A managed Grexit

Greece and the 'troika' must accept reality

Over the weekend, a last-ditch effort to reach an agreement between Greece and the troika consisting of the European Union, the European Central Bank and the International Monetary Fund failed. The Greek government has now decided to put the terms offered by troika to a referendum, which will be conducted on July 5. It has indicated that it will abide by the inclinations of the majority. On its part, the troika has signalled that it will not accommodate the demand for the extra few days that this requires. Effectively, this means that Greece will default on the $1.6 billion due to be paid by June 30. The trajectory of events following this precipitating act is apparently not clear. It will, almost certainly, trigger off a process that will eventually lead to Greece exiting from the euro arrangement. As things stand, this may well mean an exit from the larger customs union as well. It is clear that the global economy will be better off if the European system quickly comes to terms with reality and tries to manage as smooth a transition as possible.

The fundamental reality that this stalemate has underscored many times over is that Greece's continuation in the euro currency arrangement is not tenable. It has and will continue to appreciate the country's real effective exchange rate, making it largely uncompetitive. The only channel of adjustment left in this arrangement, which is painfully playing out, is a decline in real wages. In theory, this can make the arrangement viable; in reality, it will take a long time and, as Greeks now know well, can be extremely burdensome. The only way out is a sharp depreciation of the nominal exchange rate, which will happen if Greece were to re-introduce its own currency. This will also bring with it several immediate problems, but, over a period of time, competitiveness will be restored and macroeconomic stability can return, with manageable fiscal and balance of payments parameters.

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However, it must be emphasised that this will not happen without the active involvement of the troika. If exit from the monetary union is accepted as inevitable, the possibility of allowing Greece to continue as part of the customs union must be considered. This will put it in the category of the Eastern European members and the United Kingdom, which appear to have benefitted from this option. Further, given the time it will take to operationalise the new currency, some reliable stand-by arrangements need to be put in place. A clear deadline, say, April 1, 2016, will need to be committed to. During the transition, some indicative exchange rate will have to be identified. Greek banks will have to be provided some lines of credit during the transition. Balance of payments support to ensure that critical imports will not be disrupted will be necessary. On its part, the Greek establishment needs to move quickly from desperate fire-fighting mode to thinking about a sustainable transition plan and long-term growth and stability issues. It's obviously not going to be easy for anyone. But the alternative promises to be even more painful for Greece, Europe and the rest of the world.