Greek euro exit looms as coalition talks falter

Greece's president Karolos Papoulias is continuing to hold talks with political leaders in a bid to salvage an agreement on forming a government, as the possibility of the stricken country being forced out of the eurozone looms larger. Meanwhile there will also be key discussions in Brussels later today as eurozone finance ministers meet, with the crisis in Greece and the turmoil in the Spanish banking system expected to dominate the agenda. It comes after the eurozone's austerity-led response to the crisis suffered another electoral blow, with German Chancellor Angela Merkel's party suffering losses in the country's most populous state.

Negotiations are set to continue without Alexis Tsipras – the leader of the radical left party Syriza, which finished second in last Sunday's elections – who has said he will not join a government that pushes ahead with the European Union and International Monetary Fund's austerity programme. It leaves the conservative New Democracy, socialist Pasok and Democratic Left parties in the frame. Together they would command a majority in parliament, but the Democratic Left party has said it would not join a coalition without Syriza's participation. Tsipras has reportedly said he would rejoin talks if all parties except the neo-fascist Golden Dawn were invited.

New Democracy leader Antonis Samaras, Tsipras, and Pasok's Evangelos Venizelos have already failed in previous efforts to form a government in the wake of the elections, in which 60 per cent of Greeks voted for anti-austerity parties. The faltering talks increase the likelihood that new elections will be needed. A second ballot, if required, is expected to take place on June 17. European stocks markets suffered heavy losses this morning amid the uncertainty about Greece's future.

Talk of a potential Greek exit from the eurozone has intensified over the weekend, with officials attempting to downplay the contagion effect on the rest of the single currency bloc. Speaking in the Estonian capital Tallinn, Irish central bank governor Patrick Honohan said it would be "rather destabilising" but "not necessarily fatal", while his Belgian counterpart Luc Coene told the Financial Times that an "amicable divorce – if that was ever needed – would be possible". European Commission vice-president Olli Rehn, responsible for economic and monetary affairs, said the eurozone was "certainly more resilient" to a Greek exit than two years ago. However, he warned that it would be "much worse for Greece and Greek citizens, especially for the less well-off Greek citizens, if Greece did ever leave the euro."

British-based group Fathom Consulting was more pessimistic about the impact of a Greek exit on the rest of the euro area. In said it was "more likely than not" that Greece would be "forced to issue its own currency within a few months". In a research note it said: "A Greek exit would be highly damaging both to the European banking system, and to the integrity of the single currency," it warned. "We have long held the view that, following the departure of just one member, a total break-up would be very much on the cards." Spelling out the dangers, it warned: "Holders of Greek sovereign debt would undoubtedly suffer, as they risk having their assets redenominated into a rapidly falling new Greek currency.

"But holders of Greek corporate debt would also be exposed, with Greek companies forced still to make payments in euros likely to face an effective doubling in the cost of servicing their debts. Then, of course, there is the cost of re-capitalising the ECB, and bolstering the other peripheral nations, which the Institute for International Finance has recently estimated could run to €1 trillion. This burden would fall on taxpayers in the remaining 16 member states."

Meanwhile in Spain, protesters dubbed the 'indignados' have continued their demonstration marking a year since the movement against government-imposed austerity measures began. The Spanish government was forced to part-nationalise the country's fourth biggest lender Bankia last week, in a bid to stem the crisis in the cash-strapped financial sector. The European Commission predicted in its spring forecasts that Spain, which has unemployment of 24.4 per cent, would remain in recession throughout this year and next, while it was also expected to meet its 2012 deficit target of 5.3 per cent by more than 1 per cent. In the bond markets today, the yield on Spanish 10-year bonds rose to 6.218 per cent, a high for this year. Italy's yields rose to 5.6 per cent.

However, Rehn welcomed a series of banking reforms introduced by the centre-right government of Prime Minister Mariano Rajoy. "A prompt and profound reform of the banking sector is a cornerstone of Spain's crisis response and its overall reform strategy," he said. "It is an indispensable supplement of the determined fiscal consolidation and front-loaded structural reforms that can bring sustainable growth and more and better jobs." He added: "These actions should dispel the lingering doubts about the stability of the Spanish banking sector."

Merkel's austerity agenda suffered a setback in Germany's most populous state, North Rhine-Westphalia yesterday. The centre-left Socialist Democrats won 39 per cent, to the 26 per cent achieved by Merkel's Christian Democrat Union. It was the CDU's worst results there since the 1940s. The Greens took 12 per cent, making an SDP-Green coalition viable. Merkel' coalition partners at national level, the Free Democratic Party, won 8.5 per cent, while the Pirate party entered a fourth regional parliament with 7.5 per cent. The German Chancellor – whose party also suffered regional electoral losses last weekend – is due to meet Francois Hollande in Berlin tomorrow after he is sworn in as French president.

Hollande has called for more measures to boost growth in the eurozone. The need for growth was emphasised again today, with the bloc's economic woes compounded by data showing that industrial production fell 0.3 per cent in March compared with February. The statistics, published by Eurostat, followed an increase of 0.8 per cent in February. Since March 2011 industrial production has collapsed by 2.2 per cent. It comes on top of the commission's spring forecasts published last week forecast a recession in the eurozone this year of 0.3 per cent.