SINCE the euro crisis erupted five years ago, the possibility of “Grexit” has been a recurring nightmare. It is looming again, as large as it did in 2012, when Greece was ultimately kept in the fold by a second big bail-out from the IMF and other euro-zone governments. Negotiations over the release of the remaining rescue funds have virtually broken down, as a new Greek government dominated by the radical-left Syriza party continues to balk at the reforms its creditors are demanding. The chances of a deal when euro-zone finance ministers met on June 18th (after The Economist had gone to press) looked slim. Yet Grexit looks no better an option now than it did three years ago.

The Greek population overwhelmingly wants to stay in the euro and the government led by Alexis Tsipras says it does too. This is understandable, since leaving the monetary union would be a bloody business rather than a surgical operation—or so the IMF predicted in 2012. The reintroduction of the drachma would entail the forcible conversion of all domestic assets and liabilities to the new currency, which would immediately plunge by 50% against the euro, the IMF estimated, gutting bank deposits and other savings. As the drachma fell, pushing up import prices, inflation would surge to 35%, it reckoned, while the toll on GDP would be a decline of around 8%. Even the smallest of transactions would become difficult, it pointed out: after the short-lived Czech-Slovak monetary union broke up in 1993 it took six months to introduce new banknotes.

Is the likely outcome still as grim? Unlike the situation in 2012, advocates of Grexit point out, the euro area’s economy is growing, which should help it withstand the turmoil Grexit would bring.

Before this year’s setbacks Greece was running both a primary budget surplus (ie, before interest payments) and a current-account surplus, enabling it to cope without new loans. The default on foreign debts that would precipitate Grexit (or would become unavoidable since the burden of the euro-denominated liabilities would soar in devalued drachma terms) could also be seen as an advantage, resolving once and for all the seemingly oppressive burden of public debt, which is now close to 180% of GDP. Once the initial shock had been absorbed, Greece could benefit from the boost to competitiveness devaluation would bring.

This scenario, however, underestimates the damage Grexit would do to the Greek economy.

Confidence would be shattered in the long term as well as the short, since Greece would struggle to regain any semblance of trust. There would be endless wrangles with the IMF and other euro-zone governments, which would be nursing big losses on their loans to Greece. That would unsettle private investors, who would also worry that without pressure from official creditors, the Greek government would revert to the bad policies and poor governance that lie at the root of the country’s misfortunes.

The relief achieved through defaulting on government debt would be minimal. Even though public debt is high as a share of GDP, the interest that Greece is paying is very low, at 3% of GDP this year, helped by a deferral of payments on most of its loans from the euro zone’s rescue fund until 2022. In all its borrowing from European creditors, Greece is already benefiting from debt relief in the form both of maturity extensions (some loans stretch out until the 2050s) and ultra-low interest rates.

Indeed if Greece left the euro it could find itself paying more interest on its debt, even though its remaining loans would have become far smaller as a share of GDP.

A cheaper currency would boost exports and tourism, but the benefits could easily be frittered away in higher inflation, especially as the central bank would be unlikely to enjoy genuine independence. In any case, Greece no longer needs to enhance its competitiveness with a devaluation since it has already achieved an “internal devaluation” through a sharp fall in wages. What is more, because exports make up an unusually small share of the economy, the gain from a devaluation would be limited.

Grexit would still be troubling for the rest of the euro area too. The direct cost to euro-zone governments of a Greek default would be higher than in 2012, because they have since lent the country more money. Arguably, this would simply be recognising reality and would at least stop them throwing good money after bad. However, they could well find themselves having to provide large amounts of aid to Greece, if Grexit led to a humanitarian disaster.

A particular worry in 2012 was that Grexit would unleash a domino effect whereby panic in the bond markets pushed one country after another into default. This scenario, which has informed the Greek government’s bargaining strategy, is now less convincing. Although the difference in yield between safe German Bunds and the bonds of other vulnerable countries in southern Europe has recently widened slightly, this year’s Greek drama has largely been confined to Greece (see chart). It helps that just days before the Greek election in January, the European Central Bank (ECB) announced a programme of quantitative easing, which involves buying lots of euro-zone government debt.

Moreover, the European Court of Justice affirmed this week the ECB’s (unused) policy of throwing a lifeline to governments under siege in the markets through unlimited purchases of their bonds.


 That has prompted some to argue that removing the perpetual troublemaker would make the euro zone stronger. By demonstrating that those who do not abide by the rules can be shown the door, the theory runs, Grexit would spur fiscal prudence and structural reform among the remaining members. In contrast, if Mr Tsipras faced down Greece’s creditors, anti-austerity movements such as Podemos in Spain would take heart.

The euro area may therefore seem to have good reason to countenance the upheaval of Grexit, but it would still be a risky move. Crucially, it would debunk the idea that membership of the euro was irrevocable. That would turn the single-currency club into just another fixed-exchange-rate system that might be vulnerable to speculative attack.

On balance, then, the costs of Grexit still outweigh the benefits for the euro area as well as Greece. There are sound economic grounds for both sides to compromise and strike a deal.

Whether strident politics in Greece and the creditor countries will allow that to happen remains an open—and pressing—question.