IMFThe Return of the Drachma?
By: Arthur Wong
Tags: Greece, Imf, Drachma, Grexit

IMFThe Return of the Drachma?

The Greece Referendum looms over the horizon. The “Yes/No” decision of the Greek population on July 5th will ultimately determine the future of Greece. Off to a bad start, Greece has not been able to pay back the €1.55 billion owed to the IMF. Although not considered as a technical default, Greece is likely to appear “in arrears” to them. However, the absent payment of €3.5 billion to the ECB will mean the imminent Grexit will become closer to reality. This brings us to the departure of Greece from the Eurozone, withdrawing their right to use the Euro as their common currency. For a lot of people, having the returning of the drachma seems to be the logical solution to saving the country.

Since 2001, when Greece first joined the EU, there has been a decrease in cost competitiveness and Greece heavily relied on foreign capital to stay afloat. Throughout the time, Germany has cut its inflation adjusted labour cost four fold compared to Greece where they lived beyond their means and accumulated IOUs to pay for imports.

Once the drachma is in effect, the Greek government can pay off its debt with significantly devalued drachmas. Though having a cheap currency makes Greece’s goods and services more appealing, the risk is immense.

The devaluation of the drachma against other currencies is rumoured to exceed 1,000 ΔΡΧ/1€. As history has shown, the attempt to lock the conversion rate of the drachma to the euro may fail, as seen in Argentina’s case. Totalling €332 billion worth of public debt, the depreciation will increase it dramatically. The depletion of the foreign exchange reserves and the huge capital flight may be too much to take on, leading to the collapse of the real economy.

The purchasing power of the Greek citizens will be severely limited if inflation skyrockets to levels higher than 40%. With the existing capital control, eventually the wage payments and pensions will freeze until liquidity in the market returns.

Despite lacking export materials, beauty is one thing Greece has in abundance. With the currency devaluation, people hope the tourism sector will begin to thrive compared to other industries because it would be a cheaper holiday destination compared to its neighbours, such as Turkey and Croatia. Combining the factors mentioned in the above paragraph, the consequences from social unrest that will likely follow are unpredictable. Hence the outlook for tourism as the major drive saving the Greek economy appears gloomy.

Local businesses will also suffer due to the weakened economy. Higher interest rates due to a poor credit rating will make it somewhat challenging for businesses to raise capital. Greece is not self-sufficient in raw materials, and the lack of trade imports would trigger shortages of basic goods. The gap in the market will likely see a series of M&A from hostile foreign investors, and the bulk loss of companies to properties may result to a sell out of Greece.

With everything grinding to a halt, GDP is likely to free fall, with the worst case scenario being the declaration of bankruptcy. Even after a partial debt restructuring, the road to recovery will be tough. A rescue package issued by the IMF will only be accompanied by impossible fiscal and austerity adjustments, which will almost suffocate the Greek population financially.

It is clear that hopes of the drachma as the solution for debt repayment is near suicidal. Staying in the EU proves more advantageous as there is more time for Greece to adapt to tight adjustments by having the support of fiscal transfer provided by the ECB. No matter the outcome, it is vital for Greece to lower its cost and increase productivity efficiency. They can also follow China’s recent crackdown in corruption. Only with the combined actions will they start recovering as a nation.