Nightmare scenario of a return to the drachma

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Ms. Katerina Kapernarakou is a journalist for the Greek newspaper “Kathimerini”, and a contributor to the covering the international business, economic, and financial issues.

In a hypothetical exit from the euro and a return to the drachma, the new Greek currency would have to be devalued by a gigantic 120 percent against the euro in order to play any part in reducing the country’s deficit, according to a study by New York-based financial analysis firm Roubini Global Economics.

The firm estimates that Greece would lag in terms of its labor cost per unit by 38 percent compared to the eurozone average and by 62 percent compared to Germany.

The analysis suggests that Greece could eliminate its current account deficit with an approximate devaluation of 50 percent, all else being equal, according to Roubini Global Economics strategist Michael Hart, who added that “markets have become less forgiving during this crisis.”

With the real exchange rate between the drachma and the euro weaker by 120 percent, the euro would become 2.2 times stronger in comparison to the original drachma-euro exchange rate (around 750 drachmas to the euro), a percentage that the analysts find neither unreasonable nor excessive, if it helps deal with the country’s deficit immediately. According to the analysts, it can also be seen as a simple starting point as an acceleration of inflation brings the original debt down to zero.

Hart invokes the most recent example, where Brazil in 1999 abandoned the dollar peg and devalued its currency by 78 percent in order to boost domestic demand and reduce inflationary pressure. Limited activity in the financial markets means that the country’s fiscal adjustment was extremely lengthy, as it took one year to balance the current account budget and two to show a surplus.

According to HSBC, the possible exit of Greece from the eurozone would also ultimately signal its exit from the European Union. The consequences of such a scenario would be devastating, according to the global banking and financial services company, which lists the most likely effects:

1. The nominal value of the assets and debts of the banking system would have to be calculated anew in order to devalue the currency.

2. There would have to be a system of capital monitoring because of the massive current exchanges deficit, but also in order to put a cap on daily withdrawals in order to protect the banking system from crashing, given that it would no longer have access to the liquidity of the European Central Bank.

3. A default would not avert the need for fiscal adjustment as the budget would continue to show a deficit, meaning that more austerity measures that are even more stringent than those required by the current Memorandum would need to be enforced. Assuming that this is politically possible, the Bank of Greece would have to be in charge of printing money.

4. The ensuing downward spiral of salaries (especially if the Bank of Greece is printing money) would kill any chance of boosting competitiveness, unless the country went ahead with radical structural reforms.

5. A return to the drachma would entail an enormous number of technical difficulties, not least of which would be rewriting all of the codes of exchange and reprogramming ATM machines.

6. Greece would be forced to exit the European Union, meaning that it would be liable to non-EU member trade regulations.

7. A Greek euro exit would spread the crisis to other countries on the periphery of the eurozone and would trigger an explosion in the spreads and massive capital flight from banks.

8. The credit crisis that would result from a Greek exit would make the 2008 crisis seem mild by comparison, as the global economy would sink into a deep recession.


About the Author:

Ms. Katerina Kapernarakou is a journalist for the Greek newspaper “Kathimerini”, a contributor to the, covering the international business, economic, and financial  issues. She keeps a weekly page in the Saturday edition on the “Newsmakers of the Week”. She has worked for private and public R / S, as well as for the Greek Service of BBC WORLD. She is a freelance writer for business magazines. She has served as the Chair of the Greek Section of Amnesty International

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