Unhappy in their own ways

Economist
May 12, 2012

The deep uncertainty over what will happen next in Greece unnerved financial markets. On May 7th the euro touched its lowest value against the dollar since January while in Athens the stockmarket fell by 7% and bank stocks by 13%. Greek bonds also took a hit, with the yield on the ten-year bond rising to 22.9% (from 20.5% at the end of April). Investors piled into the havens of German government bonds and American Treasuries. The Dow Jones Euro Stoxx 50 fell to its lowest level so far in 2012.

On the same day Angela Merkel, the German chancellor, was swift to insist that there could be no backtracking on the commitments Greece made at the time of its second bail-out earlier this year. By the end of June a Greek government is supposed to specify a further package of reforms and spending cuts, worth 5.5% of GDP; these are to be carried out in two instalments, the first in 2013, the second in 2014. But that timetable now looks more or less impossible, even if a government can be found that wants to stick to the bail-out’s conditions. Relations between the country and its creditors may sour to such a point that a Greek exit from the euro—a “grexit”, as it is coming to be known—becomes inevitable. This need not be a self-fulfilling prophecy. But the more real it comes to seem, the more corrosive its effects on confidence, which adds further to the risks.

Even before an exit Greece’s banks could collapse if the steady withdrawal of deposits—they are 30% below their peak, according to Credit Suisse—were to develop into an outright run. After an exit debts to foreign creditors would soar as the new drachma fell, leading to further defaults. On strict legal grounds, Greece could find itself cast out of the European Union as well as the euro area, at risk of losing access to the single market.

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