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Greek tragedy: stay and suffer in EU, or exit and regret

Shivangi Shah | Updated on: 1 July 2015, 23:58 IST
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Brewing tension

  • Austerity forced by IMF, ECB has wrecked Greek economy.
  • Taxes are rising, public spending has been cut drastically.
  • Growth has stalled, unemployment is at 27%.

The flashpoint

  • Greece can\'t repay loan of EUR 1.6 billion to IMF, ECB.
  • EU creditors won\'t lend more unless Athens agrees to austerity.
  • Leftist PM calls referendum, tells Greeks to reject EU demands.

Lasting damage

  • The Greeks reject the referendum, submit to more austerity.
  • The country defaults on its debts and exits EU, risking chaos.
  • Grexit emboldens Spain, Italy and others to leave EU.

Greece is set to default on a loan repayment of 1.6 billion euros to the IMF due on 30 June. The government has announced a bank holiday until 6 July as well as capital controls restricting movement of funds outside the country. It has also limited cash withdrawals to EUR 60 per day.

Greece, being part of the Eurozone, shares a common currency, the Euro, with 18 other countries. The Eurozone's central bank, the European Central Bank, equivalent of the Reserve Bank of India, is headquartered in Frankfurt, Germany.

The ECB acts as the lender of last resort to the 19 Eurozone countries. This means the Greeks cannot devise their own monetary policy - setting interest rates, inflation targets, etc - and instead rely on the ECB.

When the idea of the monetary union was conceived and implemented, it was thought that the ECB would act keeping in mind the interests of all member states. That is turning out to be difficult task given the different political and economic motivations of the member states.

Current policy measures favour strong economies like Germany and impose harsh, punitive measures on weak, profligate economies like Greece.

Trapped in debt and recession. How did this come about?

When the global financial crisis of 2008 hit, Greece was heavily indebted and ran a high budget deficit. The crisis worsened the debt situation and caused the Greek economy to collapse.

In such a situation, any other country with a sovereign monetary policy would have simply printed more money, allowing its currency to depreciate and, thereby, boosting exports. Greece didn't have the luxury.

Greece doesn't have the money to repay a loan of EUR 1.6 billion. Default is likely

If its fiscal policy was not so constrained by Brussels, the European Union headquarters, Greece would not have had to make savage cuts to public spending at a time when it was least prepared to deal with the consequences.

Is it Greece's fault entirely? Is the EU also to blame?

Greece has run out of money to repay the bailout loans it had received from the IMF and the ECB.

The IMF and the ECB are holding out on giving more money to the country until it agrees to tough economic measures, including VAT hikes, pension cuts and structural reforms.

The Leftist Prime Minister Alexis Tsipras balks at these reforms because over the past five years, the ECB and the IMF have forced Greece to implement harsh austerity measures - tax hikes, cuts in government spending - that have left the Greek economy reeling.

Unemployment is now at 27%, higher than even what the US suffered during the Great Depression of 1929-1939.

Spending cuts in a shrinking economy reduce the tax base further, thus lowering tax collections. Falling revenue, in turn, necessitates more spending cuts. This has resulted in a vicious circle.

Greece's unemployment rate is 27%, higher than even America's during the Great Depression

The reform programmes, forced through by the IMF and the ECB, so far have been largely counterproductive. The resulting widespread discontent among Greeks swept Tsipras' far-left anti-austerity Syriza party to power in the January elections.

What's the solution? Put up with austerity or leave EU?

European Union officials were set to discuss some proposals, mostly VAT hikes and pension cuts, with Athens this month, but the Greek government has called a referendum on the proposals.

Tsipras has argued that the proposals will harm Greece and is urging his people to reject them. EU leaders, on the other hand, have warned that a 'No' vote would mean Greece's exit, or Grexit, from the Eurozone.

Greek voters are caught between Scylla and Charybdis: Grexit or further austerity. Exit will create chaos in the Greek economy (there's no precedent here as no member state has left the Eurozone so far), and probably result in bank runs and higher borrowing costs. It may also lead to greater political instability.

On the other hand, further austerity will condemn Greece to prolonged suffering, with little to show for it in terms of growth and recovery.

For the Greeks, it seems, there are no easy answers.

First published: 1 July 2015, 23:58 IST
 
Shivangi Shah @CatchNews

Shivangi Shah is an economist, formerly with Societe Generale. Passionate about macroeconomics, she is on a sabbatical until she heads further west for her third degree, this time at the University of Chicago.

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