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Polarized Greece heads to the polls

ReutersSunday's Greek election could have far-reaching and grave implications for the euro zone.

LONDON (MarketWatch) -- Greece voted in a national parliamentary election Sunday for the second time in less than two months, and the euro zone's future could hang in the balance.

Greek voters failed to conclusively back a new government on May 6 to lead them out of a debt crisis that has seen the nation flirt with default and shake the euro zone to the core.

That failure, which resulted in days of painstaking negotiations as the nation's main parties scrambled unsuccessfully to form a coalition government, set the stage for the June 17 election.

Surveys taken before a 14-day polling blackout came into force showed that the election is now a two-horse race between the conservative, bailout-supporting New Democracy party and the left-leaning and anti-austerity Syriza.

The vote is seen as a referendum on Greece's current bailout and its strict austerity measures. The outcome, however, could determine not just Greece's future political landscape but the trajectory of the entire European debt crisis and could have far-reaching and potentially grave implications for Europe's single currency.

"It is not the election result in itself that matters," said John Ventre, a fund manager at Skandia Investment Group. It is a litmus test that will give an indication of whether the euro zone can be held together, he said. MarketWatch Topics: Euro crisis in depth.

Roman Gerodimos, founder of the Greek Politics Specialist Group, an association of political experts, said it is likely that a coalition will nevertheless be reached following Sunday's election because the situation in Greece is now more desperate than it was in May.

"What has changed since May is that it's dawning on politicians that exports are being stopped because people from other countries are requesting cash rather than credit, medicines are running out, electricity is running out, and it's getting quite dramatic," Gerodimos said. "There is a realization that there needs to be a government now."

Still, this time around, a more decisive outcome could be on the cards.

"If Greece goes any longer without a government, it could be worse off than if it just left the euro now," said Jonathan Bristow of London-based Valbury Capital. "Indecision is what got us here in the first place, so the best-case scenario is that a government is decided this weekend, so everyone can figure out what we're dealing with."

The National Bank of Greece released a report at the end of last month that envisioned a doomsday scenario were Greece to depart the euro zone. The report said that a Greek exit "would lead to a significant decline in living standards of Greek citizens" and result in severe economic contraction. Per-capita income, the NBG said, could collapse by more than 50%.

Financial markets are also girding for a so-called Grexit, a scenario where Greece would abandon the euro and return to the drachma. This week, one of France's largest banks, Crédit Agricole, said it was drawing up contingency plans to respond to such a development.

"Losing Greece would hit the euro hard, but it can recover," Valbury Capital's Bristow added. "It isn't like Spain, which [the euro zone] can't afford to lose, as it has the fourth-biggest gross domestic product in the euro zone."

Given that, a nonconclusive result on Sunday or posturing by its politicians is not in the interests of Greece, Bristow said. "The countries that have followed a plan, like Ireland, are starting to recover."

Euro or drachma

Most polls gave New Democracy a slight edge over Syriza, which managed a shock second place in the May election. A June 1 poll by Kapa Research saw New Democracy bag 26.1% of the votes, with Syriza capturing 23.6%.

"The first thing we must determine in the elections on June 17 is to choose between the euro or drachma," New Democracy leader Antonis Samaras told backers gathered in an Athens square Friday night, according to a Bloomberg News account.

"We don't need the euro," read a slogan on the campaign sign of a small far-left party, posted on an Athens wall, an Associated Press report said Saturday.

On Saturday, Spanish Prime Minister Mariano Rajoy called for greater political and fiscal union in Europe, calling on Greeks to stay with the euro, Reuters reported.

"Europe has to transmit to the world that the euro is an irreversible project," Rajoy said during an event in northern Spain.

Greek Socialist party Pasok has for 35 years been a dominant force in Greek politics, but it could found itself out in the cold, with a mere 9.9% of the votes, according to many polls.

However, other surveys suggested the tide is turning toward Syriza, headed by Greece's youngest major political leader, 37-year-old Alexis Tsipras. The Greek firm Public Issue found that 31.5% of poll respondents would back the party, while 25.5% favored New Democracy.

Complications from Spain

Complicating matters, a recent bailout for Spain's financial sector has failed to allay fears that the crisis is under control in the Iberian nation. This past week, yields on Spanish government debt, a useful barometer of market and investor confidence, breached euro-era highs. Italian yields have also spiked. See: Spain enters the danger zone as bonds yields near 7%.

Stephen Tindale, an associate fellow at the think tank Centre for European Reform, said Tsipras of the Syriza party will have gained a late boost this week from the announcement that Spain is to receive a 100 billion euro ($125 billion) bailout to save its ailing banking sector.

Tsipras himself told reporters that the bailout demonstrated a failure of European austerity policies, calling them "completely ineffective and socially disastrous." The fact that Spain's deal comes with far less rigorous terms than those attached to Greece's bailout is also fueling Tsipras's campaign.

"Spain now having been bailed out without the very stringent austerity measures that Greece, Ireland and other bailed-out countries were forced to accept has complicated the issue in Greece, making it more likely that the anti-austerity party will win," CER's Tindale added. He also said that Syriza has not been clear about what it actually wants.

"They come across more as a campaign group than as a potential leadership," he said. "Financial markets will be pretty unhappy if Syriza forms a government, not particularly because it throws [Greece's] bailout into turmoil but because it isn't clear about what it stands for."

A Syriza victory, Tindale said, is the most daunting scenario for the rest of Europe because the results would be unpredictable.

The New York Times reported Saturday that a broad plan to solve the euro-zone's problems would be unveiled in coming days. Euro-zone crisis solution?