22 May 2012

WSJ: Ex-premier to Greece - Stick to austerity

Greece's former Prime Minister, Lucas Papademos, warned that Greeks have no choice but to stick with a painful austerity programme dictated by its lenders or face an exit from the eurozone that would devastate the economy, boost inflation and generate new social strains.

Mr Papademos said that dropping the common currency would have "catastrophic" economic consequences for Greece, and profound and far-reaching implications for the rest of the eurozone. "This is why some European states and institutions are considering contingency plans for any eventuality."

"Although such a scenario is unlikely to materialise and it is not desirable either for Greece or for other countries, it cannot be excluded that preparations are being made to contain the potential consequences of a Greek euro exit", Mr Papademos said.

Mr Papademos said he worries that many Greeks don't fully appreciate the gravity of the situation. "European political leaders have sent a clear message comprising two parts: Greece should remain in the eurozone and the country should respect its commitments. Hence, the risk of Greece leaving the euro is real and it depends effectively on whether the Greek people will support the continued implementation of the economic programme", Mr Papademos said. "I share the view that if Greece defaults and exits the euro, the consequences for the eurozone—its financial system and real economy—will be profound and the associated cost will be significant and far-reaching. It will also affect the economies of other countries outside the eurozone."

If necessary, the government could tap funds held by the Hellenic Financial Stability Fund that are supposed to be used for bank recapitalisations. By the end of this week, the HFSF is expected to distribute €18 billion in fresh bailout funds to Greek banks to boost their liquidity, after which it will be left with a cushion of €3 billion.

There is no upside to a Greek departure from the euro, Mr Papademos said. The impact of a sharp devaluation in a new national currency would erase any competitive gains in foreign trade. Under Mr Papademos's exit scenario, Greek inflation will accelerate, real incomes will shrink, the banking system will experience extreme stress, and Greece's access to the capital markets will become more remote. Greece's public debt will increase because it will be denominated in the new currency, and then higher real interest rates would be required to stabilise the exchange rate and bring inflation under control.

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© Wall Street Journal