Cat’s Credit Crunching: Has Grexit been averted?

Thoughtful Thanos asks: Has a Grexit been averted?

Photo: Jan Wellmann (CC BY-NC-ND)
Photo: Jan Wellmann (CC BY-NC-ND)

Dear Thanos,

When Tsipras caved in to Troika pressures and accepted the implementation of austerity measures, the impression policy makers wanted to create was that a Grexit had been averted. But the reality is a lot more complicated.

The Greek state remains broke, and in this the re-election of Syriza over the conservative Nea Demokratia on 20 September has made no difference. Because the Troika refuses to write off Greek debt, the only possible way Greece could repay its debt is by getting its economy to grow.

Sovereign debt is usually measured against economic growth. If a country has high levels of economic growth, then it isn’t a major problem if it also has high levels of debt. However, if a country has low levels of growth or is even facing a recession, the debt burden becomes an issue. The problem is that with the current austerity measures, it is impossible for growth to pick up.

Even the IMF now describes Greek debt as “highly unsustainable” and estimates that in the best case scenario it will reach 200% of GDP within the next two years. The IMF now accepts that the EU will have to write off a large amount of Greek debt.

To cut a long story short, Greek debt is now even less sustainable than before, but the EU refuses to write it off – which is why a Greek exit from the Eurozone remains likely.

Angela Merkel has claimed that the European Central Bank can’t write off all of the Greek debt even if they leave the euro, because it’s illegal in EU law. Is that true?

There is no legal procedure for member states leaving the Eurozone – when politicians and bureaucrats drafted these laws, they wanted to give the impression that this could never happen. Likewise, there isn’t really a procedure on member states defaulting. However, European law does specify that member states are not allowed to bail out other member states. According to their own logic, European governments did not directly bail out Greece, they put money into a rescue fund (the European Financial Stability Fund) which was regarded as a loan to Greece.

It is possible to write off debt from private creditors – this is what happened with the partial write off of Greek debt, the so-called “haircuts”. But as of January 2015, only 17% of Greece’s debt was held by private creditors. At the moment, about 60% of the €323bn total is held by other European governments, 10% by the IMF and only 6% by the European Central Bank, the ECB. So writing off Greece’s debt isn’t mainly an issue for the ECB. If Greece were to stay in the Eurozone and default, it would be up to the European governments to collectively agree not to ask for a refund of their loans.

The other option for Greece would to exit the Eurozone and then default on its debt. Like any other sovereign state, Greece can decide not to repay its creditors, in this case other European governments. This would probably be a very difficult step, resulting in massive capital outflows and a short term economic collapse. But given that the IMF is now forecasting that it would take decades to pay off the debt, a default is still the more sustainable option in the long run.

In any case, it’s important to remember that laws are made by politicians who had their own motives when drafting them. Laws are not set in stone – they can change, if enough people want them to change. These are all political issues, not legal ones.


This article originally appeared in the Autumn 2015 issue of the rs21 magazine


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