficit means more borrowings. Secondly, devaluation brings further troubles to an import dependent country like Greece. They import inflation. It is estimated that a 60% devaluation of Drachma against the Euro corresponds to a 40% increase from existing price levels on almost all products. And, not to mention the other cascading effect it would have on the economy - rise in interest rates affecting consumer and business sentiments. A country where unemployment is 27% and close to 30% of the population is on the verge of being edged into poverty; the least they want at this point in time is a drastic hike is prices! Thirdly, adopting a devalued Drachma means a rapid surge in the debt servicing of foreign loans. With Drachma replacing Euro, the foreign debt will be denominated in Euros and US dollars. A devalued Drachma would further increase the debt burden. Fourthly, all these factors would bring Greece onto the doorsteps of a fresh debt default. Without the backing of European Central Bank, bond yields would splurge rapidly while institutional investors will shun Greece from the credit market. If Greece does go down this path, then it would certainly find that financial markets, banks and the international financial institutions such as IMF refusing to lend money at reasonable rates unless Greece convinces them by undertaking pretty much the same set of reform measures which the 'troika' is asking them to carry out anyway! In fact, life would be much tougher for Greece without the EU than with the EU prescription of 'austerity'.

So, what is the way forward? History provides some guidance here. Generally, it has been observed that countries carry out economic reforms only when they have their backs against the wall. Vadlamannati and de Soysa (2015) in their empirical work spanning over a 32-year period (1980-2011) find that countries reform when they are faced with severe economic crisis. Several countries embarked on structural reforms when confronted with a crisis. Examples include from China (1978, 1990) and India (1981, 1991) to South Korea (1987, 1998) and Indonesia (1998) to Argentina (1990, 2002) and Brazil (1994, 2002) to Mexico (1995, 2012) and Turkey (2001). After a hard landing in 1997-98, the so-called Asian tigers surprisingly converted the crisis into an opportunity to reform and clean up their desks. Like today in the case of Greece, the IMF was then loathed in East Asia and castigated globally for imposing 'austerity' in return for bailouts. Since then, Asian tigers have undergone many painful structural reforms. But that really set the stage for a buoyant economic recovery for the next 15 years. The countries which were in the abyss and suffered the most, viz., Indonesia, South Korea, and Taiwan, made a sturdy comeback and continue to exhibit a strong momentum to date. Even Mr. Putin amidst plummeting oil prices on one hand and battling economic sanctions on the other, is finally talking about developing viable non-extractive industries by undertaking badly needed economic reforms. Instead of searching for an easy exit which would trigger further panic and crisis, Greece must try to turn this crisis into an opportunity to pull itself out of the rut. Long term economic interests of the country should triumph over short term political interests.

But if Greece chooses to exit anyway, what does it mean for the EU? I have a slightly different take on this. For the EU, the exit of Greece will send a strong signal not only to its member countries but also to yhe international community that rules once framed cannot be mended for a country or two. Of course, one could argue that it could also set a dangerous precedent for others, especially countries like Portugal, to follow suit, thus triggering an exodus from the EU. More importantly, it would bolster the anti-austerity and anti-EU intelligentsia. But the underlying fact remains that the EU can live without countries like Greece but not Greece without the EU (for the reasons mentioned above). After all, beyond a point one can't expect others to solve your problem when it is largely self-made!