The extraordinary tale of Greece’s negotiations with its creditors and European neighbours is full of unknowns and the unexpected; Sunday’s referendum has stirred emotions, and now the country’s leaders have sought a fresh bailout programme. But with an exit from the euro still very much on the cards, the emerging focus is the uncertain effect of possible default and Grexit on the rest of the continent. Britain’s Chancellor George Osborne has warned this week that we should beware underestimating quite how far and how fast the ripples will spread.
At first sight, there doesn’t seem like a dramatic impact on the cards for the UK. Greece accounts for no more than 1% of our exports. UK financial institutions have about €50 billion worth of Greek debt. That is a sizeable sum. But almost all of that is owed by the private sector and so is likely to be repaid even if there is a complete default on all public debt.
Another exposure is through the IMF. Greece owes the IMF a total of about €25 billion. About 5% of this (just over €1 billion) came from the UK. Although some of this may be lost, 1 billion is not actually a huge amount in the grand scheme of things. Things would have been a lot worse if the UK had joined the euro. It would probably have given Greece something like €40 billion in bailout funds (the amount given by France.
However, looking beyond the immediate financial impact in euros and cents, there are two key reasons why events in Greece matter urgently for the UK, one economic and one political.
Recent research has shown that stress in financial markets has important negative effects on the economy. Financial stress leads commercial banks to reduce the amount they lend and to increase the interest rates on what lending they still do. Modern economies are completely dependent on credit; any slowdowns in the flow of credit leads to sharp contractions in output and employment. Financial stress spiked in 2008-9 in the global financial crisis and was also high in 2011 and 2012, during eurozone crises.
If the current crisis has similar effects, the negative impact on the UK through financial stress would far outweigh the small direct costs to it of a Greek default. So far, markets have not reacted strongly; a 2% fall in the UK stock index was a mild response to the political turmoil of the last few days and the stock prices of European (non-Greek) banks have held up pretty well. But these are early days and the situation will remain fragile for some time, whatever the outcome of Sunday’s referendum.
The other risk is political. In my view, it would be a catastrophe if the UK voted to leave the EU. This would be a backward step that would greatly damage the economy, dislocating essential trading relationships, marginalising the country and setting back growth for decades. So the really important question for us is: “will this make Brexit more likely?”. This is hard to call.
The eurozone has made some serious and avoidable mistakes in recent years. Although the EU is not the eurozone, this has, to put it mildly, not made membership of the EU more attractive. It has given anti-EU campaigners the ammunition to fire at the electorate as the UK approaches its own referendum. On the other hand, Greece’s experience has meant that the consequences of withdrawing from the largest trading block in the world have become more apparent. In the end, the Brits, like the Scots, might go for the argument: “You might not like what you have got, but the alternative is much worse.” We can only hope that they do.