European heads of state meet tomorrow in an extraordinary session to discuss the Greek crisis. With the June 30 deadline for agreeing a new deal with creditors closing in fast, prospects for a breakthrough remain highly uncertain.

With compromise still needed from both sides, perhaps the key element that still appears to be missing that may make a deal politically viable for Greek Prime Minister Alexis Tsipras to sell to his support base in Greece is some type of debt write-down. It is widely agreed that the country’s debt burden, which is over a staggering 175 per cent of its GDP, is unsustainable.

In a dramatic last few couple of weeks, Greece has been warned that it could soon face a “state of emergency” if it does not reach a deal with its creditors by Guenther Oettinger, Germany’s European Union Commissioner. Moreover, the International Monetary Fund (IMF) pulled out of talks after it accused Athens of failing to compromise in key areas, including labour market and pension reforms, whilst Standard & Poor’s downgraded Greece’s credit rating one notch further into junk territory from “CCC+” to “CCC”.

The rating agency’s move follows Athen’s decision to postpone a 300 million euro (Dh1.25 billion) instalment due at the start of the month to the IMF. Instead, it has asked to bundle this with other payments due in June into a single 1.6 billion euro deposit due to the IMF at the end of the month.

It is reported that Tsipras has asked Greece’s creditors for a 9-month extension of its current bailout package until March 2016. While this would ‘buy time’ for the new left-wing government that has been in crisis-mode since its election in January, it would probably only defer a potential crisis for a few months.

While many uncertainties remain, it is clear that an end-game could now be fast approaching that will determine whether Greece defaults and potentially also stays in the Eurozone. In the absence of new loans from its creditors, a cash-strapped Athens is now engaged in a high stakes game of poker and it has been reported it has already made plans to potentially nationalise the banking sector and introduce a parallel currency to pay bills in the event its cash reserves are exhausted.

The stakes have been raised in recent days by Greece’s highly unusual decision to bundle its payments to the IMF this month. Only one other country, Zambia, has reportedly used the procedure to bundle payments before, which happened in the mid-1980s.

Moreover, should Greece not make the bundled payment in coming weeks, it will become the first developed country ever to fall into arrears to the IMF or any other Bretton Woods institution. Highlighting the risky nature of the territory the country may be headed into, United States Treasury Secretary Jack Lew warned recently of the dangers of an “accidental” Greek exit from the euro (so-called Grexit) with deadlines now closing in so fast.

The prospects for such a rupturing of the Eurozone, with the possible economic earthquake this could bring, have grown since Syriza’s coming to power, which saw a radical left party win power for the first time in the EU in years. Syriza is the Greek ‘Coalition of the Radical Left’, comprising a broad spectrum of socialists and communists, anti-fascists, environmentalists, anti-globalisation campaigners and human rights advocates.

This loose grouping only came together in 2012 as a single political entity, rather than an alliance of multiple different parties. And it appears to be fraying in its unity over Athens’s stance in recent negotiations with its creditors.

While Grexit cannot, therefore, be dismissed, some market participants appear to be more sanguine about this possibility today than compared to a few years ago. In part, this is because of the changed ownership of Greek public debt.

Today, more than 80 per cent of Greece’s public debt is owned by institutional investors, whereas private investors held the vast bulk of Greek bonds in 2011. This may mean further turmoil in Athens will not spread significant contagion through the Eurozone.

Nonetheless, Grexit would still be highly unpredictable. Some have noted the potential parallels with 2008 when it was widely assumed that the international financial system was sufficiently resilient to manage collapse of a single major bank (Lehman Brothers).

The IMF has also asserted that it is not yet clear what the true contagion risk would be from Grexit. However, the fact that it is likely to have significant economic fallout for Europe is reflected by estimates that, even under the mildest of financial stress scenarios, there would potentially be a contraction in Eurozone GDP of at least 1.5 per cent. This is greater than the current contribution of the Greek economy.

Moreover, the fact that Eurozone membership would be shown to be reversible could change investor perceptions of risk. In the words of European Commission’s Economic Affairs Commissioner, Pierre Moscovici, a disorderly Greek exit could be the “beginning of the end” for the currency union, and “a catastrophe for the Greek economy, but also for the eurozone as a whole”.

Whether or not Grexit happens, increased sabre-rattling from Athens could heighten investor fears about the strength of populist and euro-sceptic parties in other Eurozone countries. It is perhaps Spain, which will also hold an election in coming months, which has the strongest parallels with Greece.

The Spanish economy has suffered a major economic downturn that has fuelled the rise of anti-establishment, radical left party Podemos, only founded in 2014, which is currently a strong third in the polls behind the ruling right-of-centre People’s Party. Meanwhile, the long established Socialist Party is in second place, and might yet win power in coalition with Podemos at the election.

Taken overall, the end-game may be approaching that could be crucial in resolving whether Greece remains in the euro. Exit is by no means certain, but the prospects will increase if the country either fails to reach an extension to its bailout, or agree new loans, in coming days from its creditors.


— Andrew Hammond is an Associate at LSE IDEAS (the Centre for International Affairs, Diplomacy and Strategy) at the London School of Economics, and a former UK Government Special Adviser