Greece’s upcoming election forces Germany to once again confront the possibility of a Grexit

Julian Rappold: The far left Syriza party is poised to win January 25 parliamentary elections in Greece, and will likely demand a renegotiation of the terms of its continued eurozone membership if it does. Angela Merkel’s government in Germany, fearing the precedent this would set for other crisis countries, seems willing to let Greece go instead.

The euro crisis picked up speed once again after Greece plunged into political crisis. The failure of the Greek government to organize the  majority required in parliament to elect a President of the Republic triggered snap elections, set to take place on January 25, which recent polls give the far-left opposition Syriza party a good chance to win. Its leader, Alexis Tsipras, has frequently stated his aim of renegotiating Greece’s bailout terms, writing-down Greek debt, and ending the austerity policies, leaving international lenders worried about the future of Greece and the eurozone.

All European eyes are now on Germany – again: A report by German news magazine Der Spiegel has suggested nothing less than a fundamental policy shift on the part of Chancellor Angela Merkel. Quoting government circles, Spiegel claimed that the German government would no longer rule out a Greek exit (“Grexit”) from the common currency, which had up till then been a taboo in Merkel’s euro crisis management rulebook. The euro’s contagion firewall was strong enough now, the Spiegel sources argued, and a “Grexit” would probably be inevitable if a Syriza government were elected.

Thus Pandora’s box was opened: Europe is again discussing the possibility of Greece leaving the euro, troubling financial markets.

In fact, however, Germany’s position has not fundamentally changed. Rather, Merkel is sending a warning shot to the Greek electorate, confirming the narrative of Greek Prime Minister Samaras’ election campaign: Vote for the old government! Otherwise Greece might drop out of the euro.

To Berlin it is clear that Greece will be the litmus test of whether the German-designed “conditionality approach” will remain the prevailing prescription for euro crisis management. Giving way to Syriza’s demands and thus loosening the insistence on structural reforms and austerity would not only undermine the efforts undertaken so far, but would create a fundamental precedent for the rest of Europe. France and Italy, which over the past two years have already tried to do away with fiscal discipline, would seize the opportunity to call for a more fundamental change of course, enabling fiscal stimulus and relaxing austerity conditions. Likewise, Syriza’s success would also help populist parties in European member states like Podemos in Spain or Sinn Féin in Ireland to gain support as they could finally offer voters an alternative to the existing crisis management. As elections in crisis-stricken Portugal and Spain as well as in five other EU member states are approaching later in 2015, the risk of political “contagion” is high and could shift the political momentum in favor of populist parties.

This does not mean, however, that Berlin is eager to cold-shoulder Athens and to push for a “Grexit”. Rather, Merkel and Tsipras have entered a high-stakes poker game in which both sides have raised with the biggest bluff possible.

Merkel’s motives to keep Greece remain in the common currency are twofold: First, from an economic perspective, the costs of a “Grexit” remain impossible to calculate, and would have uncontrollable repercussions for both Greece and the eurozone, even though the currency is better protected today by the ESM rescue mechanism and the banking union than it was two or three years ago. In addition, a “Grexit” would make it nearly impossible for Greece to meet its liabilities to its international lenders – among which Germany counts itself, having contributed 77 billion Euro – because the re-introduced Greek drachma would depreciate substantially and the Greek economy contract. Overall, it is not in Germany’s long-term economic interest to let Greece go, as it profits most from a strong and complete eurozone. This should be reason enough for Berlin to play it safe.

Merkel’s main rational is actually more political this time: the domestic political scene has changed. In 2012, when the German Bundestag had to confirm the European rescue measures for Greece, only Germany’s Left party voted against Merkel’s key decision to keep Greece in the euro, at least under the agreed terms. Today, a “Grexit” would also be fodder for the anti-euro party Alternative for Germany’s (AfD), which is gaining support, particularly among Conservative voters.

Moreover, a Greek exit from the eurozone would mean that German-led crisis management had failed. Merkel does not want to be the one who let Greece go. Indeed, it has been her top priority for the past four years to keep the country in the euro. Saving Greece to save the euro is still prevalent on Berlin’s mind.

A Greek exit from the Euro might also bring long-term political risk, which should not be underestimated: it would send a signal that membership in the common currency is not necessarily forever. Aside from the potential for this to shift to be exploited by populist parties in crisis-stricken countries, it could also prompt a reaction from the financial markets, potentially increasing borrowing costs for those countries considered to be at risk of an exit, such as Spain or Italy.

Against the backdrop of the conflict with Russia, additional fragmentation would lay bare the EU’s internal weakness and expose single member states to outside influence, for instance through investments.

In Greece popular support for euro membership remains strong, as a recent polling indicates. Syriza seems to have abandoned its radical rhetoric of the past, as its party leader frequently stresses his intention to keep Greece in the eurozone – under the condition that austerity measures end, that is.

A Syriza victory would make future negotiations on Greek debt a complex task for Merkel and her European partners; the common ground remains small. With no government experience at all, a Syriza-led government might find it difficult to balance its responsibilities to meet the expectations of its voters while finding a compromise with its European lenders.

At the same time, it remains to be seen how much Berlin would be willing to concede to Syriza, as the danger of thus undermining its policy fundamentals is high. Merkel and finance minister Wolfgang Schäuble have always assured the public that German taxpayers will not lose money bailing out Greece. Someone’s bluff, it seems, will be called eventually.