By Nicholas Economides, professor at NYU Stern, CNBC
As we approach Sunday’s Greek election, the extreme left party Syriza is leading in the polls, causing many in Europe and the United States to fear the worst when it comes to Greece’s future economic stability and its status in the European Union.
While everyone should be closely watching Greece’s actions, it is unlikely that even a Syriza victory will spark widespread sovereign bank contagion or a Greek exit from the EU, recently referred to as a “Grexit.”
Syriza has proposed significant increases in wages, pensions and of the state sector in general, conservatively estimated to cost 20 billion euros, with no immediate sources of funding. Existing uncovered financial needs of Greece in 2015 are about €20 billion, bringing the total needs of Greece to €40 billion in 2015 if the Syriza program is implemented. Syriza has also threatened not to pay Greek sovereign debt to European countries unless there is a reduction of the total Greek sovereign debt from 177 percent of GDP to 60 percent of GDP. This is a whopping €212 billion reduction — a 95 percent write-off when applied to the official sector loans from European countries, the European Financial Stability Facility and the European Central Bank (which total €222 billion). Syriza has also committed to voters not to renew the agreements between the European Union, the ECB, the IMF and Greece on fiscal consolidation and economic reforms.
While these decisions would have serious implications for Greece, the likelihood of a Grexit causing a euro-zone ripple effect is more hype than fact. Here’s why.
The short-term impact of a Grexit on sovereign debt of other weak euro-zone countries, such as Portugal, Spain and Italy, is expected to be limited. Although in the early days of the European crisis (2010 to 2012) the yields of comparable debt of these three countries (indicating the extent of risk) were highly correlated with the yield of Greek debt, that is no longer the case. As the political uncertainty and the extreme positions of Syriza caused Greek 10-year bond yields to climb in the last six months to over 9 percent from 6.5 percent, the yields of comparable bonds of other weak European countries hardly moved. They remain quite low, with the corresponding Spanish bond yielding 1.52 percent and the Italian one 1.69 percent. These yields clearly show that a Grexit is expected to have only a small impact on any euro zone sovereign bond.
A Grexit will impact the euro club which, by law, has no exit doors. Once one country exits, others may follow over time. But, currently, there are no other candidates for exit, and the crisis will be contained.
If Syriza gets elected, there are two distinct paths of a Grexit, one based on budgetary shortfall and the other on a failed debt renegotiation.
In the first path, Syriza tries to implement its program but it has no Euros to do it. The financial markets give Greece a prohibitive (over 9 percent) interest rate, the Europeans will not lend under threat and without conditions, and the internal financial market is too shallow and already tapped. To implement its program, Syriza voluntarily exits the euro and prints new drachmas.
In the second path of a Grexit, Syriza demands a large debt write-off and the Europeans refuse since their taxpayers have no appetite to pay the Greek debt. As Syriza refuses to pay the upcoming interest and capital payments to the ECB (which happens to come up first in the calendar), the ECB withdraws its support from the Greek banking system (currently at €100 billion guarantees with €65 to €70 billion used in December). As a result, the Greek banks collapse, and Greece is de facto outside the euro. Based on Greek bond yields, the two paths of Grexit are cumulatively assessed at 25 percent to 30 percent probability.
Depending on the path that leads to a Grexit, there could be different implications for the euro club. A voluntary exit by Greece will be seen as a failure of Greece to fix its finances rather than a European problem. An exit based on a failed Greek demand for steep debt reduction will be seen as a failure of the Greece political system. In either case, the European politicians will not consider it a failure of their own.
Commentary by Nicholas Economides, a professor of economics at the NYU Stern School of Business. He is also executive director of the NET Institute, a worldwide focal point for research on the economics of network and high technology industries. He is advisor to the U.S. Federal Trade Commission, the governments of Greece, Ireland, New Zealand and Portugal, the Attorney General of New York State, major telecommunications corporations, a number of the Federal Reserve Banks, the Bank of Greece and major financial exchanges. He serves on the advisory board of the Economist Intelligence Unit.
