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Briefing

What would a Greek exit from the eurozone look like?

Rumors are rife of a Greek exit from the eurozone. While no country has yet dropped the common currency, there are some indications of what will transpire if Greece does.

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“Leaving the euro means we have to default first,” says Nicholas Theocarakis, economist at the National University of Athens. “There is no way we can pay back debts made in euros in any other currency, say the drachma.”

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How would this affect the value of the euro? How would they determine the value of the drachma? 

The uncertainty created by a Greek default and eurozone exit would certainly weaken the euro, at least in the short term. But in the longer run it could have the opposite effect.

“Taking out the most problematic part of the eurozone, both economically and politically, could theoretically strengthen the common currency,” says Raoul Ruparel, head of economic research at Open Europe, a London-based think tank. “Of course it depends on whether the eurozone succeeds in preventing contagion – the spread of mistrust in other countries’ ability to service debts.”

A new drachma would be a very weak currency – there is little in Greece's coffers to give it value. The devaluation relative to the euro could reach 50 percent, according to Mr. Ruparel. On top of that the Greek central bank would have to print massive amounts of fresh money to keep the banks afloat. These two factors could lead to hyper-inflation.

Would a Greek exit be expected to have a domino effect, or will it be possible to isolate Greece?

This is what concerns EU leaders most. Their answer is that the European Stability Mechanism (ESM) – the rescue fund which will be operational in July and will contain €500 billion – will be there to bolster other struggling European economies.

But the fears among investors are still there.

“A Greek exit sets a dangerous precedent,” says Jane Foley, senior foreign exchange strategist at Rabobank in the City of London. “Huge amounts of investors are trying to get out of Spanish bonds right now, because they fear that if Greece goes, Spain will be next.”

Consequently, the interest rates for Spanish 10-year bonds climbed to over 6 percent this week.

What EU policy makers have to do now, says Ms. Foley, is reassure the world that Greece is a one-off. “If Greece leaves unilaterally and in a more or less orderly fashion, contagion might be avoided.”

Given the social unrest Greece is already experiencing, and given the capital flight taking place right now – according to President Karolos Papoulias, Greek citizens withdrew €700 million from banks last week alone –  an orderly exit is far from certain.

What impact would a Greek exit have on world markets? The US?

The effect on markets will, again, depend on the degree to which a Greek exit affects other eurozone economies.

Many analysts believe that the creation of the ESM and the ECB’s recapitalization of private banks have provided a certain level of calm in international markets. Traders reacted rather measured to the news of a Greek election rerun. 

“Particularly the US economy is in a somewhat better condition than it was six months ago,” says Mr. Ruparel. “So for the US recovery a Greek eurozone exit will be more of a speed bump, not a dead end.”

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