Negotiations between Greece and the EU have hit another difficult patch and speculation that Greece may be heading for default, or a messy exit from the euro zone, have resurfaced. Experience has taught us not to try to look too far ahead in euro zone negotiations, where key decisions are generally taken at the last minute. There is still time to sort out a deal, although the lack of progress in negotiations is worrying.
In February, it appeared that a basis for progress had been found, with Athens agreeing to provide a list of reforms in return for which the last instalment of cash on the existing bailout would be extended, and talks would commence on a new arrangement. However, since then the Syriza-led government has failed to convince its euro zone partners and the institutions – the EU Commission, IMF and ECB – that it is committed to a reform programme. Its negotiating style has provoked frustration in other European capitals, notably Berlin.
We must hope that what we are watching is brinkmanship. The Greek government needs to engage in putting forward a detailed reform plan. And Europe needs to respond in a flexible way, recognising that Greece continues to carry an unsustainable debt burden. As was clear at the time, the 2012 debt restructuring simply did not go far enough. Common sense may pull the two sides back from the brink. The Greek government will realise that default could lead to euro exit and certainly lead to capital controls and considerable financial upheaval. There is speculation that prime minister Alexis Tsipras could call a referendum on euro membership, betting that a Yes vote would allow him to push through the necessary reforms. Time is, however, now running short.
In European capitals, meanwhile, Greek default and a possible euro exit should not be taken lightly. The negotiating position is that a Greek exit could be managed without significant knock-on effects. It is not clear that this is the case, although so far markets outside Greece have taken a relaxed view. In the long term a Greek exit would threaten the whole concept of the euro and nobody would believe that it could never happen to another member state.
Politically, this would be a blow to the entire European project. Greece would default on bond obligations and its central bank would not be able to repay what it owes to the ECB banking system. Some argue that losing money in this fashion is not really an issue for a central bank, given that it can create new money at will. However, this might have serious political implications, particularly in Germany. We must hope these wider economic and political risks are recognised across Europe. A deal should be done, but that will require goodwill and flexibility on both sides.