Grexit strategy

Will Hodges looks at the big questions surrounding Greece's potential expulsion from the eurozone

Will Greece leave the eurozone?

Having appeared a worst-case scenario just a few months ago now a "Grexit" (the term the media has adopted to refer to Greece leaving the eurozone) seems a very real possibility, with Greek citizens rejecting the parties in favour of continued austerity, pretty much a condition to Greece's continued membership of the eurozone club, in the 6 May election.

The country now finds itself between a rock and a hard place; it must find a way to convince the rest of the European Union that it is able to get its spending under control, while assuaging the fears of a population loath to accept a further round of cuts to public spending. A repeat election is scheduled for 17 June with observers predicting a victory for the Syriza party, who stand against the austerity measures. If they gain an overall majority, it seems unlikely the country will be in a position for reconciliation with the European Union and a continued presence in the single monetary union.

Is Greece better off without the euro?

Having been battered by an continually more severe series of austerity measures over the past year, many Greeks have come to see an exit from the euro as the lesser of two evils. Public sector workers have born the brunt of the changes, with teachers, for example, seeing their salaries halved to just £500 a month in a country where the cost of living is not much below that of the UK. The unemployment rate has spiralled as the result of mass lay-offs of state employees and at nearly 22 per cent is the second highest in the eurozone after Spain. Some citizens in major cities have resorted to food handouts in order to feed themselves and their families. For those facing such obstacles, the price of Greece keeping the euro - several more years of austerity - looks unappealing to say the least.

The alternative, however, is no less daunting. Were it to resign itself to an exit, Greece would be forced to readopt the drachma as its currency, instantly rendering the average citizen worse off in relation to their European counterparts. The cost of importing essential goods such as oil, food and medicines, would be far higher in relative terms, placing the economy under severe strain. On the plus side, Greece would be able to find willing markets for its exports, providing a boost to sectors including agriculture, manufacturing and tourism, and possibly resulting in economic growth and job creation.

Is all of the eurozone suffering?

No. While many areas of the eurozone (predominantly the southern European states) have found themselves in an economic maelstrom in recent months, other parts have been performing quite well. The eurozone's largest economy, Germany, saw GDP rise by 0.5 per cent in the first quarter of 2012, largely on the back of increased exports to China and other emerging markets. Elsewhere, many eastern European states such as Poland have weathered the storm, having boasted positive growth so far this year. Taken as a whole, however, the eurozone is tottering on the brink of an overall recession, with the region registering zero growth during the first quarter.

What would a Greek exit mean for the future of the eurozone?

Greece's exit from the eurozone is likely to have a domino effect across other indebted European states, in particular, Italy, Spain, Portugal and Ireland. Should Greece bow out, speculation that one or more of the above were to follow could potential cause panic amongst investors, many of which would be quick to withdraw deposits from banks in these countries. This could leave banks in short of capital, heightening the risk of an overall national default. What's more, the borrowing costs for the governments involved would likely rise significantly as the risk premiums attached to their sovereign debt increased, severely impeding their ability to meet existing debt obligations. The cost of bailing out a major economy (the likes of Italy or Spain) would be astronomical and would severely test the limits of the European Central Banks (ECB). Even if they were able to save these countries from financial collapse, the repercussions for economic growth, currency, and stock market valuations would be severe, doing lasting damage to the political credibility of the eurozone.

What would a Greek exit mean for the UK?

The UK banking sector's exposure to Greek debt is negligible. But British interests in the region as a whole are considerable. With much of the eurozone already in recession, the UK can ill afford a further hit to consumer confidence in what is the largest export market for British manufactured goods. A further decline in value of the euro against the pound (the currency was valued at 80p to £1 in mid-May, compared with 83p at the beginning of April) would only exacerbate slumping demand for our exports.