Is Greece facing disorderly default?

By Barry Neild and Irene Chapple, CNN
Feb 10, 2012

Greece is in negotiations over its latest bailout deal, but needs to meet harsh new terms
The country is implementing austerity measures but faces protests and deteriorating finances
The default of a eurozone member is politically and economically charged

London (CNN) — Will Greece default?

Greece is negotiating to repay some creditors less than what it owes in order to avoid a disorderly default. If Greece is unable to repay its bills at all on the day they fall due, this would trigger a sudden default which would send shockwaves through the market. Greece faces its next large bond redemption, of €14.5 billion, in March, and is in negotiations over its latest bailout deal as the deadline to this payment approaches.

However, it needs to meet harsh new terms laid out by Europe’s leaders. Jean-Claude Juncker, the prime minister of Luxembourg and head of the Eurogroup, has said three elements must be nailed down in order for the country to access the funds.

The sweeping reform package agreed to by Greece and the so-called troika, made up of the European Commission, European Central Bank and International Monetary Fund, must be approved by parliament this weekend.

Secondly, Greece’s political leaders must pledge that they will continue to implement the measures after elections in April. Finally, Greece must also find a further €325 million in “structural expenditure” cuts for 2012.

Greece has been implementing harsh austerity measures to try to balance its books, but has faced protests on the streets, and finances that are worse than expected. Its economy is deteriorating, and it cannot raise money with investors due to the high premiums they demand — leaving it dependent on the bailout funds.

Why is Greece still being supported?

The default of a eurozone member is politically and economically charged. The common currency lies at the heart of the “European dream” and a default by one its members would be devastating.

So Greece is being financially supported by its eurozone peers as Europe’s leaders, led by Germany’s chancellor Angela Merkel and France’s president Nicolas Sarkozy, desperately attempt to figure out how to fix the problems. But the situation is getting worse as the eurozone economy heads toward recession.

The potential for the crisis to spread to Italy and Spain — the so-called “contagion” effect — is a powerful incentive to contain the problem. Bailouts of Greece, Ireland and Portugal have created backlashes in countries such as Germany; the prospect of holding up the bloc’s far larger economies is economically and politically unpalatable.

So what are Europe’s leaders doing?

Most European leaders have agreed on a fiscal pact which strengthens a financial firewall and is designed to prevent governments running excessive deficits. The €500 billion permanent bailout fund — called the European Stability Mechanism — is being introduced mid year, rather than next year as originally planned.

But Europe’s leaders have come up with grand plans before and been knocked back by the markets. Unless this plan addresses all the concerns with some force, the crisis is likely to escalate.

How serious is default?

It depends if it is disorderly, or controlled. It is now clear some creditors will not be paid back in full, and markets will likely be relieved once a deal on this is done. However, there have been numerous grim predictions should Greece be suddenly unable to pay its bills. Most doomsday scenarios see global panic and market sell-offs. A default might mean French and German banks exposed to the debt will begin to struggle, resulting in a credit lockdown by the wider banking sector.

If banks are forced to take this hit, it could have global economic consequences similar to those seen in the financial crisis that followed the collapse of Lehman Brothers in 2008.

Investors would also begin looking at which other countries are facing financial difficulties, including Italy and Spain. If investors stop supporting these countries, the eurozone’s stronger countries could again be leaned on for financial assistance.

But that’s where the help from Europe, and further afield, could run out of capacity. Italy’s economy, for example, makes up 17% of the eurozone — nearly seven times bigger than that of Greece. These countries are regarded as “too big to fail,” because bailouts would be too expensive.

How did we get here?

Greece’s economy has struggled since the country joined the euro in 2001. In 2004, it admitted its budget deficit was higher than allowed under rules of entry.

By 2008 the government had narrowly passed a belt-tightening budget, designed to trim its massive national debt burden, triggering massive protests. In 2009, Greece admitted its deficit would be more than 12% of gross domestic product — far higher than previous estimates and more than four times the requirements of entry into the eurozone.

The country was hit with ratings downgrades, pushing its sovereign bonds into so-called “junk” territory. At the same time, resistance to the austerity measures and a contracting economy have made it extremely difficult for Greece to clamber its way out of the financial problems.

Is it time for Greece to drop out of the euro?

Greece is running out of options as pressure grows on its finances. Unless it can make good on massive debts it faces financial collapse, with heavy consequences not only for the eurozone countries but for the global economy.

The ECB, IMF and eurozone countries have poured money into Greece to prevent this outcome and may have to continue doing so unless another solution can be found.

This has led some to call for Greece to be allowed to quit or be thrown out of the euro, to ease the burden. Some Greeks also support this since they believe it would spare them from harsh austerity measures demanded as conditions for assistance.

Economists are divided. Many say it is impossible for Greece to drop out because the consequences would be so disastrous that eurozone economies will not allow this to happen.

However, the likelihood is increasing as Greece continues to struggle with its financial obligations.

How would quitting the euro affect the Greeks?

This would liberate Greece from the eurozone’s fixed exchange rate, allowing it to become a more competitive exporter and an even more attractive tourist destination.

But it would come with a heavy price. It would still leave Greece in debt and reliant on handouts that former eurozone partners would be less willing to supply. It would also mean Greeks would face higher prices for imported goods.

It is also likely to drive people out of the country, as they face lower wages and higher taxes, leaving the country unable to recover for years.

CNN’s Laura Smith-Spark and CNNMoney’s Ben Rooney contributed to this report

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