By Dr. Jim Leontiades
The Cyprus International Institute of Management
It used to be unthinkable. It is still strongly denied, but a few voices are stating the obvious. Greece may leave the Euro. Default and exit if not a probability is definitely a possibility. The Dutch prime minister has openly declared that countries breaking Euro-zone budget rules should face expulsion. After repeated denials, even the German Finance minister has now hinted that Greece leaving the Euro-zone is a distinct possibility if it does not comply with the demands of the troika negotiating on behalf of the Euro-zone (the IMF, EU and European Central Bank). The European negotiators walked out of their most recent meeting with Greek authorities when it became clear that Greece has so far not been able to comply with several previously agreed requirements. Shortly afterwards the leading economist of the ECB resigned. Does he know something we don’t?
It is not just a matter of economics. Leaving the Euro-zone is also a political decision, one which may be imposed by the electorate. Dissatisfaction among the public is rising, not only within Greece but also within Euro-zone countries providing the Greek rescue funds. Angela Merkel, the German chancellor, has suffered a string of defeats in elections at home in which opposition to Greek financial aid has figured prominently. Voters in Finland, the Netherlands and Austria have made their disapproval with the Greek rescue effort quite plain. No wonder the international financial markets are pointing to a 90% chance of a Greek default.
The cost of such a departure from the Euro-zone would be enormous, not only to Greece but to many countries in the Euro-zone and beyond. There is also the enormous uncertainty that such an event would unleash. Such a move is unprecedented. If the best economists cannot fix the current situation – it is hard to even imagine what uncertainties Greece leaving the Euro-zone would pose.
Considering the close relationship politically and economically between Cyprus and Greece, it is also clear that the impact on Cyprus would be great. Is Cyprus prepared? Given the government’s track record on our economic situation to date, I think it is safe to say we have no “plan B”. What does Cyprus do if Greece leaves the Euro and the Euro-zone?
An optimistic scenario is one where both parties come to their senses and assistance is given to Greece to either stay in the Euro-zone or exit gradually and gracefully. The objective would be to minimize the “collateral damage” on other member countries. Measures would have to be in place to prevent bank failures particularly of those banks which hold Greek sovereign debt (France and German banks are major holders of Greek debt). Such a process is conceivable even after a default.
The probability of this optimistic exit scenario is not great. There is a distinct chance that a Greek departure would be swift with little or no prior coordination with member countries. The impacts of such a departure are difficult to identify and anticipate since the response of other member counties to such an event is unknown. There has been talk of a two speed Euro-zone. The financially stronger Northern countries would form one group. The exchange rate of their currency, the “northern Euro” would appreciate. The Southern countries would form another group with a weaker Euro. This is also an unlikely scenario, given the absence of any institutions among the Southern group that could manage financial matters across all members.
Another option mentioned by economists as a possible solution would be for Germany to leave the Euro-zone. Considering that Germany has provided the bulk of the funds to prop up the weaker members, this presents obvious problems.
One near certainty in the event of Greece leaving the Euro is a steep drop in the exchange rate of any new Greek “drachma”, replacing the Euro. What would the Cypriot reaction be in such an eventuality? That is the central issue for any Cyprus contingency plan. Could this country still remain a member of the Euro-zone with an exchange rate much higher than that of Greece, with all the implications that raises for Cypriot banks and other businesses? How would any new Cypriot currency be introduced? What would be the exchange rate compared to the new Greek currency and the remaining Euro-zone countries? These are obvious questions with no obvious answer.
We can hope for the best but be prepared for the worst. Are we prepared? There is no department or think tank within or outside government which appears to be addressing such a contingency. Our present method of reaching economic decisions through bargaining with unions and other pressure groups is hopelessly inadequate. Current Cypriot economic planning has become an exercise in crisis management, reacting to one externally imposed event after another. At the end of the day, we may have little more choice than Greece as to whether we stay or exit the Euro.