Grexit is back on the menu: Election scenarios and the future of the Eurozone

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On Sunday, Greek voters will go to the ballot to vote in a parliamentary election for the fourth time in the last eight years. The stakes could not be higher; after seven years of recession the Greek people are set to say ‘enough is enough’ by voting for the radical left-wing anti-austerity party Syriza.    

Syriza is looking certain for victory with the latest polls putting it at around 3-6% ahead of the centre-right New Democracy (ND) party. However, the more pressing question is whether Syriza will achieve an absolute majority or whether it will be obliged to form a coalition.

 

Election scenarios

Latest polling suggests that Syriza will fall short of an absolute majority. The threshold for an absolute majority in the Greek Parliament is about 35% of the vote. Currently, Syriza is expected to secure around 32-33.5%, which means that it will have to find partners to form a coalition.

This will not be an easy endeavour. The centre-left parties ‘Pasok’ and ‘Potami’ are the most likely coalition partners but hold a markedly more pro-EU stance than Syriza. Major compromises will be required from both sides to form government. This is likely to lead to some moderation in Syriza’s plan with regards to negotiations over debt restructuring and the austerity program with the EU.

Given the level of political polarisation in Greek politics, the scenario that parties fail to reach an agreement and a second round of elections is called for early February is highly probable. A protracted round of negotiations and a hung Parliament will lead to further uncertainty and another rally on Greek bond yields.

 

Implications for the future of the Eurozone

A Syriza government with an absolute majority or to a lesser extent in coalition with anti-austerity parties means that a Grexit is back on the menu. Eurozone leaders have made it clear that existing arrangements on debt repayments and the structural reform package will have to be honoured and are non-negotiable. On the other hand, Syriza has pledged debt relief and a range of social policies that firmly contradict austerity.

Both stances are set to be less uncompromising when the time for negotiations has arrived. While it’s true that the balance of power has shifted against Greece since 2012 both sides have a lot to lose. The massively expanded powers of the ECB, the 50% haircut on Greek debt three years ago, the marginally but still better economic situation of the Eurozone, and simply the unavoidable conclusion back in 2013 that Syriza will soon be in government mean that the EU has limited its exposure to a Grexit and the potential damage of contagion has deteriorated.

Still, the longer term consequences cannot be discounted. A Grexit will undermine the movement towards further integration in the EU and provide precedent for other ailing economies in the European periphery to head for the door. The already fragile growth in the Eurozone will be under jeopardy and progress made in the last few years could revert back to ground zero.

With regards to Syriza, a fine balance will need to be achieved. The party knows that its potential victory in the elections will be achieved on the premise of avoiding an exit from the Eurozone while succeeding in scaling down the austerity program. Any sign that Greece is moving closer to an exit will cause panic and at the first opportunity Syriza will be out of the door – hopefully before Greece is.

A likely scenario is that the EU will grant some moderate victory to Syriza in order to appease its voters while maintaining the core of the current arrangements. Longer maturities on the debt and a flooring of the interest rate in combination with some review of the structural reforms package could do the trick.

 

Implications for UK manufacturing

Trade links between the UK and Greece are limited. Currently, only about 0.6% of total UK exports to the EU go to Greece. The small size of the Greek market means that the direct impact of a Grexit for UK manufacturers is likely to be minimal.

However, the indirect effects of a Grexit are not confined to trade with Greece. A possible Grexit has the potential to drag the Eurozone back into recession or close-to-zero growth. With the EU accounting for almost 50% of total exports, the protracted struggle for growth in the Eurozone has already hurt the UK’s trade performance. A renewed crisis will widen the current account deficit through another slump in export demand and cheaper imports from the EU.

In addition, the Eurozone is likely to once more descend into an existential crisis. Debates about the sustainability of the Eurozone will remerge and the economic performance of the Southern periphery will again be under scrutiny. At a time where growth has finally returned after years of austerity such a development could further damage perceptions over the ability of the EU to deliver prosperity in the long term – especially in the Southern periphery.

Following such a scenario, the ECB will probably need to inject more money in the Eurozone to boost growth and prevent government bonds yields from soaring than it would have to if it adhered to some of Syriza’s demands. All in all, despite limited trade links with the UK and the smaller probability of contagion than 2012 the risk of a Grexit for British manufacturers is sizeable via its indirect impact on the UK's largest export market.

 

A glimmer of hope

There is a glimmer of hope from all this turbulence; that the Eurozone’s existential crisis can finally be resolved. Transcending moral hazard arguments, a better deal for Greece will be of practical benefit to all, not least to Germany. Getting the Greek economy going and the commitment of the major EU countries to support the Southern periphery will reinstate confidence about the sustainability of the Eurozone and open room for growth-boosting policies that would bring an end to its lacklustre economic performance.

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