Who Will Determine Greece's European Future?

Greeks ?

By El-Erian

Many feel that Greece's fate, including its continued membership of the eurozone, rests in the hands of the Troika - officials from the European Commission, European Central Bank and the International Monetary Fund charged with evaluating Greek's reform efforts, its financing needs and how they should be met. But this is not the entire story by any means.

The country's fate is also closely linked to what happens in Italy and Spain, and in a manner that is yet to be sufficiently understood by many. (Read More: Can Spain Avoid Greece’s Vicious Circle?)

Domestic political stability and economic reforms are clearly critical for Greece's continued membership of the eurozone. Many are thus interested in how the Troika, acting on behalf of official creditors, will react to the government's request to stretch out the budgetary adjustment over an extra couple of years.

Will they agree? If they do, how will the accompanied structural reforms be tweaked? And who will pony up the additional financing, either explicitly or through indirect methods (such as the refinancing undertaken recently by the ECB ?

Important as they are, these questions are just part of the required analysis. You see, Greece's triple problem - of way too little growth, much too much debt, and a political elite that has lost popular credibility and legitimacy - cannot be solved by adding a couple of years to the adjustment program and finding a bit more money.

A sustainable solution requires a major reset of the country's parameters - economic, financial political, and social.

Domestic conditions are of course key here. Without common vision and a sense of shared responsibility - both of which are lacking in Greece today - it is virtually impossible for the country to regain its employment engines, realign its cost and revenue structure, and regain Eurocentric and global competitiveness.

Yet it is not all about internal challenges. Greece's continued membership of the Eurozone depends also on the evolution of the situation in Italy and Spain - two countries that will have an important impact on what the Greek reset looks like and when it would occur.

If the situation in Italy and Spain were to deteriorate further, Greece would get even less sympathy from the Troika; and certainly less money. (Read More: IMF's Lipton is Hopeful Greece Getting "Back on Track")

Any relaxation in policy conditionality would be viewed by the Troika as giving the wrong signal to other vulnerable Eurozone members. And creditors would be even more reluctant to pour good money after bad.

With the social fabric of Greek society already highly stressed, the government there would find it even more difficult, if not impossible, to implement an approach that promises the population greater austerity and pain. A disorderly exit (or "Grexit") from the eurozone would only be a matter of time. To make things worse, it is likely that this would occur in the context of an increasingly unstable Eurozone.

What if collective European efforts were to succeed in stabilizing Italy and Spain? You may think that this would be unambiguously good for Greece as a more robust Eurozone would be more willing to support its weakest member. But it is not that simple.

The stronger the eurozone firewalls protecting Italy and Spain, the greater the inclination for some European officials to de facto push Greece out.

This is not just about the difficulties that Greece faces to deliver on its policy commitments, regain competitiveness and create jobs within the confine of the single currency. It also goes beyond the realization that Greece would require another major debt restructuring which, this time around, would likely involve money owed to official creditors.

There are several member countries that believe that Greece never belonged in the Eurozone to begin with. Moreover, its membership was enabled only by questionable numbers.

Up to now, their desire to create conditions that would accelerate a Grexit has been held back by the fear that this would significantly disrupt other peripheral economies - something that strong eurozone firewalls would overcome.

Greece's future thus depends on the outcome of both domestic events and developments in Italy and Spain. Greek officials should certainly hope that collective European action will succeed in stabilizing these other two countries' economies. But they should also realize that too great a success could, ironically, map into a higher probability of a Grexit.

It could well be that continued muddle through for the eurozone as a whole, rather than full resolution or fragmentation, is what would deliver the most official support for Greece. This may be attractive for the current Greek government. It certainly won't be for the rest of the eurozone.