13 May 2012

Wolfgang Münchau: Default now or default later?

In his FT column, Münchau wonders what would constitute an economically rational choice for Greece, given the economic and political situation. He sees four options, each of which is fraught with uncertainty.

The first would be the status quo: more austerity and economic reforms as outlined by the International Monetary Fund and the EU. One risk is that this would keep Greece in an eternal depression and a debt trap, where economic output fell faster than growth. Another is that, while on paper it might just work economically, it would almost certainly fail politically... Since this option would work neither economically nor politically, it cannot conceivably be a rational choice.

The second option would be to pursue the same plan until Greece achieves a primary balance – the fiscal balance before the payment of interest – and then to default, or at least to renegotiate the programme with the IMF and the EU. This is more realistic than the first option. A variant of this option was under discussion in the negotiations last week. But there is a risk the austerity needed to reach this point is either so severe, or would take so long, that the political risk would start to have an impact as well.

The third option is the one outlined by Alexis Tsipras, the Syriza leader. He wants Greece to cancel the programme immediately, reverse some of the reforms and consider the possibility of a default on the remaining foreign debt. He claims this would not lead to an exit from the eurozone. He is saying that the EU is bluffing. I am not sure he is right about the latter. But then again, I am not sure he is wrong either...

There are also uncertain risks of financial contagion. As Fitch Ratings said at Friday’s coalition talks, a Greek exit would have a negative impact on the eurozone’s ratings. Mr Tsipras has a point when he says the EU has no interest in pushing Greece out of the euro. The trouble is the eurozone may still do it because its leaders misjudge the situation.

The fourth option would be an immediate voluntary departure. Greece has only a tiny export sector and, as Willem Buiter of Citibank has said, the initial competitiveness gains would be quickly eroded through domestic policies.

Of the four, the worst option is actually number one. By following the EU-IMF programme, Greece will end up with 10 years of depression, an inevitable euro exit and a possible breakdown of democracy. The best option, in my view, would be a strategy to achieve a primary balance by 2013 and then to default on all outstanding foreign debt, public and private. It would not be popular outside Greece but it would be hard to push Greece out of the eurozone.

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