What Greece Government Should Think about

The possibility of Grexit has been like dark clouds hanging above heads of financial institutions and people concerning this issue. Potential problems such as inflation, bank run, default risk and loss of competitiveness make “Grexit or not” a vital battle.

To keep a smooth international trade just as time before Grexit, Greece government should manage to maintain the resemble trading environment, i.e. to keep the advantages unified currency brought about, such as minimal transaction barriers and elimination of cost of trade. Substantial internal devaluation in Greece generated a small export boost, however, the regain of competitive led to an even excess export demand in Spain, Portugal, Ireland and Italy. Therefore, the international trade shock due to Grexit cannot be overlooked.

In order to achieve low target inflation and a relative fixed exchange rate against US dollar, Euro and Swiss Franc short after Grexit, the central bank of Greece should guard an interest rate close to major countries in Eurozone to shocks of hot money. The inflation is more likely to occur due to the pressure on printing money for recapitalize the banking system to guarantee a normal banking liquidity. The sour of quantity of Greek drachma will intensify the pressure on fixed exchange rate policy and the demand for Euro could drain the bank out of currency. Exchange control may help this problem.

Foreign investors are the primary hope of Greece to survive out of the swamp. The bailout program with the European Central Bank, the European Commission and International Monetary Fund will expire at the end of February after Prime Minister Antonis Samaras secured a two-month extension in December. Obtaining confidence from foreign investors decides the backup inflow of funds, and especially for the debt redemption and the repayment of principal. Inevitably, the success in the approaching vote and sustaining a situation under control will be the life-or-death bet. If the policy and tendency under the new government is not in favor of foreign investors, Greece should find out new ways to boost the economy.

No one knows how the situation will walk to; it is possible that Greece can hardly default its debt. Due to the fear of default risk, the real interest rate in Greece could be high, which will lead to high interest rate risk for banks and corporates who hold bond portfolios and loans. Financial institutes should carry out pressure tests with respect to interest rate risk in order to keep a steady and predictable cash flow.

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