Greece crisis: Is there a solution?

By Robert Plummer and Laurence Peter
BBC News

Image caption,
Street politics and strikes are putting the Greek government under pressure

The impact of Greece's financial woes is being felt ever more keenly in European financial markets as fears grow that some kind of debt default may be inevitable.

Experts say a default could have a dire impact on other weak economies in the 17-nation eurozone and fuel doubts about the single currency's viability.

The Greek crisis raises big questions about the euro.

Above all, can you have monetary union without full-scale co-ordination of economic policy?

So what are the possible scenarios? Can Greece find a solution, or is it just forestalling disaster?

Scenario 1: New bail-out succeeds

The Greek government is racing against time to fulfil the demands of international lenders and qualify for a new lifeline to avoid default.

The immediate priority is to secure a 12bn-euro (£10.6bn; $17bn) loan instalment by 3 July - part of the 110bn-euro loan package granted by the EU and International Monetary Fund in May 2010.

But even if the Greek parliament adopts the new austerity measures - tax rises, spending cuts and privatisation - necessary to get that 12bn euros, it will only bring temporary relief.

Jittery markets may calm down if the EU agrees on a new rescue package for Greece worth about 120bn euros, which would give Greece time to restructure its economy, boost much-needed tax revenue and eventually return to commercial lenders.

The new package is deemed necessary because the ratings agencies have downgraded Greece's sovereign bonds so much that it cannot afford to borrow from commercial lenders.

European leaders have staked their credibility on the euro succeeding as a political project, so they are reluctantly preparing the new rescue package as a last resort to prevent the eurozone's first sovereign default.

That rescue could buy enough time to restore confidence in the euro and reduce Greece's debt mountain.

But it is a big if.

Germany - a key contributor to any rescue package - is arguing with France and the European Central Bank over the extent to which private investors should buy new Greek bonds and share the risk burden.

Prime Minister George Papandreou is scrambling to shore up support in his ruling Pasok (Socialist) party, but the programme of cuts and tax increases has made him unpopular.

He appointed a new finance minister on 17 June - Evangelos Venizelos - to help quell dissent in the Pasok ranks. Pasok now has 155 seats in the 300-seat chamber.

The opposition New Democracy party objects to certain aspects of the Pasok austerity programme. If parliament fails to adopt that programme in late June, Mr Papandreou could lose more support inside Pasok and his government could fall.

The political uncertainty would have dire consequences. It would make a default look inevitable.

In that scenario, the IMF and EU would probably freeze any further lending to Greece.

New Democracy could rescue a weak Pasok minority government by forming a "national unity" coalition with it - probably demanding key cabinet posts in a last-ditch deal to appease the international lenders and markets.

But a snap election would be more likely.

It would be quite unpredictable, as Greece is seeing daily mass protests and strikes against the austerity measures. Such an election could quickly become a referendum on the international bail-out and Greece's future in the eurozone.

So what happens if Greece cannot meet its debt obligations?

Well, in that case, it will have to come clean and tell its creditors that they won't be getting all the money they were owed. They will get most of it, but later than they had expected.

This process is euphemistically known as "debt restructuring".

For it to work, holders of Greek government bonds would have to accept less than they were worth - or in the jargon of the markets, "take a haircut".

According to analysts, the size of that haircut could be anything between 20% and 50%.

If the settlement were negotiated in an orderly fashion, it could form part of an acceptable solution - although it would make investors reluctant to buy more Greek bonds in the future.

Another problem for Greece is that the ratings agencies would probably treat a debt restructuring as a default anyway.

In their view, it would just be postponing the day of reckoning that they believe Greece must face.

It would also raise interest rates for bonds issued by other troubled eurozone "periphery" economies - especially the Irish Republic and Portugal - and depress the value of the euro.

Being in the eurozone, Greece is unable to restore its economic competitiveness by devaluing its currency.

Some commentators have entertained the notion that Greece could give up the euro, but not for good.

Instead, it could take a "eurozone holiday," temporarily sloughing off the obligations of the single currency and returning when the time was right.

In this scenario, Greece would return to the drachma at a new exchange rate: one euro would equal one drachma.

It would then devalue by nearly a quarter and return to the eurozone after a few years had passed at, say, 1.3 drachmas to the euro.

Such a measure would certainly cut labour costs and boost exports.

However, it would increase the size of Greece's debt mountain.

But if you're contemplating a stealth default in Greece, what about an outright default? How bad could it be?

Well, it would be big.

Bigger than Russia's 1998 default and Argentina's 2001 default put together, in fact.

And the consequences would be felt mainly by the big EU economies that have lent to Greece.

German and French financial institutions are thought to hold up to 70% of Greek debt and would be severely hit.

The credibility of the ECB would suffer, and that could hurt international investment in the eurozone.

A default could bankrupt Greek banks, which together are reckoned to hold about a quarter of the Greek sovereign debt.

The fear is of contagion - the weaker eurozone countries would find it more expensive to borrow in commercial markets. The Irish Republic and Portugal might need a further EU-IMF bail-out.

For reasons of self-interest, therefore, the EU is likely to go to any lengths to stop Greece defaulting.