Grexit and Its Domino Effect

Grexit and its domino effect

In the European Union, most real decision-making power, particularly on matters involving politically delicate things like money and migrants, rests with 28 national governments, each one beholden to its voters and taxpayers. This tension has grown only more acute since the January 1999 introduction of the euro, which now binds 19 nations into a single currency zone watched over by the European Central Bank but leaves budget and tax policy in the hands of each country, an arrangement that some economists believe was doomed from the start.

Greece Debt crisis

Since Greece’s debt crisis began in 2010, most international banks and foreign investors have sold their Greek bonds and other holdings, so they are no longer vulnerable to what happens in Greece.

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In the 4th quarter of 2014, Greece had the highest gross debt as a percentage of GDP

The Greek Debt Crisis Story in numbers

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Greece's debt to GDP ratio is now the highest in Europe, running at 174% in the final quarter of 2014, according to Eurostat.

Grexit and Graccident: Probable impending scenarios for Greece

Exit from the Eurozone (Grexit) and Accidental exit (Graccident) have been touted as the most probable scenarios since Greece debt crisis began in 2010. To understand this, let us have a look at the crisis timeline in detail.

Greece debt crisis timeline (2010-till date)

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Current economic situation in Greece: Speculation of Grexit

Almost two-thirds of Greece’s debt, about 200 billion euros, is owed to the eurozone bailout fund or other eurozone countries. Greece does not have to make any payments on that debt until 2023. The International Monetary Fund has proposed extending the grace period until mid-century.

In the short term, though, Greece has a problem making payments due on loans from the International Monetary Fund and on bonds held by the European Central Bank. Those obligations amount to more than 24 billion euros through the middle of 2018, and it is unlikely that either institution would agree to long delays in repayment.

How big is the risk of Grexit?

Prime Minister Alexis Tsipras said he was unhappy with the bailout deal he negotiated with other Eurozone leaders but he was faced with a clear choice: "A deal we largely disagreed with, or a chaotic default." So there is a chance a government that does not believe in a bailout deal and that relied on opposition MPs to get it past parliament might not last to see it through.

There are plenty of politicians and economists who believe Greece should leave the euro, most notably German Finance Minister Wolfgang Schaeuble, who believes Greece needs debt relief, which is not seen as legal within the single currency. But at a European level, politically the decision appears to have been taken to do whatever it takes to keep Greece in.

What will happen after the bailout rejection?

Millions of Greeks were given the chance to have their say on whether to accept the terms of the latest international bailout. A country-wide referendum held on 5 July asked voters if they supported the austerity demands of its creditors, which included raising taxes and slashing welfare spending. In the end, voters decisively rejected the bailout terms, with 61.3% voting "No" and 38.7% voting "Yes".

This can lead to 3 possible scenarios-

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1. A failed deal that leads to Greek exit of the eurozone
2. A Greek bank collapse leads to Greek exit or a deal
3. EU leaders agree deal and avert bank collapse

The suspected Domino effect of Grexit

A domino effect or chain reaction is the cumulative effect produced when one event sets off a chain of similar events. The term is best known as a mechanical effect, and is used as an analogy to a falling row of dominoes. It typically refers to a linked sequence of events where the time between successive events is relatively small.

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The fear factor in terms of a potential domino effect throughout Europe will be impossible to ignore if Greece is pushed to a point where it will have to consider exiting the Eurozone

A default in Greece would have a ripple effect on the European economy, as Greece’s debt is tied to the European Central Bank, and shares a currency with 18 other eurozone members. Further, some of the financial markets might speculate “who’s next?” and would then drive at the bond yields.

Sooner or later, this is going to start raising interest rates resulting in political tensions and capital flight, make it more and more expensive for these governments to service their debts.

For Greece, the exit scenario would imply national insolvency, a massive devaluation of the new Greek currency, unemployment, sharply declining domestic demand and many other problems. All these domestic effects would have a direct impact on its trading partners.

A study conducted by Prognos AG on behalf of the German Bertelsmann Stiftung, analysed the financial consequences of different exit scenarios covering a “Grexit” as well as a secession of different groups of crisis-stricken countries from the Euro. From the study, the author concluded that if Greece exits, in Greece alone, the ensuing losses of growth would amount to 164 billion euros or 14,300 euros per capita by the year 2020. The 42 top national economies in the world would have to absorb total losses amounting to 674 billion euros in total.

Since, however, a “Grexit” might seriously put at stake the Eurozone membership of other crisis-ridden countries in the EU’s South, the economic impact of three more far-reaching exit scenarios was also evaluated. In the event of an additional EU secession of Portugal, for example, this would mean a loss of 225 billion euros for Germany by 2020 and necessary debt write-offs amounting to 99 billion euros. Globally accumulated losses in growth would add up to 2.4 trillion euros at this point, of which the USA would have to bear 365 and China 275 billion euros respectively. With this scenario, per capita losses in income in Germany would total 2,790 euros over eight years.