Why Tsipras needs to turn on the charm with Merkel

Optimism has made a welcome return to the negotiations surrounding Greece’s financial future. Prime Minister Alexis Tsipras left a top-level meeting of heads of state in Brussels last Friday saying he was hopeful about his country’s future.

 Meanwhile German Chancellor Angela Merkel said that if Greece presented specific reforms, financial aid would be unlocked, remarks that sent the euro and oil soaring at the end of the week. But the Greeks need to do a lot more to remove any chance they might be forced into a “Grexit” that would be ruinous to the country and the other members of the euro zone.

Tsipras and Merkel will be meeting again Monday evening in Berlin in an effort to improve their strained relationships. The countries’ two finance ministers, Wolfgang Schaeuble and Yanis Varoufakis, have been continuously clashing on issues including the Greek loan agreement and German war reparations.

Left-wing Tspiras and his Syriza party were elected on January 25th on a promise to scrap harsh austerity, which came as a condition of the two bailout loans, worth 240 billion euros, that the country received to stop it from defaulting. But SYRIZA’s suggestions on rolling back the agreement have met with steely resistance from Germany. In the meantime, the government has to deal with pressing financing needs, capital flight from Greek banks and a reduction in tax receipts. Amid all this, the Greek government’s strong rhetoric not to back down has made analysts wonder, whether the country would actually want out of the common currency.

According to a YouGov poll, 59 percent of Germans are already willing to let Greece go but some analysts stress that for all the fighting talk, Greece realises the folly of going it alone.

“Some in Germany, don’t understand that the rhetoric of the Greek government is a way for them to keep their ground at home and that they are addressing the Greek electorate. It’s becoming a bit problematic,” Raoul Ruparel, head of Economic Research for London-based think tank Open Europe told CNBC.

And even though “Merkel doesn’t want a Grexit, there are some within the German government who would consider it”, says Ruparel.

But what would a “Grexit” actually mean and why do the two countries – and their governments — need to smooth their relationships?

“For Greece a forced exit would be a disaster, but it would also be a great problem for the euro zone. A Grexit would transform the euro zone into a peg and from the next day investors would be asking who is next”, Alberto Gallo, head of European macro credit research at RBS, told CNBC.

If Greece was to leave the euro zone, either by accident or design, it would have go back to the drachma or adopt a “shadow currency” that would run along the euro. Either way, investors would rapidly lose faith in the country.

Greek companies are already finding it hard to do business with the rest of the euro zone. “Even though we pay cash, there are some companies who don’t want to cooperate with Greeks. Also even though we are a healthy business, funding from banks is very limited”, Nikos Tsilinikos, a Greek importer operating in the wholesale retail business, told CNBC.

On top of this a lot of companies and depositors have taken out loans denominated in euros. If there is a Grexit, they would have a tougher time paying back that loan with the new devalued currency.

A weak currency, also, easily becomes the target of speculative attacks. Greek banks’ foreign currency reserves would come under pressure amid a massive sell-off and capital controls would possibly have to be imposed. This would hurt depositors, but also the already shrivelled Greek private sector, since it would make it harder for companies to make investments or pay existing liabilities. Especially in the beginning, the massive strain on Greece’s welfare state, which Syriza is already trying to alleviate, would be made worse. For example, pharmaceutical companies would ask for strict guarantees that they get paid before releasing much needed drugs.

One more problem: no country has ever left the euro zone: Once you are in, there is no way out. So the technicalities of such a move are not clear either. Would leaving the single currency mean that Greece would also have to quit the broader European Union? On the one hand, this would help the Greeks as it would get rid of the EU’s export caps and allow manufacturers sell as much they could abroad. But on the other, Greeks would find it harder to emigrate for work. This would send unemployment levels soaring and increase the burden on the country’s already fragile welfare state.

The majority of Greeks would like to stay in the Euro zone, according to polls but hate the austerity they’ve had forced on them. Tsipras will have a hard task convincing his German counterpart of the need to please his electorate on these two fronts. The German Chancellor on her side is expected to try and improve relationships, but defer any agreement to the next meeting of Euro zone finance ministers.