After the resounding victory of the «no» vote in the referendum on 5 July, a new phase has begun in negotiations between the institutions and the Greek government but essentially there are still just two political and economic options open to Greece.

The first is to continue in the euro area. This entails a new and complex negotiation in which the institutions are only prepared to grant further funding to Greece in exchange for firm evidence that the country is adopting the reforms and adjustments required to ensure its economy becomes competitive and fiscally stable.

Undoubtedly these negotiations could include measures to relieve the effective burden of debt on the Greek economy (as has already happened in the past) but the real key to any possible agreement is the timing between the reforms, the payout of funds and relaxation of financing conditions. In other words, to what extent the reforms and adjustments need to precede the granting of further funds and particularly any changes in the conditions of existing debt.

Apart from the specifics of the agreement, this first alternative is the one that makes most political sense for the euro area. And also for Greece if the country wants to modernise its economy and institutions.

Greece's second option is to effectively leave the euro by introducing promissory notes to tackle the extremely limited liquidity that would result from not reaching an agreement with the institutions. These promissory notes would act like a new currency in practical terms. In the immediate future this option would lead to shortages in shops and a lot of firms and financial institutions going bankrupt which, added to the sharp devaluation the new currency would undergo, would make it impossible for the country to repay its debts with international lenders as these would still be in euros.

Greece leaving the euro would be bad news for the euro area and for the European Union as a whole as it would jeopardise the European political project and involve significant risks from a geostrategic point of view. Although the resulting euro area might be more cohesive in the medium to long term, Grexit would be a hard knock at an inopportune time. Since 2008 it has become clear that greater political union is required to guarantee the viability of monetary union and a great deal of effort has been invested to accomplish this. A stumble right now could represent a serious setback.

In any case Grexit would be bad business particularly for Greece. Although it is true that, in the medium term, devaluation could lead to a certain upswing in economic activity, its effectiveness in terms of long-term growth is doubtful as, in the absence of structural and institutional reforms and fiscal and financial stability, the country would not improve the real competitiveness of its economy nor ultimately its well-being.

In short, after the referendum of 5 July the next few weeks are crucial for the euro area (and, by extension, the European Union as a whole). Strong political leadership will be required to reach an agreement: the negotiators will need to be totally committed and maintain a clear view of Europe's role in the world beyond the troubles and strife of the Member states. Only in this way can the European project tackle the formidable challenge it is facing and emerge even stronger than before.

Jordi Gual

Chief Economist
6 July 2015