(This is a paraphrase on the Latin proverb, denoting a boastful man who marveled in Rome how high and far he had jumped once in Rhodes, until finally somebody, most likely an economist exhorted him, “hic Rhodos, hic salta!” – assume we are now in Rhodes, now jump!”).
So it has been a lengthy birth process for Aphrodite’s plagued island. Finally, in the wee hours of March 16, the Eurogroup finance ministers, with the help of the IMF’s Christine Lagarde, extended an aid package to Cyprus in the amount of 10 billion Euro, by far less than the 17 bill which Cyprus had requested. The size of the package was determined by “debt sustainability” considerations, i.e. estimates of how much Cyprus will actually be able to repay. 17 bill, the size of Cyprus’ GDP was just too much.
The large “rest” of nearly 7 billion will have to be made up by an unprecedented tax on deposits in Cyprus, amounting to 6.7% of deposits up to 100.000 Euro, and 9.9% above that. This squares the circle. Cypriot banks (whose balance sheet is nearly 9 times GDP, more than three times the Eurozone average) lost a lot of money when last year they suffered from the “voluntary” haircut imposed on Greek banks now have to “bail in” depositors. It is estimated that about one half of the deposits are held by foreigners, many of them, but by no means all, Russians. Thus, this measure also hits “small” Cypriot depositors, in spite of the country’s deposit guarantee scheme – which still holds. While many Cypriots (whose parliament will decide on the package in the afternoon of March 17) are furious, as well as many of the British and other pensioners who spend their retirement in Cyprus and also brought their savings along, the fact that Cypriot banks not only have a reputation for not looking very closely of whether this money has been earned by legal means, but Cyprus also has one of the most advantageous tax regimes in Europe and Cypriot banks paid higher interest than many other European banks until recently, should not worry equity proponents too much.
Corporation income tax rates will go up by 2.5 percentage points (to 12.5%!!!), the budget deficit needs to be cut and privatisations should go ahead quickly. How successful this latter endeavor will be can be seen by neighboring Greece’s frantic but futile attempts to sell some of their government assets.
The major worry in the EU is that depositors in other “problem countries” will also get this message and withdraw their money from their local banks. While Cyprus imposed severe limitations on withdrawals immediately after the Eurogroup decision (at 4 o’ clock in the morning), a monitoring mechanism in Portugal, Spain, Ireland and Italy will report on “unusual” activities in these countries.
- The EU is finally responding to the lesson that the hypertrophic development of banks in some member countries was not a viable business model for the country. While the European Commission has unilaterally looked at, observed and penalized countries for “excessive” public debt, the inordinate growth of private debt had remained without consequences. This now comes to an end.
- While the “haircut” imposed on other banks in Greece was called a “unique” event, the Cyprus case – while different from Greece for a variety of reasons – shows that the deleterious connection between bank debt being turned into public (taxpayer) debt is finally being broken. This had been a taboo in the EU, because the financial sector invoked the fear of “contagion” to other countries.
Of course, this fear is a risk, but whether it materializes, does not depend on God, but on an adequate policy response. The Eurozone has shown that the political pressure by the financial sector may have run its course, or at least, it is no longer cast in stone.
- Cyprus will not only have to shrink its banking sector (who will bear the costs??), but also needs to reduce its 10% current account deficit. Like Greece, Cyprus’ economic base is weak and little developed, its “business model” to attract foreign money, especially from Russia, needs to be rebalanced, in favor of a wider portfolio than tourism, agriculture and (shady?) banking. Of course, the destruction of its only oil refinery poses additional challenges to reduce imports.
- I doubt strongly that the policy conditionality imposed on Cyprus – while necessary as a clean-up action – will lead to a healthy economy in the future. The package leaves little or no room for growth prospects, the traditional export markets of Cyprus are in trouble themselves, its strong connection to parts of the Russian economy may increase its volatility in the future.
- It is a real pity that the EZ/IMF package did not put pressure on the (Greek) Cypriots to come to an agreement with their Northern (Turkish) compatriots. The anomaly of a divided country as an EU member must come to an end. The dire situation of Cyprus could have provided enough leverage for the other EZ countries to finally heal this age-old sore.
The Eurogroup, also with the help of the IMF, has attempted to jump, but it has remained a one-legged leap: it was high time to come to the aid of a member country, it is a positive signal to “bail in” also depositors, but the tired old austerity cure without growth elements will likely be self-defeating.