Greece’s already dismal debt crisis took another turn for the worse on April 16th with the news that Standard & Poor’s had once again downgraded Greece’s sovereign credit rating from a B-/B to a CCC+/C. The further downgrade, which puts Greece in the “imminent default” category of sovereign debt, reflects the fear that the indebted country will be unable meet its upcoming loan repayment deadlines. Between 2010 and 2013, member states of the Eurozone, the European Central Bank, and the IMF provided Greece with a combined bailout package of over €240 billion. The Greek government has continued to delay its loan repayments, extending its first set of deadlines in February of 2015 to May 2015.

While its repayments deadlines to the European Central Bank and its individual state creditors have some potential for flexibility, Greece’s loan repayments to the IMF are a serious issue of contention. There is some indication that Greek officials have approached the IMF informally in order to request delayed payments, but IMF director Christine Largarde is standing by the fund’s 30-year precedent of delaying payments. On Thursday the 16^th of April, the same day S&P further downgraded Greek debt, Lagarde summarized the situation as follows: “We never had an advanced economy actually asking for that kind of thing, delayed payment… I very much hope this is not the case with Greece. I would certainly, for myself, not support it.” Greece has met its repayment obligations up to this point, but there the Greek government’s fiscal shortcomings make the May 1^st deadline of €203 million and May 12^th deadline of €770 million to the IMF nearly impossible to meet.

The Greek government now faces the choice between meeting the repayment deadline and effectively cutting Greek public sector funding. For the month of April, the bill for salaries of civil servants and pensions in Greece will reach around €2.4 billion. Considering that the country is still posting negative GDP growth of around -3.3%, and the budget deficit remains at 3.5% of total GDP, meeting both domestic and external payment obligations will not be possible. Greece has the option of soliciting further loans from the EU. Given Greece’s inability to meet the structural requirements of austerity mandated by the EU in February, it is unlikely that the EU would be willing to commit to additional loans to Greece until there is evidence of concrete structural reform. In response to the further downgrading of Greek debt, EU official Margaritis Schinas stated that the EU was “not satisfied with the level of profess made so far” in the Greece’s request for further funding, casting doubt on the union’s willingness to bail Greece out any further.

The Greeks’ election of Syriza in January based on the party’s platform of no austerity eliminates the option of cutting public sector funding as it is not politically viable for the current party in power. This leaves Greece with a strong likelihood of failing to make its IMF payment deadlines in the event that its creditors in Europe are unwilling to provide them with further flexibility?. Greek’s inability to meet its fiscal obligations of loan repayment will leave the country at serious risk of default. This would be a disaster for Greece, but also the rest of the Eurozone. Rather than meeting their domestic payments in Euros, Greece would have to rely on a “virtual second currency” in the form of IOUs. These IOUs have no value for the rest of the Eurozone, and the European Central Bank would be forced to cut Greece’s access to the emergency liquidity fund. A parallel currency runs completely contrary to the shared currency standard, and Greece would likely be pushed out the Eurozone completely.

If Greece were to exit the Eurozone, it would destabilize the entire region, especially Germany, an owner of a significant amount of Greek debt. It is estimated that German banks hold nearly €25 billion in Greek government bonds. The European Central Bank would find itself short by nearly €70 billion euros. This substantial loss would severely damage the German economy, which is also the Eurozone’s engine of economic growth. Therefore, the possibility of considerable market contagion after a Greek default is highly possible and even likely within the still fragile Eurozone.

Sources:

http://www.wsj.com/articles/imf-chief-warns-greece-against-payment-delays-1429197479

http://www.ft.com/cms/s/0/1d44b25c-e401-11e4-9e89-00144feab7de.html#axzz3XayrEi5i

http://www.bbc.com/news/business-32326547

http://www.reuters.com/article/2015/04/17/us-eurozone-greece-ecb-exclusive-idUSKBN0N824Y20150417

http://www.reuters.com/article/2015/01/05/us-eurozone-greece-banking-exposure-idUSKBN0KE16H20150105

http://www.forbes.com/sites/deanpopplewell/2015/04/16/grexit-threat-returns-as-investors-bet-on-greek-default/