Greek Exit Fears Are Growing

The weekend’s inconclusive elections in Greece were seen by many as an indication of a rising risk that Greece may exit the euro zone.

The New Democracy won the elections with 19 percent of the vote, gaining 108 seats; Syriza was second with 17 percent, winning 52 seats; and Pasok came third with 13 percent, or 41 seats.
The elections results have raised European concerns over Greece’s ability to hold to the terms of its two bailouts negotiated since May 2010, when the European authorities demanded Greece’s government to implement 11.5 billion euros budget cuts.

Alexis Tsipras of Greece’s Syriza announced that he expected Antonis Samaras of New Democracy and Evangelos Venizelos, the former finance minister who leads the Pasok party, to inform the EU leaders about revoking their written pledges to implement austerity measures by the time he meets them today to discuss a government alliance. Tsipras handed in this ultimatum to renounce support for the EU’s rescue terms as a condition for the political leaders to enter government. Tsipras told reporters that “there will be no 11 billion euros of additional austerity measures; 150,000 jobs will not be cut.” Samaras and Venizelos rejected his request.

Some analysts said, it is possible that Greek political turmoil could result in a new government that actively renounces the bailout—leaving Greece without its rescue aid. If official funding from the International Monetary Fund (IMF) and the rest of Europe were cut off, the Greek government would have no new sources for cash. It could try to stretch out payments to suppliers and government workers and live off its remaining funds for some time. If there would be no spending cuts, the only alternative left to the government would be to print the country’s own currency to pay for government services.

An exit from the currency would throw into doubt contracts denominated in euros, with consequences for the real economy, not just the financial sector. In absence of assurance that a euro payment will actually be made in euros, companies might be less willing to conduct business or trade with vulnerable member states. Investors would start looking at other countries in an environment, where there is already a weakness of natural demand for Spanish and Italian government bonds, particularly among foreign investors.

The bailout has left the governments of Europe, the European Central Bank and the IMF as Greece’s main creditors. While the international creditors urged Greek leaders to hold to the agreed terms of their EU-IMF bailouts, letting Greece exit euro zone would mean significant losses for them. The two-year-old bailout program and the massive debt restructuring earlier this year have helped insulate Europe’s banking system and private sector from Greek troubles.

In the weekend, Tsipras’s party, Syriza, won just 52 of the 300 seats in parliament, and many economists said that the chances it could have to form a governing coalition appeared slim. If Greece is unable to form a government, it faces another election in June and will be on a collision course with its creditors.

Sources: Wall Street Journal and Bloomberg

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