Cyprus avoids Euro exit for now

Jonathan Lindsell, 25 March 2013

Cypriot President Nicos Anastasiades has agreed a 10bn Euro bailout agreement with the “troïka” consisting of EU Commission, European Central Bank and IMF leaders. The island’s second largest bank, “Laiki” (Popular Bank), is to be closed, with losses of up to 40% incurred by bondholders and those (mostly Russian) depositors with over 100,000EUR (£85,000). Smaller deposits will be guaranteed and moved to the largest bank, the Bank of Cyprus, where depositors of over 100,000EUR will again face restructuring losses coming to “billions”.

This deal came on the day of the Troika’s deadline after the failure of numerous other suggestions, including a 6.7% levy on small deposits, and the sale of Cypriot church contents and Cypriot natural resources. Cyprus failed to secure a bailout from the Russian government, one of its largest banking customers.

The Cypriot economy has been especially weak since the onset of the global recession. Its banking sector, which held seven times more than the country’s GDP, was overexposed to Greek debt and dependent on tourism, which contracted in the face of the ‘credit crunch’. When the EU decided to ‘haircut’ Greek bonds in 2011, the financial sector was severely hit, causing the markets to lose confidence. Russia provided a 2.5bn EUR bailout in early 2012 to cover the government’s deficit, but both Moody’s and Fitch soon degraded Cyprus bonds’ credit rating to BB+ (‘junk status’), which disqualified them from being offered as collateral for an ECB loan. The Cyprus government then requested a bailout from the European Financial Stabilisation Mechanism (EFSM) or European Financial Stability Facility (EFSF). Harsh austerity measures were published in November 2012 as a prerequisite for today’s deal.

Since the country is already experiencing high unemployment, falling tax receipts, paralysed liquidity and rising prices, the future looks grim. The Wall Street Journal suggests citizens will face strict capital controls which will isolate the island just as it loses its ‘tax haven’ assets. Olli Rehn, European Economic and Monetary Commissioner, forecast: “The near future will be very difficult for the country and its people”. Last week Standard & Poor’s downgraded Cyprus from ‘CCC+’ to ‘CCC’ and predicted a 6% GDP contraction, meaning there’s a significant chance the small nation will fail to meet today’s bailout terms, and may again face exit.