The redenomination risk of exiting the Eurozone: An estimation based on the Greek case

Date01 May 2018
Published date01 May 2018
The redenomination risk of exiting the Eurozone:
An estimation based on the Greek case
Costas Lapavitsas*
Changing a country's currency involves a redenomination risk arising due to assets and liabilities that
are impossible to redenominate because of contracts governed by foreign law. Depreciation or
appreciation of the new currency could, therefore, result in losses or gains, thus creating a risk for
economic agents. The risk can be estimated by splitting the economy into public, private, banking
and central banking sectors, and summing up exposed aggregate assets and liabilities. This method
is applied to Greece showing that exiting the EMU would certainly entail forbidding redenomination
losses for the Greek public sector, leading to default. Surprisingly, however, the impact on the
private and the banking sectors would actually be positive (gain). The impact on the Bank of Greece
would be ambiguous depending primarily on the legal status of TARGET2 liabilities. It is notable that
even the Bank of Greece possesses a significant cushion in the form of bonds under foreign law.
In all, the redenomination risk for the Greek economy is modest, with the exception of the
public sector.
The prospect of currency redenomination emerged in the course of the Eurozone crisis and the most likely candidate
was Greece. The country faced a major crisis as international private capital flows to the Greek state suddenly
stopped in 2010. For several years public debt was serviced by receiving substantial loans from official lenders
through three bailout agreements, in 2010, 2011 and 2015. Macroeconomic policy was determined by the severe
conditionality attached to these agreements, subject to periodic reviews by the IMF and the EU.
The terms of conditionality were effectively shaped by, first, the absence of substantial debt relief and second,
the impossibility of currency depreciation. Both factors resulted directly from the country's decision to avoid
reintroducing its national currency, and thus to remain in the European Monetary Union (EMU). The main aim of
conditionality was to achieve stability by eliminating the fiscal deficit as well as the deficit on the current account.
A further aim was to accelerate growth through wage reductions, market deregulation and privatisation.
Greece has engaged in severe fiscal contraction since 2010, with frontloaded cuts in public spending followed
by major increases in taxes. During this period monetary and credit conditions also became tight as deposits drained
*SOAS, University of London, London, UK. ( Thanks are due to S. Villemot, T. Mariolis, S. Cutillas, and J. Ebbing for
comments on the text. All errors are the author's responsibility.
DOI: 10.1111/eulj.12276
226 © 2018 John Wiley & Sons Ltd. Eur Law J. 2018;
away from Greek banks; moreover, banks faced heavy pressures to recapitalise and to deal with rising volumes of
nonperforming equity. Finally, income policy was severely restrictive and real wages could reasonably be said to
have declined by a third since 2010. The combined result was an unprecedented recession, cumulatively reducing
GDP by a quarter during 20082013, while pushing unemployment above 27% in 2014.
The recession brought a form of stability to the economy since about 201314. Severe fiscal austerity gradually
eliminated the huge budget deficit recorded in 2010, and after 2016 the country began to show substantial primary
surpluses. The equally huge current account deficit recorded in 2008 was also greatly reduced. Achieving balance in
the current account was due to the collapse of the domestic economy, which brought a precipitous decline in
imports, while exports rose very modestly. In sum, stability was gained at the cost of national poverty that was
heavily borne by wage labour and other lowincome social strata. There has been no balanced recoveryin Greece
but only a dramatic shrinkage of the economy that greatly exacerbated inequality.
Growth has been very weak since 2014, and there is no realistic prospect of rapid acceleration reversing the
losses from the recession and substantially reducing the enormous unemployment. Especially notable in this respect
is the collapse and lack of dynamism of investment. To make matters worse, the conditionality attached to the third
bailout agreed by Greece in August 2015 has forced the country to accept further extraordinary fiscal tightness by
achieving primary surpluses rising to 3.5% of GDP in 2018 and for several years subsequently.
On balance, the Greek bailout programmes were failures. They have certainly reduced the country's fiscal and
external deficits but through tremendous contraction of GDP, with attendant social risks, and without creating
conditions for rapid growth. Greece was made poorer and left in stagnation. Consequently, the question of an
alternative strategy has never left the policy agenda. Such a strategy would inevitably include a deep restructuring
of public debt and a boost to aggregate demand to reduce unemployment that would require, at the veryleast, lifting
fiscal restrictions. The country would also need targeted industrial policy to strengthen the supply side by focusing
mainly on its primary and secondary sectors.
It is immediately apparent that none of these actions would be possible
without Greece exiting the EMU and reintroducing its national currency.
In this respect Greece is only the most extreme case within the EMU. The option of exit also emerged at the
margins of policy debate for other peripheral countries hit severely by the crisis (Portugal, Ireland, and Spain).
After 2011, peripheral countries were stabilised through policies similar, but not nearly as severe, to those
imposed on Greece, and thus the issue of reintroducing national currencies became less pressing. Moreover, after
years of poor economic performance, the Eurozone as a whole registered better growth in 2017. However, its
fundamental institutional and economic weaknesses have hardly been addressed in the course of the crisis, espe-
cially the extraordinary current account surplus of Germany and the persistent application of fiscal austerity across
the monetary union.
Consequently, the question of exit with its attendant risks and benefits has continued to receive attention,
including in core countries. The recovery of monetary sovereignty has become a major political cleavage, the rele-
vance of which is closely related to the eventual costs and benefits of exiting the euro. This is perhaps why it has
become a central part of the political debate in both France and Italy in the last two years. The French presidential
election in 2017 focused closely on the issue of the euro. Even more strongly, the Italian parliamentary elections
The literature on the Eurozone and the Greek crisis is extensive and much of it is not directly relevant to our purposes. For the the-
oretical and empirical analysis that supports this paper, see C. Lapavitsas, T. Mariolis, with K. Gavrielidis, Eurozone Failure, German
Policies, and a New Path for Greece: Policy Analysis and Proposals(Rosa Luxemburg Stiftung, 2017). Available at https://www. (last accessed 7 March
2018); for a useful empirical summary of the crisis along more mainstream, lines, see P.O. Gourinchas, T. Philippon and D. Vayanos,
The Analytics of the Greek Crisis, in M. Eichenbaum and J. Parker (eds.), NBER Macroeconomics Annual 2016, Volume 31 (University
of Chicago Press, 2017); for additional penetrating observations on the macroeconomic policies applied to Greece, see also M.
Nikiforos, D. Papadimitriou, and G. Zezza, The Greek Public Debt Problem, Working Paper No. 867, Levy Economics Institute of Bard
College, May 2016. Available at (accessed 10 March 2018).
See Lapavitsas et al., above, n. 1.

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