Beyond the referendum

Now, EU has to face the challenge of Greece's exit

The Greek referendum has come and gone, remarkable for its unexpectedly strong endorsement of the government's position. The Greeks may have done some good to their national pride. But the course that the economy will now take is going to be unquestionably turbulent. Interestingly, the response to the results from German Chancellor Angela Merkel and French President Francois Hollande was relatively conciliatory, indicating that there was still room for a negotiated settlement. A new Greek finance minister should also bring some calm to an extremely stormy atmosphere around the negotiations. And, most strikingly, global financial markets simply shrugged their shoulders and went about their business as though nothing had happened. Evidently, what was perceived by many as a potential precipitator of another global meltdown has, in reality, been confined quite effectively to Greece alone.

Even as the world heaves a sigh of relief, it is important to understand why the containment was so successful. The simple answer to this is the way in which the rescue package that has been under implementation over the past five years enabled a restructuring of Greece's external debt. In essence, all the new funds that were provided by the package were used to pay off Greece's obligations to private sector financial institutions, mainly European banks. This may have been done at a discount, but some repayment is better than none at all. At this point, the bulk of Greek external debt sits on the balance sheet of public institutions - the International Monetary Fund and the European Central Bank. For them, a Greek default is hardly a blip. With the private sector relieved of this debt, the default did not have any direct impact and, consequently, did not disrupt normal financial activity. Hence, the equanimity with which markets took the development.

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In effect, the EU has achieved what would have been its primary objective: insulate the rest of the union, particularly the financial sector, from the impact of a Greek collapse. This having been demonstrated, the process must now move concretely to the next phase. The proof of insulation should make it that much easier for the EU to banish Greece from the currency union, if that is legally possible. There are powerful compulsions to do just this. If the EU were to go soft on Greece, other members who have gone through painful fiscal restructuring and are still facing recessionary conditions will have legitimate grounds for complaint. The EU's credibility would take a beating. For this reason, the Merkel-Hollande reassurances should be interpreted in a nuanced way. At one level, they can claim credit for achieving the objective of insulating the European and the global financial systems from the Greek exit. At another, they also presumably see the strength of the verdict in the referendum as an indication of popular resentment against the heavy-handedness of the northern European elite in the EU. This does not bode well for future solidarity and consensus within the larger group. Mitigating this potential risk to the durability of the union would require them to ensure that Greek citizens, who are still members of the EU, do not suffer a massive and irreversible deterioration in their standard of living. The Shakespearean adage "justice tempered with mercy" may be an appropriate principle to follow beyond the referendum.