The Economic Consequences of Debt Repayment

If either the troika or the Greek government does not blink, a Greek default on its loans and exit from the Euro (Grexit) is a very real possibility.

With about €320 billion involved, the standoff between the left wing Syriza Government in Greece on one side and the IMF, ECB and the European Union (collectively known as the Troika) on the other makes it the most glorified and high risk game of chicken played. Monday, the 22nd June, presents one of the last opportunities for a deal to be brokered between the two sides and neither side is willing to back down and give in to the other’s requests.

In short, the situation reads thus: Greece has an outstanding debt of about €320 billion to various creditors. Recognising its inability to pay the amount, in 2010 and again in 2012, the IMF, the EU and the ECB decided to formulate a bailout package totally amounting to €240 billion. However, this money would be given to Greece only on the condition that it makes wide sweeping reforms and introduces a severe austerity drive. Further, 9 out 10 Euros from this bailout package will be used to pay back the creditors and not for Greek citizens. In June, Greece owes about €6.74 billion as part of its monthly debt repayment schedule (about €1.5bn to the IMF) and it does not have the resources to pay for that, while the last tranche of the bailout package worth €7.2 billion is also due to be given to Greece. While this situation is complicated enough, throw in a bit of political economy to the mix and there exists a true conundrum for everyone involved. The present government came into power in the last election in 2014 on a strict anti-austerity platform. It refused to prioritize repaying the creditors by cutting back on government expenses towards citizens’ welfare.

The IMF refuses to hand out the last €7.2 billion of the bailout package unless Greece undertakes severe austerity measures and also pays back the €6.74 billion that is due by the end of the month. The Greek government, with tremendous support from the citizens, refuses to take either action.

If one of the sides does not blink – the IMF extending the deadline for Greece to pursue fiscal consolidation and debt repayment or the Greek government undertaking reforms and paying part of the bailout money to its creditors – a Greek default on its loans and exit from the Euro (Grexit) is a very real possibility.

The IMF and Germany would do well to revisit Keynes’ classic work “The Economic Consequences of Peace” (1919), where he hinted at the possible consequences of the Allied countries extracting huge sums of money as reparations for the war (WWI) damages from Germany. He had rightfully explained that Germany will have no means to pay back the sums demanded by the Allied countries, especially given the economic downturn they were facing, except by resorting to the printing press. The predictions came true later on as Germany printed large sums of money in an expansionary monetary policy, which later resulted in hyperinflation, political upheaval, economic chaos, etc. The consequences of this are well known.

In this game of who blinks first, if neither of them blink by the looming deadline, everybody loses.


There is a chilling parallel here. If Greece defaults and exits the Euro, there will firstly be a bank run, where depositors will rush to withdraw their savings from the banks. This will result in a loss of liquidity. In the past few days, hundreds of Greeks are queuing up outside the cash points, in order to withdraw their money, in anticipation of a financial crisis. This will only worsen as the deadline approaches. Further, there will be a new, deep and prolonged recession. It would also be forced to go back to printing its own currency, the Drachma, or some other variant of it. Its financial system will collapse in the wake of a liquidity crunch and loss of access to the ECB. The Independent explains: “To prevent these institutions collapsing Athens would have impose controls on the movement of money out of the country. The international value of the new Greek currency would inevitably be much lower than the euro. That would mean an instant drop in living standards for Greeks as import prices spike. And if Greeks have foreign debts which they have to pay back in euros they will also be instantly worse off. There could be a cascade of defaults”.

This will obviously have a contagion effect, where banks, financial institutions and governments who are over exposed to Greek debt will lose their principal amount. The Euro currency and Euro stocks will crash, which can have renewed negative consequences for a world economy just recovering from the previous recession.

Thus, in this game of who blinks first, there is a unique scenario, where if neither of them blink by the looming deadline, everybody loses.

Anupam Manur is a Policy Analyst at Takshashila Institution. He tweets @anupammanur


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