How could Greece leave the euro?

There are several possible ways in which Greece could leave the single currency. All are bumpy.

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“Greece will be forced to leave the euro” has long been a favourite throwaway line among television presenters and financial-market pundits. But it was only last week, after the Greek prime minister’s shock referendum announcement, that it entered the vocabulary of EU leaders.

Official resistance to the idea of a Greek withdrawal from the eurozone is not just a response to fears of the losses it would imply for Europe’s banks, or of contagion spreading to the government bond markets of Italy and Spain, or even of the collapse of the Greek economy and mass south-north migration. At a purely technical level, a Greek exit from the eurozone presents formidable challenges – something that European Commission officials are discovering as they conduct what Olli Rehn, the commissioner for economic and monetary affairs, this week called “scenario planning”.

So far, officials have considered three possible scenarios: one is for Greece to invoke Article 50 of the consolidated treaty and to leave both the eurozone and the EU; another is for an intergovernmental conference to rewrite the treaty and insert a clause allowing a forced exit from the eurozone but continued membership of the EU; the third is for the Council of Ministers to revoke Decision 2000/427/EC of 19 June 2000, which allowed Greece to join the eurozone in January 2001. All three options present problems. The first and second rely on Greek compliance and, as an opinion poll carried out for the Ethnos newspaper this week showed, 81% of Greeks want to remain in the single currency area. The third option would be a legal novelty, and vulnerable to challenge at the European Court of Justice.

In fact, the likeliest form of exit – if Greece ever does leave – would be a much less tidy affair. In this scenario, in December a new interim government would receive its overdue €8 billion instalment from the ‘troika’ overseeing international financial support – the International Monetary Fund, the Commission and the European Central Bank – and would complete a bond swap with the Institute of International Finance that writes off more than €100bn of its debts.

Then, the scenario suggests, a February election would lead to the installation of a new government that would, like its predecessor, be shown not to be meeting targets in the quarterly monitoring exercises. After much internal debate, and in full awareness of the consequences, the troika would then withhold an instalment of the funding, and Greece would, as a result, default on payments to its creditors. From that moment, the ECB would be unable to accept Greek government bonds as collateral in return for lending money to banks. As a consequence, the Greek banking system would collapse.

Greece’s government, which would have no banking system and no cash with which to pay salaries, could then temporarily seal its borders, impose capital controls and accept only Greek euro coins, and notes stamped with the symbol of the new currency. It could announce by decree that all assets and liabilities and all external debts must be denominated in Hellenic euros. The government would then face a choice. It could choose to devalue the currency or peg it 1:1 to the euro. The first route would be politically and economically risky, and, given the state of Greece’s export sector, would be of little benefit. Wim Boonstra, chief economist at Rabobank Nederland, has calculated that the 30%-40% currency devaluation required to restore Greek competitiveness would also cause net loss of domestic wealth of as much as a third. For this reason, the likeliest outcome would be a decision to maintain the euro as Greece’s currency but stay locked out of the ECB and effectively from economic decision-making in the EU. Greece would, like Montenegro and Kosovo, be ‘euro-ised’ but outside the eurozone.

The prospect of such an exit is so traumatic that EU officials believe Greek politicians will never risk it. Officials negotiating with the Greek government over the past two years have been frustrated by the slow pace of policy implementation and believed this was largely because Greeks did not take the prospect of withheld instalments or an exit seriously. That certainly changed last week. Greece’s official creditors are now prepared to consider a hard default and the Greeks believe them. Perversely, that conviction makes the doomsday scenario less likely.

Tom Judd is a journalist based in the UK.