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Will Greece Exit Euro?

 May 30, 2012 11:58 AM

(By Mani) The sovereign debt crisis in the Eurozone, which has been waxing and waning for more than two years, has come back into the forefront of investors' minds recently.

Markets around the globe are tiding in a negative sentiment over the potential exit of Greece from the Eurozone. Greece, which has received about $300 billion in bailouts in the past two years, has been struggling to narrow its fiscal deficit and ultimately staring at a huge fiscal gap in fiscal 2013-14

The catalyst for the most recent outbreak of market concern was inconclusive parliamentary elections in Greece on May 6. Roughly 70 percent of the electorate backed parties that campaigned on a platform that would either scrap or water down the austerity measures that previous Greek governments negotiated with its creditors.

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Although 70 percent of Greek voters supported parties that want to renegotiate austerity measures, polls show that a similar percentage wants the country to remain in the Eurozone.

As talks to form a coalition government ultimately failed, President Papoulias has called for another election that is now scheduled for June 17. At present, Greece is governed by a technocratic government headed by Panagiotis Pikrammenos.

In this scenario, the key question on the investors mind is whether Greece should exit Euro?

Greece is in a similar situation to what Argentina was in a decade ago. The Greek economy is extremely weak at present as real GDP in Greece has plunged more than 15 percent over the past five years and further declines are inevitable, at least for the foreseeable future.

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Although there are parallels between the Argentine and Greek cases, there are important differences, as well. The key difference is that Argentine pesos circulated in tandem with U.S. dollars. Therefore, when the peg was broken in early 2002, Argentina still had a domestic currency that was in circulation. The Greek drachma last circulated in 2001.

"Therefore, an abandonment of the euro and a reintroduction of a "new" drachma would entail significant adjustment costs across different sectors of the economy," Wells Fargo economist Jay Bryson wrote in a note to clients.

 "If Greece refuses to live up to the austerity measures and reform its economy, the so-called "troika" (i.e., the European Commission, the European Central Bank (ECB) and the IMF) likely would be unwilling to approve the next tranche of financial aid to the Greek government," Bryson added.

In that case, the Greek government would probably default on its debt as its government bonds would be worthless as collateral, the ECB would not be able to extend liquidity to Greek banks, leading to their collapse.

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