Blog post

Greece: from default to Grexit?

The government of Greece has rejected the creditors’ conditions of the continuing bailout program and is heading to imminent default on its obligation

Publishing date
29 June 2015
Marek Dabrowski

The government of Greece has rejected the creditors’ conditions of the continuing bailout program and is heading to imminent default on its obligations vis à vis the International Monetary Fund (end-of-June) and European Central Bank (July).The chaotic manner in which negotiations were broken off, and Prime Minister Tsipras’ decision to call a referendum on July 5, 2015 on accepting or rejecting creditors’ conditions triggered an immediate banking panic: people in Greece started to queue at ATM machines to withdraw cash from their accounts.

Greece’s banking sector has already been under huge pressure since Syriza’s parliamentary victory

In fact, Greece’s banking sector has already been under huge pressure since Syriza’s parliamentary victory in January 2015. Only the systematically increasing liquidity support of the ECB, through the Emergency Liquidity Assistance (ELA) special lending facility has kept banks afloat.

From default to Grexit – the hypothetical scenarios

Does Greece’s sovereign default and banking crisis mean its immediate and automatic exit from the Eurozone as many commentators have suggested? The short answer is not necessarily and, definitely, not immediately. Leaving aside quite complicated legal issues, such as the lack of a formal procedure for leaving the Eurozone, let us concentrate on different economic scenarios, which may or may not lead to Grexit. In any case, an exit is unlikely to happen during the next few days or weeks.

Considering hypothetical scenarios of leaving the Eurozone (Dabrowski, 2012), the most likely variant could be involuntary exit caused by lack of another option acceptable to Greek authorities or loss of control on macroeconomic developments. Two other potential scenarios, such as a voluntary and deliberate decision by Greece to leave the Eurozone and reintroduce its national currency, an involuntary exit forced by other EU/Eurozone members do not look probable. Most of Greek society, including the ruling Syriza party, wants to keep the Euro. The remaining EU partners have neither the legal instruments, nor the interest to force Grexit.

The first trigger - banking crisis

Greece’s involuntary exit from the Eurozone may be triggered by a banking crisis

In the current situation, Greece’s involuntary exit from the Eurozone could be triggered, in the first instance, by a banking crisis. Facing a run on bank deposits and having frozen the size of ECB liquidity support at the level of June 26, 2015, the authorities had to introduce limits on cash withdrawals and money transfers outside Greece and announced bank holidays for one week, most likely subject to further extension. In case of reduction or complete withdrawal of the ELA support, banks will have to be closed immediately because they will become both illiquid and insolvent.

Although living with closed banks and frozen deposits is technically possible (as demonstrated, for example, by the US banking crisis in the early 1930s or, in a lighter form, in Cyprus in 2013), this cannot last for long. This is the case even in Greece, where the general population and small businesses are used to relying on cash operations, and large enterprises often operate via foreign banks. Sooner or later, the government may want to offer the owners of blocked Euro deposits the chance to voluntarily convert them into the new national currency, a move which would require reverting to a national monetary policy (to provide banks with liquidity in the new currency) and then printing new banknotes and coins to allow free deposit withdrawals.

Another hypothetical sub-scenario involves taking political control over the Bank of Greece (in violation of the EU treaties) and forcing it to act against ECB instructions, i.e., providing commercial banks with liquidity support beyond ECB limits and lending conditions (related to eligible collateral and its quality). This kind of “rebellion” was observed both in the former USSR and in former Yugoslavia during their political disintegration between 1990 and 1992. The republican central banks (formally the branches of the State Bank of the USSR or the National Bank of Yugoslavia) started to issue credit money on their own, without authorization from their headquarters.

The most likely ECB reaction to such hypothetical scenario would be cutting Greek banks off from the Target-2 payment system. As a result, the Euro non-cash turnover in Greece would become separated from the remaining part of the Eurozone. Once owners of Euro deposits learn about this separation, they would likely start testing the ability of local banks to cash their deposits, leading to either bank closures or the necessity to print local cash currency.

The second trigger – government cash shortage

Since 2013, Greece has enjoyed a primary fiscal surplus. That is, the government can pay salaries, pensions and other current bills out of current revenues, especially if it stops serving its debt. However, the increasing uncertainty associated with the economic policies of the Syriza government and negotiations with creditors have recently led to problems in revenue collection (Merler, 2015). The chaos caused by the failure of the bailout negotiations, sovereign default and banking crisis, could cause the situation to drastically deteriorate in the coming weeks.

Facing a cash shortage, the government may postpone its payments and continue building up arrears (which already exist) as was done by several governments in the former USSR in the 1990s. However, this solution would work for a few weeks, perhaps months, not longer, and the consequences for payment discipline in the entire economy are obviously negative. At some point, the government may try issuing promissory notes or other kinds of monetary substitutes. Even if denominated in Euro (still the official legal tender), these substitutes would be traded on the private market at a discount. And the government would have to accept them as the means of payment, for example, of taxes or fees for government services. If it remains unable to redeem them at nominal value in some reasonable period of time, a parallel currency, a kind of “local” Euro will be de facto installed. This is another avenue, which may lead Greece to gradual departure from the Eurozone.

Doubtful benefits of leaving the Eurozone

Could leaving the Eurozone help Greece to solve its economic and fiscal problems as suggested by many commentators? According to them, reintroducing a weaker national currency would allow the country to regain its external competitiveness. However, today competitiveness is not such a dramatic problem as it was a few years ago, thanks to the progress in structural reforms achieved in recent years (Darvas 2015). Furthermore, Greece’s exports have not reacted much to decreases in wage costs due to other factors such as rigid product markets and limited innovation (Wolff 2015; Velasco 2015), the policy areas that require further deep reforms. The structure of Greece’s exports (the large share of international services) also plays a role (Gros, 2015).

Exiting a highly integrated monetary union with a single legal tender in which all the contracts are denominated in a common currency, is a much more complex and hazardous operation than a simple devaluation of the national currency (like the devaluation of the British pound in 1992). Even such an “ordinary” devaluation is usually contractionary in the short-term, because it negatively affects domestic demand. In countries in which a substantial part of public and private debt is denominated in foreign currency, the consequences of a devaluation are much more severe (like the example of Argentina in early 2000s) as the size of external liabilities increases in the local currency and in relation to GDP.

A departure from the Eurozone would mean an immediate default on all public and most private liabilities

A departure from the Eurozone would mean an immediate default on all public and most private liabilities, as old contracts would remain denominated in Euro. Any attempt to redenominate them involuntarily into the new weaker currency (as well as the discrimination of residents against non-residents or vice versa) would involve serious legal objections that are not easily overcome in an EU country with democratic rule-of-law.

The economic chaos resulting from exiting the Eurozone, a collapse of the financial system and a rapidly deteriorating economy would further reduce tax revenues and, therefore, the capacity of the government to provide basic public goods and services.

Technical and economic challenges of new currency

Finally, reintroducing a national currency (unlike currency devaluation) is quite a complex technical operation, which requires time and the administrative capacity to be prepared in secrecy. The operation itself would most likely have to include a temporary bank holiday and the reintroduction of customs controls on a country’s borders to stop the outflow of euro cash. Given the inexperience of the current government, the weakness of the Greek public administration and potential opposition to leaving the Eurozone, it may pose a serious challenge.

Despite its formal status as legal tender, a new currency might not be trusted and accepted by economic agents who would prefer to continue using the euro. If not supported by tough monetary and fiscal policies (a rather unlikely scenario for the government, which just rejected the much softer conditionality of the bailout package) a new currency would rapidly depreciate, which could lead to high inflation or even hyperinflation. This was the experience of many of the successor states of the former Austro-Hungarian Empire (after 1918), as well as the former Soviet Union and former Yugoslavia (both after 1991).

It’s not too late to avoid havoc

Greece faces an uneasy period of serious financial, economic and (perhaps) political turbulence. Whether the rejection of the “Troika” bailout package and the resulting sovereign default will lead to exiting the Eurozone and reintroducing national currency is hard to tell. If it eventually happens, it will take several weeks or months. However, Grexit does not need to happen. There is still a window of opportunity (although rapidly decreasing over time) for the Greek government to come back to the negotiation table and relaunch economic reform. The result of the forthcoming referendum will play a decisive role.


Dabrowski, M. (2012): The need for contingency planning: potential scenarios of Eurozone disintegration, CASE Network E-Briefs, No. 11/2012

Darvas, Z. (2015): Is Greece Destined to Grow?, Bruegel Blog, 16th June,…

Gros, D. (2015): Why Greece is Different, Project Syndicate, May 13,…

Merler, S. (2015): Greece budget update. The same story, with a twist for the worse, Bruegel Blog, 19th June,

Velasco, A. (2015): Greece, Argentina, and the Middle-Income Trap, Project Syndicate, May 30,…

Wolff, G. (2015): Why Grexit would not help Greece - debunking the myth of exports, Bruegel Blog, 6th January,…

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About the authors

  • Marek Dabrowski

    Dr. Marek Dabrowski is a Non-Resident Scholar at Bruegel, co-founder and Fellow at CASE - Centre for Social and Economic Research in Warsaw and Visiting Professor at the Central European University in Vienna.

    He was Chairman of the CASE Supervisory Council and its President of Management Board (1991-2011), Chairman of the Supervisory Board of CASE Ukraine in Kyiv (1999-2009 and 2013-2015), Member of the Board of Trustees and Scientific Council of the E.T. Gaidar Institute for Economic Policy in Moscow (1996-2016), Professor at the Higher School of Economics in Moscow (2014-2022), and Fellow under the 2014-2015 Fellowship Initiative of the European Commission – Directorate General for Economic and Financial Affairs. He is a former First Deputy Minister of Finance of Poland (1989-1990), Member of Parliament (1991-1993) and Member of the Monetary Policy Council of the National Bank of Poland (1998-2004).

    Since the end of 1980s he has been involved in policy advising and policy research in Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Egypt, Georgia, Iraq, Kazakhstan, Kyrgyzstan, Macedonia, Moldova, Mongolia, Montenegro, Poland, Romania, Russia, Saudi Arabia, Serbia, Somali, Syria, Turkmenistan, Ukraine, Uzbekistan and Yemen, and in a number of international research projects related to monetary and fiscal policies, growth and poverty, currency crises, international financial architecture, perspectives of European integration, European Neighborhood Policy, trade policy, and political economy of transition.

    He has also worked as a consultant in a number of EU, World Bank, IMF, UNDP, OECD and USAID projects. Marek is the author of several academic and policy papers, and editor of several book publications.

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