by George Hatjoullis

There is an emergency summit of all 28 EU member states to discuss Greece. This is unprecedented as only 19 are members of the eurozone. It is a bad sign. The expectation must be Greece will not be able to meet the now even tougher conditions for reaching a bailout agreement. There will be no interim finance and no further ELA unless the ESM will underwrite Greek  government debt as collateral. This cannot happen without a full agreement. It is circular and there is no hope of breaking the circle. Merkel has made clear that any chance Greece has will be on tougher terms than could have been achieved before the referendum. This is part a matter of (lost) trust and part an economic consequence of delay. There will be no debt relief up front. The offer on the table will be the sort of grim austerity package that the Greeks voted against in the referendum and that they elected Tsipras to avoid. He has failed. It was a difficult task, to be fair, but his approach made it unlikely to succeed. He must either capitulate and subject Greece to another few years of impossible pain or accept the inevitable and bow out of the eurozone.

He can bow out gracefully or just walk away. If he wants help from the EU he needs to do it gracefully. This is what the summit will determine. The presence of the 28 is a sure sign that Greece’s future out of the eurozone, but still within the EU, is to be discussed. The legal aspects are simply not developed. It seems no one wanted to plan for such an eventuality. The summit on Sunday may be a defining moment for the EU and the eurozone. It will be yet another defining moment for Greece. Playing the blame game is pointless. The question is what next?

It is conceivable that Tsipras may capitulate and accept whatever terms he is offered. The Memorandum of Understanding will need to implemented pretty damn quick. This can only be achieved if all parties back the government and necessary legislation is rushed through. This will suddenly inflict wholesale changes on the Greek people. Many are already in dire straits so a humanitarian crisis of third world proportions confronts Greece. This is where the EU comes in. Assistance in medical care will be a priority. The situation is already appalling. Food and clothing is already an issue for too many families (something I am aware of from personal experience) and may also need EU attention. The deal will beggar Greece but keep them in the eurozone. The problem is that the alternatives are no better. There are two possibilities.

First, Greece could agree an orderly exit. It would not repudiate its debt but a moratorium could be agreed until Greece returned to health. Greece would remain within the EU and receive EU assistance under available programmes. A parallel currency would be introduced until the mechanics of reintroducing the drachma could be organised. This will enable Greece to achieve an internal devaluation. However, this will not make Greece more productive. It will not improve tax collection. It will not reduce the burden on the public purse of a too large public sector and over generous (in terms of GDP, not in absolute terms) pension system. The regulatory and administrative inefficiencies that plague Greece’s private sector will not disappear. The reforms demanded by the MoU will still need to be implemented if the devaluation is to be translated into more growth and more investment and not simply inflation.

Second, Greece could repudiate all debt and walk away. This risks expulsion from the EU, though the legal process would be convoluted and might take a while. It could certainly be suspended from various programmes and might not receive humanitarian support. On the other hand it would be a sovereign state and could organise itself as it sees fit. It might form new alliances, both economic and political. It would start with a fresh slate and without the burden of debt.

It is impossible to say which option is best from the point of view of Greece. One problem is the domestic reaction. A large minority voted yes in the referendum Greece is politically a polarised society so domestic unrest could be a problem in all three  scenarios. The army is a proud member of NATO and might not take kindly to having its capacity or allegiance altered. All sorts of horrible possible scenarios can be conjured up.

From the point of view of the eurozone and the EU, Greece is an irritation. It can overcome the contagion risk. Greece can be sold to the world as a ‘one off’, the exception that proves the rule. It will also inspire the eurozone to accelerate integration and complete a structure that ensures a Greece cannot emerge again and put into place contingency plans to cope if it did. The structure will of course embody fiscal orthodoxy into law, which seems to be the fashion these days. This is the eurozone’s way of coping with the moral hazard that such an enterprise inevitably introduces. It will work, though it will do so only by creating new problems such as excessive population movement and social reaction. However, this is a different story and not one that will worry bond markets as much. And this is the punchline. It all comes down to keeping the bond markets happy.