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The costs of Grexit are high for Greece, not just the Eurozone

Anna Sonny, 19 June 2015

Another round of Greek bailout negotiations has been agreed for next Monday after talks broke down yesterday. Greece has less than two weeks to pay back an IMF loan of €1.6bn, or risk default. The troika of the IMF, the ECB and the European Commission, are unwilling to hand out more loans unless Greece agrees to reforms.

Low confidence in Greece’s ability to pay back its creditors and to come up with plausible reforms is fading into no confidence at all. The atmosphere in Europe is heavy with accusation and acrimony and there are fears of imminent runs on Greek banks – €1.7bn was withdrawn between Monday and Wednesday alone this week.

While much of the discussion surrounding the Greek debt crisis has been about keeping the euro together, avoiding huge losses for Greece’s creditors, and preventing the markets from driving out other struggling member states – it is important to weigh up the political, social and economic costs of Grexit for Greece itself.

Economically, some argue that it would be better for Greece to temporarily leave the Eurozone and get its economy back on track. Staying inside the euro is effectively acting as a rigid exchange rate, rendering Greece powerless to implement any fiscal policy; if Greece returned to the drachma, it could devalue its currency in an attempt to boost exports and gain competitiveness. But this would make imports dearer, potentially leading to high inflation and a balance of payments crisis; besides, exports make up a small share of Greece’s economy. Defaulting on its debt would have a serious impact on the confidence of investors in the future – although this is already low.

The social and political costs of Grexit would be huge. The left-wing Syriza government was elected on the mandate of fighting austerity – if this fails then extremist groups such as Golden Dawn, that rose to in popularity in a climate of chaos and fear, would fester.

Greek finance minister Yanis Varoufakis outlined the plans he put before the Eurogroup yesterday in a blog post. He proposes a privatisation agenda, public administration reforms and a Fiscal Council to keep the Greek budget under control. He describes the narrow balancing act the Greek government faces between earning trust in Europe without losing the confidence of Greek citizens at home. He highlights the necessity of seeking the difference between structural reforms that change culture and encourage growth, and harsh cutbacks that hit the poorest the hardest. For instance, instead of hiking up VAT rates, which impoverishes law-abiding citizens and strengthens the incentive to cheat the system, he emphasises the importance of adjusting to a new culture of paying taxes.

But in a climate of rapidly depleting confidence, Greece’s balancing act is left with little room to manoeuvre, and is losing its battle against the inevitability of gravity. Adjusting to a new culture takes time, which Greece is fast running out of.

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