A Greek euro exit and return to the drachma; Standard Chartered say a return to primary surplus is a key trigger

Last Updated on Wednesday, 22 February 2012 12:16 Written by Will Peters Wednesday, 22 February 2012 12:14

The euro exchange rate (Currency:EUR) is trading slightly lower against the US dollar this morning. The single currency is however nearly half a percent higher against a struggling pound sterling.

This morning Standard Chartered, the London based banking giant, have issued some thoughts about Greece's future in the Eurozone and the possibility of Greece exiting the Euro.

---

Advertisement - Article Continues Below

---

Indeed, the prospect of a return to the drachma is as possible as ever despite yesterday's patch-up announced by Eurozone finance ministers.

According to a note from Standard Chartered, released today, the possibility of a Greek euro-exit will become increasingly likely as the Greek economy continues to recover.

"As Greece moves to a primary surplus (probably by 2013), the temptation to press for further restructuring – or failing that, a 'hard default,' will rise, in the face of the obligation to sustain primary surpluses over the medium term, especially if the economy remains very weak," says the bank.

The Troika's baseline scenario is for GDP to contract by 4.3% in 2012, be flat in 2013, and return to growth in 2014 (2.3%).

Politics will be key. Countries such as Italy and Belgium have in the past sustained high primary surpluses for a prolonged period, so Greece is not being asked to do the impossible.

Standard Chartered say:

"But structural reforms will be needed to raise Greece's potential growth rate; so far progress in this respect has been slow, and privatisation has barely got off the ground.

"The threat of an interruption to debt servicing is therefore unlikely to go away, and alongside that, the more extreme threat of an exit from the euro will linger, especially if the politics remains unsettled. Any decision to reintroduce a national currency (new drachma) would ultimately be a political choice on the part of the Greek parliament, though creditor countries could accelerate the decision by cutting Greece off from any further EU (including ECB) financing in the event of a disorderly, hard default.

"That said, a decision to leave the euro would be politically costly for whichever government embarked on that route: among the population there is still majority (70%+) support for the euro; the near-term economic impact of exiting would be a substantial upheaval (massive deposit flight, collapse of the banking system, hyper-inflation, deeper depression and a chaotic macro environment). The benefits, such as they are, come over the longer term.

"For Greece, the competitive boost of a devaluation would be tempered initially by the reliance on imported inputs. Continued structural reform and limited pass-through of imported inflation to domestic wages would be needed in order not to squander the benefits of devaluation – similar to the requirements (reform and cuts in real wages) which are central to the current programme."