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Eurozone crisis: contingency plans in place for Greek debt default Eurozone crisis: contingency plans in place for Greek debt default
(about 4 hours later)
The European commission insisted on Wednesday it wants Greece to remain in the euro, but also confirmed that it has extensively analysed the potential impact of Athens defaulting on its national debt. Central banks across Europe have a collective nightmare. It is of the day Greece defaults on its debts, and the Aegean Sea is awash with small boats in which fleeing Greeks huddle with suitcases full of euros. Guards patrol the border in an attempt to prevent the flight of capital. Things get ugly and there are shootings, captured on film. Despite the best efforts of policymakers in Athens, Brussels and Frankfurt, it proves impossible to contain the panic, which spreads to Portugal and Ireland, the other two countries going through tough austerity programmes in return for bailouts from the EU and the IMF.
"The consequences would be devastating for Greek citizens and particularly for the most vulnerable. Consequences would be felt throughout the eurozone and beyond," predicted Amadeu Altafaj, spokesman for Europe's commissioner for economic and monetary affairs, Olli Rehn. Across Europe, governments are engaged in contingency planning for this sort of scenario. In the UK – which had first-hand experience of how crises can escalate when there was a three-day run on Northern Rock in 2007 – the Bank of England, the Treasury and the Financial Services Authority have been "war-gaming" what might be expected in the event of Greece repudiating its debts and leaving the single currency.
The Bank of England governor, Sir Mervyn King, also made clear on Wednesday that the "government and the Bank together have been discussing a range of policy options and devising contingency plans". Most big businesses across the UK have also made preparations for a euro meltdown, fearful not just of the direct impact on sales but of a drying up of credit and trade finance. Few doubt that a messy Greek default would lead to a credit crunch at least equal in severity to that which followed the collapse of Lehman Brothers in September 2008.
Neither King nor EU officials would say what policy options were being considered. Sir Mervyn King, the governor of the Bank of England, said it was impossible for any government to be fully prepared, but said the UK authorities were braced for a range of outcomes. Threadneedle Street is convinced that failure to end Europe's long-running debt crisis would have severe implications for the UK economy. King said there would be a substantial fall in spending, exports would collapse and hopes of rebalancing the economy would be dashed.
But Wolfgang Schäuble, the German finance minister, declared: "We're better prepared than two years ago." Policymakers have stepped up the pace of their planning in recent days following the marked deterioration in the relationship between Greece and its single-currency partners. Athens believes that the rest of the eurozone wants Greece out, while Germany is leading the group of hardline countries demanding assurances before the €130bn bailout is agreed.
Opinion is divided on whether Greece would need to exit the euro if it defaulted. Arguably there would be huge damage from a default with little compensating gain if it stayed in the euro as Greece would be unable to borrow and yet would also be unable to benefit from devaluing a reminted drachma in order to boost competitiveness. While Germany's finance minister, Wolfgang Schäuble, says "we're better prepared than two years ago", others believe the ramifications of a Greek exit would be felt globally. "The consequences would be devastating for Greek citizens and particularly for the most vulnerable," predicted Amadeu Altafaj, spokesman for Europe's commissioner for economic and monetary affairs, Olli Rehn. "Consequences would be felt throughout the eurozone and beyond."
Default, said Altafaj, "would solve absolutely none of the problems the Greek economy suffers from". He added: "When we make these kind of statements it is because they are substantiated by thorough economic analysis. I am not in a position to share that with you." European policymakers are looking beyond contingency planning for a Greek default to the possibility of the country crashing out of the euro. Greece would probably have to impose capital controls – limits on the amount of money that can be taken in and out of the country – while it implemented "drachmatisation". All balances at Greek banks would probably be redenominated at a fixed exchange rate with the new (or rather the old) currency; but banks could be shut, or strict limits placed on withdrawals from cash machines, while the details were worked out.
European policymakers are looking beyond contingency planning for a Greek default to the possibility of the country crashing out of the euro.
The crisis-hit country would be likely to have to impose capital controls – limits on the amount of money that can be taken in and out of the country – while it implemented "drachmatisation".
All balances at Greek banks would probably be redenominated at a fixed exchange rate with the new (or rather the old) currency; but banks could be shut, or strict limits placed on withdrawals from cash machines, while the details were worked out.
These capital controls, and the difficulty of getting hold of cash inside Greece, would have knock-on effects for any businesses, holidaymakers or ex-pats in the country at the time.These capital controls, and the difficulty of getting hold of cash inside Greece, would have knock-on effects for any businesses, holidaymakers or ex-pats in the country at the time.
In the UK, Whitehall insiders said the various government departments that would have to be involved have been discussing how to minimise the impact for months. In the UK, Whitehall insiders said the various government departments that would have to be involved have been discussing how to minimise the impact for months. The Foreign Office would have to think about how to bring home Britons trapped in Greece without enough funds to get out; Vince Cable's Department for Business, Innovation and Skills would have to offer advice, and possibly funding, to businesses with exposure to the country; and the Treasury would also have a key role.
The Foreign Office would have to think about how to bring home Britons trapped in Greece without enough funds to get out; Vince Cable's Department for Business, Innovation and Skills would have to offer advice, and possibly funding, to businesses with exposure to the country; and the Treasury would also have a key role. The other direct impact would be on the financial sector – for any banks still holding Greek bonds, for example. In the UK, the much-derided "tripartite committee" – the Bank of England, the Treasury, and City regulator the Financial Services Authority – would still be the locus for decision-making. As part of the government's new arrangements for coping with financial crises, the new Financial Policy Committee, chaired by King, would also meet to decide what action was necessary.
The other direct impact would be on the financial sector – for any banks which are still holding Greek bonds, for example. In the UK the much-derided "tripartite committee," which brings together the Bank of England, the Treasury, and City regulator the Financial Services Authority, would still be the locus for decision-making. As part of the government's new arrangements for coping with financial crises, the new Financial Policy Committee, chaired by King, would also meet to decide what action was necessary. In the worst-case scenario, Greece could be followed by more countries as the markets speculated on whether Portugal, Ireland or Spain would be the next to default. If the bonds of all these countries were called into question, Britain's banks could be hit hard, and the Treasury could even be forced to contemplate fresh taxpayer-backed nationalisations.
UK government insiders believe a Greek default alone would be manageable; but if global investors lost confidence in the euro as a whole and started pulling out their investments in the single currency, it could have much wider ramifications. It is to forestall a Greek domino effect that the European Central Bank has flooded Europe's banks with cheap money over the past two months, easing funding concerns and bringing down interest rates on Spanish and Italian bonds. Brussels believes the replacement of Silvio Berlusconi as Italian prime minister by Mario Monti has helped to create a firewall between Greece and its southern European neighbours. The containment strategy has worked up until now, but may be about to face its biggest test.
In a worst-case scenario, Greece could be followed by more countries as the markets speculated on whether Portugal, Ireland or Spain would be the next to default. If the bonds of all these countries were called into question, Britain's banks could be hit hard, and the Treasury could even be forced to contemplate fresh taxpayer-backed nationalisations.
Despite these potential concerns, there is a growing view that Greece should be allowed to default in order to make a fresh start.
Until a few months ago the consensus was that a Greek default could wreck the single currency and profoundly damage the European Union itself because of the knock-on effects, triggering a wave of national insolvencies among the vulnerable combined with fury and a refusal to help from the eurozone's AAA-rated creditors in the north.
That perception has shifted in several ways. Italy was seen as the big risk, but the disappearance of Silvio Berlusconi and the start of radical reforms under the caretaker economist-prime minister, Mario Monti, have gone a long way to restoring confidence and Italy's borrowing costs have come down.
The European Central Bank's €500bn in liquidity operations for the banking sector have also served as a colossal safety valve, relieving the pressure on the euro.
The German drive for legally enshrined fiscal probity has resulted in a new euro rulebook and there is also a belief that the eurozone's fledgling bailout fund will be topped up if need be to deter the markets from driving up borrowing costs. In short, the containment strategy may be working, but its biggest test may be yet to come.