A big, fat Greek no: What the rejection of bailout terms means for the country

Greeks overwhelmingly rejected conditions for a rescue package from creditors on Sunday, throwing the future of the country’s euro zone membership into further doubt and deepening a standoff with lenders. After five years of bailouts, it could become the first country to leave the eurozone. The country owes $271 billion to its lenders and Germany is its largest creditor, said a Reuters estimate.

Without a deal, the EU will most likely cut off Greece from long-term funding from the European Central Bank.

Stunned European leaders called a summit for Tuesday to discuss their next move after the surprisingly strong victory by the ‘No’ camp defied opinion polls that had predicted a tight contest.

In Athens, thousands of jubilant Greeks waving flags and bursting fire crackers poured into the city’s central square as official figures showed 61 percent of Greeks had rejected a deal that would have imposed more austerity measures on an already ravaged economy.

Here is what the ‘No’ means for Greece: 

Bigger spending cuts? Now that Greece has walked away from the table it’s going to have to immediately find some other way to plug the huge hole in its budget. One option would be spending cuts and tax hikes even bigger than the ones the rest of Europe has been demanding. This is likely to be a non-starter for the party that came to office campaigning against austerity.

The vote leaves Greece in uncharted waters: Risking a banking collapse that could force it out of the euro. Without more emergency funding from the European Central Bank, Greece’s banks could run out of cash within days after a week of rising desperation as banks shut and cash machines ran dry. That might force the government to issue another currency to pay pensions and wages. Greek banks, already closed for a week, were supposed to reopen on Tuesday but will have to stay shut or get new funding from somewhere. They depend on emergency cash funding from the European Central Bank. That funding lifeline has already been capped.

According to the Telegraph , Greece will have to find a factory to print drachmas.

“British firms like De La Rue, which prints 150 currencies worldwide, are believed to have been contacted with a view to providing such services. It’s done in great secrecy to prevent currency speculation. The other big problem is the logistical challenges of switching a currency. All ATMs, computers and other machinery of commerce that bears the euro symbol will have to be adjusted. It could, and would, take months,” it argues.

Outright bankruptcy: Many of Athens’ partners have warned over the past week that a ‘No’ vote would mean cutting bridges with Europe and driving Greece’s crippled financial system into outright bankruptcy. No country has ever left the 19-member eurozone, established in 1999. Banks in Greece are already shut

An angry message to creditors: For millions of Greeks the outcome was an angry message to creditors that Greece can no longer accept repeated rounds of austerity that, in five years, had left one in four without a job and shrank the economy by a quarter.

Probability of Greece leaving the Eurozone is now 75 percent: The vote could mean an exit for Greece from the eurozone since it now needs more money from Europe if it has to stay afloat

A ‘No’ vote means that the probability of a Grexit would rise to 75 percent, Credit Suisse said in a report. “We think that Syriza would be less willing to compromise, statements from European politicians would imply that it is no longer trusted as a reliable counterparty in the negotiations with the European creditors. Moreover, any deal would be highly conditional and thus we would likely be back to square one quite quickly. The bank holiday would continue, with some banks likely to run out of cash.

The global research firm is of the view that now the crunch date is July 20th: if Greece defaults to the ECB, then Greek banks are, in our view, insolvent, and the emergency liquidity assistance (ELA) would be withdrawn (unless this was during an election period).

“On ELA withdrawal the probability of Grexit rises even further. We doubt that it is politically acceptable for the ESM to recapitalise Greek banks,” said the report.

July 20th is when the Greek government has to repay 3.5 billion euros worth ECB-held bonds. Without an agreement by that time, the Greek government will default to the ECB and if this happens, then Greek banks would likely become insolvent.

Unable to borrow money on capital markets, Greece has one of the world’s highest levels of public debt. The IMF warned last week that it would need massive debt relief and 50 billion euros ($55 billion) in fresh funds.

How the Grexit will take place:

The  Washington Post quotes Joseph Gagnon, senior fellow at the Peterson Institute for International Economics, explaining the mechanics of  “Grexit:”

The first step would be to enact legislation to convert all financial assets and liabilities and all commercial contracts and wage agreements issued under Greek law from euros to drachmas at par (one for one). Banks would need to close for at least a couple days, possibly more, to reprogram their systems. Legislation would also specify the introduction of drachma notes and coins at the earliest possible time, perhaps within six months.

The drachma would be allowed to float against the euro as soon as the banks reopen. It would surely depreciate, probably by a lot at first and with considerable volatility before settling down. It is impossible to predict how much the drachma would depreciate; in Iceland’s experience, the financial and debt crisis of 2008 caused an initial depreciation of nearly 40 percent that has since stabilized at around 25 percent in real (price-adjusted) terms. The euro notes and coins currently circulating in Greece would increase in value. During the months before drachma notes and coins are introduced, euro notes and coins would be used for small purchases, with merchants accepting them at the market-determined premium.

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Government debt held by Greek financial institutions would be converted to drachmas at par. These institutions would be required to accept new government debt for principal and interest payments coming due. The government would declare a moratorium on principal and interest payments on the rest of its debt, including the debt of the Bank of Greece to the European Central Bank. Negotiations would begin on a restructuring of this nonconverted debt.

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There may be chances of a better deal: Opinion polls over the months have shown a large majority of Greeks want to remain in the euro. But many appear to have shrugged off the warnings of disaster, trusting that a deal can still be reached without the tax hikes and pension reform demanded by lenders and rejected by Tsipras.

If Eurozone wants to avoid the reversion to Greece’s pre-euro currency the International Monetary Fund could cut Alexis Tsipras a significantly better deal. As this Business Insider article points out, “Emergency assistance for Greece will continue while the troika of the European commission, the ECB and the International Monetary Fund sees how events in Greece unfold.”

In a nutshell, if central bankers do not provide the euros, Greece will in all probability have to print its own currency to reopen banks, and the dice would be cast on the path to “Grexit”.