The Cyprus bellwether
Jan 25, 2013
Last June, Cyprus asked for a bail-out. Given that the island’s GDP is only about €18bn, 0.2% of the eurozone’s output, you wouldn’t have thought hammering out a rescue package would be all that difficult. But it’s now clear that there will be no agreement before late March, when Cyprus is set to run out of cash.
Cyprus’s problems are due to its role as a financial centre and to Greece, says Richard Barley in The Wall Street Journal. The banking sector is five times bigger than the economy and held Greek loans and bonds worth 160% of GDP by 2011.
Greece’s debt restructuring and economic meltdown blew a huge hole in the banking sector – and the national budget. It’s Ireland and Spain all over again. The banks need around €10bn. With the overall bail-out package set to reach about €18bn, the country’s debt-to-GDP ratio is expected to rise to 150%.
One key problem is that EU policymakers, notably Germany, are demanding that the government raise money from privatisations, which could bring in €2bn. But the communist prime minister is adamant that there will be no privatisations on his watch. His term, however, is set to end with next month’s elections, and his successor, probably of the centre-right, is likely to prove more pliable.
The government is also resisting an overhaul of the tax haven’s money-laundering rules: the banks are “stuffed with Russian money evading tax at home”, says Lex in the FT. The value of Russian deposits is thought to be about €20bn.
As Russian oligarchs are such keen lenders to the banks, “there are mutterings in Berlin and Brussels” that senior bondholders of Cypriot banks, and depositors, should take a haircut, says Lex. But this “would be a game changer for how banks are rescued”: it didn’t happen in Ireland. So Ireland could insist on renegotiating its bank bail-out to lower the burden on taxpayers. And the move would rattle depositors elsewhere.
Meanwhile, restructuring the sovereign debt to reduce the huge burden on Nicosia would make sense, but EU leaders have vowed that Greece’s restructuring was a one-off. So while Cyprus is small, it’s worth keeping an eye on to see “how the eurozone handles the problem and what signals it sends”, says Barley. A messy compromise or failure to reach a deal could “raise the political temperature” and rattle markets again.
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